Last weeks ruling by the Mumbai income- tax tribunal in a case pertaining to SET India Pvt will help income-tax authorities collect as much as Rs 5,000 crore since the decision will have a bearing on all satellite companies, several BPOs and shipping companies operating in India.
According to the ruling, the entire operation of a foreign company in India is liable to be taxed even if the company makes an arms-length payment to its agent. For example, a US-based entity X contracts its agent Y in India to make a software. Y develops the software at the cost of Rs 80,000 and sells it to X at Rs 1,00,000, making a profit of Rs 20,000. Y, in turn, sells the software in the US at Rs 10 lakh, making a profit of Rs 9 lakh.
The question here is what would be the taxable income in India. The prevalent thinking in India is in favour of taxing the profit of Y, i.e, Rs 20,000. The view here is that payment of an `arms-length remuneration by a foreign enterprise to its dependent agent (in this case Rs 1,00,000 given by X to Y) extinguishes the tax liability of foreign enterprise in India.
However, the ITATs order reverses the trend. Its categorical that the whole profit of X arising from its operation in India, in this case Rs 9 lakh can be taxed in India. The Organisation for Economic Development and Co-operation (OECD) also has a similar view on such issues.
The Australian Tax Office, too, follows the same approach to tax income of non-residents. All these tax bodies think mere payment of an `arms-length price to a dependent agent does not necessarily extinguish the tax liability of the non-resident in the host country.
Following this order, the Income-Tax Department can make a tax claim amounting to over Rs 80 crore on SET Satellite Singapore for the assessment years 1999-2000 to 2005-06. Similar tax demand can be raised on other satellite channels, BPO firms and shipping companies.
The order will effectively put an end to the practise by foreign firms of avoiding tax in India by setting up a company in another country with which India has a tax avoidance treaty. In such a structure, the earnings are shown in the name of the offshore company. The order, reaffirming the income-tax demand of Rs 13 crore, was given out by ITAT last week on an appeal filed by the I-T department in the case of SET Satellite (Singapore).
The company had said that tax cannot be levied on income generated in India through selling airtime and advertisement revenue because the purchase and sale of airtime are affected in Singapore. Besides, an arms-length price was paid to the companys Indian agent, SET India. It said the money paid to SET India is the only income that can be taxed in India.
The ITAT bench, comprising Pramod Kumar and Madhavi Devi, rejected the contention. It said payment of arms-length remuneration to the agent by a foreign company is its expenditure, and the taxability of such expenditure in the hands of the recipient cannot extinguish the taxability of foreign company paying it.
In coming to this conclusion, ITAT has disagreed with the AAR ruling in the case of Morgan Stanely, which was in favour of the taxpayer. ITAT has held that irrespective of whether one carries on the business directly or through the dependent agent, the profit will continue to be taxed in the source country.