Reimbursement of Expenses – Withholding Tax
Taxability of reimbursement of expenses in the hands of Non-resident recipient is extremely litigated issue. The payers of the reimbursement is always in an extremely confusing state of mind. There are so many conflicting decision of various Courts which further add to the confusion. The exponential increase in cross border transactions and genuine situations in which it is extremely different to avoid reimbursement of expenses incurred by Non-resident holding companies for the purpose of large scale economy and standardization. Here are some of the insight which may help the payer to take wise decision on Reimbursement of Expenses – Withholding Tax as per Section-195 of the Indian Income tax Act:
Commonly understandable meaning of reimbursement is to pay to the person who spent on your behalf. So, there are at least three parties in the Transactions. This is very common in trade and commerce especially in case of Multinational Enterprises who three parties in the Transactions. This is very common in trade and commerce especially in case of Multinational Enterprises who have to maintain standardization in multiple processes in its operations throughout the World. Example: Reimbursement towards allocation of cost for common infrastructure. E.g. IT cost, advertisement cost, R & D cost etc.
Bangalore Tribunal in the case of Bovis Lend Lease (I) Private Limited v. ITO in 2010 noted certain essentials conditions to term some payment as reimbursement:
- The actual liability to pay should be of the person who reimburses the money to the original payer.
- The liability ought to have been clearly determined. It should not be an approximate or varying amount.
- The liability ought to have crystallized. In other words, payments which were never required to be done, but were done just to avoid a potential problem may not qualify as reimbursement.
- The payment should be first be made by somebody else whose liability it never was and the repayment should then follow to that person to square off the account.
- There should be clearly three parties existing.
Type of reimbursement
Based on various decisions of various Courts/tribunals, reimbursement may be following type:
- Independent third party reimbursements for common service availed by MNE group at head office level to be utilised by the all constituents of the group worldwide e.g. lease line connectivity, ERP system etc.
- Reimbursement on account of cost sharing/cost contribution arrangements e.g. cost of Shared services centre for centralized processes. Here the cost is incurred by MNE which is not directly related as in point no. 1 above.
- Reimbursement of salary cost in secondment of employee. This basically charging of cost of the employee of overseas company deputed at Indian group Company.
- Reimbursement of out of pocket expenses along with service fee. This is quite common even in domestic transactions e.g. Reimbursement of air ticket, hotel expenses etc.
Section-195 of the Indian Income Tax Act which cast an obligation on the payer to withhold tax on any payment to non-resident on the ‘sum which is chargeable tax under the provision of ITA. So the core legal issue which revolves in all judicial decision is whether or not the sum payable as reimbursement is chargeable tax under the provision of ITA.
The following are some of the broad principles enumerated from judicial decisions:
- If the reimbursements are on cost to cost basis and not creating any income to recipient is not chargeable to tax as per the provision of ITA.
- In some cases the tribunals has adopted a ‘look through’ approach meaning thereby that one need to test the transaction as if the payer is directly paying to the third party then see the chargeability under section-195 of the ITA and decide accordingly. This view is quite logical on the principle that something which cannot be done directly cannot done indirectly too.
- Based upon the intention of the parties and terms of the agreement between the Courts in many cases decided the income as FTS or Royalty and chargeable to tax.
- In some cases, the documents in support of reimbursement given at most importance to determine chargeable to tax.
- In case of reimbursement cost of employees on secondment, most of the Courts decided against the assesse and treated this as fee for technical services. However, the payer can test the Transaction on the ‘make available’ clause in the tax treaty to come out of ambit of taxation.
Points to Consider
The following are the important guiding principles for the payer in discharging his obligation without inviting any tax liabilities for himself:
- All payments of reimbursement should be based on detailed agreement clearly specify the intent and term and conditions specially mentioning the facts.
- In case of pure cost to cost reimbursements, back up documents should be kept separately to show that there is no income elements is present in the Transaction.
- Prepare your case property with all matching favourable decisions and differentiating the unfavourable decision as per the facts of your case.
- Talk with the payee either to take Advance rulings or pay the tax if credit is available in resident state.
- Last but not the least, never take risk in case of unrelated party reimbursements.
Reimbursement of Expenses – Withholding Tax is a highly controversial issue, take at most care to deal with it. Keep detailed agreement and complete documentation in your support. Also keep legal backing based on decided cases.
(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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