Transfer Pricing Adjustment Vs
DTAA’s Article 11(6)/12(6)
Brief on relevant Articles of
DTAA
Article 11 – UN Model
1. Article
11 deals with allocation of Taxability right of Interest income in source state
(Payer State) between source state and Resident state
2. Article
11(1) gives resident state right to tax Interest Income in Source state.
3. Article
11(2) gives source state right to tax interest income at prescribed rate
(ranging from 10-15% on GROSS Interest amount)
4. Article
11(6) provides as under:-
a) There
is special relationship between payer and beneficial owner of Interest
b) As
a result of special relationship, the amount of Interest paid exceeds the
amount, having regard to debt claim, which would have been agreed upon by the
payer and the beneficial owner in the absence of such relationship.
c) In
such case, the provision of Article 11 will apply to Normal Interest (Interest
which would have agreed between Payer and beneficial owner in the absence of
special relationship)
d) The
excess Interest will be taxable
according to laws of respective state, due
regard has to other provisions of DTAA
5. Thus
Article 11(6) provides that Source state is not restricted to tax EXCESS AMOUNT
at the rates prescribed under Article 11(2) and it can tax the said amount according
its own domestic laws, with due regard to other provisions of DTAA.
Article 12- UN Model/OECD Model
1. Article
12 deals with Royalty and Fees for Technical Service (FTS)
2. Article
12 also contains provision similar to article 11(6) i.e Source state is not
constrained to tax EXCESS AMOUNT at a beneficial rate provided in Article 12.
(For our analysis, the corresponding Article is christened as 12(6))
Example
1. Suppose
an Indian Company paid Rs. 50 lacs as FTS to Foreign Company (Associated
Enterprise (AE) of Indian Company and deducts withholding tax @ 15% as per DTTA.
2. Later
on in Transfer Pricing assessment of Indian Company, Rs. 20 lacs was disallowed,
being not at ALP.
Issue
1. Whether
can AO invoke Article 12(6) and tax Rs. 20 lacs in the hands of foreign AE @
40%, being rate applicable to foreign Company.
2. Whether
can AO make Indian Company as an agent of foreign AE u/s 163 and ask it to pay
differential tax of 25% (40% -15%) on Rs. 20 lacs.
Analysis
1.
We
need to evaluate about the satisfaction of conditions of 12(6) on two counts:-
a) Special
Relationship
b) Excess
Royalty.
i)
The Words special relationship has not been
defined in Article but OECD commentary provides that said term is wide enough
to cover not only relationship envisaged in Article 9 but also cover
relationship by blood or marriage and, in general, any community of interests
ii)
Excess royalty – Article has adopted imaginative
criteria, rather comparative criteria to determine EXCESS Amount. Under
Comparative mode, an amount is compared with certain benchmark to arrive at
excess amount i.e Actual Amount –ALP. In imaginative method, the excess amount
is determined by evaluating what could have Normal amount in the absence of
special relationship. It seems that imaginative way to determine excess amount
is wide enough to embrace comparative approach.
Thus based on afore-said a conclusion can
be drawn that excess royalty disallowed under TP assessment of Indian Company
also satisfy the conditions for invoking provisions of Article 12(6)
2.
Taxability
of Excess Amount under Income Tax Act, 1961.
Article
12(6) confers the right to tax excess amount to source state according to its
own domestic law but also obligating to simultaneously respect other provisions
of DTAA.
The
taxability of Excess amount is analyzed as under:-
a) Nature of Excess Amount – In
Transfer pricing assessment, AO held that having regard to service involved,
the Arm’s Length Price is Rs. 30 lacs. Thus 20 lacs paid by Indian Company to
foreign company are not for services but due to some extraneous factors. In
view of stated reasoning, a vibrant
conclusion can be drawn that Excess Amount does not retain the nature of
income, to which it was originally made part i.e Rs. 20 lacs cannot be
treated as fees for technical services
in the hands of foreign Company to be taxed at the rates provided in the
domestic legislation.
b)
Determining
taxability under Income Tax Act
·
For Taxability of any amount, following
requirement is must:-
i)
Amount meeting the criterion of Income.
ii)
Classification of said Income to particular
Category.
iii)
Determination of Source rule applicable to said
category.
iv)
Computation methodology for said income to
arrive at net taxable income.
·
Income Tax Act, 1961 does not presently contains
explicit provisions treating such excess amount as deemed income in the hands
of foreign company and providing other essentials, as narrated above, to draw
taxability. Express categorization of amount to particular Income category is
must to enable the Foreign Company at least to claim benefit of concessional
tax under relevant Article of DTAA relating to said categorized income. For
Example, had the Excess amount is to be treated as Dividend under Income Tax Act;
the foreign company can claim the beneficial tax rate under Article 10(2)
relating to Dividend.
·
The
argument to treat such excess amount as Income from other sources in the hands
of foreign Company in current scenario, may also fail to attract taxability on
account of following:-
i)
Foreign company may claim that excess amount
represents debt repayable to Indian Counterpart.
ii)
Further, in the absence of specific computation
provision for such Excess amount, charging such amount as Income from other
sources will not attract taxability. i.e charging provision fails in the absence
of computation provision.
iii)
Further Article 21 (UN Model) provide that ‘Other
Income” shall be taxable in the Resident state, unless such other income is
attributable to PE of fixed place in source state, in which case source state
also has right to tax such income. Thus on this count, taxability of such
excess amount will fail as in the instant case foreign Company does not have PE
or fixed place of business in India.
Thus in my view, the excess
amount as discussed above, cannot be bought to tax again in the hands of
Foreign Company by making Indian company as agent of foreign Company . On
extreme side, , foreign company may claim for refund of withholding tax on Rs.
20 lacs deducted earlier, since in the absence of categorization of excess
amount to the Income under domestic law and under DTAA, there is no
justification for levy withholding tax and same justify refund.
