ASSOCHAM - Seminar on TDS - Part II Non-residents

Allrightsreserved|Preliminary&Tentative
May 22, 2015
TDS Provisions related to
Non-residents

2 |
A S S O C H A M
NET OF TAX ARRANGMENTS
IMPACT OF SECTION 206AA ON NON-RESIDENT PAYMENTS
TDS ON REIMBURSMENTS TO PASS THROUGH ENTITIES

3 |
A gross up clause is a provision in a contract which provides that all payments must be made
in the full amount, free of any deductions or withholdings
Usually indicate that if there is a mandatory withholding or deduction by operation of law
(usually with respect to tax), then the paying party shall "gross up" the payment so that the
receiving party receives the same net amount
Dependent on the business judgment of the parties involved
International practice - Prohibition on gross up clauses in cross border transactions - countries
such as Ukraine, Canada etc
What is it?

4 |
“[In a case other than that referred to in sub-section (1A) of section 192, where under an
agreement] or other arrangement, the tax chargeable on any income referred to in the foregoing
provisions of this Chapter is to be borne by the person by whom the income is payable, then, for
the purposes of deduction of tax under those provisions such income shall be increased to
such amount as would, after deduction of tax thereon at the rates in force for the financial year
in which such income is payable, be equal to the net amount payable under such agreement or
arrangement.”
Extract of Section 195A of the IT Act
Tax to be deducted after grossing up of the net payment to be made
Applicable to all sections under Chapter XVII-B of the IT Act
Circular 370 dated 30 October 1983 - Tax deduction on gross amount in case of “net of tax”
payments
Friction between Section 206AA and 195A?
Section 195A - Income Payable “Net of Tax”

5 |
(iii) for the purposes of deduction of tax under section 195, the rate or rates of income-tax
specified in this behalf in the Finance Act of the relevant year or the rate or rates of income-tax
specified in an agreement entered into by the Central Government under section 90, or an
agreement notified by the Central Government under section 90A, whichever is applicable by
virtue of the provisions of section 90, or section 90A, as the case may be
Extract of Section 2(37A) of the IT Act - Rate or rates in force
Rates of income tax specified in the IT Act or DTAA - Beneficial rates to be applied [Circular
No 728 dated October 30, 1995]
Rates prescribed by DTAA generally inclusive of surcharge and education cess [Supported by
decisions of Cochin ITAT in case of ITO vs Far Hotels Ltd & CIT vs Arthusa Offshore
(Uttarakhand High Court)
Rates in force

6 |
Prescribed rate Effective rate *
10 percent 11.11 percent (10/90)
20 percent 25 percent (20/80)
Impact of Section 195A of the IT Act on the Payer/ Deductor
*Surcharge and education not to be considered
Particulars Without gross up With gross up
Amount payable 100 100
Tax gross up at the rate of 10 percent NA 111.11
Less: Tax at 10 percent 10 11.11
Net payment 90 100
Total cost 100 111.11
Grossing up and its impact on cost to the Payer/ Deductor

7 |
Grossed up amount - deductible expenditure in the hands of the payer?
Section 198 of the IT Act - Tax withheld and deposited shall be income in the hands of
recipient:
“All sums deducted in accordance with [the foregoing provisions of this Chapter] shall, for the
purpose of computing the income of an assessee, be deemed to be income received.”
[Supported by CIT vs Superintending Engineer (1985) 152 ITR 753 AP High Court and Asian
Development Service vs CIT (1999) 239 ITR 713 Kerala High Court]
Section 203 of the IT Act/ Circular No 785 dated November 24, 1999 - Payer under the legal
obligation to furnish TDS certificate within time prescribed to the payee in respect of payment
made ‘net of tax’
Contractual payment of tax-free remuneration - Interplay with Section 197 of Companies Act,
2013 (erstwhile Section 200 of the Companies Act, 1956)
Points for consideration

8 |
Gross up in the case of net of tax contracts (even in case agreement provides for remittance
without deducting taxes) - Barium Chemicals (175 ITR 243) (AP)
Grossing up of income not applicable to notional income under Section 44BB read with Section
195A of the IT Act - CIT vs ONGC (264 ITR 340) (Uttaranchal)
Points for consideration
Commercial considerations
Payee's liability (if any) - Indemnifications, warranties etc
Payer liability - Withholding tax only (Not final India tax liability)
Gross up not to apply on certain payments (such as Section 10(6A) payments)
Tax Protected Contracts - Key Aspects

A S S O C H A M
TDS ON REIMBURSMENTS TO PASS THROUGH ENTITIES

10 |10 |
APPLICABILITY OF SECTION 206AA ON NR
PAYMENTS
Section 206AA - Applicability on non-residents
View 1
No specific mention in the IT Act - NR to obtain PAN [Section 139A(8), Rule 114C etc]
Section 206AA intended mainly to create a taxpayer identification number and increase
monitoring by entry in the database of Indian Tax Authorities
View 2
Section 206AA - Non-obstante clause
CBDT Press Release No 402/92/2006-MC (27 of 2010) - PAN of deductee and TAN of deductor
required for claiming tax credits
Section 206AA of the IT Act provides that if the payee fails to furnish PAN to the payer, who is
responsible for withholding taxes, then taxes should be withheld at the rates specified in the
relevant provisions of the IT Act or the “rates in force” [defined to mean “rates of income-tax”
specified in the Finance Act or relevant tax treaty whichever is lower, in the context of section 195
of the Act] or 20 percent, whichever is higher.
Section 206AA

11 |
SECTION 206AA VS TAX TREATY
Section 206AA meant for improving compliance and not to impose punitive tax incidence on
the payee
Tax treaty is a distinct code in itself and is a mini legislation
Treaty override is an international principle of law
Anti-avoidance provisions are specifically enacted to prevent treaty misuse and hence the
same can not override treaty - OECD/ UN commentaries
Pune ITAT Ruling - Serum Institute of India Limited vs DDIT [TS-158-ITAT-2015 (PUNE)]
206AA starts with a non-obstante clause - Could override Section 90(2)
Section 206AA supplements the primary withholding tax sections in case of default by not
furnishing PAN. Hence, rates prescribed by Section 206AA could be used to discharge
withholding obligations
Bangalore ITAT in case of Bosch Ltd vs ITO (ITA No 552 to 558/ Bang/ 2011)
View 1 - Section 206AA does not overrides the Treaty provisions
View 2 - Section 206AA overrides the Treaty provisions

12 |
INTERPLAY - SECTION 195A AND 206AA
Section 206AA of the Act were introduced with the object of improving compliance and not to
impose any punitive tax incidence on the payee
Though Section 206AA does not by itself create any withholding obligation, it starts with a non-
obstante clause
Section 206AA supplements the primary withholding section in case of default in PAN
Thus, the rate of 20 percent as provided in Section 206AA would be substituted for the rate
provided under the respective provisions which creates the withholding tax obligation
View 1 - Section 206AA not applicable for grossing up under Section 195A
View 2 - Section 206AA applicable for grossing up under Section 195A
View 1 upheld by Bangalore ITAT in case of Bosch Ltd

13 |
BREATHER ON “NET OF TAX” CONTRACTS
Bosch Ltd vs ITO [2012] 28 taxmann.com 228 (Bangalore Tribunal)
The assessee was required to make payment ‘net of tax’. Once the liability to withhold tax is
established, it is necessary to consider the issue of grossing up of tax under Section 195A of the Act
and tax is required to be withheld at the ‘rates in force’ ie rates of withholding tax under the Act or
tax treaty whichever is beneficial to the assessee. Therefore, the Bangalore Tribunal held that the
grossing up of tax would be required to be done at the ‘rates in force’ and not at 20 percent under
section 206AA of the Act which is applicable only where PAN is not furnished.

14 |
GENERAL GUIDANCE POINTS
Advisable to apply Section 206AA on remittances to non-residents which is subject to
withholding taxes (though favorable jurisdictional ITAT ruling exists)
Non-resident service providers need to be educated about hassle free process of obtaining PAN
Tax protected contracts - Some benefits may be passed to the NR (commercially) if NR agrees
to apply for PAN - Win-win situation

15 |
A S S O C H A M
TDS ON REIMBURSEMENTS TO PASS THROUGH ENTITIES

16 |
TDS ON REIMBURSEMENTS
Reimbursement could include:
Cost to cost reimbursement (pure reimbursement); or
Reimbursement with mark-up (possibility of embedded income?)
Typical instances:
Reimbursement of salary of seconded employees to the overseas entities
Reimbursement of incidental expenses in addition to payments of Royalty/ FTS
Reimbursement of cost of services of a third party engaged by the non-resident
Reimbursement of allocated costs (ie costs sharing arrangements)
Reimbursement of traveling expenses of technicians
Reimbursement of living allowance etc of a person deputed to India

17 |
Nature of Expense No TDS position TDS position set
Reimbursement of allocated
cost (ie cost sharing
arrangements)
Dunlop Rubber Co (142 ITR 493)
(Cal HC)
Danfoss Industries (In
dia) Ltd (268 ITR 1) (AAR)
Payment for services rendered
at cost
Timkin India Ltd (273 ITR
67)(AAR)
Reimbursement of incidental
expenses in addition to
payments of FTS/ Royalty
− Telco Ltd (245 ITR 823)
(Bombay HC)
− Industries Engg. Project (P) Ltd
(202 ITR 1014)(Del HC)
− Clifford Chance (82 ITD
106)(Mum HC)
− Mahindra and Mahindra Ltd (1
SOT 896)(Mum ITAT)
− Cochin Refineries Ltd (222 ITR
354) (Ker)
− Hindalco Industries Ltd (278 ITR
(AT) 125)
Reimbursement of living
allowance etc of a person
deputed to India by the non-
resident
− BHEL (252 ITR 218) (Del HC)
− Goslino Mario (241 ITR 312)
(Del HC)
− HCL Infosystems Ltd (274 ITR
261)(Del HC)
TDS ON REIMBURSEMENTS
Reimbursements - Watch out for TDS

18 |
TDS ON REIMBURSEMENTS TO PASS
THROUGH ENTITIES
ABC India
ABC
Germany
India
Germany
Raises an invoice
for reimbursement
Case Study 1
Incurs
expenditure
Employee visits
Germany
Facts:
An employee of XYZ Ltd visits USA
ABC Inc incurs expenses on behalf of the
employee
ABC Inc in turn raises a debit note against
XYZ Ltd for the expenses incurred
Issue:
Is XYZ Ltd required to withhold tax on the
above payment to ABC Inc?
Ref:
DIT (IT) vs Krupp UDHE GmbH (Bombay
High Court) Income tax Appeal No 2626 of
2009

19 |
THROUGH ENTITIES
ABC India
ABC
Netherlands
India
Netherlands
Consultancy
services
Case Study 2
Facts:
ABC India receives consultancy services
from a third party located outside India
ABC Netherlands, the holding company of
ABC India makes payment to third party
and then subsequently raises an invoice
for expenses
Issue:
Is ABC India required to deduct tax on
payment made to ABC Netherlands?
Ref:
CU Inspections (I) Pvt Ltd [TS-132-ITAT
2013(Mumbai ITAT)]
Third Party
Reimbursement of
expenditure

20 |
THROUGH ENTITIES
Case Study 2 (Contd..)
Held:
Third party payment via related concern
not "reimbursement“ - TDS applicable
TDS provisions apply on payment for
training services (if taxable) from external
trainers - Holding Co arranged training for
subsidiary’s employees
Payment to be considered as
reimbursement only when it ultimately
stops with related party, not otherwise
Routing of payments as reimbursements
impermissible to thwart flow of law
ABC India
ABC
Netherlands
India
Netherlands
Consultancy
services
Third Party
Reimbursement of
expenditure

21 |
THROUGH ENTITIES
XYZ & Co (Firm)
Indian Company
Partner 1
(UK)
Partner 3
(Germany)
Partner 2
(Germany)
India
Germany Consultancy
Services
Case Study 3
Pays consideration
Facts:
Indian Co pays consideration to XYZ & Co
for consultancy fees
XYZ & Co is a registered firm in Germany
and has 3 partners sharing profits equally -
2 residents of Germany and 1 resident of
UK
Under Germany tax laws, income of firm
taxed in the hands of the individual
partners
Issue:
Can Indian Co apply India-Germany DTAA
for the entire payment?
Would India-UK treaty needs to be applied
for the transaction?

22 |
THROUGH ENTITIES
XYZ & Co (Firm)
Indian Company
Partner 1
(UK)
Partner 3
(Germany)
Partner 2
(Germany)
India
Germany Consultancy
Services
Case Study 3 (Contd..)
Pays consideration
Issue:
Whether firm / partners would be treated
as a residents under DTAA?
Definition of the term Resident and Person
OECD Commentary recognizes the end
person as a person; Indian law?
Whether payments made by Indian Co for
consultancy services taxable in India?
Ref:
Schellenberg Wittmer along with its
partners (AAR) AAR No 1029 of 2010
Linklaters LLP vs ITO (2011) 9 ITR 217
(Mumbai)

23 |
KEY TAKE AWAYS
Payment to non-residents to be methodically examined from tax withholding perspective
In case of uncertainty coupled with a substantial amount, it is suitable to obtain tax withholding
order under Section 195(2) of the IT Act as it mitigates against severe consequences of non
compliance with Section 195
Payments may be remitted under the alternate mechanism (CA Certificate) if the case is
strongly supported by judicial precedents

DISCLAIMER
This presentation provides general information existing as at the time of preparation of this presentation.
This presentation is meant for general guidance and no responsibility for loss arising to any person
acting or refraining from acting as a result of any material contained in this presentation will be
accepted by BMR Advisors. It is recommended that professional advice be sought based on the
specific facts and circumstances. This presentation does not substitute the need to refer to the original
pronouncements.
Sandeep Jhunjhunwala | Associate Director
BMR & Associates LLP
Level 3 | Prestige Nebula-I | 8-12 Cubbon Road |
Bangalore - 560 001
E: sandeep.jhunjhunwala@bmradvisors.com
D: +91 80 4032 0011
M: +91 97401 55469

ASSOCHAM - Seminar on TDS - Part II Non-residents

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