The Hindu Business Line : No tax to sniff

THE myriad provisions in the tax law will apparently make it difficult for any taxpayer to get out of the clutches of the taxman if income is earned through transactions in India. Yet, quite often, one comes across cases where non-residents are able to get away from tax obligations in India by drafting agreements cleverly so as to escape the ambit of the law.

In respect of non-residents, Section 5 of the Income-Tax Act, 1961 defines the scope of total income and makes liable to taxation income which is received or deemed to be received in India or which accrues or arises or is deemed to accrue or arise in India. Quite often, liability for non-residents arises for incomes by way of royalties or fees for technical services (FTS). Section 9 takes care of this situation.

Unless the benefit of right, property or information is used for the purposes of a business carried on by non-residents outside India or for earning income from a source outside India, payments to non-residents by way of royalty or FTS will attract Indian tax.

Wherever there is a Double Tax Avoidance Agreement (DTAA), Section 90(2) enables non-residents to claim the benefits of the Act or the DTAA provision, whichever is more favourable. Under the Indo-US DTAA, royalties and fees for included services shall be deemed to arise in the state which is the payer.

Consider the following case. The American Trade and Development Agency (TDA) offered to fund through a grant the money required by Airports Authority of India (AAI), a public sector undertaking owned by the Government, for feasibilities study on air traffic management. AAI entered into an agreement with the TDA making it explicit that the specified grant of $450,600 shall not be used to pay any Indian tax or duty. The contractor, it was agreed, will have to be an American entity.

Innovative Solutions International Inc of Virginia was chosen as the contractor for carrying out the feasibility studies. On the contractor performing the feasibility study, AAI arranged that the grant be disbursed by the TDA directly to the contractor in four periodic instalments.

It was agreed that if any taxes were found payable in India by the contractor, the same would be borne by the applicant. The contractor would not have any permanent base in India nor would any office be set up here.

The contractor's experts may visit India briefly for a few days to seek inputs and feedback. Indian vendors will collect data and assist the contractor's personnel in discussions with the AAI. The TDA would directly disburse the grant of funds to the contractor and the AAI would have nothing to do with this.

On these facts, the question posed was whether the payment received by Innovative Solutions was liable to tax in India even though it happened to be a non-resident American company. AAI approached the Authority for Advance Ruling (AAR) in this regard.

The Authority examined the agreements and found that the work of preparation of feasibility reports was to be done only in the US. Innovative Solutions had some meetings with AAI officials.

The American company did not have any office or establishment in India. Therefore, no part of its income can be said to have been received or deemed to have been received or accrued/arisen in India under Section 5(2) of the Act.

In substance, the amount was not payable by AAI at all. AAI cannot even be termed as a conduit agency for passing the money, because the amount was never transferred to India to the full and exclusive control of AAI.

The American Government exercised full control over the grant of funds. For accounting purposes, the amount was transferred to the TDA for disbursement after the approval of the invoices by AAI. Under these circumstances, no income can be deemed to accrue or arise in India under Section 9(1)(vi) or Section 9(1)(vii).

The Authority also referred to the enabling provision under Section 90(2) under which the more favourable law can be invoked.

The Indo-American DTAA created no liability on Innovative Solutions under the domestic law. Even the DTAA does not impose any tax obligations because the payment was by the US Government and under Article 12 Para 7(a), royalties and fees for included services is deemed to arise in the US and subject to tax only in the US.

Consequently, the payment received by Innovative Solutions in the transactions under considerations was held not liable to Indian income-tax.

Quite an innovative way to avoid Indian income-tax.

(The author is a former chief commissioner of income-tax.)