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When the going gets tough for foreign tax payers
September, 06th 2008

Globalisation has brought in not just newer methods of conducting business but also controversies, in the taxation space. Of late, one has seen a spurt in the number of taxation-related decisions by various tribunals and courts.

A prominent expert in the field of international taxation, Mr S. P. Singh, Senior Director with Deloitte Haskins & Sells, India has been closely associated with the development of transfer pricing and international taxation in India.

In this email interview with Business Line, Mr Singh raises a note of caution for foreign companies entering into a contractual arrangement relating to high-investment turnkey projects and says that high incidence of tax may not make these projects economically viable. He is of the view that unexpected tax provisions, which are not in line with the internationally accepted norms, make it tough for the foreign tax payers.

Mr Singh also brings to light issues relating to capital gains arising from transfer of foreign enterprises trademarks registered in India and a recent ruling clarifying this.

Excerpts from the interview:

Is there clarity on the taxability of bandwidth charges, a major expense item for IT companies in India?

To facilitate transmission of huge amount of data and voice, dedicated bandwidth is being provided by several companies.

A question recently came before the Authority for Advance Ruling (AAR) in the case of Dell International Services India Pvt. Ltd. (AAR No. 735 of 2006) , and before Delhi High Court in the case of Estel Communication P. Ltd. (ITA 527/2007), whether a payment against this facility is liable to taxation in India or not, particularly when the service provider is outside India.

While the Revenue authorities were of the view that this is taxable either as royalty or fees for technical services or business income, the AAR, in their decision dated July 18, 2008, held that such payment cannot be characterised as royalty or fees for technical services. However, in the absence of sufficient information, they did not decide whether the service provider constitutes a permanent establishment in India or not.

In the case of Estel, the question before High Court was whether the services provided can be said to be technical services or not. In their order dated March 7, 2008, the court held that the Internet bandwidth does not amount to providing technical services.

These two decisions would have far-reaching implications as most of the outsourced units in India depend on such services for their smooth functioning.

In the past, telecom service providers have also been under the microscope of not only the Income Tax authorities but also those under other taxes. A question had come before the Supreme Court in the case of BSNL vs Union of India [Writ Petition (Civil) 183 of 2003] whether the facility provided by mobile phone connections amounted to sale or service. In the landmark ruling dated March 2, 2006, the Court held that there was no delivery of goods and the subscriber to a telephone service could not have intended to purchase or obtain any right to use electro-magnetic waves.

What are the tax implications of foreign companies undertaking turnkey projects in India?

There has been a substantial rise in the number of large turnkey projects, which require a lot of investment and variety of technical expertise. It is not possible for any one company whether domestic or foreign to provide all of them. Consequently, companies partner with a PSU to carry out the work. The question is whether this amounts to creation of an Association of Persons (AOP), in which case there would be heavy tax incidence (taxable on a net basis at 41 per cent).

This was the issue before the AAR in the case of Geoconsult ST GmbH. The applicant (Geoconsult) formed a JV with two Indian companies to provide consultancy services to a PSU of Himachal Pradesh. It was provided that JV parties were jointly and severally liable for the satisfactory execution and completion of the assignment. Share of the fee of each JV partner was predefined. Based on these facts the AAR held that these companies constitute an AOP.

Interestingly in this case, though initially the question posed before the AAR by the Applicant was that its share of income from the contact is taxable as FTS (fees for technical services) under the India-Austria treaty and hence taxable on gross basis at

10 per cent, it ended with a tax liability on net basis at 41 per cent.

Given this scenario, any company entering into a contractual arrangement of the nature discussed above needs to be careful as the high incidence of tax may not make the project economically viable.

What is the current scenario on the issue of attribution of profits to a Permanent Establishment (PE) in India and the taxability of foreign taxpayer?

Interpretation of various tax provisions always poses a dilemma, more so in the case of foreign tax payers who are new entrants to the Indian shores and are not much aware about the Indian tax laws. Unexpected tax provisions, which are not in line with the internationally accepted norms, make the going all the more tough for the foreign taxpayers.

For example, it is generally accepted internationally that if a non resident carries on its business through a PE, then only so much profit may be taxed in that country which is attributable to the business activities being carried on by that PE.

The controversy lies in the attribution of profits, wherein the taxman is always eager to attribute as much profits as possible to the operations of the PE. This controversy came to the forefront after the decision of the Mumbai Tribunal decision in the case of SET Satellite (Singapore) Pte Ltd. wherein it was decided that the foreign taxpayers liability does not extinguish even if the PE is remunerated at an arms length price (ALP). It was ruled that the foreign company is additionally taxable in India on the basis of Functions performed, Assets employed and Risks taken (FAR analysis).

The Supreme Court had also pronounced a path breaking decision in the case of Morgan Stanley & Co. Inc, where it was emphasised that determination of income of a PE would depend on proper functional analysis. Given this, it is possible that a foreign company may not have any tax liability in India if the Indian PE was remunerated at ALP. Based on this decision, Mumbai High Court recently reversed the earlier mentioned decision of Mumbai Tribunal in the case of SET Satellite.

It is relevant to point out here that the approach suggested by the Organisation for Economic Cooperation and Development (OECD) is totally different from that of the Mumbai High Court.

Given the conflicting approaches and the court decisions, it is important that the Government takes steps to settle the issue taking into account the views of the courts in India and internationally accepted norms.

What is your view on the tax Departments claim on capital gains arising from transfer of foreign enterprises trademarks registered in India?

The capital gain arising from transfer of trademarks registered in India has always been a bone of contention between taxpayers and the Department. The basic issue is whether the capital gains on intangibles are taxable on the basis of the situs or the residential status of the taxpayer. A related question is where does an intangible arise where the IPR holder is located or where the business is carried on.

Trademarks may be created either by publicity and advertisements or by continuous R&D. The issue is if both of these should be taxed as significant business carried out here or if there should be a difference in treatment for the two types of trademark.

These issues have been discussed in the recent ruling by the AAR in the case of Fosters Australia Limited. The AAR ruled that the registration of trademark has no bearing on the ownership. It has been observed that the commercial exploitation of the trademarks and brand, aided by the marketing and advertising efforts, would result in creation of valuable intangible asset in the place of business, which happens to be India in this case.

It is immaterial that the trademarks and names originated in another country and were initially registered there. However, the AAR is of the view that intangibles which involve R&D would be located in the place where such activities are carried out.

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