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APAC Tax Matters - July 2012 - India - EY - China

APAC Tax Matters - July 2012

India

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Special Bench (SB) rules on taxability of interest paid by an Indian branch to a head office of a foreign bank

In a recent ruling, the Special Bench (SB) of Mumbai Income Tax Appellate Tribunal (ITAT) held that interest paid by a branch office (BO) of the Taxpayer in India to its foreign head office (HO) is a deductible expenditure in computing the BO's income in India.

It further held that the interest received from the BO is not liable to tax in India in the hands of the HO, being a payment made to self and, hence, the BO would not be required to withhold tax on the interest while making payment to its HO.

Background and facts

The Taxpayer, a Japanese company, was engaged in banking business through BOs in India which constituted its permanent establishment (PE) in India in terms of the India-Japan Double Taxation Avoidance Agreement (DTAA).

The BO paid interest to the HO and various other overseas branches of the HO abroad in respect of the deposits placed/moneys lent by the HO to the BO and this was claimed as a deduction by the BO in computing its income in India.

No taxes were withheld on the interest paid, since it was a payment made to self. The Tax Authority denied the deduction on the grounds that there had been no withholding of tax.

SB's ruling

Under the Indian Tax Laws (ITL), the interest paid by a BO to its HO, being payment made to self, is not a deductible expense. However, the DTAA provides that for the purpose of computing profits attributable to the PE in India, the PE should be treated as a separate and distinct entity.

The DTAA further provides for disallowance of deduction of interest charged between different parts of the same enterprise. However, the same is not applicable to banking business and, hence, in the present case, the deduction is allowed.

Under the ITL, an HO and a BO are not two separate and independent entities which are assessed to tax separately in India.

The BO is part of the HO and its income is chargeable to tax in the hands of the HO, which alone is the person assessable to tax in India.

Hence, there would be no requirement for the BO to withhold tax on the interest payments made to its HO.

The deeming fiction, under the DTAA, of PE being a separate and distinct enterprise is applicable only for the purpose of determining profits attributable to the PE and the same cannot be extended and applied to tax the income of the HO.

Furthermore, in the present case, the moneys lent by HO to the BO represents the BO's liability and the interest receipts by the HO is not on account of any debt claim that can be taxable under the DTAA.



Comments

This favorable ruling may provide comfort to taxpayers for similar transactions made between foreign banks and their branch offices in India. Considering that it is a decision of a Special Bench, it would have an overriding effect on all other Tribunal Benches in the country.



International tax and anti-abuse provisions within Finance Bill, 2012

The Finance Bill, 2012 (FB 2012), that was introduced in the Indian Parliament as part of the budget proposals, contains far reaching international tax proposals for amending the Indian Tax Laws (ITL)

The key proposals are the taxation of offshore asset sale transactions, amendments to the definition of royalty, significant amendments to transfer pricing (TP) provisions to expand their scope, the introduction of an advance pricing agreement (APA) regime and the introduction of a General Anti-avoidance Rule (GAAR).

The key international tax provisions, anti-abuse and anti-tax evasion provisions proposed to be introduced by the FB 2012 are:

There has been keenly followed litigation in India on the interpretation of the source rule provision on the taxation of offshore asset sale transactions with the issue going to the Supreme Court of India (SC).

The SC earlier in the year held that the scope of this source rule should not be extended to tax the sale of assets located outside India having an indirect interest in certain assets in India.

The FB 2012 proposed certain clarifying amendments which appear to overturn the SC decision. These clarifications propose to bring to tax all transactions where the actual gain or income arises only in consequence of or is attributable to underlying assets in India.

Various expressions and terms such as the expression 'through' in the source rule, the term 'property' in the definition of 'capital asset' have been clarified to have a wider meaning. These amendments are proposed to apply retrospectively with effect from 1 April 1962 i.e., tax year 1961-62.

In addition, the FB 2012 proposes a validation clause for the demands raised in respect of the above issue on transfer of capital asset.

On account of this validation clause, any notice of demand sent or taxes levied prior to this clause coming into force shall be deemed to have been validly made and such notice shall not be called in to question the ground of any interpretation of the above source rule.

The clause would be valid irrespective of any favorable view taken by any judicial or other authority.

The FB 2012 proposes that consideration for the transfer of all or any right would include right 'for use' or right 'to use' computer software, including the granting of license to be taxable as royalty regardless of the medium through which the right is transferred.

Further, definition of 'royalty' would also include consideration paid for right, property or information, regardless of its location in India or its possession or use by the payer. Another clarification provided is that the term 'process' includes transmission through up-linking and amplification by satellite or cable.

The above amendments are proposed to apply retrospectively w.e.f. 1 June 1976.

The ITL empowers the Government of India (GoI) to issue notifications assigning meaning of certain terms used in the Double Taxation Avoidance Agreements (DTAAs), since they are not defined either in the DTAA or under the ITL.

The FB 2012 proposes that the meanings of the terms defined by such notifications would usually apply from the date on which such DTAAs, in which the terms have been used, would come into force.

The FB 2012 proposes that resident of a foreign country is required to obtain a Tax Residency Certificate (TRC) containing prescribed particulars of his being a resident of the foreign country in order to claim the benefits under the DTAA entered into by India.

However, though this is necessary, it may not be sufficient for availing DTAA benefits.

The FB 2012 proposes to introduce a scheme of APAs by empowering the tax administrative body in India to enter into an APA with any person undertaking an international transaction.

In addition, the ambit and scope of TP provisions is proposed to be widened under the proposals by expanding the definition of 'international transaction; to cover business restructuring or reorganization between associated enterprises.

A definition of the term 'intangible property' is proposed to be introduced.

The proposals also extend the applicability of TP provisions to cover specified domestic transactions.

GAAR proposal made in the FB 2012 seeks to provide wide powers to the Tax Authority in determining and taxing aggressive tax planning arrangements.

The GAAR provisions would have an overriding effect over tax treaties and, hence, the provisions under the ITL can be invoked even if they are not beneficial to the taxpayer.

These provisions provide that the Tax Authority may declare an arrangement entered into by a taxpayer as an 'impermissible avoidance arrangement' and, thereafter, determine the tax consequences of such declaration.

Even if a part of the arrangement is found to obtain a tax benefit, then, notwithstanding the fact that the main purpose of the whole arrangement is not to obtain a tax benefit, the arrangement shall be presumed to have been entered for the main purpose of obtaining a tax benefit.

FB 2012 stipulates that the burden of proof vests with the taxpayer.

The provisions of GAAR, as contained in the FB 2012, were applicable from tax year 2012-13 onwards. They have since been deferred by a year to apply from tax year 2013-2014 onwards.

It also contains specific provisions that the period of existence of arrangement shall not be taken into account while applying the 'lack of commercial substance' test.

The application of GAAR would need the confirmation of an approving panel, which comprises largely of senior level tax officials.

The benefit of a concession rate of 15% tax on gross basis, introduced by Finance Bill 2011, is now proposed to be extended to tax year 2012-13 as well.

The FB 2012 proposes that interest paid to a non-resident ("NR") in respect of ECBs made in foreign currency from a source outside India between 1 July 2012 and 1 July 2015 under an agreement approved by GoI would be taxable at 5% and the withholding rate on such payments is also pegged at 5%.

The FB 2012 proposes certain procedural amendments such as:

  • A NR, irrespective of its residence, place of business, business connection or business presence in India, is required to withhold taxes on payments made to another NR, if the same is chargeable to tax in India
  • Every resident taxpayer, having any asset located outside India, is to mandatorily furnish a return of income (ROI), irrespective of its income exceeds threshold limit or not.
  • The time limit for collection of information from foreign authorities in case of taxpayers having certain income or assets outside India is to be extended to one year.
  • The time limit for issue of notice for reopening an assessment in case of income escaping assessment in relation to income of any asset situated outside India is to be extended to 16 years.
  • The time limit for issue of notice, for the purpose of income escaped assessment, to a person who is treated as an agent of a NR is to be extended to six years.


Comments

The proposal to introduce APAs would be welcome by taxpayers who find themselves in the challenging position of documenting and defending TP issues.

The GAAR is sufficiently all-embracing to deter tax avoidance. However, there is always a danger of penalizing those who have genuine reasons for entering into a bona-fide transaction.

Hence, it is likely to increase taxpayer's uncertainty and, therefore, goes against the fundamental canon of a tax system. A criticism often leveled against GAAR is that it detracts from the rule of law by being vague or indeterminate.

It is unfortunate that the GoI has sought to resort to retrospective amendments on some fundamental tax principles relating to determination of source of income of NRs and characterization of income, especially on matters that have been decided by Courts in the taxpayers' favor.

 


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