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Non Resident Taxation

Royalty vs. Fee for technical services vs. Business Profit

As per International tax rules for Non-Resident Taxation, specific income of Non-residents have been excluded from the business Income so as to give taxing rights to the source Countries in respect of excluded incomes. Business profits of the Non-residents is taxable in the source state only when such Non-residents are having fixed place of business in the source state and income earned is attributable to that fixed place of business. While the specific income like, interest, dividend, Royalty and fee for technical services (FTS) may be taxable in the source state based on the bilateral negotiations between two states based on their economic needs. The tax rate is also negotiated based on the gross income to simplify the process of taxation on such specific Incomes.

There is always a tug of war between the person in the source Country and the person in the Resident Country to determine the true Characterization of income in the hands of Non-resident due to different tax effect amongst the varied nature of Income. We in the blog discuss few tips how to optimize tax in international Transactions.

(A)     Domestic Tax provisions on the nature of Transactions proposed to be entered into and the probable tax effect thereon need to Analysis;

(B)     Existence of tax treaty between the two Countries should be the next step, of the persons who are proposed to enter into Transactions, if yes, need to deep drive into treaty provisions to find out suitable Article of the treaty which may applicable to the proposed Transaction.

(C)     Now the key matter is the drafting of Agreements between two parties. Obviously, the main consideration must be the actual services which are subject matter of agreement. But by changing few words and few phrases the tax effect may change completely or very specifically, the desired tax effect may be achieved by utilizing the variations between domestic tax laws and treaty provisions. This can be achieved in the following reasons:

    • Domestic tax laws in India do have comprehensive coverage of taxability of fee for technical services (FTS) while many Countries do not have FTS clause in tax treaties or some others have restricted scope of FTS in tax treaties. In this situation, the income may be covered under business profit and to be taxable in source state, the recipient must have permanent establishments in the source state and such income should be attributable to such permanent establishments;
    • Similarly, domestic tax provision in relation to taxability of Royalty in the hands on non-residents are quite comprehensive while tax treaties do have wide variation on the coverage of royalty e.g. Computer Software Royalty is especially included in the definition of Royalty in Section-9 (1)(vi) through explanation-4 in 2012 with retrospect effect from 1976 but the Apex Court in Engineering Analysis Case in 2021 set aside the retrospective effect of this explanation. While, very few tax treaties do have specific inclusion of Computer Software in Royalty definition there Computer Software Royalty is still not taxable in most of the treaty Countries in India.
    • Equipment Royalty is another important issue as many tax treaties with India do not have Equipment Royalty provision in tax treaties and thus not taxable under treaty.
    • There is a very thin difference between the scope of Royalty and provision of Services i.e. where the owner of IPR may provide services himself instead of just using the IPR may be covered under FTS and in the absence of FTS clause in Treaty will out of scope of taxation. e.g. consideration for an opinion given by Engineer, advocate or an accountant.
    • Similarly, the payments made by telecommunications net operator to another operator under roaming arrangements may not constitute equipment royalty as payment is not for the use, or right to use the equipment but rather for telecommunications services.

 

Even after implications of G-20/BEPS Inclusive Framework in International tax rules for Non-Resident Taxation, there are wide variations amongst the tax treaties and domestic laws of the various Countries which provides wide opportunities for tax payers to align their service level agreements (SLAs) for optimization of tax at Transaction level.

 

(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)

Please feel free to write on sanjay@dsrvindia.com or contact at: +91 9810116321

 

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