Table of Contents Introduction: Applicable provisions for Tax implication: Sec 195 of income tax act Scope of Total Income: Sec 5 (2) of Income Tax Act Income deemed to accrue or arise in India: Sec 9 (1) of Income Tax Act Tax Implication on Various type of expenses: Reimbursement of Expenses to Non-Resident Professional and Technical Services including Commission: Civil, erection & commissioning Supply of goods Documentation: Concluding Remarks:

 

Introduction:

Section 195 of Income Tax Act, 1961 talks about TDS on foreign payments. TDS on foreign payments is always a matter of litigation specially in countries like India. In the era of globalization and digital transformation, cross-border transactions become a common phenomenon. A lot of project opportunities are coming in the way of Indian entities in international market especially African sub-continent. For execution of such projects, a lot of local agencies are hired for various activities like market survey, govt liaisoning,  design & engineering, civil and erection-commissioning works etc for cost-effectiveness and to create job opportunities. However, this may also lead to lot of tax compliance for these entities. Sometimes, a mis-interpretation or non-compliance may have severe implication on financial performance and cash flow of the entities. An attempt has been made to understand the TDS implication on payment made by Indian entities to local agencies in non DTAA territories.

In this article, we will understand applicability of TDS on foreign payments with an example and all applicable provision thereon.

Mr X Ltd, an Indian Company, executing an Engineering, Procurement and Construction (EPC) contract in Cameroon which do not have DTAA agreement with India. Mr. X Ltd appointed a local company Mr Y Engineering for liaisoning with Cameroon Government during and after tendering stage. They will be reimbursed for all the expenditure incurred on behalf of Indian Company at actual basis. For this, they will be given a fees for his services. Apart from this, he will also get certain percentage of contract value as commission. A separate work order is further awarded to Mr. Y Engineering for civil and erection-commissioning works. Design & Engineering, the supply of goods and overall supervision work is to be done by Indian Company.

We will not discuss tax implication in Cameroon on the revenue earned thereon (camerooin Tax). It is only from the point of Indian Tax perspective for services received for this project. From the above, it appears that following type of expenses is going to be incurred by the Indian Company for above mentioned project: –

Nature of expenses

• Reimbursement of Expenses to Non-Resident
• Liaisoning Fees
• Commission Payment
• Civil and erection-commissioning works
• Supply of goods

Applicable provisions for Tax implication on Project mentioned above

• Sec 195 is the main Sec governing the provisions for deduction of TDS on payments to NRI. Sec 195 (1) provides for deduction of TDS at rates in force on payment of interest or any other sum chargeable under the Act to Non-resident

The important points for consideration are as under: –

• First to determine, whether amount paid to NR, represent income which is chargeable under the Act as per sec 5(2).
• Second, where it is established that amount paid represent the income, then we need to assess whether same will fall under income deemed to accrue or arise in India as per sec 9 of income tax act.

Sec 5 (2) of Income Tax Act: Scope of Total Income

Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—

(a) is received or is deemed to be received in India in such year by or on behalf of such person; or

(b) accrues or arises or is deemed to accrue or arise to him in India during such year.

Explanation 1. —Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.

Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.

From the above sec, two important aspect is coming a) received or deemed to be received in India and b) accrues or deemed to accrue in India

• Received or deemed to be received in India: – Receipt means the first occasion when the recipient gets the money under his own control. If remittance is directly made to Non- resident in his account outside India, it can not be said to received or deemed to be received in India merely because it is accounted in the books of payer in India.
• Accrues or deemed to accrue in India: – Accrual means the right to receive. The place of accrual of income is the place where the right to receive income arises to non-resident. Generally, the right to receive payment to non-resident accrues or arises outside India. For dealing Income deemed to accrue in India, we will have to study Sec 9 of the Act.

Sec 9 (1) of Income Tax Act: Income deemed to accrue or arise in India

As per sec 9(1) of Income Tax Act, certain incomes are deemed to be accrue in India, even though they actually rendered from outside India or receive outside India. We will discuss only those income which is relevant for above case. As per sec 9(1) of the act, following income shall be deemed to accrue or arise in India if it is through or from: –

• Business connection in India as per sec 9(1)(i)(a)
• Salary income if it is earned in India as per sec 9(1)(ii)
• Fees for Technical Services as per sec 9(1)(vii)

Business connection in India as per sec 9(1)(i)(a) shall mean and include any business activities carried out through person if

• Such person is an agent working exclusive for such non-resident and
• Habitually conclude contracts or authority to conclude contract in India on behalf of non-resident or
• Habitually maintains stock of goods in India on behalf of non-resident or
• Habitually secure orders in India on behalf of Non-resident
• Significant economic presence of non-resident in India

From the point mentioned above, first we need to understand what is business connection in India. It consists of four elements: –

• Business
• Connection
• In
• India

All four elements have meaning and importance of its own. As per Sec. 2(3) of income tax act, 1961, business includes “any trade, commerce, manufacturing activity or any adventure or concern in the nature of trade, commerce and manufacture”. The definition does not specify profession. So, question may arise whether profession can be treated as business or not. The definition of ‘business’ is inclusive one and not being exhaustive. The word business has wider meaning and not restricted to definition mentioned in the Act. Any economic activity carried on for earning profits is said to be Business. If profession is carried out for earning profit, it may constitute Business. What is important is profit motive. Further, trade involves the transfer of goods and services from one person or entity to another in exchange of monetary considerations. Profession in another way is provision of services.

The Allahabad High Court in P. Stanwill & Co. Vs. CIT (1952) 22 ITR 316 (All) observed that the All professions are businesses, but all businesses are not professions. Further, as per circular 23 dated 23.07.1969 business connection includes professional connection. Hence, we can say business includes profession.

Now, comes to connection, it means an association or relation between two or more person. There has to be real and intimate relation between the persons involved. A single and stray case can not be regarded as business connection. The activity should be on systematic and continuous basis. So business connection is something more than mere doing business.

“In India” has wider connotation in the sense that non-resident has to represent his business in India through its representative (agent) which may be in different form and status like Liasoning office, Branch office etc.

Mere selling of goods & services to an Indian entity can not said to be doing business “in India” but is doing business “with India” since it is on principal to principal basis. So mere importing of goods directly from non-resident can not be treated as business connection due to the fact that it is on principal to principal basis and business with India but not in India.

what is necessary for business connection is that there should be a) an exclusive agent in India b) connection between non-resident (principal) and its representative (agent). c) business has to be carried out in India.

From the above it appears that business connection can be established if non-resident is doing business in India through its representative and not vice versa. So, an Indian company appointed any person outside India for doing any business/ project outside Indian can not fall under Business Connection in India.

Now, we will analyse each type of payment for TDS point of point:

• Reimbursement of Expenses to Non-Resident

The term “Reimbursement” has not been defined in either Income Tax Act or GST Act and hence its meaning has to be understood as in common parlance. A reimbursement is a mere repayment of what has been already spent. The payer of the reimbursement generally has an option to incur the cost on its own by making all the requisite arrangements. However, the reimbursement route is taken only as a mode of logistical convenience since the payee would be in a better position to undertake the arrangements.

Further, as per Income Tax Act, the term ‘income’ has been exhaustively defined to include various types of gains, profits, accretion, value addition, etc. In the absence of any profit-related element, a receipt cannot be generally classified as income. In this scenario, any reimbursement cannot be treated as income, and therefore, should not be subject to Withholding Tax (TDS).

Further, The Delhi bench of ITAT clarifies that if separate invoices are raised – one for service fees and the other for reimbursement of expenses, tax should not be deducted on reimbursement of expenses.

In a landmark judgement, the Supreme Court of India, in the case of GE India Technology Center P Ltd. vs CIT, held that the obligation to withhold tax should be limited to the appropriate proportion of such income chargeable to tax under the IT Act. According to the Court, one cannot state that the obligation to withhold tax arises the moment there is a remittance. If we were to accept such a contention, it would mean that income is said to arise or accrue in India on any payment. Such an interpretation would mean effacement of the expression “sum chargeable under the provisions of the Act’”.

Therefore, plain reimbursement to a non-resident is not his or her income chargeable under the IT Act, and consequently, should not attract TDS on foreign payments provisions.

• Documentation

The  following documentation is required to substantiate reimbursement of expenses and to avoid TDS on foreign payments in the arrangement or transaction

• Written Agreement between the foreign company (Agent) and the Indian company to facilitate reimbursement of expenses
• Invoices or Debit notes raised by the foreign company (Agent) on the Indian company for reimbursement of expenses
• Invoices or receipt or any other documents raised by the third parties towards reimbursable expense incurred by the foreign company (Agent)
• Reference number of written agreement has to be mentioned on the face of invoices or debit notes or any other correspondence.

 

• Professional and Technical Services including Commission:

As per sec 9(1)(vii)(b) of Income Tax Act, income by way of fees for technical services payable by a person who is a resident, except where the fees are payable in respect of services utilised in a business or profession carried on by such person outside India or for the purposes of making or earning any income from any source outside India then incomes shall be deemed to accrue or arise in India.

The Delhi High Court decision dated 27 May 2015, in the case of DIT v/s. Lufthansa Cargo India (ITA No. 95/2005) has held that the expenses incurred outside India in respect of services utilized for the purpose of making or earning any income from a source outside India is not subject to tax in India and so there is no requirement to withhold tax at source in India (TDS on foreign payments). The Delhi High Court held that the substitution of Explanation1 to section 9 does not affect the ‘source rule’ in section 9(1)(vii)(b) of the Income-tax Act, 1961 and the retrospective amendment makes no difference to the non-taxability of such income.

From the above it appears that though TDS on foreign payments is applicable on technical and professional fees, it is falling under exception clause & hence no TDS on foreign payments should be deducted.

Let’s understand this by an example:-

Description	Country	Condition for deemed income satisfied
Payment of Fees (X Ltd)	India	Yes
Receipt of Fees (Y Engineering)	Cameroon	Yes
Location of Project	Cameroon	No
Place of service utilisation	Cameroon	No

Since, all conditions have not been met; it is falling under exception of sec 9 (1)(vii)(b). Accordingly TDS on foreign payments is not applicable even on payment of Fees for Technical & Consultancy Services.

• Civil, erection & commissioning

As per explanation 2 of the sec 9 (1)(vii)(b), “fees for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head “Salaries”.]

From the above it appears that fees for technical services does not include consideration for any construction, assembly, and mining or like project undertaken by the recipient.  Hence, TDS on foreign payments is not applicable on Civil, erection & commissioning and like project, since it is falling under exception clause.

• Supply of goods

As per sec9(1)(i)(b) of Income Tax Act,  in the case of a non-resident, no income shall be deemed to accrue or arise in India to him through or from operations which are confined to the purchase of goods in India for the purpose of export. Hence, TDS on foreign payments is not applicable

Documentation for foreign remittance

As per rule 37BB of the Income Tax Rules, 1962, any person resident in India who is making a foreign remittance is required to to furnish the prescribed information to income tax authorities even though the said income is not chargeable to tax in India (TDS on foreign payments). However, there are few exceptions to the said rule.

Followings are the documents which needs to be taken care of before remitting foreign payments:

1. Outward Remittance Application – A2
2. Form 15CA- by Remitter
3. Form 15CB- certificate from Chartered Accountant

However, there is an exception wherein 15 CA & 15 CB is not required:-

• When remittance is made by an individual and it does not require prior approval of the RBI due to liberalized remittance Scheme;
• When remittance is covered under 33 specified list. For details click here

4. Contract/Agreement/Work Order copy between remitter & service provider
5. Invoice copy raised by service provider
6. a tax residency certificate must be obtained from the party
7. No PE Certificate from the foreign party

Concluding Remarks:

TDS on foreign payments compliance is always a matter of complexities. The pertinent questions that arise in such a matrix are whether such payments can be subjected to withholding tax or not as per section 195 of income tax act. The only answer is: the detailed analysis is required to be performed to each transaction to understand TDS on foreign payments before we initiate a payment. No TDS/ Wrong TDS on foreign payments may put any company at greater risk in later years when the assessment is done.