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Characterization of Foreign Remittances

Characterization of Foreign Remittances – Key for Withholding Tax under Section -195 of the Income Tax Act

Setting Context

Section-9 of the Income Tax -Act plays a super important role in determining taxability of Non-resident in India. Accordingly, certain income of the non-residents shall be deemed as accrue or arise in India based on some nexus like business connection for business Income, rendering of services for Salary income, location of the assets for capital gains, place of incorporation of company for dividend income and source of income for interest, royalty and fee for technical services irrespective of the residence, place of business and rendering of such services. In this hyper digital age, it is possible for regulator to get 360 degree view of all foreign remittances form multi-fold angles and trace the default almost instantaneously. Therefore, approach in compliance required to study relevant documentation/information to determine proper characterization of Foreign Remittances and basis for forming opinion either based on law or decided court cases more specifically from most appropriate Court jurisdictions.

As taxability and rate of tax will depend on proper Characterization of Foreign Remittances, therefore this is the first STEP for complying withholding tax obligation on the payer of foreign remittances. If one do the first step correctly, more than half work is already done. Let us find out key consideration to be taken into account for winning the first STEP:

  • Awareness about the need of proper characterization of Foreign Remittances:

As discussed above, the taxability and rate of tax always depend on proper Characterization of Foreign Remittances in the hands of non-residents, because as per international understanding on tax matters, the business profits are taxable ONLY if the non-resident is having fixed place of business in India. But all the developing Countries would like to tax the income of the non-residents source in their countries and therefore, have carved out certain nature of Income of the non-residents like salaries, capital gain, dividend, interest, royalty and fee for technical services which will be taxable even the absence of residence, fixed place of business and permanent establishments of the non-resident in source Country.

  • Complete Awareness about the meaning of key terms as used in determining taxability and tax rate both under Income Tax Act and DTAAs:

One should know clearly all key terms and expressions as used under domestic tax laws and DTAAs to correctly determine the taxability and rate of tax in the hands of non-residents and withholding tax obligations of foreign remittances in the hands of payer under Section-195 of the Indian Income Tax Act read the relevant tax treaty. Most of the key terms are not defined neither in domestic law nor in DTAAs e.g. the terms Managerial, Technical and Consultancy services to define fee for technical services. Guidance may be taken from plethora of judgements from Tribunals, High Courts and Supreme Courts.

  • Analysis of all relevant documentation/information like Agreements, Invoice copy, email communication, nature of business of both payer or receiver of foreign remittance:

Having talk about the need and terminology used in proper Characterization of Foreign Remittances in the hands of non-residents, here are some tips to use documentation/information like Agreements, Invoice copy and email communication between payer -and receiver of foreign remittances. We need to bifurcate the transactions involving Foreign Remittances so as to appropriately fit into the Characterization and source of income provided in domestic tax laws and DTAAs. In some cases, we need to deep drive into business processes of the recipient and provides of services to know exactly the usage of services to determine correct Characterization of Foreign Remittances.

Concluding Remark:

The actual accrual of Income in the hands of non-residents is distinct and separate from deemed accrual. The accrual is based on the general principles of law while deemed accrual is tested against the deeming provision of Section-9 of the Income Tax Act. The provision of DTAAs prevail over Section-9 of the Income Tax Act, therefore interpretation of each term must be used within the true spirits of domestic law read with tax treaties wherever applicable in Characterization of Foreign Remittances-Key of Section-195.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

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