"Death and taxes are inevitable. The way you face them makes you wiser of course."
The development of any economy compels a sovereign to garner taxes and the duty of every responsible citizen is to participate in such development activity through individual contributions. It is the desire of every economist to reprehend any greed shown by sovereign in the collection of taxes and to condemn every individual who wants to evade payment of taxes. If the wishes of the economists were to be horses, all of us would be in heaven. As you could see, the conflict between the taxpayer and the tax gatherer is a continuing one and the public debates and the criticisms generally act as the moderators. It is the general experience of nations that "the simpler the tax structure, greater is the degree of voluntary tax compliance.
In the arena of international commerce, the right to tax any person, transaction or the entity assumes importance as there are more tax gatherers than one. In appreciation of the long-term economic development of the respective states, the tax gatherers generally enters into some understanding through treaties and conventions to promote and regulate free interchange of commerce and business without sacrificing on public revenues. A convention exists between India and USA since December 18, 1990 for the avoidance of double taxation and the prevention of fiscal evasion between the countries with respect to taxes on income.
In view of the growing importance of Indo – US trade and commerce that impacts even the life of an individual, we propose to divide this presentation into three parts – (i) Knowledge management which covers consultancy and knowledge transfers which is the scope of this article, (ii) Business between the countries, and (iii) The impact of cross border taxation on others. In our subsequent two articles we intend covering the rest.
In the area of cross border taxation, the residence of the individual, the exact nature of contractual relationships, the power to tax by the contracting states and the determination of the relief arising out of the treaty, are the factors to be considered.
Concept Of Residence:
- For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, provided however, that
- this term does not include any person who is liable to tax in that State in respect only of income from sources in that State ; and
- In the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries.
- Where by reason of the provisions of paragraph 1, an individual is a resident of both Contracting States, then his status shall be determined as follows:
- He shall be deemed to be a resident of the State in which he has a permanent home available to him ; if he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (centre of vital interests) ;
- if the State in which he has his centre of vital interests cannot be determined, or if he does not have a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode ;
- if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a national ;
- if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
- Where, by reason of paragraph 1, a company is a resident of both Contracting States, such company shall be considered to be outside the scope of this Convention except for purposes of paragraph 2 of article 10 (Dividends), article 26 (Non-discrimination), article 27 (Mutual agreement procedure), article 28 (Exchange of information and administrative assistance) and article 30 (Entry into force).
- Where, by reason of the provisions of paragraph 1, a person other than an individual or a company is a resident of both Contracting States, the competent authorities of the Contracting States shall settle the question by mutual agreement and determine the mode of application of the Convention to such person.
Royalties And Fees For Included Services
Royalties and fees for included services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State to the extent of 15% of the gross amount of the royalties or 20% as the case may be in the first five years and scaled down to 15% during the subsequent years. Where the fees for included services are ancillary and subsidiary to the enjoyment of the property for which the payment is received, the payment would be determined at 10% for the included services.
The fees for included services does not include amounts paid:
- for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a) ;
- for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic ;
- for teaching in or by educational institutions ;
- for services for the personal use of the individual or individuals making the payment ; or
- to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in article 15 (Independent Personal Services).
Independent Personal Services
- Income derived by a person who is an individual or firm of individuals (other than a company) who is a resident of a Contracting State from the performance in the other Contracting State of professional services or other independent activities of a similar character shall be taxable only in the first-mentioned State except in the following circumstances when such income may also be taxed in the other Contracting State:
- if such person has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities, in that case, only so much of the income as is attributable to that fixed base may be taxed in that other State ; or
- if the person's stay in the other Contracting State is for a period or periods amounting to or exceeding in the aggregate 90 days in the relevant taxable year.
- The term "professional services" includes independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants.
Relief From Double Taxation
- In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income :
- the income-tax paid to India by or on behalf of such citizen or resident ; and
- in the case of a United States company owning at least 10 per cent. of the voting stock of a company which is a resident of India and from which the United States company receives dividends, the income-tax paid to India by or on behalf of the distributing company with respect to the profits out of which the dividends are paid.
For the purposes of this paragraph, the taxes referred to in paragraphs 1(b) and 2 of article 2 (Taxes Covered) shall be considered as income taxes.
- Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in the United States, India shall allow as a deduction from the tax on the income of that resident an amount equal to the income-tax paid in the United States, whether directly or by deduction. Such deduction shall not, however, exceed that part of the income-tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States
- Further, where such resident is a company by which a surtax is payable in India, the deduction in respect of income-tax paid in the United States shall be allowed in the first instance from income-tax payable by the company in India and as to the balance, if any, from surtax payable by it in India ;
- For the purposes of allowing relief from double taxation pursuant to this article, income shall be deemed to arise as follows :
- income derived by a resident of a Contracting State which may be taxed in the other Contracting State in accordance with this Convention (other than solely by reason of citizenship in accordance with paragraph 3 of article 1 (General Scope) shall be deemed to arise in that other State ;
- income derived by a resident of a Contracting State which may not be taxed in the other Contracting State in accordance with the Convention shall be deemed to arise in the first-mentioned State.
Notwithstanding the preceding sentence, the determination of the source of income for purposes of this article shall be subject to such source rules in the domestic laws of the Contracting States as apply for the purpose of limiting the foreign tax credit. The preceding sentence shall not apply with respect to income dealt with in article 12 (Royalties and Fees for Included Services). The rules of this paragraph shall not apply in determining credits against United States tax for foreign taxes other than the taxes referred to in paragraphs 1(b) and 2 of article 2 (Taxes Covered).
The Impact On Consultancy Profession And Knowledge Transfers:
It is proposed to explain the impact of the treaty on the consultancy profession by way of few illustrations for better understanding of the subject. This list is only illustrative and not exhaustive.
A U. S. manufacturer grants rights to an Indian company to use manufacturing processes and agrees to provide certain consultancy services to the Indian company such as provision of information and advice on sources of supply for materials needed in the manufacturing process, and on the development of sales and service literature, for the manufactured product. The payments allocable to such services do not form a substantial part of the total consideration payable under the contractual arrangement. The services described in this example are ancillary and subsidiary to the use of a manufacturing process and the fees for these services are considered fees for included services.
The U. S. company enters into a contract with the Indian company under which the former will clean the latter's machinery on a regular basis. As part of the arrangement, the U. S. company leases to the Indian company a piece of equipment which allows the Indian company to measure the level of bacterial deposits on its machinery in order for it to know when cleaning is required.
The provision of cleaning services by the U. S. company and the rental of the monitoring equipment are related to each other. However, the predominant purpose of the arrangement is the provision of cleaning services and the cleaning services are not "included services", as they are not "ancillary and subsidiary" to the rental of the monitoring equipment.
An Indian builder contracts with the U. S. company to send experts to India to show engineers in the Indian company how to produce the extra-strong wallboard using their expertise and also rents a plant from the US company. The U. S. contractors work with the technicians in the Indian firm for a few months. The payments would be fees for included services as they are of a technical or consultancy nature. The services made available to the Indian company are technical knowledge, skill, and processes.
An Indian builder hires the U. S. company to produce wallboard at that plant for a fee and provides the raw materials and the U. S. manufacturer fabricates the wallboard in its plant, using advanced technology. The fees would not be for included services. Although the U. S. company is clearly performing a technical service, no technical knowledge, skill, etc., are made available to the Indian company, nor is there any development and transfer of a technical plan or design. The U. S. company is merely performing a contract manufacturing service.
An Indian firm owns inventory control software for use in its chain of retail outlets throughout India. It expands its sales operation by employing a team of traveling salesmen to travel around the countryside selling the company's wares. The company wants to modify its software to permit the salesmen to assess the company's central computers for information on what products are available in inventory and when they can be delivered. The Indian firm hires a U. S. computer programming firm to modify its software for this purpose. The fees are for included services as the U. S. company clearly, performs a technical service for the Indian company, and it transfers to the Indian company the technical plan (i.e., the computer program) which it has developed.
An Indian vegetable oil manufacturing company wants to produce cholesterol-free oil from a plant which produces oil normally containing cholesterol and contracts with the U. S. company to modify the formulas which it uses so as to, eliminate the cholesterol, and to train the employees of the Indian company in applying the new formulas. The fees are for included services as the technical knowledge is made available to the Indian company.
The Indian vegetable oil manufacturing firm has mastered the science of producing cholesterol-free oil and wishes to market the product worldwide and hires an American marketing consulting firm to do a computer simulation of the world market for such oil and to advise it on marketing strategies. The fees would not be for included services as the American company is merely providing a consultancy service which involves the use of substantial technical skill and expertise and there is only transfer of commercial information. The fact that technical skills were required by the performer of the service in order to perform the commercial information service does not make the service a technical service.
An Indian company purchases a computer from a U. S. computer manufacturer which inter alia includes the setting up the computer and installing the operating system including the updates for a period of 10 years and to train the Indian personnel. The fees for installation assistance and initial training, therefore, are not fees for included services, since these services are not the predominant purpose of the arrangement.
An Indian hospital purchases an X-ray machine from a U. S. manufacturer and the manufacturer agrees to install the machine, to perform an initial inspection of the machine in India, to train hospital staff in the use of the machine, and to service the machine periodically during the usual warranty period.
The initial installation, inspection, and training services in India and the periodic service during the warranty period are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the X-ray machine because the usefulness of the machine to the hospital depends on this service, the manufacturer has full responsibility during this period, and the cost of the services is a relatively minor component of the contract. Therefore these fees are not fees for included services. Neither the post-warranty period inspection and repair services, nor the advisory and training services relating to new developments are "inextricably and essentially linked" to the initial purchase of the X-ray machine and fees for these services may be treated as fees for included services.
An Indian automobile manufacturer decides to expand into the manufacture of helicopters and deputes a group of engineers from its design staff to a course of study conducted by the Massachusetts Institute of Technology (MIT) for two years to study aeronautical engineering. The Indian firm pays tuition fees to MIT on behalf of the firm's employees and this tuition fee is clearly intended to acquire a technical service for the firm. However, the fee paid is for teaching by an educational institution and is therefore not an included service.
In the above example, if the automobile manufacturer approaches an Indian university about establishing a course of study in aeronautical engineering and the university contracts with a U. S. helicopter manufacturer to send an engineer to be a visiting professor of aeronautical engineering on its faculty for a year, the fees paid are for teaching in an educational institution and they are not fees for included services.
An Indian wishes to install a computerized system in his home to control lighting, heating and air conditioning, a stereo sound system and a burglar and fire alarm system and hires an American electrical engineering firm to design the necessary wiring system, adapt standard software, and provide instructions for installations. The fees paid to the American firm by the Indian individual, is not fees for included services as they are intended for the personal use.
From the above examples, it is clear that the classification of the nature of the relationships assumes importance and therefore it would be prudent to seek proper professional advice prior to sentering into contracts.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.