Co-written by Mr Raghavachari S Nambi
The developments in the legal domain in India have ignited the interests in respect of taxation of e-commerce transactions. This coupled with the slow down of the economy world over has forced the domestic companies as well as the foreign companies to pay more attention to the tax treaties and examine the tax related issues in respect of cross border transactions. In this article, we propose to dwell upon the salient features of the Indo-US tax treaty convention as the trade between India and USA is gaining more currency.
From the income tax perspective, a non-resident assessee has an option to be governed either by the provisions of the domestic tax laws or the Double Taxation Avoidance Agreement (DTAA), whichever is more beneficial. This position of law is well established and leaves no room for ambiguity or mistake.
According to the Indo-US 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 residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature, provided however, that the 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 an individual is a resident of both Contracting States his status shall be determined based on his residence or where he has permanent home in both the states, his status shall be determined based on the closeness of his economic relations (Centre of vital interests). In case his status cannot be decided based on the above mode, he shall be deemed to be a resident of that state in which he has a habitual abode. Where he has a habitual abode in both the states or in neither of them, his residence will be determined based on his citizenship. In case where the concerned person enjoys dual citizenship, the contracting states shall settle the question by mutual agreement.
The concept of residence assumes greater significance in the taxability of cross border transactions and it is therefore necessary to understand the semantics behind the term "Permanent Establishment (PE)." For the purposes of this convention, PE means a fixed place of business through which the business of an enterprise is wholly or partly carried on. The term "permanent establishment" includes place of management, branch, office, factory, workshop, mine, oil or gas well, quarry or any installation or structure used for the exploration or exploitation of natural resources for a period of more than 120 days in any twelve-month period, warehouse, farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on, sales outlet, building site or construction, installation or assembly project or supervisory activities for a period of more than 120 days in any twelve-month period, the furnishing of services, other than included services as defined in the subsequent paragraphs (royalties and fees for included services), within a Contracting State by an enterprise through employees or other personnel if such activities exceed 90 days duration within any twelve-month period or the services are performed for a related enterprise.
However PE will not include use of facilities for storage, display, or occasional delivery of goods or merchandise, maintenance of a stock of goods or merchandise, maintenance of a stock of goods or merchandise for processing by another enterprise, maintenance of a fixed place of business for purchasing goods or merchandise or of collecting information or the maintenance of a fixed place of business for advertising, supply of information, scientific research or for other activities which have a preparatory or auxiliary character for the enterprise.
Where a person merely acts as an agent of an independent status on behalf of an enterprise located in the other Contracting State, the enterprise shall be deemed to have a PE in the first-mentioned State, if the agent habitually enjoys the authority to conclude contracts on behalf of the enterprise, unless his activities are limited to those mentioned in the above paragraph or he has no such authority but habitually maintains in the first-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise and some additional activities conducted in that State on behalf of the enterprise have contributed to the sale of the goods or merchandise or where he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise.
An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's-length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph.
The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.
The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a PE situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that PE; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that PE; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that PE. Where there is a conflict regarding the definition of a term between the DTAA and the local tax laws, the option of the assessee shall prevail. In the absence of a definition under the tax treaty, the local laws shall be followed.
Where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that PE the profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly at arm's length with the enterprise of which it is a PE and other enterprises controlling, controlled by or subject to the same common control as that enterprise. In any case where the correct amount of profits attributable to a PE is incapable of determination or the determination thereof presents exceptional difficulties, the profits attributable to the PE may be estimated on a reasonable basis. The estimate adopted shall, however, be such that the result shall be in accordance with the principles contained in the tax treaty.
In the determination of the profits of a PE, there shall be allowed as deductions expenses which are incurred for the purposes of the business of the PE, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the PE), whether incurred in the State in which the PE is situated or elsewhere, in accordance with the provisions of and subject to the limitations of the taxation laws of that State. However, no such deduction shall be allowed in respect of amounts, if any, paid (otherwise than towards reimbursement of actual expenses) by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of banking enterprises, by way of interest on moneys lent to the PE. Likewise, no account shall be taken, in the determination of the profits of a PE, for amounts charged (otherwise than toward reimbursement of actual expenses), by the PE to the head office of the enterprise or any of its other offices, by way of royalties, fees or other similar payments in return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices.
No profits shall be attributed to a PE by reason of the mere purchase by that PE of goods or merchandise for the enterprise.
The profits to be attributed to the PE shall include only the profits derived from the assets and activities of the PE and shall be determined consistently unless there is good and sufficient reason to the contrary.
Profit From Shipping And Air Transport:
In the wake of the ongoing war against terrorism, the need for avoidance of multiple-taxation assumes greater significance and this concern has a more direct impact on the shipping and air transport industry. Profits derived by an enterprise of a Contracting State from the operation by that enterprise of ships or aircraft in international traffic should be taxable only in that State. The profits derived by an enterprise from the transportation by sea or air respectively of passengers, mail, livestock or goods carried on by the owners or lessees or charterers of ships or aircraft includes the sale of tickets or other activity directly connected with such transportation and the rental of ships or aircraft incidental to any activity directly connected with such transportation. The profits of such an enterprise shall be taxable only in the contracting state. This proposition applies to profits from participation in a pool, a joint business, or an international operating agency. The interest on funds connected with the operation of ships or aircraft in international traffic shall be regarded as profits derived from the operation of such ships or aircraft only. The profits derived by an enterprise from the alienation of ships, aircraft or containers owned and operated by the enterprise in a contracting state, shall be taxed by that State only.
Where an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State or the same persons participate directly or indirectly in the management, control, or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which, but for those conditions would have accrued to one of the enterprises, but by reason of those conditions have not so accrued, may be included in the profits of that enterprise and taxed accordingly.
Where a Contracting State includes in the profits of an enterprise of that State, and taxes accordingly, profits on which an enterprise of the other Contracting State has been charged to tax in that other State, and the profits so included are profits which would have accrued to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the various provisions of the Indo-US Convention and the competent authorities of the Contracting States shall, if necessary, consult each other.
Limitation On Benefits:
A person (other than an individual) which is a resident of a Contracting State and derives income from the other Contracting State shall be entitled under this Convention to relief from taxation in that other Contracting State only if:
More than 60 per cent. of the beneficial interest in such person (or in the case of a company, more than 50 per cent. of the number of shares of each class of the company's shares) is owned, directly or indirectly, by one or more individual residents of one of the Contracting States, one of the Contracting States or its political sub-divisions or local authorities, or other individuals subject to tax in either Contracting State on their worldwide incomes, or citizens of the United States; and
1. The income of such person is not used in substantial part, directly or indirectly, to meet liabilities (including liabilities for interest or royalties) to persons who are not residents of one of the Contracting States, one of the Contracting States or its political sub-divisions or local authorities, or citizens of the United States.
2. The above provisions shall not apply if the income derived from the other Contracting State is derived in connection with, or is incidental to, the active conduct by such person of a trade or business in the first-mentioned State (other than the business of making or managing investments, unless these activities are banking or insurance activities carried on by a bank or insurance company).
3. The above provisions shall not apply if the person deriving the income is a company which is a resident of a Contracting State in whose principal class of shares there is substantial and regular trading on a recognized stock exchange. For purposes of the preceding sentence, the terms "recognised stock exchange" means:
In the case of the United States, the NASDAQ System owned by the National Association of Securities Dealers, Inc. and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Act of 1934;
In the case of India, any stock exchange which is recognized by the Central Government under the Securities Contract Regulation Act, 1956; and
Any other stock exchange agreed upon by the competent authorities of the Contracting States.
4. A person who is not entitled to any benefits according to the above paragraphs may, nevertheless, be granted the benefits of the Convention if the competent authority of the State in which the income in question arises so determines.
Relief From Double Taxation:
In accordance with the provisions, 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.
(a) 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 the Indo-US convention, 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 the Convention (other than solely by reason of citizenship), 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 the convention 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. However the Royalties and fees for included services are to be excluded.
In the ever-escalating revenue needs of developing and under-developed economies, the greed for imposing multiple-taxation always grows. Normally objectivity in taxation of cross border transactions is brought in due to the good efforts of the various international agencies such as OECD, International Chambers of Commerce and Manufacturers’ associations. The more the tax harmonisation measures taken by a state, the more it enjoys the benefits of international trade and commerce. The efforts never cease. In our next and concluding article under this series, we propose to deal with income of certain individuals in international trade and commerce.
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