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Remuneration
paid to expatriate held as "borne by PE " when PE taxed on Presumptive
Tax Scheme
In
a significant decision by the Authority for Advance Rulings ("AAR"),
in the case of DHV consultants BV, it was held that remuneration
paid by the foreign employer to its employee for services rendered
in India to the Indian Project Office ("PO"), would be
taxable in India.
The
applicant, DHV Consultants ("Dutch BV/applicant"), a foreign
company incorporated in the Netherlands, is engaged in the business
of providing consultancy services in the areas of highways, transportation,
water supply and waste water, urban development, environment,
agricultural, natural resources, etc. It has set up several projects
offices to carry out its activities in India. The POs constitute
permanent establishment ("PE") of the Dutch BV in India
under Article 5 of the tax treaty between India and the Netherlands
("tax treaty"). The income derived by the Dutch BV from
these activities are taxed as fees for technical services accruing
to its PE, on a presumptive basis under section 44D and section
115A of the Indian Income Tax Act, 1961 ("ITA"). It should
be noted that section 44 D is no longer applicable in case of
agreements entered into after March 31, 2003. However, this ruling
is important for the purposes of the analysis of presumptive scheme
of taxation. The Dutch BV sends its employees from the Netherlands
to the Indian POs to work on various projects being executed by
it in India. While in India, the employees continue to receive
salary and allowances in their home country. Under the ITA, the
Dutch BV is obligated to deduct Indian taxes at source in respect
of salary taxable in India. As the employees are residents of
the Netherlands, the applicant sought exemption from tax in India
under Article 15 of the tax treaty. This article exempts salary
from tax in India if all of the following conditions are satisfied:
a)
The total duration of the stay of the employee in aggregate
in India does not exceed 183 days in a tax year;
b)
The remuneration for services rendered by the employee is paid
by, or on behalf of, an employer who is not a resident of India
: and
c) The remuneration is not borne by a PE or fixed base, which
the employer has in India.
The
applicant approached the AAR to determine whether condition (c)
is satisfied when the Dutch BV is taxed in India based on the
presumptive tax provisions of section 44D and 115A of the ITA.
The
applicant argued as follows:
As the
applicant (Dutch BV) is liable to tax as prescribed under Section
115A and 44D on its gross receipts, none of the expenses incurred
by it for its Indian operations are deductible in computing
the taxable profits in India; Therefore,
the remuneration paid to its employees in India cannot be treated
as being borne by the PE or the applicant in India and, hence
the condition under Article 15(2) (c) of tax treaty is satisfied;
And hence,
remuneration paid to employees in India would be exempt from
tax in India.
The
AAR did not agree with this reasoning. They examined the specific
import of the terms "borne by" and deemed "deductions"
in the presumptive taxation scheme. They referred to various case
law and the fundamental accounting standards followed in India
and abroad for computing taxable income. In the AAR's view, the
expression "borne by" in sub-clause(c) of clause 2 of Article
15, means "deductible" or "liable to be deducted", similar to
the use of the words in Section 10(6) under the ITA. As the term
"borne by" is not defined in the tax treaty the AAR applied the
meaning that it has under the ITA. Accordingly, they held that
the remuneration would be a deductible expense. They took the
view that the presumptive taxation scheme such as the one under
section 44D of the ITA is brought on to the statute book to simplify
the computation of income and enhance tax compliance and is an
accepted method of taxation in tax jurisprudence the world over.
However, such scheme only provides alternative computation of
tax on royalty and fees for technical services. The scheme dispenses
with the normally applicable provisions of computation of income
under sections 28 to section 44C,as it prescribes a specified
rate of income-tax payable by a foreign company i.e at 30 per
cent on royalty and fees for technical services received for agreement
entered into on or before May 31, 1997 and 20 per cent for agreement
entered into after May 31, 1997. As against this scheme, rates
of tax on a non-resident company for other income are much higher,
e.g., 40 per cent for the assessment year 2004-2005. The AAR concluded
that the lower rate of tax under section 115A is clearly due to
the fact that tax on such income is computed on gross basis whereas
in case of other income (other than royalty and fees for technical
services) of a foreign company, tax is computed on net basis.
The lower rate of tax prescribed under section 115A is clearly
with a view to allowing margin for the deduction of expenses which
include remuneration paid to employees working in India.
The
AAR maintained that while computing taxable income of a PE, all
proper outgoings have to be allowed as deductions to the extent
permitted under the ITA. Thus, the salaries paid to the employees
and all revenue expenses incurred for running the PE would have
to be taken into account in determining the PE's profits in India
and the same would be deemed to have been treated as deductible
in the scheme of sections 44D and 115A. Any attempt to treat gross
receipts of technical fees as income without deducting expenses
connected therewith would run counter to the basic principle of
accountancy as well as provisions of tax laws and tax treaties.
The
AAR answered the applicant's question in the negative. They ruled
that the condition specified under sub-clause (c) of clause 2
of article 15 of the tax treaty relates to the taxability of employees
and not of the applicant and is therefore not relevant when the
Dutch B.V. is taxed in India on presumptive basis under section
44D and section 115A of the ITA.
Interestingly,
before parting, the AAR referred to the two international commentators,
Dr. Phillip Baker and Dr. Klaus Vogel with respect to their interpretation
on what constitutes "borne by" as used in sub clause (c) of clause
2 of Article 15 of the OECD model convention. Dr. Baker has stated
that, the fact that the employer has, or has not, actually claimed
a deduction for the remuneration in computing the profits attributable
to the PE is not necessarily conclusive, since the proper test
is whether any deduction otherwise available for that remuneration
would be allocated to the PE. The test would be met even if no
amount was actually deducted as the PE was exempt from tax in
the source country or employer simply deciding not to claim deduction
to which he was entitled.
Dr.
Klaus Vogel has commented that the condition laid down in Article
15(2) (c) would be satisfied and the remuneration would be taxed
in the state of residence if the PE in the source state bears
the remuneration but where, by virtue of Article 8 (income from
shipping, inland waterways transport and air transport), the PE's
profits are not taxed in the source state. The reason is that
in this case, the deduction of the remuneration as business expense
does not adversely affect the tax revenue of the source state.
This
is a very important ruling in applying the provisions of Article
15 of the tax treaties. It should be noted that advance ruling
is only binding in case of the applicant who has applied for it,
though it may have persuasive value in determining taxability
in respect of similar transactions.
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You
can direct your queries or comments to the authors
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Source:
In re DHV Consultants BV [2005] 147 TAXMAN 521 (AAR-NEW DELHI)
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