INCOME TAX REVIEW

1. Introduction
   It is said there are two certitudes in life, namely, death and taxes. "Indeed, taxes are as old as civilization. The only difference is the method of collection. In modern days more emphasis is on deduction/collection of tax at source by the tax-payer on behalf of the Government. This method being simple with least cost of collection is widely resorted by the Governments world over. In India it is known as "Tax deduction at source" whereas internationally it is known as "withholding tax."

   A country levies tax either based on a ‘residence link’ or a ‘source link’ of the tax-payer. Non-residents are taxed based on their source link to the country. In this Article, we shall discuss at length what are the provisions under the Income-tax Act, 1961 (the "Act") for deduction of tax at source while making payment to non-residents. The subject being very wide, only those provisions are covered which are of day-to-day importance to the readers.
    

2. Payments to Non-residents (Section 195 of the Act)
   This section casts an obligation on the person who is making any payment to a non-resident to deduct tax at source. The sweeping language of the section brings almost every payment made to a non-resident, which is chargeable to tax, within its ambit. The only exclusion here is that of a salary payment. section 192 of the Act deals with TDS provisions relating to salaries paid to a non-resident, which is chargeable to tax in India. Let us study the provisions of section 195 at length.

   1. Provisions of section 195
      Section 195 provides that, "Any person responsible for paying to a non-resident not being a company, or to a foreign company, any interest or any other sum chargeable under the provisions of the Act (not being income chargeable under the head "salaries") shall, at the time of credit of such income to the account of the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax thereon at the rates force."
      (Emphasis supplied)

      The dissection of the above provision reveals that

      1. The obligation to deduct tax at source is cast on every person making payment be it individual, company, partnership firm, Government or a public sector bank etc. The term ’person’ as defined in section 2(31) of the Act is relevant here.

      2. The payee may be any type of the entity (i.e., individual, company etc.)

      3. The payee must be a non-resident under the Act

      4. The payment may be for interest or any other sum except salaries.

      5. Tax deduction has to be made at the time of credit or payment of the sum to the non-resident, whichever is earlier.

   2. Income chargeable to tax
      The Hon’ble Supreme Court in the case of Transmission Corporation of A.P. Ltd. and Another vs. CIT (1999) 239 ITR 587 (SC) has held that the scheme of sub-sections (1), (2) and (3) of section 195 and section 197 leaves no doubt that the expression " any other sum chargeable under the provisions of this Act" would mean "sum" on which income-tax is leviable. In other words, the said sum is chargeable to tax and could be assessed to tax under the Act. The consideration would be whether payment of the sum to the non-resident is chargeable to tax under the provisions of the Act or not. That sum may be income or income hidden or otherwise embedded therein. The scheme of tax deduction at source applies not only to the amount paid which wholly bears "income" character such as salaries, dividend, interest on securities, etc., but also to gross sums, the whole of which may not be income or profits of the recipient." The above decision of the Supreme Court has been discussed and distinguished in a number of High Courts and Tribunal decisions. Reference may be made to the following Tribunal decisions:–

      1. Maharashtra State Electricity Board vs. DCIT (2004) 90 ITD 793 (Mumbai).

      2. Raymond Ltd vs. DCIT (2003) 86 ITD 791 (Mum)

   3. Exempt income or income not chargeable to tax
      The crux of the provisions of the Section 195 is that the income in the hands of the recipient must be chargeable to tax. Thus, if any income is exempt in the hands of the non-resident, the resident making payment to such a non-resident need not deduct tax at source u/s 195. (CBDT Circular No. 786 dated 7th February, 2000 has clarified this issue)

      It is interesting to note here that such an exemption need not only arise out of provisions of the domestic tax laws, but it may be due to application of the provisions of a tax treaty.

      In Tekniskil (Sendirian) Bernhard in re (1996) 222 ITR (AAR) 551, the AAR held that "where the non-resident is not chargeable to income tax in India on the income by way of royalty/ fees for technical services which effectively would form part of the business profits of the non-resident in its hands and the fact that the non-resident has no permanent establishment in India, is not in dispute, the question of deduction of tax at source would not arise merely because the non-resident gets income from a resident in India. The Act would not, therefore, apply to non-resident in such cases to levy income tax and/or to require deduction of tax at source to be made under section 195 (1) ignoring the agreement for avoidance of double taxation between India and respective foreign country."

      In Hyderabad Industries Ltd. vs. ITO [1991] (188 ITR 749), the Karnataka High Court held that "an amount which will not be included in the total income of a person cannot be considered as "income" for the purpose of deduction of tax at source at all".

      Thus there is no need to deduct tax at source in respect of all income, which are exempt under the Act. Illustrative list of income under the Act, which are exempt in the hands of non-residents, is as follows:

      1. Section 10(4) – Interest on NRE account and notified securities; (upto 31-3-2005)

      2. Section 10(6BB) - Tax paid on behalf of the non-resident by an Indian company which is engaged in the business of operation of aircraft;

      3. Section 10(6C) – Income by way of royalty or fees arising to a foreign company in respect of projects connected with security of India;

      4. Sections 10(8A) and (8B) – Income of a consultant/individual out of funds made available to an international organisation under a technical assistance grant between the agency and the government of a foreign State/Government of India;

      5. Section 10 (15) – Income by way of interest and

      6. Section 10 (15A) – Any payment made by an Indian company engaged in the business of operation of aircraft, to acquire aircraft or an aircraft engine on lease from the Government of a foreign State or a foreign enterprise).

      Besides above income, if any other income of a non-resident is exempt from tax in India, then there is no necessity to deduct tax at source by the payer.

   4. Consequences of failure to deduct tax at source
      There are severe consequences of failure to deduct tax at source while making payment to a non-resident. Besides the normal interest and penalty, such payments will not be allowed as deduction in the hands of the payer while computing the profits and gains from business and profession under the Act (Refer provisions of section 40 (a) (i)). Moreover, the payer may be regarded as an ‘agent’ of the non-resident under section 163 of the Act and the tax may be recovered from him. Thus, one needs to be extremely careful in applying provisions of the Act for non-deduction of tax at source.
      But then on what amount tax is required to be deducted?

   5. Amount on which tax is to be deducted at source
      As stated earlier, notwithstanding the language of section 195, tax is to be deducted at source only from those payments to non-residents, which results into income chargeable under the Act. At times the entire payment may not constitute income. In such a scenario, the payer has to compute the income and deduct tax at an appropriate rate or deduct the tax on the gross amount, which may not be acceptable to the non-resident.

      1. Payments to Permanent Establishment (PE) or Purchase of Property
         The difficulty to determine the amount chargeable to tax would be more pertinent in case of payments to a PE of a non-resident situated in India and payment in respect of purchase of immovable property situated in India. In the former case even though every payment made includes the component of income, the same is determinable only at the year end, whereas in the later case, the person acquiring property from the non-resident has to compute the capital gains arising to non-resident, the details for which are normally not available with the buyer of the property. Is there any recourse available to the payer or the payee in such a scenario?

      2.  Recourses available to the payer/payee

         1. Application to the Assessing Officer (AO)
            Section 195(2) provides that, "where the person responsible for paying any such sum chargeable under this Act (Other than Salary) to a non-resident considers that the whole of such sum would not be income chargeable in the case of the recipient, he may make an application to the Assessing Officer to determine, by general or special order, the appropriate portion of such sum so chargeable, and upon such determination, tax shall be deducted under sub-section (1) only on that portion of the sum which is so chargeable". Thus, it is advisable to obtain such certificate in case of doubt.
            Likewise, the payee can apply to the AO for lower deduction or NIL deduction certificates if the income received by him is either not chargeable to tax or chargeable at the lower rate than what is prescribed for the withholding. Such an application can be made either under section 195(3) or 197 of the Act.

         2. Application to the Authority for Advance Rulings
            The payer or payee may make an application to the Authority for Advance Rulings (AAR) under section 245N for determination of question of law or fact as the case may be. The decision rendered by the AAR would be binding on the applicant for the transaction for which the ruling is sought and to the Commissioners and the Income Tax authorities subordinate to him in respect of the applicant and the said transaction.

      3. TDS from payment of interest, etc. to a branch of a foreign bank
         In case of branch of a foreign bank operating in India, every person making payment of interest or other sum to it, is technically liable to deduct tax at source under section 195. However, Indian branches of foreign banks normally obtain annual certificates from the respective assessing officers to the effect that the payer need not deduct tax at source from such payments.

   6. Rate at which tax is to be deducted at source

      1. Income-tax Act vs. Double Taxation Avoidance Agreement (DTAA)
         Clause (iii) of the section 2(37A) of the Act specifies the rates in force for the purposes of deduction of tax at source under section 195. Accordingly, one has to apply the rate/s prescribed in the Finance Act of the relevant year or the rates specified in a DTAA entered into by the Central Government whichever is applicable by virtue of provisions of section 90 of the Act. In view of provisions of section 90(2) of the Act in case of a remittance to a country with which a DTAA is in force, the tax should be deducted at the rate provided in the Finance Act of the relevant year or at the rate provided in the DTAA, which is more beneficial to the assessee. (This position has been clarified by the CBDT vide Circular No. 728 dated 30th Oct., 1995).

      2. CBDT Circular No. 333 dated 2-4-1982
         Even before insertion of section 90(2) reproduced above by the Finance (No. 2) Act, 1991, with retrospective effect from 1-4-1972, the CBDT had clarified vide Circular No. 333 dated 2-4-1982 to the effect that where a specific provision is made in the DTAA, the provisions of the DTAA will prevail over the general provisions contained in the Income-tax Act and where there is no specific provision in the DTAA, it is the basic law; i.e., the Income-tax Act that will govern the taxation of income.

         The said Circular has been accepted and explained by various judicial authorities in the following decisions :

         1. ITO vs. Degremont International (1985) 11 ITD 564 (Jp – Trib)

         2. Elkem Spigerverket vs. ITO (1988) 32 TTJ (Cal. – Trib) 5

         3. DCM Ltd. vs. ITO (1989) Taxation 92 (4) – 16 (Delhi – Trib)

         4. CIT vs. Davy Ashmore Ltd. (1991) 190 ITR 626 (Cal)

         5. Banque National De Paris vs. IAC (1991) 94 CTR (Bom-Trib) 57

         6. CIT vs. R.M. Muthiah (1993) 202 ITR 508 (Kar)

         7. Agencia General (P) Ltd. vs. First ITO (1993) 45 ITD 243 (Pune-Trib)

         8. CIT vs. VR S.R.M. Firm (1994) 208 ITR 400 (Mad)

         9. CIT vs. Hindustan Paper Corpn. Ltd. (1994) 77 Taxman 450 (Cal)

         The above is not an exhaustive list. This principle has been well accepted and applied by the Authority for Advance Rulings and other High Courts and Income-tax Appellate Tribunals in a large number of Rulings and judicial decisions in a wide variety of cases.

         Even before the issue of the said Circular and insertion of section 90(2), the Andhra Pradesh High Court held in CIT vs. Visakhapatnam Port Trust (1983) 144 ITR 146 (AP) that the provisions of section 90 will prevail over the provisions of sections 4, 5 and 9 of the Income-tax Act.

         Further, in Gujarat Narmada Valley Fertilizers Co. Ltd. vs. ITO (1982) 2 ITD 515 (Ahd), the Tribunal has held that the provisions of the would constitute "provisions of the Act" for the purposes of deduction of tax at source.

         Hence, if the particular payment to non-resident subject to deduction of tax at source under the Act, but under the relevant DTAA the same is not chargeable to tax or taxable at the lower rate in India then such lower/NIL rate would be applicable.

      3. Levy of surcharge and the education cess
         The rates prescribed under the Act are to be increased by the Surcharge (@ 2.5 or 10 per cent as the case may be) and the Education Cess (@ 2 per cent on the tax amount).

         However, wherever the rate is applied as prescribed under the DTAA, then the same would be final and the Surcharge and the Education Cess need not further increase it. Since DTAA are agreements between the two sovereign States and the rate prescribed therein are the maximum rate (i.e., the upper ceiling) it includes the Surcharge and the Education Cess. Education Cess is levied by the Finance Act by way of a surcharge and therefore, it assumes the character of the Surcharge.

      4. Specific rates prescribed in the certain sections
         Where a particular section in the Act provides for income to be taxed at a specified rate (e.g. Section 115A – Tax on dividend, royalty and fees in the case of foreign companies; Section 111A - Tax on Short Term Capital Gains etc.) then in such cases that specified rate would be applicable for deduction of tax at source.

         The CBDT has, in the context of section 115A prescribing special rates of tax on dividends, interest, income from Mutual Funds, royalty and fees for technical services payable to a non- resident (not being a company) or a foreign company, clarified vide Circular No. 740 dated 17th April, 1996 that if the DTAA provides for a lower rate of taxation, the same would be applicable. The Circular is reproduced below for ready reference:

         "Taxability of interest remitted by branches of banks to the head office situated abroad, under the Foreign Currency Packing Credit Scheme of Reserve Bank of India

         1. The Reserve Bank of India has introduced a Foreign Currency Packing Credit Scheme (FCPCS) for Indian exporters. Under this scheme, the Authorised Dealers in India can arrange for lines of credit from abroad for providing preshipment credit to Indian exporters at internationally competitive rates of interest. Such credit can also be arranged by Indian branches of foreign banks from their head offices or any other branch abroad.

         2. References have been received seeking clarification as to whether interest remitted by a branch in India to its head office or a branch abroad on the lines of credit arranged under this scheme would be chargeable to tax in India and whether tax would have to be deducted at source in terms of section 195 of the Income-tax Act, 1961.

         3. It is clarified that the branch of a foreign company/concern in India is a separate entity for the purposes of taxation. Interest paid/payable by such branch to its head office or any branch located abroad would be liable to tax in India and would be governed by the provisions of section 115A of the Act. If the Double Taxation Avoidance Agreement with the country where the parent company is assessed to tax provides for a lower rate of taxation, the same would be applicable. Consequently, tax would have to be deducted accordingly on the interest remitted as per the provisions of section 195 of the Income-tax Act, 1961." (emphasis supplied)

         The ratio of the above Circular would equally apply to other special provisions applicable to non-resident such as provisions contained in sections 44B (Special provisions for computing profits and gains of shipping business in case of non-residents), 44BBA (Special provisions for computing profits and gains in connection with the business of operation of aircraft in case of non-residents), 44BBB (Special provisions for computing profits and gains of foreign companies engaged in the business of civil construction, etc., in certain turnkey power projects), etc.

      5. No TDS from payments to foreign shipping companies or agents
         By Circular No. 723 dated 19th September, 1995, the CBDT has clarified that there would not be no overlapping of section 172 which provides for recovery of tax from foreign shipping companies and sections 194C and section 195. Where payments are made to shipping agents of non-resident ship owners or charters of carriage of passengers, etc. shipped at a port in India, the agent acts on behalf of the non-resident ship owner or charterers, he steps into shoes of the principal and accordingly, the provisions of section 172 shall apply and those of sections 194C and 195 will not apply. Therefore, a resident making payment of freight to or foreign shipping companies or their agents will not require to deduct TDS under section 195 or 194C.

   7. Extra Territorial Jurisdiction of section 195?
      Provisions of section 195 makes it mandatory for withholding of tax when the payee is non-resident if the income is chargeable to tax in India. The payer in such a may be a non-resident. A situation may arise when both, payee and the payer are non-residents yet the income is taxable in India. In such a situation provisions of TDS u/s 195 would be applicable. For example, Mr. A (NRI) owns a property in India. He sells the same to Mr. B another non-resident. Then Mr. B, notwithstanding he being an individual and a non-resident needs to deduct tax at source and deposit it with the Government treasury.

      In AAR No. 250 of 1995 [White Consolidated Industries, Inc. (USA)], the Authority for Advance Ruling held that the royalty paid outside India by Whirlpool Corporation (a US company) to White Consolidated Industries (a US subsidiary of a Swedish company) for use of a trademark (Kelvinator) in India was subject to tax in India.

      Consider a situation where a foreign company deputes its employees to India for a period of two years. His salary is directly credited to his bank account abroad. In such a situation, how can a foreign company discharge its obligation to deduct tax at source if it does not have any presence in India? A practical way out here could be that the said employee can pay monthly advance tax on his own. This arrangement/method was upheld by the Delhi Bench of the ITAT in case of Babcock Power (Overseas Projects) Ltd. vs. Assistant Commissioner of Income Tax (2002) 81 ITD 29.

3. Payments to Non-resident sportsmen or sports association (Section 194E read with section 115 BBA of the Act)

   1. Payee
      Under section 194E of the Act, any person who is responsible for making payments (referred to in paragraphs 3.2 and 3.3 infra) to the following person is liable to deduct tax at source @ 10% (plus surcharge and education cess) on gross basis:

      1. Any non-resident sportsman (including athlete) who is not a citizen of India; or

      2. A non-resident sports association or institution

      If a person were a non-resident Indian citizen (NRI) then he would not get the benefit of the reduced rate of taxation. However, he can avail the benefit of liberal provisions of the applicable DTAA.

   2. Income earned by Non-resident sportsmen
      Under section 115BBA (a) of the Act, following income earned by non-resident sportsman who is not a citizen of India, are liable for deduction of tax at source under section 194E:

      1. Income from participation in India in any game (other than winnings from lotteries, crossword puzzles, races, card games or any sort of gambling or betting of any form or nature which is taxable under section 115BB) or sport of a non-resident sportsmen (including athlete) who is not a citizen of India; or

      2. Income from advertisement; or

      3. Income from contribution of articles relating to any game or sport in India in newspaper, magazines or journals.

       

      1. CBDT Circular No. 787 dated 10th February, 2000
         CBDT has issued a Circular No. 787 dated 10th February, 2000 wherein it is clarified that in case of non-residents in addition to the provisions of the Act, the applicability of DTAA should be examined. The Act provides that in case of sportsmen or artists participating in such events or shows, all income accruing or arising or deemed to be accruing or arising, received or deemed to be received in India is taxable in India. Under the DTAAs, too, the separate Article on "Artistes and Sportsmen" usually provides for taxation in the country of source. Income accruing to another person and not directly to the artist or sportsman, it is still taxable in India in accordance with provisions of this Article. The advertising or sponsorship income, etc., of the sportsman or artist, or appearance in India would also be covered under such Article in DTAA. However, if the performance is recorded and royalties are paid on the same then the same would be covered by the Article on Royalties.

         A typical Article on "Artistes and Sportsperson" in a DTAA as follows:

         Article 17 – "Artistes and Sportsperson" of United Nation - Model Convention – "Income derived by a resident of a Contracting State as an entertainer, such as theatre, motion picture, radio or television artiste or a musician, or as a sports person from his personal activities as such exercised in the other Contracting State, may be taxed in that other State."

      2. Illustrations on taxability of income of the non-resident artists or performers in India
         The Circular further clarifies that in connections with the taxability of income of the non-resident artist or performer in India, the facts and circumstances of each event need to be considered. A few situations are illustrated below:

         1. If an artist performs in India gratuitously without any consideration, there would be no income and consequently no tax;

         2. Where the artist performs in India to promote sale of his records and no consideration is paid for this performance by the record company or anyone else; there will be no tax as he does not receive any income for performance in India;

         3. Any consideration received by artist or performer for the live performance or simultaneous live telecast or broadcast (on radio, television, internet etc.) in India would qualify as income and consequently should be taxable. Even if separate consideration is received for simultaneous live telecast etc. of performance, the same shall be taxable in India and is to be treated under the Article on "Artistes and sportsmen" in the DTAA;

         4. The consideration paid to the artist to acquire the copyrights of performance in India for subsequent sale abroad (of records, CDs, etc.) or the consideration paid to the artist for acquiring the license for broadcast or telecast overseas in not taxable in India due to exclusions provided in section 9(1)(vi) of the Income-tax Act;

         5. The consideration paid to the artist to acquire the copyrights of performance in India for subsequent sale in India (as records, CDs etc.) or the consideration paid to the artist for acquiring the license for broadcast or telecast in India is taxable in India as per section 9(1)(vi) of the Income-tax Act as royalties. Under the DTAA also, this would fall under the "Royalties" Article;

         6. The portion of endorsement fees (for launch or promotion of products etc.), which relates to artist’s performance in India shall be taxable in India in accordance with the provisions of section 5 of the Income-tax Act. Under the DTAA, this would fall under the Article on "Artistes and sportsmen".

         In view of above, the contract of the artists or performers with event managers, sponsors etc., are of vital importance in deciding the taxability of their income in India. It is therefore necessary to obtain and examine the contracts of the artists or performers relating to the event. The apportionment of income attributable to India would have to be done by the purpose of illustration and do not cover all possible cases.

   3. Income earned by non-resident sports association or institution
      Under section 115BBA (b) of the Act, following income earned by non-resident sports association or institution are liable for deduction of tax at source under section 194E:

      —	Income by way of amount guaranteed to be paid or payable to sports association or institution in relation to any game (other than game the winnings wherefrom are taxable under section 115BB) or sports played in India.

      1. Taxability of guarantee money under a DTAA
         CBDT Circular No. 787 dated 10th February, 2000 has clarified that the payment by way of guarantee money to non-resident sport associations needs to be considered in terms of Article on "Other Income" or on "Income not expressly mentioned" of the relevant DTAA.
          

4. Income from Units (Section 196B read with section 115AB)
   Section 196B deals with deduction of tax at source on long-term capital gains or income in respect of Units referred to in section 115AB of the Act payable to an Offshore Fund.

   1. Meaning of Offshore Funds
      Overseas Financial Organisation has been referred to as the "Offshore Funds" in the Explanation to section 115AB of the Act as follows:

      1. "overseas financial organisation" means any fund, institution, association or body, whether incorporated or not, established under the laws of a country outside India, which has entered into an arrangement for investment in India with any public sector bank or public financial institution or a mutual fund specified under clause (23D) of section 10 and such arrangement is approved by the [Securities and Exchange Board of India, established under the Securities and Exchange Board of India Act, 1992 (15 of 1992),] for this purpose;"

   2. Income covered under section 115AB
      Following income are covered under section 115AB:

      1. Income received from units of specified mutual fund or from Unit Trust of India which are purchased in foreign currency; or

      2. Income by way of long-term capital gains arising from transfer of units purchased in foreign currency.

      Effective from 1st April, 2003, income from units of specified mutual fund is exempt under section 10 (35) of the Act. Similarly effective from 1st April, 2005 long-term capital gains in respect of unit of an equity oriented fund is exempt from tax under section 10 (38) of the Act. Thus, the scope of the applicability of this section is considerably reduced.

   3. Deduction of Tax at Source
      Income referred to here in above (at Para 4.2 supra) would be subject to tax deduction at source @ 10 per cent plus surcharge @ 2.5 per cent and the education cess @ 2 per cent of the tax amount.

      The tax has to be deducted on the gross amount without deduction of expenses under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VIA of the Act.

   4. Non applicability of provisions of section 48
      Sub-section 2 of section 115AB provides the second proviso (which deals with cost inflation indexation) to section 48 shall not be applicable while computing income under this section.

5. Income from foreign currency bonds or shares of Indian companies (Section 196C read with section 115AC)
   Section 196C of the Act deals with deduction of tax at source on certain income of non-resident referred to in section 115AC of the Act.

   1. Income referred to in section 115AC of the Act
      Section 115AC of the Act deals with income of non-resident from the following sources:-

      1. Income from foreign currency bonds
         Interest income from foreign currency bonds purchased in foreign currency by a non-resident, which are issued by an Indian company as per the prevailing guidelines or by a public sector company is taxable under clause (a) of section 115AC(1) of the Act.

      2. Income on Global Depository Receipts (GDRs)
         Dividend income (other than dividends referred to in section 115-O) on following Global Depository Receipts will be taxable.

         1. GDRs issued as per the scheme notified by the Central Government against the initial issue of shares of an Indian company and purchased by him in foreign currency through an approved intermediary; or

         2. GDRs issued against the shares of a public sector company sold by the Government and purchased by Non-resident in foreign currency through an approved intermediary; or

         3. GDRs issued or re-issued as per scheme notified by the Central Government against the existing shares of an Indian company purchased by him in foreign currency through an approved intermediary

      3. Income from long-term capital gains
         Income by way of long-term capital gains arising from transfer of foreign currency bonds or global depository receipts of a non-resident would be liable to tax.

         Clause (viiia) of section 47 provides that gains arising on transfer of a capital asset, being bonds or GDRs referred to in section 115AC is not regarded as transfer provided the transfer is made outside India by a non-resident to another non-resident.

   2. Deduction of Tax at Source
      All income referred in the paragraph 5.1 above are taxed @ 10 per cent which are to be further increased by the surcharge and the education cess as may be applicable.

      The tax has to be deducted on the gross amount without deduction of expenses under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VIA of the Act.

   3. Non applicability of provisions of section 48
      Sub-section 3 of Section 115AC provides that the first proviso (which deals with computation of capital gains in the same currency as that of original investment) and the second proviso (which deals with cost inflation indexation) to section 48 shall not be applicable while computing income under this section.

   4. No need to file Return of Income
      Sub-section 4 of section 115AC provides that where the total income of a non-resident consists of only of income referred to in that section and that the tax deductible at source has been properly deducted then he need not submit the return of income.
       

6. Income of Foreign Institutional Investors (FIIs) (Section 196D read with section 115 AD)
   Section 196D of the Act deals with deduction of tax at source on income from securities referred to in section 115AD of the Act in respect of Foreign Institutional Investors.

   1. Income from securities (Section 115AD (1)(a))
      Income (Other than exempt dividend) of FIIs from securities, other than units referred to in section 115AB, is taxable at the rate of twenty per cent plus surcharge and education cess.

   2. Deduction of Tax at Source
      Section 196D of the Income tax Act cast an obligation of any person who is responsible for payment of income referred above to an FIIs would be liable to deduct tax @ 20% plus surcharge and education cess of the income before making payment or at the time of credit of such income to the account of the payee whichever is earlier.

      However, as per clause (2) to section 196D, no tax has to be deducted on income by way of capital gains arising from the transfer of securities referred to in section 115AD payable to FIIs.

      The tax has to be deducted on the gross amount without deduction of expenses under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VIA of the Act.

   3. Non applicability of provisions of section 48
      Sub-section 3 of section 115AD provides that the first proviso (which deals with computation of capital gains in the same currency as that of original investment) and the second proviso (which deals with cost inflation indexation) to section 48 shall not be applicable while computing income under this section.
       

7. Reimbursement of expenses

   1. Danfoss Industries P. Ltd. and Other Cases
      There is no unanimity of views among judicial authorities in India regarding taxability of reimbursement of expenses or what constitutes reimbursement of expenses. In DECTA vs. CIT (1999) 237 ITR 190 (AAR) and CIT vs. Dunlop Rubber Co. Ltd. (1983) 142 ITR 493 (Cal), CIT vs. Industrial Engg. Projects (P) Ltd. 202 ITR 1014 (Del.), Clifford Chance, United Kingdom 82 ITD 106 (ITAT- Mumbai); it was held, on the facts of the case, that the payments in question constituted reimbursement and therefore, not liable to tax in India. However, the first two decisions have been distinguished by the AAR in the case of Danfoss Industries P. Ltd. [2004] 268 ITR 0001.

      On the Indian company applying for a ruling on the question whether the payments to be made to DS, the foreign company, as fees for the services would be subject to withholding tax under section 195 of the Income-tax Act. 1961, the Authority ruled on the stated facts as follows:

      1. That an element of profit was not an essential ingredient of a receipt to be taxable as income;

      2. That in the absence of the break up of the cost incurred by DS, the foreign company, in providing services and the fees payable by each individual company, the only conclusion possible was that there was no direct nexus between the actual cost incurred by the foreign company in providing the services to a company of the group of companies and the fees payable by each individual company which availed of the services. Therefore, it could not be said that the fee payable by the Indian company was nothing but reimbursement of cost incurred by the foreign company in providing services to the Indian company;

      3. That, even assuming that the fees charged by DS, the foreign company, to the applicant company and the companies in the group were equivalent to the expenses incurred by it in providing the services and the was no profit element, it would be case of quid pro quo for the services and not reimbursement of expense;

      4. That, therefore, payment of fees had to be made by the Indian company only after withholding tax under section 195.

      It is surprising that, in this case, the parties did not refer to and rely upon the Tax Treaty between India and Singapore. Further, the applicant did not raise the question that if the payment does not constitute reimbursement of expenses, what is the nature of payment: whether Business income or Fees for Technical Services?; and if so what is the applicable rate of tax?

      These questions remain unanswered. In my view, if these questions would have been raised, it was possible to successfully contend that payment in question does not constitute FFTS in terms of the Treaty and in the absence of a P.E. in India, the same would also not be taxable as business income.

      Further, even in other cases wherein it has been held that reimbursement of expenses is not income and therefore not taxable, no detailed guidance has been provided as to what constitutes reimbursement of expenses (what are essential elements/ingredients) and what kind of evidence is required or acceptable to satisfy that payment in question meets the criteria.

   2. ITAT decision in Arthur Anderson’s Case
      In this case, the assessee, Arthur Anderson’s & Co., India, contended that the payment to Arthur Anderson’s & Co., Switzerland represented reimbursement of its share of establishment expenses incurred by the Swiss Entity. The assessee did not make available accounts of the Swiss entity. No supporting documents were placed before the ITAT except the auditor’s certificate to the effect that Swiss entity is to be reimbursed all expenses incurred and it operates on a break-even basis and that it does not contain any profit element.

      On the facts of the case, the Tribunal held that "repayment of money cannot be construed to be the income of the recipient but it is to be proved that the amount in question is actually "reimbursement" bereft of any profit for the services rendered. The nomenclature is not decisive to ascertain the real character of payment. In the present case, attendant circumstances suggest that ex-facie the amount paid is not just reimbursement. It could be fee for technical services in the garb of reimbursement. The assessee did not produce any material or document in respect of the establishment expenses of Andersen, S.C., and its cost equalization programme. The material relied upon to buttress the claim is ipse dixit and does not throw light on the real nature of the payment".

   3. Author’s views
      In view of the aforesaid decisions, it would appear that judicial authorities as well as Assessing Officers are not likely to easily accept allocation of common expenses incurred by a parent company as constituting "Reimbursement of Expenses"

   4. Documents substantiating claim for reimbursement
      In the absence of any clear and specific judicial guidance in the matter, the issue has to be decided on the facts of each case. It appears to us that following details and documents would strengthen the assessee’s case that payment in question represents "Reimbursement of Expenses":

      1. Full particular of the expenses (including date, particulars of Invoice, particulars of payee, particulars of the expense and particulars of payment).

      2. Photocopies of relevant Bills, Invoices, Vouchers, Debit Notes etc.

      3. Basis of allocation ("Allocation Keys") and the details of allocation amongst the group entities.

      4. Auditor’s certificate to the effect that he has audited all the expenses & allocation thereof and that the same have been allocated among the beneficiaries on the basis of the pre-determined allocation keys on a fair, equitable and consistent basis.
          

8. Conclusion

   The subject of tax deduction at source from payment to non-residents has not only been complex, but full of litigation. There are many controversies and gray areas, which are intentionally avoided in this Article, as the object here is to understand the fundamentals concepts.

   Any study on non-resident taxation is incomplete without understanding of section 5 (dealing with Scope of Total Income) and the section 9 (dealing with income deemed to accrue or arise in India) of the Act. Even though the same are not discussed here, the reader is advised to examine the taxability of every transaction with a non-resident in the light of these two sections.

   As per the new remittance provisions, authorised dealers are permitted to make remittance to non-residents based on an undertaking from the remitter along with a certificate for proper deduction of tax from a Chartered Accountant (Refer CBDT Circular No. 759 dated 18-11-1997 r/w. Circular No. 767 dated 22-5-1998 as amended by the Circular No. 10 of 2002 dt. 9th October, 2002 and the A.D. (M.A. Series) Circular No. 48, dated 29-11-1997 issued by the RBI). This casts an onerous responsibility on the Chartered Accountant Therefore, before applying provisions of the Act for deduction of tax at source, he must check the special provisions applicable to non-residents as well as provisions of the applicable tax treaty provision, as the tax treaty has an overriding effect on the taxability of a transaction with a non-resident.

   Looking at the accelerating growth in the cross border business transactions and the ease and low cost of collection of taxes at source, the subject of TDS from payments to non-resident is gaining great importance.