BOMBAY CHARTERED ACCOUNTANTS’ SOCIETY …...•An employer is someone to whom an employee is...

BOMBAY CHARTERED ACCOUNTANTS’ SOCIETY

INDEPENDENT AND DEPENDENTPERSONAL SERVICES(ARTICLE 14 AND 15)

BY SUSHIL LAKHANI

O N D E C E M B E R 2 0 , 2 0 1 4

TAXABILITY OF REMUNERATION UNDER THE ACT

Employee of Indian company ( WOS (or) JV. Company)

Employee of foreign company

(Deputed to P.E. or project in India or for rendering service to Indian entity)

Remuneration taxable u/s 5 as income accrues or arises or is received in India

( Where services rendered outside India , mere receipt of salary in India not “receipt” as “constructive receipt” was outside India .

(Arvind Singh Chauhan Vs. ITO (42 taxmann.com 285 –Agra ITAT)

•Sec 9(1)(ii) –Income is deemed to accrue in India for services ‘rendered’ in Indiaincluding rest periods .

•Indian salary plus foreign salary is taxable in India.

•Also applies to salaries paid by foreign governments .

Duration of employment is not relevant.

220/12/2014

By SUSHIL LAKHANI for Bombay Chartered Accountants’ Society

Exemption for short visits –Sec 10(6)(vi) :

Salary is exempt if all the following conditions are satisfied:

Foreign enterprise not engaged in trade or business in India,

Employee ‘s stay < 90 days in a previous year in India, and

Salary not deductible from the employer’s income chargeableunder Income-tax Act.

(Expat also entitled to ship stay exemption S.10(6)(viii); exempt allowances

Sec.10(14) and exemption for tax on perquisites Section 10(10CC)

SHORT STAY EXEMPTION UNDER ACT

320/12/2014


TAXABILITY OF REMUNERATION UNDER DTAA

DEPENDENT PERSONAL SERVICES (Article 15)

Article 15 (UN and OECD model) deals with employment income.

Article 15 applies only to private sector employees. It does not apply to:

Director’s fees.

Artist’s & sportsperson’s remuneration.

Pension.

Salary& pension of Government employees.

Payments to students, professors &

foreign teachers in some cases.

Primarily salary is taxable in the Country of Residence (say Foreign country)unless, the employment is exercised in the other country (say India). [Article15(1)].

If the employment is exercised in India, then salary is also taxable in Indiasubject to three conditions being cumulatively satisfied.

520/12/2014


DEPENDENT PERSONAL SERVICES (ART 15(1) R.W ART 15(2))

Country of residence has the exclusive right to taxsalaries etc derived in respect of employmentexercised if all the following three conditions aresatisfied:

•Employee’s stay in source country < 183 days in 12 monthperiod;

• Rem. is paid by a non-resident employer; and

• Remuneration is not borne/deductible by PE

(Corollary – If any of the above three conditions are not satisfied, sourcecountry also get a right to tax the remuneration)

(“derived” –thus taxation right continues even if received before or afterpresence)

(Art. 15(3) provides for taxation in country of effective management of theshipping company for taxation of remuneration for employees of a ship)

620/12/2014


• An employer is someone to whom an employee is committed to supply hiscapacity to work and under whose directions the latter engages in his activitiesand whose instructions he is bound to obey” ( page 899 Klaus Vogel)

• A key consideration will be which enterprise bears the responsibility ofrisks produced by individual ‘s work. ( OECD)

• Distinction between “contract of service” and “contract for service”(OECD Commentary)

• Performance of duties subject to directions, instructions andsuperintendence of the employer and various other tests laid down byIndian Courts.

(Lakshminarayan Ram Gopal (25 ITR 449); Piyare Lal Adishwar Lal (40ITR 17); Ram Prashad (86 ITR 122))

INTERPRETATION OF KEY TERMS –ARTICLE 15(1)

(I) “EMPLOYER” –Meaning

720/12/2014


WHO IS THE EMPLOYER ?

Economic Employer—Judicial PrecedentsIn Favour of Assessee IDS Software Solutions (2009 –TIOL-82-BANG)

HCL Info systems 274 ITR 261 (Del)

Abbey Business Services (India) (P.) Ltd v DCIT [2012] 23 taxmann.com 346 (Bangalore

– Trib.)Against Assessee Verizon Data Services India (AAR)

AT&S (287 ITR 421)

Centrica India Offshore Pvt. Ltd. [2012] 364 ITR 336 (Delhi)

Target Corporation India Pvt. Ltd. [2012] 348 ITR 61 (AAR)

INTERPRETATION OF KEY TERMS –ARTICLE 15(1) (Contd…)

820/12/2014


NON-RESIDENT EMPLOYER TEST

• Certain principles laid down in the OECD Commentary to determine Economic employer vs Real employer :

• Who has authority to instruct about manner of work performance

• Who takes responsibility or risk of results of work

• Who controls place at which work is performed

• Who provides tools/material for the work

• Employment contract

• Control, superintendence, instruction, directions, manner of work provisioning of tools and material for work, etc.

• Code of conduct, dress code, service rules, who controls place of work, reporting

• Who enjoys confidentiality and fruits of labour

• Responsible for conduct / risks of result of work

• Bearing economic burden of salary cost


920/12/2014


• Place where “Services Performed” [US Model Commentary (2006)]

• Place where the employee is physically present when performing [OECD Model

Commentary (2008)]

• Gallotti Raoul (61 ITD 453 –Mum)—rem for period he visited home country for work

related to host country employer not taxable in India under Art 15(1) of India-France

DTAA

(Time or place of payment of Salary and place where results exploited

irrelevant . The term used in Art 15(1) is “derived”)

(Canadian Court determined pilots’ country of exercising employment in a

novel manner!!! (16 taxmann.com 217)

II. Meaning of “employment exercised in othercontracting state” i.e. source country


1020/12/2014


“Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting

State in respect of an employment exercised in the other Contracting State shall be taxable only in the

first-mentioned State if:” …

(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183

days in any 12 month period commencing or ending in the fiscal year concerned;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State;

and

(c) the remuneration is not borne by a permanent establishment or a fixed base which the employer

has in the other State

Article 15(2) provides an exception to Article 15(1) that remuneration to be taxed in

State R even if derived from employment exercised in State S

• Exception does not cover individuals whose remuneration falls under other Articles

and specifically excluded under Article 15(1)

• Only if all the three conditions specified in Article 15(2) are satisfied, remuneration

shall be taxable only in State R

ARTICLE 15(2)

1120/12/2014


Computing no of days

Possible interpretations:a) Day of arrival is to be excluded for calculating number of days

Manoj Kumar Reddy, [2011] 201 Taxmann 30 [2009] 30 SOT 18 –B’lore) ;

Fausta C. Cordeiro [2012] 53 SOT 522. (Mumbai ITAT)

b) Both days should be counted as “in India”.

Advance Ruling (233 ITR 462) –

c) Only day of departure has to be considered as “in India”.

Jaipur Tribunal (No. 1230 dated. 22.8.86) (ITO V/s. Dr. R. K. Sharma)

INTERPRETATION OF KEY TERMS -ARTICLE 15(2)

183 days Rule:

• The recipient is present in the other state for a period or periods not exceeding

in the aggregate 183 days in any twelve month period commencing or ending in

the fiscal year concerned

1220/12/2014


OECD Commentary – “days of physical presence” method

Inclusions:

• Both days to be added ;

• all other days spent inside the State of activity such as Saturdays and Sundays,

national holidays, holidays before, during and after the activity, short breaks

(training, strikes, lockout, delays in supplies), days of sickness and death or

sickness in the family

Exclusions:

• Days in transit

• Any entire day spent outside the State S, whether for holidays, business trips, or

any other reason, should not be taken into account

COMPUTING NO OF DAYS -


1320/12/2014


“BORNE BY”/ “Deductible”—Meaning?

An economic concept rather than an accounting concept. Remunerationhaving Direct and proximate relation with the PE and attributable to PE is“borne by “ PE (OECD and Klaus Vogel)

Emphasis on deductibility and not on actual deduction. Some DTAs use thewords “deductible”. (Indian DTAs with Australia, Belgium, UK.)

The expression “borne by” encompasses all expenses that are economicallyincurred by PE and not merely expenses that are “tax deductible”. ( USTechnical Explanation)


1420/12/2014


Judicial Precedents :• PE commercially liable or actually pays for the expense

(Ensco Maritime Ltd vs DCIT (2004) 91 ITD 459 (Del));

• Expense has a direct and proximate connection with PE and is deductible in hands of PE.(Coverspresumptive taxation)DHV Consultants BV 227 ITR 97 (AAR))Lloyd Helicopters International Pty. Ltd., [2001] 249 ITR 162 (AAR)

• Expense is actually deducted when profits (and not gross receipts) are taxed on deemed basis.[Nakazono vs. ACIT (2003) SOT 31(Del)]; (Pride Foramer SA V/s ACIT 2007 15 SOT 562 (Delhi)]

• Expense is actually paid(CIT v. Elitos S.P.A (2005) 145 Taxman 210 (Allhbd. HC

• If the expense is attributable to or deductible by PE , it should be considered as “borne by”. whetherdeduction claimed or not irrelevant

[Sedco Forex International Inc v. CIT (2005) (147 Taxman 389)(SC)]

WHAT DO YOU MEAN BY - “BORNE BY”


1520/12/2014


Article 15(2) or Article 16(2): Physical Presence Test

• India – US Treaty

“for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year”

• India – UK Treaty

“period or periods not exceeding in the aggregate 183 days during the relevant fiscal year”

• India – Malaysia Treaty

“for a period or periods not exceeding in the aggregate 183 days in any twelve month period commencing or ending in the fiscal year concerned”

• India – Indonesia Treaty“for a period or periods not exceeding in the aggregate 183 days in any twelve-month period”

• India – Philippines Treaty

“for a period or periods not exceeding in the aggregate 183 days in the relevant “previous year” in the case of Republic of India or ‘calendar year’ in the case of the Republic of the Philippines”

1620/12/2014


Article 16(2): PE Connect Test

• India- USA Treaty

“the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has in the other State”

• India – UK Treaty

“the remuneration is not deductible in computing the profits of an enterprise chargeable to tax in that other State”

• India- Malaysia Treaty

“the remuneration is not borne by a resident or permanent establishment or fixed base which the employer has in the other State or by a person carrying on independent personal services in the other Contracting State”

1720/12/2014


Article 15(2) – variation in the clause

• Article 15(3) – India-Singapore Treaty

• In the case of a recipient who satisfies all the conditions under sub-paragraphs (a), (b) and (c) of paragraph 2,

• if his remuneration is deductible as an expense against fees for technical services (dealt with under Article 12) derived by his employer and

• the employer has no permanent establishment in the other Contracting State, the remuneration may,

• notwithstanding the provisions of paragraph 2, be taxed in that State

• In such case, the tax so charged shall not exceed 15 per cent of the gross amount of the remuneration

1820/12/2014


Article 15(3) – Special Rule for employment aboard a ship/ aircraft

• OECD/UN Model

• Notwithstanding the preceding provisions of this Article, remuneration derived in respect of an

employment exercised aboard a ship or aircraft operated in international traffic, or aboard a

boat engaged in inland waterways transport, may be taxed in the Contracting State in which the

place of effective management of the enterprise is situated”

• Scope of Taxation

• Exception to Article 15(1) and 15(2)

• Follows rule applied to taxability of income from business of shipping, inland waterways and air

transport as provided in Article 8

• Employment income may be taxable in State where effective management of the employer is

situated

1920/12/2014


WITHHOLDING TAX - Issues 1. Is tax required to be deducted at source from salaries of expatriates working in India

even in cases where such salaries were paid abroad?

Yes, the Supreme Court in the case of Eli Lilly& Company (India) Pvt. Ltd. [2009] 312ITR 225 has ruled that salary payable for services rendered in India should besubjected to tax deduction at source/ withholding tax provisions, even on that part ofthe salary which is paid overseas.

2. Is Section 192 to be interpreted to impose a liability to collect tax which is eventuallynot payable at all?

Andhra Pradesh High Court in the case of Rajagopal (P.V.) vs. Union of India (233 ITR678), held that “a scheme cannot be abused by collecting more than the tax leviableand driving the assessees to wait indefinitely for refunds.”

AAR in its ruling in the case of British Gas [2006] 287 ITR 462 held that the IndianCompany was not required to withhold taxes on the salary paid in India toemployees deputed to UK if it is satisfied that such salary is taxable in UK and not inIndia.

3. TDS u/s 192 not applicable to Overseas Allowance paid by Indian company toemployees seconded by foreign company ( CIT Vs. Petroleum India ( 29 taxmann.com250—Bombay HC)

2020/12/2014


4. Can Interest/ penalty be levied on the employer who fails to deduct tax at source, if theemployee has paid tax by the way of advance tax or self-assessment tax?

If all conditions of proviso to Section 201 are satisfied, no interest/penalty are leviable.The Supreme Court in the case of Hindustan Coca-Cola Beverages Pvt. Ltd. vs. CIT [2007]293 ITR 226 also held that penalty cannot be levied on the employer who fails todeduct tax at source, if the employee has paid tax by the way of advance tax or self-assessment tax.

5. Are Reimbursement of expatriate’s salary payments in the nature of FTS?

YES - AT&S India Pvt. Ltd. [2006] 287 ITR 421 (AAR)

Verizon Data Services India Pvt. Ltd. [2011] 337 ITR 192 (AAR)

Centrica India Offshore Pvt. Ltd. [2012] 249 CTR 11 (AAR)

Target Corporation India Pvt. Ltd. [2012] 348 ITR 61 (AAR)

WITHHOLDING TAX – Issues (Contd…)

2120/12/2014


6. Reimbursement of expat salaries by Indian Company not FTS –

ADIT vs. Mark & Spencer Reliance India Pvt. Ltd. [2013] 27 ITR(T) 448 (Mumbai ITAT)

Cholamandalam MS General Insurance Co. Ltd. [2009] 309 ITR 356 (AAR)

IDS Software Solutions vs. ITO [2009] 32 SOT 25 (Bengaluru)(URO)

Tekmark Global Solutions LLC [2010] 131 TTJ 173 (Mumbai)

ACIT vs. Karl Storz Endoscopy India Pvt. Ltd. (ITA No. 2929(Del)/2009)

Cerner Healthcare Solutions Pvt. Ltd. vs. ITO (ITA No.627(Bang)/2011)

Caterpillar India P Ltd. vs. DDIT (ITA No.630(Bang)/2010)

Ariba Technologies India Pvt. Ltd. vs. Dept. of Income-tax (ITA No. 616(Bang)/2011)

Abbey Business Services (India) (P.) Ltd. [2012] 53 SOT 401 (Bengaluru)

CMS (India) Operations & Maintenance Co. (P.) Ltd. [2012] 135 ITD 386 (Chennai)

Temasek Holdings Advisors (I) P. Ltd. vs. DCIT [2013] 60 SOT 134 (Mumbai ITAT)

WITHHOLDING TAX – Issues (Contd…)

2220/12/2014


CONVERSION RATE FOR SALARY EARNED IN FOREIGN CURRENCY

• RULE 26 vs. RULE 115

• Rule 26:

For the purpose of deduction of tax at source on any income payable in foreigncurrency, the rate of exchange for the calculation of the value in rupees of suchincome payable to an assessee outside India shall be the telegraphic transferbuying rate of such currency as on the date on which the tax is required to bededucted at source under the provisions of Chapter XVIIB by the person responsiblefor paying such income.

• Rule 115:

The rate of exchange for the calculation of the value in rupees of any incomeaccruing or arising or deemed to accrue or arise to the assessee in foreign currencyor received or deemed to be received by him or on his behalf in foreign currencyshall be the telegraphic transfer buying rate of such currency as on the specifieddate.

2320/12/2014


OTHER INCOME TAX ISSUES - PAN, RETURN FILING, NOC

PAN:

• All Inbound employees are required to obtain a PAN by making anapplication to the tax authorities.

RETURN FILING:

• All Inbound employees must file their tax returns in the prescribed form onor before 31 July. The income tax payable as per the tax return must becomputed and paid before the return is filed.

NOC ( Section 230) :

• Every person, who is not domiciled in India and who has come to India inconnection with business, profession or employment, is required to obtain aNo Objection Certificate from the tax authorities before departing fromIndia.

• For this purpose, employees will have to furnish an undertaking obtainedfrom the employer to the effect that the tax payable by such person shall bepaid by the employer.

2420/12/2014


• Per Diem Allowance

• Hypothetical Taxes

• Social Security and Pension

TAXABILITY OF CERTAIN COMPONENTS OF SALARYSTRUCTURE OF AN INBOUND EXPAT

2520/12/2014


PER DIEM ALLOWANCE

Conditions for claiming exemption u/s 10(14)(i) r.w. Rule 2BB :

• The allowance must be granted to meet expenses in the performance of the duties of an office;

• The allowance is granted to an employee on tour or transfer;

• The allowance is granted to meet the ordinary daily charges;

• The said charges are incurred on account of absence from his normal place of duty; and

• The exemption is available only to the extent to which the expense is actually incurred.

(Caution: The allowance must be granted as a reimbursement rather than a personal advantage)

( Relevant for Inbound and outbound expat !!!!)

2620/12/2014


PER DIEM ALLOWANCE – SOME JUDICIAL PRECEDENTS

In CIT vs. S. G. Pgnatale [1980] 124 ITR 391(Gujarat), it has been held thatexpenses given as reimbursement of the money which would be required bythe expatriate to spend for his stay in India rather than a personaladvantage was not a "perquisite" within the meaning of section 17(2) and/or"salary" within the ambit of section17(1)(iv), it would not be taxable.

Supreme Court in the case of CIT vs. Goslino Mario [2000] 241 ITR 312 heldthat where the employees were required to stay away from their homes, dailyallowance given to them to incur expenditure, wholly, necessarily andexclusively for the purpose of duties and such expenditure was in nature ofreimbursement, the same will be excluded from the net cast by the Act

Supreme Court in the case of CIT vs. Morgenstern Werner[2003] 259 ITR486 held that daily allowance received by an employee and incurred by himon account of absence from normal place of duty was not taxable in hishands

( Note: Definition of Income retrospectively amended to include theseallowances )

2720/12/2014


PER DIEM ALLOWANCE—SOME JUDICIAL PRECEDENTS

•AAR in Hindustan Powerplus (271 ITR 433) held living expenses, furnishedhouse, airfare and per diem for rest period, home travel, car etc exemptu/s 10(14)(i) in hands of foreign deputees

•ITO vs. Saptarshi Ghosh [2011] 15 Taxmann 328 (Kolkata) - employeesshould be considered to be on tour where employees were sent ondeputation by TCS Ltd, an Indian company to USA as they are nottransferred to USA. Further, the period of deputation or the fact that thefamily accompanies during the deputation does not alter the position evenif they are sent for more than 12 months.

•(Whether transfer of employment from one company to another withinthe same group would qualify as “transfer” in Section 10(14)(i) ??)

2820/12/2014


HYPOTHETICAL TAX AND TAX EQUALISATION

Suppose an employee is drawing asalary of USD 10,000 per monthand is liable to income tax @ 35%in the Home country. In such acase his post-tax income would beUSD 78,000 computed as follows:

Now, suppose the employee istaxed @ 40% in the Host country.In such a case, his post-tax incomewould be USD 72,000 computedas follows:-

Particulars USD

Original Salary 120,000

Less : Income Tax @ 35% (42,000)

Net Salary 78,000

ILLUSTRATION

Particulars USD

Original Salary 120,000

Less : Income Tax @ 40% (48,000)

Net Salary 72,000

Thus, an employee is worse off by USD 6,000 (USD 78,000 - USD72,000)if he accepts the assignment of going abroad on the same terms.

2920/12/2014


HYPOTHETICAL TAX AND TAX EQUALISATION

Particulars USD

Salary in home country 120,000

Less :Hypo Tax @35% (42000)

Net Salary 78000

Add Tax in host Country (78000*40/60) 52000

Revised Salary (includes tax equalisation of 10000) 130000

Income Tax @ 40% in host countryLess : Credit for tax in host country (restricted to 42000)

52,000

Thus, the tax payable in the Home Country is USD 42,000 against which isavailable a credit of $ 52,000 paid in the Host Country and as a result of thisno tax is payable in the Home country.

3020/12/2014


AMOUNT TAXABLE AS REMUNERATION IN INDIA

Particulars USD

Gross Salary Receivable in Host Country 130,000

Less: Hypo Tax exempt u/s 10(10CC) Reimbursement Receivable

42000

Taxable Salary in India 88,000

Note :Had all conditions specified in Article 15 (2) are satisfied,entire remuneration would have been taxable only in the homecountry

3120/12/2014


ISSUES WRT DEDUCTION OF HYPOTHETICAL TAX

Hypo tax held deductible in:

• Yoshio Kubo ( 357 ITR 452 (Del) and Jaydev

Raja ( 357 ITR 292 (Bombay) and

• CIT vs. Dr Percy Batlivala and others (2010

TIOL 175) (Delhi)

“In our opinion, the income arising in India in the

present case is actual salary plus the

incremental tax liability arising on account of

Indian assignment. Hypo Tax never accrued to

the assessee and thus is deductible” . Reliance

was placed on E.D. Sasoon & Co. Ltd. ( 26 ITR

27 (SC) for meaning of “accrued”.

3220/12/2014


TAXABILITY OF SOCIAL SECURITY CONTRIBUTION OF HOME COUNTRY FOR EXPATRIATE

Mandatory contribution - tax deductible / not taxable –’ diversion by overriding title’

Favorable court rulingsCIT, Delhi – XVII v. NHK Japan Broadcasting Corporation [Civil Appeal No. 1712 of 2009 (SC)

ACIT vs Harashima Naoki Tashio, ITA No. 4634/Del

ACIT vs Eric Matthew Gottesman (2007) 15 SOT 301 (Del)

ACIT, Circle 47(1) vs Hideki Ishihara in ITA No. 1906/Del/08

ITO vs Lukas Fole (2009) 124 TTJ (Pune) 965

Gallotti Raoul vs ACIT 61 ITD (Bom.) 453

Voluntary contributions

By employer – taxable on accrualL.W. Russel (1963) 53 ITR 91Dr. Jan Nuyten (1999) 112 Taxmann 238

By employee – not tax deductible / taxable

NotTaxable

Taxable

3320/12/2014


TAXABILITY OF SOCIAL SECURITY CONTRIBUTION OF HOME COUNTRY FOR EXPATRIATE

Guiding principles:

• Compulsory / mandatory nature• The employer should be authorised to deduct the social security

contribution from the monthly remuneration payable to theemployee

• Contributions are required to be made by all employeescompulsorily

• Certain penal implications for default• No vested right conferred on an employee• Contributions are required to be made by all employees

compulsorily.• Overriding title on income from remuneration

• It should not be a “company framed scheme”

• Guarantee the workers and their families against all types of riskssusceptible to reduce the earning power.

3420/12/2014


EMPLOYER’S CONTRIBUTION TO PENSION

Employer’s contribution to the Pension Funds is not taxable in theyear of contribution as it does not vest in employee till a much laterdate :

• CIT vs. L W Russell [1964] 53 ITR 91 (SC)

• Yoshio Kubo vs. CIT, 2013 [2013] 357 ITR 452 (Delhi)

• CIT vs. Vinay Bharat Ram [1981] 129 ITR 128 (Delhi)

• CIT vs. Cama Motors Pvt. Ltd. [1998] 234 ITR 699 (Guj)

• CIT vs. Bharat Ram Charat Ram P. Ltd. [1986] 157 ITR 199 (Delhi)

However the employers’ contribution would be taxed at the time ofreceipt of the retirement benefits to the extent it relates to servicesrendered in India as per the ITA (subject to treaty provisions) .

3520/12/2014


Independent Personal Services(Article 14)

Article 14 – UN Model

1. Income derived by a resident of a Contracting State in respect of professional services or other activities of an independent character

shall be taxable only in that State except in the following circumstances, when such income may also be taxed in the other Contracting State:

(a) If he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other Contracting State; or

(b) If his stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned; in that case, only so much of the income as is derived from his activities performed in that other State may be taxed in that other State

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

3720/12/2014


Article 14 – US Model

1. Income derived by an individual who is a resident of a Contracting State from the performance of services in an independent capacity

shall be taxable only in that State, unless such services are performed in the other Contracting State and the income is attributable to a fixed base regularly available to the individual in that other State for the purpose of performing his activities

3820/12/2014


OECD MODEL

• Article 14 was deleted from the model tax convention on 29 April 2000 on the basis of the report entitled issues related to Article 14 of the OECD Model Tax Convention (adopted by the committee on Fiscal affairs on 27 January 2000 and reproduced in volume II at page R(16)-1)

• That decision reflected the fact that there were no intended differences between the concepts of permanent establishment, as used in Article 7, and fixed base, as used in Article 14, or between how profits were computed and tax was calculated according to which Article 7 or 14 applied

• In addition, it was not always clear which activities fell within Article 14 as opposed to Article 7

• The effect of the deletion of Article 14 is that income derived from professional services or other activities of an independent character is now dealt with under Article 7 as business profits

3920/12/2014


Scope…

• Deals with income from professional services by resident of one state to resident of another state

• Thrust is on services of an independent nature : (Contra : Dependent services of an employee)

• Article covers independent activities involving skills – Exportation of Skills – Most commonly known as Professional Skills

• Combines the effect of Article 5 and 7

• Income of Artistes, Athletes and Sportsman, etc not covered. Fees for Technical Services also not covered?

• Excludes industrial and commercial activities – covered in Article on Business Profits

• Also excludes professional services while in employment – covered in article on Dependent Personal Services

• Permits for furnishing of the services of employees or other personnel

Article 14 applies where service provider bears risk and rewards

4020/12/2014


Scope

• The scope is wide. The treaties say :

Professional Services Or Other independent activities of a similar character

Professional Services Or Other activities of an independent character

• The expression is wider than the words “professional services or other activities

of a similar character”

• Meaning of professional activity vs business activity

• CIT vs Upasana Hospital (225 ITR 845) (Ker)

• Dr P Vadmalayan vs CIT (74 ITR 94)(Mad)

4120/12/2014


Key Factor: Professional Services…

► Article 14(1) of the UN Model convention reads as follows:

“Income derived by a resident of a contracting state in respect of professional services or other activities of an independent character shall be ……………except in following circumstances, when such income may also be taxed in other contracting state……………”

► Article 14(2) defines “professional services” to include:

► Independent scientific, literary, artistic, educational or teaching activities;

► Independent activities of physicians, lawyers, engineers, architects, dentists and accountants

► The definition illustrates the meaning of “professional services” and is not exhaustive

► “Professional services” involves any vocation requiring predominantly intellectual skills, dependent on individual characteristics of the person (pursuing that vocation) and requires specialized and advanced education or expertise in related field.

4220/12/2014


Key Factor: Professional Services

► What can be covered under “other services of independent character”

► Distinguishable from business profits

► Should be services

► Be similar to professional services

► Capital is secondary importance

► The expression is wider than the words “professional services or other activities of a similar character”

4320/12/2014


Professional fees under Article 14 versus FTS under Article 12

► There are overlapping areas in professional services covered under Article 14 and in technical, managerial or consultancy services covered under Article 12 in as much as a professional service can be rendered in a technical, managerial or consultancy field

► In such case, some treaties expressly exclude income covered under Article 14 from the purview of Article 12 (FTS), whist in other cases, wherein there is no such express exclusion, it has been held that if a case fell under more beneficial provisions of a treaty (Article 14) then it would be futile to stretch the interpretation to bring it under some other provisions of the treaty (Article 12)

► Graphite India Ltd. Vs (2003) 86 ITD 384 (Cal) – IPS vs FTS

► Dieter Eberhand Gustav Van Der Mark v CIT (235 ITR 698) (AAR) – IPS vs Director’s fees

► DIT vs The Paper Products Ltd. – IPS vs Other income

4420/12/2014


Applicability to Non-individuals

► There is a divergence of opinion regarding applicability to non-individuals

► Under certain treaties, the Article is restricted in its application when services are rendered by an individual

► Some treaties amplify: for example India-SA – “an individual or a firm of individuals”; India-UK – “an individual, whether in his own capacity or as a member of a partnership”; India-Singapore – “an individual”

► This partly explains thrust on “personal” services as part of the title

► Some treaties may even make it open to all residents including a company which provides professional services (Eg Japan, Netherlands)

► Literal reading suggests that article applies to non-individuals

► It refers to “resident of a Contracting State” *Refer MSEB vs DCIT (90 ITD 793)(Mum)

► Combined reading of Article 4 and Article 3(1)(a), has a broader connotation than “individual and would include firms and companies

4520/12/2014


Entities Covered

► Treaty specific coverage of Individual and /or firms of Individuals

• India –US treaty: an Individual or a firm of individuals

• India – UK treaty: an Individual whether in his own capacity or as a member of a partnership

• India – Singapore treaty: an Individual

• India – Netherlands / India –Japan: All residents including a company which provides professional services

• Applicability of tax treaty benefits to partnership firms

• Linklaters LLP vs ITO (40 SOT 51)(Mum) – Applicable

• Schellenberg Wittmer (AAR No. 1029 of 2010) – Not applicable

• ADIT vs Ess Vee Intellectual Property Bureau – Remitted back to determine status of foreign entity

• Applicability of Article 14 to firm of individuals

• Clifford Chance v/s DCIT (318 ITR 237) (Bom)

• Dy CIT vs Chadbourne & Parke LLP (2 SOT 434)(Mum)

• IMP Power Ltd. vs ITO (9 SOT 156)(Mum)

• Linklaters LLP vs ITO (40 SOT 51)(Mum) – relying on UN model held that Article 15 is applicable to individual only

4620/12/2014


Right to Tax: Source Country

• Article 14(1) provides for taxation in the other ContractingState (ie state of performance of services), if:

• He has a “fixed base” regularly available to him in the othercontracting state for the purpose of performing his activities; or

• his stay in the other contracting state is for a period or periodsamounting to or exceeding in the aggregate 183 days in any 12months period commencing or ending in the fiscal year

• Thus following two test emerges:

• Fixed base test; and

• Duration test (similar to DPS article)

4720/12/2014


Fixed Base Test

► Term “Fixed Base” is not defined

► Fixed Base is permanent facility rather than temporary use to performindependent activity – denotes entire activity

► Fixed Base need not be of ownership or leased premises

► Fixed Base should be regularly “available” to the professional; it need not be inregular continuous use

► Expression “base” is narrower than “place of business”

► Availability must be for performing the services

► No time limit prescribed

► PE requires greater degree of permanence as compared to a Fixed Base

► Decisive point is where the person works and not where result of his work isexploited

► Article 5(3) to 5(7) dealing with Agency, Construction PE do not apply to fixedbase

4820/12/2014


Fixed Base Test - Illustration

Fixed Base No Fixed base

► Office of an Architect/Lawyer

► Physician provided consulting room

twice a week by polyclinic

► Definite space in office of an associate

► A Lawyer exercising profession from

second home in another state

► Auditor provided room at client’s place to

perform Audit

► Desk made available to the manager

situated in another enterprise without

presence of necessary infrastructure

► Temporary camping by a researcher at

base camp in Himalayas

Note : Income attributable to the fixed base can alone be taxed

4920/12/2014


Duration Test

• On plain reading suggests, the stay for all purposes, whetherpersonal, employment or professional has to be aggregated.However, in context of India-UK tax treaty, it appears that theMumbai Tribunal in case of Clifford Chance [82 IDT 106]accepted the argument of the taxpayer that when noprofessional services were rendered, (Eg businesspromotional visits), such visits have to be excluded

• Purpose of stay is relevant

• Solar days are to be considered and not man days

5020/12/2014


Other Treaty Variations

► Right of Taxation to Source Country:

► If aggregate fees paid by residents or borne by PE exceed certain limit

► Examples : Canada > $2,500

: Trinidad & Tobago > INR 40,000

► Treaties like Brazil provide for taxation of every payment by Residents / PE in India even if offshore service

► Treaties like Mauritius, Korea provide for taxation based on Fixed Base criterion only

5120/12/2014


Attribution

► Income attributable to fixed base shall be taxable in other contracting state

► Once there is fixed base in other contracting state, it is not necessary that the services should be actually rendered in that state

► India – US DTAA – only to the extent of services performed in the state

► Deduction of cost attributable to fixed base would computed as per principles of Article 7

► “Fixed base” would be akin to professional’s chamber from where the person conducts his independent professional activity – Graphite India Ltd. (86 ITD 384)

5220/12/2014


Case Laws – Independent Personnel Services

Graphite India Ltd. Vs (2003) 86 ITD 384 (Cal)

Graphite India Ltd…

Facts

• Graphite India Ltd. (GIL), an Indian company is engaged in the business of manufacturing and marketing

• GIL appointed Mr. F, a resident of the USA as consultant to keep GIL abreast of matters concerning technology up gradation and development of new products as well as sharing his various research and development

• While making application for remittance to Assessing Officer (AO), GIL contended that remittance payable to Mr. F are covered by Article 15 of the India-USA Tax Treaty and as his stay is less than 90 days, the same is not taxable

• AO was of the view that such services are covered by the scope of fees for technical services as explained in Article 12(4) of India-USA Tax Treaty

• AO also commented that the entire factory premise was available to Mr. F and therefore it created a “fixed base” for Mr. F under Article 15. “Fixed base” is much broader than “Fixed Place”

• On appeal, the CIT(A) upheld the view of AO and GIL aggrieved by the same appealed to ITAT

Issue

• Whether the consultancy services fall within the ambit of Article 12(4) or Article 15 of the India-USA Tax Treaty ?

5520/12/2014


Ruling

• Article 12(5) specifically provides that “fees for included services” does not include amount

paid to individual or firm of individuals for professional services as per Article 15

• Article 12(4) and Article 15 are non-competing and mutually exclusive

• Tribunal held that services rendered by Mr. F fell within the ambit of Article 15 and

consequently outside the scope of Article 12(4) of the India-USA Tax Treaty

• “Fixed base” would be akin to professional’s chamber from where the person conducts his

independent professional activity

• Tribunal also held that no ‘fixed base’ was ‘regularly available’ to the consultant in India and

as the stay in India in the relevant previous year was less than 90 days, the remittance made

is not liable to withholding tax in India by virtue of Article 15

Graphite India Ltd

5620/12/2014


Maharashtra State Electricity Board (MSEB) Vs DCIT(2004) 90 ITD 793 (Mumbai)

MSEB…

Facts

• MSEB entered into an agreement with a London based firm of solicitors (M/sFreshfields) for availing certain legal advisory services with an intent to enter into apower purchase agreement

• The services provided by M/s Freshfields were in the nature of legal advisory, assistingin negotiations for finalization of power purchase agreement and review of commercialand financial arrangements

• MSEB took the view that remittance for the advisory services is covered under Article15 of India-UK Tax Treaty and as the firm has spent less than 90 days, the payment arenot chargeable to tax in India

• AO observed that Article 15 covers only Individual and do not cover the firm. Therefore,the same is covered under Article 13 of the India-UK Tax Treaty

• On appeal, the CIT(A) upheld the AO’s view. MSEB further challenged it to ITAT

5820/12/2014


MSEB…

• Article 15(1) of the India-UK Tax Treaty:

“income derived by a resident of a Contracting State in respect of professional servicesor other independent activities of a similar character may be taxed in that State. Suchincome may also be taxed in the other Contracting State if such services are performedin that other State”

• Article 15(1) of new India-UK Tax Treaty [Notification dated 11 February 1994]:

“income derived by an individual, whether in his own capacity or as a member of apartnership, who is a resident of a Contracting State in respect of professional servicesor other independent activities of a similar character may be taxed in that State. Suchincome may also be taxed in the other Contracting State if such services are performedin that other State”

Issue

• Whether payment to M/s Freshfields are covered by the scope of Article 13 or Article15 of the India-USA Tax Treaty ?

5920/12/2014


MSEB

Ruling:

• The New tax treaty is not applicable to the year. It is applicable from AY-1995-96

• Article 4(3) specifically refers to “person other than individual” which gives nodoubt that meaning of the expression “resident of the Contracting State” isnot confined to individuals only but also extends to firms, companies andother entities since place of effective management can arise only in case ofthese entities

• The old tax treaty is much wider than new amended treaty to include firm

• Tribunal also held provisions of Article 15 being specific provision forprofessional services overrides the general provisions of “managerial,technical or consultancy” services

• ITAT relied upon Graphite India Ltd. Vs Dy.CIT (ITD)

6020/12/2014


I.T.C. Ltd Vs Dy.CIT (2003) 85 ITD 162

I.T.C. Ltd…

Facts

• ITC engaged the services of Mr. S as a consultant for up gradation, improving efficiencyand cost effectiveness of the products

• ITC made application to AO for nil withholding on the premises that consideration paidtowards the services is in the nature of fees for technical services under the scope ofArticle VII of the old India-Austria Tax Treaty i.e. taxable only if activities are performedin India

• Article VII of the old India-Austria tax treaty dated 24 September 1963 provides:

“amounts paid by an enterprise of one of the territories for technical services furnishedby an enterprise of the other territory shall not be subject to tax by the first mentionedterritory except insofar as such amounts are attributable to activities actuallyperformed in the first-mentioned territory. In computing the income so subject to tax,there shall be allowed as deductions the expenses incurred in the first-mentionedterritory in connection with the activities performed in that territory”

• AO held that the services provided from Austria is basically in continuation of theactivities actually performed by Mr. S in India during his visit

6220/12/2014


I.T.C. Ltd…• On appeal, the CIT(A) held that the services were provided outside India and therefore

not taxable within Article VII of India-Austria tax treaty

• Article XIV of old India Austria tax treaty provides

“1. Subject to Art. XII, profits of remuneration from professional services or from services as an employee derived by an individual who is a resident of one of the territories may be taxed in the other territory only if such services are rendered in that other territory

2. An individual who is a resident of Austria shall not be taxed in India on profits or remuneration referred to in para (1) if—

(a) he is temporarily present in India for a period or periods not exceeding in the aggregate 183 days during the relevant "previous year".

(b) the services are rendered for or on behalf of a resident of Austria,

(c) the profits or remuneration are subject to Austrian tax, and

(d) the profits or remuneration are not deducted in computing the profits of an enterprise chargeable to Indian tax”

Issue

• Whether provisions of Article XIV or Article VII of the India-Austria Tax Treaty will be applicable for the services rendered ?

6320/12/2014


I.T.C. Ltd

Ruling

• Article II(1)(f) of the India-Austrian tax treaty defines the term “Austrian enterprise” and “Indian enterprise” as “an industrial or commercial enterprise or undertaking carried on by a resident of Austrian” and “an industrial or commercial enterprise or undertaking carried on by a resident of India”. While even this provision enlightens us little about connotations of the expression “enterprise”, it is clear that only “industrial” or “commercial” entities are included in the scope of expression “Austrian enterprise”

• ITAT held that the services were covered under Article XIV and not Article VII

• Since conditions under Article XIV not fulfilled, the service is not taxable in India

• ITAT held that Article XIV of the India-Austria Tax Treaty is applicable as consultancy services provided by Mr. A are of independent character, do not constitute commercial or industrial activities and not in course of employment

6420/12/2014


SUSHIL LAKHANILakhani & Associates, Chartered Accountants4th Floor, Bharat House,104, Mumbai Samachar Marg,Fort, Mumbai-400023Tel: +91-22-40693946(M) : 9821111852E-mail : [email protected]

mailto:[email protected]

BOMBAY CHARTERED ACCOUNTANTS’ SOCIETY …...•An employer is someone to whom an employee is...

Documents

Transcript of BOMBAY CHARTERED ACCOUNTANTS’ SOCIETY …...•An employer is someone to whom an employee is...