TDS on Foreign Comission

TDS on Foreign Commission

In the present article, attempt is made to evaluate TDS implication u/s 195 of the Income Tax Act on commission charges paid by Indian exporters to foreign agent for their services availed outside India.

In this article analysis is done from three angles to arrive at the conclusion:-

1.       Circulars issued by CBDT

2.       Precedent Case laws on foreign commission.

3.       Position in Double Taxation avoidance agreement

CBDT Circulars

1.       Circular No. 23 dated 23-07-1969

Foreign agent of Indian Exports – Where a foreign agent of India exporters operates in his own country and his commission is usually remitted directly to him and is, therefore, not received by him or his behalf in India. Such an agent is not liable to income tax in India on the commission

2.       Circular No. 786 dated 07-02-2000

As clarified in circular No. 23 dated 23-07-1969, where non-resident agent operates outside the country, no part of his income arises in India and since the payment is usually remitted directly abroad, it cannot be held to have been received by or on behalf of agent in India. Such payment were therefore, held to be not taxable in India.

3.       Circular No. 7 dated 22-10-2009

Circular No. 23 dated 23-07-1969 & Circular No. 786 dated 07-02-2000 were withdrawn, reasoning that interpretation of the Circular by some of the taxpayers to claim relief is not in accordance with the provisions of section 9 of the Income-tax Act, 1961 or the intention behind the issuance of the Circular

CBDT has not has given any cohesive reason for withdrawl of Circular Nos 23 & 786, except that claim by taxpayers under those circulars were not in accordance with provision of section 9. In other words, CBDT has not clarified/commented on whether where non-resident agent operates outside India, whether his income will deemed to accrue or arise in India or not. The matter has been left for determination by Courts.

Thus in the absence of any specific reason for withdrawal of circular and major change in taxation law at that point of time (22/10/2009), can only withdrawal of circular will also change the position accepted by CBDT for 40 years i.e where non-resident agent operate outside India, no part of his income arise in India ?

Though on withdrawal of Circular , Income Tax Department is not bound by  circular nos 23 & 786, but position remained the same that where non-resident agent operate outside India, no part of his income arise in India and hence no liability for TDS u/s 195 on foreign commission.

Case laws

1.       CIT v Toshoku (1980) 125 ITR 525 (SC)

In the instant case, the non-resident assessee did not carry on any business operations in the taxable territories. They acted as selling agents outside India. The commission amounts which were earned by non-resident for services rendered outside India cannot, therefore, be deemed to be incomes which have either accrued or arisen in India

2.       CIT v EON Technology (P) Ltd 343 ITR 366 (Delhi HC)

In the instant case, commission was paid to non-resident agent on the sales and amounts realize on exports contract procured by it for assessee.

Held, no income deemed to accrue to arise in India for non-resident agent.

In the said judgement, Delhi High court explained the concept of business connection as mentioned in section 9(1)(i).

“The term "business connection" has been interpreted by the Supreme Court to mean something more than mere business and is not equivalent to carrying on business, but a relationship between the business carried on by a non-resident, which yields profits and gains and some activities in India, which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of the non-resident and the activity in India [CIT v. R.D. Aggarwal and Co. [1965] 56 ITR 20 (SC), Carborandum and Co. v. CIT[1977] 108 ITR 335 (SC) and Ishikawajma-Harima Heavy Industries Ltd. v. DIT [2007] 158 Taxman 259 (SC). The test which is to be applied is to examine the activities in India and whether the said activities have contributed to the business income earned by the non-resident, which has accrued, arisen or received outside India.”

In other words High Court simply reiterated what is stated in Explanation 1(a) to section 9(1)(i). The said explanation run as under:-

“in the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause 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”

Thus for income deemed to accrue or arise in India on account Business connection, operations/activity in India is must.

3.       SKF Boilers and Driers (P) Ltd 284 CTR 121 (AAR)

In the instant case, the AAR was required to evaluate the source of income of the non-resident agents who had earned commission from the business activity of the applicant.

Held, Sections 5 and 9 of the Act thus proceed on the assumption that income has a situs and the situs has to be determined according to the general principles of law. The words 'accrue' or 'arise' occurring in section 5 have more or less a synonymous sense and income is said to accrue or arise when the right to receive it comes into existence. No doubt the agents rendered services abroad and have solicited orders, but the right to receive the commission arises in India when the order is executed by the applicant in India

We therefore hold that the income arising on account of commission payable to the two agents is deemed to accrue and arise in India, and is taxable under the Act in view of the specific provision of Section 5(2)(b) read with section 9(1)(i) of the Act.

At this juncture it is important to discuss the words “Business Connection” and “Source of Income” appearing in section 9(1)(i)

Section 9(1)(i) provides as under:-

“all income accruing or arising, whether directly or indirectly^, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India”

Attempt is being made here, to arrive at the meaning of the words “Source of Income”

The words “Source of Income” is part of section 9, which itself is deeming section, providing for certain income to  deemed to accrue or arise in India. In deeming section, the words have to be interpreted in the context of section and not to be loosely interpreted.

Had the words “source of income arising in India” being defined to include any income having connection with India, then such interpretation will rendered entire section 9(1)(i) will rendered otiose.

There is a principle of interpretation, ejusdem generis, which provides that meaning of general words should be gathered from specific words preceding general words.

The words “Source of Income” is preceded by words property or assets. Thus words “source of income arising in India” can be interpreted to include income arising from any asset based in India.

Further, from plain reading of section 9(1)(i), it appears that said section talks about broadly three type of income:-

a)      Active Income – Business Connection/Business Activity

b)      Passive Income – Property, asset, source of income etc.

c)       Capital gain – Transfer of Capital asset

The taxability rules, for being taxable in India, can be summarised as under;-

a)      Active Income –  carrying of activity in India

b)      Passive Income – Situs of Income in India

c)       Capital Gain- Situs of Capital asset in India

The activity of foreign agent rendering service to exporter in India can be best describe as income accruing from business connection, thus carrying on some activity in India is must for making their foreign commission taxable in India, as also held by Hon’ble Supreme court CIT v Toshoku (1980) 125 ITR 525 (SC). Thus in the absence of any service rendered in India, foreign commission paid to non-resident for service rendered outside India is not taxable in India and hence no liability to deduct TDS u/s 195.

Double Taxation Avoidance Agreement (DTAA)

India has entered into DTAA with most of the countries and most of them are based on UN model convention.

The commission income earned by foreign agent can be at best fall in either of following two distributive rules:-

1.       Article 7 – Business Profit

2.       Article -21- Other Income

If commission income is falling under Article 7, then for its taxability in India, it is essential that foreign agent has PE in India. Since foreign agent is not carrying on any activity in India, commission income taxability in India is ruled out absolutely under DTAA.

For Article 21, sub Article 3 is relevant, which provide as under;-

“Notwithstanding, provisions of paragraph 1 and 2, items of income of resident of a contracting state not dealt with in the foregoing articles of convention and arising in the other contracting state may also be taxed in that other state.”

In said Article, the “arising in other contracting state” has not been defined.

In order to attempt to arrive at meaning of these words, we need to look at following articles:

1.       Article 3(2)- Interpretation of terms used in DTAA

2.       Article 7- Business Profit

3.       Article 11- Interest Income

4.       Article 12- Royalty

5.       Article 14 – Independent Personal Service

Article 3(2)

It provides that for interpretation of any terms used in DTAA, unless context otherwise requires, reference shall be made to domestic tax laws. The words arising in contracting state has also not expressly defined in Indian Taxation laws. For interpretation of these words, it become necessary to see other articles to understand the context in which said words are used in DTAA.

Article 7

It provides profits of enterprise of contracting shall be taxable in that state only, unless enterprise carry on business in other contracting state through PE. In that case, other contracting state shall be entitled to tax so much tax of the profits of enterprise as attributable to PE

Article 11

It provides that interest arising in contracting state may be taxed in both source and resident state.

It further provides that interest shall be deemed to arise in contracting, where payer is resident of contracting state.

Article 12

It provides royalty arising in contracting state may be taxed in both source and resident state.

It further provides that royalty shall be deemed to arise in contracting, where payer is resident of contracting state.

Article 14

It provides that income derived by a resident of contracting state in respect of professional services shall be taxable in that state only, except in the following circumstances, when such income may also be taxed in other contracting state:-

a)      If he has fixed based regularly available to him in other contracting state for the purpose of performing or

b)      If his stay in other contracting states exceed specified period; in that case only so much of income as is derived from his activities performed in that other state may also be taxed in that other state.

From afore –said Articles, source based taxation pre-requisites under DTAA can be summarise as under:-

1.       Business Profit – Performance of activity in source state

2.       Interest – Deemed in source state where payer is resident

3.       Royalty – deemed in source state where payer is resident

4.       Independent person services- Performance of activity is source state.

Thus the context of DTAA is that for any income to be taxed in source state, performance of activity in that state is essential, unless otherwise provided as in case of Interest and Royalty, where it is deemed.

Based on this, it can be interpreted that for other income falling under article 21, it shall be deemed to arise in contracting state, when resident of contracting state carry on some activity in source state.

Thus for foreign agent, not carrying on any activity in india, his commission income cannot be deemed to arise in India under Article 21 and hence not taxable in India.

Conclusion

It can concluded that commission paid to non-resident agent for services rendered outside India is not taxable in India, because no services are rendered in India.