The Hindu Business Line : The price of `fee' ill-defined

CORPORATE houses, in general, are of the view that payments made to non-residents abroad for consultancy work done abroad will not attract Indian income-tax. Quite often, collaboration agreements are entered into with foreign participants abroad in the hope that payments made will be tax-exempt in India. In two recent decisions, the Authority for Advance Ruling (AAR) has shown this notion to be misconceived.

In the first case (278 ITR 97 AAR), Wallace Pharmaceuticals (P) Ltd entered into an agreement with the Penser Group in March 2004 to expand its business. This involved identifying pharmaceutical and biotech companies in the US and elsewhere to market Wallace's products and convince foreign entities to enter the Indian market. The services also included telephone time, on-site consulting at Wallace or elsewhere, preparation of documents, and so on. Penser utilised the services of an advocate and paid him $30,000 which was reimbursed by Wallace. American law does not recognise tax deduction at source (TDS) in India. The services were rendered outside India and the question about applicability of Indian tax to the payments to be made to Penser was referred to the AAR. The AAR read Sections 9 and 5 of the Indian Income-Tax Act, 1961. It pointed out that where fees for technical services are payable by a resident of India, it will be deemed as income arising in India within the meaning of Section 9(1) irrespective of whether the recipient of such income is a resident or a non-resident of India.

According to the AAR, consultancy services provided by Penser were utilised in India by Wallace. Sales were effected by Wallace in India with customers outside the country as well.

As the consultancy fee payable was not in connection with a business or profession carried on by Wallace outside India for the purposes of making or earning any income from any source outside India, such fee would be the deemed income of Penser in India.

The commission of 10 per cent to Penser on orders procured by it would also be deemed income for Penser in India. There was no specific mention in the agreement about reimbursement of advocate fee, but as it was part of consultancy services it would also suffer TDS under Section 195.

The same views were reiterated by the AAR in the South West Mining Ltd (278 ITR 233) case. The Central Board of Direct Taxes (CBDT) had laid down in Circular No 23 of 1969 that where the non-resident agent operated outside India, no part of the income can be said to arise in India and, therefore, Section 195 was not attracted.

The AAR clarified that the said circular related to income accruing or arising through or from business connection in India.

As regards the rate of tax to be applied, the AAR clarified that either the rate prescribed under the Finance Act, 2005 or under the relevant article of the Double Taxation Avoidance Agreement (DTAA) would apply, whichever was more beneficial.

Fee for technical service (FTS) should be precisely defined; the current definition under Section 9 can be interpreted in two ways. Also, there should be a uniform procedure with regard to TDS both in the US and in India and conflict of jurisdiction should be avoided. After all, that is the very purpose of entering into DTAAs.

The latest Finance Act has removed the distinction between royalty and FTS as far as rate of tax goes. Article 12 of the Agreement with Canada was considered by the AAR in the South West case.

The Agreement prescribes 20 per cent tax rate in the first five years and 15 per cent for subsequent years. The newly introduced sub-clause (BB) of Section 115A of the I-T Act imposes a beneficial 10 per cent rate for FTS received in pursuance of an agreement made on or after June 1, 2005. The same rate applies for royalty too.

Also, the old Circular No 23 of July 23, 1969, should be suitably modified in the light of judicial pronouncements.

The Supreme Court declined to take note of the circular in the Right Society Ltd (106 ITR 11) case on the grounds that the circular contemplated a situation quite different from that envisaged under Section 9.

(The author is a former Chief Commissioner of Income-Tax.)

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