International Tax Practice Part 2

Diploma in International Taxation
Paper – 2
International Tax - Practice

(Part-II)
(Set up by an Act of Parliament)

The Institute of Chartered Accountants of India
New Delhi
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First Edition : May, 2016

Second Edition : July, 2017
Third edition : September, 2018
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SYLLABUS
Broad Objective
(a) To gain working knowledge of the provisions of International taxation laws.

(b) To acquire an analytical approach to apply the working knowledge to specific problem
areas in a variety of practical situations.
Paper 1 - International Tax –Practice
(a) Provisions of Income-tax Act, 1961 and Income tax Rules, 1962, relevant to
International Tax in India, Principles of International Taxation, Double Taxation
Avoidance Agreements, Tax Information Exchange Agreements, Anti-Avoidance
Measures etc
(b) Model Tax Conventions (UN, US and OECD), Basics of International tax Structures,
International Financial Centre, other issues in International Taxation which may arise
from time to time like digital economy & e-commerce, financial Instruments and Trusts
etc.
(c) Any new legislation having impact on International Taxation, introduced from time to
time
Note:
1. The participant will have to undergo 120 hours International taxation Professional
Training (INTT PT) which would cover the above-mentioned syllabus. Considering the
dynamic nature of International taxation, the Committee on International Taxation be
authorized to make changes in the said curriculum within the broad framework of
above-mentioned syllabus as approved by the Council.
2. If new legislations are enacted in place of the existing legislations the syllabus will
accordingly include the corresponding provisions of such new legislations in the place
of the existing legislations with effect from the date of its notification or effectiveness.
Contents
Sr Topic Page No.

No.
D. IMPACT OF DOMESTIC TAX SYSTEMS 4.1-4.73

• Source of Income or Gain for Non-resident 4.1
• Basis of Tax Computation 4.30
• Treatment of Tax Losses 4.38
• Foreign Tax Relief 4.43
• Authority for Advance Ruling 4.48
• Tax deduction at source/ Withholding taxes 4.53
E. BASIC INTERNATIONAL TAX STRUCTURES 5.1-5.75

• International Tax Structures 5.1
• Tax structuring for Cross-border Transactions 5.12
• International Tax structuring for Expatriate Individuals 5.24
• Avoidance of Economic Double Taxation of Dividends 5.49
• Tax Consolidation Rules (“Group Taxation”) 5.66
F. ANTI-AVOIDANCE MEASURES 6.1-6.42

• Judicial Anti-avoidance Doctrines 6.1
• Anti-treaty Shopping Measures 6.19
• Controlled Foreign Corporation 6.26
• Some Other Anti-avoidance Measures 6.34
G. OTHER ISSUES IN INTERNATIONAL TAXATION 7.1-7.142

• Electronic Commerce 7.1
• Cross – Border Mergers & Acquisitions – Key Tax Aspects 7.19
• Treatment of Exchange Gains and Losses 7.30
• Trusts 7.39
• Base Erosion and profit Shifting (BEPS) 7.49
Sr Topic Page No.
No.
• Diverted profit tax 7.62

• Partnership 7.67
• Recent judicial developments in India 7.86
• Triangular Cases 7.129
GLOSSARY G.1-G.5
Module D
Impact of Domestic Tax Systems
1. Source of Income or Gain for Non-resident

1.1 Introduction
Scope of taxable income is linked to the residential status of a person in India i.e. resident or
non-resident.
Resident: In the case of a resident, it is immaterial where it accrues or arises or received is in
India or outside India since the world income is taxable in India.
Non-resident: In the case of a person who is a non-resident in India, the total income taxable
in India for a particular previous year shall include all incomes from whatever source derived
during that year which:
(a) is received in India; or
(b) is deemed to be received in India; or
(c) accrues or arises in India; or
(d) is deemed to accrue or arise in India.
Note:
To summarise in the case of a non-resident, only those incomes which are received or
accrued or deemed to accrue or be received in India are taxable in India. Consequently, the
income accruing or arising outside and received outside India by a non-resident is not taxable
in India.
The above concepts have been explained in detail below:
1.2 Income received in India

Any income received by a non-resident in India shall be taxable in India even if it has accrued
or arisen outside India.
4.2 International Tax — Practice
However if the money had already been received abroad by a non-resident as income and the
non-resident later remitted the same into India, it will not be taxable in India on receipt of the
same in India.
Illustration
Mr X, a resident of USA, received rental income outside India from a property situated in USA.
Mr X was assessed to tax in USA on the income received from the property situated in USA.
Mr X remitted rental income received, to his family in India for their livelihood. The rental
income transferred by Mr X is already taxed in the country in which the property is situated.
Moreover the income does not accrue or arise in India to Mr X. Accordingly in the current
scenario it is a mere remittance of money to India. Hence the same cannot be taxed in India
on the basis of receipt in India.
1.3 Taxability of Dividend income - Section 8 of the Income-tax Act

Dividend (other than interim dividend) is taxable in all cases as income of the previous year in
which it is so declared and not in the year in respect of which it is declared.
Income accruing or arising in India
The terms ‘accrue’ or ‘arise’ are not defined in the Income-tax Act.
The dictionary meanings of the terms ‘accrue’ or ‘arise’ are given below:
The term ‘accrue’ means ‘to arise or spring as a natural growth or result [1], ‘to come by way of
increase’ [2].
The term ‘arising’ means ‘coming into existence or notice or presenting itself.
The Authority for Advance Ruling in the case of Cushman & Wakefield (S) Pte. Ltd. [3] held “An
income is said to accrue or arise at the location where the services or activities for earning the
income or the contract which gives rise to such income has been entered into.”
The Income-tax Act does not set out how the place of accrual of income is to be determined.
Section 5 proceeds on the assumption that income, profits and gains have a situs, though
there is no indication as to how the situs is to be determined. Hence, the situs has to be
determined according to the general principles of law and in the light of particular facts.
Illustration: In a money-lending transaction the decisive factor would be the place where the
money is actually lent irrespective of where it came from, since, without actual advance, no
interest can accrue or arise; the actual place of user of the money may not have a bearing in
deciding the situs in such a case.
[1] Murry’s Oxford Dictionary

[2] Webster’s Dictionary
[3] In Re (AAR no. 757 of 2007) and 172 TAXMAN 179 – Para 22
Impact of Domestic Tax Systems 4.3
Income deemed to accrue or arise in India

Section 9 provides types of income which are deemed to accrue or arise in India.
Ordinarily, in the case of a non-resident, unless the place of accrual or arisal of income is in
India, the said income cannot be taxed in India. However income which accrues or arises
outside India but is fictionally deemed to accrue or arise in India under the deeming provisions
of section 9 will be subject to tax in India.
The word ‘deemed to accrue’ means ‘deemed by the statute’ to accrue or to be received in
India. In other words section 9 enlarges the ambit of taxation by deeming certain income to
accrue or arise in India in certain circumstances.
Following incomes shall be deemed to accrue or arise in India:
1.3.1 Any income accruing or arising to a non-resident:
(a) Out of a business connection in India
(b) Through or from any property in India
(c) Through or from any asset or source of income in India, or
(d) Through the transfer of a capital asset situated in India;
1.3.2 Any salary income earned by the non-resident in India;
1.3.3 Any salary payable by the Government to a citizen of India for services rendered
outside India;
1.3.3 Dividend paid by an Indian company outside India;
1.3.5 Interest income;
1.3.6 Royalty income;
1.3.7 Income by way of fees for technical services.
Under the source rule of taxation, income is taxed in the country where it is earned ie the
country where the actual economic nexus of income is situated has a right to tax the income
irrespective of the place of residence of the non-resident who derives the income.
In the context of the Income-tax Act, any sum in the nature of interest, royalty or fees for
technical services paid by a resident to a non-resident shall be deemed to accrue or arise in
India, except where such interest, royalty or fees for technical services are incurred by the
resident in relation to a business or profession carried on by the resident payer outside India
or for the purpose of making or earning any income from any source outside India.
Thus a legal fiction was created whereby interest, royalty and fees for technical services
utilised for a business or profession carried out in India were brought to tax in India on the
basis of the source rule of taxation.
Hence irrespective of the situs of the services, the tax jurisdiction will be determined by situs
of the payer and situs of utilisation of services.
1.3.1 Section 9(1)(i)

(a) Any income out of a Business connection in India:
Any income earned by a non-resident from a business connection in India is taxable in India.
The term ‘business connection’ has not been expressly defined in the Income-tax Act.
However, the expression ‘business connection’ has been the subject matter of judicial
interpretation. Based on well established principles, the following prerequisites must exist for a
non-resident to have a ‘business connection’ in India:
• there must be a business activity carried on outside India;
• there must be some business activity carried on within India;
• the relation between the two activities should contribute to the earning of income by the
non-resident;
• there must be an element of continuity between the business of the non-resident
undertaken outside India and the activity carried out in India;
• a stray or isolated transaction is normally not regarded as a business connection.
The Income-tax Act provides an inclusive definition of ‘business connection’ which solely deals
with the case of a business connection arising on account of an agent of a non-resident in
India [Explanation 2 to section 9(1)(i)].
As per the Act, the expression ‘business connection’ shall include any business activity carried
out by a non-resident in India through a person who acting on behalf of the non-resident:
(a) has an authority to conclude contracts on behalf of the non-resident and habitually
exercises such authority in India; or has and habitually exercises in India, an authority
to conclude contracts on behalf of the non-resident or habitually concludes contracts or
habitually plays the principal role leading to conclusion of contracts by that non-resident
and the contracts are—
(i) in the name of the non-resident; or
(ii) for the transfer of the ownership of, or for the granting of the right to use, property
owned by that non-resident or that non-resident has the right to use; or
(iii) for the provision of services by the non-resident; or1
(b) has no authority to conclude contracts, but habitually maintains in India, a stock of
goods or merchandise from which he regularly delivers goods or merchandise on behalf
of the non-resident; or
(c) habitually secures orders in India, mainly or wholly for the non-resident or for that non-
resident and:
1 Inserted by Finance Act , 2018 w.e.f. 1st April 2019

(i) other non-residents who control the above mentioned non-resident,

(ii) other non-residents controlled by that non-resident,
(iii) all other non-residents who are subjected to the same common control as that
non-resident.
Where a business is carried on in India by a non-resident through a person as referred to in
clause (a), (b), (c) above, only so much of the income of the non-resident as is attributable to
the operations carried out in India shall be taxable in India.
Exclusions from “Business connection”:
It may be noted that a broker, general commission agent or any other agent shall not be
deemed to have an independent status where such person works mainly or wholly on behalf of
the non-resident or for that non-resident and:
(i) other non-residents who control the above mentioned non-resident,
(ii) other non-residents controlled by that non-resident,
(iii) all other non-residents subjected to the same common control, as that non-resident.
Explanation 2A.—For the removal of doubts, it is hereby clarified that the significant economic
presence of a non-resident in India shall constitute "business connection" in India and
"significant economic presence" for this purpose, shall mean—
(a) transaction in respect of any goods, services or property carried out by a non-resident
in India including provision of download of data or software in India, if the aggregate of
payments arising from such transaction or transactions during the previous year
exceeds such amount as may be prescribed; or
(b) systematic and continuous soliciting of business activities or engaging in interaction
with such number of users as may be prescribed, in India through digital means:
Provided that the transactions or activities shall constitute significant economic presence in
India, whether or not,—
(i) the agreement for such transactions or activities is entered in India; or
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
Provided further that only so much of income as is attributable to the transactions or activities
referred to in clause (a) or clause (b) shall be deemed to accrue or arise in India. 2
2 Inserted by Finance Act 2018 ; Applicable w.e.f. 1st April 2019

Interpretation of the expression ‘business connection’ as per judicial

precedents:
R.D. Agarwal and Co [(1965) 56 ITR 20 (SC)]
The landmark decision in the context of business connection is the decision of Supreme Court
in the case of R.D. Agarwal and Co [(1965) 56 ITR 20 (SC)].
In CIT v R. D. Aggarwal and Co 56 ITR 20, the Supreme Court held that business connection
involves:
(a) a relation between a business carried on by a non-resident which yields profits or gains
and some activity in the taxable territories which contributes directly or indirectly to the
earning of those profits or gains.
(b) There has to be element of continuity between the business of the non-resident and the
activity in the taxable territories,
(c) A stray or isolated transaction not being normally regarded as a business connection.
Thus Business connection may take several forms:
(a) It may include carrying on a part of the main business or activity incidental to the main
business of the non-resident through an agent, or
(b) It may merely be a relation between the business of the non-resident and the activity in
the taxable territories, which facilitates or assists the carrying on of that business.
Thus for constituting “business connection” there should be a real and close relation between
the trading activity carried on outside the taxable territories and the trading activity within the
territories, the relation between the two contributing to the earning of income by the non-
resident in his trading activity.
Anglo French Textile Co Ltd v CIT reported in [1953] 23 ITR 101 (SC)
A Ltd, a company incorporated in the UK, owned a spinning and weaving mill at Pondicherry.
A Ltd had appointed another company in Madras as its constituted agent for the purpose of its
business in India. In a particular assessment year, A Ltd had not made any sales of yarn or
cotton manufactured by it in India, but all purchases of cotton required for the factory at
Pondicherry were made by the agents in Madras and no purchases were made through any
other agency. The question put forth for consideration was whether A Ltd could be said to
have a business connection in India.
In this case, the Supreme Court held that: The activity performed by the Madras entity for A
Ltd was not in the nature of an isolated transaction of purchase of raw materials. In this case,
a regular agency was established in Madras for the purchase of the entire raw materials
required for the manufacture abroad and the agent was chosen by reason of his skill,
reputation and experience in the line of trade. The terms of the agency fully establish that the
entity in Madras was carrying on an activity almost akin to the business of a managing agency
in India of the foreign company and the latter certainly had a connection with the agency.
When there is a continuity of business relationship between the person in Madras who helps
to make the profits and the person outside Madras who receives or realizes the profits, such
relationship does constitute a business connection in India.
G V K Industries Ltd v ITO reported in [1997] (228 ITR 564)
There are various factors, which need to be kept under consideration while determining
whether a BC exists in a particular situation, or not. The landmark judgment of the Andhra
Pradesh High Court compiles the ratios of various other judgments and lays down the
following principles of business connection:
(i) Whether there is a business connection between an Indian person and a non-resident is
a mixed question of fact and law which has to be determined on the facts and
circumstances of each case;
(ii) The expression business connection is too wide to admit of any precise definition;
however it has some well known attributes;
(iii) The essence of business connection is the existence of close, real, intimate relationship
and commonness of interest between the non-resident and the Indian person;
(iv) Where there is control or management or finances or substantial holding of equity
shares or sharing of profits by the non-resident of the Indian person, the requirement of
principle (iii) is fulfilled;
(v) To constitute business connection there must be continuity of activity or operation of the
non-resident with the Indian party and a stray or isolated transaction is not enough to
establish a business connection.
Illustrations of existence of Business Connection:
Illustrations – Business connection
Illustration:
A liaison office is set-up in India by ABC Co, a Company resident in Dubai, to receive trade
inquiries from customers in India. If the work of the liaison office is restricted only to
forwarding the trade inquiries to ABC Co, no business connection exists. However, if the
liaison office negotiates and enters into contracts on behalf of ABC LLC with customers then it
may be construed that a business connection exists in India. In such a scenario, the profits
attributable to the operations conducted in India will be taxable in India in the hands of ABC
Co.
Illustration:
XYZ Inc, a resident of USA has set up a branch in India for the purpose of purchase of raw
materials for manufacturing its products. The branch office is also engaged in selling the
products manufactured by XYZ Inc in India and in providing sales related services to
customers in India on behalf of XYZ Inc. The branch of XYZ Inc will constitute a business
connection in India since there is an element of continuity in the business transactions with
XYZ Inc owing to the business activities carried out by the branch in India.
Branch is generally considered to be an extended arm of an entity/ company. In law there
cannot be a valid transaction of sale between the branch office of the assessee in India and its
head office in a foreign country. It is an elementary proposition that a person cannot enter into
contract with itself. Hence if a non-resident maintains a branch office in India which carries out
transactions in India then business connection can be said to exist.
Illustration:
Raw material required by a foreign company was purchased by its agents in British India
continuously for several years. The sale proceeds of the manufactured goods were collected
by them in British India and were credited in their books to the account of the company as they
acted also as bankers. They met all the expenditure out of the collections in their hands, paid
for the purchase, and made also other payments referred to in the managing agents' accounts.
They were given absolute discretion with reference to the purchases as to when to buy, where
to buy and at what rate. The purchase of goods continuously to meet the requirements of
manufacture in the mills required skill and judgment and that is exclusively vested in the
managing agents. Practically the entire management of the business was left to the agents
and though it is said that they had an office also at Bangalore it is clear that most of the
activities connected with the management of the business at Bangalore were carried out in
British India. In view of the above, it was held that the foreign company had a Business
Connection in India. [Bangalore Woollen, Cotton & Silk Mills Co Ltd v CIT [1950] 18 ITR 423,
433 (Mad)].
Illustration – Business connection does not exist
Illustration
Mr X, a resident in India is appointed as an agent by PQR Inc, a company incorporated in USA
for tracking the Indian markets. Mr X only canvassed orders and communicated them to PQR
Inc. Mr X had no authority to accept them. The orders were directly received and accepted,
the price received and delivery of goods was given by PQR Inc outside India. No purchase of
raw material or manufacture of finished goods took place in India. Mr X was only entitled to
commission on the sales so concluded. Since Mr X does not have any authority to accept or
conclude any contracts on behalf of PQR Inc or procure any raw material, it can be said that
business connection does not exist in India in the case of PQR Inc.
Illustration:
X Ltd imported machinery from Y Inc of USA on a principal to principal basis. The purchase of
machinery was the sole transaction between X Ltd and Y Inc. No business connection of Y Inc
can be said to exist in India since the purchase of machinery by X Ltd from Y Inc was a
solitary transaction and there is no continuity of business relationship between Y Ltd and X
Ltd.
Emerging Issues: Taxability in case of E-Commerce

Innovation in technology has had far reaching influence on our ways of life, including the way
businesses transact. The last decade in India has seen a steady rise in e-commerce. E-
commerce has facilitated new products, services and business models. Goods or services can
be ordered electronically but their payment does not necessarily have to be conducted online
(Cash on delivery). In case of e-commerce transactions, the business is effectively carried on
in India (and/ or other countries), without having any ‘tangible’ presence/ assets/ employees in
that country.
Business connection requires some operations to be conducted in India. Further for
constituting “business connection” there should be a real and close relation between the
trading activity carried on outside the taxable territories and the trading activity within the
territories, the relation between the two contributing to the earning of income by the non-
resident in his trading activity. Accordingly, in case of e-commerce, companies may face
challenges in determining whether a business connection is constituted in India in the absence
of any tangible presence/ operations in taxable territory.
Difference between Business connection and Permanent Establishment:
Concept of PE
Under the Double Taxation Avoidance Agreements [2] (DTAA), business income of a non-
resident is not taxable in India unless the non-resident taxpayer has a Permanent
Establishment [3] (PE) in India and the business income is effectively connected to such PE.
PE is defined in section 92F(iiia) to include a fixed place of business through which the
business of a non-resident is wholly or partly carried on (For example, if a non-resident set up
a branch office in India). The fixed place should be available at the disposal of the non-
resident in India for carrying out such business. It is irrelevant whether the fixed place is
owned or rented by the non-resident.
It may be noted that the Income tax Act restricts the definition of PE in India to a fixed place
from which business operations of the non-resident are wholly or partly carried out. However
the concept of PE as defined in the DTAA entered into by India is wide and contemplates
different kinds of PE. For instance, service PE, construction PE etc.
Accordingly where a non-resident carries on business through a PE in India, income
attributable to such PE shall be taxable in India.
Business connection vs PE
Income derived by a non-resident from a business connection in India is taxable in India under
the Act. In contrast, under most DTAA’s, business income of a non-resident is taxable in India
only if the income is derived by the non-resident from a PE in India.
[2] The concept of Double Taxation Avoidance Agreements has been discussed in detail in Chapter
The concept of Permanent Establishment as defined in Article 5 of the Double Taxation Avoidance Agreements
[3]
has been discussed in detail in Chapter

“Business connection” under the Income-tax Act is wider than the term “Permanent
Establishment”.
Existence of a PE in India will always give rise to a business connection in India. However a
Business connection may exist independent of PE. Accordingly, there may be a situation
where there is business connection in India under the Income-tax Act but there may not be a
PE under the DTAA.
Hence where the non-resident is eligible for treaty benefit there will be no liability to pay tax in
India in a scenario where the non-resident has a business connection in India but does not
have a PE in India as per the DTAA.
Illustration:
XYZ Inc, is a company incorporated in USA and also a tax resident of USA for income tax
purposes. The income earned by XYZ Inc is liable to tax in USA. XYZ Inc conducts business
operations in India as well. Accordingly where the operations conducted in India constitute a
business connection for XYZ in India, such profits attributable to such business operations
conducted in India will be taxable in India as per section 9(1)(i) of the Income tax Act.
However, under the India-USA DTAA, XYZ Inc shall be liable to tax in India only where a PE
of XYZ Inc is constituted in India as per Article 5 of India-USA DTAA. Accordingly, even
though XYZ Inc constitutes a business connection in India, owing to beneficial provisions
contained in India-USA DTAA, XYZ Inc shall be liable to tax in India only if it conducts its
business through a PE in India. In case the non-resident has a PE in India, the profits
attributable to such PE shall be taxable in India.
Section (9A) Certain activities not to constitute business connection in India
(1) Notwithstanding anything contained in sub-section (1) of section 9 and subject to the
provisions of this section, in the case of an eligible investment fund, the fund management
activity carried out through an eligible fund manager acting on behalf of such fund shall not
constitute business connection in India of the said fund.
(2) Notwithstanding anything contained in section 6, an eligible investment fund shall not be
said to be resident in India for the purpose of that section merely because the eligible fund
manager, undertaking fund management activities on its behalf, is situated in India.
(3) The eligible investment fund referred to in sub-section (1), means a fund established or
incorporated or registered outside India, which collects funds from its members for investing it
for their benefit and fulfils the following conditions, namely:—
(a) The fund is not a person resident in India;
(b) The fund is a resident of a country or a specified territory with which an agreement
referred to in sub-section (1) of section 90 or sub-section (1) of section 90A has been
entered into [or is established or incorporated or registered in a country or a specified
territory notified by the Central Government in this behalf];
(c) The aggregate participation or investment in the fund, directly or indirectly, by persons
resident in India does not exceed five per cent of the corpus of the fund;
(d) The fund and its activities are subject to applicable investor protection regulations in the
country or specified territory where it is established or incorporated or is a resident;
(e) The fund has a minimum of twenty-five members who are, directly or indirectly, not
connected persons;
(f) Any member of the fund along with connected persons shall not have any participation
interest, directly or indirectly, in the fund exceeding ten per cent;
(g) The aggregate participation interest, directly or indirectly, of ten or less members along
with their connected persons in the fund, shall be less than fifty per cent;
(h) The fund shall not invest more than twenty per cent of its corpus in any entity;
(i) The fund shall not make any investment in its associate entity;
(j) The monthly average of the corpus of the fund shall not be less than one hundred crore
rupees:
Provided that if the fund has been established or incorporated in the previous year, the
corpus of fund shall not be less than one hundred crore rupees at the end of such
previous year:
Provided further that nothing contained in this clause shall apply to a fund which has
been wound up in the previous year;
(k) The fund shall not carry on or control and manage, directly or indirectly, any business in
India
(l) The fund is neither engaged in any activity which constitutes a business connection in
India nor has any person acting on its behalf whose activities constitute a business
connection in India other than the activities undertaken by the eligible fund manager on
its behalf;
(m) The remuneration paid by the fund to an eligible fund manager in respect of fund
management activity undertaken by him on its behalf is not less than the arm's length
price of the said activity:
Provided that the conditions specified in clauses (e), (f) and (g) shall not apply in case
of an investment fund set up by the Government or the Central Bank of a foreign State
or a sovereign fund, or such other fund as the Central Government may subject to
conditions, if any, by notification in the Official Gazette, specify in this behalf.
(4) The eligible fund manager, in respect of an eligible investment fund, means any person
who is engaged in the activity of fund management and fulfils the following conditions,
namely:—
(a) The person is not an employee of the eligible investment fund or a connected person of
the fund;
(b) The person is registered as a fund manager or an investment advisor in accordance

with the specified regulations;
(c) The person is acting in the ordinary course of his business as a fund manager;
(d) The person along with his connected persons shall not be entitled, directly or indirectly,
to more than twenty per cent of the profits accruing or arising to the eligible investment
fund from the transactions carried out by the fund through the fund manager.
(5) Every eligible investment fund shall, in respect of its activities in a financial year, furnish
within ninety days from the end of the financial year, a statement in the prescribed form, to the
prescribed income-tax authority containing information relating to the fulfilment of the
conditions specified in this section and also provide such other relevant information or
documents as may be prescribed.
(6) Nothing contained in this section shall apply to exclude any income from the total income
of the eligible investment fund, which would have been so included irrespective of whether the
activity of the eligible fund manager constituted the business connection in India of such fund
or not.
(7) Nothing contained in this section shall have any effect on the scope of total income or
determination of total income in the case of the eligible fund manager.
(8) The provisions of this section shall be applied in accordance with such guidelines and in
such manner as the Board may prescribe in this behalf.
(9) For the purposes of this section,—
(a) "associate" means an entity in which a director or a trustee or a partner or a member or
a fund manager of the investment fund or a director or a trustee or a partner or a
member of the fund manager of such fund, holds, either individually or collectively,
share or interest, being more than fifteen per cent of its share capital or interest, as the
case may be;
(b) "Connected person" shall have the meaning assigned to it in clause (4) of section 102;
(c) "Corpus" means the total amount of funds raised for the purpose of investment by the
eligible investment fund as on a particular date;
(d) "Entity" means any entity in which an eligible investment fund makes an investment;
(e) "Specified regulations" means the Securities and Exchange Board of India (Portfolio
Managers) Regulations, 1993 or the Securities and Exchange Board of India
(Investment Advisers) Regulations, 2013, or such other regulations made under the
Securities and Exchange Board of India Act, 1992 (15 of 1992), which may be notified
by the Central Government under this clause.
Certain income streams not taxable in India
Explanation 1 to section 9(1)(i) carves out certain exceptions from income deemed to accrue
or arise in India under section 9(1)(i) which are given below :
The above exceptions are pictorially represented below:
Business carried out partly Only such part of the income as is

outside India and partly in reasonably attributable to the
India operations carried out in India, would
be deemed to accrue in India
Business of which operations No income shall be deemed to accrue in

are confined to purchase of India
Business
goods in India for export
Connection
Non-resident engaged in the

business of running a news
agency or publishing
newspapers, journals etc, whose
activities are confined to
collection of news and views in
India for transmission out of
India
No income shall be deemed to accrue

in India
Individual/ firm /company

whose operations are
confined to the shooting of
cinematographic film in India
(b) Through or from any property or asset or source of income in India:

Any income that accrues or arises to the non-resident through or from any property or asset or
source of income in India, shall be taxable in India in the hands of the non-resident.
(c) Through the transfer of a capital asset situated in India:
Where a non-resident derives income through the transfer of a capital asset situated in India,
the capital gains derived by the non-resident on such transfer shall be subject to tax in India.
The term ‘transfer’ has been defined in section 2(47) of the Income-tax Act and the term
‘capital asset’ is defined in section 2(14) of the Income-tax Act.
Illustratively, transfer of all rights in relation to a patent to manufacture a product in India,
transfer of residential property situated in India, etc.
The Vodafone Controversy:

Shares/ interest in an Indian company is a capital asset situated in India and hence gains
derived from such transfer is taxable in India. However, shares of a foreign company, not
being an asset situated in India, gains derived by a non-resident from transfer thereof is not
taxable in India.
However in the case of Vodafone International BV (247 CTR 1), the Indian Tax Authorities
sought to tax the gains arising to a non-resident company on account of transfer of shares of a
foreign company to another non-resident company on the basis that such transfer involves an
indirect transfer of the underlying Indian assets (shares held in an Indian company) .
The facts of the case are as under:
A diagrammatic presentation of facts is given below:
F CO 1 F CO 3 Netherlands
Sale of shares
of CGP
Transfer of F CO 2
shares to F CO 3
F CO 2
Cayman
Outside
India
I CO
The issue before the SC was whether the Tax Authority had jurisdiction under the Indian Tax
Laws to tax the gains arising to the foreign company (F CO1) from transfer of shares of a
foreign holding company (F CO2), which indirectly held underlying Indian assets (shares of I
CO).
The Supreme Court in a landmark judgment, held that the indirect transfer, would not be
taxable in India. The Supreme Court held that the subject matter of the transaction was the
transfer of F CO2 (a company incorporated in Cayman Islands and accordingly asset situated
outside India). Consequently, the Indian Tax Authority had no territorial tax jurisdiction to tax
the said Offshore transaction.
Accordingly in the absence of specific provision in the Indian tax law to tax income which
arises indirectly from the assets situated in India, the Supreme Court held that the gains
arising to F CO1 on transfer of the shares of a foreign company (F CO2) which indirectly held
interest in an Indian company (I CO) would not be taxable in India.
Thus, considering the impact and the controversy that arose due to the Supreme Court ruling
in the Vodafone case, the Finance Act, 2012 inserted explanation 5 to section 9(1)(i) to bring
to tax in India gains arising on transfer of shares/ interest in a foreign company which results
in an indirect transfer of underlying Indian assets.
Explanation 5 provides that a share or interest in a company or entity registered or
incorporated outside India would be deemed to be situated in India, if the share or interest
derives, directly or indirectly, its value substantially from the assets located in India.
Illustration – Indirect transfer of shares/ interest in an Indian Company
X Inc - USA Y Inc - USA
Y Ltd - Mauritius
Z Ltd - India
X Inc, USA holds 100% shares of Y Ltd, Mauritius which in turn holds 100% shares in Z Ltd a
company incorporated in India.
X Inc, USA has entered into a transaction to transfer 100% of its shareholding in Y Ltd,
Mauritius to Y Inc, USA. The shares are transferred by X Inc, a non-resident to Y Inc, another
non-resident outside India.
The taxpayers generally adopted a position that the above transaction is not taxable in India
since the asset transferred i.e. the shares of Y Ltd are not situated in India.
In view of Explanation 5 to section 9(1)(i) inserted by the Finance Act 2012, the transfer of
shares of Y Ltd, Mauritius by X Inc to Y Inc will be taxable in India if the shares of Y, Ltd
derive its value substantially from the India assets [ie investment held in shares of Z Ltd (an
Indian Company)].
Following amendments were made retrospectively by the Finance Act 2012:

The meaning of the terms “capital asset”, “capital asset situated in India” and “through” and
“transfer” have been separately defined / explained under the Income-tax Act.
Retrospective amendments have also been made to definition of ‘capital asset’ in section
2(14) of the Income-tax Act and of ‘transfer’ in section 2(47) of the Income-tax Act.
The provisions as amended by Finance Act 2012 have been summarized below:
Meaning of the term “capital asset”
The term capital asset is defined in Section 2(14) of the Income-tax Act and reads as follows:
“Capital asset means property of any kind held by an assessee, whether or not connected
with his business or profession …
Explanation 2 – For the removal of doubts, it is hereby clarified that “property” includes and
shall be deemed to have always included any rights in or in relation to an Indian company,
including rights of management or control or any other rights whatsoever.”
Meaning of the term “capital asset situated in India”
Explanation 5 to Section 9(1)(i) of the Income-tax Act clarifies the scope of the term “capital
asset situated in India” and reads as follows:
“Explanation 5 - For the removal of doubts, it is hereby clarified that an asset or a capital asset
being any share or interest in a company or entity registered or incorporated outside India
shall be deemed to be and shall always be deemed to have been situated in India, if the
share or interest derives, directly or indirectly, its value substantially from the assets
located in India.”
Meaning of the term “through”
The meaning of the expression “through” in Section 9(1)(i) of the Income-tax Act:
“Explanation 4 – For the removal of doubts, it is hereby clarified that the expression “through”
shall mean and include and shall be deemed to have always meant and included “by means
of”, “in consequence of” or “by reason of”.”
Meaning of the term “transfer”
The term “transfer” has been defined in Section 2(47) of the Income-tax Act and reads as
follows:
“transfer, in relation to a capital asset, includes, -
(i) The sale, exchange or relinquishment of the asset; or
…
…
Explanation 2 – For the removal of doubts, it is hereby clarified that “transfer” includes and
shall be deemed to have always included disposing of or parting with an asset or any
interest therein, or creating any interest in any asset in any manner whatsoever, directly
or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement
(whether entered into in India or outside India) or otherwise, notwithstanding that such
transfer of rights has been characterised as being effected or dependent upon or flowing
from the transfer of a share or shares of a company registered or incorporated outside
India.”
Amendments made by the Finance Act 2015
By virtue of Explanation 5 to section 9(1)(i), gains arising from transfer of share or interest in a
Foreign Company shall be taxable in India only if the share or interest derives, directly or
indirectly its value substantially from assets located in India.
The term ‘substantially’ was not defined by Finance Act 2012. Considering the hardships faced
by Taxpayers in determining what constitutes substantial value, the meaning of the term
substantially has been recently defined by the Finance Act 2015 by way of Explanation 6 and
Explanation 7 to section 9(1)(i).
Explanation 6 clarifies that shares or interest of the foreign entity will be deemed to derive its
value substantially from assets (whether tangible or intangible) located in India, if on the
specified date, the value of Indian asset:
(i) exceeds the amount of ten crore rupees; and
(ii) represents at least fifty per cent of the value of all the assets owned by the company or
entity, as the case may be;
(b) the value of an asset shall be the fair market value as on the specified date, of such asset
without reduction of liabilities, if any, in respect of the asset, determined in such manner as
may be prescribed;
(c) "Accounting period" means each period of twelve months ending with the 31st day of
March:
Provided that where a company or an entity, referred to in Explanation 5, regularly adopts a
period of twelve months ending on a day other than the 31st day of March for the purpose of—
(i) complying with the provisions of the tax laws of the territory, of which it is a resident, for
tax purposes; or
(ii) reporting to persons holding the share or interest,
then, the period of twelve months ending with the other day shall be the accounting period of
the company or, as the case may be, the entity:
Provided further that the first accounting period of the company or, as the case may be, the
entity shall begin from the date of its registration or incorporation and end with the 31st day of
March or such other day, as the case may be, following the date of such registration or
incorporation, and the later accounting period shall be the successive periods of twelve
months:
Provided also that if the company or the entity ceases to exist before the end of accounting
period, as aforesaid, then, the accounting period shall end immediately before the company
or, as the case may be, the entity, ceases to exist;
(d) "specified date" means the—
(i) date on which the accounting period of the company or, as the case may be, the entity
ends preceding the date of transfer of a share or an interest; or
(ii) date of transfer, if the book value of the assets of the company or, as the case may be,
the entity on the date of transfer exceeds the book value of the assets as on the date
referred to in sub-clause (i), by fifteen per cent.
The above amendments made by the Finance Act, 2015 have been explained by way of
illustrations in below paragraphs:
Illustration: Substantial value derived from assets situated in India
Consider a hypothetical standalone balance sheet (at FMV) of Y Ltd and Z Ltd as given below:
(Rs In Crore)
Liabilities Y Ltd Z Ltd Assets Y Ltd Z Ltd

Capital 6000 1000 Other Assets 5000 5000
Liabilities 4000 Investment in Z 1000
Ltd.(includes
nominee investment)
Total 6000 5000 Total 6000 5000
In order to fall under the provisions of Explanation 5, the shares of Y Ltd should substantially
derive their value from the shares of Z Ltd i.e. as on the specified date the value of Indian
asset (i.e. shares of Z Ltd in this case):
In the above case, the value of assets held by Y Ltd is determined at Rs 6,000 crore and the
value of Indian assets (shares of Z Ltd) in gross terms (ignoring liabilities) is Rs 5,000 crores.
Hence the value derived by Y Ltd from shares of Z Ltd is to the extent of Rs 5,000 crores.
The value derived from the shares of Z Ltd by shares of Y Ltd satisfies the above conditions
i.e. its value exceeds Rs. 10 crore and represents 50% or more of the value total of assets of
Y ltd. Hence it can be said that the shares of Y Ltd substantially derive their value from asset
situated in India ie shares of Z Ltd, an Indian Company.
Illustration: Determining the specified date
Assuming that the date of transfer of shares of Y Ltd is 31 August 2015, the specified date in
various scenarios is given in the table below:
Particulars Situation 1 Situation 2 Situation 3

Book Value of Y Ltd as of 31.3.2015 1000 1000 1000
Book Value of Y Ltd as of 31.8.2015 3000 1100 300
Specified Date for FMV determination 31.8.2015 31.3.2015 31.3.2015
However a few exceptions have been carved out so that shareholders having minority stake
as mentioned in Explanation 5 to section 9(1)(i) are exempted from tax implications arising in
India on account of transfer of their stake. The exceptions have been given below:
Exceptions – Clause (a) of Explanation 7 to section 9(1)(i):
No income shall be deemed to accrue or arise to a non-resident from transfer outside India, of
any share of or interest in a company or an entity registered or incorporated outside India, as
referred to in explanation 5 in the following cases:
(i) if such company or entity directly owns the assets situated in India and the transferor
(whether individually or along with its associated enterprises), at any time in the twelve
months preceding the date of transfer, neither holds the right of management or control
in relation to such company or entity, nor holds voting power or share capital or interest
exceeding five per cent of the total voting power or total share capital or total interest,
as the case may be, of such company or entity; or
(ii) if such company or entity indirectly owns the assets situated in India and the transferor
(whether individually or along with its associated enterprises), at any time in the twelve
months preceding the date of transfer, neither holds the right of management or control
in relation to such company or entity, nor holds any right in, or in relation to, such
company or entity which would entitle him to the right of management or control in the
company or entity that directly owns the assets situated in India, nor holds such
percentage of voting power or share capital or interest in such company or entity which
results in holding of (either individually or along with associated enterprises) a voting
power or share capital or interest exceeding five per cent of the total voting power or
total share capital or total interest, as the case may be, of the company or entity that
directly owns the assets situated in India;
Illustration:
X Inc - USA Y Inc - USA
Y Ltd - Mauritius
Z Ltd - India
Continuing the above example, if X Inc, USA holds 4% shares (each share is entitled to one
vote) of Y Ltd, Mauritius which in turn holds 100% shares in Z Ltd a company incorporated in
India.
X Inc, USA has entered into a transaction to transfer its shareholding in Y Ltd, Mauritius (i.e.
4% shares held by it in Y Ltd) to Y Inc, USA. The transfer of shares takes place outside India.
X Inc does not hold any right of control or management of the transferred foreign company ie
Y Ltd.
In view of clause (a) of Explanation 7 to section 9(1)(i) of the Income-tax Act, the gains arising
to X Inc on transfer of shares of Y Ltd to Y Inc will not be taxable in India since X Inc does not
hold any right in Y Ltd entitling it to voting power or share capital exceeding 5% of the total
voting power or share capital of foreign company ie Y Ltd.
Illustration
A Inc - USA Y Inc - USA
Transfer of 4% shares of X Inc to Y

4% Inc
X Inc - USA
60%
Y Ltd - Mauritius
Outside
100%
India
Z Ltd – a
company
incorporated in
India
A Inc, USA holds 4% shares of X Inc, USA (each share is entitled to one vote). X Inc
holds 60% stake in Y Ltd, Mauritius which in turn holds 100% shares in Z Ltd a
company incorporated in India.
A Inc has entered into a transaction to transfer its shareholding in X Inc, USA to Y Inc,
USA. The shares are transferred by A Inc, a non-resident to Y Inc, another non-
resident.
A Inc neither holds any right of control or management of the transferred foreign
company/ entity ie X Inc nor does A Inc hold any rights in, or in relation to X Inc which
would entitle it to the right of management or control in Y Ltd which directly owns the
assets situated in India (shares of Z Ltd);
In view of clause (a) of explanation 7 to section 9(1)(i) of the Income-tax Act, the gains
arising to A Inc on transfer of shares of X Inc to Y Inc will not be taxable in India since A
Inc does not hold any right in X Inc which will entitle it to voting power or share capital
exceeding 5% of the total voting power or share capital of foreign company ie Y Ltd
which directly owns the assets situated in India ( shares of Z Ltd).
Clause (b) of Explanation 7 to section 9(1)(i): In a case where all the assets owned, directly
or indirectly, by a company or, as the case may be, an entity referred to in the Explanation 5,
are not located in India, the income of the non-resident transferor, from transfer outside India
of a share of, or interest in, such company or entity, deemed to accrue or arise in India under
this clause, shall be only such part of the income as is reasonably attributable to assets
located in India and determined in such manner as may be prescribed;
Certain transactions not regarded as transfer: The following transactions are exempt from
tax in India subject to satisfaction of conditions stipulated:
Transfer of capital asset being shares held in an Indian company in a scheme of
amalgamation by an amalgamating foreign company to the amalgamated foreign company
shall not be taxable in India if the following conditions are satisfied [Section 47(via)]:
• The amalgamation should qualify as amalgamation as defined under Section 2(1B) of
the Act;
• At least 25% shareholders of the amalgamating F Co continue to remain shareholders
of amalgamated F Co
• Such transfer does not attract capital gains tax in the country in which the
amalgamating F Co is incorporated.
Finance Act 2015 has recently inserted section 47(viab) for exempting capital gains tax arising
on account of transfer of shares of a Foreign company (which derives its value substantially
from assets located in India) pursuant to a scheme of amalgamation between foreign
companies on fulfilment of similar conditions as specified above.
Similarly section 47(vic) grants capital gains exemption to demerged foreign company on the
transfer of shares held in an Indian company which are transferred to a resulting foreign
company under a scheme of demerger, subject to satisfaction of following conditions:
• The demerger should qualify as a demerger as defined under Section 2(19AA) of the
Act;
• At least 75% shareholders of demerged F Co continue to remain shareholders of
resulting F Co
• Such transfer does not attract capital gains tax in the country in which the demerged
company is incorporated.
Finance Act 2015 has extended similar exemption to gains arising on transfer of shares of a
Foreign company (which derives its value substantially from assets located in India) pursuant
to a scheme of demerger between foreign companies on fulfilment of similar conditions as
specified above [section 47(vicc)].
Reporting obligation:
An Indian company/ entity shall be obligated to furnish information relating to the off-shore
transactions having the effect of directly or indirectly modifying the ownership structure or
control of the Indian company or entity. In case of any failure on the part of Indian concern,
penalty as per section 271GA shall be leviable. The penalty shall be-
(a) a sum equal to two percent of the value of the transaction in respect of which such
failure has taken place in case where such transaction had the effect of directly or
indirectly transferring the right of management or control in relation to the Indian
concern; and
(b) a sum of five hundred thousand rupees in any other case.
Salary for services rendered by a non-resident in India is deemed to accrue in India and hence
taxable in India irrespective of the place of payment.
Salary shall include the income payable to a non-resident for the leave period which is
preceded and succeeded by services rendered in India and which forms part of the
employment contract. Accordingly such income shall also be deemed to have been earned for
services rendered in India and is taxable in India.
Illustration:
A technician resident of USA, non-resident in India rendered employment services in India.
The salary to the Non-resident was paid in USA. As per section 9(1)(ii) of the Income-tax Act
such salary income for services rendered in India is deemed to accrue in India and hence
taxable in India.
1.3.3 Section 9(1)(iii):
Salary paid by the Indian Government to a citizen of India for services rendered outside India
shall be deemed to accrue or arise in India and shall be taxable in India.
The above clause intends to cover salaries of Government employees irrespective of whether
they are paid in India or outside India or the services are rendered in India or outside India.
1.3.4 Section 9(1)(iv):
A dividend paid by an Indian Company outside India.
Dividend paid by an Indian Company to a non-resident shareholder outside India is includible
in the total income of the non-resident and is taxable in India.
It may be noted that dividends paid by an Indian company are tax exempt in the hands of the
shareholders in view of provisions of section 115-O of the Income-tax Act.
Note: As per section 115-O, all domestic companies in India are liable to pay a dividend
distribution tax @ 15% on the profits distributed as dividends to shareholders thus resulting in
a net dividend payout to recipients. Accordingly the dividend is tax exempted in the hands of
shareholders.
Illustration:
ABC Ltd a company incorporated in India has distributed dividend during FY 2014-15. Z Co, a
company incorporated in UK holds 25% of the share capital of ABC Ltd and accordingly is
entitled to dividend distributed by ABC Ltd on such shares. ABC Ltd pays the DDT as per
section 115-O and distributes the dividend to its shareholders.
The dividend income so received by Z Co will be deemed to accrue or arise in India and thus
taxable in India. However by virtue of section 115-O of the Income-tax Act, such dividend
received shall be tax exempt in the hands of Z Co.
Source Related Income - Interest, Royalty and Fees for Technical services:
Unlike business income, for taxability of which there has to be a business connection in India
as explained in para 1 above, income in the nature of interest, royalty, fees for technical
services are taxable in India even if there is no business connection in India.
It is specifically stated in Explanation to Section 9(2) that the income of the non-resident in the
nature of royalty, interest or fees for technical services shall be deemed to accrue or arise in
India and shall be included in his total income, whether or not:
(i) the non-resident has a residence or place of business or business connection in India;
or
(ii) the non-resident has rendered services in India.
It is thus no longer necessary that, in order to attract taxability in India, the services must also
be rendered in India. As the law stands now, utilization of these services in India is enough to
attract its taxability in India. The explanation has thus virtually negated the judicial precedents
supporting the proposition that rendition of services in India is a sine qua non for its taxability
in India. This is called the source rule of taxation.
The source rule would mean that irrespective of the situs of services, the situs of taxpayer and
the situs of utilization of services will determine the tax jurisdiction.
1.3.5 Section 9(1)(v)
Interest income earned by any person shall be deemed to accrue or arise in India if it is
payable by-
(a) the Government ; or
(b) a person who is a resident, except where the interest is payable in respect of any debt
incurred, or moneys borrowed and used, for the purposes of a business or profession
carried on by such person outside India or for the purposes of making or earning any
income from any source outside India ; or
(c) a person who is a non-resident, where the interest is payable in respect of any debt
incurred, or moneys borrowed and used, for the purposes of a business or profession
carried on by such person in India.
Illustration:
X Inc, a multinational company and tax resident in USA carries on business both outside India
and in India.
X Inc borrows money from ‘Y’, another non-resident and invests the same in a business in
India. Interest paid by X Inc to Y will be deemed to accrue or arise in India by virtue of section
9(1)(v)(c).
Amendment made by Finance Act, 2015:
The Special Bench of the ITAT in the case of Sumitomo Mitsui Banking Corporation [136 ITD-
66 TBOM], Bank of Tokyo Mitsubishi OFJ Ltd v ADIT (ITA No 5364/Del/2010, ITA No
5104/Del/2011), Deutsche Bank AG vs ADIT, ADIT vs Mizuho Corporate Bank Ltd (54 SOT
117) ABN Amro Bank NV v. CIT [2011] 343 ITR 81 held that where interest is payable by an
Indian Branch of a foreign bank to the overseas head office, the interest so paid is deductible
while computing income of India Branch. Moreover in the hands of the recipient head office,
the same is not; taxable in India as the payer and recipient are the same since branch is
considered as an extension of the parent company for all legal purposes.
To supersede the aforesaid rulings, the Finance Act, 2015 inserted an Explanation to clause
(c). The said explanation provides as under:
Explanation.—For the purposes of this clause,—
(a) it is hereby declared that in the case of a non-resident, being a person engaged in the
business of banking, any interest payable by the permanent establishment in India of
such non-resident to the head office or any permanent establishment or any other part
of such non-resident outside India shall be deemed to accrue or arise in India and shall
be chargeable to tax in addition to any income attributable to the permanent
establishment in India and the permanent establishment in India shall be deemed to be
a person separate and independent of the non-resident person of which it is a
permanent establishment and the provisions of the Act relating to computation of total
income, determination of tax and collection and recovery shall apply accordingly;
(b) "permanent establishment" shall have the meaning assigned to it in clause (iiia)
of section 92F;
If the above conditions are fulfilled then such PE in India shall be deemed to be a person
separate and independent of the non-resident of which it is a PE. In such a case the interest
will be deemed to accrue or arise in India and will be chargeable to tax in addition to any
income attributable to the PE of the non-resident in India.
1.3.6 Section 9(1)(vi):
Royalty will be deemed to accrue or arise in India when it is payable by-
(b) a person who is a resident, except where the royalty is payable in respect of any right,
property or information used or services utilised for the purposes of a business or
profession carried on by such person outside India or for the purposes of making or
earning any income from any source outside India ; or
(c) a person who is a non-resident, where the royalty is payable in respect of any right,
property or information used or services utilised for the purposes of a business or
profession carried on by such person in India or for the purposes of making or earning
any income from any source in India :
Provided that nothing contained in this clause shall apply in relation to so much of the income
by way of royalty as consists of lump sum consideration for the transfer outside India of, or the
imparting of information outside India in respect of, any data, documentation, drawing or
specification relating to any patent, invention, model, design, secret formula or process or
trade mark or similar property, if such income is payable in pursuance of an agreement made
before the 1st day of April, 1976, and the agreement is approved by the Central Government :
Provided further that nothing contained in this clause shall apply in relation to so much of the
income by way of royalty as consists of lump sum payment made by a person, who is a
resident, for the transfer of all or any rights (including the granting of a licence) in respect of
computer software supplied by a non-resident manufacturer along with a computer or
computer-based equipment under any scheme approved under the Policy on Computer
Software Export, Software Development and Training, 1986 of the Government of India.
Illustration:
Y Inc, a company incorporated in US is the owner of “ONE UP” technology used in mobile
phones which is patented in US. X Ltd, is a company incorporated in India and engaged in the
business of manufacturing mobile phones. X Ltd has obtained from Y Inc right to use the ONE
UP technology for the purpose of manufacturing mobile phones at the plant of X Ltd based in
US. The mobile phones manufactured in the plant based in US are sold only in the US
markets. X Ltd makes an annual payment of USD 1 Million for use of ONE UP technology
owned by Y Inc. The amount paid by X Ltd, a resident to Y Inc, a non-resident for right to use
the ONE UP technology falls under the definition of royalty as per the Indian Income-tax Act
however the same is not taxable in India as it is utilised for a business carried on by X Ltd, a
resident outside India.
Mr P, a non-resident makes payment to an Indian Company, (ICo) to use I Co’s trademark for
products manufactured and distributed by Mr P in India. The payment for right to use the
trademark would constitute royalty as per the provisions of Income-tax Act. Since payment in
nature of royalty is made by a non-resident towards earning of income from business carried
on in India, such income shall be deemed to accrue or arise in India.
Exception to taxability as royalty income:
Meaning of the term royalty
Explanation 2 to section 9(1)(vi) defines the term ‘royalty’. Royalty means consideration
(including any lump sum consideration but excluding any consideration which would be the
income of the recipient chargeable under the head ‘Capital gains’) for:
(i) the transfer of all or any rights (including the granting of a licence) in respect of a
patent, invention, model, design, secret formula or process or trade mark or similar
property ;
(ii) the imparting of any information concerning the working of, or the use of, a patent,
invention, model, design, secret formula or process or trade mark or similar property ;
(iii) the use of any patent, invention, model, design, secret formula or process or trade mark
or similar property ;
(iv) the imparting of any information concerning technical, industrial, commercial or
scientific knowledge, experience or skill ;
(iva) the use or right to use any industrial, commercial or scientific equipment but not
including the amounts referred to in section 44BB;
(v) the transfer of all or any rights (including the granting of a licence) in respect of any
copyright, literary, artistic or scientific work including films or video tapes for use in
connection with television or tapes for use in connection with radio broadcasting, but
not including consideration for the sale, distribution or exhibition of cinematographic
films ; or
(vi) the rendering of any services in connection with the activities referred to in sub-clauses
(i) to (iv), (iva) and (v).
Important Points:
“Computer software” has been defined in Explanation 3 to mean any computer programme
recorded on any disc, tape, perforated media or other information storage device and includes
any such programme or any customized electronic data.
Explanation 4 to section 9(1)(vi) further clarifies that the definition of royalty under the Income
tax Act includes within its ambit the transfer of all or any right for use or right to use a
computer software (including granting of a licence) irrespective of the medium through which
such right is transferred.
The expression “process” includes and shall be deemed to have always included transmission
by satellite (including up-linking, amplification, conversion for down-linking of any signal),
cable, optic fibre or by any other similar technology, whether or not such process is secret.
The definition of the term royalty begins with the expression “means”, indicating an
exhaustive coverage. The use of the phrase “or similar property” at the end of some of the
limbs of the definition indicates an expansive coverage having wide application.
Typically, the expression, “royalty” indicates existence of an Intellectual Property that is “let
out” or allowed to be “used” for a consideration. It is not important that the Intellectual Property
should be compulsorily registered under any of the relevant Intellectual Property laws. It is
sufficient if the payment made is for the use of the Intellectual Property as against a case of its
complete transfer.
The royalty definition of the Income-tax Act also excludes any consideration which is
chargeable as capital gains in the hands of the recipient. Hence, the use of the expression
“transfer of ’all‘ rights” in clause (i) relating to patent, invention, etc. and clause (v) relating to
copyright of Explanation 2 to section 9(1)(vi) does cause concerns. This is because income
from transfer of “all rights” is generally taxed as capital gains and capital gains is specifically
excluded in the beginning of the royalty definition. Accordingly, the nature of transfer shall
need to be analyzed to determine the classification of income as royalty or as capital gains, for
determination of taxability of the same.
Illustration:
Where there is an outright transfer of designs and drawing, and the transferor does not retain
any rights in the asset, the transfer would result in capital gains income to the transferor and it
would fall outside the ambit of royalty
The definition of “royalty” also includes services in the last limb of the definition. Services that
are rendered “in connection with” the activities mentioned in the earlier limbs of the definition
are also sought to be taxed as royalties under the Income-tax Act. The inclusion of services in
the royalty definition is likely to result in classification issues and overlaps between royalty and
fees for technical service (section 9(1)(vii) discussed in point 7 below) income streams.
1.3.7 Section 9(1)(vii)
Any Fees for technical services (‘FTS’) will be deemed to accrue or arise in India if they are
payable by-
(b) a person who is a resident, except where the fees are payable in respect of services
utilised in a business or profession carried on by such person outside India or for the
purposes of making or earning any income from any source outside India ; or
(c) a person who is a non-resident, where the fees are payable in respect of services
utilised in a business or profession carried on by such person in India or for the
purposes of making or earning any income from any source in India :
Provided that nothing contained in this clause shall apply in relation to any income by way of
fees for technical services payable in pursuance of an agreement made before the 1st day of
April, 1976, and approved by the Central Government.
The term ‘FTS’ has been defined in Explanation 2 to section 9(1)(vii) to mean any
consideration (including any lumpsum consideration) received for rendering of any technical,
managerial or consultancy services (including the provision of services of technical or other
personnel) but does not include income which would be chargeable under the head ‘salaries’
or consideration for any construction, assembly, mining projects.
The term technical, managerial or consultancy services are not defined in the Income-tax Act.
However based on general understanding and various judicial precedents, the same would
generally be interpreted as under:
Managerial services
The ordinary meaning of the term ‘managerial’ would suggest that the services rendered ought
to be in the nature of management services. It may involve controlling, directing and
administering the business. The term ‘managerial services’ may also be construed to be
involving functions related to how a business is run as opposed to functions involved in
carrying on that business. For example, function of hiring and training commercial agents
would be ‘managerial services’, whereas the actual selling function performed by these hired
commercial agents would not be so.
Consultancy
The provision of advice by a professionally qualified person would be ‘consultancy services’. It
can also mean the act of offering expert or professional advice in a field.
Technical
The term technical services may be meant to be services relating to, or involving the practical,
mechanical, or industrial arts or the applied sciences.
Explanation to section 9(2)
Explanation to section 9(2) clarifies that for the purposes of section 9, income of a non-
resident shall be deemed to accrue or arise in India under clause (v) or (vi) or (vii) of
subsection (1) of section 9 (i.e. interest or royalty or fees for technical services respectively)
and shall be included in the total income of the non-resident, whether or not:
(i) the non-resident has a residence or place of business or business connection in India;
or
(ii) the non-resident has rendered services in India.
Determination of income taxable in India of a Non-resident:
Sections 5 to section 9 as discussed above define the scope of total income of a non-resident
taxable in India under the Income tax Act. However considering that the non-resident may be
subject to tax on the same income in country of residence, India has entered into Double Tax
Avoidance Agreements [DTAAs] with various countries with a view to avoid double taxation
and for granting relief in respect of income on which tax has been paid both in India and
country of residence.
Accordingly, where DTAA exists between India and the specified country, the non-resident
who is eligible for such treaty has an option to apply either the provisions of the Act or the
treaty whichever is more beneficial. Hence it is very important to do a comparative analysis of
DTAA provisions vis-à-vis domestic tax provisions where a non-resident is entitled to benefits
of DTAA as the latter may afford a non-resident to be rather not taxable at all due to restricted
meaning/ coverage of relevant income or to lower rate of taxes where the DTAA so provides.
2. Basis of Tax Computation

2.1 Introduction – Business Connection/ Permanent Establishment
The Indian Income-tax Act, 1961 (‘the Act’) provides for levy of income-tax on the income of
foreign companies and non-residents, but only to the extent of their income sourced from
India. Under section 5 of the Act, a foreign company or any other non-resident person is
liable to tax on income which is received or is deemed to be received in India by or on
behalf of such person, or income which accrues or arises or is deemed to accrue or arise to
it in India.
Section 9 thereafter specifies certain types of income that are deemed to accrue or arise in
India in certain circumstances. These two sections (viz section 5 and section 9) embody the
source rule of income taxation in the domestic law. Income of a non-resident can only be
taxed in India if it falls within the four corners of section 5 read with section 9 of the Act.
2.2 Business connection under the Act
Section 9(1) of the Act specifies the income to be taxed in India, including income arising from
‘business connection’ in India. The term ‘business connection’ is the Indian equivalent of PE in
the international double taxation conventions and creates a charge for all income arising
directly or indirectly, through or from any business connection/ activity in India.
Though the term ‘business connection’ has not been expressly defined in the Act, Explanation
1 and Explanation 2 to section 9(1)(i) of the Act deal with the situation which may lead to
business connection and provides for certain cases of inclusions and exclusions therefrom.
To begin with, Explanation 1 to section 9(1)(i) carves out certain exceptions from income
deemed to accrue or arise in India [which are covered under section 9(1)(i)] and are briefly
stated as below :
Further, business connection also includes any business activity carried out by a non-resident
through a person acting on behalf of the non-resident. These cases are covered under
Explanation 2 to section 9(1)(i), and are as follows:
Under Explanation 2 to section 9(1)(i) as enumerated above, business connection shall not
exist where the business activities are carried through a broker, general commission agent or
any other agent of independent status, if such person is acting in the ordinary course of his
business.
2.3 Business Connection – Mode of computation of income
2.3.1 Under the Act
Section 9 of the ITA does not seek to bring into tax net the profits of a non-resident, which
cannot reasonably be attributed to operations carried out in India. Business income of a
foreign company or other non-resident person is chargeable to tax to the extent it accrues
or arises through a business connection in India or from any asset or source of income
located in India, and to the extent such income is attributable to the operations carried out
in India.
Further, there is a specific provision, ie Explanation 3 to section 9(1)(i), which provides that,
where a business is carried on in India by a non-resident through a person referred to in
clause (a), (b), (c) of Explanation 2 to section 9(1)(i) as stated above, only so much of income
as is attributable to operations carried out in India shall be deemed to accrue or arise in India.
Rule 10 of the Income Tax Rules, 1962 ('the Rules') lays down the procedure to be followed
for determination of income in the case of non-residents. The Rule provides that where the
actual amount of income accruing or arising to a non-resident cannot be specifically
determined, the income accruing to the business connection may be determined:
(i) at such percentage of the turnover so accruing or arising as the Assessing Officer may
consider to be reasonable, or
(ii) on any amount which bears the same proportion to the total profits and gains of the
business of such person (such profits and gains being computed in accordance with the
provisions of the Act), as the receipts so accruing or arising bear to the total receipts of
the business, or
(iii) in such other manner as the Assessing Officer may deem suitable.
2.3.2 Computation of Income under the Act
For computation of total income of a taxpayer, the Act has classified income under five heads,
viz. Salaries; Income from house property; Profits and gains of business or profession; Capital
gains; and. Income from other sources. Different rules govern computation of income falling
under each of the specific head.
Computation of income of a non-resident arising from business connection in India is covered
under the head "Profits and gains of business or profession" under sections 28 to 44DB.
These sections provide for certain expenses, allowances, disallowances, etc. which are to be
factored while determining taxable profits.
2.4 Typical method of computation of income under the head “Profits
and Gains from Business or Profession” under various scenarios
A non-resident carrying out business operations in India can choose to operate through either
of the following ways:
A non-resident operating directly or through its branch office or a project office in India, has an
option to offer income to tax either on net basis or gross basis (i.e. presumptive tax regime)
depending on the nature of business activities.
Once the income is classified under the ambit of section 28, effect has to be given to expenses
allowable/ disallowable as stated above, so that the net taxable income can be computed
appropriately.
2.4.1 Treatment of Head office expenditure
Non-residents carrying on business activities in India generally have their head office (‘HO’)
situated outside and their branch/branches situated in India. In computing the taxable income
of the BO/ PE in India, apart from the deduction of allowable expenses, the BO would normally
claim deduction in respect of certain portion of the general administrative expenses incurred
by the foreign HOs, which are attributable to the branch operations in India.
Section 44C of the Act lays down certain ceiling limits for the deduction of HO expenses in
computing the taxable profits in the case of non-resident taxpayers. This section applies to all
non-resident taxpayers and not only to foreign companies.
A non-resident can claim expenditure in the nature of executive and general administration
incurred by HO outside India against the taxable profits of BO situated in India, which shall be
lower of:
Where the adjusted total income of the taxpayer is a loss, the amount shall be computed at
the rate of 5 percent of the average adjusted total income of the taxpayer. The term average
adjusted total income in relation to different circumstances is summarized in the following
table.
Where the total income of BO/ PO is Average ATI

assessable for
3 assessment years (AYs) immediately 1/3rd of the aggregate amount of ATI in
preceding the relevant AY respect of such AYs
2 AYs immediately preceding the relevant AY 1/2 of the aggregate amount of the ATI
1 AY immediately preceding the relevant AY ATI of the preceding AY
The term ‘executive and general administration expenditure' includes expenditure incurred in
respect of:
(a) Rent, rates, taxes, repairs or insurance of any premises outside India used for the
purposes of the business or profession;
(b) Salary, wages, annuity, pension, fees, bonus, commission, gratuity, perquisites or
profits in lieu of or in addition to salary, whether paid or allowed to any employee or
other person employed in, or managing the affairs of, any office outside India;
(c) Travelling by any employee or other person employed in, or managing the affairs of,
any office outside India; and
(d) Such other matters connected with executive and general administration as may be
prescribed.
2.4.2 Gross/ presumptive basis of taxation

As per the provisions of the Act, a person engaged in business is required to maintain
regular books of account as per the provisions of section 44AA and further get his accounts
audited under section 44AB.
To give relief to specified taxpayers from the tedious work of preparing and maintaining
books of account, the Act has framed the presumptive taxation scheme under sections,
44AE, 44B, 44BB, 44BBA and 44BBB. Under the presumptive taxation scheme, certain
percentage of the gross receipts/ turnover is deemed to be profits of a taxpayer. However,
a person adopting the presumptive taxation scheme has an option to maintain books of
account and get his books of account audited u/s 44AB and offer lower profits and gains to
tax in India as compared to the profits and gains estimated under the presumptive basis of
taxation.
Illustrative Gross/ presumptive basis of taxation under the Act
(a) Sections 44B: Shipping Business
Section 44B is a special provision for computing profits and gains of shipping business of a
non-resident taxpayer. In the case of non-residents, such profits and gains will be taken at
an amount equal to 7.5 percent of the amount paid or payable to the non-resident or to any
other person on his behalf on account of the carriage of passengers, livestock, mail or
goods shipped at any Indian port as also of the amount received or deemed to be received
in India on account of the carriage of passengers, livestock, mail or goods shipped at any
port outside India.
(b) Section 172: Shipping business
Section 172 is a complete code in itself and is a special provision for taxation of occasional
shipping business of non-residents. In the case of non-resident, any income derived from
carrying passengers, livestock, mail or goods shipped at a port in India, is taxed in the year
of its earnings. Such profits and gains will be taken at an amount equal to 7.5 percent of the
amount paid or payable on account of such carriage. The ship is allowed to leave the port if
the tax on such income has been paid or alternative arrangements to pay tax are made.
However, the taxpayer has an option to be assessed in accordance with the other
provisions of the Act.
(c) Section 44BB: Business of Providing Services and Facilities in Connection with
Exploration etc. of Mineral Oils
Section 44BB is a special provision for computation of taxable income of a non-resident
taxpayer engaged in the business of providing services or facilities in connection with, or
supplying plant and machinery on hire, used or to be used, in the prospecting for, or
extraction or production of, mineral oils.
As per section 44BB, 10 percent of the amount paid or payable to, or the amount received
or receivable by, the taxpayer for provision of such services or facilities or supply of plant
and machinery shall be deemed to be the taxable income of such non-resident taxpayer.
(d) Section 44BBA: Special provision for computing profits and gains of the business
of operation of aircraft in the case of non-residents
Notwithstanding anything to the contrary contained in sections 28 to 43A, in the case of an
assessee, being a non-resident, engaged in the business of operation of aircraft, a sum
equal to five per cent of the aggregate of the amounts specified in sub-section (2) shall be
deemed to be the profits and gains of such business chargeable to tax under the head
"Profits and gains of business or profession".
(2) The amounts referred to in sub-section (1) shall be the following, namely :—
(a) the amount paid or payable (whether in or out of India) to the assessee or to any
person on his behalf on account of the carriage of passengers, livestock, mail or
goods from any place in India; and
(b) the amount received or deemed to be received in India by or on behalf of the
assessee on account of the carriage of passengers, livestock, mail or goods from
any place outside India.
(e) Section 44BBB: Profits and Gains of Foreign Companies engaged in the Business of
Civil Construction, etc
Section 44BBB applies to income of a foreign company engaged in the business of civil
construction or the business of erection of plant or machinery or testing or commissioning
thereof, in connection with turnkey power projects.
It provides for determination of the income of non-resident taxpayers on presumptive basis
at a flat rate of 10 percent of the amount paid or payable to such taxpayer or to any person
on his behalf, whether in or out of India. For this purpose, the turnkey power project should
be approved by the Central Government.
(f) Special provision for computing income by way of Royalties, etc, in case of non-
residents (Section 44DA and section 115A)
Where income is effectively connected to a PE in India (Section 44DA)
Income by way of royalty or fees for technical services received from Government or an
Indian concern in pursuance of an agreement made by a non-resident (including a foreign
company) with Government or the Indian concern would be computed under the head
“Profit and gains of business or profession” in accordance with the provisions of the Act on
net basis. While computing income under section 44DA, deduction would be allowed in
respect of any expenditure or allowance which is wholly and exclusively incurred for the
business of the PE or fixed place of profession in India. Taxability under section 44DA of
the Act would be at an effective rate of 40 percent (plus applicable surcharge and cess) on
net income basis.
(f) Where income is not effectively connected to a PE in India or in absence of PE

(Section 115A)
On the other hand, in absence of PE, royalty or fees for technical services received from
Government or an Indian concern in pursuance of an agreement made by a non-resident
with Government or the Indian concern is taxable at the rate of 10 percent 3 (plus applicable
surcharge and education cess) as provided under section 115A of the Act (subject to
certain conditions).
As stated earlier, where a business is carried on in India by a non-resident through person
referred as agent as per Explanation 2 to section 9(1)(i) above, only so much of the income of
the non-resident as is attributable to the operations carried out in India shall be taxable in
India.
Circular No. 23 dated 23rd July 1969 stated that only that portion of profit which can
reasonably be attributed to the operations of the business carried out in India, is liable to
income-tax. The said Circular No. 23 provided clarifications envisaged to be useful in deciding
the application of provisions of section 9 in certain specific situations including sale of goods
by a non-resident through an Indian agent.
Thereafter Circular No. 163 was issued on 29 May 1975 which clarified that tax liability will not
be trigged for a non-resident in India where the activity is restricted to purchase of goods
through an agent for export out of India.
The above circulars have been withdrawn by Central Board of Direct Taxes (‘CBDT’) with
effect from 22 October 2009. The said circular has been relied upon in several judgements to
determine attribution in the case of DAPE.
Where the tax officer is of the opinion that income arising to a non-resident cannot be properly
ascertained, he may also resort to adopt Rule 10 of the Income Tax Rules for attribution of
income.
As can be seen, there is no much guidance on the attribution of the profits to DAPE and
accordingly, the taxability would need to be evaluated, having regard to the provisions of the
Act and the judicial precedents available on the subject.
2.4.3 Disallowance due to default in deduction of tax at source (‘TDS’)
Entities making payments to non-residents that are taxable in India are required to withhold
tax on the payments, which are set off against the recipient’s actual tax liability. On the other
hand, withholding tax on payments to residents have been made applicable only in case of
specified payments under the Act, such as salary payments, payments to contractors and
payments towards rent, commission and fees for professional and technical services.
3 Recently amended by the Finance Act, 2015, with effect from Assessment Year 2016-17
As a step toward enforcing compliance of TDS provisions, the legislature has provided for
disallowance of certain expenses where taxes have not deducted or after deduction have not
been deposited with the Government, while computing the taxable profits under ‘net’ basis of
taxation.
A brief summary of such disallowances are as under:
Section Description
40(a)(i) Any sum (other than salary) payable outside India or to a non-resident,
which is chargeable to tax in India in the hands of the recipient, shall not be
allowed to be deducted if it was paid without deduction of tax at source or if
tax was deducted but not deposited with the Central Government till the due
date of filing of return.
However, if tax is deducted or deposited in subsequent year, as the case
may be, the expenditure shall be allowed as deduction in that year.
40(a)(ia) Any sum payable to a resident, which is subject to deduction of tax at

source, would attract 30 percent disallowance if it was paid without
deduction of tax at source or if tax was deducted but not deposited with the
Central Government till the due date of filing of return.
However, where in respect of any such sum, tax is deducted or deposited in
subsequent year, as the case may be, the expenditure so disallowed shall
be allowed as deduction in that year.
40(a)(iii) Salaries payable outside India, or in India to a non-resident, on which tax

has not been paid/deducted at source is not deductible.
40(a)(iv) Payments to provident fund or other funds for employees’ benefit shall not
be deductible if no effective arrangements have been made to ensure
deduction of Tax at source from payments made from such funds to
employees which shall be chargeable to tax as ‘salaries’.
Non-deduction/ non-payment of TDS may result in treating the person responsible for
deducting the tax as “assessee in default” and accordingly, consequences for being an
“assessee in default” will follow.
2.5 Applicability of Minimum Alternate Tax (MAT) provisions

If the income tax payable by a taxpayer on its total income as computed under the Act in
respect of any previous year, is less than 18.5 percent of such book profit (computed as per
the manner laid down in the Act) plus surcharge plus education cess then such book profit
shall be treated as total income of the company and the tax payable for the relevant previous
year shall be deemed to be 18.5 percent of such book profit under section 115JB. This non-
absolute provision will override any other provision of the Income Tax Act. Thus, where the
income-tax payable is less than 18.5 percent of book profit, such book profit will be deemed to
be total Income and MAT will be payable @ 18.5 percent on such book profit plus surcharge
plus education cess.
Credit for excess taxes paid as MAT as per section 115JB in earlier years (in which MAT
liability was more than tax liability as per normal provisions of the Act) is available in the
assessment year in which tax payable on the total income computed under the normal
provisions of this Act is more than tax payable under section 115JB for that assessment year.
Circular- not to levy Mat on foreign companies
As per recent Instruction No. 111/2015 F. No.153 /12/2015-TPL dated 23rd December, 2015,
with effect from 1-4-2001, the provisions of section 115JB shall not be applicable to a foreign
company (including an FII/FPI) if—
(i) the foreign company is a resident of a country with which India has a Double Taxation
Avoidance Agreement and such foreign company does not have a permanent
establishment in accordance with the provisions of the relevant Double Taxation
Avoidance Agreement, or
(ii) the foreign company is a resident of a country with which India does not have a
Double Taxation Avoidance Agreement and such foreign company is not required to
seek registration under section 592 of the Companies Act, 1956 or section 380 of the
Companies Act, 2013.
Source
• International Taxation - A Compendium, The Chamber of Tax Consultants
• Sampath Iyengar’s Law of Income Tax
• Chaturvedi & Pithisaria’s Income Tax Law
• Other articles on public domain
3. Treatment of Tax Losses – How Domestic Tax System

Impact Non-resident
3.1 Introduction
Diagrammatic depiction of inter-head set off of losses in the year in which such loss is
incurred is given below:
Head/ Below losses can be adjusted as follows in the year in which they are incurred:
Source of House Business Loss from Loss from Long term Short Other Loss from
Income property Loss specified speculatio capital term sources owning
loss of (other business n loss capital loss and
the than business loss (other maintaini
current speculati than loss ng race
year set on or from race horses
off specified horses) of
business the
loss) of current
the year set
current off
year set
off
Salary  X X X X X  X
House Can be  X X X X  X
property adjusted
against
income
from any
other
property
under the
head
income
from
house
property
Non  Can be X X 
Speculati adjusted
on against
Business income X X X
income from any
other non
business the
loss) of current
the year set
current off
year set
off
speculatio
n business
Speculatio   X 
n Business  X X X
income
Specified    
business
income X X X X
(Section
35AD)
Short-   X 
term
capital X X  X
gain
Long term   X 
capital
gain X   X
Other   X Can be
sources adjusted
(excluding against
profit income
from from any
owning source
X X X X
and under the
maintainin head
g race income
horses) from other
business the
loss) of current
the year set
current off
year set
off
sources
Profit   X X X X  
from
owning
and
maintainin
g race
horses
Note:
‘’ denotes eligible for set off
‘X’ denotes not eligible for set off
Short term Capital Loss (3,00,000)
Long term Capital Gain 2,00,000
Total income/ (loss) under the head capital
gains after intra-head adjustment as per section (1,00,000)
70
Step 2 : Inter-head adjustment – Section 71
Loss under the head house property (8,000)
Loss under the head profits or gains from business (1,00,000)
or profession (refer Note 1)
Income under the head salaries 2,00,000
Loss under the head capital gains (refer Note 2) (1,00,000)
Total income of Mr R after inter-head
adjustment under section 71 1,92,000
Note 1:
Loss under the head profits or gains from business
or profession can be set off against income under
any other head of income except income under the
head salaries.
Note 2:
Short term capital loss can be set off only against
short term capital gains and long term capital gains
Total taxable income of Mr R for AY 2016-17 1,92,000
3.2 Carry forward and set off of Losses

During a particular financial year, it may so happen that even after making intra-head and
inter-head adjustments, still the loss remains unadjusted (ie there is no sufficient income to
absorb the loss). Such unabsorbed loss can be carried forward and set off against income of
the taxpayer in future years as enumerated below:
Section Nature of loss to Maximum To be set off against Para

be carried forward permissible Reference
period for
carry
forward of
losses
71B Loss from house 8 years Income from house -
property property
72 Unabsorbed 8 years Income under the head C
business loss Profits or gains from
business or profession
32(2) Unabsorbed Indefinite Any head of income C
depreciation period except income under the
head salaries
73 Speculation 4 years Income from Speculation D
business loss business only
73A Loss from Specified Indefinite Income from Specified E
business under period business under section
section 35AD 35AD only
74 Capital Gains 8 years Short term Capital gain F
Short term Capital Long term Capital gain
Loss
Long term Capital 8 years Long term Capital gain

Loss only
74A Loss from certain 4 years Income from owning and G
specified sources maintaining race horses
falling under the only
head ‘Income from
other sources’
ie Loss from owning
and maintaining
race horses *
* Loss from any source other than owning and maintaining race horses under the head income
from other sources cannot be carried forward to subsequent year for set off.
Carry forward of losses (other than loss from house property and unabsorbed depreciation) is
permissible only if the return of income for the year in which the loss is incurred is filed within
the due date of filing of return of income (Section 80). However unabsorbed depreciation can
be carried forward to the subsequent previous year even if the return is not filed within the due
date.
If in any particular assessment year, even after intra-head and inter-head adjustment, the net-
result under the head profits or gains from business or profession is a loss, the same can be
carried forward for a maximum period of 8 years immediately succeeding the year in which the
loss was incurred. Such losses so carried forward can be set off only against income under
the head ‘Profit and gains of business and profession’ in the subsequent assessment year.
The above provisions are not applicable in case of unabsorbed depreciation.
In a particular year, if there is no income under the head profits and gains from business or
profession or the income under the head profits and gains from business or profession is less
than the depreciation allowed to the taxpayer as per section 32 then the amount of
depreciation which remains to be absorbed against the said income is called unabsorbed
depreciation.
Unabsorbed depreciation can be carried forward for indefinite period and can be set off
against income under any head of income. Unabsorbed depreciation can be carried forward
and set off even if the business owing to which depreciation was allowed ceases to exist.
Section 72(2) prescribes the order in which the business losses shall be set off. In a case
where the business profits are insufficient to absorb the current depreciation allowance,
brought forward business losses and unabsorbed depreciation, the same should be set off in
the following order:
Illustration:
Following are the details of income/ loss earned by Permanent Establishment (PE) in India of
X Inc, a company incorporated in USA.
For AY 2015-16
Particulars Amount (In Rs)
Profits or gains / (loss) from business or profession
Business Loss (2,00,000)
Unabsorbed depreciation (1,00,000)
Note:
The return of income of the PE was filed on 15 December 2015 however the due date of filing
of return of income was 30 November 2015.
For AY 2016-17
Particulars Amount (In Rs)

Business Income 2,00,000
Computation of income of PE of X Inc for AY 2016-17:
Particulars Amount (In Rs) Amount (In Rs)
Business Income 2,00,000
Less: Brought forward business loss of AY 2015-16 Nil
(refer Note1) (1,00,000) 1,00,000
Less: Unabsorbed depreciation
Total taxable income of PE of X Inc for AY 2016- 1,00,000
17
Note 1:
Business loss of AY 2015-16 cannot be carried
forward and set off in AY 2016-17 since the return of
income for AY 2015-16 was not filed within the due
date (Section 80).
4. Foreign Tax Relief

4.1 Introduction
What is Foreign Tax Relief or Foreign Tax Credit?
In simple words, when a credit is given by a country for taxes paid in another country, it is
called as Foreign Tax Credit. One of the fundamental principles of international taxation is that
no income should be taxed twice in the hands of the same person. Thus, the objective of the
foreign tax credit is to avoid the double-taxation burden in accordance with the Double
Taxation Avoidance Agreements (‘DTAA’) that have been entered into between various
countries. Article 23 of the DTAAs generally provide for the bilateral relief from double taxation
and Section 91 of the Indian Income Tax Act, 1961 (‘the Act’) provides for a unilateral relief
under the Indian domestic law.
Why Foreign Tax Credit?
The DTAAs are entered into to avoid double taxation of the same income in the hands of one
person in more than one jurisdiction. Thus, the basic aim of the DTAA is achieved by
assigning an exclusive right of taxation to either of the countries for different categories of
income.
However, when such exclusivity is not possible and conflicting claims to levy tax are not
reconciled and both the countries insist upon exercising their right, it leads to double taxation.
This arises due to difference in the approaches adopted by the countries in treaty negotiation.
Given the above, Article 23 of the DTAAs provides a mechanism to eliminate double taxation
where the same income is taxable in the hands of one person in both the Contracting States/
countries. Typically, as per Article 23, it is the Country of Residence (‘COR’) which is obliged
to give credit for taxes paid in the Country of Source. The method by which the COR provides
relief from double taxation depends primarily on its general tax policy and the structure of its
tax systems and DTAAs.
4.2 Methods of granting Foreign Tax Relief
A pictorial representation about the methods which are generally applied for granting foreign
tax relief is depicted below:
As can be seen, there are two primary methods for eliminating double taxation – (i) Unilateral
credit, which is given under the domestic laws of a particular country and (ii) Bilateral credit,
which is given under the provisions of the DTAA.
4.2.1 Unilateral credit

A unilateral credit/ relief is provided by a country in its domestic tax laws to provide relief to its
residents for the foreign sourced income which is doubly taxed. Many countries including India
have provisions in their local domestic laws offering unilateral credit in respect of such doubly
taxed income in order to mitigate the adverse impact of double taxation.
Section 91(1) of the Act contains provisions dealing with Foreign Tax Credit (FTC) for
countries with which India does not have a DTAA. The text of the section is reproduced below:
‘If any person who is resident in India in any previous year proves that, in respect of his
income which accrued or arose during that previous year outside India (and which is not
deemed to accrue or arise in India), he has paid in any country with which there is no
agreement under section 90 for the relief or avoidance of double taxation, income-tax,
by deduction or otherwise, under the law in force in that country, he shall be entitled to
the deduction from the Indian income-tax payable by him of a sum calculated on such
doubly taxed income at the Indian rate of tax or the rate of tax of the said country,
whichever is the lower, or at the Indian rate of tax if both the rates are equal.’
Conditions to be satisfied to avail FTC under section 91 of the Act
Accordingly, in case of income arising to the assessee in countries with which India does not
have a DTAA, foreign tax relief would be granted under section 91 of the Act provided all the
conditions mentioned therein are fulfilled.
Method of computation of relief as per section 91 of the Act
Thus, FTC = Lower of “Indian rate of Income tax” or the “foreign rate of tax” on the doubly
taxed income
Illustrations:
•
Tax in country X 100,000*35% = 35,000
Tax in India 100,000*30% = 30,000
Doubly taxed income 100,000
FTC available [lower of (a) and (b)] 30,000
Actual tax payable in India Nil
• Income of Mr Y, an Indian resident, is tabulated below:
Foreign business income 250,000
Business loss in India (100,000)

Other income in India 50,000
Total income 200,000
Tax rate in foreign country 20%
Tax rate in India 30%
In the above example, foreign tax relief would be granted on ‘doubly taxed income’ which is
200,000 in this case. Thus, the tax liability in India would be as follows:
Net taxable income 200,000
Tax @ 30% 60,000
Less: Foreign Tax Credit (200*20%) (as the tax rate in (40,000)
foreign country is lower than the Indian tax rate)
Tax liability in India 20,000
4.2.2 Bilateral credit
Under section 90 read with treaties signed by Government with other countries tax credit is
available depending on the language of DTAA. Under this method, the Governments of two
countries enter into an agreement to provide relief against double taxation by mutually working
out the basis on which the relief is to be granted. India has entered into DTAA’s with more
than 98 countries as on date.
4.3 Foreign tax Credit Rules

Rule 128 has been inserted by the Income-tax (Eighteenth Amendment) Rules, 2016, w.e.f. 1-
4-2017 pertaining to Foreign Tax Credit. It provides as under:
(1) An assessee, being a resident shall be allowed a credit for the amount of any foreign tax
paid by him in a country or specified territory outside India, by way of deduction or otherwise,
in the year in which the income corresponding to such tax has been offered to tax or assessed
to tax in India, in the manner and to the extent as specified in this rule :
Provided that in a case where income on which foreign tax has been paid or deducted, is
offered to tax in more than one year, credit of foreign tax shall be allowed across those years
in the same proportion in which the income is offered to tax or assessed to tax in India.
(2) The foreign tax referred to in sub-rule (1) shall mean,—
(a) in respect of a country or specified territory outside India with which India has entered
into an agreement for the relief or avoidance of double taxation of income in terms of
section 90 or section 90A, the tax covered under the said agreement;
(b) in respect of any other country or specified territory outside India, the tax payable under
the law in force in that country or specified territory in the nature of income-tax referred
to in clause (iv) of the Explanation to section 91.
(3) The credit under sub-rule (1) shall be available against the amount of tax, surcharge and
cess payable under the Act but not in respect of any sum payable by way of interest, fee or
penalty.
(4) No credit under sub-rule (1) shall be available in respect of any amount of foreign tax or
part thereof which is disputed in any manner by the assessee:
Provided that the credit of such disputed tax shall be allowed for the year in which such
income is offered to tax or assessed to tax in India if the assessee within six months from the
end of the month in which the dispute is finally settled, furnishes evidence of settlement of
dispute and an evidence to the effect that the liability for payment of such foreign tax has been
discharged by him and furnishes an undertaking that no refund in respect of such amount has
directly or indirectly been claimed or shall be claimed.
(5) The credit of foreign tax shall be the aggregate of the amounts of credit computed
separately for each source of income arising from a particular country or specified territory
outside India and shall be given effect to in the following manner:—
(i) the credit shall be the lower of the tax payable under the Act on such income and the
foreign tax paid on such income :
Provided that where the foreign tax paid exceeds the amount of tax payable in
accordance with the provisions of the agreement for relief or avoidance of double
taxation, such excess shall be ignored for the purposes of this clause;
(ii) the credit shall be determined by conversion of the currency of payment of foreign tax at
the telegraphic transfer buying rate on the last day of the month immediately preceding
the month in which such tax has been paid or deducted.
(6) In a case where any tax is payable under the provisions of section 115JB or section
115JC, the credit of foreign tax shall be allowed against such tax in the same manner as is
allowable against any tax payable under the provisions of the Act other than the provisions of
the said sections (hereafter referred to as the "normal provisions").
(7) Where the amount of foreign tax credit available against the tax payable under the
provisions of section 115JB or section 115JC exceeds the amount of tax credit available
against the normal provisions, then while computing the amount of credit under section
115JAA or section 115JD in respect of the taxes paid under section 115JB or section 115JC,
as the case may be, such excess shall be ignored.
(8) Credit of any foreign tax shall be allowed on furnishing the following documents by the
assessee, namely:—
(i) a statement of income from the country or specified territory outside India offered for tax
for the previous year and of foreign tax deducted or paid on such income in Form No.67
and verified in the manner specified therein;
(ii) certificate or statement specifying the nature of income and the amount of tax deducted
therefrom or paid by the assessee,—
(a) from the tax authority of the country or the specified territory outside India; or
(b) from the person responsible for deduction of such tax; or
(c) signed by the assessee:
Provided that the statement furnished by the assessee in clause (c) shall be valid if it is
accompanied by,—
(A) an acknowledgement of online payment or bank counter foil or challan for
payment of tax where the payment has been made by the assessee;
(B) proof of deduction where the tax has been deducted.
(9) The statement in Form No.67 referred to in clause (i) of sub-rule (8) and the certificate or
the statement referred to in clause (ii) of sub-rule (8) shall be furnished on or before the due
date specified for furnishing the return of income under sub-section (1) of section 139, in the
manner specified for furnishing such return of income.
(10) Form No.67 shall also be furnished in a case where the carry backward of loss of the
current year results in refund of foreign tax for which credit has been claimed in any earlier
previous year or years.
Explanation.—For the purposes of this rule 'telegraphic transfer buying rate' shall have the
same meaning as assigned to it in Explanation to rule 26.
5. Authority for Advance Ruling

5.1 Introduction and background
Since the adoption the of new economic policy of liberalization, privatization and
globalization in 1991, the foreign direct investments (‘FDI’) and joint ventures involving
Indian Companies have increased.
To facilitate foreign investment into the country a number of steps have been taken by the
Government of India in the past. Setting up an Authority for Advance Rulings (‘AAR’) to give
binding rulings, in advance, on Income Tax matters pertaining to an investment venture in
India is one such measure.
The scheme of advance rulings (Chapter XIX-B) was introduced from 1st June, 1993 in the
Income-tax Act, 1961 (‘the Act’) for the benefit of non-residents (‘NR’), to enable them to
obtain a ruling in advance from the AAR. This measure ensured that they are not saddled
with problems of uncertainty with regard to the taxability of income arising out of activities
or transactions undertaken or proposed to be undertaken in India. This scheme sought to
expedite the resolution of disputes between the Income-tax authorities and the taxpayers to
achieve finality of a particular transaction in a simple and inexpensive manner.
The provisions of law pertaining to AAR are covered under sections 245N to 245V of the
Act (Chapter XIX – B) and the procedure is spelt out in Income-tax Rules, 1962 – Rules
44E and 44F and also the Authority for Advance Ruling (Procedure) Rules, 1996 [‘Rules’].
5.2 Importance and advantages of AAR

Advance Rulings are an indispensable tool in the modern world of tax administration and
compliance. Very useful material on the advantages to be achieved by such a system is
found in the reports of official commissions or working parties established in many
countries to investigate and advise on tax reforms generally, or the need for establishing a
system of formal rulings specifically.
5.3 Importance of AAR
(a) To foster and encourage self-assessment;
(b) To contribute to good relations between income tax administrators and the general
public;
(c) To give certainty to transactions;
(d) To give more consistency in the application of the law;
(e) To minimize controversy and litigation; and
(f) To achieve a more coordinated system.
Another event that has led to an increase in uncertainty and, therefore, to a greater demand
for advance rulings is the introduction of General Anti-Avoidance Regulations (‘GAAR’) in
many countries. Such provisions contain potential overkill and could reach transactions that
have a perfectly legitimate business purpose. The GAAR, therefore, could become real
obstacle for genuine and desirable transactions, and an advance ruling mechanism could
provide the answer to break the potential deadlock.
W.e.f from 1 April 2015, an applicant, being resident or Non-resident, can approach AAR to
determine whether the transaction proposed to be undertaken is an impermissible avoidance
arrangement as referred to in Chapter X-A [special provision relating to GAAR]. GAAR
provisions are effective from 1 April 2017.
5.4 Advantages of AAR
Some of the advantages of seeking an advance ruling are:
(a) It enables the non-residents to ascertain the liability of income tax even before making
investments or entering into the transactions in India. Hence, the non-resident can
mould its investment plans accordingly to avoid long-drawn litigation;
(b) The authority is to pronounce its ruling within a statutory time limit of six months of the
receipt of the application. This enables the investor speedy resolution and draw up the
details of his transaction without undue delay on this account and ensure full certainty
regarding its tax implications;
(c) Complex issues of Income-tax including those concerning double taxation avoidance
agreements (DTAA) which arise as a result of difference in opinion between the tax
collectors and the tax-payers can be resolved;
(d) The rulings of the Authority are binding on the applicant as well as the Commissioner,
and the income-tax authorities subordinate to him. Further, having obtained the ruling
on a given set of facts the taxpayer may be sure about his liability not only for one year
but for all the years covered under the transaction unless there is a change in the facts
or law;
5.5 Composition of the AAR
The AAR comprises of three members:
(a) Chairman, who is a retired judge of the Supreme Court;
(b) Member from the Indian Revenue Service, who is qualified to be a member of the
Central Board of Direct Taxes; and
(c) Member from the Indian Legal Service who is, or is qualified to be, an Additional
Secretary to the Government of India.
Currently, the bench of the Authority is located at Delhi. Further, the Union Cabinet has
approved formation of two additional benches of AAR - one in New Delhi and other in
Mumbai 4.
The salaries and allowances payable to, and the terms and conditions of service of the
Members have been prescribed by the Government of India.
The constitution of the Authority is such that it functions as an independent quasi-judicial body
deemed to be a Civil Court for the purposes of section 195 of the Code of Criminal Procedure,
1973.
Application to the AAR
5.5.1 Who can make an application?
(a) Applicability to Non – residents 5
The AAR provisions were originally introduced to address resolution of tax disputes
arising in case of non-residents. NRs were the first set of taxpayers who came to be
included within the scope of AAR. Further an amendment was also brought which
enable residents to approach AAR for determining the tax liability of a non-resident
arising out of transaction undertaken by such resident. There is no threshold limit for
approaching AAR when an application is made by a NR
(b) Applicability to residents (effective from 1 October 2014)
The Finance (No.2) Act, 2014, introduced a new provision S.245N(a)(iia) which enables
a resident taxpayer to approach the AAR for determining his own tax liability in
advance.
4 Source : Press Information Bureau[pib.nic.in]

5Broadly divided into individual, Hindu Undivided Family, Company, Firm, Association of persons, any other
person.
Accordingly, a resident applicant can approach AAR for determining tax liability on
transactions entered by him either with Resident or Non-Resident. This provision is for
determining the resident’s own liability and not in relation to tax liability of another
person, with whom he may be transacting and the threshold limit qualifying for
approaching AAR under this provision is transactions valuing INR 100 Crores or more.
The Form and the Rules in this regard have been notified by the CBDT.
(c) Applicability to Public Sector Undertakings (PSU)
In order to rationalise the provisions in respect of a resident taxpayer, with effect from 1
October 1998, the Act covered PSUs as ‘applicant’ eligible to file application before
AAR. PSUs can approach AAR even in cases where the matter is pending before the
tax authority or the appellate authority.
(d) GAAR transactions covered within the ambit of meaning of “advance ruling”
An applicant, being resident or Non-resident, may approach AAR for the transaction to
be undertaken to determine whether the same is an impermissible avoidance
arrangement as referred in S.98(1) of the Chapter X-A [special provision relating to
avoidance of tax]. The aforementioned provision was introduced w.e.f 1 April 2015.
GAAR provisions to be effective only from 1 April 2017.
5.5.2 Questions on which Advance ruling can be sought
(a) Though the word "question" is unqualified, it is only proper to read it as a reference to
questions, of law or fact, pertaining to the income-tax liability (ie considering the
provisions of the Act and/or the relevant DTAA) of the applicant qua the transaction
undertaken or proposed to be undertaken.
(b) The questions may be on points of law as well as on fact; therefore, mixed questions of
law and fact can also be included in the application. The questions should be so drafted
that each question is capable of a brief answer. This may need breaking-up of complex
questions into two or more simple questions.
(c) The questions should arise out of the statement of facts given with the application. No
ruling will be given on a purely hypothetical or academic question. Questions not
specified in the application cannot be urged. Normally, a question is not allowed to be
amended but in deserving cases the Authority may allow amendment of one or more
questions.
(d) Even though the word used in the definition is `question', it is clear that the applicant
can raise more than one question in one application. This has been made amply clear
by the columns of the form of application for obtaining an advance ruling.
As discussed above, an AAR can be sought on any question of law or fact specified in the
application in relation to a transaction which has been undertaken, or is proposed to be
undertaken, by the non- resident applicant. However, an advance ruling cannot be sought
where the question:
(a) Is pending before other authorities

The Authority cannot allow any application where the question raised in it is already
pending before any income-tax authority, Tribunal or any Court. For eg: even a general
notice, say, notice for initiation of assessment proceedings may be regarded as
pendency of proceedings and may create an embargo on maintainability of application
before AAR.
(b) Involves determination of Fair Market value of any property
The second prohibition is on questions relating to the determination of fair market value
of any property, movable or immovable.
(c) Is designed prima facie for tax avoidance
Thirdly, the Authority would not allow any application if it relates to a transaction which
is designed prima facie for the avoidance of income-tax.
What can be said to be prima facie avoidance of income-tax? To determine whether a
particular transaction is designed, it is not necessary to go into greater factual details.
Clause (c) of the proviso to section 245R(2) refers only to the prima facie impression
created in the mind of the Authority on the facts stated before it. For eg, in the case of
XYZ [220 ITR 377] (AAR), where the British Bank holding shares in Indian Bank
indirectly through companies incorporated in Mauritius thereby indirectly gaining
benefits of DTAA between India and Mauritius, it was held that the transaction is prima
facie to avoid income-tax and cannot be adjudicated by AAR.
(d) Other points
Questions cannot be put before AAR with respect to quantification of income of a
taxpayer (eg quantum of taxable income/ profits of a PE of a taxpayer in a contracting
state) and for determination of arm’s length price under Indian Transfer Pricing
regulations.
The following table provides a summary of discussion above on various applicants who can
approach AAR for an advance ruling
Applicant Relevant Issue that can be put up Applicable limitations
Sections of before AAR
the Act
NR for his 245N(a)(i), Transaction undertaken • No pendency before tax
own tax 245N(b)(i) or proposed to be authority / Tribunal/ Court
liability undertaken by NR • Non determination of FMV
• Not relating to an issue
designed prima facie for tax
avoidance
Resident for 245N(a)(ii) Transaction undertaken • No pendency before tax
Applicant Relevant Issue that can be put up Applicable limitations

Sections of before AAR
the Act
determining 245N(b)(ii) or proposed to be authority /Tribunal/ Court
tax liability of undertaken by resident with • Non determination of FMV
a NR NR • Not relating to an issue
designed prima facie for tax
avoidance
Resident for 245N(a)(iia) Transaction undertaken • No pendency before tax
his own tax 245N(b)(iia) or proposed to be authority / Tribunal/ Court
liability undertaken by resident the • Non determination of FMV
value of which is INR • Not relating to an issue
100 crores or more designed prima facie for tax
avoidance
PSUs 245N(b)(iii) Transaction undertaken • Non determination of FMV
or proposed to be • Can file an application even
undertaken if the issue is pending before
the tax authority or the
Tribunal
Resident or 245N(a)(iv) Determination of whether an • No pendency before tax
NR himself 245N(b)(iiia) arrangement which is authority / Tribunal/ Court
proposed to be undertaken • Non determination of FMV
is an impermissible
avoidance arrangement
under Chapter XA
Examples of matters dealt by AAR
• Taxability of direct, Indirect transfer of shares of an Indian Company by a NR
Company eg Dana Corporation [321 ITR 178], Z [249 CTR 225], etc
• Taxability of payments received from use or sale of/ access to software - eg
Dassault Systems K.K. [ 322 ITR 125], Acclerys KK, [68 DTR 206], etc
6. Chapter-XX Tax Deduction at Source/Withholding taxes

6.1 Introduction
The tax deduction at source (TDS) is an important tool of revenue collection and therefore
more and more items of income are being added to the already substantial list of items liable
to TDS. The objective behind application of TDS provision to non residents is to save the
country from hassles of subsequent recoveries which may at times become difficult due to
geographical distances and different legal jurisdictions. Therefore, the burden is cast on the
“Person responsible for paying” to non-residents to deduct tax on the sum which is chargeable
to tax at the rates, either prescribed under the Act or under the appropriate Double Tax
Avoidance Agreement (DTAA), whichever is lower. This method has proved to be a very
effective tool in collection of taxes from the non-residents.
The withholding tax rate applicable for Non-resident being a company and/or other than
company: A.Y. 2019-20:
Sec. Applicability Time of Limit Rate
Deductor Deductee Deduction
192 Employer Employee At the time Basic Average

of Payment exempt-ion rate of
limit income-
tax
compute
d on the
basis of
the rates
in force
192A Trustees of the Individual At the time 50,000 10%
EPF Scheme or (Employee) of Payment (30% if
any authorised No PAN)
person under the
Scheme
193 Any person Any resident Earlier Of: > 10,000, 10%
responsible for Credit in case of
paying any or; 8% Savings
income by way of (Taxable)
Payment
interest on Bonds,
securities 2003
> 5,000, in
case of
interest on
debentures
issued by a
company in
which the
public are
substantiall
y interested,
paid or
credited to

a resident
individual or
HUF
No
threshold
specified in
any other
case.
194 Domestic Resident Earlier Of: 2,500, in 10%
Company Shareholder Declared/Dis case of an
tributed or; individual
Paid shareholder
, where
payment is
made by
A/c payee
cheque
194A Any Person Resident payee Earlier Of: 5000/ 10%
(Except Ind/HUF; Credited 10000** (for **Bank/P
not liable to audit or; Senior ost
u/s 44AB in the citizen Office
Paid
immediately 50,000)
preceding FY)
194B Any Person Any person At the time 10,000 30%
of Payment
194BB Any Person Any Person At the time 10,000 30%
of Payment
194C Any Person Any Resident Earlier Of: 30,000 1% (if
(Except Ind/HUF; contractor for Credit (single paid to
not liable to audit carrying out or; Payment) or Ind/ HUF)
u/s 44AB in the any work more than otherwis
Payment
immediately (including 1,00,000 e;
preceding FY) supply of during FY 2%
labour)
194D Any Person Any Resident Earlier Of: 15,000 5%
payee Credit
or;

Payment
194DA Any Person Any Resident At the time 100,000 1%
payee of Payment
194E Any Person Non-Resident Earlier Of: Income u/s 20%
Sportsman/ Credit 115BBA
Entertainer (not or;
Indian Citizen)/
Payment
non-resident
sports
association
194EE Payer; paying Any Payee At the time 2,500 10%
any amount as of Payment
referred u/s
80CCA(2)(a)
194F Payer; paying Any Payee At the time 20%
any amount as of Payment
referred u/s
80CCB
194G Any Person Any Payee Earlier Of: 15,000 5%
Credit
or;
Payment
194H Any Person Any Resident Earlier Of: 15,000 5%
(Except Ind/HUF; payee Credit
not liable to audit or;
u/s 44AB in the
Payment
immediately
preceding FY)
194I Any Person Any Resident Earlier Of: 1,80,000 10% (land
(Except Ind/HUF; payee Credit or
not liable to audit or; Building
u/s 44AB in the or
Payment
immediately Furniture)
preceding FY) plant and
machiner
y 2%

194IA Any Person (i.e. Any Resident Earlier Of: >50 Lakh 1%
Transferee) Transferor Credit
or;
Payment
194IB Individual /HUF Any Resident At the time 50,000 p.m. 5%
payee of credit of
rent, for the
last month of
the previous
year or the
last
month of
tenancy, if
the property
is vacated
during the
194J Any person, other Any resident At the time 30,000 in a - Payee
than an individual payee of credit of financial engaged
or HUF; such sum to year, for only in
However, in case the account each the
of fees for of the payee category of business
professional or or at the income. of
technical services time of (However, operatio
paid or credited, payment, this limit n of call
individual/HUF whichever is does not centre
whose total earlier. apply in 2%
sales, gross case of [w.e.f.
receipts or payment or 1st June,
turnover from director’s 2017]
business or fee or
profession remuneratio
n). - Others
carried on by him
10%
exceed the limits
specified u/s
44AB in the
immediately
preceding
financial year is

liable to deduct
tax at source u/s
194J, except
where such sum
is credited or
paid exclusively
for his personal
purposes.
194LA Any Person Any resident At the time 2,50,000 10%
Payee of Payment
194LB Any person Non-Resident Earlier Of: NA 5%
(Other than Credit
Company) or; or;
Foreign
Payment
company
194LC Indian Company Non-Resident Earlier Of: N. A. 5%
or business trust (Other than Credit
Company) or; or;
Foreign
Payment
company
194LD Any person Foreign Earlier Of: N. A. 5%
Institutional Credit
Investor or or;
Qualified
Payment
Foreign
Investor
195 Refer to
paragrap
hs below
196B The person Offshore Fund Earlier Of: 10
responsible for Credit
paying or;
Payment
196C The person Non-Resident Earlier Of: 10
responsible for Credit
paying or;

Payment
196D The person Foreign Earlier Of: 20
responsible for Institutional Credit
paying Investor or;
Payment
Snapshot of key provisions- S. 195, S. 197, S. 206AA, Rules & Circulars:
Section (S.)/ Rules Description
(R.) / Circular (C.)
S. 195 195(1): Scope and conditions for applicability
195(2): Application by payer to A.O. to determine the appropriate
portion of the sum chargeable to tax
195(3): Application by payee to A.O. for grant of a certificate for NIL /
Lower deduction of tax
195(4): Validity of certificate issued by the AO u/s 195(3)
195(5): CBDT power to make Rules in respect of Section 195(3)
195(6): Furnishing of prescribed information - CBDT empowered to
prescribed rules/ forms
Sec. 195(7): CBDT empowered to specify class of persons or cases
who shall make mandatorily application to AO for determination of
sum chargeable
S. 197 Certificate for deduction at lower rates
S. 206AA Tax rates applicable in absence of Permanent Account Number
R. 21AB Certificate for claiming relief under an agreement referred to in
sections 90 and 90A
R. 29B Payee to comply with conditions prescribed under Rule 29B before
making any application for nil withholding certificate
R. 37BB Furnishing of information by payer for making payment to non-
resident (amended by C.67 of 2013) [Form 15 CA & CB]
C.152/1974 Deduction of tax at source under section 195 of the Income-tax Act,
1961, from payments to non-residents
C.333/1982 Conflict between the provisions of the Income-tax Act, 1961, and the
provisions of the Double Taxation Avoidance Agreement
Section (S.)/ Rules Description

(R.) / Circular (C.)
C.370/1983 Deduction of tax at source under section 195 of the Income-tax Act,
1961, from payments to non-residents where tax is to be borne by
the payer
C.726/1995 Payments to persons resident in India by Foreign Companies or
foreign law firms that have no presence in India
C. 728/1995 Deduction of tax at source under section 195 of the Income-tax Act,
1961--Correct rates of tax applicable
C.785/1999 Issue of certificate for tax deducted at source in respect of payment
made "net of tax" in terms of section 195A of the Income-tax Act
1961
C.7/2007 Procedure for refund of tax deducted at source under section 195 to
the person deducting the tax – section 239 of the Income Tax 1961
Press Release Transactions which are liable to TDS at the higher rate under new
dated 20-01-2010 TDS provision applicable with effect from 1-4-2010 [S. 206AA]
6.2 Sec. 195(1) – ‘any person responsible for paying’ & ‘any sum
chargeable’
Unlike other provisions in Chapter XVII (TDS provisions), S.195 uses a special phrase “any
sum chargeable under the provisions of this Act” and casts a burden on any person
responsible for paying to a non-resident to deduct tax at source on any interest (not being
interest referred to in s.194LB, pr s.194LC or s. 194LD) or any other sum chargeable under
provisions of the Act. Section excludes income chargeable under the head “Salaries” and
dividend referred in s. 115-O at the rates in force. Salary is governed by s. 192 and not by s.
195.
6.2.1 Amount on which tax has to be deducted:
Person making payment to a non resident is liable to TDS irrespective of legal or residential
status of the payer or liability to withhold TDS under other provisions of the Act. For example,
individuals and HUFs who are not liable to TDS under general provisions of the Act are under
an obligation to TDS u/s. 195 in respect of payments to a non-resident, including payments in
India if such payments are chargeable to tax in India.
The Hon’ble Supreme Court in Transmission Corporation of A.P. Ltd. vs.CIT reported in 239
ITR 587 held that the provisions of s. 195 shall apply not only to the amounts which wholly
bear the character of income but also to gross sums, the whole of which may not be income or
profit, but have income element embedded therein.
This observation of the Hon’ble Supreme Court was misinterpreted by several authorities
taking a view that tax withholding was required on the gross sums paid to non-residents even
when only a portion of the remittance was chargeable to tax unless an application was made
to AO u/s. 195(2). This lead to considerable controversies and authorities taking divergent
views until the decision of the Hon. Supreme Court in GE India Technology Centre P. Limited
vs CIT & Others reported in 327 ITR 456(SC) wherein the Hon’ble Court clarified that tax has
to be deducted on the income element embedded in the payment and not on the whole sum,
except where income is taxable on gross basis.
The Hon’ble Supreme Court while deciding the issue categorically recognized that under the
provisions of s. 195, the words used were "any other sums chargeable under the provisions of
this Act" as against the term "any sum" used in the other provisions falling in Chapter XVII of
the Income-tax Act, 1961. The Hon’ble Court observed that obviously, what the AO was
demanding is that TDS is liable to be made under the provisions of section 195 of the Act. If
the provisions of section 195 are to be invoked, it is only such sum which is chargeable to tax
under the Income-tax Act, 1961 on which TDS can be made.
The CBDT Circular No. 152 dated 27.11.1974 has clarified that when it is not possible to know
or compute the exact income element, the deduction has to be on the whole (gross) amount
payable unless an order under s. 195(2) of the Act is obtained from the Income-tax Office
making determination of the appropriate portion as taxable income on which tax is deductible.
6.2.2 DTAA vs. the Act:
S.s 90 & 90A of the Act authorize Central Government to enter into DTAA with other countries/
ratify DTAA between other specified associations for granting relief in respect of income on
which tax is payable.
The purpose of such treaties is to avoid double taxation and sharing of tax revenue by two
states and not to create additional charge which is non-existent under the Act or levy
additional tax. Prior to insertion of s. 90(2) through the Finance (No. 2) Act, 1991, the Andhra
Pradesh High Court in CIT vs. Visakhapatnam Port Trust reported in 144 ITR 146 held that the
assessee is immune from liability either wholly or partly to levy income-tax in view of the
beneficial provisions of DTAA. This position was affirmed by the Hon’ble Supreme Court in
Union of India vs. Azadi Bachao Andolan reported in 263 ITR 706. The Supreme Court again
in CIT vs. Kulandagan Chettiar and Other Appeals (2004) reported in 267 ITR 654 (SC), held
that though sections 4 and 5 of the Act provide for taxation of global income, these sections,
however, will have to make way wherever there are provisions to the contrary under the
DTAA.
The provision of s. 90(2) inserted through the Finance (No. 2) Act, 1991 with retrospective
effect from 1-4-1972 is a statutory recognition of the rule laid down by the Andhra Pradesh
High Court which is subsequently affirmed by the CBDT Circular No. 333 dt. April 2, 1982
reported in 137 ITR 1 (st.). Insertion of s. 90(2) does not change the overriding nature of
DTAAs.
S. 90(2) provides an option to choose beneficial provisions of the Act. It is now well
established that even for the same type of income from two different countries, the assessee
can opt to be governed by DTAA for country A and opt for the provisions of the Act for country
B. For example, an Indian company having branches in state A and state B may opt for DTAA
in state A where the branch makes profit and opt for the provisions of the Act in state B where
the branch has incurred losses. It is also permissible to change the position from year to year.
The relevant provisions under the Act and corresponding Articles under UN Model Convention
are summarized in the following table-
Nature of Income Under the Act Under the DTAA
Business/Profession S.9(1)(i) Articles 5, 7 & 14
Salary Income S.9(1)(ii) Article 15
Dividend Income S.9(1)(iv), S. 115A Article 10
Interest Income S.9(1)(v), S.115A Article 11
Royalties/ Fees for Technical Services S.9(1)(vi), S. 115A Article 12
Capital Gains S.9(1)(i), S. 45 Article 13
6.2.3 Tax Residency Certificate (TRC):

The Finance Act, 2012 inserted a new sub-section (4) to s.90 of the Act which provided that a
non-resident shall not be entitled to claim any relief under DTAA unless he provides a
certificate of his being a resident in a country or specified territory outside India, as the case
may be, of which he claims to be tax resident obtained from the Government of that country or
the specified territory containing the prescribed particulars.
This provision led to considerable hardships. In response to representations made by various
trade and professional bodies, the Government through the Finance Act, 2013 amended sub-
section (4) and done away with the requirements of obtaining prescribed particulars in tax
residency certificate (TRC) and instead inserted new provision through insertion of sub-section
(5) requiring the tax payers to furnish such other information or document as may be
prescribed. In exercise of its powers, the CBDT notified new Rule 21B prescribing the
additional information which are required to be furnished by non-residents along with TRC in
prescribed Form 10F as follows-
 Status of the tax payer
 Permanent Account Number
 Nationality or country or specified territory of incorporation or registration
 Tax payers identification number in the country or specified territory of residence and in
case there is no such number, a unique number based on which the person is identified
by the government or specified territory of which the tax payer claims to be resident
 Period for which the residential status as mentioned in TRC, is applicable
 Address of the taxpayer during the period for which TRC is applicable
The CBDT has clarified that additional information prescribed in Form 10F may not be
required from the taxpayers if it already formed part of TRC. The taxpayer is required to keep
and maintain the documents to substantiate the above information whenever asked by the
income-tax authorities.
6.2.4 Extra territorial jurisdiction
The section covers payments made by a non-resident payer to another non-resident payee,
even if the payment is made outside India, if the underlying income is chargeable to tax in
India. TDS is also attracted for payments made in kind.
The constitutional validity of the extra territorial application of the provisions was upheld by the
constitutional bench of the Supreme Court in GVK Industries Ltd reported in 332 ITR 130(SC).
6.2.5 Exempt Income
The income in the hands of the recipient must be chargeable to tax to attract tax withholding
obligation. If any income is exempt in India in the hands of the non-resident, the resident
payer is not required to deduct tax at source u/s 195. CBDT Circular No. 786 dated 7th Feb.,
2000 has also clarified this issue. The exemption can arise either under provisions of the
domestic tax law or on application of the relevant provisions of the DTAA.
6.2.6 No threshold exemption/No prescribed rate of TDS
No basic threshold exemption is provided u/s. 195 and therefore tax is deductible even if the
payment to a non resident which is chargeable to tax is negligible. Section does not prescribe
any rate for TDS. Tax is required to be deducted at the rates in force.
6.2.7 Rates in Force [Sec. 2(37A)(iii)]
For the purpose of deduction u/s. 195, the ‘rate or rates in force’ means rate or rates of
income-tax specified in the Finance Act of the relevant year or the rate or rates specified
under DTAA notified under s.90 or s.90A, as the case may be, whichever is beneficial to the
assesse.
Tax payers can also explore the benefit of reduced rate of tax by virtue of Most Favoured
Nation clause (‘MFN’) present in certain DTAA’s like France, Spain etc.
During the period when the Finance Bill is awaiting approval, the tax payer can adopt the rates
which are more beneficial to him.
6.2.8 Levy of Surcharge & Education Cess:
The rates prescribed under the Act need to be further increased by Surcharge and Education
Cess as may be prescribed under the relevant Finance Act.
However, when DTAA is invoked, Article 2- ‘Taxes covered’ of almost all the treaties uses the
phrase ‘income-tax including any surcharge thereon’. This means the rates under DTAA are
the maximum rates agreed between two sovereign states and cannot be further enhanced by
Surcharge and/or Education Cess.
6.2.9 Time of tax deduction

Tax has to be deducted at source at the time of credit or payment whichever is earlier.
Explanation-1 to s. 195 (1) provides that a payer is liable to TDS although amount is credited
to “payable account” or “suspense account”.
In case of interest payable by Government or public sector banks or public financial
institutions within the meaning of s. 10(23D), TDS is to be made only at the time of payment
thereof in cash or by issue of cheque or draft or any other mode.
6.2.10 Income chargeable on Presumptive basis:
Business income of non residents in certain cases is taxed on presumptive basis under the
Act. The presumptive tax provisions applicable to various types of income of non-residents are
contained in Chapter IV (from s. 44BB to s. 44BBB) of the Act. On account of special
provisions, a specified percentage of the gross amount payable to the non residents is
deemed as income chargeable to tax in India. A question arises as to how much of the
amounts paid to the non-resident is the income chargeable to tax under the Act.
Following the decision of the Hon’ble Supreme Court in GE India Technology Centre (P.) Ltd.,
(supra), where in it was categorically held that the obligation to TDS is limited to the
appropriate portion of income chargeable under the Act forming part of the gross sums of
money payable to the non-resident, the Hon’ble ITAT, Chennai Bench in Frontier Offshore
Exploration (India) Ltd. v. Deputy Commissioner of Income-tax [2011] [ITA No. 200/Mds/2009]
10 taxmann.com 250, held that TDS is required only on the income element. Hence, for
example, income of a non-resident from operation of ships is taxable @ 7.5 percent of the
gross receipts under s. 44BB of the Act. Therefore, TDS is required on the income element i.e.
7.5 percent of the sum payable to the non-resident.
However, in cases where there exists any degree of ambiguity with regard to the applicability
of the provisions of presumptive taxation, it would be prudent to seek a lower withholding
certificate to hedge against any potentially adverse consequences.
6.2.11 Income chargeable at concessional rates on gross basis:
Under Chapter XII of the Act, certain types of income of the non-residents such as dividend,
interest, royalty, fees for technical services, etc. are taxed on gross basis at the concessional
rate of tax subject to fulfillment of the prescribed conditions. For example, royalty and fees for
technical services are taxed at the concessional rate of 10 percent of the gross receipt. When
special provisions are invoked, TDS is required at the rates prescribed under such special
provisions.
6.2.12 Exchange rate applicable for foreign currency payments :
Rule 26 of the Income-tax Rules provide a machinery provision for conversion of TDS
obligation in rupees for contracts in foreign currency payments. As per Rule 26 for the purpose
of TDS on any income payable in foreign currency, the rate of exchange for conversion to be
used shall be the telegraphic transfer buying rate of such currency as on the date on which tax
is required to be deducted at source.
Telegraphic transfer buying rate as per Explanation to Rule 26 means the exchange rate
adopted by State Bank of India for buying such currency.
6.2.13 Grossing up on Income payable Net of Tax (S. 195A and S. 198)
When the resident payer agrees to bear burden of tax on payments due to the non-resident,
the amount paid is considered as net of tax payment and the payment is required to be
grossed up for calculation of tax liability. The grossed up amount will be treated as the amount
agreed to be paid and tax shall be calculated at the prescribed rate on the gross amount.
This can be understood with the help of the following Example:-
Particulars Amount (INR)
Amount payable to non-resident (net of tax) 100
Tax rate applicable 20%
Grossed-up income: 100 * 100____ 125
(100-20)
Tax payable (INR 125 * 20%) 25
Net amount paid to non-resident (INR 125 – INR 25) 100
In respect of “net of tax” payment, the CBDT Circular No. 785 dated 24-11-1999 has clarified
that income grossed up under s. 195A is deemed to be income of the payee u/ s. 198 of the
Act and the payer is under legal obligation to furnish a certificate of tax deducted at source in
the prescribed form.
The Banglore ITAT in Bosch Ltd Vs. ITO – ITA No. 552 to 558/Banglore/2011 held that higher
rate of tax deductible under s.206AA is not applicable for grossing up.
6.3 Application for lower/NIL deduction

6.3.1 Application U/s. 195(2) by the payer:
S. 195 (2) enables a payer to make application to AO for determination of chargeable portion
of the consolidated payment when only a part of the payment construes income chargeable to
tax. Practically, application u/s 195(2) is filed for both nil as well as lower tax withholding.
No specific form is prescribed. The AO is required to follow Rule 10 of the Income-tax Rules to
determine the income element.
No time limit is prescribed under the law for passing the order. The order passed u/s 195(2) is
provisional and not conclusive and the AO can take a contrary view during the assessment
proceedings.
The order passed by the A.O. u/s. 195(2) is appealable u/s 248. In view of the amendments in
s. 248 through Finance Act 2007; an appeal against this order can be filed only if tax is borne
by the payer. The appeal can be filed within thirty days of the receipt of the order and only
upon payment of tax as directed in that order.
6.3.2 Application U/s. 195(3) by the payee:
S. 195 (3) provides a machinery under which a non- resident payee may apply to his AO for
grant of a certificate to authorize resident payer to make payment to him without any TDS i.e.
nil withholding tax order.
The non-resident is eligible to make an application under s. 195(3) only if the following
conditions as laid out in rule 29B are satisfied, namely –
(i) the applicant has been regularly assessed to income tax in India and has furnished
returns of income for all assessment years for which such returns became due on or
before the date on which the application is made;
(ii) he is not in default or deemed to be in default in respect of any tax (including advance
tax and tax payable under s. 140A, interest, penalty, fine, or any other sum payable
under the Act);
(iii) he has not been subjected to penalty under clause (iii) of sub-section (1) of section 271;
(iv) where the person concerned is not a banking company -
(a) he has been carrying on business or profession in India continuously for a period
of not less than five years immediately preceding the date of the application, and
(b) the value of the fixed assets in India of such business or profession as shown in
his books for the previous year which ended immediately before the date of the
application or, where the accounts in respect of such previous year have not
been made up before the said date, the previous year immediately preceding that
year, exceeds fifty lakhs of rupees.
The application is to be made in Form No. 15C by a banking company and Form No. 15D by
any other person. The AO will issue a certificate U/s. 195(3) authorising the recipient to
receive the income without deduction of tax. The “certificate” issued under s. 195(3) is not an
“Order” and therefore is not appealable.
6.3.3 Application U/s. 197:
Under s. 197 a payee can make an application to the AO for grant of a certificate authorizing
him not to deduct tax at source or for determination of the appropriate (lower) rate of
deduction at which the payer shall make TDS. The application shall be made in prescribed
Form No. 13.
The “certificate” issued under s. 197 is not an “Order”. Therefore it is not possible to file an
appeal under s. 248 of the Act or make an application for revision under s. 264 of the Act
against this certificate.
6.3.4 Sections 195(2), 195(3) & 197- Comparison:

Particulars 195(2) 195(3) 197
Application by Payer Payee Payee
(subject to Rule 29B)
Purpose To determine For claiming ‘Nil’ For claiming
appropriate withholding rate for a ‘Nil’/lower rate of
withholding rate for specified receipt withholding for all
a specified receipts
payment
Applicability Applicable to Applicable to specified Applicable to all
specified payments receipts receipts
Whether appealable Yes- after payment No appeal No appeal
u/s. 248? of tax by the payer
Whether revisable Yes Yes Yes
u/s 263 or 264
6.4 Certification by Chartered Accountants for remittances &

Furnishing of information U/s. 195(6)
The Finance Act 2008 inserted a new sub-section (6) to s.195 requiring the person
responsible for making payment to a non-resident to furnish certain information in the
prescribed format.
The CBDT vide Notification No. 30/2009 dated 25th March 2009 issued Income-tax (Seventh
Amendment) Rules. 2009 and prescribed following formats through insertion of Rule 37 BB –
 Form 15CA – Format for furnishing of the prescribed information and verification by the
payee.
 Form 15CB - Format for certificate from a chartered accountant.
These provisions became effective from 1st July, 2009.
The CBDT further vide notification no. 67 of 2013 amended Rule 37BB to revise the
information reporting requirement on payments to non- residents and notified new Forms
15CA and 15CB. The amended notification lays down a specified list of payments which are
not required to be reported under the revised Rule. Post amendment, Form 15CA is dividend
in two parts.
Part A is to be filled in for remittances not exceeding Rs. 50,000/- per transaction provided
aggregate of such remittances do not exceed Rs. 2,50,000/- during the financial year.
Furnishing certificate from a chartered accountant in Form 15CB is not mandatory.
Part B is to be filled in for remittances other than those specified in Part A and is to be
accompanied by a certificate from a chartered accountant in Form 15CB except 28 specified

categories provided in the following list-
Sr. No. Purpose as Nature of payment
per RBI
1 S0001 Indian investment abroad-in equity capital (shares)
2 S0002 Indian investment abroad-in debt securities
3 S0003 Indian investment abroad-in branches and wholly owned
subsidiaries
4 S0004 Indian investment abroad-in subsidiaries and associates
5 S0005 Indian investment abroad-in real estate
6 S0011 Loans extended to Non- residents
7 S0202 Payment for operating expenses of Indian shipping companies
operating abroad
8 S0208 Operating expenses of Indian Airlines companies operating
abroad
9 S0212 Booking of passages abroad- Airlines companies
10 S0301 Remittance towards business travel
11 S0302 Travel under basic travel quota (BTQ)
12 S0303 Travel for pilgrimage
13 S0304 Travel for medical treatment
14 S0305 Travel for education (including fees, hostel expenses etc.)
15 S0401 Postal services
16 S0501 Construction of projects abroad by Indian companies including
import of goods at project site
17 S0602 Freight insurance- Relating to import and export of goods
18 S1011 Payments for maintenance of offices abroad
19 S1201 Maintenance of Indian embassies abroad
20 S1202 Remittances by foreign embassies in India
21 S1301 Remittance by non- residents towards family maintenance and
savings
22 S1302 Remittance towards personal gifts and donations
23 S1303 Remittance towards donations to religious and charitable

institutions abroad
24 S1304 Remittance towards grants and donations to other
Governments and charitable institutions established by the
Governments
25 S1305 Contributions or donations by the Government to international
institutions
26 S1306 Remittance towards payment or refund of taxes
27 S1501 Refunds or rebates or reduction in invoice value on account of
exports
28 S1503 Payments by residents for international bidding.
The distinctive features of the old & new Forms 15CA /15CB are highlighted in the following
table-
Criteria Earlier position till 30th New Provisions Applicable
September, 2013 from 1st October, 2013
Applicability of Applicable to all outward  Reporting only in respect of
Form 15CA remittances, whether or not payments which are taxable
taxable. under the Act. This is in
contradiction to s.195(6)
substituted by Finance Act,
2015 w.e.f.1.06.2015
 Additionally, no reporting for
28 specified category
payments
 Small payments, not
exceeding Rs. 50,000
individually or aggregate Rs.
2,50,000 per financial year to
be reported in Part A of Form
15CA.
 All other payments to be
reported in Part B of Form
15CA.
Obtaining Form  Applicable to all outward  Form 15CB is not required
15CB remittances without ceiling where Part A of Form 15CA is
whether or not taxable filled in (small payments).
 Included cases where an  For Part B payments, it
Criteria Earlier position till 30th New Provisions Applicable

September, 2013 from 1st October, 2013
order or a certificate of the appears that an AO order /
Assessing Officer was certificate or 15CB may be
obtained u/s. 197/ 195(2)/ used alternatively.
195(3).
Manner of  Though, practically Form  Sub – rule (2) of the revised
furnishing 15CA is furnished to AD Rule 37BB mandates that
along with Form 15CB, the Form 15CA shall be furnished
same was not mandated by to the authorized dealer prior
Rule 37BB. to making the remittance.
Onus on  There was no onus on AD  The revised Rule 37BB casts
Authorized Dealer under the Income – tax Act or a duty on AD to furnish Form
Rules to deal with the details 15CA submitted by the
furnished by the remitter. remitter for any proceedings
under the Income-tax Act.
Section 206AA  The Forms did not contain  The revised Form specifies
specific reference to s. that in absence of the PAN of
206AA. the recipient, provisions of
section 206AA shall apply.
Form 15CB  The certificate format  The revised Form 15CB
referred to rate of TDS under requires detailed enumeration
the provisions of Income-tax of taxability of the amount
Act only. under the Income-tax Act
 In respect of the DTAA, the without giving effect to the
applicable rate of incomes DTAA.
needs to be provided.  However, where DTAA
 The nature of remittance provisions are applied,
categorized into – for relevant article number, Tax
Royalties, FTS, Interest, Residency Certificate (TRC)
Dividend, Supply of articles and liability under the DTAA
or things; Business income; are required to be furnished.
and any other remittance.  The nature of remittance is
divided as – for royalties,
FTS, interest, dividend; on
account of business income;
on account of short-term and
long-term capital gains; and
any other remittance.
The Finance Act 2015 substituted sub-section (6) to s.195 with effect from 1st June, 2015. The
new sub-section (6) makes it mandatory to furnish the prescribed information whether or not
the sum payable to a non-resident is chargeable to tax. Simultaneously, a new s.271-I is
inserted by the Finance Act, 2015 from 1st June, 2015 prescribing penalty of Rs. 1 Lac for
failure to furnish or for filing inaccurate particulars.
However, till date, rules are not amended in line with the Act and continue to require furnishing
of information only in relation to payments which are chargeable to tax in India. Pending
amendments/new rules, remitting banks/ ADs may insist on electronic filing in Form 15CA and
CA Certificate in Form 15CB before processing the remittances.
6.5 Mandatorily application to AO for determination of sum
chargeable U/s. 195(7)
The Finance Act 2008 has empowered CBDT to specify class of persons or cases (where
recipient is non-resident) who will be mandated to furnish application to AO for determination
of tax withholding rate for paying any sum, whether or not chargeable under the provisions of
the Act by general or special order to determine the appropriate proportion of sum chargeable,
and upon such determination, the payer is liable to deduct tax under sub-section (1) on that
proportion of the sum which is so chargeable.
Notification specifying such class of persons or cases is not yet issued by CBDT.
6.6 Implication of s. 206AA
There are contradictory views when income of a non resident is chargeable under provisions
the Act but it is either not chargeable or is chargeable at the concessional rate of tax provided
under DTAA. When the payee does not hold Permanent Account Number (PAN), on account
of the provisions of s. 206AA of the Act, which starts with non obstante clause providing tax
withholding at the higher of the following three rates : when the non-resident payee does not
hold PAN–
(a) Rate specified under the relevant provisions of the Act, or
(b) At the rates in force (includes DTAA rates), or
(c) At the rate of twenty percent
CBDT Press Release dated 20th January, 2010 categorically states that provisions of S.
206AA will apply to non-residents as well.
Recently, the ITAT Pune & ITAT Bangalore Benches had occasion to examine the validity of
this provision in following cases –
 Pune ITAT in the case of Serum Institute of India Private Ltd- 56 taxmann 1- ITAT Pune
 Bangalore ITAT in the case of Infosys BPO Ltd- ITA No.1143/(B)2013 & IT(IT)A Nos.8 &
9-14 & CO Nos.83 & 84-141
Both the authorities were of the view that rate of TDS cannot be higher than the rate
prescribed under the DTAA or the Act, whichever is more beneficial to the payee. Both the
authorities have followed the settled principle laid down by the Andhra Pradesh High Court in
CIT vs. Visakhapatnam Port Trust reported in 144 ITR 146 and approved by the Hon’ble
Supreme Court in Union of India vs. Azadi Bachao Andolan reported in 263 ITR 706
reaffirming the supremacy of the DTAA.
The implication of the provision are summarized in the following table-
PAN Tax Residency Does treaty Applicable WHT rate
Certificate(TRC) provide for a lower
rate?
   Treaty rate
 × NA Act rate
×   ?
× × × Act rate subject to S.
206AA
However, newly inserted Rule 37BC under Income Tax Rules 1962, provides relaxation from
deduction of tax at a higher rate under section 206AA. In such a case, such non- resident is
required to provide documents/details to deductor as mentioned in the aforementioned rule i.e.
name, address, email id, contact number, Tax residency certificate, address, Tax identification
Number of the deductee or unique number by which such nonresident deductee is identified in
his country of residence.
6.7 Refund of Excess TDS to the deductor
In certain situations referred to in CBDT Circular 7 of 2007 dated 23-10-2007, where no
income has accrued to the non-resident due to cancellation of contract or where income has
accrued but no tax is due on that income or tax is due at a lesser rate, etc. where genuine
claim for refund arises, the excess amount can be refunded to the deductor with prior approval
of the Chief Commissioner of Income-tax or the Director General of Income-tax as may be
concerned.
Where an assessee has paid any sum chargeable to tax under the Act to a non-resident on
which tax has not been deducted or after deduction it has not been paid, then he may face any
of the following consequences -
Section Nature of Default Consequence
40(a)(i) & Failure to deduct the whole or Disallowance of expenses deduction in
(iii) any part of tax computing income chargeable under the
head ”Profits and Gains of Business or
Profession”
Section Nature of Default Consequence

201(1A) Failure to deduct, pay or pay Would be considered as an assessee in
after deducting default + simple interest @ 1% or 1.5%
for month or every part of the month.
221 Default in making payment of tax Simple interest @ 1% + Maximum

within prescribed time penalty to be 100% of the tax arrears
271C Failure to deduct the whole or Penalty equal to 100% of whole or part of
any part of tax tax, as applicable
271-I Failure to furnish information or Penalty of Rs. 1,00,000.
furnishing inaccurate information
under section 195.
272A Failure to file TDS Return Penalty of Rs.100/- per day (maximum
up to the tax deductible) for failure to file
the TDS Return within time.
276B Failure to pay tax deducted Rigorous imprisonment for 3 months to 7
years along with fine.
Module E
Basic International Tax Structures
1. International Tax Structures

1.1 Introduction 1
The proliferation of income tax system and the increase in tax rates have made it necessary
for multinationals (‘MNCs) to engage in robust tax planning to eliminate double taxation and
reduce excessive tax costs. The process of globalization has also eliminated most of the
barriers to cross border trade and investment, leading to increased cross border activities –
hence putting global tax management on the radar of MNCs/ conglomerates.
Several other factors led to an increasing emphasis on international tax planning –
Technological advancements made it possible for enterprises to do business in a country
without having any physical presence there The liberalization of the international financial
system and development of new financial instruments allowed MNCs to change the source,
character and timing of income and growth in the number of tax treaties facilitated
international tax planning.
With heightened cross border activities, the traditional business models of MNCs were altered
opening way for global operations, which also meant interaction with multiple tax regimes that
sought to impose taxes on cross trade transactions based on the respective domestic laws.
Each country and its revenue body face different environment within which they administer
their taxation system and differ in respect of their policy/ legislative environments and their
administrative practices and cultures. Given the same, MNCs engaged in global tax
management (eg. planning) by organizing into various structures/ forms and developing cross-
border tax strategies to optimize global tax liabilities, while adhering to all applicable laws.
Using various tax structures MNCs could benefit from differences in the tax systems (including
tax rates/ method of computation of tax profits) in various countries within which they operated
- the aim being minimizing of global tax costs and maximizing global after tax profits.
While, MNCs can conduct operations through various combinations of legal forms/ structures,
financing methods and acquisition techniques, tax is not usually a primary or overriding factor
in the decisions to engage in overseas business activities or to invest abroad. The decisions
are primarily driven by commercial, economic, and even social and political considerations.
Such business decisions can have a larger tax implication given that cross-border activities
suffer a higher tax liability on a worldwide basis than domestic or one-country transactions.
Hence, organizing and operating through efficient tax structures (using tax efficient funding
1Research paper by The School of Public Policy, University of Calgary, Volume 7, Issue 29, September 2014
strategies, mergers and acquisitions, inbound and outbound restructuring etc.) assumes larger
significance in ways to enable MNCs to cope with inconsistent tax laws, erratic tax
administration and high taxes in various jurisdictions as well as efficiently organize business
operations globally.
However, it needs to be kept in mind that, any cross border tax structuring should be backed
by business and commercial considerations and not be governed by pure tax considerations.
This is important especially in light of General Anti Avoidance Rule (GAAR) and OECD’s Base
Erosion and Profit Shifting Project which has suggested measures to counter cross border tax
avoidance strategies adopted by MNEs. Therefore, each country is adopting several anti-
abuse rules in its domestic laws and double taxation avoidance agreements (DTAAs) to be
compliant with BEPS recommendations. India is adopting GAAR in its tax legislation from
1.04.2017.
1.2 Planning tax structures 2

The tax impact on cross border transactions for MNCs can be at 1) source or host country 2)
intermediary countries 3) residence or home country, necessitating global tax management/
planning to minimize tax costs and eliminate double taxation. Hence, it is of significance for
MNCs to organize global operations in a tax efficient manner.
The taxation on profits repatriated to the home country could be reduced through:
• The use of appropriate global corporate structures
• The optimal use of available foreign tax credits and exemptions to reduce domestic tax
liabilities etc.
Further, taxes in source country can be reduced through one or more of the following ways:
• Local tax planning that optimizes the use of tax deductions, incentives, tax losses and
special tax concessions available under the domestic law and tax treaties.
• Tax-exemptions from the break or fracture of the connection tax factors with either the
source or the Residence State (or both).
MNC could also seek to reduce taxation on profits in the intermediary company by for
instance; subject to commercial substance demonstration:
• Selecting an intermediary jurisdiction in a manner to ensure that the withholding taxes
(under the treaty with home country and host country) are not very high
• Holding intellectual property rights in a tax efficient jurisdiction etc.
Given the above, MNCs need to carefully plan global operational structure across host,
intermediary and home countries. MNCs could engage in several cross border structuring
strategies some of which are mentioned below:
2Presentation International Taxation - Basic International Tax Planning by Dr. Richard Watanabe
Adjunct, Assistant Professor
Basic International Tax Structures 5.3
International Holding Co. structuring

• Deferring taxation of dividend / income flows
• Optimizing capital gains tax on exit
Funding structuring
• Compliance with thin cap rules
• Maximizing interest deduction for overall tax efficiency
Acquisition structuring
• Mode of acquisition
• Mode of financing
Intellectual Property Rights Structuring
• Separating IPR and locating it in a separate holding vehicle in a tax efficient jurisdiction
Tax Efficient Supply Chain Management
• De-risking the various group entities so that significant profit resides with Principal Co
located in a tax efficient jurisdiction
• Overall Group tax rationalization
Global Transfer Pricing
• Structure transfer prices to maximize business and tax benefits
• Minimize transfer pricing audits
Tax treaties, profit repatriation and loss utilisation strategies
Structuring asset purchase transaction
Restructuring of existing overseas holding structure
By structuring operations using one or more of the above, MNCs can look at meeting their tax
objectives for eg optimize capital gains tax on exit, generate alternate revenue streams in tax
efficient jurisdiction, timing up-streaming of dividend, deduction of funding costs etc. Apart
from tax advantages, efficient structuring of global operations may also aid in achieving
operational synergies (economies of scale, operating efficiencies, research & technology,
marketing & distribution etc.) and financial synergies (improve shareholders value, listing
options, consolidated operations have higher ROCE & stable earnings) in business.
Some of the tax planning opportunities / strategies outlined above along with case studies are
explained in detail in the subsequent Chapter 2 Tax Structuring for Cross Border Transactions.
The technical coverage in respect of each of the above topic will be generic in nature and will
involve conceptual discussions with examples.
Any cross border tax structuring strategy cannot be divorced from business or commercial
rationale. Also each step in the transaction needs to be backed by such rationale, as tax
authorities may challenge and disregard/re-characterize a particular step in the transaction by
alleging lack of substance.
When a particular transaction can be structured in more than one manner and
commercial/business rationale can be demonstrated for all the options then the taxpayer may
opt any one option which most tax efficient.
Tax authorities around the world are challenging the transactions which lack substance but are
undertaken only to avail tax benefits. Hence, taxpayer needs to maintain adequate
documentation to demonstrate satisfaction of substance requirements and business rationale
behind undertaking a transaction.
Strategies given in this chapter are only to increase awareness among future/current tax
practitioners about the industry practices and should not serve as guidance in any manner. A
particular strategy may only be explored if it complements business arrangement/transaction
and is backed by substance.
1.3 Forms of business entity 3
With globalization of business and structuring of operations, MNCs can consider various entry
strategies (business entity forms) while setting up operations in another jurisdiction. Business
entities can provide protection to the business owner, dictate the amount and types of taxes
paid and control how the business operates and functions internally. Further, each of them
would have their own advantages/ disadvantages and tax implications.
Some of the considerations by MNCs while choosing the most appropriate business form
could be (1) the degree to which the business assets are at risk from liabilities arising from
business; (2) how to best pursue tax advantages and avoid multiple layers of taxation; (3) the
ability to attract potential investors; (4) the ability to offer ownership interests to key
employees; (5) the costs of operating and maintaining the business entity (6) reaching out to
potential customers etc. For instance, as operations expand, a full – time representative or
dependent agent may be appointed. A branch or a company is usually established when a full
business presence is justified. A partnership (general or limited) or an equity joint venture may
be an alternative entity in certain situations. Other legal forms include licensing or franchising
arrangements, joint ventures, economic interest groupings or consortiums, etc. A minority
equity participation in a joint venture is often used for a strategic business alliance in
high-risk technologies and markets. Some of the business entity forms in which MNCs may
conduct business areas under:
3Basic International Taxation by Roy Rohatgi (Volume II)

1.3.1. Licensing Arrangement

A licensing agreement is a legal contract between two parties (licensor and the licensee)
whereby the licensor grants the licensee the right to produce and sell goods, or use a brand
name or trademark, or use patented technology owned by the licensor. In exchange, the
licensee usually agrees to make payments known as royalties
Licensing can be a low-cost alternative to setting up one's own business presence abroad.
Setting up a licensing entity requires minimal investment and earns royalties (guaranteed pay-
out and variable royalty). Further, access to an existing market share of the licensee,
distribution network, business systems also benefits the licensor.
Licensing can be a tax efficient strategy. The royalty paid for usage of an intangible is tax
deductible in the hands of licensee. For example, if the licensor entity is incorporated in a
jurisdiction where tax is levied at a lower rate than that of a licensee entity, it shall result in tax
savings.
However, one of the major disadvantage of this arrangement is that it creates competition -
The licensee places the licensor on a level playing field because the licensee now has the
right to use the same production processes as the licensor. A licensing company may attempt
to limit competition by limiting the scope of the license as much as possible. For example, the
license may contain geographic, time or quantity restrictions that protect the market of the
licensing company. Further, it also increases the risk of increased exposure to confidential,
proprietary production process of the licensor.
1.3.2. Franchising
By way of a contractual relationship, the franchiser grants a limited license to the franchisee to
use its business systems (trademark, associated brand, proprietary knowledge) for a
prescribed period of time against which the franchiser receives varied fees such as royalties or
service fees, contributions towards common expenses (e.g. marketing, advertising), etc. The
franchiser offers important pre-opening support i.e. site selection, design and construction,
financing, training along with ongoing assistance i.e. training, national and regional
advertising, operating procedures, operational assistance etc.
The franchisee operates under the brand image of the franchisor, according to the procedures
and restrictions set forth by the franchisor in the agreement. These restrictions usually include
the products or services which can be offered, pricing and geographic territory. For some
people, this is the most serious disadvantage to becoming a franchisee.
Tax implication in case of a franchisee arrangement varies depending on the nature of income
earned. Taxes may have to be withheld while making payments by the franchisee to
franchisor.
Since the franchisee has to conform to the expected service level requirements and product
specifications, he shall incur product and service level liability risks. The exposure to these
risks may lead to adoption of a higher mark-up (for assumption of higher risk) by the tax
authorities, which shall give rise to an issue from transfer pricing perspective, if applicable.
1.3.3. Liaison Office
As per FEMA regulations, ‘liaison office’ is defined to mean ‘a place of business to act as a
channel of communication between the principal place of business or Head office (by
whatever name called) but which does not undertake any commercial/ trading/ industrial
activity, directly or indirectly, and maintains itself out of inward remittances received from
abroad through normal banking channel’. Thus, it only aids in communication between two
different entities to work together. It may provide information on business environment of the
country in which it is set up, market research and studies. It can also identify and co-ordinate
with the customers in that country, however, it cannot conclude contracts on behalf of the
head office.
Under OECD MC Article 5(4), a permanent establishment is not taxable if it confines itself to
non-commercial preparatory and auxiliary activities such as advertising, or supply of
information regarding customer requirements and specifications, scientific research, or
servicing of patent or know-how contracts, or as a purchasing office. In certain jurisdictions, a
representative office can also maintain a supply of goods for delivery or display on a tax-free
basis.
1.3.4. Branch
A branch of a company assumes the same legal status as the head office and is established
for undertaking permitted commercial activities. Accordingly, operating a branch office is akin
to having the foreign parent corporation operating in the host country. The financial results of
a branch are usually consolidated with that of the parent company and hence this structure
does not shield the parent corporation from liability incurred at the branch level.
For a branch, there are no restrictions imposed on minimum capital, no levy of capital taxes
or, stamp duties. The transfers of assets and funds from/to head office are not usually subject
to taxation. A branch entails low compliance costs. The profits repatriated by the branch to the
head office do not suffer from double taxation, unless non-creditable branch tax is payable.
Moreover, the controlled foreign corporation rules do not normally apply to branches since
there is no tax deferral of the current income of the branch.
By virtue of Article 5 of OECD model of Double Taxation Avoidance Agreement, a branch
engaged in the core business activities of the company is a taxable permanent establishment.
Thus, profit generated by branch is taxable in the host country of the head office under their
respective domestic rules and accounting practices, however, only to the extent profits
attributable to the branch. The dual taxation of the branch profits could lead to additional
taxes, even when the head office is entitled to relief for the foreign taxes paid by the branch.
That is because; any variation in the method of the tax computation could result in either
insufficient or excess foreign credits for the foreign taxes paid by the branch. Moreover,
although the branch losses can be offset against the home profits, the foreign taxes paid by
profitable branches may not be given credit in certain situations.
Many countries lack detailed rules for the allocation of the income and expenses to a branch
as a permanent establishment and hence sometimes lead to adhoc allocation. Besides that,
domestic taxation provisions and rules often vary. Profit allocation of the branch is also
generally subject to a closer scrutiny by tax authorities and is a debatable transfer pricing
issue. The rules governing the deductibility of allocated expenses to the branch by the- head
office are often more restrictive than for a local company. For example, management fees,
interest and royalty payments from, and to, the head office or other sister branches may be
disallowed (fully or partly) for tax purposes. Thus, such a situation calls for a tax planning.
A branch structure is usually considered unsuitable for long-term overseas investment or
operations. As it is not a separate legal entity, it subjects the parent company to unlimited
liability on its obligations. Despite the disadvantages, it is not uncommon to set up a branch
during the period of start-up losses and explore later to convert it to a subsidiary. It may also
be useful tax planning for a holding company to operate overseas through a branch and not a
subsidiary in certain situations. Unlike a subsidiary, the company can claim tax credit at home
currently for the underlying taxes paid overseas by its branch. To avoid the exposure of
unlimited liability to the parent company, it can be set up as the branch of a separate
subsidiary company at home.
1.3.5. Subsidiary Company
A subsidiary is a separate legal entity from the parent, although owned by the parent
corporation. A subsidiary may/ may not be wholly-owned by the parent corporation.
Taxation of the subsidiary is on the subsidiary's income alone, and when properly structured
and operated, the liabilities of the subsidiary are not attributable to the parent corporation. A
subsidiary qualifies as a "resident" for treaty benefits in the other Contracting State.
A subsidiary has to act in accordance with domestic taxation and legal requirements. It is
subject to anti-avoidance measures, such as thin capitalization rules, transfer pricing and
controlled foreign corporation rules. The profits from which the dividend is distributed may be
subject to double taxation in countries imposing both, the corporate tax as well as dividend
distribution tax. The losses of the subsidiary are generally not eligible for setoff against the
profits of the parent company. The transfer of shares of the subsidiary may also be imposed
with capital gains tax in the hands of parent company.
A subsidiary company is operationally more flexible than a branch. It denotes a long-term
commercial existence in a country and offers limited liability status. The laws and regulations
in numerous countries require that foreign enterprises function as a company as it is easier to
regulate as against a branch.
Broad Comparison between Branch versus Subsidiary
Parameters Branch Subsidiary
Separate Legal Entity It is an extension of the parent Yes
company
Operational flexibility Restriction on the nature of Maximum flexibility of
activities that can be operations.
undertaken
Registered capital Not required Minimum share capital may be
requirement required
Financing Inward remittances from Financed by means of various
foreign entity and internal capital instruments such as
accruals equity, debt etc.
PE risk for parent Will be considered for PE Not just because of parent
subsidiary relationship
Compliance cost Relatively lower compliance Greater compliances to be met
cost
Case Study 1
Facts:
• X Ltd, an Indian Company, engaged in the business of manufacturing and selling of
garments.
• X Ltd proposes to establish its manufacturing facilities in Sri Lanka for worldwide
exports.
• Garments manufactured in Sri Lanka will be exported to various countries worldwide.
• Sri Lankan operations will be standalone operations and will have substantial value
additions and the expected profitability is very high.
Issues:
Whether Sri Lankan Operations should be established either through a branch office or
through a subsidiary company?
The factors that need to be considered while making the decision are:
Particulars Branch Subsidiary

Sri Lankan corporate tax rate 28% 28%
Tax on profit repatriations 10% [Branch Profit 10% [Dividend WHT]
Remittance Tax]
Availability of foreign tax Yes Yes
credit [India-Sri Lanka Tax Tax sparing also available No tax sparing
Treaty]
Tax deductibility • Interest on financing • Interest and other
cannot be claimed management charges
• Management and other can be claimed with
service charges cannot be markup.
claimed
Repatriability Permitted Permitted
Exposure of Head Office Yes No
Capital Gain Tax Liability No Yes
1.3.6. Agency
When starting trade in another country, it is very common to outsource the activity to an agent
rather than setting up a new shop/ own business premises staffed by own employees. An
agent is a person who acts on behalf of the principal and can be dependent or independent,
with varying tax implications.
Independent Agent: Based on OECD MC Article 5(5), an agent carrying on business through
a broker, general commission agent or any other agent, acting in the ordinary course of
business shall not be construed as a permanent establishment. However, such agent must be
economically and legally independent, bear entrepreneurial risks and must not act for only a
single principal. If the agent’s activities are devoted wholly or almost wholly on behalf of the
enterprise, and transactions between the agent and the non-resident are on other than at
arm’s length basis, the agent will be considered as dependent agent.
Further, an agent, who performs the economic activities that should be done by the principal,
may have difficulty in proving that he is acting in the ordinary course of his business.
Example of Independent Agent: A newspaper publishing company, whose principal business

is publication of newspapers in India also carries on business of collection of advertisements
for non-resident publishers may be considered as agent of independent status as it acts in the
‘ordinary course’ of business.
Dependent Agent: The OECD MC specifies three conditions in which a dependent agent will
constitute a permanent establishment:
• If the agent has and habitually exercises in the other State an authority to conclude
contracts in the name of the non-resident
• Even if the agent has no authority to conclude contracts, he will give rise to a
permanent establishment for the non-resident if he habitually maintains a stock of
goods or merchandise in the other State on behalf of the non-resident and regularly
makes deliveries from that stock, and carries some additional activities on behalf of the
non-resident contributing to the sale.
• An agent who habitually secures orders wholly or almost wholly for the
non-resident of a Contracting State will constitute a permanent establishment of the
non-resident in the other Contracting State.
A person is said to have authority to conclude contracts if, he/she has sufficient authority to
bind non-resident and decide final terms or can act independently, without control from the
principal non-resident or is authorised to renegotiate all elements and details of a contract or
where approval of contract by the non-resident is a mere formality.
Example on Dependent Agent: A domestic custodian of non-resident, who is obliged to act in
accordance with instructions of non-resident in relation to its securities in India and also liable
and maintaining its bank account on its behalf.
Case Study 2
Whether the agent is an independent agent in the below scenarios?
Scenario A
Nature of activities % of total revenue
Selling agency activities for Company A 50
Processing agency activities for Company B 50
• An independent agent since the agent works on behalf of two non-resident principals (in
equal proportion). Therefore, the agent would not be construed as a dependent agent
of any of the principal. However, if both Company A and Company B are part of the
same multinational group, thus being under common control, it may be alleged that the
agent is a dependent agent.
Scenario B
Nature of activities % of total revenue
Trading business (on principal to principal basis) for Company A 95
Selling agency activities for Company B (Non-resident) 5
• While determining independence status of an agent, generally only those activities

carried out in the capacity of an agent are to be taken into consideration.
• The trading activities that are carried by the person are on principal to principal basis
and will not be considered in determining agency permanent establishment condition.
• However, since the agent works mainly and wholly on behalf of a non-resident principal
w.r.t. selling agency activities, the agent may be construed as a dependent agent of the
principal.
1.3.7. Partnership
Partnership is a contractual relation of two or more persons carrying business to share profit
or loss in an agreed ratio. The two varieties of partnerships are general partnerships and
limited partnerships. In a general partnership, the partners manage the firm and assume
responsibility for the partnership's debts and other obligations. A limited partnership has both
general and limited partners. The general partners own and operate the business and assume
liability for the partnership, while the limited partners serve as investors only; they have no
control over the company and are not subject to the same liabilities as the general partners.
In some countries like India, partnerships are regarded as separate legal entity from its
partners and thus the firm bears the tax, while in few others, partnership firms are treated as
tax transparent with only individual partners bearing the tax.
Unlike companies, partnerships do not have to disclose their profits to the public (i.e. greater
privacy). Changing the legal structure is relatively simple (i.e. changing from a partnership into
a company at a later stage). Non-resident partners may be deemed to have a permanent
establishment in the country where the partnership is organized. Such transparent
partnerships may or may not benefit from tax treaties, except through the treaties with the
resident Contracting State of each partner.
A partnership is easier and less expensive to set up than a company. Also, no profit
distribution tax is applicable to a partnership firm. Further, the foreign controlled corporation
rules do not normally apply to fiscally transparent partnerships. However, personal liability
could be a major concern in case of a general partnership.
1.3.8. Hybrid Entity
A hybrid entity is an entity which may be subject to corporate income tax in one jurisdiction but
qualifies for tax transparent treatment in another.
There could also be hybrid instruments whereby an instrument can be treated as debt in one
jurisdiction and equity in another jurisdiction. Thus, capital could be infused in the form of
equity to an entity established in tax havens, which could in turn lend the same funds in the
form of a loan to an entity established in a country levying higher tax rates. The interest
charged shall be tax deductible in the hands of the entity set up in higher tax jurisdiction and
the profits generated from the usage of funds raised from issue of equity capital, may be
retained with the entity set up in lower tax jurisdiction.
1.4 Examples of tax efficient forms 4
In light of the discussion above, some examples of tax efficient forms in which MNCs can
organize their business are listed below:
1. Setting up presence in another jurisdiction using appropriate business entity form (as
explained earlier).
2. Set up a company providing finance and/or treasury services to group companies in
appropriate tax network jurisdictions.
3. Set up a headquarter/ management services company offshore for coordinating various
services to group companies at a cost with mark-up wherein entire billing is done
through the headquarter/ management services company.
4. Form a holding company in a treaty country owning investments offshore to provide
ease of exit.
5. Transfer intellectual property rights to a licensing company in a tax efficient jurisdiction.
However, it would also be important to keep track of the BEPS developments on these
issues which may impact these decisions.
2. Tax structuring for Cross-border Transactions

2.1 Background
The liberalization of Indian economy has encouraged several multinational enterprises to
invest in India. Several reforms in respect of foreign direct investment (FDI) have helped India
to achieve cash inflow of USD 100+ billion 5 in 2014-15. Also the Indian companies/
conglomerates are encouraged to make investments outside India within a liberal regulatory
framework. Hence, many Indian companies/conglomerates have been establishing their
presence outside India or making several overseas acquisitions.
Such inflow and outflow of investments may give rise to several cross border transactions.
Also these involve cross border operations. Hence, appropriate planning for such
4 Basic international taxation by Roy Rohatgi (Volume II)

5http://dipp.nic.in/English/Publications/FDI_Statistics/2015/FDI_FactSheet_JulyAugustSeptember2015.pdf
DIPP, Ministry of commerce and industry (Data uploaded upto Sep 2015)
arrangements is important; as such transactions/arrangements are governed by laws of

several countries.
Apart from regulatory structuring of these transactions, it is important to conduct tax
structuring of these transactions to make them tax efficient. This is because, tax can prove to
be a substantial cost in respect of cross border transactions and in many cases, the incidence
of double or multiple taxation may make transactions financially unviable.
Flow of investments into a country may create issues in respect of funding i.e. debt (related
interest pay-out) v equity, royalty, technical fees payments and profit repatriation to parent
company. Also the divestment/exit needs to be planned in advance from tax perspective so as
to be certain about the tax consequences of divestment.
Such cross border tax structuring is to be done taking into account regulatory requirements
(e.g. investments allowances/restrictions in particular sector, funding guidelines etc.) and
compliances.
Cross border tax structuring in advance helps to avoid surprises or inefficient tax consequence
while actually undertaking the transaction. It is extremely important to eliminate double or
multiple taxation. A particular transaction/arrangement may be structured in more than one
way and it is extremely important to evaluate the tax consequences of each and every
alternative so as to make the transaction tax efficient.
An effective tax structuring may make business expansion as well as exit easy for the
company. More importantly, apart from tax benefits, cross border tax structuring may help a
company in getting certainty and consequently avoiding potential litigation.
However, it needs to be kept in mind that, any cross border tax structuring should be backed
by business and commercial considerations and not be governed by pure tax considerations.
This is important especially in light of General Anti Avoidance Rule (GAAR) and OECD’s Base
Erosion and Profit Shifting Project (BEPS) project which has suggested measures to counter
cross border tax avoidance strategies adopted by MNEs. Therefore, each country is adopting
several anti-abuse rules in its domestic laws and double taxation avoidance agreements
(DTAAs) to be compliant with BEPS recommendations. India is adopting GAAR in its tax
legislation from 1.04.2017.
2.2 Aspects of cross border tax structuring

There are several aspects of cross border tax structuring. We will discuss following
aspects/mechanisms in subsequent paragraphs:
1. Setting up an entity - Choice of entity type
2. Tax efficient funding strategies
3. Inbound cross border tax structuring
4. Outbound cross border tax structuring
5. Cross border mergers and acquisitions

6. Profit repatriation strategies
7. Use of leasing
The technical coverage in respect of each of the above topic will be generic in nature and will
involve conceptual discussions with examples.
2.2.1. Setting up an entity – Choice of entity type 6

MNE group may operate in a jurisdiction through an entity which may be a branch
(unincorporated entity), private limited company, public limited company, unlimited liability
partnership or limited liability partnership (LLP).
Legal characterization of an entity may predominantly depend on business and regulatory
considerations. This is because, customers and stakeholders with whom MNE group deals will
feel more comfortable to deal with certain type of entity as compared to others banks and
financial institutions may provide higher degree of funding to a certain type of entity or
regulations may allow ease of compliances, funding or entity structuring for certain type of
entities as compared to others.
However, it is important for the group to consider the tax aspects/consequences of choosing a
particular type of entity.
Each type of entity may have its own set of advantages/disadvantages from tax standpoint.
The entity types and tax aspects can be given as under:
(a) Branch :
When a company/firm establishes its presence in the form of office in other jurisdiction, such
presence is called a branch office. The branch does not have separate legal existence and is
said to be part of the main enterprise.
The branch is a non-resident taxpayer for tax purposes in the jurisdiction in which it has
established its presence. In case non-resident taxpayers are subjected to higher rate of tax
than resident taxpayers in the country (e.g. India) then, such higher tax rate will be applicable
to the branch office. In some countries, taxation of branch is also governed by separate tax
regime and tax rate called branch profit tax regime (e.g. US).
A branch may be established to act as liaison office (LO). Generally such liaison office may
not undertake and may not be even allowed by regulations to undertake business operations
in the jurisdiction it operates.
The LO may be allowed and may carry out activities like:
• Representing the head office (HO) and other group companies in the LO jurisdiction
6 Also refer to Chapter 1 International Tax Structures, Para 1.4

• Promoting export/import from/to LO jurisdiction

• Promoting technical/financial collaborations between HO/group companies and other
third party entities in LO jurisdiction
• Acting as a communication channel between the head office and third party entities in
LO jurisdiction
• Collection of information/data from LO jurisdiction
The LO may not be considered as permanent establishment (PE) of the enterprise in the LO
jurisdiction as such LO does not carry such business and hence, may not be liable to tax in
respect of its activities in LO jurisdiction. However, in case, the branch carries on the business
activity and has fixed place of business at its disposal then, the branch office may be
considered to be PE of its main enterprise.
A branch of a foreign company may be taxed both in its home as well as host (branch)
jurisdiction. Hence, it is important, to evaluate the remedies both under the domestic law as
well as DTAAs to remove double taxation before setting up branch office.
If the foreign company is new in a jurisdiction then there are likely to be start-up losses.
Hence, it may be important to utilize such losses from tax standpoint. Hence, a branch
structure may be useful in initial years. However, it is important to bear in mind that,
conversion of branch to a subsidiary involves a disposal of assets of foreign branch to be
purchased by a new subsidiary. Such disposal may attract capital gains tax.
(b) Company :
A company is a treated as a separate legal entity than its parent company for both legal and
tax purposes. It is generally treated as tax resident of the country in which it is incorporated
(unless tax residence rules of the country in which the company is incorporated determine the
residence as per place of management/place of effective management).
The compliance burden of a company is usually higher than a branch or partnership firm. Such
compliance burden may be highest in case of public limited company as compared to private
limited company.
Further, the private limited company may be subjected to variety of anti-avoidance provisions
e.g.: provisions to prevent private limited from issuing deemed dividend to shareholders in the
form of loan etc.
The dividend declared by the company may be subject to dividend distribution tax.
The Controlled Foreign Company (CFC) rules in jurisdiction of parent company may expose
the profits of the subsidiary company to tax in parent company’s jurisdiction. (CFC rules treat
the undistributed profits of the MNE group’s intermediary holding company located in low or no
tax jurisdiction as deemed dividend of parent company and such profits are subject to tax in
parent company’s jurisdiction)
(c) Partnership firm/LLP :

The partnership firm may be unlimited liability partnership (which is unincorporated entity) or
limited liability partnership (LLP) (which is incorporated entity).
In many jurisdictions, the partnership may not be recognized for tax purposes and the profits
may be taxed in the hands of the partners. Problems of double taxation may arise in cases
where the firm is recognized for tax purposes in one jurisdiction but not in the other jurisdiction
where entity operates. This is because; the person being subjected to tax on the same income
may be different in two different jurisdictions which may make it difficult for the entity to obtain
credit or exemption to remove double taxation.
Hence, an in-depth analysis may be needed before choosing firm as an entity for proposed
transactions.
The profits of the firm are not subjected to dividend distribution tax as they are already taxed
in hands of the firm.
In certain countries (for e.g. India) a deduction may be available on interest on capital paid to
partner of the firm subject to interest rate cap.
It is important to note, that statutory and regulatory compliances applicable to the partnership
firm are lesser as compared to company.
However, it needs to be noted that, in case of unlimited liability partnership firms, the tax and
other liabilities may be recovered from personal assets of partners in case if the partnership
assets are insufficient.
2.2.2 Tax efficient funding strategies

The capital structure of an organization plays an important role in the cost of funds to that
organization. Debt may be tax efficient than equity since the interest on debt is tax deductible;
whereas equity funding leads to increase in cost due to levy of dividend distribution tax on the
dividend pay-out.
Equity shareholders are entitled to ownership rights in the company and an exempt dividend
income, however they receive uncertain returns; whereas debenture holders receive a steady
stream of taxable interest income over a specified period of time, also debenture holders
receive payment in priority as compared to all creditors.
In countries like India which have the dividend distribution tax (DDT) in their tax regime, the
dividend payment may lead to economic double taxation. This is because; the dividend is paid
to the shareholders post deducting the DDT. The incidence of DDT lies on distributing
company and not the shareholder. Therefore, though the shareholder is taxed on gross
amount of dividend (before deducting DDT) in its home jurisdiction, it may not receive the
credit of DDT paid by distributing/subsidiary company. Further, though dividend may be
exempt upto a particular threshold if DDT is paid, there may be further tax implications in the
hands of the shareholder in case the threshold is exceeded.
From the company’s perspective, issuance of equity is simpler than raising debt in a country
where there are strict exchange control regulations. As such regulations may lay down various
criteria in relation to eligible lender, end-use of funds, ceiling on amount of borrowing and
interest payable on the same, etc. which need to be complied with.
Use of debt may provide a taxpayer with several tax planning opportunities. A prominent
among them is use of hybrid instrument. The hybrid instrument may have features of both
equity and debt. Such instrument may be used to fund entity using debt which may be in form
of quasi equity. A hybrid instrument like compulsory convertible debenture may be
compulsorily converted at a future point of time into equity.
Recently, companies are also issuing optionally convertible debentures/preference shares.
An instrument may be treated as debt in the country in which it is issued and accordingly an
interest deduction may be allowed to the taxpayer issuing the hybrid instrument. On the other
hand, the country of funding entity may treat instrument as equity and may characterize the
pay-out by issuing entity as dividend thereby granting tax exemption on account of
participation exemption regime (Special regime granting exemption to dividend income
received from overseas subsidiary on account of participation in equity of such subsidiary
higher than certain percentage by holding company which is tax resident/incorporated in such
jurisdiction where special regime exists. Such regime is to prevent double taxation and
encourage cross border investments).
However, Action 2 of OECD’s BEPS project has now introduced steps to remove such
mismatch by recommending that, exemption given by countries should depend on the tax
treatment in the jurisdiction of issuing country in hands of such entity. Hence, countries are
making changes to their tax legislations in order to remove such mismatch arbitrage.
Further, some countries may provide special tax benefits for companies raising funding
through debt. This is to boost economic activity in the country and facilitating investments
inflow. For example, in India, Section 194LC of the Indian Income Tax legislation, provides
that in case of external commercial borrowings by an Indian company engaged in certain
business or any business trust, tax shall be withheld at a reduced rate of 5% on interest
payments to non-residents, on monies borrowed by it in foreign currency from a source
outside India under a loan agreement or through issue of long-term infrastructure bonds.
2.2.3 Inbound cross border tax structuring
The different options available in Inbound cross border tax structuring are:
(a) Direct holding
A company who wishes to invest in other jurisdiction can directly invest in the form of setting
up a subsidiary or by acquiring an existing company. However, detailed evaluation may be
required in respect of tax outgo resulting from both the options so as to choose the most
beneficial option. Exit may not be tax efficient in case of direct holding in the absence of
relevant favorable DTAA provisions as gains may be subject to high capital gains tax. Also
acquiring a new company may require several regulatory compliances and other procedural
and legal requirements like conducting due diligences etc. Other alternatives are discussed as
below.
(b) Investment through tax efficient jurisdiction
It is common for foreign investors to invest though Intermediate Holding Company (‘IHC’)
located in a tax efficient jurisdiction to gain tax benefits on repatriation of profits as well as on
exit. For example: For Investing into India, interalia Mauritius and Singapore are considered to
be tax efficient jurisdictions. The tax treaty signed between India and these 2 countries
provides for a tax exemption on capital gains earned in India. This benefit is being phased out.
India – Singapore DTAA also requires evidence of substance (active operations) in Singapore
IHC for such IHC to be eligible for capital gains tax exemption on share sale.
Diagrammatic explanation of an investment in the form of a subsidiary or IHC is as below:
Ultimate Holding company,

France
Subsidiary in India Intermediate Holding Company,

Singapore
Subsidiary in India
However, such setting up of IHC in favourable tax treaty jurisdiction has been challenged by
tax authorities and has been perceived as a vehicle to obtain tax benefits without any
‘commercial substance’. The tax authorities also often allege that ‘beneficial ownership’
(beneficial owner is the person with whom benefits attached to an asset are vested, even
though he may not possess legal title attached to it.) of the capital asset located in underlying
investment jurisdiction (India in above diagram) is actually vested in the ultimate owner sitting
in a different foreign country.
Anti-abuse rules in the domestic tax legislation and also limitation of benefits (LOB) provision
in tax treaties need to be analysed before using the tax favourable jurisdiction for investing in
underlying investment jurisdiction.
(c) Acquisition of shares of an offshore IHC
A foreign company desirous of investing in India may acquire shares of an offshore IHC
already holding shares of the target company. In this case, location of IHC would not be
relevant in deciding taxability on capital gains on sale of shares of the target company as it is
presumed that, IHC may already be located in the tax favourable jurisdiction. However, the
indirect transfer provisions (section 9) needs to be analysed along with relevant treaty.
(d) Acquisition of shares of chain of intermediary holding companies (Indirect
transfer transaction )
This involves acquisition of an intermediary holding company from the chain of intermediary
holding companies.
In the above example, D Co. is held by chain of intermediary companies. D Co. is bought by K
Co. by acquiring shares of B Co. which is one of the intermediary holding companies of D Co.
In the past few years, this option has been used by multinational companies to avoid capital
gains in the source jurisdiction (D Co. jurisdiction) and also to avoid substantial regulatory
compliances (if any) in the ultimate target jurisdiction.
These type of transactions are called as indirect transfer transactions (Refer the Indian case of
Vodafone 7) where taxability of such transaction was under dispute in the Indian Supreme
Court. The Supreme Court held that, such transactions could not be taxed in India in the
absence of specific charging provisions.
However, post this decision, a number of retroactive provisions have been introduced in Indian
income tax legislation to subject such transactions to capital gains tax. The value of
transferred shares of intermediary holding company would be valued on the basis of
underlying assets in India for calculating the capital gains for the purpose of Indian tax.
7 341 ITR 1 (SC)

Also certain other countries like China have also introduced similar provisions in their
domestic tax legislation.
(e) Outbound cross border tax structuring
The investments outside the jurisdiction of ultimate holding company can be in the form of a
subsidiary, branch office or joint venture. However, such investments would be subject to
regulatory restrictions and compliance requirements of both the jurisdiction of the ultimate
holding company and the target investment country.
The overseas investment can be made through following channels according to the degree of
product diversity and market complexity.
Diagram source: www.drawpack.com 8

The different options available in outbound cross border tax structuring:
(a) Direct holding
A company looking to invest in other jurisdiction can directly invest by setting up a subsidiary
or by acquiring an existing subsidiary. However, the profits generated by the overseas
subsidiary, when repatriated to ultimate holding company may be taxable in jurisdiction of
holding company in absence of participation exemption regime. The dividend distribution by a
foreign subsidiary may be liable to DDT in hands of subsidiary. Further, the disposal of shares
held by holding company may be subject to levy of capital gains tax, in absence of favourable
tax treaty provisions. Other entity options such as LO, BO, Partnership are also
available.(These have been analysed in detail in the section relating to outbound investments)
(b) Investment through tax efficient jurisdiction
It is more tax efficient for investors to invest though IHC located in a tax efficient jurisdiction to
gain tax benefits on repatriation of profits as well as on exit. However, as discussed above,
8 http://www.drawpack.com/index.php?route=product/product&product_id=5391
care needs to be taken by reviewing the entire arrangement from stand point of anti-avoidance
provisions in local tax legislation or LOB provisions of tax treaty.
(c) Acquisition of IHC
An investor company can acquire more than 50% of the shares of IHC located in favourable
treaty/tax jurisdiction to acquire a controlling interest. This structure may be tax efficient
structure to gain tax benefits on repatriation of profits as well as on exit.
However, one may need to evaluate the entire arrangement from the point of views of the CFC
rules existing in the tax favourable jurisdiction which may expose the profits in IHC to be taxed
in the ultimate holding company’s jurisdiction. It is also important that the rules relating to the
Place of effective management (POEM) is also examined such that the overseas company
does not become a resident company in India.
2.2.4 Cross border mergers and acquisitions
Cross border mergers and acquisitions entail cross border amalgamation/ purchase of two or
more companies located in different jurisdictions. Such cross border mergers and acquisitions
are helpful for companies to make tax efficient cash repatriation or help to make efficient use
of losses or shift country of tax residence (commonly termed as inversion).
Mergers should be viewed differently from buying a company by virtue of share purchase.
Mergers & acquisitions involve transfer of assets and liabilities of one company to another and
the shareholders get shares of new company in their own right as owners of amalgamating
company. Such amalgamation does not result in transfer of capital assets under normal
principles of income tax as amalgamation does not result in transfer for consideration.
Similar logic is applicable even for demerger. However, this is subject to specific legislation
given by particular country (for examples in India mergers and acquisitions have several
conditions which need to be fulfilled for being eligible for tax exemption).For Cross border
mergers and acquisitions tax and regulatory laws of both the jurisdictions have to be examined
in detail.
(a) Cross border mergers
We may consider following example: for tax efficient repatriation of profits, holding company
may merge with its subsidiary. This may help the group to repatriate the cash sitting in books
of subsidiary efficiently. However, the challenge is to abide by regulations and taxation
provisions of the countries of the two companies involved.
Another example may be to merge the company in high tax jurisdiction with another company
in low tax jurisdiction and shift the corporate tax residence to low tax jurisdiction. Such shift is
called inversion. Multinational companies resort to inversion to achieve cash efficient
repatriation of dividends and other payments and to switch to territorial system of taxation
rather than worldwide system which may be prevalent in their home jurisdiction.
There may be many other ways to achieve tax efficiencies through cross border mergers.
(b) Acquisition through itemized sale/ slump sale/ demerger

A foreign company could set up a holding company in target company jurisdiction, which in
turn acquires the target company through itemized sale of assets and liabilities or slump sale
or demerger of such target company.
Unlike in the case of a slump sale, in the case of itemized sale, the holding company has a
choice to pick up certain assets; however the gains on their transfer shall be taxable in the
hands of the transferor – target company. On the other hand, slump sale entails sale of an
entire business undertaking for a lumpsum consideration, which would be taxable in the hands
of transferor. An evaluation of both the options from tax efficiency perspective is required
before choosing to go for itemized sale or slump sale.
2.2.5 Repatriation
(a) Buyback of shares
As compared to dividend payment, buyback of shares is a more tax efficient strategy to
repatriate profits to the equity shareholders. The capital gains arising on buyback of shares
may be taxable. However, provisions of some tax treaties may make capital gains tax exempt
in source jurisdiction.
However, tax authorities around the world have been vigilant on the intention of entering into
such transactions and have viewed buyback as a colourable device to avoid tax outflows.
Thus such transactions need to be undertaken with commercial substance and for bonafide
reason of distribution of profits to shareholders.
However, note that, in Indian scenario, the country also has buyback distribution tax (BBT) in
its tax regime. In this case, the company earning capital gains may not be able to take the
benefit of provisions of Article 13 relating to Capital Gains of the DTAA in the source
jurisdiction as the tax incidence of BBT is not in hands of entity buying back the shares
(shareholder entity) but in the hands of the subsidiary company.
(b) Royalty and fees for technical services
Royalty is for use of tangible (industrial equipment) or intangible property (patent, know-how,
trademark/trade name/brand or intellectual property). Royalty has been employed as an
efficient way of profit repatriation by multinationals predominantly by granting right to use
intangible assets to group entities. Further, the entity paying royalty may avail tax deduction
for the same. However, such transactions among group entities may attract transfer pricing
provisions. Also, the transfer pricing authorities in different countries are examining these
transactions by applying the benefit test. This is done by scrutinizing if the asset is providing
the benefit to the royalty paying entity or whether such transaction is only undertaken to shift
profits from one jurisdiction to other.
Action 8 of OECD BEPS project - Transfer pricing aspects of intangible assets have provided
a revised and detailed guidance to transfer pricing authorities and taxpayers to benchmark the
intra-group transactions involving intangible assets.
Apart from royalty, the multinational companies may also have fees for technical services
(FTS) to repatriate profits.
FTS article is absent in OECD model convention, while the same is present in UN Model
taxation. Hence, the tax treaties based on OECD model do not have FTS article and the
taxpayers may in these cases claim exemption from withholding tax.
The taxpayer may get the deduction of payment of management service fee. However,
transfer pricing provisions continue to apply to these transactions. Management service
transactions are under intense scrutiny from transfer pricing authorities and the authorities
continue to apply benefit test to these transactions to assess the benefits obtained by service
recipient.
(c) Entity conversion
One of the common examples of entity conversion is conversion of private limited company
into limited liability partnership (LLP).
The conversion is seen in countries where dividend is subjected to DDT. LLP facilitates tax
efficient repatriation of profits.
2.2.6 Leasing
Cross border leasing is one of the strategies employed by multinational groups to finance the
purchase of high value assets.
The lessor may avail deduction of depreciation on leased asset in its jurisdiction. Also in many
cases, the lessor may buy such asset by obtaining loan which may also generate interest
deduction. Lessee may avail the deduction of lease payments. Such arrangement may also
help lessors to avail the benefits of tax losses. Cross border leasing requires careful
consideration of tax laws of both lessor and lessee jurisdiction and GAAR provisions in
domestic law, recent BEPS recommendations and other anti-avoidance provisions
2.3 Need for substance/commercial rationale and conclusion

opt any one option which is most tax efficient.
undertaken only to avail tax benefits. Hence, taxpayer needs to maintain adequate
3. International Tax structuring for Expatriate Individuals

3.1 Background
With the advent of technological advancements, the world has become a “Global Village”.
MNCs from various continents are setting up shops globally including in India and expanding
their business.
While technology has bridged the gap between East and West and connectivity is no longer an
issue; the need for skilled manpower to guide, supervise, control and manage the business
abroad still remains a challenge for MNCs. To overcome the said challenges, MNCs typically
look at sending their personnel to group companies abroad.
Typically from an MNC’s perspective, the reasons for secondment are as follow:
• Utilisation of technical as well as leadership skills of group entities for specific time
period/ projects,
• Integrating operations with group companies,
• Establishing global practices in new markets,
• Providing employees an opportunity of getting diverse international experience, etc
Separately, employees today are exploring avenues to work outside their “home country” to
get experience and explore opportunities available to them. The idea of movement of
personnel to group companies abroad for a temporary period is regarded as secondment and
the person being seconded is typically regarded as an expatriate in the country of
secondment.
The term “secondment” is not defined in the Income-tax Act, 1961 or the tax treaties or the
OECD commentary. As per Oxford Dictionary, the term “secondment” means:
“The temporary transfer of an official or worker to another position or employment..”
It may be noted that in common parlance, the words secondment and deputation are used
interchangeably.
3.2 Typical secondment arrangement

Payment of part salary
F Co Expatriate’s Foreign
Bank Account
Outside
India
Seconds Reimbursement of
salary cost borne by India
employee
F Co
Deposits taxes withheld

Indian subsidiary Government Treasury
(I Co)
Payment of part salary

Expatriate’s Indian
Bank Account
3.2.1 Typical features of a secondment arrangement:

1. F Co (Foreign Company) and I Co (Indian company) are group companies.
2. Pursuant to business and commercial reasons, F Co seconds certain employees
(assignees) to work under I Co in India for a specific time period.
3. Secondment may or may not be pursuant to a specific request by the I Co.
4. I Co may or may not select the seconded employees.
5. Assignees remain on the payroll of F Co and employment with F Co continues during
the period of secondment. However, during the period of secondment, they work
exclusively under the control and supervision of I Co. Assignees may sign employment
contracts with I Co in India (resulting in dual employment with I Co as well as F Co).
6. The secondment agreement may clarify that during the period of secondment, I Co
would be the employer, assignees would become part of I Co’s organization, risk and
reward of assignee’s work will vest in I Co and I Co alone will be legally obliged to bear
the cost of employment of assignees during the period of secondment.
7. F Co will not be responsible for any work or activities of the assignees during the
period of secondment.
8. The salary and related employment costs of the assignees are partly paid by I Co in
India and partly by F Co (on behalf of I Co) in the home country for administrative
convenience only. The portion paid by F Co in home country (if any) is cross-charged to
I Co on actual basis (i.e., without any mark-up/ profit element). Payment of employment
costs by F Co is sometimes also driven by continuity to receive social security benefits
in the home country. Since, the assignee is no longer working for F Co, such costs of
employment are cross charged to or recovered from I Co.
Assignee has a right to return to F Co on completion of term of secondment from I Co.
3.2.2 Typical tax questions
As noted above, in a typical secondment arrangement, the employee remains on payroll of F
Co during the period of secondment, while also being on the payroll of I Co. In this scenario,
the typical question that arises is whether the seconded employee is actually working as an
employee of I Co or he is rendering services on behalf of F Co. In the first scenario, the
relation between the employee and I Co is that of master and servant (i.e. contract of service)
while in the second scenario, it is a case of F Co rendering services to I Co via the seconded
employees (i.e. contract for service).
Contract for Service vs Contract of Service
The SC in Kishore Lal v Chairman, Employees State Insurance Corporation (2007, 4 SCC
579), observed a distinction between the two (i.e. ‘contract for service’ and ‘contract of
service’) which is summarized as under:
Contract for service Contract of service
Implies a contract whereby one party Implies relationship of master and servant
undertakes to render service e.g.
professional or technical service, to or for
another party
In the performance of a contract for service, Involves an obligation to obey orders in the
the party rendering service is not subject to work to be performed and as to its mode and
detailed direction and control, and exercises manner of performance
professional or technical skill, and uses its
own knowledge and discretion
OECD Commentary on ‘Contract of Service’ vs ‘Contract for service’
The OECD Commentary 2010 in the context of Article 15(2) i.e. availability of short stay
exemption, recognizes a distinction between ‘contract of service’ and ‘contract for service’,
between two enterprises. The Commentary indicates that it needs to be determined whether
the services rendered to an enterprise of a State by an individual resident of another State
constitute services rendered under (i) an employment relationship or (ii) a contract for
provision of services between two separate enterprises. The OECD Commentary recognizes
that the forms (formal contracts) under which services are rendered may be ignored and the
focus should be on the nature of services rendered.
Certain principles laid down by the OECD Commentary for ascertainment of who should be
regarded as an employer, are as under:
• Receives services and nature of services received form an integral part of its business;
• Bears the responsibility and risk to the result produced by the individual’s work;
• Has an authority to instruct the manner in which work should be performed;
• Controls and has responsibility for the place at which the work is performed;
• Bears the cost of employment;
• Provides necessary tools and materials to the employees and determines the holidays
and work schedule of that individual;
• Determines qualification of the employees;
• Has right to select the individual and terminate the contractual arrangements entered
and impose disciplinary sanctions, etc.
3.2.3 Tax implications in India
3.2.3.1 I Co is regarded as the employer:
In a scenario, where I Co is regarded as an employer, payment by I Co to F Co of salary cost
paid by F Co is regarded as reimbursement of expenses (provided back to back documents
are available to prove the same).
3.2.3.2 F Co is regarded as the employer:
(a) Fees for Technical Services (‘FTS’)
Section 9(1)(viii) of the Act deals with the taxability of income in nature of FTS paid to a Non
Resident, where the fees are payable in respect of services utilised in business carried on in
India. The said section also defines FTS to include payment made towards provision of
services of technical personnel by the foreign company.
Article 12 or Article 13 of most of the Double Taxation Avoidance Agreements (‘tax treaty’)
have defined FTS. FTS mean payments of any kind other than those referred to in other
Articles of the Agreement to any person, in consideration for any services of a technical,
managerial or consultancy nature (certain tax treaties like India – USA, India – Singapore,
India – UK, India – Switzerland, India – Australia, India – Netherland, etc state that FTS are
taxable in India only if they ‘make available’ technical knowledge to the recipient of services).
Accordingly, if the above conditions are fulfilled, there is an exposure that the services
rendered by expatriate to I Co are regarded as FTS for F Co. In such scenario, the income of
F Co would be taxable at the rate prescribed under the Act or tax treaty whichever is more
beneficial (as per provision of section 90 of the Act). Further, Transfer Pricing (‘TP’)
regulations shall typically apply to F Co and I Co for the transaction.
(b) Service Permanent Establishment (‘PE’)
Section 9(1)(i) of the Act provides for taxability of all income accruing or arising, whether
directly or indirectly, through or from any business connection in India. Further, in the case of
a business of which all the operations are not carried out in India, the income of the business
deemed to accrue or arise in India shall be only such part of the income as is reasonably
attributable to the operations carried out in India. Such income would be taxable at the rate of
40% (excluding applicable surcharge and education cess) on net basis (expenses deductible
subject to WHT, etc.)
Article 5 of most of the Double Taxation Avoidance Agreements (‘tax treaty’) has defined PE.
PE is defined to include the furnishing of services, other than those covered by Article 12/
Article 13 (Royalties and FTS), within a Contracting State by an enterprise through employees
or other personnel, but only if activities of that nature continue within that State for a period or
periods specified in respective tax treaty.
Accordingly, if the above conditions are fulfilled, there is an exposure that the services
rendered by F Co (in the above example) through employees may constitute a service PE of
the F Co. In the scenario, the income of F Co in such case would be taxable at the rate of
40% (excluding applicable surcharge and education cess) on net basis. Further, TP
regulations shall apply to F Co and I Co for the transaction.
(c) Fixed place PE:
It would be relevant to note that in case of various tax treaties (eg. Germany, Mauritius,
Netherlands etc.) which do not contain service PE clause, the tax authorities might contend
that based on Paragraph 6 of the OECD model commentary to Article 5 - which states that six
months is the minimum threshold for existence of PE, the seconded employee may constitute
a fixed place PE of the F Co. Further, existence of fixed place PE may also be evaluated if the
employee has a fixed place at his disposal in I Co through which business of F Co is carried
on.
Below are the conditions for fixed place PE as per Paragraph 2 of the OECD model
commentary on Article 5:
• the existence of a “place of business”, i.e. a facility such as premises or, in certain
instances, machinery or equipment;
• this place of business must be “fixed”, i.e. it must be established at a distinct place with
a certain degree of permanence;
• the carrying on of the business of the enterprise through this fixed place of business.
This means usually those persons who, in one way or another, are dependent on the
enterprise (personnel) conduct the business of the enterprise in the State in which the
fixed place is situated.”
Further, TP regulations shall apply to F Co and I Co for the transaction.
3.2.3.3 The above is summarised as under:
Particulars If I Co is the employer If F Co is the employer

Reimbursement of payments Not income in the hands of F Income in the hands of F Co
(i.e. salary) made by F Co to Co, if no profit element is
I Co involved
PE for F Co in India No, as I Co shall be the Possible
employer • Service PE
• Fixed place PE
(If the activities of
employees amounts to
stewardship activities, PE
may not be constituted) 9
Whether payment made by No Possible
I Co to F Co could be
regarded as FTS
Applicability of TP No. But better to report Yes

regulations to the reimbursement in Form
transaction 3CEB
3.3 Landmark rulings on secondment:

3.3.1 Morgan Stanley and Co Inc (Supreme Court)
MSCo
USA
Seconds employees
Provides support India

services
MSAS
9SC ruling in case of Morgan Stanley International – 292 ITR 416 (SC)
Facts
Morgan Stanley and Company (‘MSCo’) was a US company providing various services
worldwide and was part of Morgan Stanley group. One of the group companies of Morgan
Stanley viz. Morgan Stanley Advantages Services Pvt. Ltd. (‘MSAS’) entered into an
agreement for rendering certain support services to MSCo. Pursuant to the agreement with
MSAS, MSCo proposed to send its personnel to India for the following:
• for undertaking stewardship activities to ensure that the services rendered by MSAS
meet the standards of MSCo; or
• to be on deputation to MSAS and work as employees of MSAS
The salary costs of personnel deputed to work under the control of MSAS was to be initially
paid by MSCo and onwards be recharged to MSAS. The salary costs and other costs of the
employees who were to be sent to India for stewardship and other similar activities was to be
borne by MSCo.
Held
A. Stewardship activities:
The SC held that the Stewardship activity involved briefing the MSAS staff to ensure that the
outputs meet requirements of MSCo and Includes monitoring the outsourced operations. The
purpose of the above agreement was to protect interest of MSCo and ensure quality control.
The SC held that since no service is provided by MSCo to MSAS and that stewardship
activity by employees does not constitute a service PE of MSCo in India.
B. Deputation of personnel:
In its ruling, the SC has stated that twin conditions are to be satisfied to constitute service PE
ie (i) foreign company should be responsible for the work of the assignees; and (ii) assignees
are on payroll of the foreign company or they have a lien on employment with the foreign
company.
In the instant case, SC held that seconded employee lends its experience to MSAS as
employee of MSCo as he retained lien with MSCo. Thus, MSCo has a service PE (i.e.
MSAS) in India.
3.3.2 Centrica India Offshore Pvt Ltd (Delhi HC)
Facts
• Centrica India Offshore Private Ltd (CIOP) was a WOS of Centrica Plc., a company
incorporated in UK. Centrica Plc, had two other subsidiaries in UK and Canada
(collectively referred to as “overseas entities”), which were engaged in the business of
supplying gas and electricity to consumers across UK/ Canada.
• The overseas entities had outsourced their back office support functions (such as
consumers’ billings/ debt collections/ monthly job reporting) to third party service
providers in India (Vendors).
• CIOP entered into a Service Agreement with overseas entities to provide locally based
interface between the overseas entities and the Vendors in India. CIOP was required to:
(a) ensure that the Vendors complied with the requisite quality guidelines (b) provide
management assistance to Centrica Plc, including advice on expanding scope of
potential services in India. For this, CIOP was compensated on a cost plus basis.
• Since CIOP was newly incorporated, it needed the knowledge of processes and
practices of the overseas entities to successfully fulfil its role under the Service
Agreement. In this regard, CIOP and the overseas entities entered into a Secondment
Agreement under which the overseas entities seconded some of their assignees with
requisite knowledge and experience to work with CIOP in India.
Key terms of the Secondment Agreement were as below:

1. Overseas entities would second the assignees to CIOP, at the request of CIOP.
2. The assignees will integrate into CIOP’s organization.
3. Rules and regulations of CIOP were applicable to the assignees.
4. The assignees would work under the direct control and supervision of CIOP.
5. The overseas entities would not be responsible for any error or omission on the part of
the assignees.
6. CIOP would bear the risks and rewards of the work of assignees.
7. CIOP had a right to specify the scope and nature of the assignees’ work and the results
to be achieved.
8. Assignees to retain their entitlement to participate in Centrica Plc’s retirement/social
security plans and other benefits in accordance with Centrica Plc’s policies.
9. CIOP would bear the monthly costs of employment of assignees, including their basic
salary, cost of participation in retirement/social security plans, other compensation and
benefits as applicable and any other costs as agreed between CIOP and overseas
entities.
10. CIOP could terminate the Secondment Agreement.
11. Each assignee would enter into an individual agreement with CIOP, which would
provide for specific terms of work in India.
Further, salary of the assignees was to be disbursed overseas by the overseas entities and
the amounts were to be recovered from CIOP on actual basis. Also, CIOP would withhold
taxes on the salary paid to the assignees in respect of the services rendered.
Held
The HC held that the employees (assignees) seconded by overseas Group Entities to the
CIOP in India did not become employees of the CIOP, but continued to remain employees of
the overseas entities during the secondment period. Accordingly, the arrangement involved
rendition of services by the overseas entities to CIOP through such assignees.
Further, since the assignees were imparting their technical expertise and ‘made available’
know-how to other regular employees of CIOP for future consumption, payments from CIOP to
the overseas entities for such services was regarded as FTS/ FIS under the Act, as well as
under the relevant tax treaty.
As regards service PE, the HC held as under:
• To determine existence of a Service PE, it is the substance of the employment
relationship which must be considered, and not the form.
• It was noted that the assignees integrated with CIOP’s business and were subject to the
control, supervision, direction and instructions of CIOP. The assignees had to perform
their duties in accordance with the applicable laws, regulations, and standards of CIOP
who bore all the risks and rewards of the assignees’ work during the period of
secondment. Also, the overseas entities were not responsible for any errors or
omissions by the assignees. However, there was no employer-employee relationship of
the assignees with CIOP and they continued to be employed by the overseas entities
for the following reasons:
1. The assignees retained the right to participate in the retirement and social
security plans and other benefits of the overseas entities.
2. Salary was properly payable by the overseas entities which claimed money from
CIOP. There is no entitlement or obligation clearly spelt out for CIOP to bear the
salary costs of the assignees. All direct costs of the assignees’ remuneration
were ultimately paid by the overseas entity.
3. The assignees cannot sue CIOP to recover their salary in case of default.
4. CIOP had a right to terminate the secondment in its agreement with the overseas
entities. However, CIOP had no right to terminate the services of the assignees
vis-à-vis the overseas entities, which represents the original and subsisting
employment relationship.
5. The employment relationship between the assignees and the overseas entities
remained independent and beyond the control of CIOP.
6. The assignees were regular employees of the overseas entities and they would
return to their original employment after completion of the secondment period.
The employment relationship between the assignees and the overseas entities
was not terminated at any point of time and CIOP has no right to even modify
such a relationship.
7. While CIOP had operational control over the assignees and had to bear the risks
and rewards of their work, such limited and sparse factors cannot displace the
larger and established context of employment with the overseas entities outside
India.
8. The SC, in the Morgan Stanley case (supra), upheld the existence of a Service
PE where an employee of a foreign company rendered services to an Indian
entity while retaining the lien on employment with the foreign company.
In view of the above, the HC held that Centrica Plc has a service PE in India.
It may be noted that a Special Leave Petition filed before the Supreme Court (‘SC’)
against the above High Court’s decision has been dismissed by the SC.
3.4 International Tax Structuring for Inbound Expatriate Individuals 10

3.4.1 Payroll shifts to India
Expatriate’s Foreign
F Co Bank Account
Remittance by expatriate Outside

outside India India
Seconds’ India
employee
Payment of salary
Indian subsidiary Expatriate’s
(I Co) Indian Bank
Deposits taxes withheld

Government
Treasury
Mechanics:
• F Co would second the employees to I Co, at the request of I Co.
• The employment of expatriate with F Co is suspended and the expatriate is on the
payroll of I Co.
• I Co is responsible to pay salary to the Expatriate in India and expatriate can sue I Co to
recover the same
• Salary is paid by I Co in expatriate bank account in India (the expatriate later remits the
same to his bank account outside India).
• I Co to deposit the Indian withholding tax on the total salary into Government Treasury.
• I Co to decide on terms of employment of expatriate including their salary, increments,
bonus, leave, appraisals, etc.
• Expatriate to participate in I Co’s retirement/ social security plans and other benefits in
accordance with I Co’s Policies.
• F Co does not contribute to the Social Security Benefits of expatriate.
• I Co has the right to terminate the employment of expatriate.
10 These are personal initial views of the author and should not be considered as an opinion
• The expatriate works under the direct control and supervision of I Co as per rules,
regulations and policies applicable to I Co’s employees in India.
• I Co would bear the risks and rewards of the work of the Expatriate.
Implications:
In the scenario, following implications could arise:
• I Co would be regarded as the employer of the expatriate since he is on the payroll of
and working for I Co while in India and is neither on the payroll of F Co nor working for
F Co during his employment with I Co.
• Since I Co is regarded as an employer, the question of F Co rendering services to the I
Co shall not arise and thus taxability under FTS or as PE shall not arise.
• There shall not be any TP implications since there is no transaction between I Co and F
Co
3.4.2 Manpower supply
Country 2 Country 1
100% subsidiary
F Co1 F Co2
Seconds employee
Seconds
employe Outside India
India
Deposits Government
taxes withheld Treasury
I Co
(Group Company)
Payment of Expatriate’s India
salary (net of Bank Account
taxes)
Mechanics:
• F Co1 is a group manpower supplying company for seconding employees worldwide
within the group.
• F Co2 seconds expatriate to F Co1 for say 2 years since the expatriate intends to gain
international experience. Expatriate retains the right to return to F Co2 after the
secondment period.
• I Co is in need of personnel and requests F Co1 to provide manpower with specific

qualification/ expertise for the period of six months.
• Expatriate seconded by F Co 2 has the said qualification/ expertise and F Co 1 seconds
him to I Co.
• I Co pays salary etc. of the expatriate.
• F Co1 is paid specific fee (2 months’ salary cost) by I Co for recruitment of expatriate.
• Expatriate enters into employment contract with I Co and works under the supervision
and control of I Co.
• I Co is responsible for the work of expatriate.
• Expatriate can sue I Co to recover salary if not paid.
Implications
• Implications for F Co1:
In the scenario, F Co1 is a manpower supplying company and provides manpower to various
group companies. F Co2 seconds employee to F Co1 for a period of 2 years while F Co1
seconds employees to I Co for six months. F Co1 is paid services fee for providing manpower
by I Co. The same may be taxable as FTS and would require detailed analysis. However, on
account of the following safeguards, the risk of F Co1 creating PE in India on account of
providing manpower may be low:
1. F Co1 is in the business of providing manpower and provides manpower to various
group companies across the globe (the same would be required to be demonstrated
with documentary evidence).
2. The employee is seconded with F Co1 for 2 years while F Co 1 has seconded with I Co
for 6 months and may later second the employee to some other entity.
3. Expatriate has no lien on employment with F Co1 and F Co1 is not responsible for the
work of expatriate.
4. Expatriate cannot sue F Co1 if I Co does not pay salary.
5. F Co1 is not carrying any business in India through the seconded employees
• Implications for F Co2:
In the scenario, the expatriate retains lien on employment with F Co2. However, if it could be
demonstrated with documentary evidences that F Co2 is not responsible for the work of the
expatriate, it could be said that the twin conditions laid down by SC in case of Morgan Stanley
are not fulfilled and hence there is no PE for F Co2 in India. However, on account of adverse
ruling of Hon’ble Delhi HC in case of Centrica India Offshore Pvt Ltd, the tax authorities might
contend that F Co2 has a PE in India. In the said scenario, if it could be demonstrated with
documentary evidences that the expatriate is working under the supervision and control of I
Co during the period of employment and not conducting any business for F Co2 in India, the
risk of taxing F Co2 in India is low.
3.4.3 Stewardship Activities
Payment of salary
F Co Expatriate’s
Foreign Bank
Outside India
Seconds Provides India

employees support
Indian subsidiary
(I Co)
Mechanics:
• F Co and I Co are group companies
• I Co enters into agreement with F Co for rendering certain support services to F Co.
• Pursuant to the agreement with I Co, F Co sends its employees to I Co to carry out
stewardship activities to ensure that the output of I Co meets the requirements of F Co.
• The salary costs and other costs of the expatriate are borne by F Co.
• The employees would be working as per the control, supervision, instruction of I Co.
Implications:
In the above arrangement in light of Hon’ble SC ruling in case of Morgan Stanley and Co Inc,
it is possible to contend that there is no PE of F Co in India since the employee is carrying out
stewardship activities for F Co in I Co and are not rendering any services to I Co. However,
adequate documentary evidence to substantiate the same would be required.
3.4.4 Secondment from tax treaty friendly jurisdiction
F Co
Germany
Seconds’ India
employee
Indian subsidiary
(I Co)
Mechanics:
• I Co is in need of personnel and requests F Co (i.e. parent company) based in Germany
to provide employees with specific qualification/ expertise.
• F Co would second the employees to I Co for the period of 5 months.
• The expatriate works under the direct control and supervision of I Co.
• I Co would bear the risks and rewards of the work of the Expatriate.
• The expatriate retains lien on employment with F Co.
• I Co makes payment to expatriate in India.
• I Co pays taxes in India on net basis at the base rate of 30 per cent .
PE Implications:
In the scenario, following implications could arise:
a) The India – Germany tax treaty does not have service PE clause and accordingly, the
question of F Co constituting Service PE in India through its employees shall not arise.
b) Further, to constitute Fixed Place PE, the minimum threshold is six months as per
OECD commentary. The expatriate works in India for I Co for the period of 5 months
and therefore, Fixed Place PE risk may not get triggered. However facts need to be
examined in more detail before concluding.
Summary
The key positions that have to be evaluated in determining the tax consequences on
international tax structure for expatriate is summarised below:
• Do the facts and documentation strengthen the position of the I Co as the employer of
the expatriate? If yes, payment by I Co to F Co may be regarded as reimbursement of
expenses provided back to back supportings are available to prove there is no mark-up
charged by F Co to I Co.
• Where the facts and circumstances do not lend support to the position of the I Co as the
employer of the expatriate, the arrangement is likely to be viewed as services rendered
by the F Co to the I Co
• In such a case, it is important to analyse whether the nature of services rendered by the
F Co to I Co would fall within the definition of FTS under the provisions of the Act and
the relevant tax treaty (if any)?
• Further, it shall be relevant to evaluate the risk of PE of the F Co in India under the
provisions of the Act and the relevant tax treaty (if any)? Where a PE is constituted,
income would need to be attributed to the PE and compliances would follow for the F
Co.
3.5 Tax implications on secondment outside India

Globalisation of the Indian economy has provided opportunities for many Indian
employees to work abroad. Many Indian companies are sending their employees on
secondment to group companies for a few years, wherein the employee works with the
overseas company and gains international experience. This process of working overseas has
taken on a whole new dimension as Indian and multinational companies are sending technical
and managerial personnel overseas by the thousands.
Seconding people overseas is a complex business and there are a host of tax, immigration
regulatory and human resource issues that need to be addressed. There are tax
consequences for both the employees as well as their employer depending on the nature of
the assignment. Typical assignment models are follows:
Type of Duration Characteristics Compensation
assignment
Short Term <6months STBTs are typically Salary continues to be
Business employees who travel paid in India. Nominal per
Travellers outside India for business diem is paid outside India
(‘STBT’) purposes and who are not during their travel.
on a formal assignment or
transfer.
Short Term 6 < 12 months Active employment Stays on home country
assignment contract remains with payroll. Additionally, cost
Indian company (‘I Co’) of Living allowance is paid
and additional contract to compensate for
governing the terms and increased cost of living.
conditions of the
assignment is signed with
Foreign company (‘F Co’).
Family usually does not
accompany the employee
Long Term > 12 months Active employment Shifts to F Co’s payroll or
assignment contract with F Co. I Co continue with split payroll (
issues a secondment i.e. partly paid in India and
contract governing the balance in host country)
terms and conditions of
the assignment and
employment contract with
I Co becomes dormant.
Family usually
accompanies the
employee.
Type of Duration Characteristics Compensation

assignment
Permanent Permanent Employment contract with Salary is paid in foreign
Transfer I Co ends while a new country as newly
employment contract with determined by F Co
F Co is established
3.5.1 Basic tax provisions relating to outbound assignments
The taxability in India depends on the individual’s residential status, which in turn depends on
his/her physical presence in India. As per Section 6(1) of the Act, an individual is said to be
resident in India in any tax year if he satisfies any one of the following basic conditions:
1. He is in India in the tax year for a period of 182 days or more; or
2. He is in India for a period of 60 days or more during the tax year and 365 days or more
during the four years preceding the relevant tax year.
The period of 60 days can be extended to 182 days in following circumstances:
• For a citizen of India, who leaves India in any previous year for the purpose of
employment outside India.
• For a citizen of India or a person of Indian origin who being outside India, comes on a
‘visit’ to India in any tax year
Based on the physical stay in a tax year, an individual would qualify to be:
 Resident & Ordinarily resident (‘ROR’)
 Resident but not Ordinarily resident (‘RNOR’)
 Non-resident (‘NR’)
The outbound employees are likely to qualify as a ROR or a NR of India in the year of transfer
and year of repatriation. During the years of assignment, the employees are likely to qualify as
a NR in India.This table outlines the most likely tax residency scenarios of Indian citizens
going on overseas assignment:
Stay in India Status in year of Status in middle Status in year of
departure year – (Visit to arrival into India
India)
> 181 days *ROR *ROR *ROR
< 182 days but > 59 days NR NR *ROR
&>364 days during
preceding 4 tax years
< 60 days NR NR NR
*It is presumed that additional conditions specified in Annexure A are satisfied.
As per section 5(1) of the Act, an individual who qualifies to be ROR is taxable on all income
from whatever source derived which—
(a) is received or is deemed to be received in India; or
(b) accrues or arises or is deemed to accrue or arise to him in India; or
(c) accrues or arises to him outside India:
Thus, ROR is taxable on their worldwide income whereas individuals who qualify to be RNOR
or NR are liable to tax only on India sourced income (i.e. income directly received in India or
accrued in India).
3.5.2 Typical tax questions
Outbound assignments typically trigger the following tax issues for the employer and
employee:
• Usually in case of a long term assignment, the salary is subjected to tax in foreign
country since the employee is rendering services in the foreign country. However, if the
salary is received in India, the same is also subjected to tax in India on receipt basis
thus resulting into double taxation of salary in the hands of the employee.
• While foreign tax credit (‘FTC’) can be claimed in India under section 91 of the Act,
however India is a fiscal year country and its tax year (i.e., from April 1 to March 31) is
invariably different from other countries, hence there may be practical challenges while
claiming FTC since the foreign tax return may not have been filed at the time of filing
India tax return.
• India has signed Double Taxation Avoidance Agreement (‘DTAA’) with various countries
which has Dependent Personnel Service clause (‘DPS’) under which the salary received
in India can be claimed exempt in India, if the individual qualifies to be resident of host
country and the salary is received for services rendered outside India. However, a tax
residency certificate (‘TRC’) is required in order to claim the exemption. Further, the Act
does not explicitly provide that employer can consider any tax relief such as DPS
exemption or claiming FTC under DTAA at the time of payment of salary. Thus,
employer may face practical challenge of tax withholding at the time of payment of
salary.
• The assignment may affect the taxation of stock options or similar equity incentive
schemes for both the employee and the employer.
• The presence of employees of I Co in foreign country may trigger a permanent
establishment (‘PE’) for I Co abroad thus resulting into corporate tax compliances for I
Co in foreign country.
3.5.3 Tax structuring of secondments
Efficient structures for international assignments help in optimizing costs while mitigating tax
and regulatory risks, thereby providing a competitive advantage to the employer. The planning
of employee secondments should take into account the employer's as well as the employee's
tax situation.
Typical outbound secondment arrangement
3.5.3.1 Typical features of above secondment arrangement
 I Co will depute the employee to F Co and issue an assignment letter to the employee
 I Co will pay basic salary into the employee’s Indian bank account
 F Co will pay salary and allowances (other than basic salary) into the employee’s
overseas bank account
 I Co will continue the contributions towards retirement benefits in India
 Such employee would work under supervision, direction and under the control of F Co
 I Co would cross charge the salary cost (including contribution to retirement benefits
paid by it) to F Co
3.5.3.2 Tax implications in the hands of the employee
3.5.3.2.1 Tax implications under the Act
If the deputed assignee qualifies as ROR, then he would liable to tax on his worldwide income.
Accordingly, he would be taxable on the entire salary received in India as well as outside
India.
If the deputed assignee qualifies as RNOR or NR, then he would liable to tax on income that
accrues/arises in India or is deemed to accrue/arise in India or received or deemed to be
received in India. Accordingly, the employee would be taxable on the salary that is received in
India even though it pertains to services rendered outside India.
However, if the employees are tax residents of the other tax treaty country, then they may
choose to be governed by the provisions of the Act or DTAA whichever is more beneficial to
them.
3.5.3.2.2 Tax implications under DTAA
Generally all DTAAs have a clause on Dependent personal services (DPS0 whereby if
employee qualifies as NR in India and a ‘tax resident of the host country’ salary in respect of
services rendered in the host country would be taxable only in the host country.
Illustration: Article 16 of DTAA between India and USA reads as under:
“1. Subject to the provisions of Articles 17 (Directors’ Fees), 18 (Income Earned by
Entertainers and Athletes), 19 (Remuneration and Pensions in respect of Government
Service), 20 (Private Pensions, Annuities, Alimony and Child Support), 21 (Payments received
by Students and Apprentices) and 22 (Payments received by Professors, Teachers and
Research Scholars), salaries, wages and other similar remuneration derived by a resident of a
Contracting State (read US) in respect of an employment shall be taxable only in that State
(read US) unless the employment is exercised in the other Contracting State (read India). If
the employment is so exercised, such remuneration as is derived therefrom may be taxed in

that other State (read India)”.
As per DTAA, salaries, wages and other similar remuneration derived by a resident of USA in
respect of an employment will be taxable only in USA unless the employment is exercised in
India. Therefore, salary earned by a resident of host country will be taxable in India only in
respect of the period for which services have actually been rendered in India and salary
received in India for service rendered in US can be claimed exempt under the DTAA.
However, in case any relief is claimed under DTAA then the employee would be required to
obtain a TRC.
Where an individual qualifies as a ROR in India and is also a tax resident of host country say
USA, recourse would then have to be made to the tie-breaker rules under the DTAA.
Generally Article 4 deals with the tie-breaker rules which ensure that an individual’s tax
residency is established in only one country on the basis of following pre-defined parameters:
1. Permanent home: Permanent home means any form of home whether owned or rented
by the individual that is available to him at all times continuously and not merely for
short durations. It is not necessary that the house should be owned. Permanence of
home means that the individual has arranged to have the dwelling available to him at all
times continuously and not occasionally for short duration (i.e. travel for pleasure,
educational travel, etc.).
2. Centre of vital interests: Centre of vital interest means personal and economic relations
of an individual and his proximity to a jurisdiction location. Some of the parameters to
test his personal/economic interest are:
Personal Interest: employee’s family and social relations; employee’s activities (e.g.
political, cultural etc.), schooling of children
Economic Interest: place of occupation; income and property, assets; the place from
which the employee could administer his property
3. Habitual abode: The dictionary meaning of habitual abode is a place in which a person
resides, his residence, home or dwelling. Thus, the place where the individual plans to
reside in future can be considered as habitual abode.
4. Nationality of the individual
Tax residency under DTAA is required to be determined on case to case basis. The
following scenarios may typically arise in case an individual is a resident of India as well
foreign country where he is seconded.
(a) The individual’s residency tie breaks to host country under DTAA
The salary income relating to services rendered in host country would not be taxable in India
since the employment is exercised outside India.
(b) The individual’s residency tie breaks to India under DTAA

The employee would be taxable on his worldwide income. However, taxes paid in the host
country, if any could be claimed as credit against the tax payable in India under respective
DTAA.
Illustration: Article 25 of DTAA between India and USA which provides for FTC reads as
under:
“2. (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.”
Where any income of an Indian tax resident is also liable to tax in USA, India shall allow a
credit of the taxes paid in USA against the India taxes payable, in respect of such doubly
taxed income. The tax credit is limited to the extent of the India tax attributable to the doubly
taxed income. Generally similar clause exists in DTAAs entered by India with other countries
for grant of foreign tax credit. However, each case needs to be examined independently.
(c) The individual is a resident of host country for part of the year under DTAA- Split
residency
In a situation where Indian tax year and foreign country tax years are different, it may be
possible to consider an employee to be resident of India during the period of Indian
employment and tax resident of host country say US during the assignment period of US. This
concept is called split residency.
For e.g. Mr. A is moving to US on 1 st January 2016 and he is a tax resident of US under the
treaty from 1st January 2016 onwards. Further, he is resident of India for FY 2015-16. Under
the tie breaker clause of DTAA, he will considered as resident of India for the period April
2015 to December 2015 and he would be considered as resident of US for the period
January 2016 to March 2016.
Since the employee would be on a split residency, the salary income relating to services
rendered in USA would not be taxable in India since the employment is exercised outside
India and salary pertaining to India employment only will be subject to tax in India. However,
employee will be required to obtain TRC for claiming exemption for salary received in India for
services rendered in USA.
Summary of taxability in case salary is paid in India

Taxable in India
Taxability under the Act-
ROR, NR and RNOR YES
Taxability under DTAA-
Resident in India and Non-Resident in host country YES
(subject to FTC)
Non-Resident in India and Resident in host country 
(TRC required)
Resident in India and Resident in the host country but tie breaks to 
host country (TRC required)
Resident in India and Resident in the host country but tie breaks to YES
India (subject to FTC)
Based on the above it can be argued that section 90 overrides section 4 of the act, and since
the income is not taxable under DTAA, withholding provisions should not apply.
(a) The provisions dealing with tax to be deducted at source are only a mode of collection
or recovery of tax. To the extent tax is not payable, the question of collection or
recovery thereof by way of tax deducted at source does not arise.
(b) Authority for Advance Ruling (‘AAR’) 11:
Facts:
The applicant, an Indian company which was part of British Gas Group UK, deputed two of its
employees for upto 3 years to work with British Gas Group in the UK. The two employees
continued to be on the payroll of the Indian company and regularly received salary in India.
The question before the AAR was as under:
(i) whether salary received by the two employees in India for services rendered in the UK
was liable to tax in India and
(ii) whether British Gas India P. Ltd. was required to withhold tax on salary paid in India for
rendering services outside India.
Held:
The AAR held that though salary received in India in the case of non-resident employees was
within section 5 of the Act that defined the scope of total income, the provisions of section 5
were subject to the provisions of this Act. This meant that section 5 was subject to section 90
which empowered the Central government to enter into agreements with foreign governments
11British Gas India P. Ltd [2006] 287 ITR 462

for granting tax relief and avoidance of double taxation. The AAR held that since salary
received for services rendered in the UK was liable to tax in the UK as per Article 16 of the
India-UK DTAA, the provisions of Article 16 prevailed over the provisions of section 5.
Therefore salary which was liable to tax in the UK was not to be made liable to tax in India.
The AAR also ruled that British Gas India P. Ltd. was not required to deduct tax at source
under section 192(1) if it was satisfied from the particulars furnished by the employees that tax
had been paid on their salary in the UK.
(c) The Finance Act, 2015 has also granted powers to CBDT to make rules laying down the
procedures for claiming FTC. This amendment is effective from 01 June 2015, , the
procedure for claiming such FTC was prescribed by CBDT which is effective from April
1, 2017. In absence of a clarification to the effect by CBDT in respect of relief of section
90 while withholding tax under section 192, the assessing officer can initiate the
proceedings on the employer for non-deduction of tax.
Based on the above arguments, I Co may consider DTAA relief at the time of deduction of tax
at source under section 192 of the Act. However, in case any relief is claimed under the DTAA
then a TRC from the foreign country will be required to be obtained.
Alternatively, to avoid litigation with the tax authorities, I Co may withhold tax on salary paid in
India and the employees could claim a refund of taxes paid in India by claiming relief under
DTAA at the time of filing their personal tax returns.
3.5.4 Risk of creating a Permanent Establishment in foreign country

PE is a fixed place of business through which business of the enterprise is carried on. PE
amounts to a virtual projection of an enterprise of one country into the soil of another country.
Generally, a company is taxed in the country in which it is a resident. However, if the same
company also performs certain activities in a foreign country for instance by seconding an
employee there, it might create a PE in that country. The existence of a PE gives the host
country the right to levy taxes on profits.
The exposure of PE for I Co in the host countries needs to be analysed from the host country
tax laws perspective. Once a PE is constituted, profits attributable to the PE are taxable as
business profits of I Co in the host country.
What are the types of Permanent Establishments?
The following could be the typical kinds of PE which could exist for I Co in the host countries
from deputation of employees:
• A fixed place of business through which the business of an enterprise

is wholly or partly carried on
Fixed place PE • There are three criterions embedded in this definition – (i) existence of
physical location (ii) right to use that place and (iii) carrying out of
business through that place
• Generally created when a company provides services abroad through

Service PE employees or other personnel and such activities continue for a
specific period.
• Agency PE may exist in any of the following three situations: (i) a

‘dependent agent’ has and habitually exercises authority to conclude
contracts on behalf of the principal (i.e. I Co);(ii) the dependent agent
Agency PE
regularly maintains a stock of goods or merchandise and delivers from
the stock on behalf of the principal; (iii) the dependent agent secures
contracts for the principal.
When do employees create a PE?

In order to determine whether or not a PE is created due to presence of employees in foreign
country one should first determine who is the legal and economic employer of the employee.
The economic employer is the company which receives the benefits from the performance of
the employee and essentially bears the responsibility and risksfrom the work of the employee
while the legal employer is the company with which the employee has his working contract
signed. If I Coseconds an employee abroad but remains his legal and economic employer,
then I Co might create a PE abroad. As a consequence, the profits earned will be assessable
to the foreign Corporate Income Tax.
If it can be demonstrated that the seconded employee is not carrying on any activities on
behalf of ICo, there should not be a PE risk for ICo. The Supervision, control and responsibility
of the employees should be with F Co and adequate documentation such as employment
contract with F Co, secondment / deputation agreement, global deputation policy, etc. should
be maintained to support the legal and economic employment with F Co.. The principles
discussed in case of inbound employees would also apply in this case.
The above are general principles of determining PE exposure, however PE analysis is
required to be be done on case to case basis depending on host country tax laws.
3.5.5 Preferable long term outbound secondment arrangement
F Co Employee’s Foreign
Bank Account
Payment of salary
Indian subsidiary
(I Co)
3.5.5.1 Typical features of above secondment arrangement

 I Co will depute the employee to F Co and will issue a letter to the employee for a long
term secondment
 F Co will enter into an employment agreement with the employee
 F Co will pay the entire salary into the employee’s overseas bank account
 Such employee would work under supervision, direction and under the control of F Co
3.5.5.2 Tax implications in the hands of the employee
3.5.5.2.1 Tax implications under the Act
The deputed employees qualifying as NR or RNOR under the Act would not be subject to tax
in India as the entire salary will be received and accrued outside India. If the deputed
assignee qualifies as ROR, then he would be liable to tax on his world wide income.
Accordingly, he would be taxable on the entire salary.FTC can be claimed on doubly taxed
income.
3.5.5.2.2 Tax implications under DTAA
If the deputed assignee qualifies as RNOR or NR, then the salary received outside India is not
taxable under the Act, hence DTAA need not be examined.
If the deputed assignee qualifies as ROR and is a tax resident of host country under DTAA,
then DPS exemption can be claimed and he would not be liable to tax on salary pertaining to
services rendered in host country. In case he qualifies as a tax resident of India under DTAA,
then he would be taxable on entire salary, however, FTC can be claimed on doubly taxed
income.
3.5.5.3 Tax implications in the hands of employer i.e. I Co
Since no salary is paid by I Co, it would not be required to withhold any tax in India. However,
if the employee qualifies to be ROR then the employee may declare his salary income
received from F Co to I Co and accordingly, I Co may withhold taxes on the same.
Annexure A: Residential status of an individual under the Act
Resident and Ordinarily Resident (‘ROR’)
A resident (i.e. an individual who satisfies either of the two basic conditions) is treated as
‘ROR’ if he satisfies both of the following additional conditions:
(i) He has been resident in India in at least 2 out of 10 fiscal years (according to the basic
conditions noted above) preceding the relevant tax year; and
(ii) He has been in India for a period of 730 days or more during 7 years preceding the
relevant tax year.
In brief it can be said that an individual becomes ‘ROR’ in India if he satisfies at least one of
the basic conditions and both the additional conditions.
Resident but not Ordinarily Resident (‘RNOR’)
An individual who satisfies at least one of the basic conditions, but does not satisfy both of the
additional conditions is treated as a ‘RNOR’. In other words, an individual becomes ‘RNOR’ in
any of the following circumstances: -
a) If he satisfies at least one of the basic conditions and none of the additional conditions.
b) If he satisfies at least one of the basic conditions and only one of the two additional
conditions.
Non Resident (‘NR’)
An individual is non-resident in India if he satisfies none of the basic conditions. In the case of
non-resident the additional conditions are not relevant. Hence a person (being a citizen),
leaving India for the first time for the purpose of employment will have the status of ‘NR’ if his
stay in India is not more than 181 days in the relevant tax year.
4. Avoidance of Economic Double Taxation of Dividends

4.1 What is double taxation?
Double taxation refers to a situation where tax is paid more than once on the same stream of
income. Typically there are 2 types of double taxation i.e. juridical double taxation and
economic double taxation. Juridical double taxation refers to circumstances where a taxpayer
is subject to tax on the same income (or capital) in more than one jurisdiction. Economic
double taxation refers to the taxation of two different taxpayers with respect to the same
income (or capital).
4.2 What is economic double taxation?
Meaning
As discussed above, economic double taxation refers to the taxation of two different taxpayers
with respect to the same income (or capital).
For example, a company earning profits may be paying corporate income tax to the
government on its income. Post payment of tax, the company may be distributing some part
of its post-tax profits to its shareholders as dividend. The dividend may be taxable in the
hands of the shareholders as well.
In the example below, economically, the profits of the company (Refer A in the table below)
[on which the company paid tax (Refer B in the table below)] and dividend (Refer D in the
table below) [on which the shareholders paid tax (Refer E in the table below)] are the same
income, however taxed in the hands of two different taxpayers (i.e. the company and the
shareholders respectively).
Particulars Reference Company Shareholder

Profits A 100
Less : Corporate tax @ 30% B (30)
Income available for distribution C=A–B 70
Income received as dividend D 70
Less: Tax @ 15%* E (10.5)
Post tax Income F=D–E 59.5
*assuming the tax rate of 15% on distributed profits
Further, the OECD in its Final Report, on Base Erosion and Profit Sharing (BEPS), in Action
Plan 3, contains recommendations which constitute necessary elements for CFC Rules. The
intention of introducing this Action Plan was not to clamp down on outbound investments but
to disincentivize passive entities in low –tax jurisdiction.
The double taxation may occur (unless credit given) on account of CFC rules as these rules
treat the undistributed profits of the MNE group’s intermediary holding company located in low
or no tax jurisdiction as deemed dividend of parent company and such profits are subject to
tax in parent company’s jurisdiction. The profits are then again taxed in the hands of the
holding company.
Further, the double taxation of dividends may happen in both domestic as well as cross-border
situations. However in some instances, the tax treaties may also eliminate or reduce the
international economic double taxation – e.g. by providing a reduced withholding tax rate on
inter-company cross-border dividends (see Article 10, paragraph 2, letter a) or by providing
the obligatory corresponding adjustment in case of transfer pricing situations (see Article 9).
Effects of economic double taxation
The economic double taxation encourages investors to prefer debt to equity and creates an
incentive to retain earnings and avoid dividend payments.
4.3 What is dividend?
In common parlance “dividend‟ means the post-tax profits distributed by a company to its
shareholders.
Apart from that, i.e., dividend paid by a company to its shareholders, section 2(22)(e) of the
Income-tax Act, 1961 (‘Act’) gives the definition of deemed dividend. Hence, under the
Income-tax Act, dividend includes deemed dividend.
4.4 How is dividend taxed in India
4.4.1 Taxability of dividend in the hands of company on distribution
Dividend distributed by an Indian company to its shareholders is taxable in the hands of the
company under section 115-O of the Act as Dividend Distribution Tax (‘DDT’) at the rate of
15% (plus surcharge and cess as applicable).
The DDT was introduced with the Finance Bill, 1997, and justified in the Memorandum to the
Finance Bill, 2003 as:
“It has been argued that it is easier to collect tax at a single point, i.e., from the company,
rather than compel the company to compute the tax deductible in the hands of the
shareholder.”
The taxability of deemed dividend (sec 2(22)(e)) in the hands of recipient has posed serious
problem of the collection of the tax liability and has also been the subject matter of extensive
litigation. With a view to bringing clarity and certainty in the taxation of deemed dividends,
transactions relating to deemed dividend undertaken on or after 1stApril 2018 have also been
brought within the ambit of DDT but a higher rate of 30% (without grossing up). The intent
behind this legislative change is to prevent camouflaging dividend in various ways such as
loans and advances.
4.4.2 Taxability of dividend in the hands of shareholder
4.4.2.1. Dividend received from an Indian company
Where shareholder is either an Indian company or an individual, the dividend received by
them from an Indian company (which has suffered dividend distribution tax) is exempt from tax
under section 10(34) of the Act subject to section 115BBDA.
4.4.2.2. Dividend received from a foreign company

(a) In case of shareholder being an Individual
In case where shareholder is an individual, then the dividends received from foreign company
will be included in the total income under the head “Income from other sources” and
accordingly, will be charged to tax at the rates applicable to the individual.
(b) In case of shareholder being a company
In case where shareholder is an Indian company then the dividend received from a foreign
company is taxed in the hands of such Indian company at the normal rates applicable to its
income. Normal tax rate applicable to an Indian company is 30% (plus surcharge and cess as
applicable). Hence, dividend received from a foreign company is charged to tax at 30% in the
hands of an Indian company.
However, section 115BBD provides a concessional rate of tax in respect of dividend received
by an Indian company from a foreign company in which the Indian company holds 26% or
more in nominal value of the equity share capital.
By virtue of section 115BBD, dividends [as defined in section 2(22) except dividend as defined
in section 2(22)(e)] received by an Indian company from a foreign company in which the Indian
company holds 26% or more in nominal value of the equity share capital is charged to tax at a
flat rate of 15% (plus surcharge and cess as applicable).
It should however be noted that, in the above case no deduction on account of any
expenditure or allowance is allowed from the amount of the dividend covered under section
115BBD. In other words, the gross amount of dividend (without deducting any
expenditure/allowance) will be taxed at the rate of 15% (plus surcharge and cess as
applicable).
Dividend Income
Foreign Company Indian Company
Distributes dividend
Indian Company / Individual
Indian Company
Individual
Dividend received (which

has suffered DDT) is
exempt from tax under
section 10(34) of the
Holds less than Holds 26% or more Taxed at normal Act. subject to section
26% in nominal in nominal value of slab rates 115BBDA
value of the equity the equity share
share capital in capital in Foreign
Foreign Company Company
Normal tax rate Taxed under

30% (plus section 115BBD flat
surcharge and cess rate of 15% (plus
as applicable) surcharge and cess
as applicable)
4.5 Is double taxation in case of dividends avoided in India?

4.5.1 Basic mechanism
The company’s profits are taxed without any distinction between distributed and undistributed
profits. The after-tax profits are taxed again in the hands of the shareholders (corporate or
individual) when paid as dividends. As a result, the same profits are taxed twice; first at
corporate level and again when the profit is distributed to the ultimate shareholder.
4.5.2 Reason for introduction of section 10(34)
As discussed earlier, section 10(34) is one of the more popular sections of the Income Tax
Act, 1961. It is the section which declares that dividends received from a domestic company
are exempt from tax.
If the investor is asked to include dividend income as a part of his total individual income for
taxation, it would amount to “taxing an already taxed income”, or “double taxation”.
Thus, dividend income from domestic companies was made exempt from taxation. This is
more or less a globally embraced concept. Hence, section 10(34) was inserted by Finance
Act, 2003 to avoid this economic double taxation of dividends in India.
4.5.3 Effects of double taxation due to introduction of section 115-O
The dividend exempt in hands of shareholder in section 10(34) above does not exactly escape
double taxation. While it's only fair that a company should be free to distribute its profits after
income tax amongst its members, as per the provisions of Section 115-O, it cannot do so
unless it has paid an additional tax called the Dividend Distribution Tax (DDT) at the rate of 15
per cent (plus surcharge and cess as applicable) as discussed earlier. 12 Consequently, the net
dividend available for distribution is less by the amount of DDT paid.
The double taxation effect that is caused by the DDT has not been clearly rationalised till date.
Further, section 115BBDA was introduced w.e.f. 1.4. 2017. The reason cited for introduction of
section 115BBDA was that under the section 10(34), dividend which suffers DDT under
section 115-O is exempt in the hands of the shareholder, whereas under section 115-O
dividends are taxed only at the rate of fifteen percent at the time of distribution in the hands of
company declaring dividends. This creates vertical inequity amongst the tax payers as those
who have high dividend income are subjected to tax only at the rate of 15% whereas such
income in their hands would have been chargeable to tax at the rate of 30%. With a view to
rationalise the tax treatment provided to income by way of dividend, section 115BBDA
provides that any income by way of dividend in excess of Rs. 10 lakh will be chargeable to tax
in the case of an individual, Hindu undivided family (HUF) or a firm who is resident in India, at
the rate of ten percent. The taxation of dividend income in excess of ten lakh rupees will be on
gross basis.
4.5.4 Effects of double taxation when Foreign company pays dividend to an Indian
investor
The dividend paid by foreign companies is taxable in the hand of the shareholder separately.
With the unfortunate existence of DDT (known as just “Dividend Tax” in most countries), the
recipients of dividends from foreign companies may undergo a worse fate “triple taxation”.
First, the foreign company pays Income Tax or Revenue Tax on operating profits (Refer B in
table below) to the government of its country. Then it again pays Dividend Tax (same as
Indian DDT) (Refer D in table below) to its government. Finally, when the investor in India
receives his “doubly taxed” dividend, he has to again pay Income Tax (Refer H in table below),
as tax received from non-domestic companies is not exempt under the Income Tax Act.
12Finance (No.2) Act, 2014 levied dividend distribution tax by grossing up the dividend payable for the purpose of
computing liability towards dividend distribution tax.
Outside India
Particulars Reference Foreign Company
Income A 100
Less : Corporate tax @ 30% (assumed) B = A * 30% (30)
Income available for distribution C=A–B 70
Less: Dividend Tax (DDT in India) @ 15% D = C * 15% (10.5)
(assumed)
Post tax Income F=D–E 59.5
India
Particulars Reference Shareholder/ Investor
Dividends received from Foreign Company G 59.5
Less : Tax @ 30% (assumed) H = G * 30% (18)
Post tax Income I=G–H 41.5
4.5.5 13Economic double taxation in an International tax regime
Under international tax regime many countries relieve the economic double taxation on
dividends partly or fully by various methods at either the corporate or shareholder level, or at
both levels.
Corporate relief system
• Dividend deduction or credit approach: The dividend payment is treated as a tax-
deductible expense of the paying company.
Alternatively, the tax withheld on the dividend payments is creditable against the
corporate tax payable by the paying company.
• Split rate method: The distributed income is taxed at lower rate than retained income.
The company in subject to a higher corporate tax and it receives a credit for the tax
differential when the dividends are paid. (This systems is followed in Germany pre
2001)
• Dividend exemption system: The company pays a higher tax on distributed profits due
to an additional corporate tax (DDT in case of India) which is payable when the
dividends are declared as compared to the retained income which is taxed as per the
corporate tax rules in place. There is no withholding tax, and the income is tax-free in
the hands of the shareholders. (This systems is followed in India subject to variation
caused by insertion of section 115BBDA, South Africa)
13 Basic international taxation by Roy Rohatgi (Volume II)

Particulars Reference Company Shareholder

Income A 100
Less : Corporate tax @ B (30)
30%
Income available for C=A–B 70
distribution
Less: DDT @ 15%* D (10.5)
Distributable profits 59.5
Dividend income exempt E - 59.5
in hands of Shareholder
where DDT is paid
(subject to section
115BBDA)
Shareholder relief systems
• Imputation or tax credit systems (‘dividend relief’): The Company is subject to corporate
tax, but relief is granted at the shareholder level. The shareholders receive either:
(a) a full imputation credit based on the underlying tax paid by the distributing
company; or
(b) a partial imputation as a dividend tax credit, regardless of the corporate tax paid
For example:
(a) Company corporate tax rate - 30%
Individual tax rate – 30%
Investors who receive dividends will be taxed at difference between 30% (company tax rate)
and their own marginal tax rate. So if your individual tax rate is 30% then there will be no tax
on the dividends, i.e. the dividend is tax free.
(b) Company corporate tax rate - 30%
Individual tax rate – 46.5%
Investors who receive dividends will be taxed at difference between 30% (company tax rate)
and their own marginal tax rate. So, if your individual tax rate is 46.5%, then dividends will be
tax at the rate of 16.5% (ie 46.5% - 30%).
• Shareholder relief under the classical system (‘dividend relief’): These systems follow
the classical system but provide partial or full dividend relief to the shareholder. The dividends
received are either-
(a) fully tax-exempt (‘dividend exemption’). Under dividend exemption system regime, tax is
levied at the corporate level only and there is no tax liability on shareholders (followed
in India); or
Most countries have opted the above system.

(b) partial tax-exemption relief (‘partial exemption’). Under partial exemption there can be
following options-
− Half inclusion system- the system usually grants 50% dividend-received
exemption to non-corporate shareholders;
− Flat rate system- This system gives shareholder relief through a reduced dividend
tax rate;
4.5.6 Avoidance of double taxation in case of Dividends in international regime
Double taxation Avoidance Agreements (‘DTAA’) – A brief introduction
In view of avoiding double taxation in case of income earned by a corporate/ non-corporate
assessee, India has entered into agreements with various countries know as Double taxation
Avoidance Agreements (‘DTAA’).
A DTAA, also referred to as a Tax Treaty, is a bilateral economic agreement between two
nations that aims to avoid or eliminate double taxation of the same income in two countries.
Under the Income Tax Act 1961 of India, there are two provisions, Section 90 and Section 91,
which provide specific relief to taxpayers to save them from double taxation. Section 90 is for
taxpayers who have paid the tax to a country with which India has signed DTAA, while Section
91 provides relief to tax payers who have paid tax to a country with which India has not signed
a DTAA. Thus, India gives relief to both kinds of taxpayers.
Further, the provisions of section 90(2) states that where the Central Government has entered
into an agreement with the Government of any country or specified territory outside India for
granting relief of tax or avoidance of double taxation, then, in relation to the assessee to whom
such agreement applies, the provisions of this Act shall apply to the extent they are more
beneficial to that assessee.
Taxation of dividends in DTAAs – Country wise scenarios
Taxation of dividends in OECD model convention is governed by Article 10. As per article 10,
dividends paid by a company which is a resident of a Contracting State (say Foreign
Company) to a resident of the other Contracting State (say Indian Investor/ Shareholder) may
be taxed in that other State (India).
However, such dividends may also be taxed in the Contracting State (Foreign States) of which
the company paying the dividends is a resident and according to the laws of that State, but if
the beneficial owner of the dividends is a resident of the other Contracting State (Indian
Investor/ Shareholder), the tax so charged in the foreign state shall not exceed:
a) 5 per cent of the gross amount of the dividends if the beneficial owner is a company
(other than a partnership) which holds directly at least 25 per cent of the capital of the
company paying the dividends;
b) 15 per cent of the gross amount of the dividends in all other cases.
Usually foreign dividend income is taxable in India. However, under certain DTAAs negotiated
by India with other countries, India does not have the right to tax dividends (‘Exemption
method’). However, in case the relevant treaty allows India to tax dividend, double taxation is
typically eliminated through following tax credit methods (Chapter V “Methods for elimination
of double taxation” article 23 of OECD Model tax conventionUN Model Convention on Article
23):
• Foreign Tax Credit (‘FTC’) – Credit of taxes withheld on the dividend income as per the
relevant tax treaty/ domestic tax law in foreign country.
• Underlying Tax Credit (‘UTC’) – In addition to FTC, taxes paid overseas on the
corporate profits of the foreign company, out of which dividends are distributed, may be
available for credit in India.
4.5.7 Example of the UTC
Company X is a resident of the UK and owns 60% share capital of Company Y, a resident in
India. Tax rate in India is assumed to be 34% and tax rate in the UK is assumed to be 28%.
Company X has no other taxable income in the UK.
Sr. Particulars Foreign company in Domestic
No. UK holding 60% of dividend
share capital of distributing
Company Y company
(Company X) (Company Y)
A. Distributing Company level 10,000
1. Pre-tax income
2. Less : Corporate tax in 3,400
India @ 34%
3. Net profit after tax available 6,600
for distribution to shareholder
4. Dividend distributed out of 3,300
the profit after tax
B. Shareholder's level 1,980
5. Dividend paid to Co. X
[3,300 X 60%]
6. Add : Underlying tax paid by 1,020
Co. Y[l,980 X (34/66)]
7. Gross income of Co. X in UK 3,000
[1,980 X |100/66)]
8. Tax payable in the UK 840

[3,000 X 28%]
9. Less :Underlying Tax Credit 840
Credit
Lower of
i. [3,000-1,980] i.e. 1,020 OR
ii. 840
10. Tax payable in the UK Nil
In the above scenario the UK Company was taxed in India on profit distributed (refer 4 above)
by the Indian company (in which UK company holds 60% share capital). The credit of the
taxes paid in India was given to UK company as the lower of:
− Taxes paid on distributed income as per the rates prevailing in India (ie 34%); or
− Taxes to be paid on distributed income as per rates prevailing in UK (ie 28%)
From the above, it is evident that the concept of UTC is very important in mitigating the
economic double taxation of dividends paid to companies.
Usually foreign dividend income is taxable in India, India does not have any domestic
regulations in respect of UTC. However, India's DTAAs with around ten countries contain the
provisions relating to underlying tax credit. The relevant provisions relating to underlying tax
credit contained in various articles are given below:
Sr. Country Article of Article heading Text of the relevant portion of
No Treaty the Articles
1 Australia 24(l)(b) Methods of elimi- (b) Where a company which is a
nation of double resident of India and is not a
taxation resident of Australia for the
purposes of Australian tax pays a
dividend to a company which is
a resident of Australia and which
controls directly or indirectly not
less than 10 per cent of the voting
power of the first-mentioned
company, the credit referred to in
sub-paragraph (a) shall include
the Indian tax paid by that first-
mentioned company in respect
of that portion of its profits out
of which the dividend is paid.

2 China 23(l)(b) Methods for the (b) Where the income derived
elimination of from India is a dividend paid by a
double taxation company which is a resident of
India to a company which is a
resident of China and which owns
not less than 10 per cent of the
shares of the company paying the
dividend, the credit shall take
into account the tax paid to
India by the company paying the
dividend in respect of its
income.
3 Ireland 23(3)(b) Elimination of (3)(b) In the case of a dividend
&23(4) double taxation paid by a company which is a
resident of India to a company
which is a resident of Ireland and
which controls directly or
indirectly 25 per cent or more of
the voting power in the company
paying the dividend, the credit
shall take into account (in addition
to any Indian tax creditable under
the provisions of sub-paragraph
(a) Indian tax payable by the
company in respect of the
profits out of which such
dividend is paid.
(4) (a) For the purposes of sub-
paragraph (b) of paragraph 3,
the term 'Indian tax payable' shall
be deemed to include 75 per cent
of the Indian tax which would
have been paid but for any
exemption or reduction of tax
granted under incentive
provisions contained in Indian
law designed to promote
economic development to the
extent that such exemption or
reduction is granted for profits

from industrial or manufacturing
activities, or from the
development, maintenance and
operation of infrastructure
facilities, or from agriculture,
fishing or tourism (including
restaurants and hotels), provided
that such incentive provisions
remain in substance unchanged
since the date of signature of this
Convention and that the activities
have been carried out within India.
(b) The provisions of sub-
paragraph (a) shall cease to apply
after twelve years from the date of
entry into force of this Convention
4 Japan 23(3)(b) Double taxation (b) Where the income derived
avoidance from India is a dividend paid by a
company which is a resident of
India to a company which is a
resident of Japan and which owns
not less than 25 per cent either
of the voting shares of the
company paying the dividend, or
of the total shares issued by that
company, the credit shall take
into account the Indian tax pay-
able by the company paying the
dividend in respect of its
income.
5 Malaysia 23(2) Elimination of .... Where such income is a
double taxation dividend paid by a company
which is a resident of India to a
Malaysia and which owns not
less than 10 per cent of the
voting shares of the company
paying the dividend, the credit
shall take into account tax paid

in India by that company in
respect of its income out of
which the dividend is paid. The
credit shall not, however, exceed
that part of the Malaysian tax, as
computed before the credit is
given, which is attributable to such
item of income.
6 Mauritius 23(2)(b) Elimination of (b) In the case of a dividend paid
double taxation by a company which is a
resident of Mauritius to a
India and which owns at least 10
per cent of the shares of
the company paying the dividend,
the credit shall take into account
(in addition to any Mauritius tax for
which credit may be allowed under
(a) of this paragraph) the
Mauritius tax payable by the
company in respect of the
profits out of which such
dividend is paid.
-do- 23(4)(b) Elimination of (b) In the case of a dividend paid
which is a resident of Mauritius
and which owns at least 10 per
cent of the shares of the
company paying the dividend, the
credit shall take into account (in
addition to any Indian Tax for
which credit may be allowed under
(a) of this paragraph) the Indian
tax payable by the company in
respect of the profits out of
which such dividend is paid.

7 Singapore 25(2) Avoidance of .... Where the income is a dividend
double taxation paid by a company which is a
resident of Singapore to a
India and which owns directly or
indirectly not less than 25 per
cent of the share capital of the
deduction shall take into ac-
count the Singapore tax paid in
which the dividend is paid. Such
deduction in either case shall
not, however, exceed that part of
the tax (as computed before the
deduction is given) which is
attributable to the income which
may be taxed in Singapore.
-do- 25(4) Avoidance of .... Where such income is a
double taxation dividend paid by a company
which is a resident of India to a
resident of Singapore which
owns not less than 25 per cent
of the share capital of the
company paying the dividends, the
credit shall take into account
Indian tax paid in respect of its
profits by the company paying
the dividends.
8 Spain 25(3)(b) Elimination of (b) In the case of a dividend paid
which is a resident of Spain and
which holds at least 25 per cent
of the capital of the company
paying the dividend, the deduction
shall take into account [in addition
to the deduction provided under
sub-paragraph (a)] the income-

tax paid in India by the company
in respect of the profits out of
which such dividend is paid
provided that such tax is taken
into account in calculating the
base of the Spanish tax.
9 United 24(l)(b) Elimination of (b) In the case of a dividend paid
Kingdom double taxation by a company which is a
which is a resident of the United
Kingdom and which controls
directly or indirectly at least 10
per cent of the voting power in the
credit shall take into account (in
addition to any Indian tax for which
credit may be allowed under the
provisions of sub-paragraph (a) of
this paragraph) the Indian tax
payable by the company in
which such dividend is paid.
10 United 25(l)(b) Relief from (b) In the case of a United States
States double taxation company owning at least 10 per
of cent of the voting stock of a
America 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.
• Tax Sparing Credit (‘TSC’) – Residence country grants credit for taxes which would
have been levied by Source Country had tax exemption not been granted by latter.
X Inc. has established a subsidiary A Ltd. in India. The subsidiary exports 100% of its
production and is entitled to sec.10B benefit. A Ltd. earned income of INR 1,00,000 which is
exempt u/s 10B. Total profits are distributed as dividend to X Inc.
Particulars TSC not available TSC available

Total income earned by A Ltd. 1,00,000 1,00,000
Exempt u/s 10(B) of the Act 1,00,000 1,00,000
Amount distributed as dividend 1,00,000 1,00,000
Withholding tax on dividend @ 10% 10,000 10,000
Credit for withholding tax on dividend 10,000 10,000
available to X Inc.
Underlying tax credit - -
Tax Sparing (1,00,000 x 30% tax rate in - 30,000
India)
Aggregate tax credit available to X Inc. 10,000 40,000
4.5.8 Effects of double taxation in case of Controlled Foreign Company (CFC) rules
Multinational groups can create non-resident affiliates in low tax jurisdictions to which income
is shifted, wholly or partly for tax reasons rather than for nontax business reasons. Such
overseas profits are not subjected to tax in the hands of shareholders unless distributed/
repatriated to them. Thus tax on this income is avoided until the tax haven country pays a
dividend to the shareholding company. This dividend could be avoided indefinitely by loaning
the earnings to the shareholder without actually declaring a dividend.
The CFC rules are intended to tax these undistributed income as dividends in the hands of the
shareholders. The double taxation may occur on account of CFC rules as these rules treat the
undistributed profits of the MNE group’s intermediary holding company located in low or no tax
jurisdiction as deemed dividend of parent company and such profits are subject to tax in
parent company’s jurisdiction. The profits are then again taxed in hands of holding company.
Under CFC rules, certain situations could lead to double taxation which needs to be eliminated
by granting credit or exemption. For instance Dividends received on actual distribution or
gains on disposition of CFC shares should be exempted if the corresponding income has
previously been subject to CFC taxation.
Further, the OECD in its Final Report, on Base Erosion and Profit Sharing (BEPS), in Action
Plan 3, contains recommendations which constitute necessary elements for CFC Rules. The
intention of introducing this Action Plan was not to clamp down on outbound investments but
to disincentivize passive entities in low–tax jurisdiction.
For detailed discussion please refer to the Unit III of Module F.
5. Tax Consolidation Rules (“Group Taxation”)

5.1 Introduction 14
Earlier corporate structures involved only two levels: individual shareholders and their
company. This was the time when the separate entity doctrine under which a company is
treated as a separate entity was developed.
The rise of corporate groups in the last century has seriously challenged the traditional
separate entity doctrine under which companies are treated as separate taxpayers. Generally,
a corporate group under a common control of parent company often operates as a single
economic enterprise. In practice, senior management of a corporate group often focus on the
group as a whole instead of on individual companies. This raises the question whether the law
should recognise the commercial reality and extend the rights and duties of a company within
a group to reflect the activities of other group members.
The modern commercial world dictates a change of paradigm with respect to the treatment of
corporate groups. Instead of universal adoption of the separate entity principle, a growing
number of areas in taxation law are being supplemented by the enterprise doctrine. The
enterprise doctrine focuses on the business enterprise as a whole, instead of the fragmented
components. Under this doctrine, the economic substance overrides the legal form of
individual companies that make up the corporate groups.
Tax legislations have introduced regimes which to a great extent apply the enterprise doctrine,
under which a corporate group is treated as a single taxpayer and files a single consolidated
return.
Consolidated tax regime refers to an integrated system wherein a group of entities have an
option of adhering to compliances being a group as a whole instead of separate entities. This
has a basic application of nullifying the inter-company transactions and tax is paid by the
group as one entity. This can be attractive to taxpayers because it gives them flexibility to
organize their business activities and engage in internal restructurings and asset transfers
without having to worry about triggering a net tax.
In jurisdictions where the consolidated tax regime is operational, the group of entities has to
file a single consolidated tax return.
5.2 Advantages of consolidated returns 15
The advantages of filing a consolidated income tax return include the following:
1. Unused losses (both ordinary and capital) and credits of an affiliate may be used to
offset the income and tax liability of other affiliated group members in the current year.
14 The Taxation of Corporate Groups under Consolidation by Dr Antony Ting

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By utilizing these losses and credits in the current year, the group receives immediate
tax benefits and thereby avoids the need for carryovers to recover the benefits.
2. Intercompany profits on the sale of property and services may be deferred until they are
actually recognised when they are sold outside third parties.
3. Intercompany dividends between group members are eliminated from income and are
not subject to tax. Deductions and credits that are subject to percentage limitations can
be determined on a consolidated rather than on a separate company basis.
5.3 Disadvantages of consolidated returns 16
Some of the more important disadvantages of filing a consolidated return include the following:
1. Electing to file consolidated returns requires compliance with the consolidated return
regulations. This could create additional costs and administrative burdens.
2. The consolidated return election could be binding for future years. This election can
only be terminated in future by disbanding the affiliated group or by obtaining
permission from the competent authorities of the country to file separate returns.
3. Separate return credits and capital losses can be limited by operating losses and capital
losses from other members of the group. Thus, the credit and loss carryovers may
expire unused due to heavy losses by an affiliated member.
4. A subsidiary member is required to change its tax year to the same year as that of the
common parent corporation. This can create a short tax year that is considered a
complete tax year for purposes of carrybacks or carryovers in the case of unused
losses and credits.
5. The rights of minority shareholders must be respected both legally and ethically. As a
result, the presence of minority shareholders may create situations that may have
adverse effects for the affiliated group.
5.4 Possible application of consolidation of tax
The enterprise doctrine can be applied in following ways:
1. Consolidation at country level– In this case, the tax base is defined as sum of the
taxable income and losses of the group members that are resident to one country. The
taxable income and losses are calculated according to the tax law of the country.
2. Consolidation at bloc or worldwide level - In this case, the tax base is defined as sum of
the taxable incomes and losses of the group members that are resident to bloc or
worldwide. For example – European commission council directive on Common
Consolidated Corporate Tax Base (‘CCCTB’) which consolidates incomes of all the
group companies resident in the member states of European Union.
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Most national tax systems do not provide for cross-border tax consolidation. The CCCTB
system aims to achieve the same result as national tax consolidation in an international
context.
In case of cross border consolidation, once the income is consolidated, there are varieties of
methods to allocate the taxable income. For example: a simple method is to allocate the
group’s tax base according to the group’s overall profit margin on the costs incurred in the
country. Some have suggested value added in each country. Some have discussed using
other macro factors such as size of a country’s economy.
Nevertheless, the formulatory apportionment method has occupied the center stage in the
debates on the allocation of profits of multinational corporate groups for many decades. Under
formulatory apportionment method, a group’s tax base is allocated to a country according to
predetermined formula. The formula is typically based on the weighted average of
geographically specific apportionment factors, such as payroll, assets and sales. The
formulatory appointment method may be applied either unilaterally by a country, or
multilaterally among a group of countries.
5.5 Key structural elements 17
As a particular form of group taxation regime, consolidation regimes require the articulation of
the following key structural elements:
• Application of the single entity concept;
• Definition of an eligible corporate group and mandatory versus elective application of
the regime;
• Consolidation of group results;
• Treatment of pre-consolidation losses;
• Treatment of group losses on exit;
• Treatment of assets on entry, during consolidation, and on exit.
These structural elements are discussed below in detail:
5.5.1 The single entity concept
The consolidation regimes generally treat corporate groups as single entity, however, based
on the various existing regimes, there appear to be three different applications of the concept:
(1) pooling, (2) attribution, and (3) absorption.
(a) Pooling
The parent company and its subsidiaries in a consolidated group are treated, to a large extent,
as separate entities for income tax purposes, with the taxable income or loss of each group
17 The Unthinkable Policy Option- Key Design Issues Under a System of Full Consolidation by Antony Ting
member being computed on an individual basis. The separate entity results are then
aggregated at the group level, often adjusted for intragroup transactions, to arrive at
consolidated taxable income or loss.
The major advantage of this approach is its simplicity. Most of the existing tax rules for
companies are founded on the traditional separate entity doctrine, according to which each
company is treated as a separate taxpayer. Each subsidiary prepares its tax computation on a
stand-alone basis before aggregation at the group level. Taxability and deductibility of various
items are generally determined as if the subsidiary were a stand-alone unconsolidated
company.
The rules can therefore be applied comfortably to consolidated group members under a
pooling system that, for the most part, preserves this separate entity treatment.
A related policy issue with respect to the pooling system is whether the individual tax
computations of a consolidated group member should be prepared on a stand-alone or a
group basis. For example, an expenditure of a subsidiary may be regarded as capital in nature
on a stand-alone basis and thus not deductible. However, if the item is examined on a group
basis, so that facts and circumstances of other group members are taken into consideration,
the expenditure may be judged to have a revenue character and thus be currently deductible.
(b) Attribution
Assets, liabilities, and activities of consolidated subsidiaries are attributed to the parent
company. In other words, income and expenses of the subsidiaries are deemed to be those of
the parent company, thus achieving the aggregation of taxable income and losses of the group
members. One important feature of this option is that the subsidiaries continue to be treated
as separate entities for income tax purposes, an approach that has proved to be especially
important in the application of tax treaties
(c) Absorption
Under this single entity concept, consolidated subsidiaries are deemed to have become
divisions of the parent company and to have ceased to exist as individual companies for
income tax purposes. As a result, unlike the treatment in above approach, intragroup asset
transfers within a consolidated group are completely ignored. The transfers not only have no
immediate tax implications, but also do not require the parties to trace asset movements, keep
a record of any deferred gain or loss, or recapture the gain or loss when either the transferor
or the transferee leaves the group.
5.5.2. Definition of an eligible corporate group and mandatory versus elective
application of the regime;
Consolidation regimes tend to be restricted to resident companies under common control. The
restriction to resident companies reflects the political reality that extending general residence
taxing rights to non-resident companies is problematic. Extending consolidation to non-
resident entities also raises revenue and anti-avoidance concerns. Therefore, consolidation, in
general, is restricted to resident company groups under common control. Unincorporated

entities are, in general, excluded from consolidation.
Most countries specifically exclude certain entities from consolidation. Besides non-residents,
the most common exclusion is for companies that are not subject to the normal corporate
income tax rates—for example, those subject to a reduced tax rate or exempt from tax.
Companies in bankruptcy and liquidation are also often excluded from a consolidated group
Common Control
In practice, it is not easy to provide a simple and effective definition of common control. A
bright-line definition for example, specification of a minimum percentage of voting rights—may
be simple, but may not be effective. Control can be established by various means, such as
options and convertible securities, control over the composition of the board of directors or key
executives, or special shareholders’ agreements. Most countries adopt a bright-line option
based on share ownership, but protect it from abuse with supplementary tests or anti-
avoidance provisions.
5.5.3 Consolidation of group results
The most common approach for computing consolidated taxable income is to compute taxable
income of each member as if no consolidated return were filed, with the exception of certain
items computed on a consolidated basis. Then adjustments are made for certain transactions
between group members like dividends between group members are eliminated. Intercompany
gain or losses on such transactions are excluded from consolidated income until a later event
triggers recognition. For example, Member A sells Member B some goods at a profit. This
profit is not recognized until Member B sells the goods outside the group. These complex rules
require adjustments related to intra-group sales of property (including depreciable assets and
inventory), transactions in stock or other obligations of members, performance of services,
entry and exit of members, and certain back-to-back and avoidance transactions.
Tax liability for the consolidated group is determined by applying the rates as provided in the
regulations to the consolidated taxable income of the group. Tax liability is reduced by
consolidated credits attributable to members of the group.
5.5.4 Treatment of Preconsolidation Losses
On entry of a company into a consolidated group, the treatment of preconsolidation losses
incurred by the company must be determined. There could be three alternative treatments of
such losses: (1) quarantine, (2) transfer to the parent, and (3) cancellation.
(a) Quarantine
Under the quarantine approach, preconsolidation losses incurred by a joining subsidiary are
quarantined and are available for offset only against profits generated by that subsidiary. The
policy rationale for quarantine is that since the preconsolidation losses were incurred when the
subsidiary was treated as a separate taxpayer, those losses should remain with the subsidiary
and be available only for offset against its future taxable income. A prerequisite for this policy
is that the subsidiary maintains its separate identity for income tax purposes during
consolidation.
(b) Transfer to the Parent
Under the second of the three alternative treatments, pre-consolidation losses of a subsidiary
are transferred to the parent company upon consolidation. The policy is premised on a strong
single entity concept, under which subsidiaries are deemed to have ceased to exist as
separate entities for income tax purposes. When their pre-consolidation losses are transferred
to the parent company, they are available for offset against the consolidated group’s taxable
income.
(c) Cancellation
Under this approach, pre-consolidation losses of a subsidiary are cancelled upon entry into a
consolidated group. This harsh policy is driven primarily by tax-avoidance concerns.
The cancellation approach is simple, avoiding the need for complex rules to control the use of
pre-consolidation losses. However, this approach has been a major disincentive to
consolidation for corporate groups that would qualify to elect consolidated treatment.
5.5.5 Treatment of group losses on exit
The most significant advantage of consolidation is the ability to offset taxable income and
losses among consolidated group members. However, the treatment of group losses on exit
(that is, when a subsidiary leaves a consolidated group) is more varied among the various
regimes. There are two main approaches to this design issue: (1) stay with the group and (2)
apportionment.
Under the stay with the group approach, group losses stay with the consolidated group even if
a leaving subsidiary has contributed to those losses. This option is simple to operate since
there is no need for complex allocation rules to apportion the consolidated group losses to a
leaving subsidiary.
Under second approach, a group’s consolidated losses are allocated to a leaving subsidiary.
This option requires complex allocation rules to apportion the consolidated group’s losses to
the leaving subsidiary.
5.5.6 Treatment of Assets
On Entry
There appears to be two alternative approaches to the treatment of assets (other than
intragroup shares) on entry 1) rollover treatment and 2) mark-to-market treatment
Under the rollover approach, pre-consolidation tax attributes are rolled over to the
consolidated group, and assets of a joining subsidiary are treated as owned by the
consolidated group at the original cost bases. The whole amount of gain or loss on disposal,
including the amount attributable to the pre-consolidation period is attributed to the group.
Under the mark-to-market approach, assets are deemed to have been passed to the
consolidated group at their respective market values. Unrealized gains or losses on assets
owned by a subsidiary before entry are recognized immediately on entry.
During Consolidation:
Under the single entity concept, an intragroup asset transfer during consolidation should have
no immediate tax consequences for the group. That is, the transfer should be treated as if it
were a transfer between divisions of a company.
Another, most common approach (ie. rollover treatment) would be to defer any gain or loss on
intragroup asset transfers and the deferred gain or loss is, in general, recaptured when either
the transferor or the transferee leaves the consolidated group.
On exit:
On the exit of a company from a consolidated group, policy makers must decide how to treat
the assets and associated tax attributes that go with the leaving subsidiary. To some extent,
the approach to the treatment of assets on exit is dictated by the treatment of intragroup asset
transfers during consolidation.
Where a country adopts rollover treatment for intragroup asset transfers, the deferred gain is,
in general, recaptured when either the transferor or the transferee leaves the consolidated
group. Alternatively, a leaving subsidiary inherits the cost bases of assets that it takes away
from the consolidated group. No immediate taxation arises on exit.
5.6 Group taxation regime
The specific rules differ from country to country as to the eligibility and stock ownership
requirements of forming a tax group, the items to be included in the income and expenses,
apportionment of the taxes, etc. Often the rules are further complicated by the fact that
members of a group are treated as a single entity for many purposes, but as separate entities
for other purposes.
This section provides highlevel provisions of the group taxation regimes in European Union.
EUROPEAN UNION 18
Common Consolidated Corporate Tax Base specifically for countries within European Union
(Please note that this section is not exhaustive and based on secondary sources)
5.6.1 Introduction
On 16 March 2011, the European Commission published its proposal for a Common
Consolidated Corporate Tax Base (CCCTB). In June 2015, the Commission presented a
strategy to re-launch the CCCTB. The CCCTB aims at a far-reaching harmonization of the
corporate tax base and full consolidation of group profits across the EU while leaving tax rates
at the discretion of Member States. This is that "[a] system allowing companies to treat the
18http://online.ibfd.org/kbase/#topic=doc&url=/collections/wtj/html/wtj_2012_02_int_2.html
Union as a single market for the purpose of corporate tax would facilitate cross-border activity
for companies resident in the Union and would promote the objective of making the Union a
more competitive location for investments internationally". Under the CCCTB, the consolidated
profit would be shared according to a formula which takes into account the location of a
multinational enterprise’s assets, workforce and sales.
5.6.2 Basic Features of the CCCTB
The Commission identified high compliance costs, double taxation, transfer pricing
complications, limits on cross-border loss relief, and tax charges on cross-border business
restructurings as major impediments to the internal market. The CCCTB has been conceived
by the Commission as a comprehensive solution which would do away with all these tax
obstacles in a single stroke. Four basic features of the CCCTB is briefly outlined: 1) Eligibility
criteria 2) Consolidation of income and 3) Apportionment of consolidated tax base 4) Term
5.6.3 Eligibility criteria
The CCCTB would provide European groups of companies with an instrument for the cross-
border consolidation of profits and losses. With regard to entities eligible for consolidation, an
immediate or lower-tier subsidiary qualifies for group membership and consolidation if a
threshold with regard to control and ownership is met. Further, not only companies but also
permanent establishments may be part of a CCCTB group.
The parent company must hold more than 50% of the voting rights and must own more than
75% of the subsidiary’s capital or must be entitled to more than 75% of its profits. With regard
to lower tier subsidiaries, a holding of more than 50% of the voting rights is deemed to be a
holding of 100%.
The territorial scope of consolidation is limited to the European Union. Only EU companies
and permanent establishments may be part of a CCCTB group. However, companies which
are tax resident in third countries may form a CCCTB group with regard to their qualifying
subsidiaries and permanent establishments located in the European Union. The right to opt for
the CCCTB lies with the ultimate parent company of the group if it is tax resident in the
European Union, otherwise with one of its EU resident subsidiaries or permanent
establishments. If the group opts for the CCCTB, all qualifying subsidiaries and permanent
establishments are automatically included in the group and the consolidation extends to the
entire tax base of all group members irrespective of minority shareholdings.
5.6.4 Consolidation of income
The backbone and mainstay of the CCCTB project is a harmonization of the corporate income
tax base. If the CCCTB were adopted, a European company would only have to deal with one
set of rules in order to calculate its profit for tax purposes – instead of having to comply with
different sets of rules as at current. According to article 10 of the CCCTB draft directive
(CCCTB-D), the “tax base shall be calculated as revenues less exempt revenues, deductible
expenses and other deductible items”. The CCCTB-D has in detail explained the items which
are considered as exempt revenues, deductible and non deductible expenses.
5.6.5 Apportionment of consolidated tax base

The CCCTB applies in an international context where the situation is different because group
members may be located in different countries subject to different national tax rates. The
question then arises as to how the consolidated tax base between the competing tax
jurisdictions should be distributed. The Directive does this by apportioning the tax base
between the members of the group—and thus indirectly between the respective Member
States,based on the ‘formulary apportionment’ approach.
The CCCTB formula consists of three equally weighted factors: “labour”, “assets”, and “sales”.
The formula would share the consolidated group profit among the entities belonging to the
multinational enterprise in question. Every Member State would be entitled to tax the profit
share of “its” group companies and permanent establishments according to the applicable
national tax rate. This means that, as with the arm’s length standard, formulary apportionment
under the CCCTB would serve a double function: it would allocate a share of the consolidated
profit to each group entity and at the same time allocate taxing rights to the Member States
involved.
The formula is as under:
Share A = [1/3* SalesA / SalesGroup} +1/3[1/2* PayrollA/PayrollGroup +1/2*No. of
EmployeesA/No of EmployeesGroup] +1/3*AssetsA/AssetsGroup]*Consolidated Tax Base
5.6.6 Term
A European company would be free to decide to calculate its profit for tax purposes according
to the rules of the CCCTB or to continue to apply national tax rules. If the CCCTB is chosen, it
is binding for 5 years as per Article 105 of the CCCTB-D and is thereafter prolonged
automatically for a further 3 years unless timely notice of termination is given to the competent
tax authority.
5.7 Conclusion
The application of enterprise doctrine in real world is subject to many constraints including the
different political jurisdiction and economic enterprises, traditional single entity doctrine which
is traditionally embedded in income tax law, etc. It has been observed that it is difficult to
establish an exact family tree of the group taxation regimes around the world.
Nevertheless, Consolidation has become common considering the need of the hour. The
introduction of a consolidated regime is often a major tax reform of the income tax system.
International trend shows that number of countries have adopted consolidation regimes.
Though there is no consolidation regime in India, many other countries like
Netherlands, France, Australia, South Korea, etc have introduced consolidation regimes
in their countries.
Conclusion
opt any one option which is most tax efficient.
only undertaken only to avail tax benefits. Hence, taxpayer needs to maintain adequate
Module F
Anti-Avoidance Measures ∗
Unit-I Judicial Anti-Avoidance Doctrines

1.1 Introduction
Tax avoidance can be called an art not to pay taxes without breaching any tax law and not
reducing a tax burden. Tax avoidance is the practice of avoiding taxes through a simulated
chain of transactions in consequence of which a tax payer gets tax benefit.
There is always a war between the revenue and its people to characterize their efforts for
minimization of its tax liability as either tax avoidance or as tax evasions. Tax evasions are per
se prohibited. To reduce tax avoidance techniques, various methods have been developed by
various countries across the globe depending upon their requirement. Such measures in
general are called “Anti-Avoidance measures”.
Tax avoidance measures could be divided into general anti-avoidance rules (GAAR) and
specific anti-avoidance rules (SAAR). GAAR are used when facing tax avoidance methods
that are not regulated by SAAR.
1.2 Need and Purpose for introduction of Anti-Tax Avoidance

Measures
Internationally and in India, a constant debate has been raging over the issue of tax
avoidance. Over the years, the terms “tax avoidance” and “tax evasion” are used without much
distinction. The question whether it is a legitimate tax planning or an act of tax avoidance has
occupied the minds of all the stake holders the world over, since early twentieth century, and
no definitive answer has been found till date, when we are in the twenty first century.
Therefore to better understand the purpose of introducing Anti-Tax Avoidance measures, it is
necessary to be familiar with the concept of and distinction between Tax Evasion, Tax
Avoidance and Tax Planning.
OECD defines Tax Evasion as “illegal arrangements where liability to tax is hidden or ignored,
i.e. taxpayer pays less tax than he is legally obligated to pay by hiding income or information
from the tax authorities”. It is unlawful escaping of tax liabilities 1e.g. if a taxpayer claims
deduction under section 80C of the Act without making actual investment in eligible
investment.
∗
Major Source of reference for creating this background material have been obtained from books of Shri Roy
Rohatgi’s Basic International Taxation (Volume I & II).
1Royal Commission on Taxation of Profits and Income, UK, 1955
OECD defines Tax Planning as “an arrangement of person’s business and or private affairs in
order to minimize tax liability.” It can be achieved through movement or non-movement of
persons, transactions, or funds or other activities that are intended by legislation. It refers to
tax mitigation by the use of tax preferences given under the law or by means that the tax law
did not intend to tax.
Tax avoidance means arranging affairs where the main object or purpose of one of the main
object or purposes of the arrangements are to obtain tax advantages, such arrangements
being entered into whilst fully intending to comply with the law in all respects. Justice
Reddy 2defines Tax Avoidance as an “art of dodging tax without breaking the law”. OECD
defines it as an arrangement of a taxpayer’s affairs that is intended to reduce his liability and
that although the arrangement could be strictly legal is usually in contradiction with the intent
of the law it purports to follows”. The Carter Commission Report states that tax avoidance is
“every attempt by legal means to reduce tax liability which would otherwise be incurred by
taking advantage of some provisions or lack of provisions in the law” 3 e.g. where investments
are routed through a favorable tax treaty country with India, only with an intent to claim the
favorable tax regime under such tax treaty.
There is always a thin line between acceptable tax avoidance, also known as tax planning and
unacceptable tax avoidance. A distinction has also to be made between tax avoidance and tax
evasions; the former is legal whereas the latter is illegal.
It is stated that tax avoidance is a situation when a tax payer reduces a tax basis simulating
one or some actions, which officially fulfill the requirements of tax laws. As a consequence,
the tax payer gets a tax benefit. These actions usually are fixated in accountancy not falsifying
them. Tax evasion is a situation when a tax payer transacts contradictory to tax laws generally
unfixating real transactions revenue in accountancy. Amongst others there are four basic tax
avoidance techniques prevailing in world;
• Deferment of tax liability
• Re-Characterization of an item of income or expenses to tax at a lower or nil rate
• Permanent elimination of tax liability
• Shifting of income from a high-taxed to a lower-taxed person / jurisdiction
These techniques are carried out by using following methods:
• Treaty Shopping- use of favorable tax treaties
• Creation of artificial intermediary companies in nil/lower tax jurisdiction for utilization of
passive funds without bringing them to home country
• Excessive use of debt over equity
2McDowell v. Commercial Tax Officer, (1985), 154 ITR 148 (Supreme Court of India)
3Royal Commission on Taxation (Carter Commission), 1966, Canada
Anti-Avoidance Measures 6.3
• Manipulation of Transfer Pricing provisions & methodology

• Use of tax havens
• Transfer of residence
All the above tax avoidance techniques take advantage of inconsistencies and discontinuities
in the tax systems through various tax arbitrage techniques. Anti-Avoidance has been
introduced in the tax statute or developed by Judiciary over a period of time to curb the
practice of tax avoidance.
1.3 Judicial Anti-Avoidance Doctrines

History of judicial anti avoidance could be found in the decisions rendered in US & English
cases, which have been relied upon extensively by the Indian Judiciary, from time to time.
The two guiding principles 4 in judicial anti-avoidance doctrines are:
1. Business Purpose Rule (motive test)
2. Substance over form Rule (artificiality test)
3. Other Civil Doctrine
1.3.1 Business Purpose Rule
The “business purpose rule” says that a transaction must serve or test a business purpose. It
requires justification of a transaction from commercial point of view, other than serving a
purpose of tax avoidance. Mere tax advantage cannot be the sole or main business purpose.
U.S. Supreme Court in the famous landmark decision Gregory v. Helvering 5 held that
existence of a corporate organization under the law solely for tax purposes did not qualify for
tax benefits. Business purpose test is not seldom defined in the statutes and Courts have
taken a common-sense view. While issuing a general anti-avoidance Regulation, Indian
Parliament has tried to define the business purpose test objectively which we will discuss
under GAAR Chapter.
1.3.2 Substance over Form Rule
The principle “substance over form” is wider in scope than business purpose rule. 1987 OECD
report defines it as “the prevalence of economic or social reality over the literal wording of
legal provisions. Although substance test is being used very frequently, the true meaning of
this test has remained unraveled. Though various countries have tried to define it by
introducing GAAR provision or similar provision, it is rather impossible to codify it in its
complete form as it being a very fact specific exercise. There are various faces of “substance
v. form” as listed below:
• Legal v. Economic Substance
4Fredrik Zimmer, Form and Substance in Tax Law (IFA Cahiers, Vol 87A, General Report 2002)
5Gregory v. Helvering, 69 F.2d 809 (2nd Cir.1934)
• Sham transactions
• Label Doctrine (“wrong characterization”)
• Step-transactions doctrine
• Piercing the Corporate Veil
(a) Legal V. Economic Substance
This applies to situations where due to the legal form used for the transactions a
taxpayer has the real economic power over taxable income without the tax liability.
The most frequently quoted ruling on this subject confirming that tax avoidance is
acceptable and legal comes from the court case of IRC vs. Duke of Westminster 6. In
this case Duke of Westminster entered into an agreement by which he stopped paying a
non-deductible wage to his gardener and instead drew up a covenant agreeing to pay
an equivalent amount, which if correctly characterized as annuities, would be tax
deductible. The gardener still received the same amount in wages but the Duke gained
a tax benefit because under the then applicable law, the covenant resulted in reduction
of the Duke’s liability to surtax. When the case came before the House of Lords, the
Judge, Lord Tomlin, stated:
“Every man is entitled, if he can, to order his affairs so that the tax attaching under the
appropriate Acts is less that it otherwise would be. If he succeeds in ordering them so
as to secure that result, then, however unappreciative the Commissioners of Inland
Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay
an increased tax”
This principle at the heart of the “tax evasion- tax avoidance” impasse, also called the
Westminster principle, was a landmark decision which provided legitimacy to tax
planning, even if its sole motive was to save tax. In substance, this judgment indicated
that legal form would govern the tax consequences and that the taxpayer could arrange
his affairs for tax savings. The doctrine set forth in this case has been relied upon in a
number of cases and has been the base of various decisions on questions whether the
transactions fall within the four corners of “tax planning” or in the realm of :tax
avoidance”.
Another important case regarding economic substance is Aiken Industries v.
Commissioner 7. In this case Mechanical Products Inc. (Aiken’s predecessor) raised
debt from an Ecuadorian corporation and issued promissory notes; the Ecuadorian
corporation then exchanged these promissory notes for new promissory notes issued by
Industrias, a Honduran company. Aiken repaid the debt and interest to Industrias, which
in turn repaid its debt along with interest to the Ecuadorian corporation. Revenue
6Duke of Westminster v. Commissioner of Inland Revenue, [1936] 1 A.C.19 (H.L.) (U.K.)

7Aiken Industries v. Commissioner, 56 T.C.925 (1971) (U.K.)
contended that the entire structure was devised solely to avoid tax since interest
payments to Industrias would not be eligible to tax withholding under US-Honduras
Treaty (DTAA). The Court agreed with Revenue and held that Aiken, the successor of
Mechanical Products, was liable for withholding taxes on interest paid.
Other interesting judgment relating to economic substance is Northern Indiana Public
Service Company v. Commissioner 8 [hereinafter “Northern Indiana Public Service
Company”]. The short summary is as follows. Northern Indiana USA intended to raise
debt in Europe where interest rates are relatively lower; for this a subsidiary was set up
in Netherlands to borrow from European bond holders. The terms and two notes were
different and there was a small spread at the Dutch subsidiary level. Revenue
contended that Dutch subsidiary was set up to avoid tax. The Court disagreed with
Revenue saying financing was not with related parties and Dutch subsidiary had profit
motive from the start.
(b) Sham Transactions
In a sham transaction, they (the ‘tax avoiders’) give effect to a transaction, which they
do not carry out, or do not intend to carry out or is a cover up for another transaction or
relationship. A sham transaction essentially conceals the true nature or reality of a
transaction that exists in form only. In short, the legal form is retained but the underlying
substance is not genuine in law.
A landmark judgment regarding sham transactions is the Knetsch case 9. In this case,
the taxpayer borrowed money at 3.5% to make a return of 2.5% from an investment in
annuity issued by insurance company. Investment income was taxed at lower capital
gains rate and the interest payments were fully deductible for tax purposes. The US
Supreme Court treated the transaction as a sham and disallowed the interest paid on
the loan. It was held that there was “nothing of substance to be realized beyond a tax
deduction.”
(c) Doctrine of the Label (“wrong characterization”)
In this method, parties use incorrect labels to classify or characterize a transaction or
relationship for tax purposes. A relevant case in this regard is the Ridge Securities
case 10. where the Court rejected a loan with interest at over 400% per annum as a loan
transaction. In Council of India case 11 the Court rejected a purchase consideration
described as an annuity payable over 47 years. In the Vestey case18 the taxpayer had
agreed to sell his shares at a consideration payable over 125 yearly instalments and
treated the entire price as a capital receipt.
8Northern Indiana Public Service Co. v. Commissioner, 105 T.C.341 (1991)

9Knetsch v. United Sates, 364 U.S.361 (1960)
10Ridge Securities v. IRC, (1962) 44 T.C.373 (Ch.D)(U.K.)
11 Council of India v. Socbie, T.C.618 (UK)

(d) Step-transaction doctrine

Certain countries (like USA, UK, Japan and Canada) regard a series of connected
transactions as a single transaction under the “substance v. form” principle.In a “step
transaction”, the intermediate steps in a chain of preordained, even if bona fide,
transactions may be disregarded and several related transactions may be treated as a
single composite transaction. Alternatively, a single transaction may be broken into
distinct steps too to determine its tax acceptance.
An important case law in step-transaction is the W.T. Ramsay case 12 where the
taxpayer made a large capital gain on the sale of a farm. To offset this, he entered into
a series of separate share and loan transactions which generated both a non-taxable
gain and fully allowable loss. The multi-step transactions asa whole were circular and
self-cancelling. The taxpayer hence began and ended in the same financial position and
still claimed a tax loss. The House of Lords disallowed the loss as fiscal nullity since the
taxpayer had made no real financial loss and thereby established the “Ramsay doctrine”
(doctrine of fiscal nullity).While delivering the judgment, Lord Wilberforcce observed as
under:
“Given that a document or transaction is genuine, the court cannot go behind it to some
supposed underlying substance. This is the well-known principle of Inland Revenue
Commissioners vs. Duke of Westminster [1936] A.C.1. This is a cardinal principle but it
must not be overstated or overextended. While obliging the court to accept documents
or transactions, found to be genuine, as such, it does not compel the court to look at a
document or a transaction in blinkers, isolated from any context to which it properly
belongs. If it can be seen that a document or transaction was intended to have effect as
part of a nexus or series of transactions, or as an ingredient of a wider transaction
intended as a whole, there is nothing in the doctrine to prevent it being so regarded; to
do so is not to prefer form to substance, or substance to form. It is the task of the court
to ascertain the legal nature of any transaction to which it is sought to attach a tax or a
tax consequence and if that emerges from a series or combination of transactions,
intended to operate as such, it is that series or combination which may be regarded. For
this there is authority in the law relating to income tax and capital gain tax: see Chinn
vs. Hochstrasser [1981] A.C.533 and Inland Revenue Commissioners V. Plummer
[1980] A.C.896.”
The true principle of the decision in Ramsay was that the fiscal consequence of a
preordained series of transactions is generally to be ascertained by considering the
result of the series as a whole and not by dissecting the scheme and considering each
transaction separately. The “Ramsay principle” quickly became one of the Inland
Revenue’s favorite arms against tax avoidance schemes and they saw it as approval of
the Court to disregard steps inserted into transactions purely for tax purposes. Also in
12W.T.Ramsay Limited v. Inland Revenue Commissioner, (1981), 54 T.C.101 (H.L)(U.K.)

I.R.C. Vs. Burmah Shell Co. Ltd 13 and Furniss (Inspector of Taxes) vs. Dawson 14, it was
held that where tax avoidance was targeted through a series of transactions with no
commercial or substantial value but with only the aim of avoiding tax, the Courts have to
ignore the transactions and the tax liability has to be determined as if these transactions
never took place.
(e) Piercing the Corporate Veil
The piercing of the corporate veil is one of the most debated topics today incorporate
circles. Under the corporate law, a company is has a separate and independent status
as compared to its shareholder. Lifting of corporate veil refers to disregarding such
separate and independent status of a corporate and to consequently tax the shareholder
thereof.
The classic case for veil piercing is Salomon v. Salomon 15 where Salomon converted
the business to a limited liability corporation when it was doing well. The business then
floundered and went into liquidation. The question was ‘what was the true intent behind
the conversion of the business?’ The House of Lords ruled that the company had been
validly formed and in the famous words ofLord Macnaghten, “The company is at law a
different person altogether from the subscribers to the memorandum of association…”
On this basis, the court upheld the conversion of business as bona fide.
Another case in common law for veil piercing is Adam v. Cape Industries 16. Cape was a
large MNC based in England and in the asbestos industry. NAAC (Cape’s North-
American subsidiary) had damages claimed by its employees in Texas due to asbestos-
related illnesses. NAAC was liquidated and activities continued by a new entity called
CPC. Fact is that CPC was set up with financial support from Cape and operated in the
same premises with same employees as NAAC. However CPC was controlled via a
Luxembour gagency of Cape called AMC (i.e. Cape AMC CPC). When fresh damages
were claimed by employees, Cape refused to appear before American Courts saying
ithad no interests in America anymore and that AMC (its agency) came between CPC
and Cape. The Courts sided on the side of Cape Industries saying the corporate veil
cannot be lifted. However in coming to their decision, most importantly, the Courts went
into an analysis on the three possible grounds for piercing, i.e.,fraud, agency and the
single economic unit theory.
An interesting Indian case related to corporate veil piercing in Company Law is the
Wood Polymer case 17. In this case, the company asked for grant of sanction of scheme
13I.R.C. v. Burmah Shell Co. Ltd [1932] STC 30 (Burmah)

14Furniss (Inspector of Taxes) v. Dawson [1984] 1 ALL E.R.530
15 Salomon v. Salomon & Co.[1897] A.C.22 (H.L.)(U.K.)
16 Adams v. Cape Industries Plc, [1990] Ch.433 (C.A.)(U.K.)
17 In re:Wood Polymer Limited (1977), 109 ITR 177 (HC)(Guj.)

of amalgamation under section 391(2) of the Companies Act, 1956. The scheme of
amalgamation involved:
(i) Amalgamation of the transferor-company (Bengal Hotels Pvt. Ltd., a private
limited company) with the transferee-company (Wood Polymer, a public limited
company) along with the dissolution of transferor-company without winding up.
(ii) According to the official liquidator’s report, the transferor-company (Bengal
Hotels) was merely created to facilitate the transfer of “Avenue House”
immovable property (belonging to the transferor-company’s parent, DOC Ltd.) to
the transferee-company (Wood Polymer) so as to avoid the payment of capital
gains tax, which would otherwise have been payable under section 45 of the
Income Tax Act, 1961
(iii) In order to avoid this capital gains tax, the transferor-company was floated and
transferor-company availed of the benefit enacted in section 47 of the Income
Tax Act.
The Court looked at relevant sections of the Companies Act and held that the Court is
not merely a rubber stamp in scrutinizing a scheme of amalgamation. The following
questions were also examined in detail by the Court:
(i) What was the legislative intent in introducing the second proviso to section394 of
the Companies Act?
(ii) What is the ambit, scope and outer periphery of the concept of ‘public interest’ as
envisaged in the second proviso?
(iii) Is the disclosed purpose put forth by the companies who have moved the Court
for sanction of merger/amalgamation, relevant consideration for the Court or
could the Court probe and go behind the apparent purpose and ascertain the real
purpose and take into consideration that purpose, so as to reach a conclusion
that for such a purpose the Court would not permit its process to be utilized if the
purpose is shown to be one which is opposed to public interest?
(iv) If, except for the tax benefit, no other purpose for merger/amalgamation is
disclosed oron probing, tax avoidance appears to be the major and only purpose
for the scheme, could it not be said that the purpose is such that Court should not
sanction the scheme on the ground that it is opposed to public
interest?(Emphasis Supplied)
(v) Should the Court by its process facilitate avoidance of tax, even if it can be said
that avoidance is legal and cannot be styled as tax evasion?
The Gujarat High Court looked at various decisions of the Indian and English Courts
and came to a decision that the said scheme of amalgamation could not be sanctioned.
It held that:
The scheme of amalgamation must have some purpose or object to achieve...the

purpose and the only purpose appears to be to acquire capital asset of DOC Ltd.
through intermediary transferor-company…it can never be said that the affairs of
the transferor company sought to be amalgamated, created for the sole purpose
of facilitating transfer of capital asset, through its medium, have not been carried
out in a manner prejudicial to public interest…the Court will not lend its name its
assistance to defeat public interest, namely tax provision.…It must be confessed
that it is open to a party so as to arrange its affairs so as to reduce tax
liability…but it must be within the power of the party to arrange its affairs. If the
party seeks the assistance of the Court to reduce its tax liability the Court
should be the last instrument to grant such assistance or judicial process
to defeat a tax liability…here the tax cannot be avoided unless the Court lends
its assistance, namely, by sanctioning the scheme of amalgamation. In other
words, the judicial process is used or polluted to defeat the tax by forming an
appropriate device or subterfuge. Such a situation can never be said to be in the
public interest and on this ground the Court would not sanction the scheme of
amalgamation. (Emphasis Supplied)
The key question is “when can the corporate veil be lifted?” The answer from judicial rulings
seems to be: when the device of incorporation is used for an illegal, improper or fraudulent
purpose or when mandated by specific provisions of law or contract .India’s stand in corporate
veil piercing has been that the Courts typically will not pierce corporate veil in tax cases.
1.3.3 Other Civil Doctrines
Courts in many countries have tended to apply civil law doctrines to control general tax abuse.
The main civil law doctrines used are:
(a) Abuse of Right (“Abus de Droit”)
Several jurisdictions apply the form and purpose rules of abuse of right doctrine under
Civil Law (Example: Austria, France etc). The abuse of right is the manipulation of the
intention or spirit of the law. Courts typically disregard the legal form where transactions
are solely undertaken to avoid tax.
(b) Abuse of Law (“Fraus Legis”)
Many civil law countries apply the Roman law doctrine of fraus legis. A good example is
The Netherlands. Fraus legis resembles the business purposerule. Under this, the Court
disregards any transaction entered for tax avoidance purposes and substitutes it by a
“normal” transaction.
(c) Doctrine of Simulation
Certain civil law countries, like Belgium, apply this doctrine to ensure‘ substance over
form’. It arises when there is no real transaction or there isa hidden real transaction or
relationship. In such cases tax authorities can disregard the simulated transaction and
replace it with the real one. This principle resembles the sham transaction or doctrine of
wrong label. Examples of simulation include sale and leaseback transactions where the
respective rights and obligations of the parties are not transferred in substance.
1.4 Judicial Anti-avoidance Doctrines in Indian Scenario

In the Indian Context, few of the decisions of English Courts as discussed above came to be
discussed before the Hon’ble Supreme Court of India in CIT vs. A. Raman and Co 18. The
Supreme Court followed the maxim of Duke of Westminster’s case (supra) and held that tax
avoidance by arranging commercial affairs in a manner such that charge of tax is distributed is
not prohibited. The Supreme Court observed that:
“………the law does not oblige a trader to make the maximum profit that he can get out
of his trading transactions. Income which accrues to a trader is taxable in his hands.
Income which he could have, but has not earned, is not made taxable as income
accrued to him. Avoidance of tax liability by so arranging commercial affairs that charge
of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the
income before it accrues or arises to him. Effectiveness of the device depends not upon
consideration of morality, but on the operation of the Income-Tax Act. Legislative
injunction in tax statues may not, except on peril of penalty, be violated, but may
lawfully be circumvented….”
1.4.1 The McDowell- Landmark judgment
The views of the English Courts gained general acceptance by the Indian Courts over the
years until the Supreme Court in McDowell & Co. Ltd. vs. CTO 19 circumscribed the leeway
allowed to taxpayers. McDowell was a licensed manufacturer of liquor in Hyderabad. The
company had failed to disclose the excise duty paid on liquor sold by it to wholesalers. The
taxing authority, through a notice, called upon the company to show cause why assessments
made should not be reopened. The company challenged the validity of this notice and argued
that the excise duty paid by the buyer did not become a part of the company's turnover. The
Supreme Court dismissed McDowell's appeal and pronounced its judgment dissociating itself
from the earlier observations made in the case of CIT vs. A Raman & Co. (supra). The Hon'ble
Supreme Court, while dismissing the observation of J. C. Shah J., in CIT vs. A. Raman and
Co. (supra) based on Westminster (supra) and Fisher's Executors, observed as under (page
160)
"We think that the time has come for us to depart from the Westminster principle as
emphatically as the British courts have done and to dissociate ourselves from the observations
of Shah J., and similar observations made elsewhere." It was further stated that (page 160):
"In our view, the proper way to construe a taxing statute, while considering a device to avoid
tax, is not to ask whether the provisions should be construed literally or liberally, nor whether
18 CIT v. A. Raman & Co. 67 ITR 11 (SC)

19 McDowell v. Commercial Tax Officer, (1985), 154 ITR 148 (SC)
the transaction is not unreal and not prohibited by the statute, but whether the transaction is a
device to avoid tax, and whether the transaction is such that the judicial process may accord
its approval to it."
The Supreme Court further held as under:
"Tax planning may be legitimate provided it is within the framework of law. Colourable devices
cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is
honourable to avoid the payment of tax by dubious methods. It is the obligation of every
citizen to pay the taxes honestly without resorting to subterfuges."
Thus the principle enunciated was that a transaction could be regarded as one for avoidance
of tax if no commercial justification underpinned the transaction other than reduction of income
tax. The decision in McDowell's by the Supreme Court was a significant departure from the
Westminster principle. It sought the aid of emerging techniques of interpretation in trying to
relate tax avoidance devices to the existing legislation. It chose to rely on the famous British
ruling in Ramsay's case to expose the devices for what they really are, and denied judicial
benediction to such devices.
1.4.2. Azadi Bachao Andolan's case
The Supreme Court of India again had an occasion to consider the issue of tax planning vs.
tax avoidance in the case of Union of India vs. Azadi Bachao Andolan 20 in the context of
eligibility of treaty benefits to foreign investors who routed their investments to India through
Mauritius. The Indian tax authorities denied tax treaty benefits to companies incorporated in
Mauritius for investing funds in India on the ground that they were controlled and managed
from countries other than Mauritius and were misusing the India-Mauritius tax treaty. In this
context, the CBDT issued Circular No.789 of April 13, 2000, which stated that the Mauritius
Tax Residency Certificate issued by the Mauritius Tax Office was sufficient evidence for
accepting the status of residence and beneficial ownership for applying the Convention on the
Avoidance of Double Taxation between India and Mauritius executed on April 1, 1983 and that
the treaty benefits should be made available to such tax payers. The Circular was challenged
before the Courts and the Supreme Court, while dealing with the aspects of tax planning,
observed that the landmark decision of the House of Lords' on tax planning, namely, Duke of
Westminster (supra) and the decision of the Supreme Court in case of A. Raman & Company,
(supra) were still valid judicial precedents. The Court thus reaffirmed the view of English cases
which held that while examining a legally valid transaction, the Revenue should proceed
objectively and not hypothetically attribute “motives” behind the taxpayer’s action. However
the Court has upheld that the use of colorable devices or dubious method to avoid tax was not
permitted.
The Supreme Court also observed that it cannot be said that its decision in McDowell's case
can be read as laying down that `every attempt at tax planning is illegitimate and must be
20 Union of India v. Azadi Bachao Andolan (2003) 263 ITR 706 (SC)
ignored, or that every transaction or arrangement which is perfectly permissible under law,
which has the effect of reducing the tax burden of a taxpayer, must be looked upon with
disfavour. The Supreme Court observed that where the courts find that notwithstanding a
series of legal steps taken by a taxpayer, the intended legal result has not been achieved, the
courts might be justified in overlooking the intermediate steps, but it would not be permissible
for the court to treat the intervening legal steps as non-est based upon some hypothetical
assessment of the "real motive" of the taxpayer. The Supreme Court in the case of CIT vs.
Walfort Share and Stock Brokers Pvt Ltd (326 ITR 1), after referring to McDowell (supra) and
Azadi Bachao Andolan (supra), held that a citizen is free to carry on his business within the
four corners of the law and that tax planning, without any motive to evade taxes through
colourable devices, is not frowned upon even by its judgment in McDowell's case.
1.4.3 Vodafone’s Case
Tax planning once again came to the fore as a subject of discussion in Vodafone International
Holdings BV vs. Union of India 21. The issue under consideration was whether indirect transfer
of assets outside India by non-resident to another non-resident outside India shall be taxable
in India by disregarding legal ownership of such shares held by such non-resident.
The Tax Authority contended that the decision of the SC in Azadi Bachao Andolan (supra) on
tax avoidance, would need to be overruled as it had departed from the principles laid down in
McDowell (supra) where other judges had concurred with a separate ruling on the issue given
by one of the judges. The Supreme Court dealt with the applicability of the McDowell vs. Azadi
Bachao Andolan’s case and reconciled the same. The principles laid down by the Supreme
Court are discussed as under:
• The majority ruling in McDowell had clearly held that tax planning was legitimate,
provided that it was within the framework of law and that colourable devices could not
be a part of tax planning. The separate ruling by the fifth judge was in relation to tax
evasion through colourable devices by resorting to dubious methods and subterfuges. It
is nowhere mentioned that tax planning is illegitimate or impermissible and, moreover,
the fifth judge himself agreed with the majority ruling.
• As per the Westminster principle, emerging from the House of Lords decision in the
case of IRC vs. Duke of Westminster (supra), a taxpayer can arrange his affairs so as
to reduce the liability of tax and the fact that the motive for a transaction is to avoid tax
does not invalidate it unless a particular enactment so provides.
• However, the Ramsay doctrine, emerging from a later decision of the House of Lords in
the case of WT Ramsay (supra), was a new approach to artificial tax avoidance
schemes, wherein, a subject could be taxed only if there was a clear intendment and the
intendment has to be ascertained on clear principles and the courts could not
approach the issue on a mere literal interpretation.
21 Vodafone International Holding BV v. Union of India [2012] 341 ITR 1 (SC)

• The Ramsay ruling did not discard the Westminster ruling, but read it in the proper
context as per which a 'device', which was colourable in nature, had to be ignored as a
fiscal nullity. Thus, the Ramsay ruling lays down the Principle of statutory interpretation,
rather than an over-arching anti-avoidance doctrine imposed upon tax laws.
• In Craven vs. White 22, it was held by the House of Lords that the Tax Authority cannot
start with the question as to whether the transaction is a tax deferment/ saving device,
but that the Tax Authority should apply the 'look at' test to ascertain its true legal nature.
Genuine tax planning isnot to be abandoned.
• Applying the Westminster principle, the Tax Authority cannot tax a subject without a
specific provision in the legislature, and every taxpayer is entitled to arrange his affairs
so that his taxes shall be as low as possible and that he is not bound to choose that
pattern which will replenish the treasury.
While delivering the judgment in favor of Vodafone, the Supreme Court of India held that there
are no conflicts between McDowell ruling and Azadi ruling, and no re consideration of larger
bench on the same is required. Burden is on the tax authority to allege and establish abuse,
where there is a tax holding structure. The corporate business purpose of the transaction
would be proof that the impugned transaction is not a colorable device.
1.5 Legislative Anti-Avoidance Measures

There are two kinds of Anti-Avoidance measures available viz..SAAR andGAAR. SAAR refers
to Specific Anti Avoidance Rules. It is applied in a specific situation covered by such rule. Few
examples of SAAR are thin capitalization rule, Controlled Foreign Corporation (CFC) Rule,
beneficial ownership rule, taxation of indirect transfer etc. These rules are passed in the
domestic legislation to curb specific tax avoidance techniques.
GAAR refers to General Anti-Avoidance Rules. It is not always possible to draft a rule to avoid
tax avoidance in every type of transactions. Tax avoidance schemes are becoming
increasingly complex and tough to curb through SAARs. Therefore GAAR can be introduced
as a catch-all scheme to curb tax avoidance in general. However the real problem with GAAR
is that it can end up promoting uncertainty which is almost dangerous to operate a tax system
in a country.
1.6 Overview of various anti-avoidance measures in different

countries
It is illuminating to see the anti-avoidance measures used in various countries around the
world. It seems that a combination of the various techniques discussed above has been used
to combat tax avoidances as indicated in below table:
22 Craveen v. White (1988) (3 ALL E.R.495)

Country Short summary of anti-avoidance measures

India • GAAR to be effective from 1st April 2017. Domestic law has SAAR
provisions (Transfer Pricing Provisions –section 92-92F, 40A(2),
section 93, 94, 60 to 64, 14A, 73, taxation of gifts-56, etc.)
• Underlying principles implemented through judicial and administrative
decisions
• Courts have favoured taxpayer historically and generally taken a
literal view
USA • Does not have statutory GAAR
• The Courts have evolved several judicial anti-avoidance doctrines
• Courts tend to apply substance over form
Canada • Enacted a GAAR in 1988; specific criteria for applying GAAR set out
by the Courts and benefit of doubt given to taxpayer
Austria • Taxpayer is free to arrange affairs but broad limitations are placed
under the GAAR
• However, tax avoidance must be main or only motive of taxpayer
arrangement and strict burden of proof on tax authorities; it is
considered irrelevant that arrangements are “unusual”
Australia • GAAR was introduced in 1981 Income Tax Act
• Courts have shifted over the years to purposive interpretation from a
literal approach
Germany • Contains GAAR in the tax code. Legal structure can be disregarded
under “abuse of form and legal structures” provision.
• Courts apply substance over form; use the principal of analogy.
• Germany has one of the highest numbers of anti-avoidance case laws
Italy • Follows letter of law where form takes precedence over substance
• Tax avoidance so far handled through SAARs
• Earlier efforts to introduce GAAR were unsuccessful
Japan • Has authority to re-compute tax base of corporate income tax, amount
of net loss and corporate tax payable
Switzerland • Applies both business purpose and substance over form doctrine
under its law
• In tax avoidance cases the tax authorities can substitute the
customary construction for the transaction and tax accordingly
Netherlands • Dutch Law provides for a GAAR though Courts rely on fraus legis
(abuse of law)
1.7 Evaluation of Indian GAAR Provision, its objective and

enactment in law
In India, GAAR provisions were first introduced in the Direct Taxes Code in August 2009. As
per the discussion paper on Direct Taxes Code 2009 (DTC), the need for introduction of
GAAR was explained as follows:
“Tax avoidance, like tax evasion, seriously undermines the achievements of the public finance
objective of collecting revenue in an efficient, equitable and effective manner. Sectors that
provide a greater opportunity for tax avoidance tend to cause distortions in the allocation of
resources. Since the better-off sections are more endowed to resort to such practices, tax
avoidance also leads to cross-subsidization of the rich. Therefore, there is a strong general
presumption in the literature on tax policy that all tax avoidance, like tax evasion, is
economically undesirable and inequitable. On considerations of economic efficiency and fiscal
justice, a taxpayer should not be allowed to use legal constructions or transactions to violate
horizontal equity. “
The second draft of DTC which was introduced in the Indian Parliament in August 2010 also
contained the GAAR provisions with certain modifications. The second draft of DTC was
referred to the Standing Committee on Finance headed by Mr. Yashwant Sinha for its views.
The Committee submitted its report on 9th March 2012. In view of the time constraint,
suggestions of such committee were not incorporated by the Finance Minister while putting the
provision of GAAR in the Finance Bill, 2012 on the floor of house. Hon’ble Shri Pranab
Mukherjee, the then Finance Minister made the following statement on GAAR while presenting
the Finance Bill, 2012 in the Parliament.
“I propose to introduce a General Anti Avoidance Rule (GAAR) in order to counter aggressive
tax avoidance schemes, while ensuring that it is used only in appropriate cases, by enabling a
review by a GAAR panel.”
Further the Memorandum to the Finance Bill, 2012 provides following reasons for introducing
GAAR in India;
“The question of substance over form has consistently arisen in the implementation of taxation
laws. In the Indian context, judicial decisions have varied. While some courts in certain
circumstances had held that legal form of transactions can be dispensed with and the real
substance of transaction can be considered while applying the taxation laws, others have held
that the form is to be given sanctity. The existence of anti-avoidance principles are based on
various judicial pronouncements.
There are some specific anti-avoidance provisions but general anti-avoidance has been dealt
only through judicial decisions in specific cases. In an environment of moderate rates of tax, it
is necessary that the correct tax base be subject to tax in the face of aggressive tax planning
and use of opaque low tax jurisdictions for residence as well as for sourcing capital. Most
countries have codified the “substance over form” doctrine in the form of General Anti
Avoidance Rules (GAAR).
In the above background and keeping in view the aggressive tax planning with the use of
sophisticated structures, there is a need for statutory provisions so as to codify the doctrine of
“substance over form” where the real intention of the parties and effect of transactions and
purpose of an arrangement is taken into account for determining the tax consequences,
irrespective of the legal structure that has been superimposed to camouflage the real intent
and purpose. Internationally several countries have introduced, and are administering
statutory General Anti Avoidance Provisions. It is, therefore, important that Indian taxation law
also incorporate a statutory General Anti Avoidance Provisions to deal with aggressive tax
planning. The basic criticism of statutory GAAR which is raised worldwide is that it provides a
wide discretion and authority to the tax administration which at times is prone to be misused.
This vital aspect, therefore, needs to be kept in mind while formulating any GAAR regime.
It is accordingly proposed to provide General Anti Avoidance Rule in the Income Tax Act to
deal with aggressive tax planning.”
Considering the aforesaid objective of introducing GAAR provision in India, it reveals that such
provisions are being enacted to give value to substance rather than form while analyzing any
tax implication of any transaction. GAAR provision in nutshell codifies judicial doctrine
“substance over form” under the legal tax system of India. The substantive provisions relating
to GAAR, are contained in Chapter X-A (consisting of sections 95 to 102) of the Income-tax
Act as introduced by the Finance Act, 2012. The procedural provisions relating to mechanism
for invocation of GAAR and passing of the assessment order in consequence thereof are
contained in section 144BA. The provisions of Chapter X-A as well as section 144BA would
have come into force with effect from 1st April, 2014.
Thereafter a number of representations were received against the provisions relating to GAAR
and its applicability therefore delayed. An Expert Committee was constituted by the
Government with broad terms of reference including consultation with stakeholders and
finalising the GAAR guidelines and a road map for implementation. The Expert Committee's
recommendations include suggestions for legislative amendments, formulation of rules and
prescribing guidelines for implementation of GAAR.
The major recommendations of the Expert Committee have been accepted by the
Government, with some modifications in the Finance Bill, 2013 and thereafter the Finance Act,
2013 re-introduced GAAR provision with such modifications to be effective from 1st April 2016.
Some of the major modifications in GAAR as introduced by the Finance Act, 2013 as
compared to the Finance Act, 2012 were as under:
• The provisions of GAAR shall apply from the assessment year 2016-17 instead of
assessment year 2014-15
• Under the new provision an arrangement, the main purpose of which is to obtain a tax
benefit, would be considered as an impermissible avoidance arrangement. Whereas the
old provision provided that tax benefit should be "the main purpose or one of the main
purposes" to classify the arrangement as impermissible avoidance arrangement
• The factors like, period or time for which the arrangement had existed; the fact of
payment of taxes by the assessee; and the fact that an exit route was provided by the
arrangement, would be relevant but not sufficient to determine whether the arrangement
is an impermissible avoidance arrangement. The old provision provided that these
factors would not be relevant has been proposed to be amended accordingly.
• An arrangement shall also be deemed to be lacking commercial substance, if it did not
have a significant effect upon the business risks, or net cash flows of any party to the
arrangement apart from any effect attributable to the tax benefit that would be obtained
but for the application of Chapter X-A. The old provision does not contain such condition
to consider an arrangement- lacking of commercial substance.
• The Approving Panel for invocation of GAAR provisions shall consist of a Chairperson
who is or has been a Judge of a High Court; one Member of the Indian Revenue
Service not below the rank of Chief Commissioner of Income-tax; and one Member who
shall be an academic or scholar having special knowledge of matters such as direct
taxes, business accounts and international trade practices. The old provision contained
that the Approving Panel shall consist of not less than three members being income-tax
authorities and an officer of the Indian Legal Service has been proposed to be amended
accordingly.
• Under the new provisions the directions issued by the Approving Panel shall be binding
on the assessee as well as the income-tax authorities and no appeal against such
directions can be made under the provisions of the Act. Whereas the old provisions
provided that the direction of the Approving Panel will be binding only on the Assessing
Officer
The applicability of the GAAR provisions was further deferred by another two years by the
Finance Act, 2015. The memorandum to the Finance Bill, 2015 has mentioned that
“The implementation of GAAR provisions has been reviewed. Concerns have been expressed
regarding certain aspects of GAAR. Further, it has been noted that the Base Erosion and Profit
Shifting (BEPS) project under Organisation of Economic Cooperation and Development
(OECD) is continuing and India is an active participant in the project. The report on various
aspects of BEPS and recommendations regarding the measures to counter it are awaited. It
would, therefore, be proper that GAAR provisions are implemented as part of a comprehensive
regime to deal with BEPS and aggressive tax avoidance.
Accordingly, it is proposed that implementation of GAAR be deferred by two years and GAAR
provisions be made applicable to the income of the financial year 2017-18 (Assessment Year
2018-19) and subsequent years by amendment of the Act. Further, investments made up to
31.03.2017 are proposed to be protected from the applicability of GAAR by amendment in the
relevant rules in this regard.”
Accordingly the GAAR provision in India is applicable with effect from 1 st April 2017.
1.8 Overview of Indian GAAR Provisions

Following provisions of the Income Tax Act, 1961 deal with GAAR in India;
Section Particulars
95 Applicability of General Anti-Avoidance Rules
96 Impermissible avoidance arrangement
97 Arrangement to lack commercial substance
98 Consequences of impermissible avoidance arrangement
99 Treatment of connected person and accommodating party
100 Application of this Chapter
101 Framing of Guidelines in certain cases
[Rule 10U TO Rule 10UC contains such guidelines]
102 Definition
144BA Reference to Principal Commissioner ( also contains provision for
approving panel and its procedure for approval to invoke GAAR
provision)
Section 95 empowers the tax authority, notwithstanding anything contained in the Act, to
declare an arrangement which an assessee has entered into, as impermissible avoidance
arrangement. Once it is declared as “impermissible avoidance arrangement”, the consequence
as regards tax liability would be determined in accordance with the GAAR provisions.
Tax authority has also power to declare a step in, or a part of, the arrangement as
impermissible avoidance arrangement. The term impermissible arrangement has been defined
in section 96 of the Act and the term arrangement has been defined vide section 102 of the
Act. Section 102(1) defines “arrangement” means any step in, or a part or whole of, any
transaction, operation, scheme, agreement, or understanding, whether enforceable or not, and
includes the alienation of any property in such transaction, operation, scheme, agreement or
understanding”.
Section 96 of the Act defines the meaning of impermissible avoidance arrangement. As per
the said section an arrangement is impermissible avoidance arrangement ifits main purpose is
to obtain a tax benefit (“Main Purpose Test”) and it satisfies one or more of the conditions
mentioned in clause (a) to (d) viz.
(a) Arrangement creates rights or obligations which are not ordinarily created between
persons dealing on arm’s length
(b) Arrangement results directly or indirectly in the misuse or abuse of provision of the Act
(c) Arrangement lacks commercial substance whether in whole or in part
(d) Arrangement has been entered into or carried out in manners which are not ordinarily
employed for bona fide purposes.
It is also provided that onus to disprove that arrangement entered into by an assesse is not an
impermissible avoidance arrangement is first on the taxpayer. Section 97 elaborates the
circumstances in which arrangement to lack commercial substance e.g. round trip financing,
accommodating etc. Section 98 prescribes that if an arrangement is declared as an
impermissible avoidance arrangement there would be denial of the tax benefit or denial of the
tax treaty benefit. It also prescribes the ways how the tax officer would determine the denial of
the tax benefit/tax treaty benefit by making requisite assumptions. Further section 90(2A) of
the Act specifically provides that GAAR provisions will override tax treaty provisions. Section
99 provides for manner of treatment to reveal tax benefit in case of accommodating parties,
connected person etc.
Section 101, through rules 10U provides non-applicability of GAAR provision. It provides that
an arrangement where the tax benefit arising in aggregate to all concerned parties does not
exceed three crores, GAAR provisions will not apply. GAAR is also not applicable to FII,
certain non-resident in relation to investment made by him in offshore derivative instrument. It
is also provided that GAAR provisions do not have any implication in respect of income arising
by way of transfer of investment made before 1 April 2017.
Section 102 provides definitions of term “arrangement, asset, benefit, connected person, fund,
party, relative, substantial interest, step, tax benefit etc. as used in GAAR chapter. Section
144BA read with Rule 10UB& Rule 10UC prescribes the procedural aspect of execution of
GAAR provision by tax officer, reference to commissioner of income tax, reference to an
approving panel of GAAR, their manner of direction, time-limit etc.
The government has in January 2017, issued clarifications in form of FAQs dealing with
various issues relating to GAAR.
Unit-II Anti-treaty shopping measures

2.1 General
Tax treaties are bilateral agreements between two states for allocation of taxing rights on the
subject matter. It creates legal obligation for both parties under the contract once they come
into force. One of the main objectives of the tax treaties is the avoidance of double taxation
and prevention of fiscal evasion. The problem of tax avoidance is compounded with respect to
international transactions and arrangements. The intersection of foreign and domestic tax
systems and the existence of a growing network of bilateral tax treaties present increased
opportunities for tax avoidance. In most countries, generally speaking and in India specifically,
tax treaties prevail over domestic tax laws in the event of a conflict. Sometimes the interplay of
domestic tax system and tax treaties network is so unique that it will give rise to various
method of exploitation of such tax benefit. One of those methods is treaty shopping. The
OECD in its Commentary on “International Tax Avoidance, Treaty Shopping, Limitation on

Treaty Entitlement” states that the network of tax treaties makes possible tax manoeurvres
and artificial legal construction which provide a taxpayer with tax advantages both under
domestic tax laws as well as in claiming relief under tax treaties. However, it is for the states
concerned to adopt suitable anti-abuse provisions in order to check such instances of treaty
abuse.
2.2 What is treaty shopping?

Treaty shopping connotes a premeditated effort to take advantage of the international tax
treaty network and a careful selection of the most favorable tax treaty for a specific purpose.
The international Tax Glossary defines “treaty shopping” as a “situation where a person who is
not entitled to benefits of a tax treaty makes use-in the widest sense of the word of an
individual or of a legal person, in order to obtain those treaty benefits that are not available
directly.”.
According to Becker/ Warm “treaty shopping means that a taxpayer “shops” into the benefits
of a treaty which normally are not available to him and to this end he generally incorporates a
corporation in a country that has an advantageous tax treaty.”
The UN Ad Hoc Group of Experts defined the term “abuse of tax treaties as the use of tax
treaties by persons the treaties were not designed to benefit, in order to derive benefits that
the treaty were not designed to give them. It is defined as the routing of income arising in one
country to a person in another country through an intermediary country to obtain an
unintended tax advantage of tax treaties. E.g. a person resident of India acts through a legal
entity created in another state essentially to obtain treaty benefits which India has with that
states say Mauritius, which would otherwise not be available directly.
There are a variety of treaty shopping structures. Some of them are:
(a) Direct Conduits
A direct conduit works as shown in the diagram below. Parent Company in State R
expects to derive dividends, interest or royalties sourced in another state (State S). So it
sets up entity in a third state (State C) that will receive dividends, interest, and royalties
in a more tax beneficial way than if income were paid directly from State S to R. The tax
advantage results from fact that tax treaty between S and C provides for more
advantageous withholding tax rate in State S if paid to State C Resident than if paid to
State R resident.
(b) Stepping stone conduit

A stepping stone conduit works as follows: Residents of State R establish company
resident in State C where it is fully subject to tax on income derived from S. However it
pays high interest, royalties, service fees, commissions & other expenses to a second
related foreign company (base company) set up in a fourth state (State B) and
controlled by shareholders of the conduit company. These payments are deductible in
State C and are either not taxed or very advantageously taxed in State B because the
company enjoys a preferential tax regime there.
(c) Other structures

There are other treaty shopping techniques in practice; examples are triangular
structures where a low or nil taxed branch of a company in a treaty country receives
income from a third country. Another approach is to use hybrid entities that are
characterized differently in the two Contracting States. Individuals can also treaty shop
by transferring tax residence to another treaty country, i.e., ‘emigration’ - also a form of
treaty shopping. For instance, a resident of USA owning an important shareholding in

Indian company may emigrate to Belgium in view of later sale of shares because under
Article 18 of Belgium-France tax treaty the right to tax the capital gain is conferred to
Belgium but Belgium does not levy capital gains tax on individuals (except speculation).
Generally, developing countries favour tax treaty measures that assist them in promoting their
political, social and economic goals. They usually have wider policy objectives besides fiscal
goals when applying direct tax measures e.g. promotion of investment and employment
generation etc. They treat treaty shopping as tax incentive. It is the consideration of non-tax
gain to economy over tax revenue loss that is what is relevant for a developing country for
approving treaty shopping. Countries which are unable to benefit economically from treaty
shopping may regard it as unacceptable and improper as principle. They either have specific
anti-treaty shopping provisions under their domestic tax law, and/or under bilaterally
negotiated tax treaties. There are four main categories of anti-treaty shopping measures
currently in use:
(a) Neutral measures by combining domestic and tax treaty provisions. Example: non-
domiciled residents in U.K. may be entitled to treaty benefits on foreign income only
when remitted.
(b) Specific measures that deny benefits to entities which are not subject to tax in their
state of residence.
(c) Purpose-based measures that deny certain treaty benefits set up only for claiming such
benefits. Example is no tax refunds are given under Netherlands treaty with the U.K. in
such cases.
(d) Comprehensive measures imposed under domestic legislation or treaties. For example,
Article 22, U.S. Model Treaty on Limitation on Benefits, 1996; Swiss Abuse Doctrine,
1962
Treaty shopping, when it is beneficial may be tacitly approved and when disadvantageous may
be disapproved. For example, some of them have revoked tax treaties in cases of circular
situations when the income is sourced in the same country where the shareholder is resident
but the income passes through a company resident in another country for tax reasons, i.e.,
“round tripping”. This has been considered abusive by India, Brazil, Indonesia, etc.
2.3 Anti-treaty shopping measures

Depending upon its requirement, each country develops various measures to curb the
practices of treaty-shopping. Following are the widely used anti-treaty shopping measures in
various tax treaties:
(a) Beneficial Ownership
(b) Limitation of Benefit clause
2.3.1 Beneficial Ownership

The Concept of beneficial ownership may be of relevance in the context of conduit companies.
While the term “beneficial owner” does not boast of a specific definition, simply speaking, the
term implies restriction on availability to treaty benefit by persons who are “beneficial owners’
of income. This concept has been referred in various tax treaty Articles relating to interest,
royalty, fees for technical services, fees for included services, dividend of model tax treaty of
OECD, US, UN. Provision of beneficial ownership restricts the treaty benefit to the beneficial
owner and excludes the concessional withholding tax benefit from the legal owner if he is not
the beneficial owner and the beneficial owner is not a resident of that state. The term
“beneficial owner” is not defined in the treaty. In general parlance it implies a division between
the legal rights and the rights of enjoyment over the economic benefit recognized by law.
According to Vogel the issue of control is the most important factor to decide who the
beneficial owner is. He defines beneficial owner as a person who is free to decide (i) whether
or not the capital or other asset should be used or made available for use by others (i.e. the
right over capital), or (ii) on how the yields from them should be used (i.e. the right over
income), or (iii) both. The OECD commentary excludes an intermediary, such as an agent or
nominee as a beneficial owner. OECD has done extensive work to bring more clarity to this
concept.
The OECD Commentary makes it very clear that that source state is not compelled to give the
benefit of Article 10,11 and 12 just because the income is received by a resident of the other
contracting state. The recipient must be the “beneficial owner” of the income, and this concept
excludes conduit companies, agents and nominees.
2.3.2 Limitation on Benefit Clause (LOB)
This may be considered as Specific Anti-Avoidance (SAAR) approach against treaty shopping.
LOB clause is specifically designed to deal with “treaty shopping”. This is also a provision
which limits the use of treaties by the residents by planning restrictions. In these provisions,
conditions are specified which limit the use of the treaty benefits between the residents of
either of the contracting states. The residents of third countries are not allowed to use the
bilateral convention between two states. This provision is found in the US Model convention
which has been included by OECD in its commentary recently. The most significant advantage
of these provisions is that they provide more certainty in the application of tax treaties.
The term “Limitation on benefit “is generally never defined under International tax treaties. In
fact, at times, the concerned Article may not also be titled as “Limitation on benefit”, though in
essence, the said Article may outline various provisions for limiting treaty benefits.
The IFBD international Tax Glossary defines the term LOB as under:
“Provision which may be included in a tax treaty to prevent treaty shopping, e.g. through
the use of a conduit company. Such provisions may limit benefit to companies which
have a certain minimum level of local ownership (“look through approach), deny benefits
to companies which benefit from a privileged tax regime (“exclusion approach”) or which
are not subject to tax in respect of the income in question (“subject-to-tax approach”), or
which pay on more than a certain proportion of the income in tax-deductible form
(“channel approach or “base erosion rule”)…..”
While the aforesaid definition seems to align the concept of “limitation on benefit” mainly vis-à-
vis restriction on availment of treaty benefits by a conduit entity or an entity which has been
formed for the purposes of treaty shopping, in a broader sense, the concept of “limitation on
benefit could also include the following:
• Condition of “beneficial ownership” to be satisfied by the recipient of the owner vis-à-vis
certain categories of income such as dividend, interest etc.
• “Subject to tax’ condition under the broader “liable to tax” condition vis-à-vis definition of
a tax resident, present under certain tax treaties.
• Specific condition to be fulfilled vis-à-vis exemption from particular category of income
• Specific article on Limitation on benefit generally dealing with conduit entities or Treaty
shopping or entities attempting to claim double non-taxation
From Indian perspective let’s take an example of Article 24 of DTAA between India and USA.
The same reads as under:
“ARTICLE 24
LIMITATION ON BENEFITS
1. 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 :
(a) more than 50 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
(b) 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 resident 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 provisions of paragraph 1 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 provisions of paragraph 1 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 term "recognized stock exchange" means :
(a) in the case of 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 ;
(b) in the case of India, any stock exchange which is recognized by the Central
Government under the Securities Contracts Regulation Act, 1956 ; and
(c) any other stock exchange agreed upon by the competent authorities of the Contracting
States.
4. A person that is not entitled to the benefits of this Convention pursuant to the provisions
of the preceding paragraphs of this Article 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.”
As seen from the LOB clause supra, it will apply only to non-individuals. Unlike corporates,
firms etc. an individual cannot indulge in treaty shopping. To meet the conditions of Article 24,
an entity is required to satisfy various test e.g. Ownership test – Article 24(1)(a), Base erosion
test – Article 24(1)(b), Active business connection test- Article 24(2), Recognized stock
exchange test – Article 24(3), Competent authority test- Article 24(4). Ownership test requires
that more than 50% of the beneficial interest/50% of the number of shares of each class of
shares” is owned directly or indirectly by individuals, who are residents in India or USA,
Government of India or USA or its political sub-divisions or local authorities, other individual
subject to tax in India or USA on their worldwide income or Citizens of USA. Base erosion test
requires that the income of the particular entity should not be used in substantial party, directly
or indirectly, to meet liabilities (including liabilities for interest or royalties) of persons who are
not qualified entities. Active business connection test requires that income earned by an entity
is in connection with or is incidental to the active conduct in trade or business in the home
country. There is no need to evaluate the active business connection test if an entity fulfils
both ownership test and base erosion test. Recognized stock exchange test requires that
there is a regular trading of principal class of shares of an entity in a recognized stock
exchange of home country. If one or both of test prescribed under Article 24(1) are not
satisfied and also the active business test is not satisfied, an entity would still get tax treaty
benefit between India-USA, if it fulfils recognized stock exchange test. If the conditions under
Article 24 of the tax treaty are not satisfied by an entity, then the source country has the right
to deny tax treaty benefit.
2.4 Importance of LOB Clause in tax treaty with India

The decision of Supreme Court of India in the case of Azadi Bacho Andolan (supra) held that
there was no inherent anti-abuse rule in Indian tax treaties and hence it required a specific
Limitation on Benefit clause in the treaty itself for the denial of treaty rights. Treaty shopping is
not illegal. The Court further observed as under:
“Overall, countries need to take, and to take, a holistic view. The developing countries
allow treaty shopping to encourage capital and technology inflows, which developed countries
are keen to provide to them. The loss of tax revenues could be insignificant compared to the
other non-tax benefits to their economy. Many of them do not appear to be too concerned
unless the revenue losses are significant compared to other tax and non-tax benefits from the
treaty, or the treaty shopping leads to other tax abuses. Whether it should continue, and, if so,
for how long, is a matter which is best left to the discretion of the executive as it dependent
upon several economic and political considerations”
After the Supreme Court decision, India has included LOB clause in some of its tax treaties. In
each case, the LOB provision is based on its national treaty policy and influenced by non-
fiscal factors. LOB clause has been inserted, for specific purpose, by India, in the modified
treaties of Singapore & UAE.
Unit-III Controlled Foreign Corporation (CFC)

3.1 Introduction
Tax avoidance has been accepted as an area of concern in international tax arena and that is
why several countries have been legislating anti-avoidance measures in their domestic tax
code. Controlled Foreign Company (CFC) Regulations are one such set of anti-avoidance
measures. Taxation of foreign passive income is at the heart of CFC Regulations.
Foreign-source income is usually taxed after it is accrued or received as income in the country
of residence of the recipient. Therefore, it is possible to defer or avoid the tax on foreign
divided income until it is repatriated. Many residence states regard this tax deferral as
unjustifiable loss of tax revenue. Moreover, it gives the residents who invest overseas a tax
advantage over those who invest at home.
The CFC legislations target the income earned and accumulated in nonresident entities that
are under the influence or control of its own tax residents, who are subject to worldwide
taxation. It is generally presumed that in such situations they can influence the profit
distribution or repatriation policies as shareholders. Different countries, depending upon their
fiscal need and tax environment, develop different types of rules and regulations to tax profit
earned by their controlled foreign corporations.
3.2 What is the concept of CFC?

CFCs are corporate entities incorporated in an overseas low tax jurisdiction and controlled
directly or indirectly by residents of a higher tax jurisdiction (Parent State). Since each
corporate entity is treated as a separate legal entity, the profits earned by such CFCs are not
taxed at the owner level until they are distributed. CFCs tend to earn passive income; such
income is not distributed, thereby resulting in its deferral in the Parent State. It is to curb such
tax avoidance that CFC Regulations are legislated by various countries.
The International Bureau of Fiscal Documentation (‘IBFD’) has explained CFC legislations as
under:
“The term is generally used in the context of tax avoidance rules designed to combat
the diversion by resident taxpayers of income to companies they control and which are
typically resident in countries imposing low-or-no taxation. Under these rules income of
the controlled company is typically either deemed to be realized directly by the
shareholders or deemed to be distributed to them by way of dividend. Often only part of
the controlled company’s income is dealt with in this way, typically passive income such
as dividends, interest and royalties (“tainted income”). Many but not all controlled
foreign company regimes apply only to corporate shareholders.”
In order to protect the domestic tax base from erosion through certain tax structuring in CFC
and at the same time not disadvantaging the foreign subsidiaries with regards to income from
their genuine business in the same foreign country, many countries have introduced targeted
CFC legislation.
Even though these CFC rules differ in detail from jurisdiction to jurisdiction, they generally
function as follows:
A resident shareholder (e.g., corporation, partnership and/or individual) controls directly or
indirectly a foreign entity in a low tax jurisdiction with passive income. As a consequence the
low taxed income is attributed to its controlling shareholder(s).
Under CFC rules, CFCs depend very much on entities or structures (e.g. branches) which are
treated as separate legal entities under the domestic tax laws of respective jurisdiction and
whose profits are only taxable in the hands of the controlled shareholder upondistribution. One
may follow a global approach for classification of a CFC, wherein the rules are applicable to
every nation regardless of residency and tax rates while the others may follow a designated
approach in which CFC exposure is triggered only when an entity is set up in a low tax
jurisdiction.
Most CFC rules only apply to those CFCs (entity) over which the domestic shareholder or a
number of domestic shareholders have a certain degree of control. Control may be defined as
the voting power or factual power to influence the business of a CFC, and/or simply having a
significant stake in the CFC’s assets, profits or liquidation proceeds (i.e. controlling
ownership). Under most CFC regimes control of more than 50% of resident shareholders is
required. If there is more than one shareholder that is treated as an unrelated shareholder, a
minimum stake of these unrelated shareholders may or may not be required. CFC rules apply
to both direct and indirect subsidiaries of resident shareholder, so that taxpayers do not
misuse easily by creating multiple layers of holding companies.
The most complicated part of CFC rules are the rules of defining what kind of income is “low
taxed”. What is “low” taxation is determined by comparing the taxes levied abroad on the
relevant rates, which would have been payable at home country and what has actually been
paid abroad.
Further, which types of incomes are included in comparison? In a broad approach, all incomes
from a certain jurisdiction or only incomes from certain transactions, i.e., tainted income. When
looking at this more targeted transactional approach the “good income”, is normally called
active income, whereas the easily shifted and therefore “bad income” is usually called passive
income. If a CFC (entity) is considered having low taxed income, covered by the CFC rules,
domestic shareholders – are subject to tax on the undistributed income from the CFC. What
kind of income is the object of CFC rules (i.e. all income from a jurisdiction or only income
from certain transactions) basically determines the domestic taxpayers’ CFC income. Here
CFC rules may simply disregard the CFC, hence attributing the income, or may deem the
relevant CFC income to be distributed by way of a deemed dividend.
Irrespective of how the income is technically attributed / distributed to the domestic
shareholder, this nature of mechanism has the inherent danger of taxing the foreign income
abroad and the same income under CFC rules at home and potentially again on distribution
back home again. In order to avoid double taxation, the following normally takes place:
 A credit is given with respect to the CFC income at home with regards to foreign taxes
paid; and
 On distribution, again a tax credit is given of the (entire CFC) income distributed from a
CFC. Other jurisdictions exempt dividend from a CFC.
Thus, CFC can be defined as a corporate legal entity that exists in one low tax jurisdiction and
is owned and/or controlled by taxpayers of another higher tax jurisdiction. In summary CFC
regulations in various jurisdictions generally define the types of owners and entities affected,
types of incomes or investments subject to inclusion as CFC income, exceptions to inclusion
in computation of CFC income and means of preventing double inclusion of the same income.
3.3 Need for CFC rules in India

Indian resident companies are required to pay taxes on their worldwide income including
foreign source income. India is a developing country and it follows United Nations double tax
avoidance treaty model, and accordingly, taxes all the income earned from a foreign source
and grants credit for the taxes paid abroad for avoidance of double taxation. A non-resident
company is taxable in India in respect of income accruing or deemed to be accrued from India.
Accordingly, income derived by a foreign subsidiary (wherein Indian company is a Holding
company) is only taxed abroad, unless it gets distributed back to India. This non-taxation of
foreign source income of an Indian company’s foreign subsidiary provides a number of tax
planning opportunities to Indian corporate groups enabling them:
 To reduce foreign taxes by choosing a jurisdiction with low / zero tax rates or beneficial
regimes for certain types of income; and
 To defer or mitigate taxation in India on these (low) taxed overseas profits until
distributed to India.
These strategies seek income being earned in a low tax regime (e.g. tax havens) and not
repatriated back to India. Such an activity is possible as there are no compulsions on India’s
foreign subsidiary under exchange control regime to repatriate such profits into India. Such
strategies include but are not limited to setting up either foreign holding company or
companies holding global intellectual property (rights) or a global operating company.
In past, the Act had sections 104 to 109 to levy additional tax on undistributed profits including
that of residents. The Finance Act 1987 withdrew these provisions. Circular 495 dated 22
September 1987 explained this withdrawal as follows:
“10.1 Sections 104 to 109 relate to levy of additional tax on certain closely-held companies
(other than those in which the public are substantially interested) if they fail to distribute a
specified percentage of their distributable profits as dividends. These provisions had lost much
of their relevance with the reduction of the maximum marginal rate of personal tax to 50 per
cent which is lower than the rate for corporation tax on closely-held companies. Sections 104
to 109 have, therefore, been omitted by the Finance Act, 1987.”
As a substitute, deemed dividend provisions in section 2(22)(e) of the Act were suitably
amended to take care of the abuse. Circular 495 dated 22 September 1987 read as follows:
“10.2 With the deletion of sections 104 to 109
As per CFC Rules introduced in Direct Tax Code, profits earned by a Controlled Foreign
Company, located in territory with a lower rate of taxation, will be included in taxable profits of
parent company located in India. However, presently there are no statutory provisions in
existing Income Tax Act for enactment of CFC Rules. Pending the legislating of DTC, the
Finance Minister of India has, introduced many anti-tax avoidance provisions, the most
important being General Anti Avoidance Rules (GAAR) which is to be effective from 1 st April
2017.
Under existing Income tax Act, the Government has recently introduced concept of Place of
Effective Management ("POEM"). The ensuing paragraphs detail out the concept of Place of
Effective Management and also the guidelines for determination of place of effective
management.
3.4 CFC Regulations – Approaches

CFC regulations typically have the following approaches
(a) Jurisdictional approach
(b) Transactional approach
(c) Entity-level approach
3.4.1 Jurisdictional approach

Under the jurisdictional approach, foreign companies set-up by resident companies in low-tax
jurisdictions are targeted. Accordingly, where a resident company sets up a subsidiary mainly
to act as an intermediate holding company or non-operating holding company in a low-tax
jurisdiction, such foreign company is deemed to be a controlled foreign company for the
purpose of CFC regulations. In such a scenario, CFC regulations are deemed to be applicable
on such foreign companies in low-tax jurisdiction and all the income earned by such foreign
companies is taxed in the hands of the resident company.
3.4.2 Transactional approach
Under the transactional approach, the focus is generally restricted to the passive income
earned by foreign subsidiaries of resident companies. Passive income would tend to include
incomes like royalty, interest, rent, capital gains etc.
3.4.3 Entity-level approach
This is a hybrid approach combining the principles of jurisdictional approach and transactional
approach. Under this approach, CFC regulations are triggered both when the foreign
subsidiary is setup in a low-tax jurisdiction and when the foreign subsidiary has passive
income stream.
The CFC regulations proposed under DTC follow the entity level approach. Under this
approach, the focus is on the CFC as an entity rather than on its income, although the nature
of its income (whether active or passive income) is an important factor in the determination of
whether or not the CFC rules apply. Once a foreign company qualifies as a CFC (and none of
the exemptions apply), all of the income of the CFC is taxed in the hands of the resident-
controlling shareholder on a proportionate basis. The future dividend distribution of the
attributed income by the CFC is deductible.
3.5 Place of Effective Management in India
Section 6(3) of the Income-tax Act, 1961 (the Act), prior to its amendment by the Finance Act,
2015, provided that a company is said to be resident in India in any previous year, if it is an
Indian company or if during that year, the control and management of its affairs is situated
wholly in India. Vide Finance Act, 2015 the existing provisions of section 6(3) of the Act were
amended to provide that a company is said to be resident in India in any previous year, if-
(i) it is an Indian company; or
(ii) its place of effective management (POEM) in that year is in India.
Explanation to the aforesaid section defines "place of effective management" to mean a place
where key management and commercial decisions that are necessary for the conduct of the
business of an entity as a whole are, in substance, made. The Finance Act 2016 had deferred
the applicability of PoEM by 1 year i.e. from 1 April 2016 (FY 2016-17).Further, the Finance
Act, 2016, introduced special provisions in respect of foreign company said to be resident in
India on account of PoEM by way of insertion of a new Chapter XII-BC consisting of Section
115JH in the Act with effect from 1st April, 2017.
CBDT Circular no. 8/2017 dated 23rd February 2017 clarified that provision of section 6(3)(ii)
shall not apply to companies having turnover or gross receipts of Rs. 50 crore or less in a
financial year.
CBDT has also issued detailed guidelines vide circular 6/2017 dated 24th January 2017 for
determination of POEM giving various factors which needs to be considered for such
determination. The guidelines provide that the process of determining POEM would be
primarily based on the fact whether or not the company is ‘engaged in active business outside
India’ (ABOI).
3.5.1 Determination of PoEM
• The determination of PoEM depends on the facts and circumstances of a given case.
• It recognizes the concept of substance over form.
• The place of effective management differs from a place of management and an entity
can have only one place of effective management at any point in time.
• Based on the facts and circumstances if it is determined that during the previous year
the PoEM is in India and also outside India then PoEM shall be presumed to be in India
if it has been mainly /predominantly in India
• The determination of PoEM shall be an annual exercise.
• The process of determining PoEM would be primarily based on the fact whether or not
the company is engaged in active business outside India.
• In case the Assessing Officer proposes to hold a company as resident in India on the
basis of PoEM, then prior approval of the Principal Commissioner or Commissioner will
be required
3.5.1.1 Companies engaged in ABOI
A company shall be said to be engaged in ‘active business outside India’ if the passive income
is not more than 50% of its total income and ,-
(i) less than 50% of its total assets are situated in India; and
(ii) less than 50% of total number of employees are situated in India or are resident in
India; and
(iii) the payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.
It may be noted that passive income of a company shall be aggregate of ,-
(i) income from the transactions where both the purchase and sale of goods is from / to its
associated enterprises; and
(ii) income by way of royalty, dividend, capital gains, interest or rental income;
However, any income by way of interest shall not be considered to be passive income in case
of a company which is engaged in the business of banking or is a public financial institution,
and its activities are regulated as under the applicable laws of the country of incorporation.
If a company is engaged in ABOI and majority of the board meetings and management powers
are exercised by board outside India, then the POEM of such entity shall be based outside
India. However, if on the basis of facts and circumstances it is established that the Board of
directors of the company are standing aside and not exercising their powers of management
and such powers are being exercised by either the holding company or any other person (s)
resident in India, then the POEM shall be considered to be in India.
3.5.1.2 Companies engaged in other than ABOI
In cases of companies other than those that are engaged in ABOI the determination of POEM
is proposed to be a two stage process , namely:-
(i) First stage would be identification or ascertaining the person or persons who actually
make the key management and commercial decision for conduct of the company’s
business as a whole.
(ii) Second stage would be determination of place where these decisions are in fact being
made.
3.5.1.3 Guiding Principles for determination of POEM for companies other than in ABOI
The place where these management decisions are taken would be more important than the
place where such decisions are implemented. For the purpose of determination of POEM it is
the substance which would be conclusive rather than the form.The guidelines also provides
that the following factors can be considered for determination of POEM:
• Location of Board Meeting
• Delegation of authority
• Location of Executive committee
• Location of Head office
• Use of modern technology
• Circular resolutions or round robin voting
• Shareholders effective management
It has been clarified that day to day routine operational decisions undertaken by junior and
middle management shall not be relevant for the purpose of determination of POEM.
If the above factors are not decisive for determination of POEM, other secondary factors are
considered:-
(i) Place where main and substantial activity of the company is carried out; or
(ii) Place where the accounting records of the company are kept
The guidelines provides that determination of POEM is to be based on all relevant facts
related to the management and control of the company, and is not to be determined on the
basis of isolated facts that by itself do not establish effective management, as illustrated by
the following examples:
(i) The fact that a foreign company is completely owned by an Indian company will not be
conclusive evidence that the conditions for establishing POEM in India have been
satisfied.
(ii) The fact that there exists a Permanent Establishment of a foreign entity in India would
not be conclusive evidence that the conditions for establishing POEM in India would
have been satisfied.
(iii) The fact that one or some of the Directors of a foreign company reside in India will not
be conclusive evidence that the conditions for establishing POEM in India have been
satisfied.
(iv) The fact of, local management being situated in India in respect of activities carried out
by a foreign company in India will not, by itself, be conclusive evidence that the
conditions for establishing POEM have been satisfied.
(v) The existence in India of support functions that are preparatory and auxiliary in
character will not be conclusive evidence that the conditions for establishing POEM in
India have been satisfied.
(vi) The decision made by shareholder on matters which are reserved for shareholder
decision under the company laws are not relevant for determination of a company’s
POEM.
The guidelines provide that for determination of POEM no single principle will be decisive in
itself. The above principles are not to be seen with reference to any particular moment in time
rather activities performed over a period of time, during the previous year, need to be
considered. In other words a “snapshot” approach is not to be adopted. Further, based on the
facts and circumstances if it is determined that during the previous year the POEM is in India
and also outside India then POEM shall be presumed to be in India if it has been
mainly/predominantly in India.
3.5.2 Illustrations
The guidelines also include illustrations on interpretation and determination of PoEM.
Specifically, the illustration clarifies that,
(i) Only transactions where both purchase and sale is from/to associated enterprise needs
to be considered in computing passive income;
(ii) All conditions viz. income, value of assets and number of employee in India and payroll
expenses needs to be seen on a collective basis.
(iii) For a company engaged in ABOI, even in a case wherein all the directors are Indian
residents, the PoEM shall be presumed to be outside India if the majority of the board
meetings have been held outside India.
(iv) In case shareholders involvement results in effective management of the Company,
then the same needs to be considered in determination of PoEM.
(v) Merely because the PoEM of an intermediate holding company is in India, the PoEM of
its subsidiaries shall not be taken to be in India. Each subsidiary needs to be examined
separately.
For the purpose of determination of POEM, the assessing officer (AO) before initiating any
proceedings is required to seek prior approval of the Principal Commissioner or the
Commissioner. In case the AO proposes to hold a company incorporated outside India, on the
basis of its POEM, as being resident in India then any such finding shall be given by the AO
after seeking prior approval of the collegium of three members consisting of the Principal
Commissioners or the Commissioners, as the case may be, to be constituted by the Principal
Chief Commissioner of the region concerned, in this regard. The collegium so constituted shall
provide an opportunity of being heard to the company before issuing any directions in the
matter
Once the POEM of the foreign company is held to be in India, then its worldwide income shall
be liable to tax in India. Such foreign companies shall also be liable to undertake tax
compliances in India. The CBDT has also clarified that the intent is not to target Indian Multi
Nationals which are engaged in business activity outside India. The intent is to target shell
companies and companies which are created for retaining income outside India although real
control and management of affairs is located in India. It is emphasized that these guidelines
are not intended to cover foreign companies or to tax their global income, merely on the
ground of presence of Permanent Establishment or Business connection in India.
The administrative safeguards proposed and the clarification that the intent is not to target
Indian Multinationals which are engaged in business activity outside India are reassuring.
While the guidelines are in line with the internationally accepted principles, the determination
of POEM is subjective in nature and may lead to litigation and compliance cost in India.
The ensuing paragraphs detail out the proposed Indian CFC provisions as brought out in the
DTC and what it means for the taxpayers along with an inclusive analysis of the issues that
this new far reaching legislation throws up.
Unit-IV Some Other Anti-avoidance Measures

4.1 General
Depending upon the types and techniques of tax-avoidance, various other techniques have
been developed in international tax environment as anti-avoidance to such measures. Few of
such measures are exchange of information, arm’s length principle, thin capitalization, transfer
of tax residence and exit taxes, exchange controls, branch profit tax, stricter measures for
payments made to entities based in tax havens etc.
4.2 Exchange of information

Exchange of tax information between various states also playsa vital role to identify tax-
avoidance and works as an anti-avoidance measures. The exchange of information under tax
treaties and other bilateral agreements between states is a further measure to ensure
domestic and internal tax compliance.
The double tax treaties include an “Exchange of Information” Article. Under this Article, the tax
authorities may exchange information that is necessary for compliance with the treaty
provisions and domestic taxes, except when they contravene the treaty provisions. The tax
authorities may share the tax information on residents and non-residents, provided it does not
conflict with their own national laws and administrative policies, and the disclosure is not
against public policy. Further as anti-tax avoidance assistance, such Article also enables
comprehensive help to each other by the states in the collection of taxes.
The OECD Commentary clarifies that the information under such arrangements may be
provided in a number of ways:
• Automatic transfer of routine tax information without any prior request e.g. list of
payments made to residents of other state or any entity in which such member has
interest
• A specific information request initiated from a treaty partner for specific information
about a particular taxpayer
• A spontaneous exchange of information when one taxing authority discovers, during the
course of an examination or investigation, non-compliance with the treaty partner’s tax
laws.
• In a joint audit by tax authorities of states, tax authorities in both treaty countries
independently examine affiliated taxpayers in their respective jurisdictions. They may
meet periodically and request each other to provide necessary information in a given
case under the tax treaty provision.
The information obtained under tax-treaty may also be communicated to the taxpayer, but he
has no right either to object toor to be informed about such disclosures to the tax officials.
There is also a Model Agreement drafted by OECD, under its Harmful Tax project Initiative, on
Exchange of Information on Tax Matters. The Agreement binds the competent authorities of
contracting states to provide assistance through exchange of information as may be relevant
for the administration and enforcement of their respective tax laws. The Model contains 16
Articles including commentary on each of such articles. Some of the salient features include:
• It covers various types of direct taxes including taxes on income, capital, wealth, estate,
inheritance or gift taxes etc.
• Information must be provided on request by the competent authority of the applicant

party
• The requested State must make best efforts to meet the request, even if such
information may not be needed for its own tax purposes
• Competent authorities of the two States must have the necessary authority to obtain
and provide upon the request the tax information held by third parties, such as banks,
trust etc.
The Model also provides circumstances when the request for tax information may be declined
by the requested party. Few of such circumstances include;
• The information is not obtainable under its own laws by the applicant party
• Information is not relevant to the tax affairs of given taxpayers.
• Information that would disclose any trade, business, industrial, commercial or
professional secret or trade process, or against public policy
• Confidential communication of information between a client and his lawyers when
provided as legal advice or for use in legal proceedings
• Information that discriminates against a national of the requested party when compared
with a national of the other party under similar circumstances
• Information not in the possession or control of the authorities or any person within their
jurisdiction
The model also provides confidentiality to be maintained in respect of information obtained
under the agreement and also provides time deadlines within which the requested competent
authority must inform the applicant competent authority.
In the Indian Context, India has signed Inter Governmental Agreement (IGA) with USA to
implement Foreign Account Tax Compliance Act (FATCA) of USA to promote transparency on
tax matters. The United States enacted FATCA in 2010 to obtain information on accounts held
by U.S. taxpayers in other countries. It requires U.S. financial institutions to withhold a portion
of payments made to foreign financial institutions (FFIs) who do not agree to identify and
report information on U.S. account holders. As per the IGA, FFIs in India will be required to
report tax information about U.S. account holders directly to the Indian Government which will,
in turn, relay that information to the IRS. The IRS of USA will provide similar information about
Indian account holders in the United States. This automatic exchange of information was
scheduled to begin on 30th September, 2015. One of the peculiar conditions of the
agreement is that there will be automatic exchange of information and each competent
authority of India and USA will enable in their applicable law to collect and provide such
information
In view of such IGA, to cover flow of such information, India has also amended provision of
section 285BA of the Income Tax Act, 1961 which mandates specified persons to provide
specified information of financial transactions and reportable account to income tax authority.
Sharing of such information would reveal various financial and related interests in other
country, of residents of respective countries. This would enable tax authority to properly
monitor and assess tax position adopted by the taxpayer in respect of its assets/income lying
in other contracting states.
4.3 Thin capitalization

Debt financing of cross-border transactions is often favourable than equity financing for
taxpayer. This is because payment of interest is a tax deductible expense whereas payment of
dividend is regarded as appropriation of profit. Further in many countries (like India) tax is also
payable on distribution of profit as dividend out of tax paid profit. Further in certain cases,
dividend receipts may be preferable to interest income; for example if the dividends are tax
exempted and interest received is subject to a relatively high tax rate in the state of residence.
Thin Capitalization refers to excessive use of debt over equity capital; this can be via hidden
equity capitalization through excessive loans (or) the artificial use of interest-bearing debt
instead of equity by shareholders with the sole or primary motive to benefit from tax
advantages.
Some countries have thin capitalization rules which are primarily concerned with loan capital
provided by non-resident lenders, who are also substantial shareholders of a domestic
company. As expected, these rules vary widely in counties that do apply the thin capitalization
rules. At the basis of thin capitalization is the use of debt instead of equity; normally such use
of debt instead of equity has several tax and non-tax advantages. For example:
• Interest expense is tax-deductible whereas dividend payments are not
• Unlike interest, dividends are usually subject to economic double taxation
• Debt financing avoids wealth taxes, net worth taxes and other capital duties imposed on
equity contributions
• Debt allows the repatriation of capital invested as loan repayment without tax
consequences
• It is possible to select currency of debt to minimize foreign exchange risks; equity is
normally denominated in the currency of the host country
• Debt provides greater flexibility since it is possible to convert debt to equity but not the
reverse
• Withholding tax on interest is often nil or lower than on dividends.
Approaches to thin capitalization taken by countries worldwide can be categorized as follows:
(i) Arms-Length approach: Based on general principle of thin capitalization would an
unrelated party provide debt funds on the same basis as related party loan
arrangement?
(ii) Hidden Profit distribution: Specific provisions under tax law allow loan interest to be
reclassified as “constructive dividend”; these apply usually when lender and borrower
are related persons or have a defined relationship. It may also apply if subsidiary
company is undercapitalized and a loan from parent is of a permanent nature or on non
arm’s-length basis.
(iii) No rules” approach: No specific rules; use GAAR and judicial doctrines
(iv) Fixed Ratio approach: Specify maximum debt-equity ratio in the rules.
It must be noted that rules under domestic law on international thin capitalization may be
limited or overridden by double tax treaties. Also, many countries, as yet, do not have any thin
capitalization rules; examples are, Finland, Iceland, Ireland, Sweden, Israel, Indonesia, Brazil,
Singapore, etc.
Till recently India also did not have Thin Cap Regulations, however recently section 94B has
been inserted in the tax laws w.e.f. April 1, 2018, which provides for limitation on interest
deduction in certain cases
The rationale cited for the introduction of these regulations was:
“A company is typically financed or capitalized through a mixture of debt and equity.
The way a company is capitalized often has a significant impact on the amount of profit
it reports for tax purposes as the tax legislations of countries typically allow a deduction
for interest paid or payable in arriving at the profit for tax purposes while the dividend
paid on equity contribution is not deductible . Therefore, the higher the level of debt in a
company, and thus the amount of interest it pays, the lower will be its taxable profit. For
this reason, debt is often a more tax efficient method of finance than equity.
Multinational groups are often able to structure their financing arrangements to
maximize these benefits. For this reason, country's tax administrations often introduce
rules that place a limit on the amount of interest that can be deducted in computing a
company's profit for tax purposes. Such rules are designed to counter cross-border
shifting of profit through excessive interest payments, and thus aim to protect a
country's tax base.
Under the initiative of the G-20 countries, the Organization for Economic Co-operation
and Development (OECD) in its Base Erosion and Profit Shifting (BEPS) project had
taken up the issue of base erosion and profit shifting by way of excess interest
deductions by the MNEs in Action plan 4. The OECD has recommended several
measures in its final report to address this issue. In view of the above, it is proposed to
insert a new section 94B, in line with the recommendations of OECD BEPS Action Plan
4, to provide that interest expenses claimed by an entity to its associated enterprises
shall be restricted to 30% of its earnings before interest, taxes, depreciation and
amortization (EBITDA) or interest paid or payable to associated enterprise, whichever is
less.”
The provision is applicable to an Indian company, or a permanent establishment of a foreign

company being the borrower who pays interest in respect of any form of debt issued to a non-
resident who is an 'associated enterprise' of the borrower. Further, the debt is deemed to be
treated as issued by an associated enterprise where it provides an implicit or explicit
guarantee to the lender or deposits a corresponding and matching amount of funds with the
lender.
The provisions allow for carry forward of disallowed interest expense to eight assessment
years immediately succeeding the assessment year for which the disallowance is first made
and deduction against the income computed under the head "Profits and gains of business or
profession to the extent of maximum allowable interest expenditure.
In order to target only large interest payments, it provides for a threshold of interest
expenditure of one crore rupees exceeding which the provision would be applicable. Banks
and Insurance business are excluded from the ambit of the said provisions keeping in view of
special nature of these businesses.
4.4 Arms’ length approach (Transfer Pricing)

Such anti-avoidance techniques are widely used across the countries to substitute arm’s
length price instead of actual transaction price between two related organizations. This
approach is used to protect the tax base of respective country by determining arm’s length
prices of transactions executed within an MNC groups.
The real issue is the sharing of taxable income by countries in which the MNEs operate
lawfully. Transfer pricing affects situations when goods and services are provided, knowingly
or otherwise, on a non arm’s length basis by related entities.
Towards such transfer pricing issues, the arm’s length principle (Article 9,OECD MC) has
been evolved; it seeks to determine whether the transactions between related taxpayers (in
this case the corporation and its subsidiary S) reflect their true tax liability by comparing them
to similar transactions between unrelated taxpayers at arm’s length.
Arriving at the appropriate arm’s length price is done through a plethora of transfer pricing
methods, which usually prove to be a point of contention between the taxpayers and the
revenue. Countries typically tend to limit their transfer pricing rules to cross-border related
transactions only; however several of them include similar domestic transactions as well.
Some examples are India, Canada, Belgium, Denmark, Greece, Poland, Portugal, Slovenia,
United Kingdom, and United States.
Furthermore, as noted above, countries typically apply transfer pricing rules to certain related
party transactions. However, some countries use a broader definition of “associated
enterprises” based on mutual benefit or influence like India, China and Korea. Few countries
include transactions with preferential tax regimes and tax havens under transfer pricing rules
like Argentina, Brazil, Latvia and Turkey. Many countries still do not have specific transfer
pricing rules in their domestic tax law and rely on other anti-avoidance rules, if they exist.
There are countries which have safe-harbour rules under which they grant partial or total relief
from transfer pricing obligations. For example, in Brazil the agreed minimum percentage mark-
ups based on industry norms may be used in specific transactions. India has also notified
such types of rules [Rule 10TA to Rule 10THD of the Income Tax Rules, 1962] wherein if
necessary conditions have been fulfilled and the value of international transaction with
associated enterprises satisfied percentage of mark-up/other criteria, provision of transfer
pricing is not applicable in respect of such transactions.
Many countries have established procedures to grant transfer pricing rulings under an
advance pricing arrangement” (APA). These APAs provide for certainty for the taxpayer on the
taxation of certain cross-border transactions. These arrangements may be bilateral or
multilateral. E.g. India has notified scheme APA vide Rule 10F To Rule 10T of the Income Tax
Rules, 1962 whereby tax authority and taxpayer have been empowered to enter into unilateral
as well as bilateral APA which can have roll back effect (Rule 10MA and 10RA) by following
necessary conditions, procedures and guidelines specified under those rules. .
The provisions of secondary adjustment are internationally recognised and are already part of
the transfer pricing rules of many leading economies in the world. Whilst the approaches to
secondary adjustments by individual countries vary, they represent an internationally
recognised method to align the economic benefit of the transaction with the arm's length
position. "Secondary adjustment" means an adjustment in the books of accounts of the
taxpayer and its associated enterprise to reflect that the actual allocation of profits between
the taxpayer and its associated enterprise are consistent with the transfer price determined as
a result of primary adjustment, thereby removing the imbalance between cash account and
actual profit of the assessee. As per the OECD's Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations (OECD transfer pricing guidelines), secondary
adjustment may take the form of constructive dividends, constructive equity contributions, or
constructive loans.
W.e.f. 1 April 2018, in order to align the transfer pricing provisions in line with OECD transfer
pricing guidelines and international best practices , India has inserted a new provision
(section 92CE) in the tax laws to provide that the taxpayer shall be required to carry out
secondary adjustment where the primary adjustment to transfer price, has been made suo-
motu by the taxpayer in his return of income; or made by the Tax Officer has been accepted
by the taxpayer; or is determined by an advance pricing agreement entered into by the
taxpayer or is made as per the safe harbour rules; or is arising as a result of resolution of an
assessment by way of the mutual agreement procedure. Where as a result of primary
adjustment to the transfer price, there is an increase in the total income or reduction in the
loss, of the taxpayer the excess money which is available with its associated enterprise, if not
repatriated to India within the time as may be prescribed, shall be deemed to be an advance
made by the taxpayer to such associated enterprise and the interest on such advance, shall
be computed as the income of the taxpayer, in the manner as may be prescribed. Secondary
adjustment shall not be carried out if, the amount of primary adjustment made in the case of
taxpayer in any previous year does not exceed one crore rupees and the primary adjustment
is made in respect of an assessment year commencing on or before 1 st April,2016.
4.5 Transfer of Tax Residence and Exit Taxes

Certain countries regard a transfer of residence as a form of tax avoidance. In jurisdictions
with worldwide tax regime, taxpayers when they become nonresidents are no longer liable to
pay taxes on their foreign source income. Moreover, the gains on movable property accrued
during period of residence but realized at time of departure also escape taxation. Such
countries have enacted SAARs to prevent tax avoidance through emigration. Examples are
Australia, Canada, Denmark, U.S.A., etc.
E.g. USA taxes its US Citizens/permanent Residents (Green Card holders) on their worldwide
income. USA tax law provides that if an Individual gives up his or her citizenship or long-term
permanent US residence, US shall continue to tax the individual as a US citizen or resident for
ten years on his or her US source and effectively connected foreign source income if certain
conditions have been fulfilled. Germany subjects its long-term resident nationals to extended
unlimited taxation if they immigrate to a low-tax country but maintain their essential economic
ties (as defined under German tax law) with Germany.
Regarding Transfer of Corporate Residence, the transfer may require company to be wound
up or deemed as liquidated in several civil law jurisdictions (Example: Australia, Belgium,
Denmark, Sweden). If a German company transfers its head office abroad, the law will
dissolve it; a foreign company cannot transfer its registered office to Germany. Certain
countries choose to impose an “exit tax” when a company ceases to be their resident - the
company in such a case is subject to a capital gain on its deemed sale. Examples include
United States, UK, Canada and Austria.
4.6 Branch Entities & Branch Profit Taxes

Under a classical tax system, host country taxes the corporate profits twice at company level
and again when company pays dividend. Most countries do not tax remittances of after-tax
branch profits to non-residents. A branch entity therefore avoids this economic double
taxation.
Several jurisdictions regard the use of a branch as an unjustified loss of tax revenue that
would have been due to them as dividend withholding taxes from a subsidiary. Thus,
additional taxes either on branch profits or on remittances to head office is levied at Branch
level. In India proposed Direct Tax Code Bill, 2010 (not enacted) contains provision of levy of
branch profit tax in India.
4.7 Use of Tax Havens

Tax havens are jurisdictions which tend to have nil or low taxation. Tax havens may also be
jurisdictions which have other benefits like financial secrecy, minimum reporting requirements,
ring fencing, discretionary tax privileges, allowing ownership to be held in trust, no registry of
companies and partnerships, no taxes on dividends and interest payments to non-residents,

etc.
Several countries have SAARs, i.e., specific anti-avoidance legislation to limit the deductions
of tax expense or grant of tax benefits to entities located in certain blacklisted countries. E.g.
India has enacted section 94A under the Income Tax Act, 1961 which enables the Central
Government to notify country or territory outside India having lack of effective exchange of
information. On being notified, there could be restriction on allowability of payment made to
entity situated in such areas, higher withholding tax requirement in India and applicability of
transfer pricing provisions etc.
4.8 Exchange Controls

Exchange control and tax clearances may be used by countries as anti-avoidance measures
on cross-border transactions. These transactions are subject either to prior government
approvals or post-transaction reporting thereof. Many countries (mostly developing countries)
have a partial or full exchange control. E.g. in India all capital account transactions under
FEMA are not freely allowed unless provided otherwise and all revenue account transactions
are freely allowed unless provided otherwise. Foreign exchange earned may have to be
surrendered to the exchange control authorities or at least reported to them. The payment of
dividend, royalty, interest payment outside India may require approval from such exchange
authorities etc. Such authority may question the transfer pricing on such transactions. The
purpose and the manner in which such regulations are put in place will determine how they will
work as anti-avoidance measure for tax purposes.
Module G
Other Issues in International Taxation
Unit I E-commerce: Taxation in India

1.1 Introduction
Change is the only constant!
Order online, payment online, various innovative applications have changed the way various
transactions, businesses and activities were done in traditional modes.
Simplistically put, ‘e-commerce or electronic commerce can be explained as a transaction
which is conducted through electronic means. Such transactions could be buying and selling/
providing services on an electronic platform, electronic transfer of funds, data exchanges, etc.
The World Wide Web and mobile applications are used for trade and commerce. Websites and
applications like Amazon, E-bay, Alibaba, Flipkart, Snapdeal, Makemytrip, etc. have become
major mediums by which transactions are carried out and have completely revamped the way
business has been carried out. Online advertising has become as significant, if not more, than
traditional modes of advertising like print, television, hoardings etc.
Electronic modes have blurred the geographical boundaries and has made it difficult to identify
the physical place/ point where a particular activity in the chain of transactions which takes
place in electronic commerce. With this, there is a possibility of shifting the profits to other
jurisdiction or minimizing the taxable base in absence of physical presence and physical
delivery. E-commerce has led to making taxation complex and therefore litigations are
springing up.
The manner of taxability of such transactions are being discussed and debated the world over.
1.2 Definition of e-commerce

To understand the nuances of typical e-commerce transactions and its taxation in India, it is
imperative to gather knowledge on the definition/ interpretation of the e-commerce by various
authorities and renowned international bodies:
(a) The High Powered Committee constituted by the Central Board of Direct Taxes:
“E-commerce as generally defined covers transactions involving offer and acceptance on
networks. Mode of delivery and payment may be in digitized form or in traditional manner”.
(b) Organisation of Economic Co-operation and Development (‘OECD’)Working Party
on Indicators for the Information Society:
“the sale or purchase of goods or services, conducted over computer networks by methods
specifically designed for the purpose of receiving or placing of orders. The goods or services
are ordered by those methods, but the payment and the ultimate delivery of the goods or
service do not have to be conducted online. An e-commerce transaction can be between
enterprises, households, individuals, governments, and other public or private organisations”.
(c) National Association of Software and Services Companies (NASSCOM):

“E-commerce to be transactions where both the offer for sale and acceptance of offer are
made electronically”.
(d) The Asia Pacific Economic Co-operation (‘APEC’):
“to include all business activity conducted using a combination of electronic communications
and information processing technology”.
(e) The United Nations Economic and Social Commission for Asia and the Pacific
(‘UNESCAP’):
“the process of using electronic methods and procedures to conduct all forms of business
activity”.
1.3 E-commerce models

There are various models in which e-commerce exists which have been discussed below:
(a) Business to Consumer (‘B2C’) model
In this model, the business directly deals with the ultimate consumer.
Examples of such models include emails, online shopping, online travel, tour operators etc.
(b) Business to business (‘B2B’) model
B2B refers to a situation where one business makes a commercial transaction with another i.e.
it is a commercial transaction where theseller is business organization and the buyer is also a
business organization.
Examples of such a business model include online advertisements placed on websites by
businesses, cloud computing services taken by organisations etc.
(c) Consumer to Business (‘C2B’) model
This is a recently developed model where in the consumer sells products to business.
One of such example is Cartrade.com where consumer sells the second hand cars to Car
trade.com.
(d) Consumer to Consumer (‘C2C’) model
In this model, a consumer deals with another consumer. The seller places the product on an
e-commerce site for sale. The buyer and seller interact directly for the transaction.
Examples of such business models is the second hand goods trading portals like Quickr.com,
Olx.com or other portals where the website only acts as a marketplace or a match making
platform between two consumers.
1.4 Taxation of e-commerce

The taxability of transactions however does not depend on the above models but on
characterization as per taxability provisions. The relevant provisions which need examination
are:
Other Issues in International Taxation 7.3
1.4.1 Royalty-Whether payments flowing from e-commerce can be characterized as

‘royalty’
Many treaties contain provisions that payments for use of equipment qualify as being in the
nature of royalty. Once characterized as royalty, they are taxable on a gross basis.
Further, the Indian domestic law has included payments made for ‘transmission by cable, optic
fibre or similar processes within the meaning of royalty’.
In some e-commerce transactions, the payments could actually be for use of servers or
equipment etc.(the same is discussed in detail in subsequent paragraphs).
A controversy has been created by the amendment in the domestic law. The question that
needs to be addressed in the domestic law is whether the parties are making payment for
transmission by cable, optic fibre etc. (which obviously is the underlying infrastructure for an e-
commerce transaction) or the parties are making payments for the service / goods from an
electronic platform and not concerned with the underlying infrastructure (cables etc.) which are
means by which the service is delivered or goods are sold to them. This amendment has been
inserted by the Finance Act 2012.
1.4.2 Fees for technical services (‘FTS’)
In some cases, the Tax authorities also like to contend that the e-commerce company is
rendering technical services to the payer because e-commerce transactions involve use of
technology.
1.4.3 Permanent Establishment (‘PE’)
As discussed above, the physical location where the transaction is concluded gets blurred in
an e-commerce scenario. The original modes of doing business within countries by way of
marketing subsidiaries, distributor subsidiaries, branches which traditionally created ‘PE’ and
therefore, taxability in countries where the revenues arise is not necessarily a reality in an e-
commerce scenario.
The question is therefore where the revenues should be taxed in an e-commerce scenario:
The country where the goods are sold, or where the goods originate or the country where the
server which leads to the conclusion of transaction is located. The issue is illustrated below:
Owner of website & Server

Management
UK
US
Buy
User / Buyer
India
The website owner could be registered and have the management based in USA. It could
have the server in another country, say UK. The users or buyers may be anywhere in the
world.
The transaction is electronically concluded on the server in the UK.
Further, the OECD commentary has mentioned that where the server on which the website is
stored and through which it is accessible is a piece of equipment having a physical location it
would be considered as a fixed place of business. Hence, the company shall be taxed in the
country where the server is located, if the server is at the disposal of the enterprise.
1.5 Characterization aspects and judicial precedents in various

modes of e-commerce models of business.
1.5.1 Advertisement revenues of web sites
There are websites where one can access various services viz. content, news, e-mails, search
engines, chats, etc. These websites generate revenues from advertisement, etc. Linkedin,
Google, Facebook are many such websites which earn revenues through advertisement
(generally under B2B model).The websites generally earn revenues from the advertiser based
on number of clicks by a viewer on a particular advertisement.
Social Commerce
When a transaction is done though the social websites such as Facebook, Twitter, Youtube,
etc. then such a process / transaction is called Social Commerce. These social media
websites facilitate sharing of information, reviews, product listings, etc. amongst the social
media users.
On Youtube, the users upload and share interesting videos for viewing of the public at large.
Advertisements are also placed alongside the streaming of the videos which a user for access
for its knowledge. Both, the web-site and the content provider, share revenues generated from
such advertisements placed along with the videos.
Advertisement agencies are hired by the Indian companies to display their advertisements on
these portals owned by the non-resident companies. The tax issue here would be whether the
payment made to non-resident companies for display of advertisement would be taxed in
India. The transaction flow is explained in the below diagram:
IRELAND/ US INDIA
Google/Yahoo I Co.
PAYMENTS FOR
ONLINE
ADVERTISEMENTS
ADVERTISEMNET PLACED ON WEBSITE

ACCESSED BY POTENTIAL
CUSTOMERS IN INDIA
SERVER
• Google Ireland v. ACIT [2017] 86 taxmann.com 237 (Bengaluru – Trib.– T he Indian

group company of Google Ireland i.e. Google India had entered into a non-exclusive
Distribution Agreement with Google Ireland Ltd for distribution of “Google AdWords Program”
to various advertisers in India. This program allows visibility to businesses by placing
advertisement which may be accessed by potential customers at the very moment they’re
searching on Google for the things businesses have to offer. The Tax authorities have alleged
that Google India creates a Dependent Agent PE of Google Ireland in India.
The Tribunal held that the agreement between the assessee and Google Ireland was not in
the nature of providing the space for advertisement and displaying the advertisement to the
consumers but is an agreement for facilitating the display and publishing of an advertisement
to the targeted customer. . The module as suggested does not merely work by providing the
space in the Google search engine, but it works only with the help of various patented tools
and software. With the help of the search tool/software/data base, Google is able to identify
the targeted consumer/person as per the requirement of the advertiser. The assessee/Google,
is having the access to various data with respect to the age, gender, region, language, taste
habits, food habits, cloth preference, the behaviour on the website etc. and it uses this
information for the purposes of selecting the ad campaign and for maximizing the impression
and conversion of the customers to the ads of the advertisers. Thus, the activities of the
assessee are not merely restricted to display of advertisement but is extended to various other
facets as mentioned herein above. In other words, by using the patented algorithm, appellant
decides which advertisement is to be shown to which consumer visiting millions of
website/search engine. Therefore, it is not the advertisement or selling of the space rather it is
focused targeted marketing for the product/services of the advertiser by the
assessee/Google with the help of technology for reaching the targeted persons based on the
various parameters information etc. Therefore, the agreement entered between the assessee
and e Google India is not merely for providing the advertisement space but was in the nature
of providing the services for displaying and promoting of the advertisement to the targeted
consumers. Adword program, is working on various parameters, variables, dynamics and
using various permutation and combination to show the advertisement to targeted consumers.
The advertisements on Adword program are changing on day-to-day, week to week or month
to month basis. The online bids are required to be placed by the various competitors on
dynamic basis. If it is assumed that the space is sold by the assessee to the advertiser, then
there is no question of bidding or out-bidding for running or displaying of the advertisements.
The inter se bidding among the advertisers for displaying the advertisement in real-time basis,
clearly shows that the space is not sold by the assessee, rather the placement of the
advertisement to a particular targeted consumer at a particular time is bided among the
advertisers and for that, services were rendered by the appellant with the help of
patented Adword program here is no sale of space, rather it is a continuous targeted
advertisement campaign to the targeted and focused consumer in a particular language to a
particular region with the help of digital data and other information with respect to the person
browsing the search engine or visiting the website. The assessee and it is not merely selling
the space but it is rendering the services by making available the technology permitted by
the Google to the appellant and permitting the same to be used by advertiser for purpose of
targeted focused advertisement campaign by using the gateway of Google India/assessee.
Thus, the activities clearly fall within the ambit of 'Royalty' as mentioned in Income-tax Act and
under DTAA.
Thus Google-Ireland's Adword program is a continuous targeted advertisement campaign
making available technology to Google-India and, thus, permitting same to be used by
advertisers, payment made by Google-India to Google-Ireland was royalty chargeable to tax in
India.
• ITO v. Right Florists Limited (32 taxmann.com 99)(Kolkata Tribunal)
In this case, it was held that the payments made by Indian residents to Google and Yahoo for
advertisement services rendered through their respective search engines were not taxable in
India because such payments would not be considered to be FTS in the absence of human
intervention in the course of provision of services.
Further, in absence of PE of the foreign search engine company, it cannot be said to accrue /
arise in India.
Similar views have been taken in following decisions:
• ITO v. Pubmatic India Private Limited(36 taxmann.com 100) (Mumbai Tribunal)
The Taxpayer, an Indian company, and its holding company in US, engaged in the business of
providing services of internet advertising and marketing services including for e-commerce
transactions and provision of related technologies, systems, consultancy, devices, etc.
During the year under consideration the Taxpayer made payments to the US Company for
purchases of online advertisement space. The Taxpayer claimed that the business income of
the US Company was not taxable in the absence of PE and therefore, withholding of tax was
not required on such payment.
The issue for consideration before the Mumbai Tribunal was whether the purchase of
advertisement space on foreign websites by the Indian company from foreign holding
company constitutes PE under the Tax Treaty.
It was held that the purchase of advertisement space on foreign website falls under business
income of US Company under the Tax Treaty. However, in the absence of PE of US
Company, the said business profits were not taxable in India.
• Yahoo India Private Limited (11 taxmann.com 431) (Mumbai Tribunal)
The Taxpayer was engaged in business of providing consumer services such as search
engine, content and information on wide spectrum of topics, e-mail, chat, etc. The Department
of Tourism of India, through an advertisement agency, intended to display a banner
advertisement on portal owned by Yahoo Holdings (Hong Kong) Ltd. (YHHL) and for that
purpose, it hired services of Taxpayer to approach YHHL to provide uploading and display
services for hosting banner advertisement to Yahoo Hong Kong portal.
The Tax authorities held that payment made by the Taxpayer to YHHL was in nature of
royalty. However, since uploading and display of banner advertisement on its portal was
entirely responsibility of YHHL and Taxpayer had no right to access portal of YHHL, the
tribunal held that payment was not in nature of royalty taxable in India.
• Pinstorm Technologies Private Limited (24 taxman.com 345) (Mumbai Tribunal)
The Taxpayer engaged in the business of digital advertising and internet marketing utilizes the
internet search engine such as Google, Yahoo etc. to buy space in advertising on the internet
on behalf of its clients. During the year, the Taxpayer had made payment to Google Ireland.
The Tax authorities alleged that the services rendered by Google Ireland was in the nature of
'technical services' and hence, the assessee company was liable to deduct the tax at source.
However, it was held that where assessee made payment to non-resident for uploading and
display of banner advertisement on its portal which in absence of any PE of non-resident in
India would not be chargeable to tax in India.
1.5.2 Online provision of content
In some cases, subscribers pay for information, news, case laws, any other content which they
access online. Examples of such subscription are Bloomberg, Factiva etc.
In such cases, the critical points which need evaluation are:
(a) Know-how
Whether the content for which payments are made is in the nature of know-how and
therefore in the nature of royalty:
The definition of Royalty under Section 9(1)(vi) of the Income-tax Act,1961(‘the Act’) as well
as in the Tax treaties includes, “imparting of any information concerning technical, industrial,
commercial or scientific knowledge, experience or skill”.
Further, the India – USA Tax Treaty has interpreted the meaning of “information concerning
industrial, commercial or scientific experience” as follows:
“The above term alludes to the concept of know-how and means information that is not
publicly available and that cannot be known from mere examination of a product and mere
knowledge of the progress of technique”.
Where online access / subscription payments are made to avail the information which may be
in nature of technical, industrial, commercial or scientific knowledge, experience or skills,
whether the information is technical in nature, etc. is a question of fact and accordingly the
payment could be taxable as royalty for online access / subscription in India.
(b) Copyright vs Copyrighted article
Whether the content is downloaded by the subscriber or where the subscriber can share the
content with others. The question arises is whether the subscriber get rights in respect of the
copyright and therefore is the payment in the nature of royalty.
The controversy on rights in copyright vs. copyrighted article depends on whether the
subscribers only get access or do they get rights to make copies, share the content further,
modify it, monetize it etc. If these elements are involved, it could be said that there is rights in
the copyright of the content which the subscriber gets and should be in the nature of royalty.
Let’s look at how judicial precedents have interpreted this issue:
• Gartner Ireland Ltd. vs. ADIT (37 taxmann.com 16)(Mumbai Tribunal)
The Taxpayer is engaged in the business of distributing Gartner Group's Research Products in
the form of subscriptions, both in Ireland and through its distributors, in those territories where
the Gartner Group does not have a local presence.
The subscription research products consist of qualitative research and analysis that clarifies
decision making for Information Technology buyers, users and vendors. The Taxpayer sells
subscription to its Indian customers / subscribers by providing them access to its products
over the internet from its data server which is located outside India. The Indian subscribers
pay the subscription / access fee to the assessee. The Tax authorities alleged that the amount
to be in the nature of Royalty.
It held that the subscription fee paid by Indian Customers for qualitative research and analysis
was in the nature of royalty, taxable under the Act & India- Ireland Tax Treaty as royalty.
• A similar view was taken by Delhi Tribunal in case of ONGC Videsh Ltd vs. ITO
(TDS)(31 taxmann.com 119).
The Taxpayer has subscribed to the website of global energy and mining research unit to get
information in relation to oil and gas industry in different countries by way of a research
agreement.
It was held that oil and natural gas and its exploration being a field of specialized technical
knowledge, specific training is required in this field; therefore, information obtained by the
Taxpayer was in nature of technical consultancy, fees for which was covered under definition
of 'royalty' as being in the nature of information concerning industrial, commercial or scientific
experience.
• Fact set Research Systems Inc (317 ITR 169)(AAR)
The Applicant is an American company. It maintains a database which is located outside India
and which contains financial and economic information including fundamental data of a large
number of companies worldwide. Such database contains published information collated,
stored and displayed in an organized manner by applicant, though information contained in
database is available in public domain. To access and view applicant’s data, customers can
subscribe to specific database as per their requirement and can view data on their computer
screens - Applicant enters into a Master Client License Agreement (MCLA) with its customers
under which it grants limited, non-exclusive, non-transferable rights to its customers to use its
database, software tool, etc.
It was held that subscription fee received by applicant from customers (users of database) is
not in nature of royalty. Hence, subscription fee can be taxed only as business income, if at all
it is found by department that an agency PE exists.
• Reuters Limited v DCIT (ITA No.: 7895/Mum/2011) (Mumbai Tribunal) (pronounced
on 28-08-2015)
The Taxpayer is a resident of UK, engaged in the business of providing worldwide news and
financial information products. In India, the Taxpayer provides its products through its Indian
subsidiary under distributor/ distribution agreement. In turn, the subsidiary distributes the
products to the Indian subscriber independently in its own name.
It was held that revenue earned under from distribution of news and financial information
products is not taxable in India, in absence of a dependent agent PE and service PE under
India- UK Tax Treaty.
• SkillSoft Ireland Limited (A.A.R. No 985 of 2010)
The Applicant is Ireland based company in the business of providing on demand e-learning
courses. It entered into an agreement with SkillSoft India whereby SkillSoft India has right to
license the SkillSoft products as a distributor. It was held that the payments received by
SkillSoft Ireland from Indian end-users (permitted to access the e-learning platforms and
educational content) were covered within the ambit of ‘literary work’ and consequently,
constituted ‘royalty’ under Article 12(3)(a) of India-Ireland Tax Treaty.
1.5.3 Online buy-sell of goods and services

(a) Goods
In this kind of model, goods are sold online by the e-commerce company through an online
store. As discussed earlier, Amazon, Snapdeal, Flipkart, etc. are the examples of such a
model.
In some cases, a website owner may own the inventory and sell it to customers.This mode of
operations is,however,under the regulatory controls in India.
Another model is where the website owner is only the interface so far as the products are
concerned but does not stock the products(website only acts as a market place and the sale
takes place between the owner of goods and the buyer).
(b) Services
E-commerce is not just restricted to buying and selling of goods, various types of services are
also rendered through the e-platform. Examples of these are:
Online travel services: There are a lot of online travel sites such as Yatra.com, MakeMyTrip,
Cleartrip, Goibibo, etc. where anyone can log on and book air / train tickets or even can do the
hotel bookings. The payment can be made through any of the e-modes available. ‘Redbus’ is
one of the popular mode of booking the bus tickets.
The monetization of online services is generally that service provider gets subscription
revenues (like in online matrimony) or revenues as a percentage of ticket price (as in the
online travel model). Also, where the operator is a non-resident and has an Indian subsidiary,
the Indian subsidiary would pay license fees to foreign company for using its web address.
There are some judicial precedents here:
• eBay International AG v ADIT (ITA No. 6784/M/2010) (Mumbai Tribunal)
The Taxpayer operated India specific websites providing an online platform for facilitating the
purchase and sale of goods and services to users based in India. The Taxpayer entered into a
Marketing Support Agreement with eBay India Private Limited (eBay India) and eBay Motors
India Private Limited (eBay Motors) which are eBay group companies, for availing certain
support services in connection with its India specific websites. Please refer the diagram below
to under the transaction:
SWITZERLAND INDIA
eBAY International
Support services for India Specific

website
i) Suggest eBay legal
requirements
ii) Provide market data relating
to industry OPERATING INDIA-SPECIFIC
iii) Marketing and promotional
services WEBSITE
iv) Payment processing and
collection activities
v) Local customer support
activities
vi) Furnishing of reports and
information
vii) Other administrative and
support activities
Indian Group entities
It was held by the Mumbai Tribunal that fees paid to the Taxpayer for operating India specific
website which provides online auction is not FTS. The Indian group entities rendering
marketing support services are ‘Dependent Agents’. However, they do not constitute
Dependent Agent PE in India. Further the Taxpayer does not have a ‘place of management’ in
India.
• Galileo International Inc v DCIT (19 SOT 257) (Delhi Tribunal)
The Taxpayer, a US based company is engaged in provision of services to hotels, airlines, etc
for reservation/ bookings through its Computerised Reservation System (CRS).Subscriber
travel agents could check availability of seats/rooms in participant airlines, hotels, cab
operators, etc. and book them through access to the CRS. Additionally, the Taxpayer also
installed computer at premises of travel agents for such booking/ reservations. It was held that
the fixed PE existing form of the computer installed in the premises of the travel agents
through which business of the Taxpayer is carried on.
1.5.4 Cloud services
Cloud services refers to the process of sharing resources (such as hardware, development
platforms and/or software) over the internet. Cloud computing and storage solutions provide
users and enterprises with various capabilities to store and process their data in third-party
data centers. This helps users to get to use high end infrastructure without making the entire
investment and use it based on their requirement.
Infrastructure-as-a- Platform-as-a-service Software-as-a-

service (IaaS) (‘PaaS’) service(‘SaaS’)
• In the most basic cloud- • PaaS is a category of • A common form of cloud
service model, providers cloud computing computing in which a
of IaaS offer computers services that provides a provider allows the user
–physical or (more computing platform and to access an application
often) virtual machines – programming tools as a from various devices
and other fundamental service for software through a client interface
computing resources. developers. such as a web browser
• IaaS clouds often offer • Software resources (e.g. web based email).
additional resources provided by the platform It can be provided either
such as a virtual- are embedded in the to business customers
machine disk image code of software (B2B) or individual
library, raw (block) and applications meant to be customers (B2C).
file-based storage, used by end users. The • Unlike in the old
firewalls, load balancers, client does not control or software vendor models,
Internet Protocol (IP) manage the underlying the code is executed
addresses, virtual local cloud infrastructure, remotely on the servers,
area networks (VLANs), including the network, thereby freeing the user
and software bundles. servers, operating of the necessity to
• The customer does not systems, or storage, but upgrade when a new
manage or control the has control over the version is available – the
underlying cloud deployed applications. executed version is
infrastructure, but has always the latest, which
control over the means that new features
operating system, go instantaneously to
storage, and deployed market without friction.
applications, and may The consumer generally
be given limited control does not manage or
of select networking control the underlying
components (e.g. host cloud infrastructure,
firewalls). including the network,
servers, operating
systems, storage, or
individual application
capabilities, with the
possible exception of
limited user-specific
application configuration
settings.
• For better understanding, refer diagram below:
Cloud services Servers

(USA)
• Access to programming and

application software S Co.
• Orders stored on cloud, no (Singapore)
earmarked location
• Inventory information stored on
cloud and has earmarked
location. Payment of
• 24*7 support for trouble shooting annual fees
problems
I Co. employees I Co.

(India)
Engaged in International
Ecommerce and selling of
handicrafts in India and
outside India
Taxability:
(a) Whether the payment are in the nature of royalty for use if equipment is a key point .
(b) Another point which would need evaluation is whether the equipment is within the
control of the customer.
One of the key decisions in this regard is discussed below:
• ACIT v. Vishwak Solutions Private Limited (56 Taxmann.com 158) (Chennai
Tribunal)
The Taxpayer paid data storage space charges to INetU, a non-resident. The issue here was
on the characterization of data storage space charges. The Chennai Tribunal held that these
payments are not in nature of royalty as the same is not made for use of a right of any
industrial, commercial or scientific equipment. Further , the same is not fee for technical
services (FTS) within the meaning of Article 12 of India –US Tax Treaty because non-resident
does not ’make available’ any technical knowledge to Taxpayer such that the same can be
utilized by assessee without recourse to service provider.The same would qualify as business
income. However, in theabsence of the PE of the non-resident in India, the payment would not
be taxable in India.
1.5.5 Mobile Applications
The combination of the smartphones and internet has led to Mobile application. Recently, the
focus of doing business is shifting from website to mobile application.
Some businesses have shifted or have their business models from internet and mobile
application to only mobile applications. Few of such examples are Myntra, Uber, etc. The key
tax issue which arises is about characterization of consideration as royalty or fees for
technical services which are received by owner / developer.
1.6 Base Erosion Profit Shifting (BEPS)

The BEPS initiative is an OECD initiative which is approved by the G20 1 for ways of providing
more standardized tax rules globally. At the request of the G20 Finance Ministers, the OECD
launched an Action Plan on BEPS in July 2013.
BEPS refers to the tax avoidance strategies by the multinational companies on national tax
bases
The plan also recognized the importance of the borderless digital economy and proposed to
develop a new set of standards to prevent BEPS and to equip governments with the domestic
and international instruments to prevent corporations from paying little or no taxes
BEPS is important because, globalization of the world economy has resulted in Multinational
Enterprises (‘MNEs’) shifting from country specific models to global models which are usually
housed in low-tax jurisdictions and are characterized by integrated supply chains or
centralization of service functions. The global models led to various issues like distortion of
competition at the domestic level, critical underfunding of public investments on account of
lack of tax revenue and issues pertaining to fairness leading to non-compliance of tax rules
and regulations by taxpayers.
The OECD had identified 15 specific actions considered necessary to prevent BEPS and in
that direction on September 16, 2014 it has released its first set of recommendations on 7
action points for combating international tax avoidance by MNEs., On 5 October 2015 OECD
issued final reports in connection with all its Action Plans to address BEPS.
The above mentioned report includes Action Plan Number 1 on Digital economy. This Action
plan deals with challenges in the digital economy, new business models, taxation regime and
recommendations, etc.
OECD has also released interim report of the OECD/G20 Inclusive Framework on BEPS which
is a follow-up to the work delivered in 2015 under Action 1 of the BEPS Project on addressing
the tax challenges of the digital economy. It sets out the Inclusive Framework’s agreed
direction of work on digitalisation and the international tax rules through to 2020. It describes
how digitalisation is also affecting other areas of the tax system, providing tax authorities with
new tools that are translating into improvements in taxpayer services, improving the efficiency
of tax collection and detecting tax evasion.
1The Group of Twenty (also known as the G-20 or G20) is a forum for the governments and central bank governors from
20 major economies. The members of the G20 are Argentina, Australia, Brazil, Canada, China, France, Germany, India,
Indonesia, Italy, Japan, Republic of Korea, Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the
United States and the European Union.
1.6.1 OECD Action 1- Addressing the challenges of the Digital Economy:

The key features of Digital economy laid down in Action plan 1 are mobility, reliance on data,
Network effect, Volatility, etc. Since the existing thresholds for taxation rely on the physical
presence, the Action plan recognizes that the growth of digital economy has led to many tax
challenges which include:
• Ring-fencing of the digital economy from the rest of the economy
• Fragmentation of operations among multiple group entities and thereby qualify for PE
exceptions
• Minimizing the income allocable to function, assets and risk
• Using a subsidiary or PE to perform marketing or technical support
• Maintaining mirrored server to enable faster customer access to the digital products
sold by the group with a principal company contractually bearing the risks and claiming
the ownership of intangibles generated by these activities
• Maximize the use of deduction for payments made to other group companies in the form
of interest, royalties, fees etc.
• Avoiding withholding tax
• Absence of CFC regulations or CFC regime failing apply to certain categories of income
that are highly mobile or CFC regime that can be easily avoided by using hybrid
mismatch arrangements
The options proposed on the principle as under:
• Consistency – Residence and source countries should follow the same conceptual basis
for sharing the tax base between them.
• Neutrality – Digital economy and traditional transactions should be taxed equivalently.
• Efficiency – Tax rules should not impose an undue burden on taxpayers to comply with
them or impose excessive administrative costs on tax administrations to enforce them.
• Certainty and simplicity – Tax rules should be clear and simple to understand.
• Effectiveness and fairness – Taxation should produce the ‘right’ amount of tax at the
right time while minimising the potential for evasion and avoidance.
• Flexibility – Tax rules should be dynamic enough to keep pace with technological and
business developments.
• Compatibility – New tax rules should not infringe on existing rules of international trade.
• Consensus – Universally agreed rules are crucial for avoiding harmful tax competition.
Given that global Ecommerce giants have tapped the huge consumer base of India to earn
significant profits from Indian residents, Indian tax authorities had welcomed the entire
initiative towards BEPS taken by the OECD and in particular the recommendations on the
taxation of the Digital economy. As a result India was one of the first few countries to come up
with a Equalisation Levy.
1.6.1.1 Equalization Levy

The Finance Act, 2016 has introduced a new Chapter VIII titled “Equalisation Levy” in the
Income-tax Act as a levy for additional resource mobilisation purportedly to address the
challenges of taxation of e-commerce transactions. The Chapter constitutes a code in itself
providing for the charge of levy, its exceptions, consequences of default, appellate remedy,
penalties etc. The purpose behind the introduction of this Chapter appears to be to bring
within the tax net transactions whose source is in India and the benefit therefrom is received
by the service recipient in India, though the service provider is situated outside India.
This Chapter extends to the whole of India except the State of Jammu & Kashmir.
The CBDT issued notification no. 37 of 2016 dated May 27, 2016 stating that the provisions of
Chapter VIII relating to the equalisation levy would come into effect from June 1, 2016. In
other words, any payments being made for the specified services provided on or after June 1,
2016 shall attract the equalisation levy.
Section 164(d) defines equalisation Levy as the tax leviable on consideration received or
receivable for any specified service under the provisions of Chapter VIII.
Specified service means online advertisement, any provision for digital advertising space or
any other facility or service for the purpose of online advertisement and includes any other
service as may be notified by the Central Government in this behalf.
Thus, currently, the levy is restricted to online/ digital advertisement and related services.
However, in the future, additional services may be notified by the Government for the levy.
Charge of levy
As per section 165, there shall be charged an equalisation levy at the rate of 6% of the
amount of consideration for any specified service received or receivable by a person, being a
non-resident from—
(a) a person resident in India and carrying on business or profession; or
(b) a non-resident having a PE in India;
collectively known as “Liable persons”.
The equalisation levy shall not be charged, where—
(a) the non-resident providing the specified service has a PE in India and the specified
service is effectively connected with such PE;
(b) the aggregate amount of consideration for specified service received or receivable in a
previous year by the non-resident from a person resident in India and carrying on
business or profession, or from a non-resident having a permanent establishment in
India, does not exceed Rs. 100,000; or
(c) where the payment for the specified service by the person resident in India, or the PE in
India is not for the purposes of carrying out business or profession.
Furthermore, this Chapter VIII is not applicable to the State of Jammu and Kashmir as per
section 163(1). In other words, when the service recipient is situated in the State of Jammu
and Kashmir, the provisions of this Chapter should not apply.
Collection and recovery
Section 165, which deals with collection and recovery of the levy, places the onus on the
Liable Persons to deduct the amount of levy from the amount paid or payable to a non-
resident in respect of the specified service and pay the levy so collected during a calendar
month to the Government by the 7th day of the immediately following month. It has also been
provided that the liability to pay the equalisation levy shall trigger whether or not the Liable
Person deducts the same from the payment of the non-resident. As per section 170, simple
interest @ 1% per month or part thereof shall be paid by the Liable Person for delay in making
the payment of equalisation levy. There are penal consequences in case of failure to deduct or
pay equalization levy and failure to furnish annual return.
Equalisation Levy Rules, 2016
The CBDT has notified the Equalisation Levy Rules, 2016, which lay down the procedural
framework for implementation, including prescribing forms for filing of annual return and
appeals.
Not being content with the introduction of the Equalization levy, India has also gone one step
forward and equipped itself to tax a significant economic presence largely aimed at taxing the
digital economy.
1.6.1.2 Significant economic presence
With effect from April 1, 2018, vide Explanation 2A, the term ‘business connection’ has been
further widened to cover the cases of significant economic presence of a non-resident in India.
The said amendment is in line with recommendations related to BEPS Action Plan 1 on
addressing tax challenges of the digital economy.
The meaning of term ‘significant economic presence’ is provided as-
(a) transaction in respect of any goods, services or property carried out by a non-resident
in India including provision of download of data or software in India provided the
revenue therefrom exceeds monetary threshold as may be prescribed; or
(b) systematic and continuous soliciting of its business activities or engaging in interaction
with users (exceeding the number as may be prescribed) in India through digital means.
The above provisions will apply-
• Whether or not the agreement for such transactions or activities is entered in India or
• Whether or not, the non-resident has a residence or place of business of business in
India or
• Whether or not, the services are rendered in India
It is further provided that income deemed to accrue or arise in India will be only so much of
income as is attributable to the transactions or activities covered at clause (a) or (b) above.
The specific mechanism for computation of income if the said provisions are applied will be
laid down.
Similarly the definition of business connection which covers situations of permanent
establishments created by a dependent agents has been tightened by the Finance Act 2018 in
keeping with the recommendations in the BEPS action plans.
Thus it may noted that India has reacted immediately to ensure that the changing models of
doing business in the Digital economy are also brought to tax thereby ensuring that it gets a
right to tax such transactions based on the source of income originating in India.
1.7 Concluding remarks:

E-commerce and technology has changed not only the way business is done, but has led to a
need to relook at the way taxing rights are shared between countries. Governments globally
and locally have a lot of thinking to do on the sharing of taxing rights in the digital world.
Unit II Cross-border Mergers & Acquisitions – Key Tax

Aspects
2.1 Cross-border mergers and acquisitions in India
Until a few years ago, news about Indian companies acquiring American and European
organizations was seldom heard of. However, this scenario saw a sudden change in 2007.
The buoyant Indian economy, cash-rich Indian corporate organizations with their ability to
raise relatively large funds at low costs, helpful government policies and Indian players’ new-
found dynamism contributed to an upsurge in the acquisitions made by them in foreign
countries.
After a slowdown in the number and value of transaction deals in 2013, the Indian economy
again saw a rise in cross-border transactions in 2014. The number of Merger & Acquisition
(M&A) deals by Indian companies increased from 742 in 2013 to 870 in 2014. The value of
deals increased from ~US$ 27 billion in 2013 to ~US$ 29 billion in 2014.
The positive trend continued in 2015, which saw a double digit growth in the value of deals on
a year-on-year basis in the first quarter. The number of deals in the first quarter of 2015 was
196 and the deal value was ~US$ 3 billion.This surge in M&A activities was largely driven by a
stable government taking charge at the Centre. The focus of the new Government on reforms,
combined with its efforts to bring positive changes in taxation and other laws favourable to
business growth has brought a positive turnaround in investor sentiment.
Some large transactions worth mentioning in the recent years include a US$ 3.2 billion
acquisition of Ranbaxy laboratories by Sun Pharma; merger of global cement giants Holcim-
Lafarge, resulting in the merger of ACC-Ambuja and Lafarge in India; acquisition of PT
Arutmin Indonesia (part of Bakrie Group, an Indonesian conglomerate) from Tata Power; sale
of DLF Ltd’s step down subsidiary, Aman Resorts, to Adrian Zecha and Peak Hotels for US$
358 million; acquisition of strategic stake in Jet Airways by Etihad Airways; acquisition of stake
in Bharti Airtel by Singtel; and overseas acquisition of stake in the Rovuma Area 1 Offshore
Block, Mozambique by ONGC. Some large inbound strategic investments include acquisition
of Tirumala Milk Products by Lactalis for ~US$ 275 million, acquisition of Strides Arcolab’s
subsidiary Agila Specialties by Mylan Inc., Baring PE Asia’s investment in Hexaware
Technologies and Qatar Foundations’ investment in Bharti Airtel.
The year 2017 saw 340 cross-border deals with a cumulative disclosed deal value of US$8.9
billion. This translates into a 7% decline, in terms of deal volume, compared with 2016, while
cumulative deal value slumped by nearly 71% over the same period.
This chapter focusses on key tax aspects relating to cross-border mergers involving Indian
companies. Tax and other implications in overseas jurisdictions (being specific to each
country) are not discussed in this chapter.
2.2 Can a foreign company merge with an Indian company?
Section 394(4)(b) of the Companies Act, 1956 states that for the purpose of section 394 of the
Companies Act, a ‘transferee company’ can only be a ‘company within the meaning of this Act’
while a ‘transferor company’ can be ‘any body corporate, whether within the meaning of the
Act or not’. The expression ‘body corporate’ as defined under section 2(7) of the Companies
Act, 1956 includes a foreign company. Thus, under section 394 of the Companies Act, 1956, a
foreign company can merge into an Indian company on satisfying the prescribed conditions
and with the sanction of the High Court. However, the Companies Act, 1956 is silent about the
manner in which the consideration can be discharged in the case of such a merger.
In the case of Moschip Semi-Conductor Technology Ltd. 2004 120 CompCas 108 AP, a
California-based company (transferor company) was merged with an Indian company
(transferee company) incorporated in Hyderabad. The transferee company filed the petition for
amalgamation and the name of the transferor company was not added as a party in the
petition. The point that came up for discussion before the Andhra High Court was whether an
Indian Court has the jurisdiction to pass an order of amalgamation in respect of a company
incorporated outside India, which is consequentially wound up.
The High Court noted that the California Corporation Code allows the merger of a US
corporation with a foreign one. Therefore, being satisfied that the laws of the transferor
company allowed its merger with a foreign company, the High Court came to the conclusion
that it had jurisdiction to sanction this scheme.
The Companies Act, 2013 allows the merger of a foreign company with an Indian one.
However, it restricts the scope of such mergers to certain notified jurisdictions. ( To be notified
by the Central Government from time to time .) The Companies Act, 2013 also lays down the
criterion for discharge of consideration on a merger - an Indian company can make payment to
shareholders of a foreign company by way of, inter-alia, cash or depository receipts (subject to
receipt of approval from the regulatory authorities, where applicable).
On 7th November, 2016 Central Government issued a notification for enforcement of section
230-233, 235-240, 270-288 etc w.e.f. 15th December, 2016. MCA vide notification dated
14th Dec, 2016 has issued rules i.e. The Companies (Compromises, Arrangements and
Amalgamations) Rules, 2016. These rules will be effective from 15th December, 2016.
Consequently, w.e.f. 15.12.2016 all the matters relating to Compromises, Arrangements, and
Amalgamations (hereafter read as “CAA”) will be dealt as per provisions of Companies Act,
2013 and The Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016.
The Reserve Bank of India has issued a notification under Foreign Exchange Management
(Cross Border Merger) Regulations, 2018 vide Notification No FEMA.389/2018-RB dated 20
March, 2018 setting out RBI regulations relating to merger, amalgamation and arrangement
between Indian companies and foreign companies
2.3 Can an Indian company merge with a foreign company?
The Companies Act, 1956 does not permit an Indian company to merge into a foreign one.
According to section 394(4)(b) of the Companies Act, 1956, in any arrangement or
reconstruction, a transferee company must be one within the meaning of the Companies Act.
This means that a foreign company cannot be a transferee company.
Although the existing provisions of the Companies Act, 1956 restrict the merger of an Indian
company with a foreign company, the Companies Act, 2013 allows such mergers. Section 234
of the Companies Act, 2013 provides for mergers or amalgamations involving one or more
foreign companies, incorporated under the jurisdictions of other countries. This section also
provides that a foreign company can merge or amalgamate into a company registered under
the Companies Act, 2013 with the prior approval of the RBI, or vice versa, and the terms and
conditions of the scheme of merger or amalgamation can provide for payment of consideration
to the shareholders of the merging company in cash or partly in cash and partly in Indian
Depository Receipts.
All the provisions of the Companies Act, 2013 applies mutatis mutandis to schemes of
mergers and amalgamations involving companies registered under the Companies Act, 1956
and foreign companies that have been incorporated under the jurisdictions of such countries,
as may be notified from time to time by the Central Government.
2.4 Can the business of a foreign company in India be demerged

into that of an Indian company?
The Companies Act, 2013 specifically allows both inbound and out-bound mergers and
amalgamations, but is silent on the issue of cross-border demergers.
Section 234 of the Companies Act, 2013 only relates to mergers and amalgamations, unlike
sections 391–394 of Companies Act, 1956, which places the demerger of the business of a
foreign company into an Indian company on the same footing as the merger of a foreign
company with an Indian company.
A literal reading of the provisions leads to the question whether Companies Act, 2013 does
not specifically cover cross border demergers under section 234 of the Companies Act, 2013.
2.5 Appointed date

The concept of an ‘appointed date’ is unique to mergers and amalgamations under the
Companies Act, 1956 and under the Companies Act, 2013. Schemes of amalgamation have
the following relevant provisions in relation to appointed dates:
• With effect from the appointed date, the undertaking, assets and liabilities of the
transferor company are transferred to and vested in the transferee company.
• On and from the appointed date up to the effective one, the transferee company is to
take over the profits/losses of the transferor company.
• On and from the appointed date up to the effective date, the operations/activities carried
out/to be carried out by the transferor company are to be carried out or regarded to
have been carried out by the transferor company in trust for and on behalf of the
transferee company.
In view of the above, the appointed date can be regarded as the date of transfer or relevant
date from which the transfer of the undertaking/properties and liabilities of the transferor
company takes effect.
2.6 Effective date

The ‘effective date’ of a merger / demerger is usually the one on which the order of the
Appropriate Authority, approving the scheme of arrangement/amalgamation, is passed and the
certified copies thereof are filed with the registrar of companies. However, some practical
considerations in selecting the effective date include the one on which the orders of the
relevant authorities in respect of the foreign company approving the scheme of
arrangement/amalgamation or dissolution is passed as well as the date on which other
regulatory authorities or contractual parties approve the transfer of assets/business, which is
subject to specific regulations, etc.
2.7 Treatment of a cross-border merger for tax purposes

The following questions may arise from a tax perspective in the case of a merger of a foreign
company or demerger of a business of a foreign company into an Indian company:
• Whether any capital gains tax would arise in India in the hands of the foreign transferor
company on such cross border merger/ demerger?
• Whether any capital gains tax would arise in India in the hands of the shareholders of
the foreign transferor company on such cross border merger/ demerger?
The same is explained below with the help of an example:

Example 1
• F Co. 2 owns a wholly owned subsidiary in India (I Co.)
• The company amalgamates with I Co.
• Pursuant to the amalgamation, I Co. issues shares to F Co. 2 shareholders.
The pre- and post-amalgamation structures are depicted below:
Capital gains will be exempt in the hands of the foreign transferor company (ie F Co. 2) if the
following conditions as specified under section 47(vi) of the Income-tax Act, 1961 (IT Act) are
satisfied:
• I Co., ie, the amalgamated company, is an Indian enterprise;
• Other prescribed conditions as specified under section 2(1B) of the IT Act have been
fulfilled.
Further, capital gains will be exempt in the hands of the shareholders of the foreign transferor
company (ie F Co. 1) if the following conditions as specified under section 47(vii) of the IT Act
are satisfied:
• I Co., ie, the amalgamated company, is an Indian enterprise;
• I Co.’s shares constitute the consideration received by F Co.’s shareholders.
• Other prescribed conditions as specified under section 2(1B) of the IT Act have been
fulfilled.
The conditions stated in section 2(1B) of the IT Act are as follows:
(i) all the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company by virtue of the
amalgamation;
(ii) all the liabilities of the amalgamating company or companies immediately before the
amalgamation become the liabilities of the amalgamated company by virtue of the
amalgamation;
(iii) shareholders holding not less than three-fourths in value of the shares in the
amalgamating company or companies (other than shares already held therein
immediately before the amalgamation by, or by a nominee for, the amalgamated
company or its subsidiary) become shareholders of the amalgamated company by virtue
of the amalgamation; and
(iv) The above must be achieved by virtue of the merger and not by way of purchase of
properties by one company from another or by way of distribution of properties pursuant
to the winding up of the company concerned
The Authority of Advanced Ruling (AAR) ruled in the case of Star TV 2010-TIOL-01-ARA-IT
re-confirming the tax neutrality of cross-border mergers involving the amalgamation of foreign
companies into Indian ones. It was held that the amalgamation of a foreign transferor
company into an Indian transferee company, which satisfies prescribed conditions with respect
to amalgamation prescribed under the IT Act, would not result in any tax liabilities in the hands
of transferor companies and their shareholders.
The AAR also held that it is within the legitimate freedom of the contracting parties to enter
into a transaction that has the effect of extending to the party the benefit of exemption under
the taxation statute, as long as such a transaction is not a sham or a contrived device that has
the sole objective of avoiding tax. This ruling also highlights the importance of embedding
business purposes in transactions that seek to mitigate tax to prevent them from being
regarded as designed for tax avoidance.
2.8 Changes required under IT Act for aligning with Companies Act,
2013 in respect of tax neutral cross border merger
As stated above an amalgamation inter alia needs to be compliant with the conditions
prescribed under section 2(1B) of the IT Act to enjoy exemption from taxation of capital gains
in the hands of the amalgamating company or shareholders of amalgamating company.
Further, there are several other sections in the IT Act (illustrative list provided below) which
provide for a benefit if the amalgamation is compliant with conditions of 2(1B) of the IT Act.
One of the conditions prescribed under section 2(1B) of the IT Act is that shareholders holding
not less than three-fourths in value of the shares in the amalgamating company(s) become
shareholders of the amalgamated company by virtue of the amalgamation. This implies that
where the amalgamated company discharges the consideration by any means other than by
way of issuance of its shares to shareholders holding not less than 75% in value terms in the
amalgamating company, the amalgamation may not be regarded as being tax neutral and
hence the exemptions/ benefits may not be available. Considering that Companies Act, 2013
provides the amalgamated company a flexibility of discharging consideration by way of cash or
depository receipts to the shareholders, the same may not be beneficial since such an
amalgamation would not satisfy conditions prescribed under section 2(1B) of the IT Act. Thus
it follows that the definition of amalgamation under section 2(1B) of the IT Act will need to be
aligned with the proposed amendments in Companies Act, 2013 for the tax neutrality to
continue.
Given below is an illustrative list of tax exemptions/ benefits for a qualifying amalgamation
under section 2(1B) of the IT Act:
• Exemption from taxation of capital gains in the hands of amalgamating company under
section 47(vi)
• Exemption from taxation of capital gains in the hands of the shareholders of
amalgamating company under section 47(vii)
• Benefit of carrying forward and set-off of losses incurred by an amalgamating company
to the amalgamated company under section 72A (including definition of ‘industrial
undertaking’)
• Benefit of availing a tax deduction by the amalgamated company for expenditure
incurred by the amalgamating company on scientific research under section 35(5)
• Benefit of availing a tax deduction by the amalgamated company for amortization of
amalgamation expenses incurred by the amalgamating company under section 35DD
• Benefit of availing a tax deduction by the amalgamated company in respect of
preliminary expenses incurred by the amalgamating company under section 35D(5)
Separately, the tax neutrality of cross-border mergers involving the mergers of Indian
companies into foreign ones will be clear once amendments are made in the IT Act. Currently,
there are no such provisions that have been notified for such neutrality. Therefore, necessary
changes have to be made in the IT Act to reap the benefits of the progressive changes in the
Companies Act, 2013.
2.9 Treatment of a cross-border merger or demerger involving

transfer of shares of an Indian company for tax purposes
The following questions may arise from a tax perspective in the case of a merger involving two
foreign companies or the demerger of the business of a foreign company into another foreign
organisation, wherein the shares of an Indian company (which are held by the transferor
foreign company) are transferred to the transferee foreign company:
• Whether any capital gains tax would arise on the transfer of shares of the Indian
company?
• Whether there will be any tax incidence in the hands of the foreign transferee company
on receipt of shares of the Indian company?
• In case the Indian company is a closely held one with accumulated tax losses, whether
such tax losses would be available on change of shareholding in the Indian company?
Regarding the first issue, section 47(via) of the IT Act (in case of merger) and section 47(vic)
of the IT Act (in case of demerger) specifically provides that any such transfer of shares of an
Indian company will be exempt from capital gains tax in India, provided the following
conditions are satisfied:
• At least 25 percent (75 percent in the case of a demerger) of the shareholders of the
transferor foreign company continue to remain shareholders of the transferee foreign
organization;
• Such transfer does not attract capital gains tax in the country in which the foreign
amalgamating / demerged company is incorporated.
Regarding the second issue, section 56(2)(viia) of the IT Act provides that receipt of shares of
a company by another company (not being a widely held company as envisaged under section
2(18) of the IT Act) for nil or inadequate consideration (ie consideration which is less than the
aggregate fair market value of such shares) is taxable in the hands of the recipient as income
from other sources.
However, mergers involving two foreign companies or the demerger of the business of a
foreign company into another foreign company (wherein the shares of an Indian company,
held by the transferor foreign company, are transferred to the transferee foreign company) is
specifically excluded from applicability of these provisions.
Regarding the third issue, the IT Act provides that where the shareholding of a closely held
Indian company witnesses a change of more than 49 percent, its accumulated tax losses
lapse and they are not allowed to be carried forward. However, the tax losses of the Indian
company will not be affected due to the provisions of the IT Act (given above), provided that at
least 51 percent of the shareholders of the foreign parent continue to be shareholders of the
transferee foreign company when the shareholding of an Indian company (which is a
subsidiary of a foreign company) sees a change due to the foreign parent merging/demerging
its business (including its investment in the Indian company) with another foreign company.
Example 2
• F Co. 1 owns a wholly owned subsidiary in India (I Co.).
• F Co. 1 amalgamates with F Co. 2.
The pre- and post-amalgamation structures have been depicted below for reference:
Transfer of shares of I Co. to F Co. 2 pursuant to the merger of F Co. 1 and F Co. 2 will not be
subject to capital gains tax under the following circumstances:
• At least 25 percent of F Co. 1’s shareholders are shareholders of F Co. 2.
• Such a transfer does not attract capital gains tax in the country where F Co. 1 is
located.
In this regard, it is relevant to note the Advance Ruling in the case of Hoechst GmbH 289 ITR
312 (AAR). In this case, Aventis Pharma Holding GmbH (APH), a foreign company, was
amalgamated with Hoechst GmbH (Hoechst), another foreign organisation. APH was a wholly
owned subsidiary of Hoechst and held shares in Aventis Pharma Ltd (APL), an Indian
company. The question that arose before the Authority was the following:
“Whether any capital gains chargeable under section 45 of the IT Act arose to Aventis Pharma
Holding GmbH on its amalgamation with Hoechst GmbH in respect of the shares of Aventis
Pharma Limited, India held by Aventis Pharma Holding GmbH”
The AAR observed that the IT Act permits amalgamation of a wholly owned subsidiary with its
parent and held that that amalgamation of a wholly owned subsidiary foreign company with its
parent company does not result in a transfer for consideration, and therefore, does not attract
capital gains tax. The liability of capital gains tax (if any) can only be on the transferor
company (subsidiary), which in the present case has lost its identity and ceased to exist.
Accordingly, no capital gains chargeable under section 45 of the IT Act arose for APH on its
amalgamation with Hoechst in respect of the shares of APL India held by the former.
2.10 Treatment of a cross-border merger or demerger involving

transfer of shares of a foreign company deriving substantial
value from Indian business for tax purposes
The IT Act provides for taxation of income that is deemed to accrue or arise in India. Section
9(1)(i) of the IT Act states that income accruing or arising, whether directly or indirectly,
through the transfer of a capital asset situated in India shall be deemed to accrue or arise in
India.
Further, Explanation 5 to section 9(1)(i) of the IT Act states that shares in a company
incorporated outside India would be deemed to be situated in India if the share derives,
directly or indirectly, its value substantially from assets located in India. Accordingly, gains
arising on transfer of a foreign company’s shares which directly / indirectly derives its
substantial value from assets located in India will be taxable in India.
The IT Act has, vide Finance Act 2015, inserted Explanation 6 to section 9(1)(i) of the IT Act,
which states that shares of foreign company shall be deemed to derive its value substantially
from the assets (whether tangible or intangible) located in India, if on the specified date, the
value of Indian assets:
• exceeds the amount of INR 100 million; and
• represents at least fifty per cent of the value of all the assets owned by the company or
entity.
The IT Act, vide Finance Act 2015, also provides for exemption from taxation of capital gains
arising on transfer of shares of a foreign company, which derives directly or indirectly its
substantial value from shares of an Indian company, pursuant to a scheme of amalgamation

with another foreign company provided certain conditions are satisfied. The same is briefly
explained below with the help of an example:
Example 3
• F Co. 1 owns a wholly owned subsidiary F Co. 2
• F Co. 2 further owns a wholly owned subsidiary in India (I Co.)
• F Co. 2 derives substantial value from shares held in I Co
• F Co. 1 amalgamates with F Co. 3.
The pre- and post-amalgamation structures have been depicted below for reference.
In the above example, on merger of F Co. 1 with F Co.3, there is an indirect transfer of shares
of I Co. Capital gains arising on such indirect transfer shall be exempt if the following
conditions as stated under section 47(viab) of the IT Act are satisfied:
• At least 25 percent of F Co. 1’s shareholders continue to remain shareholders of F Co.
3; and
• Such transfer does not attract capital gains tax in the country where F Co. 1 is located.
Similarly, capital gains arising on demerger of business from F Co. 1 (comprising of shares in
F Co. 2, which derives substantial value from I Co.) to F Co. 3 shall be exempt if the following
conditions as stated under section 47(vicc) of the IT Act are satisfied:
• Shareholders holding not less than three fourth in value of shares of F Co. 1 continue to
remain shareholders of F Co. 3; and
• Such transfer does not attract capital gains tax in the country where F Co. 1 is located.
2.11 Other laws to be considered in cross-border mergers

M&A transactions are governed by a strict regulatory framework in India requiring compliance
with multiple regulations. When it comes to cross-border M&A, the number of regulations
requiring compliance increase multifold, considering that it involves more than one country.
Thus, apart from direct tax considerations, one needs to be mindful of several Indian laws /
regulations such as:
• Exchange control regulations;
• SEBI and Takeover Code regulations in case where the Indian company is listed;
• Indirect tax laws;
• Stamp duty laws; and
• Accounting implications under Indian GAAP/ Ind AS
For instance, if by virtue of a cross-border merger of a foreign company into an Indian
company, the Indian company acquires an immovable property outside India, it will have to
obtain an approval from RBI to be able to hold such overseas immovable property. Similarly
discharge of consideration to shareholders of foreign transferor company by means other than
shares of Indian Transferee Company is not permitted under the automatic route.
Further, where the cross-border merger involves acquisition of 25 percent or more shares of a
listed Indian company, SEBI’s Substantial Acquisition of Shares and Takeover Regulations,
2011 could be triggered and the acquirer could have to make an open offer to acquire at least
26 percent of the total shares of the Indian company from the open market at a price
determined under a prescribed SEBI formula.
Thus one has to be mindful about the various laws affecting cross-border mergers. Unless the
cross-border mergers and acquisitions adhere to all the requirements under various laws, a
company may not be able to leverage the benefits provided for in the IT Act.
Unit III Treatment of Exchange Gains and losses

3.1 Treatment of foreign exchange gains/ losses during import of
fixed asset
Section 43A of The Income Tax Act, 1961 (‘the Act’) which provides for treatment of gain or
loss on account of foreign exchange fluctuation of foreign currency loans obtained for import
of fixed asset. Relevant excerpts of section 43A of the Act are below:
Notwithstanding anything contained in any other provision of this Act, where an assessee has
acquired any asset in any previous year from a country outside India for the purposes of his
business or profession and, in consequence of a change in the rate of exchange during any
previous year after the acquisition of such asset, there is an increase or reduction in the
liability of the assessee as expressed in Indian currency (as compared to the liability existing
at the time of acquisition of the asset) at the time of making payment—
(a) towards the whole or a part of the cost of the asset; or
(b) towards repayment of the whole or a part of the moneys borrowed by him from any
person, directly or indirectly, in any foreign currency specifically for the purpose of
acquiring the asset along with interest, if any,
the amount by which the liability as aforesaid is so increased or reduced during such previous
year and which is taken into account at the time of making the payment, irrespective of the
method of accounting adopted by the assessee, shall be added to, or, as the case may be,
deducted from—
(i) the actual cost of the asset as defined in clause (1) of section 43; or
(ii) the amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1)
of section 35; or
(iii) the amount of expenditure of a capital nature referred to in section 35A; or
(iv) the amount of expenditure of a capital nature referred to in clause (ix) of sub-section (1)
of section 36; or
(v) the cost of acquisition of a capital asset (not being a capital asset referred to in section
50) for the purposes of section 48,
and the amount arrived at after such addition or deduction shall be taken to be the actual cost
of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost
of acquisition of the capital asset as aforesaid:
Provided that where an addition to or deduction from the actual cost or expenditure or cost of
acquisition has been made under this section, as it stood immediately before its substitution
by the Finance Act, 2002, on account of an increase or reduction in the liability as aforesaid,
the amount to be added to, or, as the case may be, deducted under this section from, the
actual cost or expenditure or cost of acquisition at the time of making the payment shall be so
adjusted that the total amount added to, or, as the case may be, deducted from, the actual
cost or expenditure or cost of acquisition, is equal to the increase or reduction in the aforesaid
liability taken into account at the time of making payment.
Analysis
Section 43A of the Income Tax Act is applicable to a taxpayer who acquires any assets from a
country outside India for the purpose of carrying out its business or profession. In case there
is increase or decrease in the liability of the taxpayer consequent to change in rate of
exchange, such differential is adjusted towards cost of the assets or repayment of money
borrowed for acquiring capital asset along with interest (expressed in Indian currency). Such
increase or reduction in the liability shall be added or deducted from the actual cost of assets
as and when paid or received. Accordingly, section 43A is applicable in case of foreign
currency loans being utilized for acquisition of imported assets purchased from outside India.
Four situations can arise where the gains/ losses shall arise from foreign exchange fluctuation
on loan for purchase of assets outside India:
• On repayment of principal amount of loan – In such a case, since the payment is
actually effected, the gains/ loss realized shall be deducted from/ added to the cost of
fixed asset, respectively;
• On payment of interest – In such a case, since the payment is actually effected, the
gains/ losses realized shall be deducted from/ added to the cost of fixed asset,
respectively;
• On annual re-instatement of loan – In such situation, the gain shall not be taxable and
the loss shall be allowed for deduction against taxable profits; and
• On booking of accrued interest in the books – In such a situation, the exchange gains
shall be taxable and the loss shall be allowed for deduction.
3.2 Whether loss on assets acquired in India can be capitalized

Section 43A specifically deals with treatment of foreign exchange gain/ loss arising on account
of loan borrowed for acquisition of assets from outside India. However, it is a litigious topic as
to whether loss arising from revaluation of External Commercial Borrowing (‘ECB’) for assets
acquired within India should be capitalized with the cost of assets or can be claimed as
revenue loss.
There are a plethora of judgements on the aforesaid issue. Ratio to identify as to whether a
particular receipt is capital receipt or revenue receipt is laid down by Hon´ble Supreme
Court in the following cases:
Sutlej Cotton Mills Ltd. vs. CIT 2

CIT vs. Tata Locomotive and Engineering Company Ltd 3
CIT vs Woodward Governor India Pvt Ltd 4
CIT vs. Tata Iron & Steel Co Ltd 5
Besides the above, there are several High Court and Tribunal cases on the matter, viz.:
CIT vs. V.S.Dempo & Co Pvt. Ltd 6
DCIT vs. Maruti Udhyog Ltd 7
Oil and Natural Gas Corpn. Ltd vs. DCIT 8
Silicon Graphics India Pvt Ltd vs. DCIT 9
Rasandik Engineering Industries India Ltd vs. DCIT12
Relevant extracts of some of the landmark judgments are provided hereunder:
In case of Sutlej Cotton Mills Ltd. vs. CIT, it was observed by the Apex court that:
“Whether the loss suffered by the assessee was a trading loss or not would depend on the
answer to the question, whether the loss was in respect of a trading asset or a capital asset.
In the former case, it would be a trading loss but not so in the latter. The test may also be
formulated in another way by asking the question whether the loss was in respect of
circulating capital or in respect of fixed capital.”
It was also observed in the case that if the amount in foreign currency is utilised or intended to
be utilised in the course of business or for a trading purpose or for effecting a transaction on
revenue account, the loss arising from depreciation in its value on account of alteration in the
rate of exchange would be a trading loss, but if the amount is held as a capital asset, loss
arising from depreciation would be a capital loss.
In case of CIT V. Tata Iron and Steel Co. Ltd., it has been held that cost of an asset and cost
of raising money for purchase of asset are two different and independent transactions and
events subsequent to acquisition of assets cannot change price paid for it. Therefore,
fluctuations in foreign exchange rate while repaying installments of foreign loan raised to
acquire asset cannot alter actual cost of assets for computing depreciation.
2 116 ITR 1 (SC) (1979)

3 60 ITR 405 (1966)(SC)
4 (312 ITR 254) (2009) (SC).
5 99 Taxmann 459 (SC)
6 (206 ITR 291) (1994) (HC-Bombay)
7 101 TTJ 760 (ITAT)
8 77 TTJ 387 (ITAT)
9 106 TTJ 1153 (ITAT)
12 1997/DEL/2011 (ITAT)
In case of CIT vs. V.S. Dempo & Co. Pvt. Ltd which has specifically laid down principles in
order to decide whether loss/gain arising out of foreign exchange fluctuations is in nature of
revenue or capital, of which at para 5 of said principles which says as follow:
“Loss resulting from depreciation of the foreign currency which is utilised or intended to be
utilised in business and is part of the circulating capital, would be a trading loss, but
depreciation of fixed capital on account of alteration in exchange rate would be capital loss.”
In case of Hon´ble Gujarat High Court in the case of Synbiotics Limited vs CIT13 is worth
noting. In that case, the assessee claimed loss on foreign currency loan on account of
exchange fluctuation as revenue expenditure. The Hon´ble Gujarat High Court in that case
disallowed the claim of assessee as revenue expenditure by making following observations:
“This issue is squarely covered by the decision of the Supreme Court in case of CIT V. Tata
Iron and Steel Co. Ltd. (1998) 231 ITR 285, wherein it is held that at the time of repayment of
loan, there was a fluctuation in the rate of foreign exchange as a result of which, the assessee
had to repay a much lesser amount than he would have otherwise paid. It was further held that
this was not a factor, which could alter the cost incurred by the assessee for purchase of the
asset. The assessee might have raised the funds to purchase the asset by borrowing but what
the assessee had paid for it was the price of the asset. The manner or mode of repayment of
the loan had nothing to do with the cost of an asset acquired by the assessee for the purpose
of his business. Following this decision, we hold that the assessee is not entitled to claim the
exchange loss of Rs. 26924/- as revenue expenditure. Accordingly, question No. 2 is
answered in the affirmative, in favor of the Revenue and against the assessee.”
Since loss on exchange is treated as capital expenditure, converse is true and therefore gain
on exchange would be regarded as capital receipt. The above principles have been followed
by various courts in deciding whether particular exchange loss or gain is of capital nature or
revenue nature. As per the ratio laid down Supreme Court in case of Sutlej Cotton Mills, it can
be concluded that it is imperative to see the nature of utilization of foreign currency loan
amount. If the purpose of utilization of such loan is capital in nature, such loss should not be
deductible being capital in nature. However, interest cost on said loan being an item of
revenue, loss on account of interest paid and interest accrued on foreign currency loan should
be tax deductible.
On the other hand, there is another school of thought that dismisses the nature of utilization of
foreign exchange loan as a basis of determination of capital or revenue tax treatment. As per
an analysis, at the time of raising of loan, no capital asset comes into existence and hence
expenses for raising loan should be treated as revenue in nature. Further the variation in the
loan amount has no bearing on the cost of the asset as the loan is a distinct and independent
transaction as in comparison with acquisition of assets out of the said loan amount borrowed.
It should be noted that utilization of loan amount has nothing to do with allowability of any
expenditure in connection with loan repayment. Both are independent and distinct transactions
in nature. It should be noted that section 43A specifically and categorically provides for
adjustment in the cost of the asset for loss or gain arising out of foreign currency fluctuations
in respect of borrowed funds in foreign currency. However, the same rationale cannot be
applied to loss or gain arising from foreign currency loan utilized for purchase of indigenous
assets.
On the basis of case laws cited above, every loan requires to be analyzed from the angle of
usage of such loan or liability. Accordingly, criteria for determination of expenditure/loss/gain
connected with loan as capital/ revenue nature shall be based on utilization of such borrowed
funds.
Interest cost allowed under section 36(1)(iii) of the Act should be analysed to understand
whether such loan in respect of which such interest cost pertains is used for capital account
transactions or revenue account transactions. However, section 36(1)(iii) does not
contemplate any such division of interest cost and plainly allows deduction of interest cost.
Section 36(1)(iii) allows deduction of interest expenditure in connection with loan irrespective
of ultimate utilization of such loan. The same principle is consistently followed by other
sections of the Act on allowability of expenditure in connection with a liability. Accordingly, the
premise on which the aforesaid judicial decisions are based is invalid and requires re-
examination.
Further, an argument may be made where section 45 of the Act can be analyzed. Section 45
creates a specific charge for taxability of capital receipts or allowability of capital loss. The
provisions of section 45 do not either create any charge on forex fluctuations on account of
foreign exchange loan nor allows the same as capital loss.
Also, as per section 43 (1), actual cost means actual cost of the assets to the taxpayer,
reduced by that portion of the cost as has been met directly or indirectly by any other person
or authority. The section also has thirteen explanations, however, the section nowhere
specifies that any gain or loss on foreign currency loan acquired for purchase of indigenous
assets will have to be reduced or added to the cost of the assets.
Reference can be had to the provisions of section 43 (6) of the Act, which defines the term
written down value. As per the section WDV means:
(a) Aggregate of WDV of the assets falling within the block of assets at the beginning of the
previous year as increased by actual cost of the assets falling within the block, acquired
during the previous year and reduced by the money payable in respect of any assets falling
within that block which is sold or discarded or demolished or destroyed during the previous
year together with the amount of scrap value, if any. However, the amount of such deduction
should not exceed WDV as so increased.
The section clearly specifies the amount which can be deducted from the WDV which includes
the money payable in respect of assets under different circumstances but it nowhere specifies
that gain accrued on valuation of foreign currency loan at the balance sheet date should be
reduced from the WDV of the asset.
Therefore, utilization of loan for either capital account or revenue account has nothing to do
with allowability of expenditure in connection with foreign currency loan.
Applicability of Accounting Standard 11 for valuation

The Companies Act 2013 mandates the financial statements of companies to be compliant
with applicable Accounting Standards. Thus, exchange gain/loss is recognized in the financial
statements in accordance with AS-11. As per generally accepted principles of accounting
provided by various Accounting Standards issued by ICAI in absence of specific provisions in
the Income Tax Act in relation to treatment of exchange fluctuation gain or loss.
Analysis of decision of apex court in case of CIT vs. Woodward Governor India (P.) Ltd.
(Emphasis supplied):
In the judgement, one of the issues involved in above mentioned case was “Whether the
taxpayer is entitled to adjust the actual cost of imported assets acquired in foreign currency on
account of fluctuation in the rate of exchange at each balance sheet date, pending actual
payment of the varied liability?”
The above mentioned decision had considered the implication of Para 10 of AS-11 along with
section 43A of the Act. While deciding the issue, it was observed by Hon’ble apex court at
para 17:
“Having come to the conclusion that valuation is a part of the accounting system and having
come to the conclusion that business losses are deductible under section 37(1) on the basis of
ordinary principles of commercial accounting and having come to the conclusion that the
Central Government has made Accounting Standard-11 mandatory, we are now required to
examine the said Accounting Standard (“AS”).”
Apex court has decided in above matter to treat foreign exchange gain or loss arising on
acquisition of fixed assets in foreign currency as per the treatment laid down in AS-11
(Revised 1994). Para-10 of AS-11 (revised 1994) provides as under:
“Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring
fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying
amount of the respective fixed assets. The carrying amount of such fixed assets should, to the
extent not already so adjusted or otherwise accounted for, also be adjusted to account for any
increase or decrease in the liability of the enterprise, as expressed in the reporting currency
by applying the closing rate, for making payment towards the whole or a part of the cost of the
assets or for repayment of the whole or a part of the monies borrowed by the enterprise from
any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring
those assets.”
AS-11(Revised 1994) provides for adjustment in the carrying cost of fixed assets acquired in
foreign currency, due to foreign exchange fluctuation at each balance sheet date which also
correspond to treatment given in section 43A. The issue accordingly decided by apex court in
view of manner laid down in AS-11 (Revised 1994) at Para-10.
“However, It is now necessary to reconsider the above decision in view of AS-11 (Revised
2003) wherein at Para 13 which provides for revision in treatment of exchange gain or loss.
The revised treatment provided at Para 13 of AS-11 (Revised 2003) is given below:
Exchange differences arising on the settlement of monetary items or on reporting an

enterprise’s monetary items at rates different from those at which they were initially recorded
during the period, or reported in previous financial statements, should be recognized as
income or as expenses in the period in which they arise, with the exception of exchange
differences dealt with in accordance with paragraph 15.”
It may be noted that apex court in case of Woodward Governor India had followed treatment of
exchange loss / gain as per AS-11 (1994). In view of revision made in AS-11 in 2003,
treatment of foreign exchange loss arising out of foreign currency fluctuations in respect of
fixed asset acquired through loan in foreign currency is required to be provided in profit and
loss account. In view of revision made in AS-11, the treatment shall be as per revised AS-11
(2003). Accordingly, exchange gain or loss on foreign currency fluctuations in respect of
foreign currency loan acquired for acquisition of fixed asset should be allowed as revenue
expenditure.
Accordingly, the taxpayer company may be allowed for deduction of any loss arising out of
foreign currency fluctuation in respect of foreign currency loan obtained and used for acquiring
indigenous assets. However, the treatment in books of account is not determinative of the tax
treatment thereof for the purpose of income tax. As held by Supreme Court in Sutlej Cotton
Mills Limited (Emphasis supplied) and also in case of Tuticorin Alkali Chemicals and Fertilizers
Limited14, it is now well settled that the manner in which the entries are made in the books of
account is not determinative of the question whether the taxpayer has earned any profit or
suffered any loss. However, to put the controversy of application of accounting standards in
place of computation of income under income tax act is put to rest with introduction of Income
Computation and Disclosure Standards.
3.3 Effect of Income Computation and Disclosure Standards (ICDS)

on taxability of foreign exchange fluctuations
The Income Computation and Disclosure Standards (ICDS) were notified under Notification
No. 32/ 2015 dated March 31, 2015, effective from April 1, 2015. ICDS VI deals with the
‘Effects of Changes in Foreign Exchange Rates’. ICDS are issued in terms of Section 145(2)
of the Income-tax Act, 1961 (the Act) and are limited to taxpayers following the mercantile
system of accounting in computing the income under the head ‘Income from Business or
Profession’ or under the head ‘Income from Other Sources’. In case there arise a conflict
between the Act and the ICDS, the Act shall prevail.
ICDS VI – Effects of changes in foreign exchange rates
This ICDS primarily deals with the following three categories of transactions with foreign
exchange recognition:
(a) Transactions in foreign currencies
As per the provisions of ICDS, a foreign currency transaction shall be initially recognized at
the rate prevailing on the date of the transaction. However, a taxpayer is permitted to use an
average rate of a week or a month that approximates the actual rate at the date of the
transaction. ‘Monetary transactions’ are required to be translated at year end at the year-end
rate e.g. balances in Exchange Earner ’s Foreign Currency (EEFC) Account would be
translated at the year-end rate applicable for that currency. ‘Monetary items’ are defined as
money held and assets to be received or liabilities to be paid in fixed or determinable amounts
of money; cash, receivables and payables as also examples of monetary items. Further,
recognition at below closing rate can also be effected where restrictions, etc. are likely to
reduce the net realizable value of the monetary item for the taxpayer, to factor in currency
restrictions, volatility, etc. Para 5(i) allows the recognized exchange difference to be treated as
income or expense of the year in which such difference is recognized under ICDS. However,
during initial recognition, conversion and recognition of exchange differences the provisions of
section 43A of the Act and Rule 115 of the Income-tax Rules, 1962 (the Rules) shall prevail.
Non-monetary transactions should be converted into reporting currency at the exchange rate
used on the date of the transaction. The exchange gain or loss should not be treated as
taxable gain or loss for the year. Non-monetary items are defined as assets and liabilities
other than monetary items. The ICDS cites examples of non-monetary items as fixed assets,
inventories and investments in equity shares.
Import inventories that are on high seas at the year-end should be treated as monetary item
and accordingly, the exchange gain or loss should be treated as taxable gain or loss. For
example: In case of purchase of inventory, on the date of shipment by the supplier, the
exchange rate was US $ 1 = 62, the year-end rate is US$ 1 = 63. In this case, the inventory
may be valued at 12.4 crores whereas the liability to the supplier will be valued at 12.6 crores
and the exchange loss of 20 lakhs can be treated as a deductible item.
(b) Translating financial statements of foreign operations
The term ‘foreign operations’ refers to operations outside India e.g. a branch. Foreign
operations are classified into the following two types:
• Non-integral foreign operations: Non-integral foreign operations have one or more
characteristics of independent operations with significant degree of autonomy of
operations, mainly financed by own operations or local borrowings, sales are in a
currency other than Indian rupees, cash flow for day-to-day operations are not
dependent on each other, sales prices are determined by local competition in the
jurisdiction of operation and such other factors.
• Integral foreign operations: Integral foreign operations implies to controlled operations
where the taxpayer exercises control on its foreign operations. Non-integral foreign
operations should be translated in the following manner:
(i) Assets and liabilities to be translated at year end closing rate;
(ii) Income and expenditure to be translated at the rates on the dates of the
transactions; and
(iii) All resulting exchange differences to be recognized as income or expense of the
year.
(c) Forward exchange contracts

A forward exchange contract should satisfy the following two conditions to qualify as a forward
exchange contract:
• Forward Exchange Contract should not be intended to be entered for trading or
speculation purpose
• Forward Exchange Contract should be entered into for the purpose of establishment of
amount of rupees required to be paid at the time of settlement of transaction.
The premium or discount arising at the inception of a forward exchange contract shall be
amortized as expense or income over the life of the contract. The term ‘premium arising’ does
not factor in the fact that the aforesaid premium never changes hands either at inception or
otherwise but is a market measure of potential movement of the currency over the period of
the contract. The premium or discount is to be measured as the difference between the
exchange rate on the date of inception of the contract and the forward rate specified in the
contract. Exchange differences on such a contract shall be recognized as income or expense
of in the year in which the exchange rates changes. Any Profit or loss arising on cancellation
on renewal shall be recognized as income or expense for the previous year. The following
example explains the treatment:
An importer Co. books a six month forward contract on February 1, 2016 to buy US $ 100,000
on July 1, 2016 for aiding an import payment that may come up on August 1, 2016. On
February 1, 2016, the spot rate is US $ 1 = 60 and importer Co.’s bank offers the six month
forward contract at US $ 1 = 62. The forward exchange premium is 200,000 i.e. 100,000 x (62-
60). The importer Co. does not have to pay any amount to its bank on February 1, 2016. The
importer Co. is required to set-off the premium over the six-month period of the contract i.e. for
the two months up to March 31, 2016. Accordingly, the importer Co. will recognize 66,667
(one-third of 200,000) as expense for that year.
In the above case, if the importer books a three month forward exchange contract to pay to his
supplier and the forward contract gives him a rate of US $ 1 = 63, the importer should
amortize 1 premium per month for each month of the contract.
Unit IV Trusts
4.1 Background
There are various forms of setting up business in India viz. Company, Limited Liability
Partnership (‘LLP’) firms, partnership firm, Hindu Undivided Family (‘HUF’) etc. A new form of
business vehicle has been introduced by Indian government in Finance Act 2014, viz.
business trusts operating as either Real Estate Investment Trusts (‘REITs’) or Infrastructure
Investment Trusts (‘InvITs’). In a bid to understand the functioning of these business trusts, it
is pertinent to first gain an understanding of the history of trusts, its evolution in Indian history
and its gaining importance in current business set-up.
Traditionally trust structure has been applied by the rich and affluent individual taxpayers as a
medium for wealth preservation and family succession planning. A business trust is an
arrangement whereby a settler/ sponsor (the person creating the trust) designates a trustee/
trustees to manage the sponsor’s assets on behalf of a beneficiary. Creating a trust has
multiple advantages viz. in case of individual sponsors, upon the death of a sponsor, the fund
of assets operated by a trust directly pass to its beneficiaries. In the post independence era,
the concept of family trusts gained prominence mainly due to tax savings attached thereto and
the preservation of family assets within the family.
In 1970s, Indian government repealed all tax benefits attached to trusts. With a tax rate of 90
percent and revocation of all tax incentives, the culture of setting up family trusts also
dwindled with time and trusts were increasingly being set up for carrying out limited purpose of
charitable and educational nature. Several different mediums of investment were established
to carry out business in a tax efficient manner and to preserve wealth in the hands of family
generation after generation, viz. formation of HUFs, scripting family wills etc.
In present scenario, the mode of conducting business has changed many folds. Most business
houses operate through forming Companies and LLPs to carry out their business operations
with limited liability. Also, investment is made in a businesses in India and abroad through
creating a maze of intermediary companies, commonly called as special purpose vehicles to
carry out business operations in a tax friendly manner. Many legal and accounting experts are
hired to undertake complex planning of wealth creation in a tax proficient manner and its
preservation and allocation to concerned stakeholders in a seamless manner.
4.2 Definition of Business Trust

A business trust is a structure through which cash flows generated from one business or
operating company are encased in a tax efficient manner by a group of investors. The services
of an expert are employed to manage a pool of assets ultimately held by the sponsor and
investors collectively. Unlike an investment fund that generates income from a diversified pool
of portfolio for its investors, in case of a business trust, a common pool of assets in same
industry are deployed to generate profits in a tax efficient manner. The trust holds debt and
equity interests of an operating business through forming an intermediary.
4.3 Background of Real Estate Investment Trust (‘REIT’)

REIT is a form of business trust through which investors along with sponsors invest in a pool
of real estate properties that generate regular rental income. In a typical REIT structure, the
owners of completed real estate assets viz. sponsors raise capital from both domestic and
foreign investors through issuing units to them. The real estate assets are owned and
managed by an intermediary company called Special Purpose Vehicle (‘SPV’). The benefits of
REIT structure over current real estate market comprising of real estate developers are as
follows:
(a) REIT is an alternate investment avenue against financial markets. The shortcomings of
investing in physical real estate assets can be mitigated by investing in real estate
assets through REIT structure. Most REIT structures are listed on stock exchange
thereby providing value appreciation on the bourses also. The entry as well as exit is
also seamless and can be planned. Hence, REIT investors can maintain their
investment liquidity just like equity investment even while investing in real estate;
(b) REITs are managed by independent trustees, managers and other professionals.
Generally, REIT structures are also stringently regulated thereby maintaining
transparency and professionalism in working.
(c) REIT ensures improved fund availability to real estate developers by sourcing long term
finance from domestic as well as foreign investors;
(d) REIT provides the investors a new investment vehicle with regular income viz. rental
income;
(e) REIT is a pass through structure that allows many tax exemptions in hands of REIT and
investors (detailed analysis in Para 4.5 and 4.6);
(f) Generally the real estate developer invests in commercial or residential real estate and
that investment stays locked for years in those real estate assets till suitable price
appreciation happens or the value can be unlocked through sale of such real estate
property. In case of REIT structure, it reduces the burden of cash trap in completed
assets owned by real estate developers.
4.3.1 Indian Background
Indian real estate industry has made significant expansion in past decade and a half. Many
real estate companies have bought their Initial Public Offerings (‘IPOs’) to raise equity
investment from retail investors. The real estate development activity has spread from cities to
Tier II and Tier III towns also. However, Indian real estate sector has been viewed largely as
an unorganised sector and corporatization of the sector is the call of the day in order to attract
better foreign capital investments. With this background, REIT structure has been viewed as a
preferred investment vehicle by many real estate experts to develop and unlock the value in
Indian real estate business.
Therefore, several representations have been made in the past by the real estate industry
before the government for setting up REITs in India. Securities and Exchange Board of India
(‘SEBI’) has responded to the industry representations in past but the attempts were neither
adequate nor timely. In a step to showcase Indian real estate business as an effective
investment vehicle, SEBI issued draft (Real Estate Investment Trusts) Regulations, 2008
(‘REITs Regulations, 2008’) open for public comments in 2008. The draft Regulations provided
that REIT scheme could be launched only through a registered trust under Indian Trust Act,
1882. As per the Regulations, the Trust should be deployed to provide for undertaking real
estate investments in India in accordance with REIT Regulations. The initial REIT Regulations
2008 remained in draft format since then. However, SEBI amended SEBI (Mutual Funds)
Regulations, 1996 (‘MF Regulations’) on April 16, 2008 introducing a new chapter 49A
providing for setting up of Real Estate Mutual Funds ‘(REMFs’). The draft REIT Regulations
2008 provided for investment in real estate industry with no investment in securities. On the
other hand, REMFs were hybrid form of structure wherein a pool of investments was allowed
to be deployed in making investments in securities as well as real estate assets.
SEBI released another set of draft REIT Regulations on October 10, 2013 open for public
comments till October 31, 2013. However, due to lack of tax and regulatory reforms to
incentivise the proposed scheme, REIT was not viewed as an alternative investment avenue.
Relevant tax amendments were also important to optimize the effective application of REITs in
Indian scenario. Therefore, the Finance Act 2014 introduced a special taxation regime in
relation to business trusts and the tax incentives were announced effective from October 1,
2014. Section 2(13A) was inserted in the Income Tax Act, 1961 (‘The Act’) to define business
trusts as comprising of REITs and Infrastructure Investment Trust registered under SEBI
prescribed regulations. Subsequently, on the basis of comments received on SEBI’s draft
REIT regulations and the Budget announcement for 2014, on September 26, 2014, SEBI
finally notified SEBI (Real Estate Investment Trusts) Regulations, 2014 (‘SEBI REIT
Regulations’) laying down framework for setting up, registration and regulation of REITs in
India.
4.3.2 Salient features of business trusts through REITs
Following are the salient features of SEBI REIT Regulations in India:
• A REIT should be structured as a trust in accordance with the provisions of the Indian
Trusts Act, 1882. The trust deed should be duly registered in accordance with
provisions of Registration Act, 1908;
• A REIT structure should comprise of separate entities in the form of a trustee, a
sponsor/ sponsors and a manager;
• The main objective as reflected in the ‘Trust Deed’ should be undertaking REIT in India
in accordance with the SEBI REIT Regulations;
• As per regulation 18(1), a REIT can invest only in SPVs or properties or securities or
time deposit receipts in India in accordance with the REIT Regulations and in
accordance with the investment strategy as detailed in the offer document as may be
amended subsequently;
• Not less than 80% of value of the REIT assets should be invested in completed and
revenue generating properties;
• Not more than 20% of the value of REIT assets should be invested in following manner:
(a) Not more than ten per cent of value of the REIT assets should be invested in the
following properties:
(i) Under-construction properties to be held by the REIT for not less than
three years after completion;
(ii) Under-construction properties that are part of the existing income
generating properties owned by the REIT which should be held by the
REIT for not less than three years after completion;
(iii) Completed and non rent generating properties which should be held by the
REIT for not less than three years from date of purchase;
(b) Mortgage backed securities;
(c) Listed / unlisted debt of companies / body corporate in real estate sector;
(d) Equity shares of companies listed on a recognized stock exchange in India which
derive not less than 75% of their operating income from Real Estate activity;
(e) Government securities;
(f) Term Deposit Receipts acquired for the purpose of utilization with respect to a
project where it has already made investment; and
(g) Money market instruments or Cash equivalents. However, investments in
developmental properties should be restricted to 10% of the value of the REIT
assets.
• A REIT should invest in at least two projects with not more than 60% of value of assets
invested in one project;
• REIT should not invest in vacant land or agricultural land or mortgages other than
mortgage backed securities, provided that this shall not apply to any land which is
contiguous and extension of an existing project being implemented in final stages. In
SPVs, a REIT shall hold or propose to hold controlling interest and not less than 50% of
the equity share capital or interest;
• SPVs should not hold less than 80% of its assets directly in properties and should not
invest in other SPVs;
• REIT should raise funds through an initial offer. Subsequent to the raising of funds
through initial offer, funds may be raised through follow-on offer, rights issue, qualified
institutional placement, etc.
• For the purpose of making an initial offer, the value of the assets owned/proposed to be
owned by REIT should be of value not less than INR 500 Crore. Moreover, the minimum
issue size for initial offer should be INR 250 Crore;
• The minimum subscription size for units of REIT should be INR 2 Lakhs. The units
offered to the public in initial offer shall not be less than 25% of the number of units of
the REIT on post-issue basis;
• REIT units shall be mandatorily listed on a recognized Stock Exchange and REIT
should make continuous disclosures in accordance with the listing agreement. Further,
the trading lot for such units should be INR 1 Lakh;
• The trustee of a REIT should not be an associate of the sponsor / manager. Also, the
trustee should be registered under SEBI (Debenture Trustees) Regulations, 1993;
• A REIT may have multiple sponsors subject to a maximum of three. Further, each
sponsor should hold at least 5% of the total number of units of the REIT. Such sponsors
should collectively hold not less than 25% of the units of the REIT for a period of not
less than 3 years from the date of listing. After 3 years, the sponsors, collectively,
should hold minimum 15% of the units of REIT, throughout the life of the REIT;
• The net worth of each sponsor in a REIT should not be less than INR twenty crores
while the collective net worth of all sponsors in a REIT should be at least INR hundred
crores;
• The sponsor should have a minimum five years experience in development of real
estate or fund management in the real estate industry. In case where the sponsor is a
developer, at least two projects of the sponsor should have been completed;
• In case the manager is a body corporate, the manager should have a net worth of not
less than INR ten crores. In case the manager is a LLP, the tangible value of its assets
should not be less than INR ten crores;
• The manager should have a minimum five years experience in fund management or
advisory services or property management in the real estate industry or in development
of real estate;
• The manager should have at least two key personnel, each of whom have not less than
five years experience in fund management or advisory services or property
management in the real estate industry or in development of real estate;
• The manager should have at least half of its directors/ members of governing body in
case of a body corporate/ LLP respectively of an independent stature and not as
directors/ members of the governing Board of another REIT;
• The manager and trustee should enter into an investment management agreement
providing for the responsibilities of the manager in accordance with Regulation 10;
• The trustee should be registered with the Board under SEBI (Debenture Trustees)
Regulations, 1993 and should not be an associate of the sponsors or manager;
• The Trustee should generally be overseeing the activities of the REIT. The manager
should assume operational responsibilities pertaining to the REIT;
• REIT should distribute not less than 90% of the net distributable cash flows, subject to
applicable laws, to its investors, at least on a half yearly basis;
• REIT should undertake full valuation on a yearly basis through a valuer. Updation of the
valuation should be done on a half yearly basis. The Net Asset Value should be
declared within 15 days from the date of such valuation/ updation;
• The borrowings and deferred payments of the REIT at a consolidated level should not
exceed 49% of the value of the REIT assets. In case such borrowings/ deferred
payments exceed 25%, approval from unit holders and credit rating should be required.
4.4 Investment Trusts

Infrastructure Investment Trusts are typical investment structures that make investment in
income generating infrastructure sector of India through owning and managing infrastructure
assets like roads, seaports, airports etc. InvITs invest in both under-completion and completed
infrastructure projects. SEBI received various suggestions from stakeholders regarding setting
up of a tax effective investment avenue in the infrastructure sector in India on lines of similar
structures being available in Singapore, Hong kong etc. Based on the suggestions, SEBI
introduced a consultation paper open for public comments on InvITs on December 20, 2013.
Another set of draft regulations were introduced on July 17, 2014 open for public comments till
July 24, 2014. SEBI issued the final regulations dated September 26, 2014. The benefits of
investing through InvITs are similar to that of REIT including attracting foreign capital in Indian
infrastructure sector, unlocking of cash trapped projects for developers, tax benefits coupled
with lowering loan exposure through availability of low cost capital availability.
4.4.1 Salient features of Investment Trusts in India
1. InvIT should be registered with SEBI and its units should be listed on a stock exchange.
In case of public InvITs, minimum 25 per cent of total outstanding units of InvIT should
be offered as offer document open for public subscription.
2. Investors have the right to remove the manager, trustee, request delisting etc.
3. A sponsor can set up an InvIT with not more than three sponsors along with other
investors. For qualifying as a sponsor, a body corporate or a company should have a
net worth of at least INR 100 crores. A Limited Liability Partnership may also set up an
InvIT provided it has net intangible assets of INR 100 crores. Further, the body
corporate or LLP should also have a minimum experience of at least five years and
should have completed at least two projects.
4. InvIT to hold investments on behalf of the Trust. A Trustee should be registered with
SEBI and should not be an associate of a sponsor or investment manager. Further, a
Trustee should have sufficient resources as specified by SEBI
5. InvITs should be managed by professional investment managers having skill and
experience in development of Infrastructure Projects. For qualifying as an investment

manager, following criterion should be fulfilled:
(a) In case of body corporate, the company should have a net worth of at least INR
10 crores. A LLP should have net intangible asset of INR 10 crores or more.
(b) The directors/ members of an InvIT should not be directors/ members of another
InvIT. Further, not less than half of the directors/ members should be
independent.
(c) The investment manager should have a minimum experience of five years in fund
management and advisory services in infrastructure development.
6. Investment in InvITs can be made by both residents and non-residents with no lock-in
restrictions on investments made by Non-residents in case of public InvITs. Foreign
investment shall be subject to Reserve Bank of India guidelines.
7. The minimum investment by an investor in case of privately placed InvIT is INR one
crore and in case of public InvIT is INR 10 lacs. Holding by an investor in either case
should not be more than 25 per cent of the units of InvITs.
4.5 Taxation of REITs and InvITS in India

From a taxation perspective, both REITs and InvITs are categorised under the definition of
‘Business Trust’ under section 2(13A) of the Act that states as under:
‘business trust” means a trust registered as:
(i) An Infrastructure Investment Trust under the Securities and Exchange Board of India
(Infrastructure Investment Trusts) Regulations, 2014 made under the Securities and
Exchange Board of India Act, 1992 (15 of 1992); or
(ii) A Real Estate Investment Trust under the Securities and Exchange Board of India (Real
Estate Investment Trusts) Regulations, 2014 made under the Securities and Exchange
Board of India Act, 1992 (15 of 1992) and
the units of which are required to be listed on recognised stock exchange in accordance with
the aforesaid regulations;
4.6 Business Trust – Special tax regime

Section 115UA was introduced under Chapter XII-FA of the Act for the purpose of determining
the taxability of income of unit holder and business trust. As per provisions of section 115UA,
the distributed income in the hands of unit holders should be deemed to be of the same nature
and in the same proportion in the hands of unit holder as the income in the hands of Business
Trust.
As per clause (2) of section 115UA, the total income of Business Trust other than capital gain
will be taxed in the hands of business trust at the maximum marginal rate. The capital gains
should be taxable in accordance of provisions of section 111A and 112.
4.6.1 Interest income

(a) Interest income received by Business Trust from SPV
Interest income in hands of Business Trust – As per section 10(23FC), any interest income
received or receivable by a Business Trust from a Special Purpose Vehicle shall be exempt in
the hands of the Business Trust. Accordingly, provisions of section 194A(3)(xi) was inserted in
Finance Act 2014 thereby exempting applicability of withholding tax provisions on interest
income received by REIT/InvIT from SPV.
For the purpose of the above section, ‘Special Purpose Vehicle’ is defined by way of any
Explanation as an Indian Company in which the Business Trust holds controlling interest and
any specific percentage of shareholding or interest, as may be required by the regulations
under which such trust is granted registration. Registration of both REITs and InvITs is
granted under respective SEBI Regulations that require shareholding of 51 per cent or more
by a REIT in a SPV.
By virtue of interplay of section 115UA and section 10(23FC), only interest income received
from SPV is exempt in the hands of Business Trust. However, interest received from non-SPV
sources shall be taxable at maximum marginal rate.
(b) Interest income received by unit-holders as distribution
As per provisions of clause (3) of section 115UA of the Act, any distributed interest income of
the same proportion as interest received from SPV received by a unit holder from a Business
Trust shall be deemed to be income of the unit holder and shall be subject to tax. Hence, it
can be said that section 115UA is the charging section for business trusts that provides for
pass-through status to business trusts wherein the interest income is exempt in the hands of
business trust and in return is taxable in the hands of unit holder at the time of distribution.
(i) Interest income in hands of resident unit-holder – Interest income received by
business trust from SPV distributed to resident unit-holder shall be subject to applicable
withholding tax rates in the hands of unit holders i.e. 10 per cent.
(ii) Interest income in hands of non-resident unit holder – Interest income received by
business trust from SPV distributed to non-resident unit-holder shall be subject to
concessional withholding tax rate of 5 per cent in the hands of non-resident unit holder
in accordance with provisions of section 194LBA of the Act.
(c) Interest paid on ECB
Interest paid on ECB by Business Trust – As per provisions of section 194LC read with
provisions of section 115A (1)(a)(iiaa)(BA), a REIT/ InvIT is required to deduct a concessional
withholding tax rate of 5 per cent on interest payments made to non-resident unit-holders or
other foreign non unit-holder lenders on the funds borrowed from such non-resident unit-
holders or foreign non unit-holder lenders (subject to fulfilment of External Commercial
Borrowings (‘ECB’) requirements under Foreign Exchange Management Act, 1999.
4.6.2 Capital gains

(a) Capital gains tax in hands of Business Trust – Capital gains realized by a Business
Trust on sale of its capital assets viz. shares of SPV, sale of properties held by SPV etc.
shall be subject to normal capital gains tax rates. However, by virtue of applicability of
section 10(23FD), capital gain component of distributed income will be exempt in hands
of unit holders. Accordingly, Business Trusts are statutorily mandated as a tax pass-
through structure wherein capital gains are levied on business trust and is subsequently
exempt in the hands of unit-holders at the time of distribution.
Capital gains implications on sale of units by unit-holder –As per section 112A
inserted by Finance Act 2018 w.e.f AY 2019-20, long term capital gains exceeding 1
lakh rupees arising on transfer of units of a business trust by a unit holder, shall be
taxable at the rate of 10% if securities transaction tax (‘STT’) is paid on the transfer of
such units.
A new proviso to section 10(38) has been inserted by Finance Act, 2018, which
provides that no exemption u/s 10(38) would be available on any income arising from
transfer of long term capital assets being unit of business trust made on or after 01-04-
2018.
As per provisions of section 111A(1) of the Act, a concessional rate of short term capital
gains at 15 per cent shall be levied on unit-holders on sale of units provided STT is paid
on the transfer of such units.
(b) Capital gains implications on share swap Implications – In accordance with section
47 (xvii), any transfer of a capital asset being share of a SPV to a business trust in
exchange of units allotted by such business trust to the transferor is exempt from the
ambit of capital gains tax in India. Accordingly no capital gains tax arises in the hands
of sponsor at the time of swapping of SPV shares with units in business trust.
(c) Capital gains implications on future sale of units by unit-holder (ex-sponsor) – In
accordance with provision of section 111A(1) and Section 112A(1) of the Act , any
transfer of units of a business trust which were acquired in consideration of transfer
referred to in clause (xvii) of section 47, shall be subject to provisions of capital gains
tax. Accordingly, the unit-holder (ex-sponsor) needs to pay capital gains tax based on
the period of holding in case it sells its units in the business trust in future.
Important provisions applicable for computation of capital gains tax in hands of unit-holder (ex-
sponsor):
• Cost of acquisition of units – In accordance with clause (2AC) of section 49, the cost
of acquisition of units for the purpose of computing capital gains shall be the cost of
acquisition of shares of SPV;
• Period of holding of units – In accordance with clause (hc) of Explanation 1 of section
2(42A) of the Act, for computing capital gains on future transfer of units by unit-holder
(ex-sponsor), period of holding of shares in SPV shall be included in the holding period
of the units;
• The exemption from Long term capital gain and concessional rate of short term capital
gains is not available for the purpose of computing capital gains in the hands of unit-
holder (ex-sponsor) on future sale of units held in the business trust; and
• As per provisions of section 2(42A), holding period for computing short term capital
gains is less than thirty six months.
4.6.3 Rental income
(a) Rental income earned by REIT – The rental income earned by REIT through renting,
leasing or letting out of any real estate asset owned directly by such business trust is
exempt in the hands of REIT in accordance with section 10(23FCA).
(b) Rental income earned by unit-holders - As per provisions of clause (3) of section
115UA of the Act, any distributed rental income of the same proportion as rent
received/accrued to REIT received by a unit holder from REIT shall be deemed to be
income of the unit holder and shall be subject to tax. Hence, it can be said that section
115UA is the charging section for business trusts that provides for pass-through status
to business trusts wherein the rental income is exempt in the hands of business trust
and in return is taxable in the hands of unit holder at the time of distribution.
(i) Rental income earned by resident unit-holders – As per section 194LBA (1),
any distributable income in the nature of rental payment made by a business trust
to its unit-holders is subject to deduction of income tax thereon at the rate of ten
per cent.
(ii) Rental income earned by foreign unit-holders – As per section 194LBA (3),
any distributable income in nature of rental payment made by a business trust to
its foreign unit-holders being a non-resident or a foreign company is subject to
deduction of income tax thereon at the rate in force.
Unit V Base Erosion and Profit Shifting

5.1 An overview
With the development of technology and globalization of businesses, Multinational enterprises
(MNEs) have started designing their business operations in a way to minimize their global tax
costs through making effective use of tax rules and applicable exemptions available under tax
treaties. On the other hand, International tax rules have not been able to keep pace with
developments in the world economy, resulting in double non-taxation and stateless income.
Due to aggressive tax planning strategies adopted by many large MNEs, there was a lot of
hue and cry around morality of such harmful tax practices. As a result, Organization for
Economic Cooperation and Development (OECD) started to shape out a plan to mitigate
harmful tax practices to ward off the negative effects of MNEs’ tax avoidance strategies on
national tax bases. The existing bilateral tax treaties had been designed in a pre-digital age
with the aim to avoid double-taxation of same income. However, in recent past many
instances of double non-taxation have been observed due to integration of tax rules and
legislations followed in different sovereign states.
In the background of the above repercussions, in February 2013, the OECD published a report
on “Addressing Base Erosion and Profit Shifting” iterating the need for analyzing the issue of
tax base erosion and profit shifting by global corporations. The OECD followed it up with
publishing an Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in July
2013. The BEPS action plan identifies fifteen actions to address BEPS in a comprehensive
manner and sets a deadline to implement those actions.
The Action Plans were structured around three fundamental pillars viz.:
(1) Reinforcing of ‘substance’ requirements in existing international standards;
(2) Alignment of taxation with location of value creation and economic activity; and
(3) Improving transparency and tax certainty.
An unprecedented amount of interest and participation has been witnessed by OECD with
more than sixty countries, both OECD members and G-20 countries, being directly involved as
a part of technical groups in the development of congruent international tax standards. In
September 2014, the OECD released the first 7 elements of the Action Plan. The final
package of measures was released on October 5, 2015 and the 13 Final Reports were duly
approved by the G20 Finance Ministers on 8 October 2015.
The summary explanatory statement indicates the level of political commitment by OECD, G20
and other states involved in the 2015 work to the various reports. The OECD has iterated the
following terms to indicate the commitment by various participant countries:
• New minimum standard - New minimum standard implies application of a new rule to
be implemented by all states; the new minimum standards are identified to fight harmful
tax practices, prevent tax treaty abuse, including treaty shopping, improve transparency
with Country-by-Country Reporting, and enhance the effectiveness of dispute

resolution.
• Revision of a standard which already exists – Such revisions should be binding but with
the caveat that all BEPS participants have not endorsed the revisions; and
• Best practice – A best practice is not a standard but optional recommendations for
states to follow.
G20 and OECD countries have continued working on an equal footing to carry out follow-up
work to these reports since the release of Final Reports. More importantly, 2017 update to the
OECD Model Tax Convention primarily comprises changes to the OECD Model that were
approved as part of the BEPS Package or were foreseen as part of the follow-up work on the
treaty-related BEPS measures. The changes to the OECD Model arise out of Action 2
(Neutralising the Effects of Hybrid Mismatch Arrangements), Action 6 (Preventing the Granting
of Treaty Benefits in Inappropriate Circumstances), Action 7 (Preventing the Artificial
Avoidance of Permanent Establishment Status) and Action 14 (Making Dispute Resolution
More Effective).
OECD also released 2017 edition of the OECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations in July 2017 reflecting a consolidation of the changes
resulting from the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project as under:
• Substantial revisions introduced by the 2015 BEPS Reports on Actions 8-10 Aligning
Transfer Pricing Outcomes with Value Creation and Action 13 Transfer Pricing
Documentation and Country-by-Country Reporting;
• Revisions to Chapter IX to conform the guidance on business restructurings to the
revisions introduced by the 2015 BEPS Reports on Actions 8-10 and 13;
• Revised guidance on safe harbours in Chapter IV.
Below is the brief summary of Final Action Plans and what it entails:
5.2 Action Plan 1 – Addressing the challenges of the Digital

Economy
A virtual PE comes into existence due to tax mismatch arising from nexus created between
income generation and physical presence. Each tax jurisdiction which comes across a
digitized enterprise doing trade in its jurisdiction has to confirm if the significant revenues are
generated from in country customers. If this is the main cause for substantial economic
presence being created, then that country can consider bringing in a suitable law to tackle
BEPS issues. Further, the following guidance is placed in the report apart from changes
suggested in definition of PE covered in Action Plan 7.
• Updating the arm’s length principle – The cross border transactions between related
parties shall be analyzed from TP stand point to mitigate the harmful effects due to
convergence of Information and communication technology (ICT). However, it is
confirmed that low risk distributors are not caught by the new provision and is suitably
covered under transfer pricing changes.
• Revision in CFC rules – OECD proposes to cover income attributable to digital sales &
services to be covered under CFC rules. Such a step will ensure that an active business
test is established against passive or low value contribution theory, being one of the
prime causes for letdown of CFC rules.
• Collection of VAT/GST on cross border sales on destination basis.
Building on the 2015 BEPS Action Plan 1 Report, the OECD released an Interim Report on
‘Tax Challenges Arising from Digitalisation’ in March 2018 which includes an in-depth analysis
of the changes to business models and value creation arising from digitalisation, and identifies
characteristics that are frequently observed in certain highly digitalised business models.
The Interim Report observes that Members of the Inclusive Framework on BEPS have
different views on the question of whether, and to what extent, the features identified as being
frequently observed in certain highly digitalised business models should result in changes to
the international tax rules. In particular, with respect to data and user participation, there are
different views on whether, and to what extent, they should be considered as contributing to a
firm’s value creation, and therefore, what impact they may have on the international tax rules.
These different approaches towards a long term solution range from those countries that
consider no action is needed, to those that consider there is a need for action that would take
into account user contributions, through to others who consider that any changes should apply
to the economy more broadly. Acknowledging these divergences, members agreed to
undertake a coherent and concurrent review of the “nexus” and “profit allocation” rules – two
fundamental concepts relating to how taxing rights are allocated between jurisdictions and
how profits are allocated to the different activities carried out by multinational enterprises,
and seek a consensus based solution. Inclusive Framework would carry out this work with
the goal of producing a final report in 2020, with an update in 2019.
In addition, the Interim Report discusses interim measures that some countries have indicated
they would implement, believing that there is a strong imperative to act quickly. In particular,
the Interim Report considers an interim measure in the form of an excise tax on the supply of
certain e-services within their jurisdiction that would apply to the gross consideration paid for
the supply of such e-services.
The Interim Report also looks at how digitalisation is affecting other areas of the tax system,
including the opportunities that new technologies offer for enhancing taxpayer services and
improving compliance, as well as the tax risks, including those relating to the block chain
technology that underlies crypto-currencies.
5.3 Action Plan 2 - Neutralise the Effects of Hybrid Mismatch

Arrangements & Branch Mismatch Arrangements
The Final Report on Action Plan 2 is detailed and complex, running into 450 pages with over
80 examples on operational practicality of various proposals for amendments to domestic law.
The Report provides recommendations for both general changes to domestic law followed by
a set of dedicated anti-hybrid rules. Treaty changes are also recommended.
Recommended general amendments are as follows:
• A rule denying transparency to entities where the non-resident investors’ resident
country treats the entity as opaque;
• A rule denying an exemption or credit for foreign underlying tax for dividends that are
deductible by the payer;
• A rule denying a foreign tax credit for withholding tax where that tax is also credited to
some other entity; and
• Amendments to CFC and similar regimes attributing local shareholders the income of
foreign entities that are treated as transparent under their local law.
Treaty changes - Action Plan 2 recommends a new provision in the case of income earned by
a transparent entity. As per the new provision, treaty benefits will only be afforded to so much
of the income of the entity as the income of a resident of that State. A specific or general
saving rule is proposed so that a state can tax a resident entity generally unrestricted by
treaty.
Anti-hybrid rules - The report further issued a series of dedicated domestic anti-hybrid rules
which would work in two stages. The primary rules would deny deductions to payers in
situations where either
(i) Those payments will not be included in the recipient’s ordinary income, or
(ii) The same amount is being simultaneously deducted by another entity.
The Examples in the Final Report demonstrate these outcomes (deduction and non-inclusion,
or double deduction) arising from various hybrid financial instruments, financing transactions
and under entity recognition and de-recognition rules.
The OECD released a further report on Action Plan 2 in July 2017 which sets out
recommendations for branch mismatch rules that would bring the treatment of these structures
into line with the treatment of hybrid mismatch arrangements as set out in the 2015 Report.
Branch mismatches arise where the ordinary rules for allocating income and expenditure
between the branch and head office result in a portion of the net income of the taxpayer
escaping the charge to taxation in both the branch and residence jurisdiction. Unlike hybrid
mismatches, which result from conflicts in the legal treatment of entities or instruments,
branch mismatches are the result of differences in the way the branch and head office account
for a payment made by or to the branch. The 2017 Report identifies five basic types of branch
mismatch arrangements that give rise to one of three types of mismatches: deduction / no
inclusion (D/NI) outcomes, double deduction (DD) outcomes, and indirect deduction / no
inclusion (indirect D/NI) outcomes. The recommendations are as follows:
• A rule limiting the scope of branch exemption;
• A rule denying deduction for branch payee mismatches by the payer jurisdiction on
account of differences in the allocation of payments between the residence and the
branch jurisdiction or between two branch jurisdictions; or payment to a branch that is
disregarded by the payer jurisdiction;
• A rule denying deduction for the payment to the extent it gives rise to a branch
mismatch resulting from fact that such payment is disregarded under the laws of payee
jurisdiction;
• A rule for denying deduction in investor jurisdiction, failing which denying deduction in
the payer jurisdiction for double deduction outcomes;
• A rule denying deduction by payer jurisdiction of any payment directly or indirectly funds
deductible expenditure under a branch mismatch arrangement.
5.4 Action Plan 3 - Strengthen Controlled Foreign Company (CFC)

Rules
The OECD Final Report does not propose a minimum standard for controlled foreign company
(CFC) regimes. However, OECD regards CFC rules as being important in tackling BEPS and
has made a series of best practice recommendations in relation to the ‘building blocks’ of an
effective CFC regime. The major reason why the OECD was unable to provide more than best
practice was fundamental disagreement over the policy of CFC regimes, in particular whether
states should use the regime to protect other states’ tax bases from earnings stripping.
The OECD recommended ‘building blocks’ are as follows.
• Computation and attribution of CFC income - CFC income should be calculated under a
notional application of the parent jurisdiction’s tax laws and attribution should be subject
to a control threshold and based on proportionate ownership.
• Prevention and elimination of double tax - CFC rules should not result in double tax.
The specific measures suggested are to provide a credit for foreign tax paid on CFC
income, provide relief where a dividend is paid out of attributed income or where a
taxpayer disposes of their interest in a CFC where there has been attribution.
• CFC definition - CFC rules apply to foreign subsidiaries controlled by shareholders in
the parent jurisdiction, exercising legal and economic of around 50% controlling
interest. OECD recommends application of CFC rules to non-corporate entities, if those
entities earn income that raises BEPS concerns and such concerns are not addressed.
• CFC exemptions and threshold requirements - Companies should be exempted from
CFC rules where they are subject to an effective tax rate that is not below the
applicable tax rate in the parent jurisdiction.
• Definition of CFC income - CFC rules should have a definition of income that ensures
that BEPS concerns are addressed, but countries are free to choose their own
definition.
5.5 Action Plan 4 – Limiting Base Erosion Involving Interest

Deductions and Other Financial Payments
The Final Report proposes the following key approaches to limit deductions of interest and
similar finance expenses:
(a) Cap based on EBITDA - The preferred approach is an earnings stripping rule wherein
an entity’s net actual interest expense would be capped at a legislated percentage of its
EBITDA both expressed in tax terms (with a tolerance of 10%-30%). However, the
Report does not prescribe the percentage of EBITDA.
(b) Safe harbor - The Report analyses that an earnings stripping approach could be harsh
for some industries and highly-leveraged groups. Therefore, it also proposes a second
rule which would reinstate the interest deduction if the interest expense of the local
subsidiary was at or below the group’s global earnings, viz. EBITDA ratio.
(c) Targeted anti-abuse rules: Countries should enact dedicated rules to buttress their
operation and to attack interest expense in a number of identified situations, such as
interest incurred to earn exempt income or under back-to-back arrangements.
The report also addresses banks and insurance companies wherein it recommends that there
should be targeted rules addressing base erosion and profit shifting in such sectors. The basic
rules might not work for them because they will typically have net interest income.
OECD and Intergovernmental Forum on Mining, Minerals, Metals and Sustainable

Development (IGF) have recently invited comments on a draft practice note that will help
developing countries address profit shifting from their mining sectors via excessive interest
deductions.
5.6 Action Plan 5 – Counter Harmful Tax Practices

BEPS Action Plan 5 is one of the four BEPS minimum standards which all Inclusive
Framework members have committed to implement. The report identifies factors for
determining a potential harmful tax practice that results in low or no effective tax rate, lack of
transparency, negotiable tax rate or base etc. A minimum standard has been set up based on
an agreed methodology to assess whether there is substantial activity in a preferential regime.
For instance, in case of R&D activities, a minimum standard has been advocated that
establishes nexus test as the means of identifying the R&D activities which provide the
substance justifying the tax concession including tracking of expense and income on a
particular products/product line.
The Action 5 minimum standard consists of two parts. One part relates to preferential tax
regimes, where a peer review is undertaken to identify features of such regimes that can
facilitate base erosion and profit shifting, and therefore have the potential to unfairly impact
the tax base of other jurisdictions. The second part includes a commitment to transparency
through the compulsory spontaneous exchange of relevant information on taxpayer-specific
rulings which, in the absence of such information exchange, could give rise to BEPS concerns.
OECD has published Peer Review Reports on the Exchange of Information on Tax Rulings in
December 2017 which reflects the outcome of the first peer review of the implementation of
the Action 5 minimum standard. The review of the transparency framework assesses countries
against the terms of reference which focus on five key elements: i) information gathering
process, ii) exchange of information, iii) confidentiality of the information received; iv) statistics
on the exchanges of rulings; and v) transparency on certain aspect of intellectual property
regimes.
OECD has also published a Progress Report on Preferential Regimes which contains the
results of the review of all Inclusive Framework members' preferential tax regimes that have
been identified. The results will be updated from time to time as approved by the Inclusive
Framework.
5.7 Action Plan 6 – Preventing Treaty abuse

Treaty abuse has been one of the most contentious areas in the BEPS. The main problem
emerging from the issue of treaty abuse is the increasing optionality permitted to countries on
international tax issues by tax treaties. While the 2014 report indicated that such issues can
be handled, it is doubtful that the degree of optionality now proposed was then in
contemplation.
• A simplified limitation of benefits (LOB) rule proposed to combine the LOB rule with a
principal purpose test (PPT) rule;
• Multilateral treaties should be entered into;
• States are not obliged to apply the rule in their treaties if they have no objection to
treaty shopping as the state of source of income;
• Detailed LOB rule plus anti-conduit rule to be incorporated in the treaty or domestic law;
• Adoption of simplified PPT rule and LOB rule;
In terms of the details, the LOB material has become very complex in recent past. There are a
number of reasons adding to the confusion viz. the existence of two versions of the LOB rules,
several parts of the two rules are scattered in the Commentary making it difficult for the
readers to view the complete version at one place. Therefore, recommendation of introducing
simplified LOB rule along with PPT rule is suggested.
5.8 Action Plan 7 – Prevent the Artificial Avoidance of Permanent

establishment (PE) Status
The minimum standards have been re-phased to advocate the following steps:
• Reworking exceptions to PE definition – The minimum standard has been changed to
advocate that an anti-fragmentation rule should be adopted to aggregate all activities
carried by an enterprise in a state, along with activities undertaken by its closely related
entities undertaking business operation that create tax mismatch and are cohesive in
nature. Determining whether activities in a state are preparatory or auxiliary. The above
test should be applied to understand whether the activities undertaken by an enterprise
in a state are ‘preparatory or auxiliary.
• Analyzing arrangements entered through contractual agreements – OECD proposes to
include Commissionaire business model under the definition of PE. The emphasis is not
on the taxable presence for a commissionaire arrangement unless it is performed as an
independent business activity. As per the revised agency PE rule, a person who
“habitually concludes contracts, or habitually plays the principal role leading to the
conclusion of contracts that are routinely concluded without material modification by the
enterprise”, leading to a contract in the name of the foreign enterprise or provision of
goods or services by that enterprise (even if it is not a party to the contract, it is covered
under the definition of agency PE.
OECD published additional guidance in March 2018 on the attribution of profits to permanent
establishments resulting from the changes in the Report on BEPS Action Plan 7 to Article 5 of
the OECD Model Tax Convention. This additional guidance sets out high-level general
principles for the attribution of profits to permanent establishments arising under Article 5(5),
in accordance with applicable treaty provisions, and includes examples of a commissionnaire
structure for the sale of goods, an online advertising sales structure, and a procurement
structure. It also includes additional guidance related to permanent establishments created as
a result of the changes to Article 5(4), and provides an example on the attribution of profits to
permanent establishments arising from the anti-fragmentation rule included in Article 5(4.1)
5.9 Action Plan 8 – Transfer Pricing Outcomes in Line with Value

Creation/ Intangible
5.10 Action Plan 9 – Transfer Pricing Outcomes in Line with Value
Creation/ Risks and Capital
5.11 Action Plan 10 – Transfer Pricing Outcomes in line with Value
Creation/ Other High-Risk Transactions
The aforesaid Action plans represent the OECD’s work on transfer pricing which has been a
core focus of the BEPS Action Plan. The specific Actions focus on Intangibles, Risks and
capital and other high-risk transactions. These are the hard areas of transfer pricing and are
summarized together in the Final Report ‘Aligning Transfer Pricing Outcomes with Value
Creation’.
As per the final report, the following are important steps:
• The OECD’s view is that contractual allocation of functions, assets and risks between
associated enterprises leaves the arm’s length principle vulnerable to manipulation
leading to outcomes which do not correspond to the value created through underlying
economic activity. In order to deal with this, the revised TPG requires careful delineation
of the actual transaction between the associated enterprises by analysing the

contractual relations between the parties in combination with the conduct of the parties.
The conduct will supplement or replace the contractual arrangements if the contracts
are incomplete or are not supported by the conduct. This kind of approach invites
intense factual scrutiny.
• The Report determines that a party that cannot exercise meaningful and specifically
defined control over the risks, or does not have the financial capacity to assume the
risks, will not be allocated those risks and consequential returns. Rather, those risks
and returns will be allocated to the party that does exercise such control and does have
the financial capacity to assume the risks.
• The Report does not allocate the returns to the party which merely owns the assets
rather, those returns are allocated to the MNE group members which perform important
functions, control economically significant risks and contribute assets, as determined
through the accurate delineation of the actual transaction. Similar considerations should
apply to MNE group members who provide funding but perform few activities.
Accordingly, the passive funder may only be entitled to a risk-free return, or less.
• The OECD advocates that effort should be made to determine the actual nature of a
transaction and then to price it, where the economic substance differs from form, or
arrangements viewed in totality differ from those that would be made by independent
enterprises.
• Pricing methods should ensure that the profits are allocated to the most important
economic activities. On low value adding intra group services, the guidance provides for
an elective approach covering a wide category of services which command a very
limited mark up on costs and which provide a consistent allocation key for all recipients
for such services.
Further, final guidance on transactional profit split method is awaited which shall provide
additional guidance on the ways in which this method can be applied to align transfer pricing
outcomes with value creation, including in the circumstances of integrated global value chains.
Similarly, further guidance is awaited on transfer pricing for financial transactions including
identifying the economically relevant characteristics for determining arm’s length conditions;
and on implementation of the approach to pricing transfers of hard-to-value intangibles.
5.12 Action Plan 11 – Measuring and Monitoring, BEPS

The report discusses reasons behind harmful tax practices that result in no or low effective tax
rate, lack of transparency, negotiable tax rate or base etc. A minimum standard has been
prescribed to maintain transparency in dealings based on an agreed methodology to assess
whether there is substantial activity in a preferential regime. A framework has been specially
designed for exchange of information on international tax rulings in relation to preferential tax
regimes viz.:
• Cross-border unilateral APAs and other transfer pricing related rulings ;
• Cross-border rulings giving downward adjustments not reflected in financial accounts;

• PE rulings (existence and attribution); and
• Related party conduit rulings.
The ruling has to be exchanged with other affected states as well as the states of the
immediate and ultimate parent of the taxpayer. To prevent information overload only summary
information should be provided at first later added by more information on request. Past
rulings (within certain time parameters) and all future rulings are covered and the timeframes
for implementation and on-going exchanges are specified.
5.13 Action Plan 12 – Disclosure of Aggressive Tax Planning

Arrangements
Action 12 provides a framework for a mandatory reporting regime against ‘aggressive tax
planning and forms the basis of the BEPS best practice guidance. The OECD feels that
mandatory reporting regimes are important because of the following reasons:
• Reporting regime applies to both promoters and taxpayers;
• Reporting acts as a greater deterrent since the tax planning scheme must be reported;
• Reporting regime allows such schemes to be identified far earlier, thus allowing greater
flexibility in attacking the scheme, including being able to stop it before use; and better
protects against revenue loss.
The final report suggests the use of different hallmarks to identify cross-border schemes,
given that the tax benefit of a cross-border scheme may arise in a different country. Such
hallmarks include use of hybrids arrangements that separate legal and tax ownership of
depreciable assets and cross-border transfers of assets at other than market value. Action 12
then notes that disclosure of schemes identified under a mandatory reporting regime should
form part of the ever-increasing exchange of information platforms between jurisdictions.
Responding to a request of the G7, the OECD has issued new model disclosure rules in
March 2018 that require lawyers, accountants, financial advisors, banks and other service
providers to inform tax authorities of any schemes they put in place for their clients to avoid
reporting under the OECD/G20 Common Reporting Standard (CRS) or prevent the
identification of the beneficial owners of entities or trusts. The design of these model rules
draws extensively on the best practice recommendations in the BEPS Action Plan 12 Report
while being specifically targeted at these types of arrangements and structures. Further,
OECD is also expected to address cases of abuse of golden visas and similar schemes to
circumvent CRS reporting.
5.14 Action Plan 13 – Re-examine Transfer Pricing Documentation

The Final Report iterates the new minimum standard for transfer pricing documentation for
improving transparency through providing the tax administrations with a global picture of the
operations of MNEs.
Action 13 contains a three-tiered standardized approach to transfer pricing documentation
which consists of:
(a) Master file: Master file requires MNEs to provide tax administrations with high-level
information regarding their global business operations and transfer pricing policies. The
master file is to be delivered by MNEs directly to local tax administrations.
(b) Local file: Local file requires maintaining of transactional information specific to each
country in detail covering related-party transactions and the amounts involved in those
transactions. In addition, relevant financial information regarding specific transactions, a
comparability analysis and analysis of the selection and application of the most
appropriate transfer pricing method should also be captured. The local file is to be
delivered by MNEs directly to local tax administrations.
(c) Country-by-country (CBC) report: CBC report requires MNEs to provide an annual
report of economic indicators viz. the amount of revenue, profit before income tax,
income tax paid and accrued in relation to the tax jurisdiction in which they do business.
CBC reports are required to be filed in the jurisdiction of tax residence of the ultimate
parent entity, being subsequently shared between other jurisdictions through automatic
exchange of information mechanism.
These new reporting requirements are to be implemented for fiscal years beginning on or after
1 January 2016 and apply to MNEs with annual consolidated group revenue equal to or
exceeding EUR 750 million.
OECD has been issuing further guidance for tax administrations and MNE Groups on Country-
by-Country reporting on a continuous basis since the release of BEPS Action Plan 13.
The automatic exchange of Country-by-Country Reports under the Multilateral Competent
Authority Agreement on the Exchange of CbC Reports ("the CbC MCAA") would start in June
2018 and will give tax administrations around the world access to key information on the
annual income and profits, as well as the capital, employees and activities of Multinational
Enterprise Groups that are active within their jurisdictions. As of April 2018, there are over
1500 bilateral exchange relationships activated with respect to jurisdictions committed to
exchanging CbC Reports.
Further, in May 2018 the OECD released the first peer reviews of the Country-by-Country
(CbC) reporting initiative covering 95 jurisdictions which provided legislation and/or
information relating to the implementation of CbC Reporting with finding that practically all
countries that serve as headquarters to the large MNEs covered by the initiative have
introduced new reporting obligations compliant with transparency requirements.
5.15 Action Plan 14 – Making Dispute resolution Mechanisms More

Effective
The final report advocates setting up a Forum on Tax Administration (FTA), a subset of MAP
Forum to deal with practical issues, as a minimum standard. States have agreed to join the
FTA MAP Forum, report MAP statistics and agree to have their MAP performance monitored.
In this way, a peer review mechanism has been set in place to ensure transparency in the
area of exchange of information. In addition there is a list of 11 best practices, being matters
which either are not readily measurable or could not be agreed by all states involved.
In October 2016, the OECD released key documents, approved by the Inclusive Framework
on BEPS, that will form the basis of the MAP peer review and monitoring process under Action
14 of the BEPS Action Plan. The peer review and monitoring process will be conducted by the
Forum on Tax Administration MAP Forum in accordance with the Terms of Reference and
Assessment Methodology, with all members participating on an equal footing.
The Stage 1 peer review for the first batch of assessed jurisdictions started in December 2016
to ensure the implementation of the minimum standard to strengthen the effectiveness and
efficiency of the MAP. Stage 1 peer review assessment is expected to be completed by
December 2019 with the completion of 10th batch. In Stage 2 of the peer review process, each
jurisdiction’s effort to address the recommendations identified in its Stage 1 peer review report
will be assessed. As of May 2018, OECD has released Stage 1 peer review reports of three
batches covering 21 assessed jurisdictions.
5.16 Action Plan 15 – Developing a Multilateral Instrument

The report explores the technical feasibility of a multilateral instrument to implement the BEPS
treaty-related measures. The report suggests possible alternatives based on a significant
economic presence, such as a virtual PE concept, withholding tax or excise tax on the digital
economy. It concludes that a multilateral instrument is desirable and feasible, and that
negotiations for such an instrument should be convened quickly.
5.17 Multilateral Convention to Implement Tax Treaty Related
Measures to Prevent Base Erosion and Profit Shifting
Based on the Action 15 interim report, a mandate to set up the Ad hoc Group for the
development of a Multilateral Instrument (‘MLI’) was developed by the OECD Committee on
Fiscal Affairs (CFA) in February 2015 and endorsed by the G20 Finance Ministers and Central
Bank Governors, open to the participation of all interested countries on an equal footing. After
adoption of BEPS package in October 2015, in November 2016, the ad hoc Group concluded
the negotiations and adopted the Text of the MLI as well as its accompanying Explanatory
Statement. In June 2017, a high-level signing ceremony took place with over 70 governments
participating. At this ceremony, the MLI was signed by 67 countries and jurisdictions, covering
68 jurisdictions from all continents and all levels of development. Since then, 10 additional
jurisdictions have joined the MLI as on March 2018.
MLI, negotiated by more than 100 countries and jurisdictions under a mandate from G20
Finance Ministers and Central Bank Governors, will modify existing bilateral tax treaties to
swiftly implement the tax treaty measures developed in the course of the OECD/G20 BEPS
Project overcoming the need for burdensome and time-consuming bilateral renegotiations.
Signatories of the MLI may choose which existing tax treaties they would like to modify using
the MLI. Once a tax treaty has been listed by the two parties, it becomes an agreement to be
covered by the MLI. The current signatories have listed over 2,500 treaties, already leading up
to over 1,200 matched agreements.
Treaty measures that are included in the MLI include those on hybrid mismatch arrangements,
treaty abuse and permanent establishment. MLI also strengthens provisions to resolve treaty
disputes, including through mandatory binding arbitration, which has been taken up by
28 signatories.
MLI will enter into force on 1st July 2018 following the deposit of the fifth instrument of
ratification by Slovenia on 22 March 2018. Earlier, the Republic of Austria (22 September
2017), the Isle of Man (19 October 2017), Jersey (15 December 2017), and Poland (23
January 2018) deposited their instruments with the OECD. The entry into force of the MLI on
1st July 2018 will bring it into legal existence in these five jurisdictions. In accordance with the
rules of the MLI, the first modifications to covered treaties will become effective from early
2019. The timing of entry into effect of the modifications is linked to the completion of the
ratification procedures in the jurisdictions that are parties to the covered tax treaty.
In June 2017, India had submitted its provisional list of expected reservations and notifications
to MLI. It is expected that India will soon provide its definitive position upon deposit of its
instrument of ratification, acceptance of approval of MLI with OECD.
5.18 Challenges ahead
The Final reports have generated good response with more than 100 countries having joined
the Group as members, and 5 regional tax organizations joined as observers. However, there
are certain challenges that lie ahead on the journey of BEPS viz. inclusiveness, consistent
implementation and monitoring impact. After widespread agreement among countries on the
measures for tackling BEPS, implementation becomes a key. Following the G20 and OECD
call for even increased inclusiveness, a new framework for monitoring BEPS has been
conceived and put in place, with all interested countries participating on an equal footing.
Inclusive Framework on BEPS (as regard its four minimum standards) have put peer reviews
in place, a process through which all members are assessing each other’s implementation of
the agreed standards. While the Global Forum’s process has been in place since 2010 for
exchange of information on request and has produced comprehensive ratings, the review of
the implementation of the BEPS minimum standards and the implementation of AEOI is more
recent and so the results of evaluations and recommendations for improvement are in an
earlier stage. Many of these reviews are being relied upon by other organisations to identify
non-cooperative jurisdictions, including the EU. Some of the measures may be immediately
applicable, such as the revised guidance on transfer pricing, while others require changes in
domestic laws and in bilateral tax treaties, hence may take time for implementation.
Unit VI Diverted Profit tax

6.1 Background
With the advent of e-commerce and availability of new IT technologies, most multinational
enterprises (‘MNE’) plan their worldwide business operations in a way so as to avoid taxes.
Most MNEs structure their businesses in different countries through creating a maze of
companies in different taxing jurisdictions with the effect that profits earned in a high taxing
jurisdiction are diverted to other low-tax jurisdictions, effectively contributing to an overall
lower tax cost in the hands of MNE on its worldwide income. An increasing amount of MNEs
have been devising complex structures like ‘Double Irish Dutch Sandwich’ that result in double
non-taxation of profits in two or more tax jurisdictions effecting low or no tax in the hands of
such MNEs.
In the past, there was a lot of hue and cry about the negligible amount of taxes paid by big
companies like Google, Facebook, Microsoft and Starbucks in countries like UK through
diverting all the profits made in UK to Ireland. They do not pay much tax in Ireland also
through creation of complex corporate structures that enables money being shifted to Dublin-
registered company of Google located in Bermuda for tax purposes. In 2013, it was revealed
that Starbucks paid nothing in corporation tax between 2009 and 2012, despite sales of
£400m in 2011, and had only paid £8.56m in corporation tax since it began trading in the UK
in 1998. Starbucks maintained it had made a loss in those years when it paid no corporation
tax 10.
Various meetings were arranged by G20 finance ministers worldwide to address issue of tax
avoidance and double non-taxation and similar international tax issues that culminated into
setting up of the Base Erosion and Profit Shifting (‘BEPS’) Action Plan Project in 2014.
Parallely, UK Government proposed to introduce Diverted Profits Tax (’DPT’), popularly known
as ‘Google tax’, a term coined by the media, being a punitive tax imposed on large companies
on diversion of profits out of UK for avoiding taxes.
HM Revenue & Customs (‘HMRC’) has introduced DPT in its taxing statute with effect from
April 01, 2015. DPT is a new tax form with extraterritorial powers imparted to UK Tax
authorities, having wide applicability to both UK based and non-UK based business
enterprises carrying out activities in UK. Under the new tax regime, a tax rate of 25 per cent
shall be levied on large multinational enterprises with business activities in UK who enter into
‘contrived’ arrangements in order to divert profits from UK by either avoiding formation of
Permanent Establishment (‘PE’) in UK or through entering into ‘contrived’ arrangements
between related enterprises. The current UK corporation tax rate is 19 per cent. DPT is higher
than UK corporation tax since it is intended as a penal tax to discourage businesses from
structuring their business arrangements resulting in profit diversion outside UK. A lower UK
corporation tax rate of 20 per cent in comparison poses as an incentive to MNEs while
structuring their business arrangements.
10 BBC business news
6.2 Applicability
The DPT, popularly also described as ‘Google Tax’ is widely perceived as a tax principally
targeting the type of tax planning which has been most effectively used by web-based
businesses that involve effective use of technology. However, the DPT has a much wider
scope and applies to all types of business that meet the relevant conditions. Large companies
that are in the business of manufacturing/ distribution models, insurance and reinsurance
structures, fund management structures and real estate transactions could also be potentially
exposed to the applicability of DPT. However, the applicability of DPT may not arise if the
following conditions are met:
1. Companies have substance in the business carried out by their offshore asset owning
subsidiaries;
2. Companies enter into arm’s length transfer pricing through their international value
chain
3. A taxable presence in UK through either a PE or an onshore distributor/reseller
Considering the above exceptional situations, it may so happen that DPT will not give rise to
any charge on certain Companies or the charge will be relatively modest. The above is
reflected in the budgeted revenue from the DPT. Since the categorization of DPT is not that of
a corporate tax/ income tax, it is unlikely that DPT shall be subject to any tax relief under
existing double tax treaties. In this backdrop, the response that DPT generates from other
countries shall be crucial. Though there is a possibility of questioning and protracted litigation
over the exceptionally extraterritorial ambit and legality/enforceability of the DPT by many
covered corporations, it is also likely that other countries may take cue from HMRC and devise
similar taxing regimes. Australian government issued its Multinational (Tax) Anti-Avoidance
Law in May 2015 Budget that is similar to DPT. The potential ambit of the DPT is broad
enough to ensure an increase in transparency related to transfer pricing policies and presence
of substance outside the UK.
6.2.1 Circumstances where DPT applies:
DPT is attracted in case the following tests are met:
• Insufficient economic substance test - Where a company, subject to UK corporation
tax (whether UK company or non-UK company) has entered into an arrangement with
another entity outside UK and such arrangement lacks economic substance.
For example: Where the Intellectual property rights of a UK company are transferred to a
subsidiary in a low tax jurisdiction and royalty payments are claimed as a deduction against
UK company’s taxable income. The subsidiary does not have the technical and management
capacity to develop and maintain such IP and it can be sufficiently proved that the transfer is
only being undertaken for tax purposes.
Arrangements having “insufficient economic substance” can be broadly classified in two ways:
(a) Transaction-based approach – wherein the related/ un-related entities enter into a
transaction specifically designed to secure a tax reduction and the non-tax benefits of
such transaction do not exceed the financial benefits of the tax reduction. The tax and
non-tax benefits associated with a single transaction are evaluated to gauge the
intrinsic substance in the conduct of parties.
(b) Entity-based test – wherein separate entity is formed in order to secure the tax
reduction and where the non-tax benefit of the contributions made by such entity (in
terms of the functional profile or activities of staff employed) does not exceed the
financial benefits of the tax reduction. Entity-based test is directed at non-resident
Special Purpose Vehicle (‘SPV’) entities set up for tax purposes that do not have the
necessary capabilities in terms of skilled staff necessary to undertake the relevant
transaction and are guided by skilled staff located elsewhere.
• Avoidance of permanent establishment test – Where a non-UK foreign company
carries on activities in UK but those activities are specifically designed to avoid creating
a permanent establishment of that foreign company in the UK
For example: a foreign company makes sales to UK customers. Such sales are generated on
the basis of sales and marketing efforts undertaken by its subsidiary in UK wherein the
sales/marketing activities are specifically designed to exclude formation of permanent
establishment under Article 7 of the Treaty. ‘Effective tax mismatch’ conditions needs to be
met wherein the main purpose of setting up of subsidiary is to avoid tax can be established.
An “effective tax mismatch outcome” arises, broadly, where the UK tax reduction derived from
the arrangements by one party exceeds any increase in tax payable by the other relevant
party to the arrangements, and the tax payable by the other party is less than 80% of UK tax
reduction derived by the first party.
6.2.2 Tax credit under DPT
DPT is a separate tax from corporation tax and any payment of DPT should be ignored to its
entirety while computing UK’s corporation tax. However, as per clause 19 of DPT, where the
profits on which the DPT is charged are also subject to UK corporation tax or a non-UK
equivalent of corporation tax, such tax will be credited against the DPT liability to avoid double
taxation. As per HMRC’s guidance, the design of the DPT is such that it is not covered by
existing double taxation treaties and therefore liability to DPT cannot be avoided pursuant to a
double tax treaty. This position however could be subject to challenge by taxpayers in the
court of law.
6.2.3 General exemptions from DPT
Arrangements may be exempt from the DPT in the following circumstances:
• Sales threshold exemption - Small and medium sized enterprises (‘SMEs’) are not
subject to the DPT. The determination of SME depends upon the total sales revenue of
a company (whether foreign or connected company). The total sales revenue arising
from sale of goods and services in UK should not exceed 10 million pounds for a twelve
month accounting period;
• Certain loan relationships are not subject to the DPT;

• Where a tax mismatch arises solely due to the persons being tax exempt solely by
reason of being a charity, pension scheme or having sovereign immunity;
• Where a non-UK person does not have a PE in UK due to fact that the entity
undertaking operations in UK being of independent status that is not connected with
such non-UK person.
6.3 Assessment and collection procedure

Any company for which it is reasonable to assume that it has any profits in a financial year
that fall within the scope of DPT is duty bound to notify an officer of revenue and customs
within three months from the end of accounting period in which DPT might arise. In case self-
notification is not made by a company, penalties are applicable. The DPT notification
provisions are intended as a wide, information gathering exercise to enable HMRC to assess
potential liabilities to DPT. The DPT notification provisions are very wide and quite broadly a
self-notification must be made to HMRC in the following circumstances:
• Where a UK company has entered into arrangements lacking economic substance that
result in a ‘substantial’ effective tax mismatch;
• Where a non-UK company has an ‘avoided PE’, resulting in an effective tax mismatch
which must be ‘substantial’; and
• Where there is no mismatch, instead of the tax avoidance purpose condition, a
notification obligation can arise where the arrangements have resulted in an overall
reduction in tax, regardless of the motive for the arrangements.
On receipt of self-notification, a designated HMRC officer issues a provisional notice for the
purpose of estimating the taxable diverted profits. The designated officer exercises a best
judgment estimate of the amount chargeable to DPT. On receipt of charging notice by the
taxpayer, payment must be made within 30 days. The tax demanded will include an amount
equivalent to interest from six months after the end of the relevant accounting period to the
date of the charging notice. The tax can be recovered from related companies, if not paid by
the assessed company. In case the company challenges the quantum of amount charged by
HMRC officer, such company is precluded from effecting any delay in payment of DPT. There
is a twelve months review period within which the company can agree with the final DPT
charge with HMRC.
6.4 Way forward

DPT has attracted much flak due to its self-contradictory nature wherein there is a self-
disclosure requirement by the taxpayer and later the same taxpayer plays defensive by
iterating that its activities are not designed to divert profit outside UK. DPT may mostly pose
as a preventive tax with corporations modifying their restructuring arrangements such that
there are no ‘diverted profits’ and their incomes are subject to lower UK corporation tax of
19%. Depending on the factual position, it may also be possible to modify the arrangements to
fall outside of the DPT while still not being Subject to UK corporation tax.
Any advance clearance from HMRC regarding the non-application of the DPT is not
contemplated in the DPT law. However, it is anticipated that going forward, Advanced Pricing
Agreements (APA’s) may pose as a combat mechanism for transfer pricing purposes wherein
application of the DPT can be alleviated on a case to case basis. However, even APAs may
provide partial comfort in respect of DPT risk only and might not protect against risks of re-
characterization and other non-transfer pricing tax avoidance matters.
Unit VII Partnership

7.1 Introduction
Partnership is one of the well-recognized and widely used forms for conducting business
operations across the world.
A basic characteristic of partnership is that the partners are generally jointly and severely
liable for the activities of the firm.
An Indian partnership is governed by The Indian Partnership Act, 1932 (“Partnership Act”).
While the said legislation does not restrict the participation of foreign individuals and/or
entities in a partnership, there is no automatic permission granted for investing in a
partnership firm under the Foreign Exchange Management Act, 1999 and the Rules specified
therein (“exchange control regulation). Thus the partnership firm structure is generally
restricted to Indian individuals, Non-resident Indians and/or Indian entities.
A Limited Liability Partnership (“LLP”) is a hybrid structure containing the key characteristics of
a partnership as well as a company. The Government of India enacted the Limited Liability
Partnership Act, 2008 after the receipt of the assent of the President of India on 7 January
2009. The said legislation explicitly permits a foreign individual and/or entity to be a Partner in
a LLP (not being a designated partner). Further, the exchange control regulations have been
liberalized to permit investment by foreign individual and/or entities in LLP under approval
route with effect from 20 May 2011. Thus, a LLP can have foreign individuals and/or entities
as its partner.
7.2 Legislation governing partnership

7.2.1 Indian partnership
An Indian partnership in India is governed by the Partnership Act.
Section 4 of the Partnership Act defines a partnership as relation between persons who have
agreed to share the profits of a business carried on by all or any of them acting for all.
As per section 5 of the Partnership Act, the relationship of partnership arises from a contract.
The key characteristics of such partnership are as under:
(a) A partnership should have minimum two partners.
(b) Sharing of Profits is an important characteristic of partnership. The profits of the firm are
shared among the partners in an agreed ratio as per the partnership deed.
(c) There exists a principal-agent relationship in partnership. As agents, the partners can
bind the partnership firm and other partners for their action in ordinary course of
business.
(d) The liability of the partners is unlimited i.e. they are jointly and severally liable for the
liabilities of the partnership firm.
(e) If the assets of the partnership firm are inadequate to meet the liabilities of the firm then
the personal assets of the partners may be used to meet the liabilities of the partnership
firm.
(f) Subject to contract between the partners, a person shall not be introduced as a partner
into a firm without the consent of all the existing partners.
7.2.2 Limited Liability Partnership
A LLP in India is governed by The Limited Liability Partnership Act, 2008 (“LLP Act”). Section
2(n) of The LLP Act defines a limited liability partnership as a partnership formed and
registered under the Act.
A LLP is a hybrid entity which contains the features of both a corporate entity as well as a
traditional partnership. It provides the partners with the flexibility of conducting the business as
a traditional partnership though retaining the characteristics of a corporate entity.
The key characteristics of a LLP are as under:
(a) LLP should be registered with Registrar of Companies;
(b) LLP is a body corporate having a legal entity separate from its partner;
(c) LLP has a perpetual succession;
(d) An individual or a body corporate can be a partner in LLP;
(e) Changes in partners does not affect the existence, rights or liabilities of a LLP;
(f) LLP should have minimum two partners;
(g) LLP should have two designated partners who are individuals and resident in India –
under the exchange control regulations;
(h) The partners are required to enter into partnership agreement, which will lay down the
eligibility to appoint a partner, relationship of partners, cessation of partnership
agreement, obligation to contribute, transfer of partnership interest, etc.
(i) Partnership interest is transferable and the same would not by itself cause dissolution
or winding up of LLP;
(j) Partner is an agent of LLP but not of other partners;
(k) Partner is not personally liable for an obligation of LLP, except where the same arises
from his own wrongful act or omission or in case of a fraud;
(l) LLP to maintain proper book of accounts; and undertake audit (turnover exceeds Rs.
40 lakhs or contribution exceeds Rs. 25 lakhs)
(m) It is permitted to convert firm/company into LLP and vice versa;
(n) LLP can be wound up either voluntarily or by the order of National Company Law
Tribunal.
7.3 Key income tax provisions

Income Tax Act, 1961 (“ITA”)
7.3.1 Definition
Section 2(23) of the Income Tax Act, 1961 (“ITA”) defines “firm” to have the meaning assigned
to it in the Partnership Act and shall include a limited liability partnership as defined in the LLP
Act.
The definition of “company” as per section 2(17) of the ITA includes any body corporate
incorporated by or under the laws of a country outside India.
Section 2(31) of the ITA defines a person to include a firm and a company.
Whether a partnership formed and/or registered outside India qualify as a partnership
for the purpose of ITA?
Section 4 of the Partnership Act defines a “partnership” as a relation between persons who
have agreed to share the profits of a business carried on by all or any of them acting for all.
Any partnership, including a foreign partnership, which satisfies the above definition, should
be recognized as a firm under the ITA.
Whether a foreign LLP qualifies as a firm for the purpose of Act?
The definition under the ITA specifically provides that a LLP as defined in LLP Act should be
considered as firm for the purpose of the ITA.
Section 2(n) of the LLP Act defines a “limited liability partnership” as a partnership formed and
registered under the LLP Act. Further, section 3 of the LLP Act provides that a LLP is a body
corporate formed and incorporated under this Act and is a legal entity separate from that of its
partners.
Thus a LLP formed and registered under the LLP Act is considered as a firm for income tax
purpose.
The question thus arises on what should be the status of a foreign LLP not formed and
registered under the LLP Act.
The answer to the aforesaid question may depend on the legislation in the country of
registration which may govern the respective LLP. The following guidance may be helpful in
the matter:-
Company If the foreign LLP is considered as a body corporate as per the laws of
the country of incorporation then it may be considered as a “company”
for the purpose of the ITA
Firm If the foreign LLP satisfies the definition of partnership as per the
Partnership Act, then it may be considered as “firm” for the purpose of
ITA
Association of If the foreign LLP does not qualify as “firm” or “company”, then it may
persons or need to be examined whether it may be considered as an “association of
body of persons” or “body of individuals” as the case may be.
individuals
The tax implication under the ITA would depend on the status of the foreign LLP.
7.3.2 Residential status
Section 6(2) of the ITA provides that a firm is said to be resident in India in any previous year
in every case except where during that year the control and management of its affairs is
situated wholly outside India.
Section 6(3) of the ITA provides that a company, not being an Indian company, is to be
resident in India if its place of effective management, in that year, is in India. “Place of
effective management” has been defined to mean a place where key management and
commercial decisions that are necessary for the conduct of the business of an entity as whole
are, in substance made.
7.3.3 Scope of taxation

A firm or LLP is considered as a taxable entity for income tax purposes.
Section 5(1) of the ITA provides that a resident firm or LLP should be subject to tax on the
following income:
(a) Income received or deemed to be received in India
(b) Income accruing or arising or deemed to accrue or arise in India
(c) Income accruing or arising outside India
Section 7 of the ITA deals with income deemed to be received in India while section 9 of the
ITA deals with income deemed to accrue or arise India
A non-resident firm or LLP should however be subject to tax only on income received or
deemed to be received in India or income accruing or arising or deemed to accrue or arise in
India as per section 5(2) of the ITA.
7.3.4 Computation of taxable income

The provisions of the ITA relating to determination of taxable income, tax liability and tax
compliances are applicable to the firm taxable as a distinct taxpayer (i.e. separate from the
partners).
The following however are specific provisions in relation to determination of the tax liability of
partnership and the partners.
Normal provisions
• In view of section 10(2A) of the ITA when a partnership is assessed as such then the
share of the partner in the total income of the partnership shall not be taxable in the
hands of the partners.
• Explanation 2 to section 15 of the ITA provides that any salary, interest, bonus,
commission, or remuneration due to or received by a partner from the partnership shall
not be regarded as “salary”. Further, as per section 28(v) of the ITA, any salary,
interest, bonus, commission, or remuneration shall be taxable under the head “Profits
and gains from business or profession” in the hands of partners.
Alternative Minimum Tax provisions
• As per section 115JEE, any person other than company having total adjusted income
more than Rs. 25 lakhs (subject to assessee claiming certain specific deductions) shall
pursuant to section 115JC, is liable to pay alternate minimum tax i.e. tax at 18.5% on
adjusted total income, where the tax liability under normal provisions is lower.
For computing adjusted total income, total income is increased by deduction claimed under
chapter VI-A (other than 80P), deduction claimed under section 10AA and deduction claimed
under section 35AD. Certificate in prescribed form to be obtained certifying adjusted total
income and alternate minimum tax is computed as per the provisions prescribed in this
relation.
Partners
• Where the partnership is separately assessed, the share of profit of
partners in the total income of the partnership is not taxable in the hands
of partners [Section 10(2A) of ITA]
• Salary, interest, bonus, commission, or remuneration paid to partners
taxable as business income [Explanation 2 to sec 15 read with section
28(v) of ITA]
• Tax under paid if higher than normal tax
Firm / Partnership
• Firm is a separate taxpayer subject to income tax and related
compliances
Firm / • Salary, interest, bonus, commission, or remuneration paid to partners is
LLP deductible subject to limit and satisfaction of conditions specified
• Tax under alternate minimum tax to be paid if higher than normal tax
7.3.5 Double Taxation Avoidance Agreement

Section 90(2) of the ITA provides that where the Central Government has entered into an
agreement with the Government of any other country outside India or specified territory
outside India for granting of relief of tax or avoidance of double taxation, then the provisions of
ITA shall apply to the extent they are more beneficial. Section 90(4) of the ITA further provides
that no relief under such agreements can be claimed by a resident of other country unless a
certificate confirming the residence in the country outside India is obtained from Government
of that country.
Thus, a firm / LLP should be eligible to claim benefit under the DTAA entered into by India.
However, a firm / LLP which qualifies as a resident of other country would require a Tax
Residency Certificate from its country of resident and provide a declaration in Form 10F, as
applicable duly signed in order to claim the benefit provided by the DTAA in India.
The provisions of the respective DTAA need to be examined in entirety to determine the
benefit or relief provided thereunder. However, the following articles 11 of the DTAA may, in
general, need to be examined in the case of a firm / LLP for determining the taxable income
depending on the facts of the case:
(a) General Scope
(b) Taxes covered
(c) General definition
(d) Residence
(e) Permanent Establishment & Business Profits
(f) Associated enterprises
(g) Interest
(h) Royalty and fees for technical services
(i) Gains
(j) Independent Personal services
(k) Income earned by Entertainers and Athletes (accruing not directly to such Entertainers
and Athletes)
(l) Other income
(m) Limitation of benefits
(n) Relief from Double Taxation
(o) Non-Discrimination clause
(p) Mutual agreement procedure
7.3.6 Challenges in application of DTAA to a foreign partnership / LLP not being a body
corporate
Under the ITA, as discussed above, a partnership qualifying as a firm is considered as a
separate tax payer. However, in the other country a partnership firm may be considered either
as an independent taxable unit or as a fiscally transparent entity (i.e. partnership is not
considered as a taxable unit and the income is taxable in the hands of its partners).
11 (Kindly refer to the respective chapters the in Module for further elaboration on the purposes, interpretation and
implication of each of the above articles under the DTAA)
The DTAA applies to persons who are residents of one or both of the Contracting States. In
relation to a partnership which is taxable as an independent taxable unit in both the
Contracting States (India treats partnership as independent taxable unit), it may be possible to
apply the provisions of Article on residence to determine the Resident State and resulting tax
implication as per the provisions of DTAA.
However, the nature of treatment of the partnership as fiscally transparent in the other
Contracting State may trigger the following challenges.
(a) As the firm is fiscally transparent, it is not a taxable entity under the domestic income
tax law of the other country. Further, the firm is not liable to tax in that other states (It is
the partners who are liable to tax). In view thereof, the provisions of Residence under
DTAA as regard the firm may fail.
Further, in such a situation, the other country may also not issue a Tax Residency
Certificate to the partnership.
(b) The partners may be taxable on the income of the firm in their individual capacity. Thus
while the firm may be taxable in India, the individual partners may be taxed in the other
country. The application of the provisions of the DTAA for granting relief in such
scenario may pose difficulty. A further complexity may arise where the partnership is a
resident of other Contracting State and the partner is a resident of a country other than
the Contracting State in which case there would be three jurisdictions involved posing
challenge of triangular treaty situation.
The OECD in its commentary on the Articles of the Model Tax Convention have dealt with the
challenges on the application of the Convention to partnership firm and suggested the manner
in which the issues may be dealt. The relevant extract of the commentary is provided in the
Annexure enclosed to the Chapter.
The above referred commentaries dealing with partnership are based on the recommendations
and suggestions of the working group set up by the committee of fiscal affairs of OECD
provided vide its report titled “The Application of the OECD Model Tax Convention to
Partnership”. The said report dealt with the application of the provisions of OECD Model Tax
Convention and indirectly of bilateral tax conventions based on the Model to partnership and
was adopted by the committee on 20 January 1999.
The OECD commentaries are not binding in relation to the DTAA entered into by India.
However, it may have persuasive value in determining the intention of the provisions of the
DTAA entered into by India.
7.3.7 Credit for tax paid outside India – No DTAA

Section 91(1) of the ITA provides that with respect to income which accrued or arose outside
India and which is not deemed to accrue or arise in India, if a resident taxpayer has paid
income tax in other country with which there is no DTAA, then the taxpayer should be entitled
to claim a deduction from Income tax payable of a sum calculated on such double taxed
income as under:
• at the Indian tax rate or the rate of tax in such country whichever is lower, or
• at the Indian tax rate, if both the rates are equal
Section 91(3) of the ITA further provides that if any non-resident person is assessed on his
share in the income of a registered firm assessed as resident in India in any previous year and
such share includes any income accruing or arising outside India during that previous year
(and which is not deemed to accrue or arise in India) in a country with which there is no DTAA
and he proves that it has paid income-tax by deduction or otherwise under the law in force in
that country in respect of the income so included he shall be entitled to a deduction from the
Indian income-tax payable by him of a sum calculated on such doubly taxed income as under:
• at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or
• at the Indian rate of tax if both the rates are equal.
7.4 Scenarios resulting in double taxation

Enumerated below are the various scenarios in which double taxation may arise either in the
hands of the partnership and/or the partners, thus warranting the examination of DTAA
entered into by India.
(a) Indian partnership or Indian LLP deriving income outside India
(b) Taxation of partners of Indian LLP who are based outside India
(c) Taxation of foreign partnership and/or partners in a foreign partnership, where the
partnership is deriving income from India and none of the partners are based in India
(d) Taxation of foreign partnership, where one of the partners is based in India.
(e) Taxation of partners of a foreign partnership who are based in India
The said scenarios are discussed in detail below:
7.4.1 Scenario I - Indian partnership or Indian LLP deriving income outside India
An Indian partnership or an Indian LLP should be qualifying as a tax resident in India as per
the provisions of section 6(2) of the ITA. Accordingly, the income derived outside India should
be taxable in India as per the provisions of section 5(1) of the ITA.
The said income may however be also taxed in the other country from which the income may
be derived under its domestic tax law. Thus there may be double taxation in the hands of the
Indian partnership or Indian LLP.
To avoid the said double taxation, the provisions of DTAA require examination if entered into
by India with the said country. Alternatively, the provisions of section 91 of the ITA may be
applicable.
It may be noted that an Indian partnership is not a body corporate. However, as per the LLP
Act, an Indian LLP is a body corporate.
The steps, considerations and challenges in determining the application of DTAA are
summarized as under:
Steps Considerations Challenges
Examine whether • Indian firm and Indian LLP • If the Indian firm is not a
qualifying as a person is taxable unit in India taxable unit in the other
as defined in the Accordingly, they should Contracting State and
DTAA qualify as a person from therefore not qualifying as
India perspective and person, whether the other
accordingly provisions of Contracting State may
DTAA should be applicable grant the DTAA benefit to
to them while determining the firm?
tax liability in India. [The response to the
• The Indian LLP being a aforesaid may depend on
body corporate may qualify the interpretation of DTAA
as a company 12 for the by the other Contracting
purpose of the DTAA and State]
accordingly, the other • Whether in such case, the
country may consider partner may claim benefit
applying the provisions of of the DTAA in his
DTAA while determining individual capacity?
the tax liability of Indian [If the partner is taxable in
LLP in that country his individual capacity in
the other Contracting State,
then for the purpose of
application of DTAA, the
other Contracting State
may consider to apply
provisions of DTAA to
partners in their individual
capacity.]
Determining the Depends on the provisions of • If the Indian firm is not a
residence under the the domestic tax law of the taxable unit in other
DTAA respective Contracting State. country, whether the
[Generally, Indian partnership residential status of partner
and Indian LLP controlled and needs to be examined?
managed from India may [If the partner is taxable in
qualify as a resident of India for his individual capacity in
the purpose of DTAA even in the other Contracting State,
the case the tie-breaker then for the purpose of
12 The term “company” in DTAA is generally defined to mean a body corporate


provisions are triggered] application of DTAA, the
may consider to apply
provisions of DTAA to
partners in their individual
capacity].
Determining the right The conditions as prescribed in • Whether the activity of
of taxation in the other the relevant Article may need to partnership firm in the other
state be examined to determine the Contracting state may
Article governing the income trigger a PE exposure to
received outside India and the the Partner in the other
taxing rights of the other country if he is taxed in the
Country in relation to said other country in his
income. individual capacity.
[As per the OECD
commentary, for
determining the residential
status of a partner of a
fiscally transparent firm in
the other Contracting State,
the activity of the
partnership firm may
require to be considered. If
the partnership firm triggers
a permanent establishment
in other Contracting State,
then the partner individually
may be considered to
trigger PE in other
contracting State]
• Article on Business Profits
v/s. Article on Independent
Personal Services
A challenge may arise
where the conditions of one
Article are satisfied vis – a
– vis the other. For
example, presence of
employee triggers a
Service PE in the other

Contracting State however,
not resulting in fixed base
in other Contracting state.
Will the said situation result
in triggering tax liability in
other contracting state?
Can it be argued that the
Article on Independent
Personal Services should
apply and therefore, in the
absence of fixed base, the
other country does not
have right of taxation under
DTAA?
[The response to the above
is subject to the
interpretation of the
provisions of DTAA by the
respective country.
However, view of one
country may not be bidding
on the other country. This
could result in litigation. In
such a case, it may be
decided to resolve the
issue under mutual
agreement procedure]
Determining the The DTAAs entered into by • Whether a partner is taxed
eligibility to claim tax India are generally following the in the other Contracting
credit in the state of credit method. State in his individual
residence As India is likely to be the capacity. The question may
resident state of the Indian arise on whether credit of
partnership and Indian LLP, the the tax paid in the other
credit under the DTAA may be country on the profits of the
required to be granted by India. partnership firm would be
allowed to the partnership.
7.4.2 Scenario II - Taxation of partners of Indian LLP who are based outside India
The share of profit received by a foreign partner from an Indian LLP is exempt in India in the
hands of the foreign partner under section 10(2A) of the Act.
The foreign partner may however be taxed in the other jurisdiction on his/her/its share of
profits as per its domestic tax laws.
Thus there may be double taxation of the share of profit received by the foreign partner.
In India, as the share of profit is exempt under the ITA in the hands of individual partners, ITA
being beneficial, the examination of the DTAA may not be required.
However, as regards tax payable in the other country in the hands of foreign partner, the
following questions may arise:
(a) Whether it could be argued that under the DTAA, Indian LLP is likely to qualify as a
resident of India and accordingly, only India should have the right to tax the share of
profit of the Indian LLP (having no operations outside India) derived by a foreign
partner?
(b) Whether under the DTAA, credit of tax paid in India by the Indian LLP may be allowed
to be claimed against the tax liability of the foreign partner in the other country.
The response to the above would depend on the interpretation of the provisions of DTAA and
the local tax laws by the other country.
The aforesaid scenario may also apply to a foreign partner of an Indian partnership.
7.4.3 Scenario III - Taxation of foreign partnership and/or partners in a foreign
partnership, where the partnership is deriving income from India and none of the
partners are based in India
The foreign partnership may be a firm or a registered LLP.
Under the ITA, the status of the foreign partnership (firm/company/association of person/body
of individuals) would depend on the legislation in the country of registration (refer discussion
above). Depending on the status, the provisions of section 6 would require examination to
determine the residential status.
It is likely that a foreign partnership may qualify as a non-resident in India under the ITA.
Accordingly, as per section 5(2) of the ITA, India may have a right to tax only income accruing
or arising or deemed to accrue or arise in India or income received in India.
The income received from services rendered in India may be taxable in India on accrual basis.
Further, the payment received for services rendered outside India by the partnership may be
taxable under the source rule (deemed to accrue or arise in India) as provided under section 9
of the Act in relation to services utilized by service recipient for business or profession carried
out in India or earning any income from any source in India.
Further, the income may also be taxable in the other country resulting in double taxation. The
provisions of the DTAA may therefore require examination to deal with the double taxation.
The steps, considerations and challenges in determining the application of DTAA in the given
case are summarized as under:

Examine whether • The foreign partnership
qualifying as a could qualify as a company
person as defined in or a taxable unit in India and
the DTAA thus, qualify as a person as
defined in the DTAA from
India perspective
Determining Depends on the provisions of the • If the foreign partnership is
residence under the domestic tax law of the not a taxable unit in the
DTAA respective Contracting country. other jurisdiction (i.e. it is a
[Generally, foreign partnership fiscally transparent), it may
controlled and managed wholly not qualify as a resident of
from outside India may qualify as the other Country. In such
a non-resident of India for the case, whether the India may
purpose of DTAA. Further, the grant the DTAA benefit to
provisions of DTAA may only the firm?
apply if the partnership firm • If the foreign partnership is
qualifies as a resident of the not a taxable unit in other
other country] Contracting State and
therefore does not qualify as
a person, whether India may
grant the DTAA benefit
based on the residential
status of the partners of the
firm?
• If answer to the above
question is in affirmative,
which DTAA should be
considered if the partners of
the firm do not belong to the
same jurisdiction?
[The aforesaid are currently
an area of contention and
there in no clear guidance in
the matter at present]
Determining the The conditions as prescribed in • Article on Business Profits
right of taxation in the relevant article may need to v/s. Article on Independent
the other state be examined to determine the Personal Services
Article governing the income A challenge may arise where
received outside India and the the conditions of one Article
taxing rights of the other country are satisfied vis – a – vis the

in relation to said income. other. For example,
presence of employee
triggers a Service PE in the
however, not resulting in
fixed base in other
Contracting state. Will the
said situation result in
triggering tax liability in
India? Can it be argued that
the Article on Independent
absence of fixed base, India
does not have right of
taxation under DTAA?
[There in no clear guidance
in the matter from an India
perspective at present.
such a case, it may be
decided to resolve the issue
under mutual agreement
procedure]
Determining the As India is likely to be the non- • If the partner is taxed in the
eligibility to claim resident state of the foreign other Contracting State in
tax credit in the partnership, the credit under the his individual capacity, the
state of residence DTAA may be claimed in the question may arise on
other country. whether credit of the tax
paid in the India on the
profits of the partnership firm
would be allowed to the
partner.
[The above is subject to the
provisions by the other
contracting state]
7.4.4 Scenario IV - Taxation of foreign partnership, where one of the partners is based
in India
As per section 6(2) of the ITA, a firm is considered as a resident in every case except whether
the control and management of its affairs is situated wholly outside India. In this context, it
may be highlighted that if one of the partners of the foreign partnership is generally based in
India and is involved in the management of the firm, the said firm may qualify as a “resident”
of India.
Further, as per section 6(3) of the ITA, a company, not being an Indian company, is said to be
a resident of India in any previous year if its place of effective management in that year is in
India. Accordingly, a foreign LLP being a body corporate may also qualify as a resident in
India if it could be held that the place of effective management is in India.
If the foreign partnership is held to be resident in India, then it may be subject to tax in India
on its global income.
This will result in double taxation requiring the examination of the provisions of the DTAA.
Examine whether • The foreign partnership
qualifying as a could qualify as a company
person as defined in or a taxable unit in India and
the DTAA thus, qualify as a person as
defined in the DTAA for
India perspective
Determining the Depends on the provisions of the • If the foreign partnership is
residence under the domestic tax law of the not a taxable unit in the
DTAA respective Contracting country. other jurisdiction (i.e. it is a
[In the given case, the foreign fiscally transparent), it may
partnership may qualify as a tax not qualify as a resident of
resident of both the countries. the other Country. In such
Under the tie-breaker test to case, whether India may
determine the country of grant the DTAA benefit to
residence, the key criteria should the firm?
generally be the place of • If the foreign partnership is
effective management. not a taxable unit in other
Contracting State and
Whether the place of effective
therefore does not qualify as
management of the partnership
a person, whether India may
is in India would depend on the grant the DTAA benefit
facts of the case. However, a based on the residential
view of one country in the matter status of the partners of the

may not be binding on the other firm?
country. This could result in • If answer to the above
litigation. In such case, it may be question is in affirmative,
decided to resolve the issue which DTAA should be
under mutual agreement considered if the other
procedure, but the same may partners of the firm do not
involve time and cost.] belong to the same
jurisdiction?
[The aforesaid are currently
an area of contention and
there in no clear guidance in
the matter at present]
Determining the The conditions as prescribed in • Article on Business Profits
right of taxation in the relevant article may need to v/s. Article on Independent
the other state be examined to determine the Personal Services
Article governing the income A challenge may arise where
received outside India and the the conditions of one Article
taxing rights of the other country are satisfied vis – a – vis the
in relation to said income. other. For example,
presence of employee
triggers a Service PE in the
however, not resulting in
fixed base in other
Contracting state. Will the
said situation result in
triggering tax liability in
India? Can it be argued that
the Article on Independent
absence of a fixed base,
India does not have right of
taxation under DTAA?
[There in no clear guidance
in the matter from India
perspective at present.

such case, it may be
decided to resolve the issue
under mutual agreement
procedure]
Determining the The credit under the DTAA may • If a partnership is taxed in
eligibility to claim be claimed in the country in the other Contracting State
tax credit in the which the partnership qualifies as a fiscally transparent unit,
state of residence as a resident for DTAA if India is a resident country,
purposes. the question may arise on
whether India would grant
credit of tax paid in other
country by the partner in
his/her individual capacity.
Further, if other country is a
resident country, the
question may arise on
whether credit of the tax
paid in India on the profits of
the partnership firm would
be allowed to the partner.
provisions by the
Contracting states]
7.4.5 Scenario V – Taxation of partners of a foreign partnership who are based in India
If the foreign partnership is taxable in India on account of partner being based in India (refer
Scenario IV above), then in view of the section 10(2A) of the ITA, the share of profit should be
exempt in the hands of the partners.
However, if the foreign partnership is not assessed to tax in India, then the share of profits
from the foreign partnership may be taxable in the hands of the partner if he qualifies as
“Resident and Ordinarily Resident” in the relevant assessment year.
This may result in double taxable requiring the examination of the provisions of the DTAA.
Examine whether The partner should qualify as a
qualifying as a person as defined in the DTAA
person as defined for India perspective
in the DTAA

Determining the Depends on the provisions of the
residence under the domestic tax law of the
DTAA respective Contracting country.
[If the partner may qualify as a
tax resident of both the
countries, the tie-breaker test
may require examination.]
Determining the The conditions as prescribed in • Whether the presence of
right of taxation in the relevant article may need to partnership in other country
the other state be examined to determine the may trigger a Permanent
Article governing the income Establishment exposure for
received outside India and the the partner in the other
taxing rights of the other country country?
in relation to said income. [The above is subject to the
provisions by the other
Contracting states]
Determining the The credit under the DTAA may • Whether a partnership is
eligibility to claim be claimed in the country in taxed in the other
tax credit in the which the partner qualifies as a Contracting State as a firm,
state of residence resident for DTAA purposes. if India is a resident country,
the question may arise on
whether India would grant
credit to the partner of tax
paid in other country by the
partnership. Further, if other
country is a resident country,
the question may arise on
whether credit of the tax paid
in the India on the profits of
the partner in his individual
capacity would be allowed to
the partnership.
provisions by the
Contracting states]
Further, in the aforesaid scenario, the other question that may need to be examined is:
Whether it could be argued that under the DTAA, foreign partnership may not be subject to tax
in India and accordingly, only the other country should have the right to tax the share of profit
of the foreign partnership (having no operations inside India)?
7.5 Concluding remarks

It could thus be observed from the above, that there are complexities and challenges involved
in the determination of the tax liability of partners as well as partnership subject to tax in more
than one jurisdiction. The challenges are higher where the tax treatment of the partnership
(i.e. if it is a fiscally transparent or a separate taxable unit) differs in the jurisdictions under
consideration.
Further, the partnership involving partners based in multiple jurisdictions requires review of
multiple DTAAs (referred to as triangular cases).
A careful review of the tax implication is therefore required.
It may be noted that this Chapter seeks to discuss the income tax implications in relation to
partnership. The implication under the Foreign Exchange Management Act, 1999 and
regulations prescribed thereunder, The Indian Partnership Act, 1932, Limited Liability
Partnership Act, 2008 and any other relevant legislation needs to be considered
independently.
Unit VIII Recent judicial developments in India

Introduction
The subject of taxation keeps on evolving with the changes in the business environment.
International tax, in India and globally, is also going through constant evolution based on the
dynamic business arrangements vis-a-vis legal framework and accordingly the judicial
developments act as a ‘lighthouse’ for the tax administration, taxpayers as well as for tax
professionals to sail through the sea of tax provisions.
In this chapter some of the key decisions handed down over the period January 2013 to
May2018are discussed. These decisions have laid down significant principles based upon
interpretation of domestic tax law and treaty wordings.
8.1 Formula One World Championship Ltd. v. CIT [2017] (80

taxmann.com 347) (SC)
Understanding of facts: Formula One World Championship Ltd. (‘FOWC’) is a UK tax
resident company. FOWC entered into an agreement with the Federation Internationale de
I’Automobile (‘FIA’) and Formula One Asset Management Limited (‘FOAM’). As per the terms
of this agreement FOAM licensed all commercial rights in the FIA Formula One World
Championship to FOWC for 100- year term effective from January 1st 2011.
FOWC further entered into a “Race Promotion Contract” (‘RPC’) with Jaypee Sports
International Limited (‘Jaypee Sports’) dated September 13, 2011. Under this agreement,
Jaypee Sports was awarded the right to host, stage and promote the Formula One Grand Prix
of India event for a consideration of USD 40 million.
The taxability of the revenues of USD 40 million earned by FOWC was a matter of concern for
both, the assessee as well as the Revenue. The matter was taken to to the AAR to determine
the taxability of the revenues earned by FOWC. The AAR held that the amount paid/ payable
by Jaypee Sports to FOWC would be treated as Royalty as per India UK Double Taxation
Avoidance Agreement (‘DTAA’); FOWC did not have Permanent Establishment (‘PE’) in India.
However, Jaypee Sports is bound to make appropriate deductions from the amount payable to
FOWC under Section 195 of the Income tax Act, 1961 (‘Act’).
When the matter reached Delhi High Court (‘HC’) 390 ITR 199, the Delhi HC, vide order dated
30 November 2016, reversed the ruling of the AAR and held that the amount paid/ payable by
Jaypee Sports to FOWC would not be treated as royalty; FOWC had a fixed place PE at the
circuit and therefore RPC fee attributable to PE in India is taxable in India. Further, the HC
has not accepted the plea of the Department on dependent agent PE (‘DAPE’). Accordingly,
Jaypee Sports is bound to make appropriate deductions from the amount payable to FOWC
under Section 195 of the Income tax Act, 1961. Aggrieved, the taxpayer filed an appeal before
the Supreme Court (‘SC’).
Ruling of the Supreme Court: The major issues and ruling of SC thereof are under;
 Whether FOWC had a PE in India through the Racing Circuit and whether it carried
on any business activity through the Circuit?
SC referred to the Organisation for Economic Co-operation and Development (‘OECD’) Model
Tax Convention commentaries by Philip Baker and Klaus Vogel, and noted that as per Article
5 of the DTAA, the PE has to be a fixed place of business ‘through’ which business of an
enterprise is wholly or partly carried on.
SC observed and held that the international circuit is a fixed place and since races are
conducted from this circuit, it is an economic/business activity. The Buddh International Circuit
from where different races, including the Grand Prix was conducted was undoubtedly an
economic/business activity. The SC completely agreed with the HC’s stern view that Formula
One “monetized” every commercial right that it possessed in conducting the event in India (in
its capacity as the commercial rights holder). The Apex Court referred to the arrangement
between assessee and its affilitaes on one hand and Jaypee Sports on other hand. SC held
that various agreements cannot be looked into by isolating them from each other and their
wholesome reading was necessary to bring out the real transaction between the parties. Such
an approach is essentially required to find out as to who is having real and dominant control
over the Event.
SC observed that FOWC is the Commercial Rights Holder (‘CRH’). These rights can be
exploited with the conduct of the F1 Championship, which is organised in various countries. It
is FOWC and its affiliates which have been responsible for all activities required for conduct of
a race (for example, racing track, participating teams, spectators, revenue from advertisement
and media rights, etc). FOWC acquired all commercial rights in championship by way of an
agreement with FIA which was entered way back in 2001 according to which said rights could
not be transferred to any party outside Formula One group. It was observed that on the same
day when assessee entered into RPC with Jaypee, another agreement was signed between
Jaypee and three affiliates of FOWC whereby Jaypee gave back circuit rights, mainly media
and title sponsorship, to Beta Prema 2 and paddock rights to All sports.
SC further observed that “FOAM is engaged to generate TV Feed. All the revenues from the
aforesaid activities are to go to the said companies, namely, Beta Prema 2, Allsports and
FOAM respectively. These three companies are admittedly affiliates to FOWC.” Accordingly,
SC held that the aforesaid arrangement demonstrated that the entire event was taken over
and controlled by FOWC and its affiliates.
SC rejected assessee’s stand that it is Jaypee who was responsible for conducting races and
had complete control over the Event in question. SC clarified that mere construction of the
track by Jaypee at its expense will be of no consequence. Further, it clarified that its
ownership or organising other events by Jaypee was also immaterial.
SC observed that “There cannot be any race without participating/ competing teams, a circuit
and a paddock. All these are controlled by FOWC and its affiliates. Event has taken place by
conduct of race physically in India. Entire income is generated from the conduct of this event
in India.” Thus, SC held that the commercial rights of this race were with FOWC which were
exploited with actual conduct of race in India. It is also difficult to accept that FOWC had no
role in the conduct of the Championship and its role came to an end with granting permission
to host the event as a round of the Championship. Entire income generated in India from the
conduct of the event in India. Exploitation of the commercial rights of FOWC became possible
only with actual conduct of the races and active participation of FOWC in the said races, with
access and control over the circuit.
Further, by virtue of the Concorde agreement 2009, FOWC enabled participation of the teams
and FIA undertook to ensure that events were held and FOWC, as CRH, undertook to enter
into contracts with event promoters and host such events. Thus, omnipresence of FOWC and
its stamp over the event was loud, clear and firm
The SC relied upon:
o Andhra Pradesh HC Ruling in the case of Visakhapatnam Port Trust [(1983) 144 ITR
146] to hold that there was a virtual projection of the foreign enterprise, namely,
Formula-1 (i.e. FOWC) on the soil of this country.
o Philip Baker wherein to constitute PE three characteristics: stability, productivity and
dependence need to be satisfied. According to the Court all such characteristics were
satisfied in the present this case.
In light of the above, the Court held that the aesthetics of law and taxation jurisprudence left
no doubt in their mind that taxable event has taken place in India and the non-resident FOWC
is liable to pay tax in India on the income it has earned on this soil. Most of the DTAAs provide
a minimum threshold in terms of the number of days for the non-resident to form a PE in a
country. Accordingly, the assessee was of the view that FOWC conducted business in India
for a limited duration of three days of the event.
SC rejected assesseee’s stand that the total duration for which limited access was granted to
it, was not sufficient duration to constitute the degree of permanence necessary to establish a
fixed place PE. Assessee had submitted that duration of the event was three days and,
therefore, control, if at all, would be for that period only. On this, Revenue had pointed out
that the duration of the agreement was five years, which was extendable to another five years.
SC clarified that “The question of the PE has to be examined keeping in mind that the
aforesaid race was to be conducted only for three days in a year and for the entire period of
race the control was with FOWC.”
SC affirmed HC finding that having regard to the duration of the event, which was for limited
days, and for the entire duration FOWC had full access through its personnel, number of days
for which the access was there would not make any difference. While pondering over the
duration tests, reliance was placed on the following rulings:
o Joseph Fowler v. M.N.R. (1990) 90 D.T.C. 1834; (1990) 2 C.T.C. 2351 (Tax Court of
Canada)
o Antwerp Court of Appeal, decision of February 6, 2001, noted in 2001 WTD 106-11
o Universal Furniture Ind. AB v. Government of Norway (Stavanger Court, Case No. 99-
00421, dated 19-12-1999 referred to in Principles of International Taxation by Anghard
Miller and Lyn Oates, 2012)
 Whether the Circuit was under the control and disposal of FOWC?
SC held that entire arrangement between FOWC and its associates on the one hand and
Jaypee on the other hand, was to be kept in mind. Various agreements cannot be looked into
by isolating them from each other.
Their wholesome reading was essentially required to find out as to who is having real and
dominant control over the Event, thereby providing an answer to the question as to whether
Buddh International Circuit was at the disposal of FOWC and whether it carried out any
business therefrom or not.
SC observed that the fixed place of business in the form of physical location, i.e. Buddh
International Circuit, was at the disposal of FOWC through which it conducted business. SC
ruled that, based on the materials placed on record, the entire event was “taken over” and
“controlled” by Formula One and its affiliates. According to the SC, this was borne out from the
facts; The event was held physically in India and income was generated from the event in
India; Commercial rights vested with Formula One, which were exploited by conducting the
event in India; The physical control of the circuit was with Formula One and its affiliates from
the inception till the conclusion of the event; and The participating teams and paddock were
controlled by Formula One and its affiliates.
Accordingly, SC rejected assessee’s argument that international circuit was not at its disposal.
In light of the above, SC held that payments made by Jaypee Sports to FOWC under the RPC
were business income of the FOWC through PE at the Buddh International Circuit, and,
therefore, chargeable to tax. Jaypee Sports was bound to make appropriate deductions from
the amounts paid u/s. 195 of the Act.
However, SC accepted assessee’s submission that only that portion of the income of FOWC,
which is attributable to the said PE, would be treated as business income of FOWC and the
Tax Deducted at Source obligation is limited to the appropriate portion of income which is
chargeable to tax in India and in respect of other payments where no tax is payable, recourse
is to be made under Section 195(2).
SC directed Assessing Officer to arrive at the profits attributable to PE in India, which would
be chargeable to tax. SC further clarified that “At that stage, Jaypee Sports can also press its
argument that penalty etc. be not charged as the move on the part of Jaypee Sports in not
deducting tax at source was bona fide.
SC, thus, dismissed assessee’s appeal.
8.2 Palam Gas Services v CIT [2017] (81 taxmann.com 43) Supreme
Court
Understanding of facts: The provisions of the Income Tax Act (‘the Act’) impose a statutory
obligation on a person, who is making payments of a specified nature, to deduct tax at source
(‘TDS’) at the time of credit to the account of the payee or at the time of payment thereof,
whichever is earlier (‘TDS provisions’). Furthermore, such taxes withheld are required to be
deposited with the Government of India (‘GOI’) within the prescribed time.
In order to augment the compliance of the TDS provisions, the Act provides for various
consequences for failure to deduct taxes, which include disallowance of expenses “payable”,
on which tax is deductible at source but such tax has not been deducted or, after deduction,
has not been paid on or before the due date of filing return of income. However, deduction of
such expenses is permitted in the subsequent year in which a assessee complies with the
TDS provisions and pays tax to the GOI.
Use of the expression “payable” in the disallowance provision gave rise to an issue of whether
the disallowance applies only in respect of expenses remaining ”payable” as on the last day of
the tax year or whether it is also applicable in respect of expenses “paid” during the tax year
without deducting tax.
Various High Courts (‘HCs’) dealt with the issue and took divergent views. While most of the
HCs (viz., Calcutta HC in the case of CIT v. Crescent Export Syndicate [216 Taxman 258] ,
Gujarat HC in the case of CIT v. Sikandarkhan N Tunvar [357 ITR 312] and Punjab &
Haryana HC in the case of P.M.S Diesels v. CIT [374 ITR 562]) took the view that
disallowance is triggered even if expenses are “paid”, the Allahabad HC (CIT v. Vector
Shipping Services (P) Ltd. [357 ITR 642]) took the view that disallowance is triggered only
when the TDS default is in respect of the amount which is “payable” as at the end of the year.
Taking note of the conflicting judicial precedents on the issue, the Central Board of Direct
Taxes (‘CBDT’) issued a Circular No. 10/DV/2013 dated 16 December 2013 which clarified
that disallowance is triggered regardless of whether the amounts are payable as at the end of
the tax year or actually paid during the year.
In the present case, the assessee Palam Gas Services (‘PGS’) was engaged in the business
of trading in LPG cylinders. It had paid freight charges to sub-contractors towards
transportation of LPG cylinders to its customer’s place. Such payments were made without
deduction of applicable taxes.
The Income Tax Department (‘ITD’) disallowed such payments on account of the PGS’s failure
to deduct taxes, by holding that disallowance is triggered even if expenses are paid during the
year and are not outstanding as at the end of the tax year.
Being aggrieved, the assessee filed successive appeals before the CIT(A) and ITAT. The
CIT(A), the ITAT and the Himachal Pradesh HC dismissed the assessee’s appeal by
upholding the ITD’s contention.
Being aggrieved, the assessee preferred further appeal before the SC.
Ruling of the Supreme Court:Applicability of the disallowance provision where expense
is already “paid” and no amount remains “payable”
Hon’ble SC observed that the TDS provisions impose a statutory obligation on the assessee to
deduct taxes at the time of credit of the sum to the account of the payee or at the time of
payment thereof, whichever is earlier. Thus, the TDS provisions contemplate tax deduction not
only on the occasion when the payment is actually made, but also at the time when the
amount is credited to the account of the payee, if such credit is earlier than the payment.
Further, the SC also observed that if the scheme of the TDS provisions is read holistically, it is
clear that the expression “payable” used in the disallowance provision covers not only cases
where the payment is yet to be made, but also cases where payment has actually been made.
Though the expressions “payable” and “paid” denote different meanings grammatically, such
distinction is irrelevant for interpretation of the disallowance provision since withholding tax is
triggered in both cases.
In view of the SC, the disallowance provision is applicable as much to assessees which follow
the mercantile system of accounting as to assessees following the cash system of accounting.
By use of the expression “payable” in the disallowance provision, the Legislature included the
entire accrued liability which, in the context of assessees following the mercantile system of
accounting, will cover the amount credited to the account of the payee and, for assessees
following the cash system of accounting, will cover the actual payment of liability.
Further, SC observed that the purpose of the disallowance provision is to augment the
compliance of TDS provisions, as also to bring more persons within the tax net. Once it is
found that the TDS provisions mandate a person to deduct tax not only on the amounts
payable but also when the sums are actually paid to the payee, the assessee which does not
adhere to such statutory obligation has to suffer related consequences, which include
disallowance of expenses. This is made clear by TDS provisions which provide that the
consequence of a assessee being regarded as an “assessee-in-default” for committing TDS
tax default shall be without prejudice to any other consequence under the Act.Accordingly, tax
is also required to be deducted on the amount of provisions made in the books of accounts.
Allahabad HC decision in the case of Vector Shipping Services overruled-The Allahabad HC
did not consider the amplitude of the TDS provisions while concluding that the disallowance
provision would apply only when the amount is “payable”. Hence, the said judgement was held
incorrect and overruled.
It is true that the Special Leave Petition (‘SLP’) of the ITD against the Allahabad HC’s ruling
was rejected by the SC earlier, but it is well settled that a mere rejection of an SLP does not
amount to an HC ruling being confirmed by the SC.
Accordingly, the SC decision puts the controversy to rest by confirming that the scope of the
disallowance provision covers not only amounts payable as at the end of the year, but also
amounts paid during the year. This view also fortifies the view expressed earlier in the CBDT
Circular.
8.3 Sale of shares of Indian company by Dutch company covered

under Article 13(5) of the India – Netherlands DTAA and hence
not taxable in India. Revenue’s approach of treating sale of
shares as sale of immovable property as per Article 13(4) of the
DTAA is not tenable - DIT(IT) v Vanenburg Facilities BV [2017] 82
taxmann.com 433 (HC of Andhra Pradesh)
Understanding of facts: Vanenburg NL, is a company incorporated in the Netherlands and
has a wholly owned subsidiary, namely Vanenburg IT Park India Private Limited (VITIPL), in
India. VITIPL is engaged in the business of developing, operating and maintaining
infrastructure facilities in India. Vanenburg NL sold 100% shares of VITIPL to Ascendas, a
Singapore based company.
The question arose regarding the gains arising on transfer of shares of VITIPL to Ascendas is
taxable as capital gains in India in view of the India –Netherland Tax Treaty under para (1),(4)
or (5) of Article 13.
Ruling of the High Court: Andhra Pradesh and Telangana HC upheld ITAT order for AY
2005-06 in favour of Vanenburg NL, capital gains arising to Vanenburg NL (a Dutch company)
on sale of shares of its Indian subsidiary (holding investment in IT park) to Singapore buyer,
not taxable in India under India-Netherlands DTAA.
The HC directed Revenue to expeditiously issue refund to assessee of the TDS deducted and
deposited by the purchaser. The HC noted that AO and CIT(A) erred in applying Article 13(1)
of the DTAA by equating alienation of a company’s shares to alienation of its immovable
property and held that the ludicrous logic that shares partake the character of immovable
property be applied here.
The HC cited legal distinction between ‘share sale’ and ‘asset sale’ as summed up by SC in
Vodafone case. The HC also approved ITAT’s findings that alienation of shares by assessee
does not fall under Article 13(1) of the DTAA and by virtue of residuary clause in Article 13(5),
gains will be exempt from taxation in India. Article 13(4) of the DTAA deals with taxability of
gains arising from alienation of company shares, the value of which is principally derived from
immovable property other than that used in the business of such company. Article 13(5) of the
DTAA is the residuary clause which provides that gains from the alienation of any property
other than that referred to other paragraphs shall be taxable only in the State of which the
alienator is a resident.
Further, the HC accepted assessee's objection to Revenue's claim raised first time before the
HC of seeking to tax the transaction under Article 13(4) of the treaty. HC noted that both AO
and CIT(A) explicitly held that Article 13(4) did not apply to the transaction and later neither
CIT nor AO/CIT(A) took remedial steps. The HC also rejected Revenue's argument that
applicability of Article 13(4) to share sale is a pure question of law and observed that "Whether
immovable property from which the company’s shares principally derived their value was
property in which the business of the company was carried on or not is a question of fact".
With respect to interest paid by the purchaser to compensate for the delay in remitting the sale
consideration, HC upholds ITAT order that such interest was not taxable u/s. 9(1)(v) of the Act
as “there is no evidence of a debt being incurred or monies being borrowed for any business
purposes in present case” Sec. 9(1)(v) of the Act provides that income by way of interest
payable by a person who is a non-resident would be deemed to be income accruing or arising
in India, where such interest is payable in respect of any debt incurred, or moneys borrowed
and used, for the purposes of a business or profession carried on by such person in India.
Further, HC affirmed applicability of Article 11 of the DTAA (which provides taxability in
Netherlands), and rejected Revenue’s stand that Article 11 was not applicable as it excludes
penal interest. Article 11(1) of the DTAA provides that interest arising in one of the States and
paid to a resident of the other State would be taxed in that other State. Article 11(6) defines
‘interest’ to mean income from debt-claims of every kind, but penalty charges for late payment
shall not be regarded as interest for the purpose of the said Article. Referring to the Share
Purchase agreement, HC observes that the purchaser “voluntarily undertook to pay interest for
such late payment of the sale consideration, the same does not partake the character of
penalty charges”
Accordingly, the HC in the above discussed case held that the shares in a company owning
immovable property cannot itself be considered as immovable property.
8.4. CIT v Hero Motocorp Ltd. [2017] (81 taxmann.com 162) (Delhi
High Court)
Understanding of facts: The Assessee is engaged in the business of manufacture and sale
of motorcycles using technology licensed by Honda Motor Co.Ltd., Japan ('HMCL'). The
Assessee set up its plant in the year 1984 to manufacture models of motorcycles by using
know-how of HMCL through a Technical Collaboration Contract dated 24th January, 1984
under which the Assessee was provided with technical assistance not only for manufacture,
assembly and service of the products but was also provided with information, drawings and
designs for the setting up of the plant.
The said agreement expired in 1994. On 2nd June, 1995 a License and Technical Assistance
Agreement ('LTAA') was entered into between HMCL and the Assessee on fresh terms for a
further period of ten years. By another LTAA dated 2nd June, 2004, the earlier LTAA was
extended for an additional period of ten years. On 21st June, 2004 a separate Export
Agreement ('EA') was entered into between HMCL and the Assessee whereby HMCL
accorded consent to the Appellant to export specific models of two wheelers to certain
countries on payment of export commission @ 5% of the FOB value of such exports.
The Transfer Pricing Officer ('TPO') held that the payment of export commission by the
Assessee to its AE i.e., HMCL was unnecessary; that it was detrimental to the Assessee and
only with a view to benefitting the AE's units/subsidiaries in those countries to which the
Assessee was permitted to export the vehicles. On this basis, the TPO proceeded to hold that
the Arm's Length Price ('ALP') of the said transaction i.e., the payment of export commission
was nil.
After the Dispute Resolution Panel (‘DRP’) concurred with the AO, the Assessee filed an
appeal before the ITAT. By the impugned order, the ITAT reversed the above orders of the
TPO, the DRP and the assessment order by holding that there was no basis for treating the
payment of export commission as an international transaction.
The Revenue urged the Court to frame a question on the alternative plea viz., that the
payment of export commission was in fact payment of royalty which required the Assessee to
deduct tax at source and the failure to do so led to disallowance of the deduction under
Section 40(a)(i) of the Act.
Ruling of the High Court: The Hon’ble High court, referring to the specific wording of the
clauses of both the LTAA and the EA, observed that it was not possible to accept the
contention that the export commission was in fact the monetisation of the negative covenant of
the LTAA viz., abstaining from exporting to territories outside India.
The Hon’ble High Court further observed that there was no question of having to be a
principal-agent relationship to justify the payment of the export commission. The amount spent
on that score by the Assessee was for the benefit of its business and in fact resulted in a
benefit. The Hon’ble High Court distinguished CIT v. Shiv Raj Gupta 52 taxmann.com 425
(Delhi) by holding that the two agreements i.e., the LTAA and EA were distinct and
independent. The Revenue had not been able to show that the EA was a colourable device
and that the export commission was a disguised royalty payment. It was not a payment for
technical services either.
The Hon’ble High Court concluded that the payment of export commission by the Assessee to
HMCL was not in the nature of payment of royalty or fee for technical services attracting
disallowance under Section 40(a)(i) of the Act. The appeal was, accordingly, dismissed.
Key Takeaways: Payment of export commission by way of export agreement and using the
technology licenced by AE abroad, could not be regarded as royalty or fee for technical
services taxable in India since no managerial, technical or consultancy services were
rendered.
8.5 Domestic software purchase payments not royalty -CIT vs Vinzas

Solutions India Pvt Ltd-[2017] 77 taxmann.com 279 (Madras HC)
Understanding of facts: The Assessee was a dealer in computer software and was engaged
in buying and selling software from various companies.
The AO made disallowance under section 40(a)(ia) on the ground that the consideration for
purchase was of the nature of ‘royalty’ by the virtue of explanation 4 & 5 to section 9(1)(vi) and
tax ought to have been deducted at source in accordance with the provisions of section 194J
of the Income-tax Act, 1961 (Act).
Ruling of the High Court:The HC stated that the assessee was engaged in buying and
selling of software in open market and ‘royalty’ cannot be made applicable to a situation of
outright purchase and sale of a product. The HC noted that there is a difference between a
transaction of sale of a ‘copyrighted article’ and one of ‘copyright’ itself and section 9(1)(vi)
would stand attracted to sale of ‘copyright’ and not on ‘copyrighted article’.
Thus, the HC ruled in the Assessee’s favour.
8.6 New Skies Satellite BV (382 ITR 114)(Delhi HC) (2016)
Understanding of facts:The non-resident tax-payer, a Thailand Company for two assessment
years and a Netherlands Company for other assessment years out of total four, was engaged
in the business of providing digital broadcasting services through satellite “Thaicom 3" and
consultancy services. Its customers were both Indian residents and non-residents, specifically
TV channels.AO sought to tax income earned in India under section 9(1)(vi) of the Act as
royalty and also contended that beneficial provision of Article 12 of India – Thailand on
Royalties would not apply.
ITAT held in favor of tax-payer considering that customers did neither use satellite nor it is a
process and they were given only access and hence such income could not be termed as
royalty.
The issue before the Delhi High Court was whether the income earned in India by providing
data transmission services would fall under section 9(1)(vi) of the Act?If yes, would tax-
payerbe eligible for India – Thailand DTAA / India – Netherlands DTAA benefits?
The Revenue contended that the programs were created for Indian audience and India was a
territory of commercial exploitation by tax-payer since services were actually utilized in India
and hence taxable under the Act. The operative words in the definition of royalty given under
section 9(1)(vi) would be “use“ and “process“ and tax-payer performed critical processes
required for satellite television broadcast and satellite internet service which amounts to “use”
or “process“ and not for hiring the transponder. Revenue further contended that Post Finance
Act, 2012 amendment to the said section by way of insertion of clauses which are clarificatory
in nature, the said income is royalty.Also DTAA benefits should not be available since it was in
relation to pre-amended statute.
The taxpayer contended that the agreement was for lease of transponder capacity and not use
of the same.Any change in domestic law could not automatically effect the position that would
be as per the provisions of the DTAA, i.e., Treaty cannot be amended unilaterally.
Ruling of the High Court:
Delhi High court dealt with the clarificatory amendment in detail so as to come to a conclusion
whether it is retrospective in nature or not. Owing to difficulty and since this was not argued by
the tax-payer, High court assumed it to be retrospective in the present case and did not
answer any question in this regard. However, it upheld that no amendment to the Act can be
extended in operation to the terms of an international treaty and hence the provisions of DTAA
are applicable in the current case. Even though the secrecy of the process is immaterial in
domestic law, in the definition given under Article 12 of the India – Thailand DTAA / India –
Netherlands DTAA the process should be a secret one.
This view was also affirmed by the commentaries of OCED as well as Klaus Vogel on double
tax conventions. OCED commentaries particularly views that such an arrangement, as in case
of tax-payer, is the lease of the transponder capacity and in no way be viewed as "for use of
or right to use". Also it cannot be termed as equipment. Klaus Vogel commentary states that
use of a satellite is a service and not rental. Relying on other judicial precedents in this matter,
HC upheld that the beneficial provisions of DTAA are applicable in the case.
Key takeaways:
• Robust documentation and agreement showing clearly the benefits and risks to be
maintained
• Is to be substantiated if the same would fall within the ambit of business profits /
business income and not royalty per se
• Since provisions of treaty would override the domestic act provisions, tax payers may
take the treaty benefits upon satisfying conditions for availing the same.
8.7 T. Rajkumar Vs. Union of India (Madras HC)(2016) (Cyprus

Notification – constitutional validity)
Understanding of facts:A tripartite agreement was entered by and between an Indian
Company, Cyprus Company and three petitioners herein by which Cyprus Company sold
equity shares and compulsorily convertible debentures of an Indian Company to the

petitioners.
Petitioners did not deduct the tax at source while remitting the sale consideration to Cyprus
Company.AO issued show cause notices inviting their attention to section 94A(1) and
Notification No. 86 of 2013 dated 1-11-2013 warranting to treat tax-payer in default.
Tax-payer contended that there was no obligation to deduct tax under section 195. They
pleaded that purchase was at less than fair value and the Cyprus Company had in fact
suffered a loss.However, AO passed orders under section 201(1)/201(1A) along with notice of
demand under section 156 to pay the demand.
Petitioners filed appeals before Commissioner (Appeals) and simultaneously filed writ petition
before High Court challenging the validity of section 94A(1), related notification and press
release.
Ruling of the High Court: The issues before the Madras HC were whether section 94A(1),
Notification No. 86 of 2013 dated 1-11-2013 and related press release dated 1-11-2013 is
constitutionally valid?
The petitioner contended that a Bilateral treaty is already entered into between India and
Cyprus; strong reliance was placed on the case of Azadi Bachao Andolan, wherein it was held
that a treaty cannot be unilaterally amended and that it takes precedence over the provisions
under the Act. Treaty itself provides for exchange of information and mutual agreement
procedure and hence recourse to section 94A is unwarranted. Section 90(1) contains non
obstante clause which is missing in section 94A.
The High Court took note of the relevant articles of constitution, Vienna convention, G20
leader’s statement and other relevant notification or press release or materials such as judicial
precedents to reach its conclusions that section 94A has constitutional validity.
Further, the argument that section 90(1)(c) cannot be diluted by section 94A(1) overlooks
fundamental fact that if the purpose of the Central Government entering into an agreement
under section 90(1) is defeated by the lack of effective exchange of information then section
90(1)(c) is actually diluted by one of the contracting states and not by section 94A(1).
It was held that the treaty specifies the obligations therein and not breach of the same.Section
94A uses the phrase "any country or territory” irrespective of whether there is treaty or not and
as such non-obstante clause contained in section 90(1) also would not impact its position.
Key takeaways:
The same issue was also dealt in another of Expro Gulf Limited Vs. Union of India
(Uttarakhand High Court) (2015) wherein a similar view was upheld. Hence the courts are
taking a view in favour of tax authorities considering the underlying circumstances which led to
this development.
8.8 Steria (India) Ltd. (386 ITR 390)(Del HC) (Most Favoured Nation
clause under the India-France DTAA):
Understanding of facts: The assesse is an Indian public Co providing IT-driven services for
its clients’ core businesses. Steria France, a French group entity of the assessee, centralizes
skills for carrying on management functions. The assesse entered into a Management Service
Agreement (MSA) with Steria France for receipt of various management services with a view
to rationalize and standardize its Indian business. The services availed broadly related to
corporate communication, group marketing, development, information systems, legal, human
relation, etc. Steria France rendered these services through telephone, fax, emails, & none of
its personnel visited India for the purpose. It also did not have an office or PE in India. The
assesse approached the AAR for the withholding tax implications of the sum payable under
the MSA. The AAR held that the sum was chargeable to tax in India. Aggrieved by the AAR’s
order, the assesse filed a Writ Petition before the Delhi HC.
The asssessee contended that by virtue of the Protocol signed between India and France, the
restricted scope of FT Sinthe India – UKDTAA is applicable to FT Sunder the India-France
DTAA. A similar proposition was accepted in [2002] ITC Ltd (82 ITD 239) (Kol ITAT). As the
services provided by Steria France do not ‘make available’ technical knowledge, skill, etc. to
Steria India, the same would not constitute FTS under the India–France DTAA.
The AAR’s ruled that a Protocol, though an integral part of the DTAA, cannot be treated as the
same as the provisions contained in the DTAA itself. The restrictions imposed by the Protocol
are only on the rates, and in the absence of a specific notification to incorporate the restrictive
provisions of the India-UK DTAA, the ‘make available’ clause cannot be read into FTS under
the India–France DTAA.
In respect of Protocol to the India –France DTAA, the HC held that the words, “a rate lower or
a scope more restricted” envisaged that there could be a benefit of either kind i.e. a lower rate
or a more restricted scope. One did not exclude the other. The benefit could accrue in terms of
lower rate or a more restrictive scope under more than one DTAA which may be signed after 1
September1989 between India and another OECD member State.
The purpose was to afford to a party to the India-France DTAA, the most beneficial of the
provisions that might be available in any DTAA between India and another OECD country. The
wording of the Protocol made itself- operational and an integral part of the notified DTAA.
Separate notification of the Protocol was not required. The benefit of the lower rate or
restricted scope of FTS under the India-France DTAA was not dependent on any further action
by the respective governments.
In respect of taxability of sum payable to Steria France it was held that FTS under the India–
UK DTAA, excludes ‘managerial services’. It was hence not even necessary to examine the
‘make available’ requirement in the second limb of the definition. Since it was projected that
the fee paid to Steria France par took the character of FTS , the question whether the French
entity had a PE in India under Article7 of the India-France DTAA did not arise.
The payment made for managerial services provided by Steria France could not be taxed as
FTS and TDS under section 195 did not apply.
Key takeaway
Unless specifically provided, Protocol need not be separately notified. Restrictive scope of
FTS in subsequent DTAA can be read into India-France DTAA.
8.9 CUB Pty Ltd. (388 ITR 617) (Del HC) (2016) – Situs of intangibles
Understanding of facts: The assessee, an Australian Co. engaged in the business of
brewing beer, owned trade marks & IPRs related to its business. It entered into Brand License
Agreements (BLA) for licensing the IPR to its subsidiaries globally including its Indian step-
down subsidiary (FIL). Four of these trade marks were also registered in India. The BLA
allowed FIL, an exclusive right to use the trade marks in the Indian territory, for a royalty which
was subject to WHT in India. The assesse entered into an India Sale & Purchase Agreement
(ISPA) with SAB Miller group for selling shares of its Mauritian down-stream subsidiary along
with the trademarks & Brand IP (including those licensed to FIL) and for grant of a perpetual
license relating to its Brewing IP confined to India.
Vide a Deed of Assignment, SAB Miller group nominated its Indian subsidiary as the
transferee in terms of the ISPA, following which the exclusive, perpetual and irrevocable
licence relating to the Brewing IP, was assigned to the nominee. The assesse simultaneously
terminated BLA with FIL.
The assesse approached the AAR for ascertaining whether the consideration arising on
transfer of its right, title and interest in and to the trademarks and Brand IP and for grant of an
exclusive perpetual licence of the Brewing IP, was taxable in India.
The AAR while holding the income from licensing of the Brewing IP as not taxable in India,
held that the transfer of right, title, interest in the trademarks & Brand IP was taxable as:
• there was no legal principle that the situs of intangible assets would always go with
ownership, and that they would have no situs other than the owner’s country of fiscal
residence.
• The trademarks registered in India & the other brand features, had generated
appreciable goodwill in the Indian market & the same had been nurtured by the
coordinated efforts of the assesse & FIL.
The IPR hence had tangible presence in India & was a capital asset situated in India.
Ruling of the Court: Before the High Court the assessee contended that a trademark did not
derive its existence from any statute, and was protected even in its absence. By the common
law maxim of ‘mobilia sequuntur personam’, the situs of an intangible asset had to be
determined based on the situs of the asset owner. Registration of a trademark did not entail its
creation or impact its location. Merely that the trademarks were registered in India did not
mean that the situs shifted from Australia to India. Since Indian laws did not specifically
provide for the situs of trademarks, the common law of ‘mobilia sequuntur personam’ would
apply.
The Revenue relied upon the AAR’s order. The brand had no value on initial introduction in
India. The substantial proceeds received on the sale thereof clearly represented the value that
the brand had gained from its India operations. It was hence transfer of a capital asset
situated in India.
The Court held that the issue of situs of an intangible asset was a tricky issue as opposed to
that of tangible assets which had a physical presence in India. The legislature could have,
through a deeming fiction, provided for the location of an intangible capital asset such as IPR,
but, it has not done so, insofar as India is concerned. Explanation 5 to section 9(1)(i) provides
for the situs of a share or an interest in a foreign Co in specific scenario. There is no such
provision for intangible assets like IPR. The well accepted principle of ‘mobilia sequuntur
personam’ would hence have to be followed i.e. the situs of the owner of an intangible asset
would be the closest approximation of the situs of that asset. The income accruing to the
assesse from the transfer of its right, title or interest in the trademarks and Brand IP was
hence not taxable in India under the ITA.
8.10 Bharti Airtel Ltd. (76 taxmann.com 256)(Del HC) (2016)-
Reasonable time limit applies to TDS proceedings for payments
to NR
Understanding of facts:
The deductor was an on-resident telecommunication provider, engaged in providing inter
connection services to its users. It engaged with non-resident entities for interconnections, for
which it made payments to such non-residents. The tax Officer issued notices for various
periods, seeking to treat the deduct as an assesse in default u/s201, for non-deduction of TDS
on the interconnection charges paid to the NR operators. Aggrieved, the deductor filed a writ
petition before the HC.
The issues before the HC were; would section 201 also apply to payments made to non-
residents? Were the impugned show cause notices barred by limitation?
The deductor contented that Section 201 did not expressly mention “non-residents”, and
prescribed a time limitation for deeming one to be a taxpayer in default for residents.
Accordingly, in the absence of express provision of time limitation, the reasoning in earlier HC
decisions (NHK Japan Broadcasting Ltd, Hutchison Essar Telecom Ltd, Vodafone Essar
Mobile Services Ltd., etc.) would set the limitation period at four years i.e. within a reasonable
time.
The amendment made in 2010 only reiterated that the power to issue show cause notice was
to be exercised within a defined time limit, and therefore, the reasoning in the aforesaid
decisions has not been disturbed. Any other interpretation would invalidate the provision itself
as it led to an artificial distinction that treated domestic deductees more favourably than
foreign deductees. For the purposes of treatment u/s201, such artificial distinction was
invidious and an impermissible classification, and was thus a violation of Article14 of the
Constitution of India. If there was a time limit for completing the assessment, then the time
limit for initiating the proceedings must be the same, if not less.
The Revenue contented that the Parliament made a conscious distinction between resident
and NR beneficiaries, based on good reasons. There was a sound rationale for such
distinction because in remittances to NRs, the true nature of the transactions, and whether
deductions were to be made, could not be easily gathered i.e. due to administrative
inconvenience’. When the earlier HC rulings were decided, the amendment had not been
brought about, and therefore, the issue of existence of a period of limitation, did not arise. The
court therefore considered, on the basis of available authority, that a four-year period was a
reasonable period as the outer limit for issuance of notice u/s 201. However, the Parliament
had consciously amended section 201 to prescribe a limitation only for residents. Instead of
actively barring the applicability of the provision to NRs, it appears that the Parliament chose
to passively do so by remaining silent on NRs and only amending the provision for residents.
The High Court held that the Amendment to section 201 by the Finance (No. 2) Act, 2009 ipso
facto is silent about the limitation applicable to payments to NRs. Hence, the legislative history
in the form of statements of objects & reasons becomes relevant. At all material times,
payments to residents & NRs were treated alike. The revenue does not state what
necessitated the distinction made through the amendment for the first time. The reasoning is
not given in the statement of objects & reasons
The only clue to be found to this silence is in that part of the Circular No. 5/2010 dtd.3 June
2010,which states that limitation for NR's payment is unfeasible "as it may not be
administratively possible to recover the tax from the NR.“ However, the basis of 'administrative
convenience' in respect of TDS provisions had already been rejected by the Apex Court in GE
India Technology Centre (P.) Ltd (327 ITR 456)
In Vodafone Essar Mobile Services Ltd [2016](385 ITR 436)(Del HC) the Court considered the
entire issue & was conscious of the absence of any limitation for payments to NRs. Yet, it was
held that proceedings could be initiated within reasonable time. This decision is hence a
precedent
The Court held that in the absence of a specific limitation, ‘reasonable time’ would also apply
to TDS proceedings in the case of NR payees. Administrative convenience cannot outweigh
the harsh and onerous consequence of maintaining books & documents for an uncertain time
period.
8.11 DIT v. B4U International Holdings Ltd (2016) 71 taxmann.com
182 (SC)-Whether advertisement revenue earned by B4U
International taxable in India
Understanding of facts: B4U International Holdings Ltd (‘B4UInternational’), a Mauritius
company having the Tax Residency Certificate is engaged in the business of telecasting of TV
channels. B4U International carried out all its activities and concluded all contracts in
Mauritius. B4U International‘s revenue from India was collections from time slots given to
advertisers in India;
The Indian companies namely B4U Multimedia International Ltd and B4U Broadband Ltd
(collectively referred as ‘B4UIndia/Agents’), were granted general permission by RBI to act as
advertisement collecting agents of the taxpayer; B4U India was remunerated by B4U
International at arm’s length for rendering collecting agent services.
Ruling of the High Court: The issue before the High Court were:
• Whether the taxpayer has a dependant agent PE in India under Article5(4) / Article5(5) of
the India-Mauritius tax treaty?
• Whether the agent being remunerated at arm's length no further profits is attributable
despite agent being dependent?
• Whether, advertisement-revenue earned by B4U International, a Mauritian based
company was taxable in India?
The assessee contended that the only activity which is carried out in India is incidental or
auxiliary / preparatory in nature which is carried out in a routine manner as per the direction of
the principal without application of mind and hence B4U India is not a dependent agent.
Assessee claimed that it had no PE in India under Article5 and hence, its income was not
taxable as per Article7 of the Indo-Mauritius DTAA; Further, Assessee also claimed that since
the agents were remunerated at an arm's length service fee of 15%,it had no further tax
liability in India.
The Revenue contented that the Assessing Officer (AO) held that the tax payer has a PE in
India in the form of B4U India ;and The payment of arm’s length remuneration does not
extinguish the tax liability of the taxpayer in India;
The High Court held that on a plain reading of the agreement it indicates that agents are not
the decision makers and it did not have authority to conclude contracts. The agents have no
authority to fix the rate or to accept an advertisement. It can merely forward the advertisement
and the taxpayer has the right to reject. In the present case, there is neither legal existence of
such authority, nor is there any evidence to prove that the agent has habitually exercised such
authority. Under Article 5(5) of the tax treaty, the wordings when the activities of such an
agent are devoted exclusively or almost exclusively on behalf of the enterprises, refer to the
activities of an agent and its devotion to the non-resident and not the other way round.
During the year under consideration the income of B4U India from the taxpayer constituted
merely 4.69 percent of its total income, B4U India cannot be treated as dependent agent of
the taxpayer. Accordingly, neither Article 5(4) nor Article 5(5) of the tax treaty was attracted in
this case. Therefore, the taxpayer has no PE in India. Even if the assesse did have a PE, it
was remunerated at arm’s length and thus no further profits could be taxed in the hands of the
assessee. Therefore, advertisement revenue earned by assessee, was not taxable in India as
assessee had no dependent agency PE or PE in India.
Revenue’s SLP against the aforesaid order by Bombay HC is admitted by the SC vide
order dated July 1, 2016
8.12 M Tech India Pvt Ltd. [TS-19-Delhi HC-2016]
Understanding of facts:
M. tech India Pvt. Ltd is a Value Added Reseller (VAR) of the software related to healthcare
and hospitality in India. The assessee entered into an VAR agreement with Track Health Pty.
Limited, Australia (“THPL”) for software purchase. The agreement entered with THPL
expressly indicated that it had appointed assessee to market and sell the products in territory
of India. The assessee made software purchase payments to THPL without deducting TDS.
Ruling of the High Court: The issue before the High Court was whether consideration paid
for purchase of goods can be considered as ‘royalty’; Whether it is necessary to make a
distinction between the cases where consideration is paid to acquire the right to use a patent
or a copyright and cases where payment is made to acquire patented or a copyrighted product
/material.
The assessee submitted that the said software was purchased from THPL under the ‘VAR
Agreement’ and the same was resold to various end-users in India. Similar purchases made in
the preceding years, had been considered as purchases and allowed as a deduction in
computing its taxable income; Being a reseller of products, the payments made by the
Assessee for acquiring the products could not be considered as royalty.
The Revenue contended that payments made by the Assessee were in the nature of royalty
and therefore, the Assessee was obliged to withhold tax on such payments. Since, the
Assessee had failed to do so, the expenditure incurred by the Assessee was liable to be
disallowed under Section 40(a) of the Act.
8.13 Wipro Limited – Karnataka High Court (2015) - Foreign tax credit
Understanding of facts: The tax-payer operates from a STPI/SEZ unit in India and qualifies
for tax holiday under section 10A of the Act. Tax-payer provides on-site software development
services in countries such as United States, United Kingdom, Canada, Japan, and Germany
through its permanent establishments and pays the applicable taxes in those countries. In
respect of these foreign taxes, the tax-payer has claimed a tax credit in India. The tax officer
refused the claim for foreign tax credits for taxes paid in the foreign countries.
The question before the Karnataka High Court, was whether credit for taxes paid in a country
outside India in relation to income eligible for deduction under Section 10A of the Act would be
available under section 90 of the Act read with the relevant DTAA?
Ruling of the High Court: Before the High Court the taxpayer contended that Section 90
provides that if the income is subjected to tax, both in India and in a foreign country, the
foreign income taxes paid attributable to such income is allowed as credit in India. Relief for
double taxation is to promote mutual economic relations, trade and investment. Section 10A
income is chargeable to tax in view of Section 4 of the Act. However, subject to the tax-payer
satisfying the conditions prescribed, income under section 10A of the Act is exempted. It was
also stated that once the tax-payer is made to pay tax on such exempted income in the other
contracting State then section 90(1)(a)(ii) of the Act enables him to claim credit of the tax paid
in the contracting country. Further, as per section 90(2) of the Act, the tax-payer was always
entitled to the said benefit as the provision of the agreement was more beneficial than the
statutory provisions.
The Revenue contended that the income exempt under section 10A of the Act does not form
part of the total income chargeable to tax as per the provisions of section 4 of the Act. The
provisions of section 90(1) of the Act are applicable in respect of income which is doubly
taxed. Based on the above, as the income exempt under section 10A of the Act was not taxed
in India, tax-payer’s claim for foreign tax credit was not admissible.
The High Court examined the availability of relief for foreign tax credit under the following
provisions:
• Section 90(1)(a)(i) of the Act – if income is subject to tax, both in India and foreign
country, the foreign income taxes paid is allowed as credit in India.
• Section 90(1)(a)(ii) of the Act – income-tax chargeable under this Act and under the
corresponding law in force in the foreign country to promote mutual economic relations,
trade and investment.
• Relief under section 10A is in the nature of exemption although termed as deduction. If
such exemption is given under the Act, but the same is taxed in a foreign jurisdiction, then
there is no relief to the tax-payer. Thus, in order to promote mutual economic relations,
trade and investment, section 90(1)(a)(ii) of the Act was inserted by the Finance Act,
2003.
• Section 10A income is chargeable to tax under section 4 of the Act and is includible in the
total income under section 5 of the Act. The exemption provision under section 10A of the
Act has the effect of suspending collection of income tax for a period of 10 years.
Therefore, the case of the tax-payer falls under section 90(1)(a)(ii) of the Act.
Based on the above, the High Court analyzed the position of availability of credit in respect of
tax paid in United States and Canada as given:
Federal Tax paid in United States– Based on Article 25 of India-U.S. DTAA, India shall allow
deduction from tax of an amount equal to income-tax paid in U.S. The said article does not
mandate of any income-tax being paid in India as a condition precedent for claiming credit of
taxes paid in U.S. Thus, this clause is in conformity with section 90(1)(a)(ii) of the Act.
Accordingly, under India-U.S. DTAA, credit can be claimed of taxes paid in U.S. even if such
income is exempt in India.
The High Court also clarified that prior to insertion of section 90(1)(a)(ii) of the Act, the tax-
payer can claim foreign tax relief based on section 90(2) of the Act by applying the provisions
of India-U.S.
Federal Tax paid in Canada– As per Article 23 of the India-Canada DTAA, foreign tax credit
would be available in India only in respect of income which has been subject to tax both in
India and Canada. Relief is available if tax-payer has paid tax both in India as well as in
Canada on the same income. This clause is in conformity with section 90(1)(a)(i) of the Act.
Thus, if the income is exempt under section 10A, no credit for taxes paid in Canada on such
income shall be granted in India. However, the High Court did not discuss the applicability of
section 90(1)(a)(ii) of the Act which is more beneficial as compared to the provisions of India-
Canada DTAA.
State Taxes paid in United States and Canada – The High Court held that even though no
agreement is entered into with the State of a Country, if the tax-payer has paid income-tax to
that State, the same is also eligible for foreign tax credit in India based on the Explanation to
section 91 of the Act.
Key takeaways:
Wordings of the tax treaty play an important role and hence foreign tax credit availability is
subject to the mechanism provided and manner prescribed in the respective tax treaty.With
respect to unilateral relief, if income taxes were paid to the state where there exists no tax
treaty specifically, then unilateral relief is available on such income taxes paid as per the
provisions of the Act.
8.14 GVK Industries Limited Vs ITO (Supreme Court)(2015) -

Taxability of Fees for Technical Services
Understanding of facts: The Company, incorporated in India, was in process of setting up a
235 MW Gas based power project at Andhra Pradesh at an estimated cost of INR 839 crores.
With the intention to utilize the expert services of qualified and experienced professionals who
could prepare a scheme for raising the required finance and tie up the required loan, it sought
services of a consultant which was resident of Switzerland. Those services included, inter
alia, preparation of financial structure and security package to be offered to the lender, making
an assessment of export credit agencies world-wide and obtaining commercial bank support
on the most competitive terms, assisting the appellant loan negotiations and documentation
with lenders and structuring, negotiating and closing the financing for the project in a
coordinated and expeditious manner. For its services the Consultant was to be paid, what is
termed as, “success fee” at the rate of 0.75% of the total debt financing. The Consultant
rendered professional services from Zurich by correspondence as to how to execute the
documents for sanction of loan by the financial institutions within and outside the country.
After successful rendering of services, the Consultant sent invoice to the Company. The
company approached the concerned income tax officer, for issuing a ‘No Objection Certificate’
to remit the said sum to the Consultant without any tax deduction since Consultant had no
place of business in India and that all the services rendered by it were from outside India. The
income tax officer refused to issue the ‘No Objection Certificate’, against which Company
preferred appeal before the higher authorities including writ petition before the High Court.
The High Court after due consideration of facts opined that the business connection between
the petitioner company and the Consultant had not been established, however the High Court
further observed that “success fee” would come within the scope of technical service within
the ambit of Section 9(1)(vii)(b) of the Act. Being of this view, the High Court opined the
Company was not entitled to the “No Objection Certificate”. The appeal was filed before the
Supreme Court against this decision, by the Company.
Ruling of the Supreme Court: Considering the Explanation to the Section 9(2) substituted by
the Finance Act 2010 with retrospective effect from June 1, 1976 alongwith another
Explanation inserted by the Finance Act, 2007 with retrospective effect from June 1, 1976,
Court stated that the relevant provisions lay down the principle what is basically known as the
“source rule”, that is, income of the recipient to be charged or chargeable in the country where
the source of payment is located, to clarify, where the payer is located. The clause further
mandates and requires that the services should be utilized in India.
The expression, managerial, technical or consultancy service, have not been defined in the
Act, and, therefore, it is obligatory for the Court to examine how the said expressions are used
and understood by the persons engaged in business. The general and common usage of the
said words has to be understood at common parlance. While interpreting the word
‘consultancy’ the Court had referred meaning of ‘consultation’ in Black’s Law Dictionary
wherein it has been defined as an act of asking the advice or opinion of someone (such as a
lawyer). It means a meeting in which a party consults or confers and eventually it results in
human interaction that leads to rendering of advice. Accordingly Court has held that in the
present case, non-resident entity had acted as a consultant, as it had the skill, acumen and
knowledge in the specialized field i.e. preparation of a scheme for required finances and to tie-
up required loans. Therefore, Court while ruling in favor of the Tax Department has held that
the nature of service provided by the non-resident can be said with certainty would come
within the ambit and sweep of the term ‘consultancy service’ and, therefore, it has been rightly
held that the tax at source should have been deducted as the amount paid as fee could be
taxable under the head ‘fee for technical service’.
Key takeaways: This ruling of Supreme Court lays down the principle which needs to be
adopted under the provisions of amended Section 9(1)(vii) of the Act ending the uncertainty
surrounding this provision, and upholding that for taxation of fees for technical services
rendering of services within India is not a pre-requisite. This ruling also summarizes the
discussion on constitutional validity of Section 9(1)(vii) and applicability as well as evolvement
of ‘source rule’ or ‘situs of source of income’.
It is to be noted that Supreme Court has delivered this ruling based on the provision of the
Income Tax Act as the provisions of relevant Tax Treaty was not been invoked by the
Company, hence principle laid down in this ruling will have limited implications where the
provisions of the relevant Tax Treaty differs from the provisions of section 9(1)(vii).
8.15 Centrica India Offshore Private Limited Vs. CIT (Delhi HC)(2014) -
Taxability of Secondment Arrangements in India
Please refer 3.3.2 of Module E- International Tax Structures for details.
8.16 CIT Vs. Van Oord ACZ Equipment BV (Madras HC)(2014) –

Equipment leasing
Understanding of facts: The Company was resident of Netherlands. The Company during
the year 2002-2003 let out dredging equipment to their Indian group company, Van Oord ACZ
India Private Limited. The Company filed its return of income along with a brief note
elucidating the provisions of the India-Netherlands Tax Treaty and stating that the income
earned by letting out of industrial equipment would not be taxable in India. However, the Tax
Officer held that since the definition of royalty, as enumerated in Section 9 of the Act, means
consideration for use or right to use any industrial, commercial or scientific equipment, the
consideration received by the Company falls within the definition of royalty in Section 9 of the
Act and accordingly, the same is liable to tax in India. The Company preferred appeal before
the Commissioner of Income Tax (Appeals) wherein the appeal was allowed in favor of the
Company by relying on the provisions of the relevant Tax Treaty. The order of Commissioner
of Income Tax (Appeals) was confirmed by ITAT. The appeal was filed before the Madras
High Court against this decision, by the Tax Department.
Ruling of the High Court: The perusal of the amendments done in the India-Netherlands Tax
Treaty would show that for all practical purposes, the 'payments for the use of equipment'
originally found in clause (1) of Article 12 as defined in clause (6) was incorporated in the
definition of the term Royalties in clause 4 w.e.f. April 1,1991 and subsequently deleted w.e.f.
April 1,1998 and thereby completely taken out from clause (1) and (2) of Article 12. This
means that the payment for the use of equipment or any consideration for the use of, for the
right to use industrial, commercial or scientific equipment is deleted and it is not taxable in the
contracting State in which they arise viz., in the given case India.
Section 90 of the Act enables and empowers the Central Government to issue Notification for
implementation of the terms of Tax Treaty. If a tax liability is imposed by the Act, the Tax
Treaty may be resorted to for negativing or reducing it; and, in case of difference between the
provisions of the Act and the Tax Treaty, the provisions of the Tax Treaty would prevail over
the provisions of the Act and can be enforced by the appellate authorities and the court. Even
accepting that the powers exercised by the Central Government under section 90 are
delegated powers of legislation, there is no reason why a delegatee of legislative power, in all
cases, has no power to grant exemption. When the requisite notification has been issued
under section 90, the provisions of sub-section (2) of section 90 spring into operation and
Non-resident taxpayer who is covered by the provisions of the Tax Treaty is entitled to seek
the benefits thereunder, even if the provisions of the Tax Treaty are inconsistent with those of
the Act.
In the case on hand the dredging equipment was leased out on bareboat basis viz., without
Master and Crew. Therefore, it will not come under the permanent establishment and the
entire control over the equipment was not with the Foreign Company, but with the Indian
Company. Accordingly, the amount received by the Company for hiring out Dredgers to an
Indian Company for use in Indian Ports is not taxable in India.
Key takeaways: This ruling of Madras High Court prescribes the framework and interplay
between the provisions of the Act and the Tax Treaty. This also signifies that provisions of
Tax Treaty differ from country to country and accordingly each Tax Treaty needs to be
analysed and dealt separately.
Further, incase of equipment leasing, this decision lays down an important principle that if the
equipment is leased on bareboat basis i.e. without the master & crew and control over the
equipment lies with the customer, then it will not constitute permanent establishment of the
non-resident equipment provider in India.
8.17 Zaheer Mauritius Vs. DIT (Delhi HC)(2014) - Taxability of

Compulsorily Convertible Debentures
Understanding of facts: The Company was resident of Mauritius and engaged in the
business of investment into Indian companies engaged in construction and development
business in India. In 2007, the Company invested into Zero Percent Compulsorily Convertible
Debentures (CCDs) issued by an Investee Company incorporated in India under an agreement
which provided call option to Investee Company to acquire the aforementioned securities
during the call period and likewise, a put option given by Investee Company to the Company
to sell the aforementioned securities during the determined period. In 2010, Investee
Company exercised the call option and purchased the CCDs from the Company. The
company filed an application under Section 197 of the Act before the Tax Officer requesting
for a ‘nil’ withholding tax certificate to receive the total consideration from Investee Company
for transfer of CCDs without deduction of tax. The Tax Officer held that the entire gain on the
transfer of CCDs would be treated as interest and tax at the rate of 20% (plus surcharge and
cess) should be withheld on the same. Thereafter the Company filed an application before the
Authority for Advance Ruling on the question of taxability of income from sale of CCDs.
Authority of Advance Ruling ruled in favor of the Tax Authority and held that that the entire
gains on the sale of CCDs held by the Company are not exempt from income tax in India by
virtue of the provisions of India-Mauritius tax treaty and that the gains arising on the sale of
CCDs are interest within the meaning of Section 2(28A) of the Income Tax Act and Article 11
of the relevant tax treaty. The appeal was filed before the Delhi High Court against this
decision, by the Company.
Ruling of the High Court: Court stated that under normal circumstances, it is undeniable that
gains arising from transfer of a debenture, which is a capital asset in the hands of the
transferor, in favor of a third party, would be capital gains and not interest. In other words, if a
debenture (which is a capital asset) is transferred by a holder to a third party, the gains that
arise i.e. difference between the costs of purchase and the sale consideration would be capital
gains in the hands of a transferor. The dispute in the present case arises only because it has
been held that the transaction between the Company and the Investee Company is a sham
transaction and is essentially a transaction of loan to Investee Company which has been
camouflaged as an investment in CCDs. The Court observed that a plain reading of the
Shareholders Agreement indicates that it is essentially a joint venture agreement and it is
common in any joint venture agreement for the co-venturers to include covenants for buying
each-others’ stakes. Although, the Shareholders agreement enables the petitioner to exit the
investment by receiving a reasonable return on it, and in that sense it is assured of a minimum
return, the same cannot be read to mean that the CCDs were fixed return instruments, since
the Company also had the option to continue with its investment as an equity shareholder of
the JV Company. Further, Shareholder agreements also clearly indicate that the affairs of the
JV Company were to be managed separately and distinctly from that of Investee Company.
The reading of the agreement as a whole clearly indicates that the Company was entitled to
participate in the management and affairs of the JV Company, not only by appointing its
nominee directors but also by ensuing independent auditors and an independent Asset
Manager.
High Court also referred to Foreign Direct Investment policy for real estate sector and
observed that as per relevant Circular issued by Reserve Bank of India, an instrument which is
fully and mandatorily convertible into equity shares within a specified time would be reckoned
as part of equity under the Foreign Direct Investment Policy. Thus, in terms of the policy of
the Government, the petitioner could invest in a project of the requisite size/nature and an
investment into CCDs would be reckoned as equity. The policy with regard to external
commercial borrowings had other conditions and it is apparent that the petitioner found the
investment in CCDs as the most appropriate route for making its investment in real estate, in
accordance with the policy of the Government of India. In these circumstances, it ought not to
be readily inferred that the entire structure of the transaction was designed solely for the
purposes of avoiding tax. Accordingly, Court opined that there is, thus no reason to ignore the
legal nature of the instrument of a CCDs and accordingly the treatment given by the Company
was upheld by the Court.
Key takeaways: This ruling of Delhi High Court also touches upon the principles of General
Anti Avoidance Rules wherein the Court has perused the relevant business agreements and
applicable commercial laws to arrive at a conclusion of not lifting the corporate veil and
treating the transaction on as-is basis i.e. ‘look at test’ principle laid down by Supreme Court in
the case of Vodafone International Holdings BV (2012). This ruling also clarifies some key
fundamentals with regard to the taxability of financial instruments which has always been a
subject of dispute between the tax authorities and taxpayers.
8.18 DIT Vs R & B Falcon Offshore Limited (Uttarakhand HC)(2015)

(235 Taxman 457)- Equipment PE
Understanding of facts: The Company was resident of United States of America who brought
in a rig in India and operated that rig for and on account of its client in India. That rig was in
India on November 21, 2002 and it was ready for use, however prior to actual commencement
of work the rig underwent some repairs. The Tax Officer held that the provisions of ‘Article
5(2)(j) - Permanent Establishment’ of Tax Treaty between India and United States of America
uses the word "used" without furnishing meaning to the said word and, accordingly, meaning
thereof should be culled out from the Income Tax Act. Under the Income Tax Act, the word
“used” includes in its ambit the words 'ready for use' and accordingly Tax officer held that
even during the time of repair and maintenance, the rig was lying ready for use and, as such,
the rig having been used for more than 120 days during the relevant assessment years, the
Company, in the form of the said rig, had a permanent establishment in India. The Company
preferred appeal before the Commissioner of Income Tax (Appeals) wherein the appeal was
allowed in favor of the Tax department. The order of Commissioner of Income Tax (Appeals)
was challenged by the Company before the ITAT which ruled in favor of the Company. The
appeal was filed before the Uttarakhand High Court against this decision, by the Tax
Department.
Ruling of the High Court: The High Court while upholding the ITAT’s decision and ruling in
favor of the Company, held that word 'used' has been sufficiently explained in the Tax Treaty
requiring no further explanation and, for that matter, there is no scope of entering into the
Income Tax Act. Inasmuch as, the word 'used' has been used in conjunction of 'an installation
or structure for exploration or exploitation of natural resources and only if so used for a period
of more than 120 days in 12 month period' and, thereby, made it absolutely clear that the Tax
Treaty meant use of installation and structure for exploration or exploitation of natural
resources and not merely being ready for use.
Tax Department, before ITAT also argued on the point that the repairs of the rig were carried
on in the territories of India in pursuance of the agreement with Customer. The Company
even received consideration for such repairs from the Customer and hence it has been argued
that the rig has been used for more than 120 days in India. ITAT after considering the
arguments and relevant provisions of Tax Treaty, has held that primary condition is that it
must have been so used for a period of 120 days in any twelve-month period. The words "so
used" clearly show that the installation or the structure should have been used for exploration
or exploitation of natural resources for it to constitute a PE. In other words, the rig should
have been used for exploration or exploitation of natural resources, i.e., the mineral oil for
more than 120 days, however the rig was not used for exploration or exploitation of the
mineral oil when it was under repairs or being moved to the appointed place for exploitation of
mineral oil. That activity was a preparatory activity so as to make the rig to be fit for
exploitation of natural resources as per the requirement of Customer and it was used for
exploitation of mineral oil when it was positioned at the appointed place for exploitation of
mineral oil. Accordingly, it has been held that the Company did not have the PE in terms of
article 5(2)(j) of the tax Treaty.
Key takeaways: This ruling of Uttarakhand High Court assumes significant importance due to
its pragmatic interpretation of the provisions of Tax Treaty wherein the business nuances have
also been considered appropriately. This decision is of vital importance to the businesses in
connection with exploration of natural resources, as its laid down the clear parameters for
determination of PE wherein only the actual working days need to be considered while
applying the prescribed threshold. It also underlines the importance of proper recording of
facts with the evidence which is important in such cases.
It is to be noted that Tax department had filed Special Leave Petition before the Supreme
Court against this decision, however during the hearing Tax department sought withdrawal of
this Special Leave Petition to file review petition before the High Court. Accordingly, the
Supreme Court dismissed the Special Leave Petition as withdrawn.
8.19 LindeAG, Linde Engineering Division Vs. DCIT (Delhi HC)(2014) -

Taxability of Turnkey Contracts
Understanding of facts: In April 2007, Indian customer floated a Tender Notice inviting bids
for executing the work (including undertaking all activities and rendering all services) for the
design, engineering, procurement, construction, installation, commissioning and handing over
of the plant for the Dual Feed Cracker and Associated Units of Petrochemical Complex in
accordance with the Bid Documents. The project was to be executed on turnkey basis. Two
non-residents, one resident of Germany and other resident of Korea, entered into a
Memorandum of Understanding (‘MOU’) whereby both the parties agreed to form a
Consortium, for jointly submitting a bid to secure the contract for execution of the aforesaid
project. The MOU was followed by an ‘Internal Consortium Agreement’ dated March 2008
executed between them. The price bid was submitted by the Consortium in July 2008 and
Indian customer awarded the work to the consortium on December 2008. The bid award was
followed by the definitive agreement in February 2009 between the Indian customer and
Consortium.
The non-resident of Germany, filed an application before the Tax Officer under section 197 of
the Act claiming that no portion of the amount payable to it for supply of equipment, material &
spares and for providing basic & detailed engineering services was liable to be subjected to
withholding of tax under section 195 of the Act as it was contended that the said transactions
were performed as well as completed outside India and payments for the said transaction
were also received outside India, therefore not chargeable to tax in India. The Tax officer did
not accept the plea of the Company and directed the Indian customer to withhold the tax.
Thereafter the Company filed an application before Authority for Advance Ruling with respect
to its tax liability in India. The Authority for Advance Ruling while disposing the application
has held that the Consortium of two non-residents constitutes an Association of Persons
(‘AOP’). It further held that Contract was indivisible contract and was incapable of being spilt
up into different components/parts, where for due performance of contract the liability of both
the Consortium members is joint and several. The Authority for Advance Ruling also held that
since Consortium members continued to be responsible for the supplies up to the stage of
acceptance of the work in relation to the erection, procurement and commissioning of the
project, the title of the equipment/material supplied could not be accepted to have been
transferred to Indian customer overseas and accordingly the income is subject to tax in India.
The appeal was filed before the Delhi High Court against this decision, by the Company.
Ruling of the High Court: The principle emerges from the judicial precedents that the
Association of Persons is one in which two or more persons join together for a common
purpose or common action and there is a joint management or joint action by the said two or
more persons. In order to treat persons as an association, it is necessary that the members
must have a common intention and must act jointly for fulfilling the object of their joint
enterprise. However, it is also necessary to bear in mind that the purpose of treating two or
more persons as an association of persons is to impose tax on the income that may be
attributed to their joint enterprise. It is, thus, obvious that it would be necessary to consider
the extent and the nature of the common purpose and the common action, in order to
determine whether the said persons form an association for the purposes of imposing tax or
not. However, treating every instance of such cooperation between two or more persons as
resulting in an Association of Persons would militate against the purpose of considering an
association as a separate tax entity. Whether an arrangement or collaborative exercise
between two or more persons results in constituting an Association of Persons as a separate
taxable entity would depend on the facts of each case including the nature and the extent of
collaboration between them. A mere cooperation of one person with another in serving one’s
business objective would not be sufficient to constitute an Association of Persons merely
because the business interests are common. A common enterprise, which is managed through
some degree of joint participation, is an essential condition for constituting an Association of
Persons.
Based on the review of the agreement, the Court observed that the allocation of the work was
done in such a manner that each member was required to perform work which was within its
field of expertise and could not be performed by the other party. The work to be performed by
both the members was separate, definite and divisible. Therefore, as far as execution of the
project was concerned, each party had to work independent of the other. The only area of
cooperation and management envisaged under the MOU was in respect of sharing of
information and material, to enable the other member to perform its work. This level of
cooperation is necessary for execution of any project where multiple agencies are involved.
The Court further observed that the internal consortium agreement between the parties clearly
specified that the scope of works of two entities were separate and independent. The
agreement also made a specific provision that in case the scope of work of the respective
members was altered and either of the members was required to execute additional work, then
the price for additional work would be payable to that party. It was also provided in the
agreement that prices and payment for the respective works to be performed by the members
would be stipulated separately in the bid and separate invoices will be raised by the
consortium members on the Indian customer. Further, the agreement clearly provided that
neither of the members would be liable to each other on account of any loss or damages
including non-payment by the Indian customer.
Court held that while it is relevant as to how a third party deals with the members of a
consortium, the same would not be conclusive in determining whether the consortium
members constitute an Association of Persons. In the instant case, both the parties shared
neither the costs nor the risks. Both managed their own deliverables and accordingly the facts
of this case do not indicate a sufficient degree of joint action between the parties either in
execution or management of the project to justify a conclusion that they had formed an
Association of Persons. Accordingly, Court reversed the ruling of Authority for Advance
Ruling and ruled in favor of the Company.
Next question which was considered by the Court was pertaining to taxability of income
received by Company for design and engineering prepared solely for manufacture and/or
procurement of equipment outside India and supply of equipment, material and spares,
outside India. Court has stated that the principle of apportionment of income on the basis of
territorial nexus is now well accepted. Explanation 1(a) to section 9(1)(i) of the Act also
specifies that only that part of income which is attributable to operations in India would be
deemed to accrue or arise in India. It necessarily follows that in cases where a contract
entails only a part of the operations to be carried on in India, the Taxpayer would not be liable
for the part of income that arises from operations conducted outside India. In such a case, the
income from the venture would have to be appropriately apportioned. The taxable income in
execution of a contract may arise at several stages and the same would have to be
considered on the anvil of territorial nexus. In the facts of the present case, where the
equipment and material is manufactured and procured outside India, the income attributable to
the supply thereof could only be brought to tax if it is found that the said income therefrom
arises through or from a business connection in India. However, in view of the decision of the
Supreme Court in Ishikawajima-Harima Heavy Industries it cannot be concluded that the
Contract provides a “business connection” in India and accordingly, the Offshore Supplies
cannot be brought to tax under the Act.
On the aspect of taxability of offshore services, the Court remanded back the matter stating
that in the event, it is found that the offshore services rendered by Company are not
inextricably linked to the manufacture and fabrication of equipment overseas so as to form an
integral part of the supply of the said equipment, the income arising from the said services
would be taxable in India as fees for technical services. By virtue of Section 9(1)(vii) of the
Act, fees for technical services paid by a resident are taxable in India (except where such fees
are payable in respect of services utilised by such person in business and profession carried
outside India). In view of the Explanation to Section 9(2) as substituted by Finance Act 2010
with retrospective effect from June 1, 1976, the decision of the Supreme Court in
Ishikawajima-Harima Heavy Industries, in so far as it holds that in order to tax fees for
technical services under the Act the services must be rendered in India, is no longer
applicable.
Key takeaways: This ruling of Delhi High Court clarifies some fundamental principles for
Turnkey Contract involving non-residents. This deals with various key aspects of Turnkey
Contracts including Association of Persons, Offshore Supplies and Offshore services. It also
underlines the importance of prudent structuring of business arrangements and effective
documentation before commencement of the business which was upheld by the Court in favor
of the taxpayer.
Further, the implications of amendments in Finance Act 2010 over the decision of the
Supreme Court in Ishikawajima-Harima Heavy Industries, has also been clarified in this
decision by the Court.
8.20 GE Energy Parts Inc. Vs. ADIT (Delhi ITAT)(2014) - Use of Social
Media Profiles as Evidence
Understanding of facts: The Company, a Tax Resident of United States of America, was
carrying its activities in India through Liaison Office in India. Survey under section 133A of the
Act was conducted at the office premises of Company on March 2, 2007 by the Tax
Authorities. During the course of survey, copies of various documents were obtained and
statements of various persons were also recorded. Pursuant to the Survey, the Tax
Authorities were of the view that this Group was engaged in various sales activities in India for
which the business head were generally expats, who were appointed to head Indian
operations with the support staff provided by its Indian group company and also by various
third parties. These expats were on the payroll of one of the group company of United States
of America but working for various businesses of this Group. As per the application made to
Reserve Bank of India and permission obtained, the liaison office was to act as a
communication channel between the head office and the customers in India. However, as a
result of survey, it was found that the Company instead of undertaking the permitted activities,
was employing various persons and providing the services of such persons to the group
entities worldwide. The activities indicated that the Company was carrying out business in
India through a Permanent Establishment (PE) and the income attributable to such PE was
taxable in India. In the assessment order, the Tax Authorities observed that the expatriate
employees of the Group were responsible and looked after the business of the Group as a
whole, irrespective of any group company making sales in India. The bifurcation of sales by
various entities was decided by the Group management, as was evident from the documents
seized during the course of survey. After detailed analysis of documents found during the
course of survey, it was observed that these expats and their team had at their disposal a
fixed place of business in the form of office premises of Company in India. From these survey
documents it was also revealed that the activities of the non-resident group entities being
conducted from the fixed place of business referred to above were not of the preparatory or
auxiliary character but constituted the PE as provided in paragraph 2 of Article 5 of respective
tax treaties. The Company preferred appeal before the Commissioner of Income Tax
(Appeals) wherein the decision was made in favor of the Tax Authorities. The appeal was filed
before the Delhi Tribunal against this decision, by the Company.
Ruling of the Tribunal: Tax Authorities has presented the profiles of expat employees in India
on LinkedIn.com which was social networking website, as additional evidence. Accordingly,
Tribunal first dealt with the power of Tribunal with regard to admission of ‘additional evidence’
during the appellate proceedings. Tribunal stated that the basic ingredient for exercising
powers under Rule 29 for admission of additional evidence is that Tribunal should come to the
conclusion that a particular document would be necessary for consideration to enable it to
pass orders or for any other substantial cause. The document can be brought to the notice of
Tribunal by either party. The Tribunal is final fact finding body and, therefore, the powers
have been conferred on it under section 131 and Rule 29 to enable it to record a factual
finding after considering the entire evidence. Tribunal held that in order to enable the Tribunal
to decide disputes before it in a lawful, fair and judicious manner, it necessarily is required to
look into and consider such and other material having a direct nexus and bearing on the
subject matter of the appeal i.e. existence of PE in the instant case.
While dealing with the aspect of treating LinkedIn profile as hearsay evidence as contended by
the Company, the Tribunal has stated that LinkedIn profiles are not in the nature of hearsay
because it is the employee who himself has given all the relevant details and the same relate
to him. These details are akin to admission made by a person. No third party is involved in
creating of this LinkedIn profiles and therefore, it cannot be said to be hearsay evidence.
Accordingly Tribunal has accepted the LinkedIn profiles produced by the Tax Authorities as
evidence and held that it is well settled law that admission though not conclusive is binding
and decisive on point unless it is successfully withdrawn or proved to be erroneous.
Key takeaways: This ruling explains the laws relating to use of additional evidence before the
Tribunal and also demonstrates the importance of modern communication modes & its
significance in the tax domain. Also it shows the progressive approach adopted by the Indian
Tax Authorities while dealing with complex issues of international taxation, and accordingly
Tax Practitioners also need to be well equipped while dealing with such subjects.
In this ruling, the Tribunal has not concluded on the taxability of the transactions in the
question as the said matters were fixed up for hearing on merits subsequently.
8.21 GFA Anlagenbau Gmbh Vs. DDIT (Hyderabad ITAT)(2014) –

Supervisory PE
Understanding of facts: The Company was resident of Germany and engaged in supervision,
erection, commissioning of plant and machinery for steel and allied plants in India. During the
relevant assessment year, the Company rendered services to four Indian customers. The
Company engaged experienced foreign technicians at the work sites and other places in India
and the receipts were categorised as in the nature of ‘fees for technical services’ under the
provisions of tax treaty between India and Germany. On going through the information
furnished, Tax Officer noticed that some of the contracts undertaken by the Company in India
have continued for a period exceeding six months. Accordingly Tax officer held that the
Company has PE in India under the provisions of Article 5(2)(i) of the India-Germany tax treaty
and its taxable income will be determined as per provisions Article 7(3) of the Tax Treaty. The
Company raised objections before the Dispute Resolution Panel which was not accepted by
the Dispute Resolution Panel. The appeal was filed before Tribunal against this order, by the
Company.
Ruling of the Tribunal: On perusal of Section 92F(iiia) of the Act, the Tribunal observed that
the supervisory activities do not constitute a fixed place of business in as much as the
Taxpayer renders its services at the project sites of its clients and does not by itself own or
operate such sites independently but rather provided under contract terms by its clients.
Tribunal further states that just because the technicians of the Company stayed in India while
supervising the work undertaken by the Company in India, it cannot be considered that their
place of stay can be ‘fixed place of business’ for the Company.
Tribunal while dealing with provisions of Article 5(2)(i) has stated that a literal reading of the
Article leads to the conclusion that supervisory activities by themselves cannot constitute a
PE; they are to be in connection with a building, construction or assembly activity of the non-
resident which is not the case here as the Company provides only supervisory activities and
do not have any building site or construction site of its own. Tribunal also noted it is incorrect
to aggregate all contracts of the foreign company in India and consider it as one. Unless
otherwise linked with each other, contracts should be individually assessed with respect to the
duration test. In conclusion, in light of the facts and circumstances of the instant case,
Tribunal opined that the Company’s supervisory activities do not constitute a Permanent
Establishment in India under the provisions of the Act as well as Article 5 of the India-
Germany tax Treaty. The Company should be assessed for its supervisory activities under
Article 12 of the India-Germany DTAA.
Key takeaways: This ruling of the Tribunal lays down the parameters for interpretation of
provisions dealing with Supervisory PE wherein it underlines the requirement of existence of
project or site to attract the supervisory PE implications. It also provides guidance that mere
stay of employees in India will not result their place of stay into Fixed Place PE in India.
8.22 Nortel Networks India International Inc. Vs DDIT (Delhi

ITAT)(2014) - Profit attribution incase of Cross-border
Turnkey Contracts
Understanding of facts: The Company was resident of United States of America. During the
relevant assessment year, the Company has supplied telecommunication hardware to its
Indian Customer. The Indian subsidiary of Nortel Group M/s Nortel Networks India Pvt. Ltd.
(Nortel India) entered into a contract with Indian Customer for supply of hardware equipment
on June 8, 2002. Immediately, after the signing this contract was assigned by Nortel India to
the Company without any consideration. The equipments supplied by the Company to the
Indian Customer was purchased from a group company i.e. M/s Nortel Canada. From the
examination of the financial statements, the Tax Officer was of the opinion that the Company
does not have any manufacturing or trading infrastructure, and it does not have any financial
or technological capability of its own. The Company had not filed its return of income
voluntarily for the relevant year and did not have any audited accounts. The Tax Officer also
noted that the profit and loss account of the Company during the year under consideration of
proceedings were unaudited and certified by Manager (Tax). In the said profit and loss
account, the Company has booked huge gross losses.
Tax officer further observed that the contract in this regard is a turnkey contract which
indivisible contract for supply, installation, testing, commissioning etc. yet the contract for
installation and commissioning were assigned to Nortel India. The entire responsibility of the
execution of turn key contract remained with the Guarantor. Tax officer observed that this
arrangement shows that the Company was getting its work executed through Nortel India.
Nortel India was working so intimately with the Company, that the contract awarded to Nortel
India was assigned to the Company and the contract awarded to the Company was assigned
to Nortel India. This shows that both of them are working in unison and are acting as one
entity for all practical purposes. In view of this analysis, the tax Officer reached to the
conclusion that Company is only a paper company incorporated for the sole purpose of
evading taxes in India accruing from the supply contract. Tax Officer thus held that Nortel
India is a fixed place of business and depended agent permanent establishment of the
Company in India. The Company filed an appeal before the Commissioner of Income Tax
(Appeals) who decided the appeal in favor of the Tax authorities. The appeal was filed before
Tribunal against this order, by the Company.
Ruling of the Tribunal: Tribunal after perusal of the facts has stated that contract entered
between the Company and the Indian customer is a turnkey contract, indivisible contract for
supply, installation, testing, commissioning etc. Nortel India has undertaken the responsibility
for negotiating and securing the contracts. The contract for installation and commissioning
was also undertaken by Nortel India. Thus, Tribunal upheld the proposition of the tax
authorities that these arrangements show that Company is getting its work executed through
Nortel India. The Company is merely a shadow company of Nortel Group and for all practical
purposes, all the facilities and services available to the Nortel Group of Companies are equally
available to the Company. The hardware supplied through it is installed by Nortel India. The
contracts were pre negotiated by Nortel India. Thus, Tribunal agreed with the Tax authorities
that Nortel India is a fixed place of the business and dependent agent PE of the Company.
Further, Tribunal also held that Liaison Office in India of its group company of Canada i.e.
Nortel Canada also constitutes fixed place PE of the Company, since the LO of Nortel Canada
was rendering all kinds of services to all the group companies including this Company.
Tribunal further observed that the contention of sale being completed overseas and
installation was done under a separate contract is also not tenable, as the Company through
Nortel India and LO of Nortel Canada approached the Indian customer, negotiated the
contract, bagged the contract, supplied equipment, installed the same, undertook acceptance
test after which the system was accepted. The equipment remained in the virtual possession
of Nortel Group till such time the equipment was set up and acceptance test was done. The
tribunal further stated that the compensation which has been represented to be the sale
consideration for the equipment represents the payment for works contract where entire
installation and customisation has been carried out in India. That the subsidiary has not only
acted as a service provider for the Company, but at the same time acted as a sale outlet
cooperating with after sale service and also providing any assistance or service requested by
the Company. Further the employees of group companies did visit India in connection with
Project in India which indicates that the employees of the group companies did carry out
business of the Company through the premise of LO of Nortel Canada or the premise of the
India subsidiary i.e. Nortel India. Thus, Tribunal concluded by stating that the entire business
enterprise activities of the Company were managed by the subsidiary in India. Tribunal upheld
the decision of CIT(A) stating that activities of the Company in India constitute PE of the
Company in terms of Article 5 of the India-USA tax treaty.
The next issue that was considered by the Tribunal was, how much of the profits arising to the
Company from supply of telecom hardware to Indian customer is attributable to the PE in
India. Tribunal stated that the accounts of the Company were not audited and the gross
trading loss incurred from transactions within the group by the Company cannot possibly be
explained, except for the reason that it has been designed as such to avoid taxation in India.
Hence, for all purpose of the law, accounts of Nortel Group would give the true and correct
picture of profit of the Company. As per the global accounts the profit arising from the Indian
transactions cannot be definitely ascertained hence following the provisions of Rule 10, the
financial statement of the Company has to be recast to arrive at the correct percentage of
profit that is likely to accrue to the Company from it’s Indian operations. As per the global
accounts of Nortel, the gross profit margin percentage for Nortel Canada was held to be the
Company’s margin of the relevant year from the specific contract, which was 42.6% in the
instant case. Specific deduction was to be allowed for other general and marketing expenses
on reasonable basis and accordingly 5% of the turnover was considered as the average rate
of expenses incurred under this head. After considering Taxpayer’s arguments of citing other
decisions where profit attributed to the PE was in the range of 20%-35%, the Tribunal held
that income of the PE has to be computed on the facts of each case and accordingly
considering the facts in the instant case tribunal upheld the attribution of 50% of the global
profits to the activities of PE in India as a reasonable attribution.
Please note that this decision has been set aside by the high court (Nortel Networks India
International Inc. v DIT [2016] 69 taxmann.com 47 (Delhi)). The Court held that where
pursuant to an agreement with Indian company all rights and obligations to sell, supply and
deliver equipments were assigned to assessee US company by its Indian AE and in terms of
assignment contract supplies and payments were directly made between assessee and the
Indian Company and Indian AE did not maintain any stock in India, no part of assessee's
income could be brought to tax in India Further where Indian AE did not exercise any
authority on behalf of assessee US company to conclude contracts in India or no officer of
Indian AE were at disposal of assessee, Indian AE would not constitute assessee's PE in India
SLP has been granted against this ruling [2017] 81 taxmann.com 166 (SC)/
Key takeaways: Tribunal being the ultimate fact finding authority, this ruling assumes
importance as it signifies the approach adopted by the judicial authorities while evaluating the
tax implications of the turnkey contract. In this decision, Tribunal has reviewed various
aspects of the contractual arrangements, entity standings and its roles in the business, further
Tribunal also decided on the profit attribution to the PE which was 50% of the global profits
earned from this contract by the Group, however Tribunal also made it clear that profit
attribution to PE is facts sensitive and hence could vary on case to case basis.
8.23 Renoir Consulting Ltd. Vs. Dy DIT (Mumbai ITAT)(2014) - Fixed

Place PE
Understanding of facts: The Company was resident of Mauritius and engaged in providing
management consulting services to Indian customers. In the relevant year, the Company
disclosed income, as business income, from contracts executed in India and claimed absence
of its Permanent Establishment (PE) in India. The Tax officer took a view that there was a PE
in existence in India within the provision of India-Mauritius tax treaty. Tax Authorities held that
the implementation programme was to be carried over three phases, aggregating to 80 weeks
and accordingly the hotel rooms where the consultants/principal consultants stayed in India
must in that case necessarily be regarded as their place of work and for carrying out their
activity in India i.e. PE. The decision of the Tax Officer was upheld by the Commissioner of
Income-tax (Appeals). The appeal was filed before the Mumbai Tribunal against this decision.
Ruling of the Tribunal: The basis of the concept of PE is that profit of an enterprise of one
contracting state is taxable in the other state only if the enterprise maintains a PE in the latter
state and, further, to the extent that profit is attributable thereto. The PE thus seeks to
compromise and harmonize the taxing jurisdiction between the source state and residence
state for the purposes of taxation of business profits. The same must be understood with a
view to arrive at the degree of economic penetration as per the applicable treaty that justifies a
nation in treating a foreign person in the same manner as a domestic person. It needs to be
clarified as well as emphasized that the word ‘permanent’ in the term ‘permanent
establishment’ does not in any manner signify or denote a permanent character, or that the
right to use the place should be perpetual, but that there must be a certain degree of
permanence. A fixed place would though not exclude a movable place of business, viz. a
petroleum drilling rig may constitute a PE if it is moved frequently from one location to another.
How the fixed place or the right to use the same is however secured is though of little
consequence, so that the same may be owned, rented or otherwise acquired in any other
manner. Even a right which is not legal in its nature may, therefore, be of no adverse
consequence.
Court after analyzing the facts of the case has commented that, it is to be appreciated that it is
for the Company to specify as to how and from where it has performed its’ work. If the team of
its personnel deputed on the contract have not functioned from the Customer’s premises, in
that case specify the place/s from where they have functioned over their continued stay in
India, which is stated to be at 874 man-days for the consultants and 81 days for the principal
consultants, and how. The communications between them and the head office, which is again
a part of their work, has again admittedly been carried out in India and, as stated, from a place
in the vicinity of the place of the stay. Whether the communication has taken place from the
hotel room through the medium of internet using laptops – a tangible asset/s, by the
personnel, or similar facilities provided by the hotel or by a retail outlet providing such services
is of little moment. Therefore some place was at the disposal of the Company or its
employees during the entire period of the stay in India is, thus, manifest and eminent and
follows unmistakably from the work nature/profile and the modus operandi followed. In our
clear view, therefore, the Company clearly has a PE in India during the relevant years.
Key takeaways: Even though this ruling is based on the peculiar facts of the case, but it
demonstrates the practical approach being adopted by the Judicial authorities which involves
the scrutiny of business arrangements, work methodology and also the modern work
techniques. The interpretation of Fixed Place PE provisions and criteria applied therein in its
analysis by the Tribunal will be a useful guidance in similar cases.
8.24 Samsung Heavy Industries Company Limited Vs DIT

(Uttarakhand HC)(2014) - Profit attribution to PE
Understanding of facts: The Company was tax resident of Korea and has entered into
contract with Indian customer. While filings its return of income for the relevant year, the
Company claimed that under the contract with Indian customer it has received certain
income in connection with activities carried on inside India and certain income in connection
with activities carried on outside India. In its income tax return for the relevant year, the
Company showed ‘Nil’ income as it has incurred certain expenses and after deducting such
expenses, it has earned a loss and accordingly, earned no income taxable in India. The Tax
Officer in its order refused to accept this contention of the Company and held that 25% of the
revenues, thus received allegedly for outside India activities, should be brought within the
taxing network of India. The order of the Tax Officer was upheld by the higher appellate
authorities including Tribunal. The appeal was filed before the Uttarakhand High Court
against this decision.
Ruling of the High Court: The Court observed that Article 7 of the India-Korea tax treaty,
recognizes two tax identities of an enterprise. The said paragraph makes it clear that the
profits of the enterprise may be taxed in the other State only so much of the same which is
attributable to that permanent establishment. In the event, an enterprise having a tax identity
in one Contracting State for having a permanent establishment there, and dealing wholly
independently with its other tax entity situate in the other Contracting State, the profit
attributable to the first tax identity will be profit which might be expected to be made.
However, the tax treaty does not give any guidance to ascertain what income is attributable to
which tax entity unless profit is generated by one tax entity dealing with the other tax entity.
Based on available facts, the Court observed that there is not even a finding either by the Tax
Officer or the higher appellate authorities, that 25% of the gross revenue of the Company was
attributable to the business carried out by the Project Office of the Company in India. Court
further stated that neither the Tax Officer, nor the Tribunal has made any effort to bring on
record any evidence to justify their claim. Therefore while ruling in favor of the Company, the
Court held that the tax liability could not be fastened without establishing that the same is
attributable to the tax identity or permanent establishment of the enterprise situated in India.
Key takeaways: This ruling assumes significant importance from PE attribution principle
perspective stating that tax treaty does not permit the tax authorities to arbitrarily fix a part of
the revenue to the permanent establishment of the Taxpayer in India. This puts an onus on
the Tax Authorities to substantiate the PE attribution with the necessary evidence and logical
basis.
8.25 CIT Vs. Nike Inc (Karnataka HC)(2013) - Taxability of Liaison

Office
Understanding of facts: The Company, tax resident of United States of America, was
engaged in business of sports apparels, and has various associated enterprises or
subsidiaries in various parts of the world. The Company from its office in United States of
America used to arrange for all its subsidiaries all over the world the various brands of sports
apparels for sale to the various customers. The arrangement was through procurement from
the manufacturer who used to directly dispatch the apparels to the various subsidiaries spread
all over the world. The Company, with prior permission of Reserve Bank of India, has opened
a liaison office in India with a view to spread its wings mainly from the point of view of
procurement of various apparels from manufacturers in India. In the application for permission
before the Reserve Bank of India, the Company had categorically stated that the liaison office
will not undertake any activity of trading, commercial or any industrial nature or enter into any
business contracts in its own name without the previous approval of the Reserve Bank.
Accordingly, the Company opened the liaison office and employed persons in various
categories defining qualifications for each post and this was with reference to its main activity
of purchase or procurement of apparels from India for the purpose of export by those
manufacturers directly to the various subsidiaries spread at various places in the world. The
liaison office used to keeps a close watch on the progress, quality, etc., at the manufacturing
workshop. Further it also used to keep a watch on the time schedule to be followed and
render such assistance as may be required in the dispatch of the goods including the actual
buyer and the place for export.
A Survey was conducted by Tax Authorities at liaison office in India under section 133A of the
Act and the activities carried on by the Company through this office were verified. The Tax
Authorities held that the activities of the Company in India are actually beyond its activities as
required as a liaison office. The Company gets the goods manufactured through various
factories by providing various data like the availability of raw materials, list of suppliers of raw
materials, cost of raw materials etc, further it also helps the manufactures in audit/quality
checks and dispatching of goods . Thus, a part of the entire business is done in India, more
specifically by Apparel Product Integrity Department and the quality checks, through the India
Liaison office. Therefore, the income accrues or arises is deemed to arise in India in view of
Clause (b) of Sub-Section (2) of Section 5 of the Act and therefore,the income of the Company
is chargeable to tax to the extent of income, which is attributable to the activities done in India.
The Company preferred appeal before the Commissioner of Income Tax (Appeals) wherein
the order of the Tax Authorities was upheld by the Commissioner of Income Tax (Appeals).
The order of Commissioner of Income Tax (Appeals) was challenged before the Tribunal
wherein Tribunal upheld the contention of the Company and set aside the order of the
Commissioner of Income Tax (Appeals). The appeal was filed before the Karnataka High
Court against this decision, by Tax Authorities.
Ruling of the High Court: Court discussed the various amendments in Section 9(1) and
observed that in respect of the Assessment Year 1964-65 and subsequent years, a non-
resident will not be liable to tax in India on any income attributable to operations confined to
purchase of goods in India for export, even though the non-resident has an office or agency in
India for the purpose, or the goods are subjected by it to any manufacturing process before
being exported from India. Court further noted that the object of establishing the liaison office
is to identify the manufacturers, give them the technical know-how and see that they
manufacture goods according to their specification which would be sold to their affiliates. The
person who purchases the goods pays the money to the manufacturer, in the said income the
Company has no right and hence the said income cannot be said to be a income arising or
accruing in the tax territories vis-a-vis the liaison office. Once the entire operations are
confined to the purchase of goods in India for the purpose of export, the income derived
therefrom shall not be deemed to accrue or arise in India and it shall not be deemed to be an
income under Section 9 of the Act. The Court stated that if we keep the object with which the
proviso to clause (b) of Explanation 1 to Sub-section (1)(i) of Section 9 of the Act was deleted
from Assessment Year 1964-65 onwards, the object is to encourage exports thereby the
Country can earn foreign exchange. Accordingly, Court upheld the order passed by Tribunal
in favor of the Company.
Key takeaways: In this ruling Court has dealt with the taxation of liaison office which is set up
through which goods are supplied to global entities. Considering India’s cost advantage in
manufacturing vis-à-vis its global peers and also increased focus of the Indian Government on
developing India as a favored manufacturing destination, this ruling will act as a guiding
principle in structuring the operations of the liaison office of similar multinationals in India.
8.26 Brown And Sharpe Inc. Vs CIT (Allahabad HC)(2014) - Taxability

of Liaison Office
Understanding of facts: The Company, tax resident of United States of America, established
a liaison office in India with prior approval from Reserve Bank of India. The Company, for the
relevant year, filed its return of income and returned a loss. The Company during the
assessment with the Tax Officer submitted that remuneration of its employees was divided
into two component i.e. fixed and sales incentive plan. When called upon to disclose the
details of the targets which were fixed and the receipts under the sales incentive plan, the
Company submitted that during the relevant assessment year no incentive had been paid to
its employees. The Tax Officer recorded the statement of the Chief Representative Officer of
the Indian liaison office and came to the conclusion that the activities of the liaison office were
not restricted only to providing a channel of communication between the buyers of the
products sold by the parent company but the activities were, it was found, extended to
searching for prospective buyers, providing required information and persuading them.
Accordingly, the Tax Officer held that the activities of the Company involved marketing
activities in India and that the liaison office was, in fact, carrying on business activities. On this
basis, Tax Officer computed the taxable income of the Company as the profit from business
activities carried on in India. The order of the Tax Officer was first confirmed by
Commissioner of Income Tax (Appeals) and thereafter by Tribunal. The appeal was filed
before the Allahabad High Court against this decision, by the Company.
Ruling of the High Court: The Court observed that the disclosures which were made by the
Company before the Tax Officer clearly indicate that during the relevant assessment year, the
activities of the liaison office were not confined only to being a channel of communication
between the Head Office in the United States of America and prospective buyers in India. The
activities of the liaison office included explaining the products to buyers in India, furnishing
intimation in accordance with the requirements of the buyers and discussing commercial
issues pertaining to the contract through the technical representative, after which an order was
placed by the buyer directly to its overseas entity. Apart from this, it is significant that the
performance of the personnel in India was, as disclosed by the Chief Representative Officer,
judged by the number of direct orders that the Company received and by the extent of
awareness of the Company that was generated in India.
The Company had an incentive plan, and it is not in dispute, as was disclosed by the Chief
Representative Officer, that in the sales incentive plan an employee was allowed to receive
upto 25% of its annual remuneration as Sales Incentive. Whether or not any incentive was, in
fact, paid to an employee during the year in question, is not material. What is relevant is that
the nature of the incentive plan would clearly indicate that the purpose of the liaison office in
India was not merely to advertise the products of the Company or to act as a link of
communication between the Company and a prospective buyer but involved activities which
traversed the actual marketing of the products of the Company in India because it was on the
basis of the orders generated that an incentive was envisaged for the employees. The Court
noted that the activity of the liaison office during the relevant assessment year was not of a
preliminary or preparatory nature so as to attract the exclusion under Article 5(3)(e) of the
India-USA Tax Treaty. Accordingly, the Court upheld the order of the Tribunal wherein
Tribunal affirmed the action of the Tax officer of holding that the income attributable to the
liaison office was taxable in India.
Key takeaways: In this ruling while assessing the taxability of liaison office the Court has
deliberated on the difference between ‘advertising’ and ‘marketing’, where the former is
eligible for the exemption provided in the tax treaty but latter is not. The observations and
principle laid down in this ruling are vital for examining the tax implications of liaison office
operating or proposed to be operating in the similar circumstances.
8.27 Production Resource Group, In re [2018] 89 taxmann.com 219

(AAR - New Delhi) -Permanence test is to be linked to nature and
requirements of the business for constitution of a PE
Understanding of facts - Applicant a Belgium company was rendering, lighting and
searchlight services to Organizing Committee, Commonwealth Games 2010, Delhi (OCCG)
under Service Agreement (SA) dated 9-7-2010 and received consideration for same. For
providing lighting and searchlight services, applicant had to do all related activities, such as
obtaining all authorizations/permits, engaging personnel with requisite skills, supply and/or
procure all necessary equipment, subcontracting and shipping and loading, insurance etc. For
carrying out its aforesaid business and related activities, applicant was provided lockable
office space as well as on-site space. The applicant’s employees were present in India for a
period of 66 days for preparatory work, installation, provision of service and dismantling of the
equipment. The issue was whether the consideration under the SA was taxable in India under
the Income-tax Act, 1961 (the Act) or Double Taxation Avoidance Agreement (tax treaty)
between India and Belgium.
Ruling of the AAR-. The degree of permanence was necessitated by the nature and
requirements of the business. The applicant’s activities and presence was spread for a
sufficiently long period of time over the entire duration of the event, thus fulfilling the
permanence test. The lighting facilities created and erected by the applicant coupled with the
space available with the applicant constituted a part of place of business. The place of
business may not be fixed to the soil, as long as it forms an intrinsic part of the income
generating activity. Therefore, the determination of the existence of a PE would be based on
the specific facts of the case and no general threshold of duration could be read into the
requirements of fixed PE. Applicant had met each of criterion for establishing a PE, viz. place
of business, power of disposition, permanence of location, business activity and business
connection which cumulatively and collectively are sine qua non of a PE; consideration
received by applicant could only be held to be taxable in India as Business Profits, as per
provisions of Article 7 of DTAA as also under section 9(1)(i).
Key takeaways
The AAR relied on the SC ruling in the case of Formula One and upheld that the degree of
permanence should be seen vis-à-vis the nature of business. The AAR also ruled out the
applicability of threshold of duration to the fixed PE clause. This could be relevant for
analysing PE exposure in future.
8.28 CIT v Mahindra And Mahindra Ltd. [2018] 93 taxmann.com 32
(SC) -Waiver of loan taken for procuring assets not taxable as
business income
Understanding of facts- The taxpayer decided to expand its product line by including two
different business models. For this purpose, an agreement was entered into with an American
Company (A Co.) which agreed to supply tooling and other equipment. A Co. supplied dies,
tooling and equipment to the taxpayer through its subsidiary (SA Co.). To procure tooling, A
Co. agreed to provide loan to the taxpayer at the rate of 6%, repayable after 10 years on
instalment basis. Later, B Co. took over A Co. Subsequent to such takeover, B Co. agreed to
waive-off the principal amount of loan advanced by A Co. to the taxpayer. The taxpayer filed
its return claiming such waiver of loan to be capital receipt, not chargeable to tax. The tax
officer (TO) concluded that the waiver of the loan represented income and not liability, and
held that the same would be taxable under section 28(iv) of the Act. On appeal, the
Commissioner of Income- tax (Appeals) [CIT(A)] taxed such waiver under section 41(1) of the
Act, rather than section 28(iv), and upheld the addition made by the TO. On appeal the
Income-tax Appellate Tribunal (Tribunal) set aside CIT(A)’s order and deleted the addition
made by the TO. This was subsequently upheld by the HC. The issue before the Supreme
Court was whether the waiver of loan by creditor was taxable as perquisite under section
28(iv).
Ruling of the Supreme Court - On the applicability of section 28 of the Act it was held that
income to be taxed under clause (iv) should have been in some form other than money. The
waiver of loan resulted in extra cash in the hands of the debtor and the condition of benefit
received in form other than money was not satisfied. Hence, provisions of section 28(iv) of the
Act did not apply. The taxpayer was paying interest but did not claim deduction under section
36(iii) of the Act for such interest payments, as the equipment purchased were capital assets
in the hands of taxpayer and was not debited to its Profit and Loss account. Therefore, they
could not be classified as a trading liability. Section 41(1) of the Act deals with the remission
of trading liability, whereas the waiver of loan amounts to cessation of liability other than
trading liability. Hence, the provisions of section 41(1) of the Act shall not be applicable.
Therefore, neither does section 28(iv) of the Act, nor does section 41(1) of the Act applies to
waiver of the principal portion of the loan taken on capital assets.
Key takeaways- This ruling supports the view that the provisions of section 28(iv) shall only
apply in cases where the benefit or perquisite was in a form other than that of money, and
waiver of a loan does not satisfy this requirement. This ruling reaffirms that provisions of
section 41(1) applies only in case of cessation of trading liability and does not apply in case of
cessation of any liability other than trading liability.
8.29 ACIT v E-Funds IT Solution Inc[2017] 86 taxmann.com 240 (SC)-
Support services performed by an Indian subsidiary, which
enables the foreign company to render IT and IT-enabled
services to its client abroad, will not create a PE of the foreign
company in India.
Understanding of facts - A Group Inc. and B Corporation, USA (hereinafter, collectively
referred to as “AB USA” were resident companies in the USA. AB USA were in the business of
providing ATM management services, electronic payment management, decision support and
risk management and global outsourcing and professional services (IT and IT-enabled
services) to its customers outside India. AB USA were assessed to tax in USA on their global
income. C Private Limited (C India) was a company resident in India. It provides various
support services to AB USA in relation to its IT and IT enabled services. C India was taxed in
India on its global income, in accordance with the provisions of the Income-tax Act, 1961 (Act).
The Revenue contended that the income of AB USA should also have been taxed in India as
they had PE in India in the form of C India, to which income from provision of IT and IT
enabled services could be attributed.
Ruling of the Supreme Court - The Supreme Court held that support services performed by
an Indian subsidiary, which enables the foreign company to render information technology
and IT-enabled services to its client abroad, will not create a PE of the foreign company in
India. The Indian subsidiary did not create a fixed place PE of its foreign company in India
unless the premises of the subsidiary were at the disposal of the foreign company. The Apex
Court also negated the possibility of service PE in India on the ground that none of the
customers of the foreign company received any services in India. In relation to agency PE, the
Apex Court held that it has never been the case of the revenue that an Indian subsidiary was
authorised to or exercised any authority to conclude contracts on behalf of the foreign
company. Even if the foreign company is held to have a PE in India, the transaction between
the foreign company and its Indian subsidiary being at arm’s length, no further profits can be
attributed in India. Further, that the Mutual Agreement Procedures (MAP) agreement for an
earlier year could not be considered as precedent for subsequent years.
Key Takeaways-The SC decision brings out certain guidelines for determination of existence
or otherwise of the PE of a foreign company in India. The principal test, to ascertain whether
an establishment has a fixed place of business or not, is that such physically located premises
have to be “at the disposal” of the foreign company. No fixed place PE can be established if
the main business and revenue earning activity of the foreign company are not carried on
through a fixed place in India, which has been at the disposal of the foreign company. The
mere fact that a 100% subsidiary may be carrying on business in India does not mean that the
holding company would have a PE in India. If any customer were rendered services in India,
whether resident or non-resident, a service PE would be established. If arm’s-length
conditions were satisfied, no further profit would be attributable, even if there exists a PE of a
foreign company in India. The MAP resolution arrived for a year cannot be considered as a
precedent for subsequent years.
8.30 Honda Siel Cars India Ltd v CIT [2017] 82 taxmann.com 212 (SC)-
Fees for availing technical knowhow to bring a new business
into existence in the form of a JV company treated as a capital
expenditure
Understanding of facts - The taxpayer was an Indian company incorporated pursuant to a
joint venture (JV) agreement between an Indian company and a foreign company. The foreign
company was engaged in the business of development, manufacture and sale of automobiles
and parts. The taxpayer entered into a technical collaboration agreement (TCA) with the
foreign company for availing technical knowhow and technical information for a lump sum fee
to be paid in five equal instalments commencing from the third year of commercial production
along with a royalty of 4% on its sales. The taxpayer treated these payments as revenue
expenditure. Simultaneously certain other agreements were entered between the taxpayer
and the foreign company for providing technicians and engineers for necessary guidance for
setting up of plant, supply of parts for manufacture of cars and supply of manufacturing
facilities (the agreement inter-alia stipulated specifications for manufacturing facilities to be
sold by the foreign company to the taxpayer). The taxpayer treated the payments made under
these agreements as capital expenditure. The tax officer in the reassessment proceedings,
treated the amount towards technical know-how and royalty payable under the TCA as capital
expenditure and disallowed the claim of the taxpayer. The matter was carried by the taxpayer
to the SC. Issue before the SC was whether the amount paid for availing technical know-how
and technical information should have been treated as revenue expenditure or capital
expenditure.
Ruling of the Supreme Court – The Supreme Court held that there is no single rule of thumb,
principle or test which is paramount and each case needs to be probed in the light of
circumstances of that particular case. The solution has to be derived from many aspects of the
whole set of circumstances, some of which may point in one direction, some in the other. It is
a common sense appreciation of all guiding features which must provide the ultimate answer.
The distinction between capital and revenue expenditure with reference to acquisition of
technical information and know-how has also been spelt out by the SC and HCs in many
cases. Where there was transfer of ownership in the intellectual property rights or in licenses,
it would clearly be capital expenditure. However, where no such rights had been transferred
but an arrangement facilitates the grant of license to use those rights for a limited purpose, it
would be in the nature of revenue expenditure as no enduring benefit was acquired thereby.
Where the technical know-how availed was for improvising the existing business, the
expenditure would be treated as revenue expenditure. This case, thus, indicates that if such
technical know-how was for the purpose of setting up a new business, the position may be
different. The very purpose of entering into the JV agreement was to set up a JV company
with an aim and objective to establish a unit for manufacture of automobiles and part thereof.
As a result of the JV agreement, the taxpayer was incorporated which entered into TCA in
question for technical collaboration. This technical collaboration included not only transfer of
technical information, but also complete assistance, actual, factual and on the spot, for
establishment of plant, machinery etc. to create a manufacturing unit for the products. Thus, a
new business was set up with the technical know-how provided by the foreign company. In
case of termination of the TCA, the JV itself would end and there may not have been any
further manufacturing using the technical know-how of the foreign collaborator. The TCA was
crucial forsetting up of the plant project in question for manufacturing of the goods. Thus, the
question of improvising the existing technical know-how by borrowing the technical know-how
from foreign company did not arise and accordingly, the expenditure in the form of fees paid
would be in the nature of capital expenditure and not revenue expenditure.
Key Takeaways- SC has reiterated the long standing position that the expenditure incurred on
formation of a new business is capital in nature. However, as noted by the SC, whether a
particular expenditure is capital or revenue in nature depends on specific circumstances and
facts of the case, a detailed investigation needs to be undertaken to determine whether a
particular expenditure of this nature has been incurred on capital field or revenue field.
Unit IX Triangular Cases

9.1 Background
Countries enter into bilateral Double Tax Convention with the objective of eliminating or
mitigating the impact of juridical double taxation. However, often situations arise where,
despite the incorporation of article on methods of elimination of double taxation (i.e., Article
23A – exemption method or Article 23B – credit method or a combination of the two), the
same income is taxed more than twice in certain specific kinds of cases.
The double taxation arises because a bilateral Double Tax Convention involves two tax
jurisdictions and takes care of double taxation in those two tax jurisdictions whereas the cases
that are being considered here involve triple taxation in three tax jurisdictions. In international
tax parlance, such cases are known as triangular cases.
9.2 What is a Triangular Case?

A triangular case, as the name suggests, involves following three tax jurisdictions.
• State ‘R’ – the State in which the taxpayer is resident. The taxpayer is subject to tax in
that State because of residence based taxation.
• State ‘P’ – the State in which the taxpayer is having a permanent establishment. The
taxpayer is subject to tax in that State to the extent of income attributable to that
permanent establishment because of source based taxation.
• State ‘S’ – the State from which the permanent establishment of the taxpayer earns
income. The taxpayer is subject to tax on that income because of source based
taxation.
Thus, while in case of two States, only one Double Tax Convention between State ‘R’ and
State ‘P’ is involved, in case of a triangular case, with the involvement of three tax
jurisdictions, three Double Tax Conventions are involved. These are: Double Tax Conventions
between (i) State ‘P’ and State ‘S’, (ii) State ‘R’ and State ‘P’ and (iii) State ‘R’ and State ‘S’.
9.3 Which sectors are generally affected?

Generally, triangular cases arise in all such sectors which are mainly service oriented and do
not require permanent ‘on-ground’ presence. Accordingly, following sectors are generally
affected.
• Banking
• Financial services
• Insurance services
• Regional headquarter operations
• Onsite technical support services (which are required to be provided urgently and
therefore, are provided from a nearby location).
9.4 Case Study

The following case study will clarify how a triangular case develops and what issues arise from
a triangular case involving three tax jurisdictions. The case study is based on certain
assumptions. These assumptions do not reflect the actual tax rates or Double Tax Convention
provisions.
Facts
• UK Co is a company incorporated in, and tax resident of, the UK.
• UK Co is engaged in time sensitive service based activity, which requires provision of
services through deputation of personnel.
• UK Co has set up a branch in India for provision of time sensitive services. In terms of
India-UK Double Tax Convention, the Indian branch of UK Co is a permanent
establishment.
• The personnel of the Indian branch are based in India but for provision of services on
emergency basis, they visit Sri Lanka from India.
• During the course of the year, the Indian branch personnel visited Sri Lanka for
providing services. The branch earned income from Sri Lanka which was subject to tax
in Sri Lanka and hence, the payer has withheld tax in Sri Lanka.
Following diagrammatic presentation will impart clarity to the aforementioned situation.
UK Co
UK
India Income
received
India PE
Sri Lanka
Sri Lankan Income
Assumptions
(a) Income earned by Indian branch from Sri Lanka 1,000
(b) Withholding tax rate in Sri Lanka 20%
(c) Tax withheld in Sri Lanka 200
(d) Income earned by Indian branch in India 2,000
(e) Tax rate in India 30%
(f) Tax liability in India on income earned in India 600
(g) Tax liability in India on income earned in Sri Lanka but attributed to 300
Indian branch
(h) Total taxable income earned by Indian branch 3,000
(i) Total tax liability in India 900
(j) Total tax borne by Indian branch (Sri Lanka, 200 + India, 900) 1,100
(k) Tax rate in UK 35%
(l) Tax in UK on income earned in India (i.e., 2,000) 700
(m) Tax in UK on income earned in Sri Lanka (i.e., 1,000) 350
Issues
(a) India has entered into Double Tax Convention with Sri Lanka. The Indian branch of UK
Co has earned income on which tax is chargeable in Sri Lanka.
Issue: whether India-Sri Lanka Double Tax Convention can apply in such case?
(b) India has entered into Double Tax Convention with Sri Lanka. The income earned by
the Indian branch of UK Co from Sri Lanka is subject to tax in India since it is
attributable to the Indian permanent establishment.
Issue: since the income earned by the Indian branch from Sri Lanka is attributable to
the Indian branch, and since the Indian branch is subject to tax in India on such income,
whether, under India-Sri Lanka Double Tax Convention, the Indian branch can claim
credit for tax paid in Sri Lanka against tax payable by it in India on the income earned
from Sri Lanka?
(c) The UK has entered into Double Tax Convention with Sri Lanka. the Indian branch of
UK Co has earned income from Sri Lanka.
Issue: whether UK Co can claim Double Tax relief under UK-Sri Lanka Double Tax
Convention?
(d) The core underlying issues are as follows.
Issue: as there are three Double Tax Conventions, which of these would apply –
Source-PE or PE-Residence or Source-Residence?
Issue: whether juridical triple taxation of the same income can be avoided or mitigated
in any manner?
9.5 Issues
Having identified the issues, it would be interesting to discuss each issue separately
9.5.1 Will India-Sri Lanka Double Tax Convention apply?
Income earned by India branch from Sri Lanka is chargeable to tax in Sri Lanka as well as in
India. A branch (or a permanent establishment) is not a legal person. Double Tax Conventions
apply to ‘persons’ which are resident of one of the two States.
This proposition can be better understood by reference to certain provisions of the Income-Tax
Act, 1961.
• Section 4 is the charging provision which charges tax on total income of every ‘person’.
• Section 2(7) defines “assessee” primarily as a ‘person’.
• Section 2(31) defines “person” to include several categories. One of the categories is ‘a
company’. However, definition of “person” does not include a ‘branch’ or a ‘permanent
establishment’.
Thus, for the purpose of the Income-Tax Act, 1961, UK Co being the ‘person’ is the ‘assessee’
and not its Indian branch. Since the Indian branch is not a ‘person’, it cannot be the ‘resident’
of the State in which it is situated (in this case, India). Therefore, the Indian branch cannot
access India-Sri Lanka Double Tax Convention. Accordingly, India-Sri Lanka Double Tax
Convention cannot apply in case of the Indian branch.
9.5.2 Will Indian Branch get Credit for Tax Withheld in Sri Lanka?
Credit for tax can be claimed only by applying the provisions of a Double Tax Convention. As
discussed earlier, the Indian branch cannot access India-Sri Lanka Double Tax Convention.
Therefore, the Indian branch cannot claim credit for tax withheld in Sri Lanka (i.e., 200 – see
3.3 in illustration).
However, since income from Sri Lanka is attributable to the Indian branch, it would be subject
to tax in India. Accordingly, in addition to the tax payable on income earned by Indian branch
in India, it will also the required to pay tax on the income earned in Sri Lanka (i.e., 300 – see
3.7 in illustration)
9.5.3 Can UK Co get credit under UK-Sri Lanka Double Tax Convention for Tax
Withheld in Sri Lanka?
As discussed earlier, only a ‘person’ can access a Double Tax Convention. Since UK Co is a
‘person’, UK Co can access UK-Sri Lanka Double Tax Convention. Since the income earned in
Sri Lanka will be subject to tax in UK, UK Co can claim credit for tax withheld in Sri Lanka (i.e.,
200 – see 3.3 in illustration).
9.5.4 Which Double Tax Convention will apply?

As discussed earlier, only a ‘person’ can access a Double Tax Convention. Since UK Co is a
‘person’, UK Co can access UK-India Double Tax Convention. Also, UK Co can access UK-Sri
Lanka Double Tax Convention. However, UK Co cannot access India-Sri Lanka Double Tax
Convention. Since the income earned in India will be subject to tax in UK, UK Co can claim
credit for tax withheld in India. Also, since the income earned in Sri Lanka will be subject to tax
in UK, UK Co can claim credit for tax withheld in Sri Lanka.
However, in this case, the issue will be: whether UK Co can claim credit in UK in respect of
only the tax paid in India on the income earned in India (i.e., 600 – see 3.6 in illustration) or
also the tax paid in India on the income that is earned in Sri Lanka and on which India has
levied tax (i.e., 300 – see 3.7 in illustration)?
9.5.5 Whether Triple Taxation can be mitigated?
Practically, income earned by the Indian branch from Sri Lanka has suffered tax thrice – firstly,
in Sri Lanka, secondly, in India and thirdly, in the UK. A bilateral Double Tax Convention
mitigates double taxation in two countries. As mentioned earlier, income from Sri Lanka is a
case of triple taxation in three countries.
Normally, under a Double Tax Convention, the obligation on the Residence State is only to
give credit for tax paid and only to the extent of tax payable in the Residence State. Hence,
the credit that UK Co may get in UK cannot exceed 350 (see 3.13 in illustration).
Sri Lankan tax on income earned in Sri Lanka is 200. Indian tax on the same income is 300.
Since India will not give credit for tax paid in Sri Lanka, the total tax paid on Sri Lankan
income is 500. However, UK tax on the same income is 350.
In terms of Double Tax Convention between UK and Sri Lanka and between UK and India, UK
will give credit to its resident (i.e., UK Co) to the extent of tax paid in Sri Lanka or India as the
case may be. Further, such credit will be restricted to the extent of tax payable in the UK. In
such case, practically, following three scenarios may emerge.
• The UK tax authority may hold that as the income was sourced in Sri Lanka and since
Sri Lankan tax was 200, only 200 can be claimed by UK Co against its UK tax liability of
350 on the same income. Thus, UK Co may, effectively, pay aggregate tax of 650 (i.e.,
200 in Sri Lanka + 300 in India + 150 in UK).
• The UK tax authority may hold that the higher of the tax paid in Sri Lanka or India will
be allowed. In that case, the maximum credit that UK Co can get is 300.
• Even if UK tax authority were to adopt the most liberal approach, the credit cannot
exceed the tax payable in the UK (i.e., 350) as granting any higher amount will amount
to the UK giving refund of tax which was collected by a foreign government.
9.6 Conclusion
As will be seen from the foregoing discussion, triangular cases may not have a satisfactory
solution under the bilateral Double Tax Conventions. The possible solution could be that the
Residence State grants unilateral relief. However, even if the Residence State were to grant
unilateral relief, full mitigation of triple taxation is not likely to happen as such relief would be
limited to the tax payable in the Residence State.
Annexure
Relevant extract of the OECD’s commentary on the Articles of the Model Tax
Convention
COMMENTARY ON ARTICLE 1 - CONCERNING THE PERSONS COVERED BY THE
CONVENTION
Application of the Convention to partnerships
2. Domestic laws differ in the treatment of partnerships. These differences create various
difficulties when applying tax Conventions in relation to partnerships. These difficulties are
analysed in the report by the Committee on Fiscal Affairs entitled “The Application of the
OECD Model Tax Convention to Partnerships”, the conclusions of which have been
incorporated below and in the Commentary on various other provisions of the Model Tax
Convention.
3. As discussed in that report, a main source of difficulties is the fact that some countries treat
partnerships as taxable units (sometimes even as companies) whereas other countries adopt
what may be referred to as the fiscally transparent approach, under which the partnership is
ignored for tax purposes and the individual partners are taxed on their respective share of the
partnership’s income.
4. A first difficulty is the extent to which a partnership is entitled as such to the benefits of the
provisions of the Convention. Under Article 3, only persons who are residents of the
Contracting States are entitled to the benefits of the tax Convention entered into by these
States. While paragraph 2 of the Commentary on Article 1 explains why a partnership
constitutes a person, a partnership does not necessarily qualify as a resident of a Contracting
State under Article 4.
5. Where a partnership is treated as a company or taxed in the same way, it is a resident of
the Contracting State that taxes the partnership on the grounds mentioned in paragraph 1 of
Article 4 and, therefore, it is entitled to the benefits of the Convention. Where, however, a
partnership is treated as fiscally transparent in a State, the partnership is not “liable to tax” in
that State within the meaning of paragraph 1 of Article 4, and so cannot be a resident thereof
for purposes of the Convention. In such a case, the application of the Convention to the
partnership as such would be refused, unless a special rule covering partnerships were
provided for in the Convention. Where the application of the Convention is so refused, the
partners should be entitled, with respect to their share of the income of the partnership, to the
benefits provided by the Conventions entered into by the States of which they are residents to
the extent that the partnership’s income is allocated to them for the purposes of taxation in
their State of residence (see paragraph 8.8 of the Commentary on Article 4).
6. The relationship between the partnership’s entitlement to the benefits of a tax Convention
and that of the partners raises other questions.
6.1 One issue is the effect that the application of the provisions of the Convention to a
partnership can have on the taxation of the partners. Where a partnership is treated as a
resident of a Contracting State, the provisions of the Convention that restrict the other
Contracting State’s right to tax the partnership on its income do not apply to restrict that other
State’s right to tax the partners who are its own residents on their share of the income of the
partnership. Some states may wish to include in their conventions a provision that expressly
confirms a Contracting State’s right to tax resident partners on their share of the income of a
partnership that is treated as a resident of the other State.
6.2 Another issue is that of the effect of the provisions of the Convention on a Contracting
State’s right to tax income arising on its territory where the entitlement to the benefits of one,
or more than one, Conventions is different for the partners and the partnership. Where, for
instance, the State of source treats a domestic partnership as fiscally transparent and
therefore taxes the partners on their share of the income of the partnership, a partner that is
resident of a State that taxes partnerships as companies would not be able to claim the
benefits of the Convention between the two States with respect to the share of the
partnership’s income that the State of source taxes in his hands since that income, though
allocated to the person claiming the benefits of the Convention under the laws of the State of
source, is not similarly allocated for purposes of determining the liability to tax on that item of
income in the State of residence of that person.
6.3 The results described in the preceding paragraph should obtain even if, as a matter of the
domestic law of the State of source, the partnership would not be regarded as transparent for
tax purposes but as a separate taxable entity to which the income would be attributed,
provided that the partnership is not actually considered as a resident of the State of source.
This conclusion is founded upon the principle that the State of source should take into
account, as part of the factual context in which the Convention is to be applied, the way in
which an item of income, arising in its jurisdiction, is treated in the jurisdiction of the person
claiming the benefits of the Convention as a resident. For States which could not agree with
this interpretation of the Article, it would be possible to provide for this result in a special
provision which would avoid the resulting potential double taxation where the income of the
partnership is differently allocated by the two States.
6.4 Where, as described in paragraph 6.2, income has “flowed through” a transparent
partnership to the partners who are liable to tax on that income in the State of their residence
then the income is appropriately viewed as “paid” to the partners since it is to them and not to
the partnership that the income is allocated for purposes of determining their tax liability in
their State of residence. Hence the partners, in these circumstances, satisfy the condition,
imposed in several Articles that the income concerned is “paid to a resident of the other
Contracting State”. Similarly the requirement, imposed by some other Articles, that income or
gains are “derived by a resident of the other Contracting State” is met in the circumstances
described above. This interpretation avoids denying the benefits of tax Conventions to a
partnership’s income on the basis that neither the partnership, because it is not a resident, nor
the partners, because the income is not directly paid to them or derived by them, can claim the
benefits of the Convention with respect to that income. Following from the principle discussed
in paragraph 6.3, the conditions that the income be paid to, or derived by, a resident should be
considered to be satisfied even where, as a matter of the domestic law of the State of source,
the partnership would not be regarded as transparent for tax purposes, provided that the
partnership is not actually considered as a resident of the State of source.
6.5 Partnership cases involving three States pose difficult problems with respect to the
determination of entitlement to benefits under Conventions. However, many problems may be
solved through the application of the principles described in paragraphs 6.2 to 6.4. Where a
partner is a resident of one State, the partnership is established in another State and the
partner shares in partnership income arising in a third State then the partner may claim the
benefits of the Convention between his State of residence and the State of source of the
income to the extent that the partnership’s income is allocated to him for the purposes of
taxation in his State of residence. If, in addition, the partnership is taxed as a resident of the
State in which it is established then the partnership may itself claim the benefits of the
Convention between the State in which it is established and the State of source. In such a
case of “double benefits”, the State of source may not impose taxation which is inconsistent
with the terms of either applicable Convention; therefore, where different rates are provided
for in the two Conventions, the lower will be applied. However, Contracting States may wish to
consider special provisions to deal with the administration of benefits under Conventions in
situations such as these, so that the partnership may claim benefits but partners could not
present concurrent claims. Such provisions could ensure appropriate and simplified
administration of the giving of benefits. No benefits will be available under the Convention
between the State in which the partnership is established and the State of source if the
partnership is regarded as transparent for tax purposes by the State in which it is established.
Similarly no benefits will be available under the Convention between the State of residence of
the partner and the State of source if the income of the partnership is not allocated to the
partner under the taxation law of the State of residence. If the partnership is regarded as
transparent for tax purposes by the State in which it is established and the income of the
partnership is not allocated to the partner under the taxation law of the State of residence of
the partner, the State of source may tax partnership income allocable to the partner without
restriction.
6.6 Differences in how countries apply the fiscally transparent approach may create other
difficulties for the application of tax Conventions. Where a State considers that a partnership
does not qualify as a resident of a Contracting State because it is not liable to tax and the
partners are liable to tax in their State of residence on their share of the partnership’s income,
it is expected that that State will apply the provisions of the Convention as if the partners had
earned the income directly so that the classification of the income for purposes of the
allocative rules of Articles 6 to 21 will not be modified by the fact that the income flows through
the partnership. Difficulties may arise, however, in the application of provisions which refer to
the activities of the taxpayer, the nature of the taxpayer, the relationship between the taxpayer
and another party to a transaction. Some of these difficulties are discussed in paragraph 19.1
of the Commentary on Article 5 and paragraphs 6.1 and 6.2 of the Commentary on Article 15.
6.7 Finally, a number of other difficulties arise where different rules of the Convention are
applied by the Contracting States to income derived by a partnership or its partners,
depending on the domestic laws of these States or their interpretation of the provisions of the
Convention or of the relevant facts. These difficulties relate to the broader issue of conflicts of
qualification, which is dealt with in paragraphs 32.1 ff. and 56.1 ff. of the Commentary on
Article 23.
COMMENTARY ON ARTICLE 4 - CONCERNING THE DEFINITION OF RESIDENT
8.8 Where a State disregards a partnership for tax purposes and treats it as fiscally
transparent, taxing the partners on their share of the partnership income, the partnership itself
is not liable to tax and may not, therefore, be considered to be a resident of that State. In such
a case, since the income of the partnership “flows through” to the partners under the domestic
law of that State, the partners are the persons who are liable to tax on that income and are
thus the appropriate persons to claim the benefits of the conventions concluded by the States
of which they are residents. This latter result will be achieved even if, under the domestic law
of the State of source, the income is attributed to a partnership which is treated as a separate
taxable entity. For States which could not agree with this interpretation of the Article, it would
be possible to provide for this result in a special provision which would avoid the resulting
potential double taxation where the income of the partnership is differently allocated by the
two States.
India’s position on the Commentary

India does not agree with the interpretation put forward in paragraphs 5 and 6 of the
Commentary on Article 1 and the corresponding interpretation in paragraph 8.8 of the
Commentary on Article 4 according to which if a partnership is denied the benefits of a tax
convention, its members are entitled to the benefits of the tax conventions entered into by
their State of residence.
It believes that this result is only possible, to a certain extent, if provisions to that effect are
included in the convention entered into with the State where the partnership is situated.
COMMENTARY ON ARTICLE 5 - CONCERNING THE DEFINITION OF PERMANENT

ESTABLISHMENT
19.1 In the case of fiscally transparent partnerships, the twelve month test is applied at the
level of the partnership as concerns its own activities. If the period of time spent on the site by
the partners and the employees of the partnership exceeds twelve months, the enterprise
carried on by the partnership will therefore be considered to have a permanent establishment.
Each partner will thus be considered to have a permanent establishment for purposes of the
taxation of his share of the business profits derived by the partnership regardless of the time
spent by himself on the site.
COMMENTARY ON ARTICLE 15 - CONCERNING THE TAXATION OF INCOME FROM
EMPLOYMENT
6.1 The application of the second condition in the case of fiscally transparent partnerships
presents difficulties since such partnerships cannot qualify as a resident of a Contracting State
under Article 4 (see paragraph 8.2 of the Commentary on Article 4). While it is clear that such
a partnership could qualify as an “employer” (especially under the domestic law definitions of
the term in some countries, e.g. where an employer is defined as a person liable for a wage
tax), the application of the condition at the level of the partnership regardless of the situation
of the partners would therefore render the condition totally meaningless.
6.2 The object and purpose of subparagraphs b) and c) of paragraph 2 are to avoid the source
taxation of short-term employments to the extent that the employment income is not allowed
as a deductible expense in the State of source because the employer is not taxable in that
State as he neither is a resident nor has a permanent establishment therein. These
subparagraphs can also be justified by the fact that imposing source deduction requirements
with respect to short-term employments in a given State may be considered to constitute an
excessive administrative burden where the employer neither resides nor has a permanent
establishment in that State. In order to achieve a meaningful interpretation of subparagraph b)
that would accord with its context and its object, it should therefore be considered that, in the
case of fiscally transparent partnerships, that subparagraph applies at the level of the
partners. Thus, the concepts of “employer” and “resident”, as found in subparagraph b), are
applied at the level of the partners rather than at the level of a fiscally transparent partnership.
This approach is consistent with that under which other provisions of tax conventions must be
applied at the partners’ rather than at the partnership’s level. While this interpretation could
create difficulties where the partners reside in different States, such difficulties could be
addressed through the mutual agreement procedure by determining, for example, the State in
which the partners who own the majority of the interests in the partnership reside (i.e. the
State in which the greatest part of the deduction will be claimed)
India’s position on the Commentary

India does not adhere to the interpretation set out in paragraph 6.2, because it does not
recognise the concept of a partner being treated as an employer in the case of fiscally
transparent partnership.
COMMENTARY ON ARTICLES 23 A AND 23 B - CONCERNING THE METHODS FOR

ELIMINATION OF DOUBLE TAXATION
I. Preliminary remarks
E. Conflicts of qualification
32.3 Different situations need to be considered in that respect. Where, due to differences in
the domestic law between the State of source and the State of residence, the former applies,
with respect to a particular item of income or capital, provisions of the Convention that are
different from those that the State of residence would have applied to the same item of income
or capital, the income is still being taxed in accordance with the provisions of the Convention,
as interpreted and applied by the State of source. In such a case, therefore, the two Articles
require that relief from double taxation be granted by the State of residence notwithstanding
the conflict of qualification resulting from these differences in domestic law.
32.4 This point may be illustrated by the following example. A business is carried on through a
permanent establishment in State E by a partnership established in that State. A partner,
resident in State R, alienates his interest in that partnership. State E treats the partnership as
fiscally transparent whereas State R treats it as taxable entity. State E therefore considers that
the alienation of the interest in the partnership is, for the purposes of its Convention with State
R, an alienation by the partner of the underlying assets of the business carried on by the
partnership, which may be taxed by that State in accordance with paragraph 1 or 2 of Article
13. State R, as it treats the partnership as a taxable entity, considers that the alienation of the
interest in the partnership is akin to the alienation of a share in a company, which could not be
taxed by State E by reason of paragraph 5 of Article 13. In such a case, the conflict of
qualification results exclusively from the different treatment of partnerships in the domestic
laws of the two States and State E must be considered by State R to have taxed the gain from
the alienation “in accordance with the provisions of the Convention” for purposes of the
application of Article 23 A or Article 23 B. State R must therefore grant an exemption pursuant
to Article 23 A or give a credit pursuant to Article 23 B irrespective of the fact that, under its
own domestic law, it treats the alienation gain as income from the disposition of shares in a
corporate entity and that, if State E's qualification of the income were consistent with that of
State R, State R would not have to give relief under Article 23 A or Article 23 B. No double
taxation will therefore arise in such a case.
32.5 Article 23 A and Article 23 B, however, do not require that the State of residence
eliminate double taxation in all cases where the State of source has imposed its tax by
applying to an item of income a provision of the Convention that is different from that which
the State of residence considers to be applicable. For instance, in the example above, if, for
purposes of applying paragraph 2 of Article 13, State E considers that the partnership carried
on business through a fixed place of business but State R considers that paragraph 5 applies
because the partnership did not have a fixed place of business in State E, there is actually a
dispute as to whether State E has taxed the income in accordance with the provisions of the
Convention. The same may be said if State E, when applying paragraph 2 of Article 13,
interprets the phrase “forming part of the business property” so as to include certain assets
which would not fall within the meaning of that phrase according to the interpretation given to
it by State R. Such conflicts resulting from different interpretation of facts or different
interpretation of the provisions of the Convention must be distinguished from the conflicts of
qualification described in the above paragraph where the divergence is based not on different
interpretations of the provisions of the Convention but on different provisions of domestic law.
In the former case, State R can argue that State E has not imposed its tax in accordance with
the provisions of the Convention if it has applied its tax based on what State R considers to be
a wrong interpretation of the facts or a wrong interpretation of the Convention. States should
use the provisions of Article 25 (Mutual Agreement Procedure), and in particular paragraph 3
thereof, in order to resolve this type of conflict in cases that would otherwise result in
unrelieved double taxation.
32.6 The phrase “in accordance with the provisions of this Convention, may be taxed” must
also be interpreted in relation to possible cases of double non-taxation that can arise under
Article 23 A. Where the State of source considers that the provisions of the Convention
preclude it from taxing an item of income or capital which it would otherwise have had the right
to tax, the State of residence should, for purposes of applying paragraph 1 of Article 23 A,
consider that the item of income may not be taxed by the State of source in accordance with
the provisions of the Convention, even though the State of residence would have applied the
Convention differently so as to have the right to tax that income if it had been in the position of
the State of source. Thus the State of residence is not required by paragraph 1 to exempt the
item of income, a result which is consistent with the basic function of Article 23 which is to
eliminate double taxation.
32.7 This situation may be illustrated by reference to a variation of the example described
above. A business is carried on through a fixed place of business in State E by a partnership
established in that State and a partner, resident in State R, alienates his interest in that
partnership. Changing the facts of the example, however, it is now assumed that State E
treats the partnership as a taxable entity whereas State R treats it as fiscally transparent; it is
further assumed that State R is a State that applies the exemption method. State E, as it
treats the partnership as a corporate entity, considers that the alienation of the interest in the
partnership is akin to the alienation of a share in a company, which it cannot tax by reason of
paragraph 5 of Article 13. State R, on the other hand, considers that the alienation of the
interest in the partnership should have been taxable by State E as an alienation by the partner
of the underlying assets of the business carried on by the partnership to which paragraph 1 or
2 of Article 13 would have been applicable. In determining whether it has the obligation to
exempt the income under paragraph 1 of Article 23 A, State R should nonetheless consider
that, given the way that the provisions of the Convention apply in conjunction with the
domestic law of State E, that State may not tax the income in accordance with the provisions
of the Convention. State R is thus under no obligation to exempt the income.
III. Commentary on the provisions of Article 23 B (Credit method)
69.1 Problems may arise where Contracting States treat entities such as partnerships in a
different way. Assume, for example, that the State of source treats a partnership as a
company and the State of residence of a partner treats it as fiscally transparent. The State of
source may, subject to the applicable provisions of the Convention, tax the partnership on its
income when that income is realized and, subject to the limitations of paragraph 2 of Article
10, may also tax the distribution of profits by the partnership to its non-resident partners. The
State of residence, however, will only tax the partner on his share of the partnership’s income
when that income is realized by the partnership.
69.2 The first issue that arises in this case is whether the State of residence, which taxes the
partner on his share in the partnership’s income, is obliged, under the Convention, to give
credit for the tax that is levied in the State of source on the partnership, which that latter State
treats as a separate taxable entity. The answer to that question must be affirmative. To the
extent that the State of residence flows through the income of the partnership to the partner
for the purpose of taxing him, it must adopt a coherent approach and flow through to the
partner the tax paid by the partnership for the purposes of eliminating double taxation arising
from its taxation of the partner. In other words, if the corporate status given to the partnership
by the State of source is ignored by the State of residence for purposes of taxing the partner
on his share of the income, it should likewise be ignored for purposes of the foreign tax credit.
69.3 A second issue that arises in this case is the extent to which the State of residence must
provide credit for the tax levied by the State of source on the distribution, which is not taxed in
the State of residence. The answer to that question lies in that last fact. Since the distribution
is not taxed in the State of residence, there is simply no tax in the State of residence against
which to credit the tax levied by the State of source upon the distribution. A clear distinction
must be made between the generation of profits and the distribution of those profits and the
State of residence should not be expected to credit the tax levied by the State of source upon
the distribution against its own tax levied upon generation (see the first sentence of paragraph
64 above).
Glossary
Advance Pricing Advance Pricing Agreement is a procedure to settle Transfer
Agreement (APA) pricing issues by the taxpayer by negotiating with the competent
revenue authorities for determination of 'arm length price' as per
applicable transfer pricing methods before entering into a
transaction(s).
Advance Ruling To save the taxpayer from being saddled with uncertainty, an
Authority for Advance Ruling has been set up which gives 'Advance
Ruling' on Income Tax matters pertaining to an investment venture
in India, in advance which are binding in nature.
Ambulatory It means interpretation of the Tax Treaty by the contracting States
Interpretation as per their respective tax laws prevalent at the time the treaty is
being applied.
Base erosion and It refers to tax planning strategies that exploit gaps and
Profit Shifting mismatches in tax rules to artificially shift profits to tax haven
(BEPS) jurisdictions when there is no or insignificant economic activity to
reduce corporate tax liabilities.
Capital Export The principle that investors should pay equivalent taxes on capital
Neutrality income, regardless of the country in which the income is earned.
Capital Import The principle that all investments within a country should face the
Neutrality same tax burden regardless of the residential status of the investor.
Consolidated Tax Consolidated Tax Regime is a system which treats a group of
Regime wholly owned or majority-owned companies and other entities
(such as trusts and partnerships) as a single entity for tax
purposes. Head entity of the group is responsible for all or most of
the group's tax obligations.
Controlled Foreign A controlled foreign company is a corporate entity that is registered
Company (CFC) and conducts business in a different jurisdiction or country than the
residency of the controlling owners.
Distributive rule The basic purpose of Distributive clause in Tax Treaties is to lay
down principles on which basis will be decided the right of the
jurisdiction to levy tax.
Double Non It is a situation where an income is not taxed in either of the
Taxation contracting states to a treaty by virtue of the right to tax being given
to one state and the income being exempt in that state.
Double Taxation Double taxation is the levying of tax by two or more jurisdictions on
the same income, asset, or financial transaction, as the case may
be.
G.2 International Tax — Practice
Double Tax A Double Tax Avoidance Agreement (DTAA) is essentially a

Avoidance bilateral agreement entered into between two countries, whose
Agreement (DTAA) basic objective is to promote and foster economic trade and
investment between them by avoiding double taxation.
Dual Residence It is possible to be resident for tax purposes in more than one
country at the same time. This is known as dual residence.
Dualist view Dualists view emphasizes the difference between national and
international law, and require the translation of the latter into
the former. DTAA becomes part of the National Legal system by
specific incorporation / legislation in case of Dualistic View.
Accordingly International law has to be national law as well, or it is
no law at all.
Economic and Double taxation is juridical when the same person is taxed twice on
Juridical Double the same income by more than one state. Double taxation is
Taxation economic if more than one person is taxed on the same item.
Entry into force Entry into Force is the effective date from which the provisions of
various bilateral Tax Treaties will come into force as per applicable
OECD, UN or US Model Tax conventions.
Exemption with It means income earned in the source Country, though considered
progression method as exempt, is included in total income in the Country of residence
for purpose of determining effective tax rate.
Fiscal Residency Fiscal Residency, also known as Tax Residence is a test
determining status of Residence of a person ( including
Companies) for the purpose of levy of tax in a state depending on
domicile, place of management, close connection, etc. A person
can be Fiscal Resident of two states at the same time wherein Tie-
Breaker rules need to be applied.
Force of Attraction It implies that if a Foreign Enterprise sets up a Permanent
Rule Enterprise in Source state, all income derived by the foreign
enterprise whether through PE or not will be taxable in source
state.
Host Country The country where source of income is situated is known as Host
country.
Instrument of Instrument of Ratification refers to a notification issued by a state to
Ratification its counterpart state that it has made necessary changes in its local
laws pursuant to the treaty.
International International Offshore Financial Centres are those tax jurisdictions
Offshore Financial where bulk of financial sector activities are of non residents. It is
Centres (IOFCs) characterised by large number of financial institutions majority of
whose ownership is with non-residents not opened to meet local
needs but because of tax havens, secrecy and anonymity.
Glossary G.3
Last Better Offer It is the approach which is used in the Arbitration process to
Approach moderate the position of the negotiators so that the likeliness of its
acceptance increases.
Monist View Monists view accept that the internal and international legal
systems form a unity. International Law and National Law are part
of the same system of Law and thus DTAA overrides domestic law.
Most Favoured MFN clause is usually found in Protocols and Exchange of Notes to
Nation (MFN) DTCs. This clause helps in avoiding discrimination amongst
residents of different countries. Once this clause is part of a treaty,
the residents of contracting states get equal treatment as was
earlier given to resident of other states.
Mutual Agreement The process of resolution of tax disputes arising between
Procedure (MAP) contracting States ( of a tax treaty) by the competent authorities
thereof.
Non Discrimination It is a clause found in many Tax Treaties whose aim is to ensure
Clause that there is no discrimination between the local assessees and
foreign assessees as far as taxation is concerned.
Permanent A permanent establishment is a fixed place of business which
Establishment (PE) generally gives rise to income in a particular jurisdiction. The term
is defined in many income tax treaties. It is a fixed place of
business through which the business of an enterprise is wholly or
partly carried on.
Protocol A protocol in essence is a Treaty entered into between two
countries at a later point of time, which nevertheless forms an
essential part of the Tax Treaty and can be referred to while
applying the earlier treaty entered into between the countries.
Ring Fencing It means to financially separate a company from its parent company
to make it immune from Financial ups and downs of parent
company.
Round Tripping Round tripping is where money is routed back into the country by
local investors through tax havens. The income is sourced in the
same country where the shareholder is resident
but the income passes through a company resident in another
country for tax reasons.
Specific Anti Specific Anti Avoidance Rules are provisions that identify with
Avoidance Rules precision the type of transactions to be dealt with and prescribe
(SAAR) against the tax consequences of such treatment.
Safe harbor rules Safe Harbor rules are those which when followed for certain
international transactions, relieve the taxpayer of much
complications as arm length price declared by him under transfer
pricing will be accepted by tax authorities.
G.4 International Tax — Practice
Shell/ Conduit Conduit Company is a company which is set up in connection with

company a tax avoidance scheme. Whereby income is paid by a company to
the conduit and then redistributed by that company to its
shareholders as dividends, interest, royalties, etc.
Stateless person A person who is not considered as a ‘national’ by any State under
the operations of its law.
Static Interpretation It means interpretation of the Tax Treaty by the contracting States
as per their respective tax laws prevalent at the time of signing of
treaty.
Switch over clause It is a clause in a Tax Treaty to facilitate switching over by a
taxpayer for foreign tax credit from exemption method to the credit
method essentially to avoid Double Non Taxation.
Tax Equity It implies that Each country whether being a country of Residence
or a country of source must be entitled to its fair share of revenue.
Also, taxpayers involved in cross border transactions must neither
be saddled with additional levy of tax nor be given any undue
concessions which results in discrimination.
Tax Information Tax Information Exchange Agreement is a bilateral or multilateral
Exchange agreement which gives legal authority to the contracting states to
Agreement exchange tax related information by tax jurisdictions with the
counterparts which was otherwise not possible.
Tax Inversion Tax inversion means relocation of a company's legal domicile to a
lower - tax nation, usually while retaining its material operations in
its higher-tax country of origin.
Tax Residency It is a certificate issued by the government of a state to which a
Certificate (TRC) person belongs containing certain details concerning his or her
residential status for claiming the benefit of any Tax Treaty in
source state.
Tax Sparing Clause Under the Tax sparing clause there is a provision where a country
applies a tax credit against taxes owed on foreign income which is
equivalent to the tax exemption provided by the foreign country.
Tax Terrorism A situation where tax officials take undue advantage of powers
conferred upon them for discharging their functions.
Tax Treaty Government - to- Government agreement to prevent Double
Taxation and Tax evasion by the resident of one country earning an
income in the other.
Thin Capitalisation A company is said to be thinly capitalised when its capital is made
up of a much greater proportion of debt than equity, i.e. its gearing,
or leverage, is too high. Also, the debt portion is financed by the
parent co. and the purpose is to minimise tax expenses and
nothing else.
Glossary G.5
Tie-Breaker Test It is a test which is used to detemine the predominance situation in

cases where a person becomes fiscal resident in both the
contracting states under a treaty.
Transfer Pricing Transfer pricing refers to pricing the goods and services sold
(TP) between associated and/ or controlled and/ or related legal entities
within a group. It is the setting of the price for goods and services
sold between controlled (or related) legal entities.
Treaty Shopping The practice of structuring a multinational business to take
advantage of more favourable tax treaties available in certain
jurisdictions. For eg. a situation where a person, who is resident in
one country (say the “home” country) and who earns income or
capital gains from another country (say the “source” country), is
able to benefit from a tax treaty between the source country and yet
another country (say the “third” country).
Triangular Taxation Triangular Taxation refers to a situation where tax incidence on a
particular stream of income is typically triggered in three countries.
Eg: A company resident of country A sets up a branch in country B
which has some economic transactions generating income in
country C.
Underlying Tax A method employed by a home country to provide fiscal incentives
Credits for outbound investments by home-based multi-national companies
in which the total tax cost on foreign dividends is capped at the
level of the home country's corporate tax rate.
Unilateral (Tax) It refers to the relief scheme which can be provided to the tax payer
relief by home country irrespective of whether it has any agreement with
other countries or has otherwise provided for any relief at all in
respect of double taxation. The purpose is to eliminate cascading
effect of double Taxation.

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Diploma in International Taxation

International Tax - Practice

(Set up by an Act of Parliament)

First Edition : May, 2016

Committee/Department : Committee on International Taxation

Price : ` 1100/- (for Part I & II)-

Published by : The Publication Department on behalf of the Institute of

(a) To gain working knowledge of the provisions of International taxation laws.

Paper 1 - International Tax –Practice

Sr Topic Page No.

D. IMPACT OF DOMESTIC TAX SYSTEMS 4.1-4.73

E. BASIC INTERNATIONAL TAX STRUCTURES 5.1-5.75

F. ANTI-AVOIDANCE MEASURES 6.1-6.42

G. OTHER ISSUES IN INTERNATIONAL TAXATION 7.1-7.142

• Diverted profit tax 7.62

1. Source of Income or Gain for Non-resident

1.2 Income received in India

1.3 Taxability of Dividend income - Section 8 of the Income-tax Act

[1] Murry’s Oxford Dictionary

Income deemed to accrue or arise in India

1.3.1 Section 9(1)(i)

1 Inserted by Finance Act , 2018 w.e.f. 1st April 2019

(i) other non-residents who control the above mentioned non-resident,

2 Inserted by Finance Act 2018 ; Applicable w.e.f. 1st April 2019

Interpretation of the expression ‘business connection’ as per judicial

Emerging Issues: Taxability in case of E-Commerce

has been discussed in detail in Chapter

(b) The person is registered as a fund manager or an investment advisor in accordance

The above exceptions are pictorially represented below:

Business carried out partly Only such part of the income as is

Business of which operations No income shall be deemed to accrue in

Non-resident engaged in the

No income shall be deemed to accrue

Individual/ firm /company

(b) Through or from any property or asset or source of income in India:

The Vodafone Controversy:

X Inc - USA Y Inc - USA

Following amendments were made retrospectively by the Finance Act 2012:

Liabilities Y Ltd Z Ltd Assets Y Ltd Z Ltd

Particulars Situation 1 Situation 2 Situation 3

X Inc - USA Y Inc - USA

A Inc - USA Y Inc - USA

Transfer of 4% shares of X Inc to Y

2. Basis of Tax Computation

Where the total income of BO/ PO is Average ATI

2.4.2 Gross/ presumptive basis of taxation

(f) Where income is not effectively connected to a PE in India or in absence of PE

40(a)(ia) Any sum payable to a resident, which is subject to deduction of tax at

40(a)(iii) Salaries payable outside India, or in India to a non-resident, on which tax

2.5 Applicability of Minimum Alternate Tax (MAT) provisions

3. Treatment of Tax Losses – How Domestic Tax System

3.2 Carry forward and set off of Losses

Section Nature of loss to Maximum To be set off against Para

Long term Capital 8 years Long term Capital gain

Particulars Amount (In Rs)

4. Foreign Tax Relief

4.2.1 Unilateral credit

Business loss in India (100,000)

4.3 Foreign tax Credit Rules

5. Authority for Advance Ruling