International Taxation

Through section 90 of the Income Tax Act 1961 (the Act), the Indian Government has entered into a number of Tax Treaties with many countries and tax jurisdictions in the form of Comprehensive Double Taxation Avoidance Agreements (DTAAs), Tax Information Exchange Agreements (TIEAs), Limited Agreements etc., generally for the the avoidance of double taxation on income, prevention of fiscal evasion with respect to taxes on income and capital gains and exchange of information on taxes and tax entities within the relevant contracting party’s jurisdiction, relevant to the determination, assessment and collection of such taxes, the recovery and enforcement of tax claims, or the investigation or prosecution of tax matters.

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With increase in multi-jurisdictional trade, investment and business, improvement in communications, greater mobilisation of humans and their financial resources along with the rise of E-Businesses and E-Commerce model of business and trade, an understanding of international taxation concepts and their application through relevant taxation legislations, DTAAs, Tax Treaties, Transfer Pricing, judicial pronouncements thereon etc. has become a necessity for appropriate advance taxation planning and compliance purposes as well as investment and operational strategies in the relevant and multiple taxation jurisdictions involved.

 

Key Topics

If a person (assessee) is determined a ‘tax resident’ of India under the relevant provision of the Income Tax Act 1961 (the Act) in respect of any source of income, then such person shall also be deemed to be a tax resident in respect of (any) other source(s) of income for the same said year and potentially liable to income tax under the Act for all such income(s).


Company

A Company is said to be an income tax resident in India in any previous year, if —

  • It is an Indian Company ; or
  • During that year, the control and management of its affairs is situated wholly in India.

Following shall be substituted for the above with effect from 1 April 2017

A Company is said to be a resident in India in any previous year, if—

  • It is an Indian company; or
  • Its place of effective management, in that year, is in India.

Explanation.—For the purposes of this clause “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made.

> Read more on ‘Place of Effective Management’ (POEM)


Individuals

Under section 6 of the Income Tax Act 1961 (the Act), an individual* is said to be an income tax resident in India in any previous year, if he/she —

  • Is in India in that year for a period or periods amounting in all to 182 days or more; or
  • Having within the 4 years preceding that year been in India for a period or periods amounting in all to 365 days or more, is in India for a period or periods amounting in all to 60 days or more in that year.

However, an individual person is said to be a (tax) resident but “not ordinarily resident in India in any previous year if such person is —

  • An individual who has been a non-resident in India in 9 out of the 10 previous years preceding that year, or
  • Has during the 7 previous years preceding that year been in India for a period of, or periods amounting in all to, 729 days or less.

*In the case of an individual —

(a) being a citizen of India, who leaves India in any previous year as a member of the crew of an Indian ship as defined in clause (18) of section 3 of the Merchant Shipping Act, 1958 (44 of 1958), or for the purposes of employment outside India, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and eighty-two days” had been substituted ;

(b) being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of section 115C, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and eighty-two days” had been substituted.

For the purposes of this clause, in the case of an individual, being a citizen of India and a member of the crew of a foreign bound ship leaving India, the period or periods of stay in India shall, in respect of such voyage, be determined in the manner and subject to such conditions as may be prescribed.


Other Tax Assessees (excluding HUFs)

Every other person is said to be an income tax resident in India in any previous year in every case, except where during that year the control and management of his affairs is situated wholly outside India.


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Double Taxation Avoidance Agreement ‘DTAA’

Through section 90 of the Income Tax Act 1961 (the Act), the Indian Government has entered into a number of Tax Treaties with many countries and tax jurisdictions in the form of Comprehensive Double Taxation Avoidance Agreements (DTAAs), Tax Information Exchange Agreements (TIEAs), Limited Agreements etc., generally for the the avoidance of double taxation on income, prevention of fiscal evasion with respect to taxes on income and capital gains and exchange of information on taxes and tax entities within the relevant contracting party’s jurisdiction, relevant to the determination, assessment and collection of such taxes, the recovery and enforcement of tax claims, or the investigation or prosecution of tax matters.

  • DTAA provisions take precedence over Indian domestic taxation laws such as the Act on subjects and issues that a DTAA expressly provides for and the provisions of the Act applies to the extent they are more beneficial to that assessee concerned.
  • DTAAs generally provide a detailed and comprehensive mechanism for determining the methodology of taxation and apportionment (if any) of taxation revenue with respect to various sources and types of income, between the ‘source’ (of income) jurisdiction and ‘residence’ (of income-earning party) jurisidiction.


Foreign Tax Credit ‘FTC’

The Central Board of Direct Taxes (CBDT) has recently notified the Foreign Tax Credit Rules by amending the Income Tax Rules 1962 by adding Rule 128 (the Rule) on the subject which shall come into force from 1 April 2017.

  • The Rule lays down the principles and methodology for computing the Foreign Tax Credit for foreign taxes paid on foreign source income and claims thereunder by Indian resident taxpayers.
  • The Rule allows an assessee, who is tax resident of India, a credit for the amount of any foreign tax paid by him/her/it in a country or specified territory outside India, by way of deduction or otherwise, in the year in which the income corresponding to such tax has been offered to tax or assessed to tax in India, in the manner and to the extent as specified in the Rule.
  • Such credit is available for taxes paid in countries with which a DTAA exists with India as well as any other country or specified territory outside India, for the tax payable under the law in force there in the nature of income-tax, as referred to in clause (iv) of the Explanation to section 91 of Income Tax Act 1961.
  • The said credit shall be available against the amount of tax, surcharge and cess payable under the Act but not in respect of any sum payable by way of interest, fee or penalty. Further, no such credit shall be available in respect of any amount of foreign tax or part thereof which is disputed in any manner by the assessee concerned.


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“Transfer Pricing” refers to pricing or value assigned to transactions with respect to goods, services, technology etc. that has been sold, exchanged, leased, transferred etc. between associated (or related) enterprises (AE), and which may have taken place under controlled conditions, differing from those taking place between independent enterprises, and also refers to the value attached to such transfers etc. between unrelated parties, but which are controlled by a common entity.

  • Such transactions may result in the “transfer price” for such goods, services etc. being assigned an arbitrary and dictated value with an incorrect or manipulated relation to actual cost incurred and value added to the same by the associated enterprise, and independent of market forces that determine price and profit margins on such transactions
  • These transactions may be subject to scrutiny and re-determination of their value (see below) etc. by the relevant revenue authorities, wherein it may be alleged that the purpose of such controlled transactions is to control the quantum and nature of taxable profits or gains of associated enterprises in a particular taxation jurisdiction for minimizing or avoiding tax obligations of the concerned entity therein and to consequentially benefit AE.


Computation of Arm’s Length Price (ALP)

“Arm’s Length Price” (ALP) means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. Section 92 of the Income Tax Act 1961 (the Act) requires the determination of any income arising from an international transaction to be computed having regard to the ALP and further provides that an allowance for any expense or interest arising from an international transaction shall also be determined having regard to the ALP.

Section 92C of the Act prescribes the methods for determining the ALP in relation to an international transaction or specified domestic transaction. The method applied as being the most appropriate one, is by having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Central Board of Direct Taxes (CBDT) may prescribe, namely —

  • Comparable Uncontrolled Price (CUP) method
  • Resale Price method
  • Cost Plus method
  • Profit Split method
  • Transactional Net Margin method
  • Such other method as may be prescribed by the CBDT


Associated Enterprise

Section 92A of the Act defines an “associated enterprise” for the purposes of transfer pricing, in relation to another enterprise, to mean an enterprise—

  • Which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise; or
  • In respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, are the same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.

For the above purposes, two enterprises are deemed to be associated enterprises if, at any time during the previous year —

  • One enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in the other enterprise; or
  • Any person or enterprise holds, directly or indirectly, shares carrying not less than twenty-six per cent of the voting power in each of such enterprises; or
  • A loan advanced by one enterprise to the other enterprise constitutes not less than fifty-one per cent of the book value of the total assets of the other enterprise; or
  • One enterprise guarantees not less than ten per cent of the total borrowings of the other enterprise; or
  • More than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or
  • More than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons; etc.


International Transaction

Section 92B of the Act defines an “international transaction” to mean a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and includes a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

  • Further, a transaction entered into by an enterprise with a person other than an associated enterprise shall, for the above purposes be deemed to be an international transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such other person is a non-resident or not.

The said section further provides that the expression “international transaction” shall include —

  • The purchase, sale, transfer, lease or use of tangible property including building, transportation vehicle, machinery, equipment, tools, plant, furniture, commodity or any other article, product or thing
  • The purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature
  • Capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business
  • Provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service
  • A transaction of business restructuring or re-organisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date


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Permanent Establishment

For determining the Arm’s Length Price (ALP) for Transfer Pricing purposes with reference to international transactions (or specified domestic transactions) between AEs, Section 92F(iiia) of the Income Tax Act 1961 (the Act) defines a “Permanent Establishment” (PE) to include a fixed place of business through which the business of the enterprise is wholly or partly carried on. This definition is very similar to most DTAA articles that define a PE, though the latter is more detailed, descriptive and uses comprehensive terms to list what does and does not constitute a PE.

  • The independent and factual determination of the existence or otherwise of a Permanent Establishment (PE) and where necessary, undertaking appropriate business setup or restructuring steps, with direct reference to the applicable and relevant DTAA is crucial, as generally such DTAAs provide that the business 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 PE situated therein.
  • If the enterprise carries on business as abovesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly attributable to that PE.


Business Connection

Subject to express provision(s) in a relevant and applicable DTAA dealing with the matter-in-issue such as taxation of ‘Business Profits’ and concept of ‘Permanent Establishment’, under section 9 of the Income Tax Act 1961 (the Act), income is deemed to accrue or arise in India, directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.

  • In the case of a business of which all the operations are not carried out in India, the income of the business deemed under the above said provision to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India.
  • In the case of a non-resident, no income shall be deemed to accrue or arise in India to him/her/it through or from operations which are confined to the purchase of goods in India for the purpose of export.

“Business connection” shall include* any business activity carried out through a person who, acting on behalf of the non-resident —

  • Has and habitually exercises in India, an authority to conclude contracts on behalf of the non-resident, unless his activities are limited to the purchase of goods or merchandise for the non-resident; or
  • Has no such authority, but habitually maintains in India a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the non-resident; or
  • Habitually secures orders in India, mainly or wholly for the non-resident or for that non-resident and other non-residents controlling, controlled by, or subject to the same common control, as that non-resident.

In such circumstances, only so much of income as is attributable to the operations carried out in India by such persons on behalf of the non-resident concerned shall be deemed to accrue or arise in India.

*However, such business connection shall not include any business activity carried out through a broker, general commission agent or any other agent having an independent status, if such broker, general commission agent or any other agent having an independent status is acting in the ordinary course of his business.


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Applicability of General Anti-Avoidance Rule (GAAR)

Section 95 of the Income Tax Act 1961 (the Act) provides that notwithstanding anything contained in the Act, an arrangement entered into by an assessee may be declared to be an ‘Impermissible Avoidance Arrangement’ (IAA) and the consequence in relation to tax arising therefrom may be determined subject to the provisions of the relevant Chapter X-A of the Act. These GAAR provisions, which are to take effect from 1 April 2017 (Assessment Year 2018-19) will override the DTAA provisions in case the latter are abused.

“Arrangement” means any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding

“Benefit” includes a payment of any kind whether in tangible or intangible form

“Step” includes a measure or an action, particularly one of a series taken in order to deal with or achieve a particular thing or object in the arrangement

“Tax Benefit” includes —

  • A reduction or avoidance or deferral of tax or other amount payable under this Act
  • An increase in a refund of tax or other amount under this Act
  • A reduction or avoidance or deferral of tax or other amount that would be payable under this Act, as a result of a tax treaty
  • An increase in a refund of tax or other amount under this Act as a result of a tax treaty
  • A reduction in total income
  • An increase in loss,
    in the relevant previous year or any other previous year.


Impermissible Avoidance Arrangement (IAA)

Section 96 of the Act defines an ‘Impermissible Avoidance Arrangement’ to mean an arrangement, the main purpose of which is to obtain a tax benefit, and it —

  • Creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length
  • Results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act
  • Lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part
  • Is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

An arrangement shall be presumed (unless it is proved to the contrary by the assessee) to have been entered into or carried out, for the main purpose of obtaining a tax benefit, if the main purpose of a step in, or a part of, the arrangement is to obtain a tax benefit, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit.


Reference to Principal Commissioner or Commissioner

Under section 144BA of the Act, if the Assessing Officer (AO) at any stage of the assessment or reassessment proceedings before him/her, having regard to the material and evidence available, considers that it is necessary to declare an arrangement as an ‘Impermissible Avoidance Arrangement’ and to determine the consequence of such an arrangement within the meaning of Chapter X-A, then the said AO may —

  • Make a reference to the Principal Commissioner or Commissioner in this regard;
  • The concerned Principal Commissioner or Commissioner shall on receipt of a reference by the said AO, if of the opinion that the provisions of Chapter X-A are required to be invoked, issue a notice to the assessee, setting out the reasons and basis of such opinion;
  • Such assessee may submit objections (if any) and is to be provided an opportunity of being heard within such period (not exceeding 60 days) as may be specified in the notice before passing necessary orders on the matter.


Consequences of IAA Declaration

Under section 98 of the Act, if an arrangement is declared to be an impermissible avoidance arrangement, then the consequences in relation to tax of the arrangement (including denial of tax benefit or a benefit under a tax treaty) shall be determined, in such manner as is deemed appropriate in the circumstances of the case, including by way of but not limited to the following —

  • Disregarding, combining or re-characterising any step in, or a part or whole of, the impermissible avoidance arrangement
  • Treating the impermissible avoidance arrangement as if it had not been entered into or carried out
  • Disregarding any accommodating party or treating any accommodating party and any other party as one and the same person
  • Deeming persons who are connected persons in relation to each other to be one and the same person for the purposes of determining tax treatment of any amount
  • Reallocating amongst the parties to the arrangement—
    any accrual, or receipt, of a capital nature or revenue nature; or
    any expenditure, deduction, relief or rebate;
  • Treating—
    the place of residence of any party to the arrangement; or
    the situs of an asset or of a transaction,
    at a place other than the place of residence, location of the asset or location of the transaction as provided under the arrangement
  • Considering or looking through any arrangement by disregarding any corporate structure


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