Withholding tax on cross-border deals: A vexed issue
Taxpayers need to know which transactions are covered under the source rules specifically relating to services and e-commerce.
Due to an increase in cross-border transactions, income sourced outside India has increased significantly. With more transactions under scrutiny, withholding tax on payments assumes importance.
Under Section 195 of the Income-tax Act, when a non-resident receives a payment that is chargeable to tax, the paying person should withhold the tax. Also, if the payer does not withhold applicable taxes, the expenses will not be deductable when computing the payer's income. Additionally, the resident payer can be subject to interest, penalty and recovery provisions for failure to deduct taxes.
Under law, even if a non-resident merely renders technical service from overseas to an Indian resident (without ever visiting the country), the amount would be subject to income tax as 'fees for technical services'. However, for 'royalty' and 'fees for technical services', there is no withholding tax when the resident payer uses them for
a business carried on outside India, or
a source of income outside India.
There is much debate over what constitutes "income sourced outside India". If a resident has foreign customer contracts, can the income be termed 'sourced outside India'? If the resident, in turn, utilises these services for rendering export services/ goods, can the income be termed 'sourced outside India'?
The Supreme Court in the case of Vodafone International BV vs. UOI made an important observation: Source in relation to an income has been construed to be where the transaction of sale takes place, and not where the item of value (the subject of the transaction), was acquired or derived from. Furthermore, it observed that substantial territorial nexus between the income and the territory that seeks to tax it is of prime importance to levy tax.
The Supreme Court in the case of CIT vs. Toshoku held that where the non-resident did not carry on any business operations in India, and merely received commission income for services rendered outside India, the income cannot be deemed to have accrued or arisen in India.
However, the Authority for Advance Rulings in Infosys Technologies Ltd held that the work outsourced by Infosys India to Infosys Australia is sourced in India. The income earned by Infosys Australia in this transaction emanates from India when the sub-contract is given. Furthermore, the payer is in India. Thus, under domestic tax laws, the AAR held that the transaction is derived from India, and should be liable to tax in India.
The view that the transaction originated in India seems in conflict with the Supreme Court's interpretation. However, the AAR finally concluded that the payment was not subject to tax under the beneficial provisions of the India-Australia tax treaty.
Let's take a hypothetical example: Alpha Ltd, an Indian company, makes a payment to Beta Pte Ltd, a Singapore subsidiary, for technical services rendered in Singapore. Alpha utilises the services of Beta, in turn, for rendering services to its customers in Singapore. Can Alpha be seen to derive its income from Singapore and, hence, should the input service from Beta not be subject to withholding tax?
Interpreting 'source of income' from the above two cases, it is clear that the services rendered by Beta should not be taxable in India.
Taxpayers need to know which transactions are covered under the source rules specifically related to services and e-commerce. This will avert unwarranted, long-drawn litigation on cross-border transactions for resident and non-resident taxpayers alike.
K.R. Sekar is Partner and Priya Narayanan is Manager, Deloitte Haskins and Sells
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