The income and capital tax treaty betweenHong Konmg and Luxenbourg, signed on 2 November 2007, entered into force on 20 January 2009. The treaty generally applies retroactively from 1 January 2008 in respect of Luxembourg and from 1 April 2008 in respect of Hong Kong.
Treaties between India and Malaysia, between India and Netherlands, and between India and UK – Indian decision re tax deduction, PE, withholding tax obligation
The Indian Income Tax Appellate Tribunal (ITAT) delivered a ruling dated 5 December 2008 in the case of Deputy Commissioner of Income Tax v. Stock Engineer & Contractors B.V. (2009-TIOL-30-ITAT-MUM) on whether payments, made to a foreign company without any withholding tax in India, could be disallowed as business expenditure for the paying entity in India if the payment was not liable to tax in India.
(a) Facts. The Taxpayer (i.e. Stock Engineer & Contractors B.V.), a Netherlands-based company, was engaged in the design and construction of oil and gas products, oil refining, chemicals and petrochemicals. The Taxpayer was awarded a turnkey contract by the Indian Oil Corporation Ltd. (IOCL) to construct a refinery in India, for which the Taxpayer established a project office in Mumbai and a site office in Haldia. The Taxpayer awarded a sub-contract in favour of its Malaysian subsidiary company, i.e. Stock Comprimo (Malaysia) Sdn. Bhd. (henceforth "SCM"). Under the agreement, SCM was required to supply technical personnel to the Taxpayer for executing the project in India. Though employed by SCM, the personnel were controlled and supervised by the Taxpayer. The Taxpayer claimed a deduction in computing its taxable income on the payments made to SCM for the use of SCM personnel.
The Tax Authorities disallowed the deduction in respect of payments made to SCM as the Taxpayer had not deducted tax at the time of making the payments as required under Sec. 40(a)(i) of the Indian Income Tax Act 1961 (ITA) read with Sec. 195 of the ITA (Note: Sec. 40(a)(i) of the ITA relates to the disallowance of payments on which tax has not been withheld pursuant to Sec. 195 of the ITA). According to the Tax Authorities, since SCM's personnel provided supervisory services in India for more than 6 months, the income received by SCM was chargeable to tax in India; consequently, the Taxpayer was required to withhold tax in India. Under Art. 5(4) of the India-Malaysia tax treaty, a PE may be constituted vide the provision of supervisory services in connection with a construction activity.
The Taxpayer also made payments to:
|-||a UK-based company for the provision of supervisory services in the construction of the refinery;|
a Netherlands-based company for engineering services; and
|-||the head office in the Netherlands for salary payments of engineers based there.|
The Tax Authorities had similarly disallowed a tax deduction for the above payments on the basis of non-compliance with the withholding tax provisions.
On appeal, the Commissioner of Income Tax (Appeals) allowed the deduction and held that Sec. 40(a)(i) of the ITA cannot be applied in the present case as SCM did not have a permanent establishment (PE) in India under the India-Malaysia tax treaty as its personnel were working under the direction, supervision and control of the Taxpayer and therefore, it could not be said that any services had been rendered by SCM. The Commissioner of Income Tax (Appeals) also held that SCM did not have any office or any presence in India and, therefore, no part of such receipt was chargeable to tax in India. Accordingly, the Taxpayer was not required to withhold tax in India. The Tax Authorities appealed to the ITAT.
(b) Issue. The issue was whether payments made to SCM for the supply of personnel could be disallowed as a tax deduction, on the basis of non-compliance with the withholding tax provisions.
(c) Decision. The ITAT held that the Tax Authorities were not justified in disallowing, as a tax deduction, the payment made to SCM as a business expenditure of the Taxpayer. The ITAT observed that:
India-Malaysia tax treaty
The personnel supplied by SCM worked under the control and direction of the Taxpayer and the entire responsibility of execution of the Indian project was that of the Taxpayer only. Therefore, the condition mentioned in Art. 5(4) of the India-Malaysia tax treaty of carrying on "supervisory activity" was not satisfied, and payment made to SCM was not taxable in India in view of the lack of a PE in India. Accordingly, the provisions of Sec. 195 of the ITA concerning the obligation to withhold tax in India and the provisions of Sec. 40(a)(i) of the ITA mandating disallowance of business expenditure for failure to deduct tax, would not apply.
India-UK tax treaty
On the issue of expenses incurred in relation to supervisory work done in India by personnel of the UK-based company, the ITAT held that the case was covered both under Arts. 5(2)(j) (Supervisory work) and 5(2)(k) (Managerial services) of the India-UK tax treaty. The specific provision of Art. 5(2)(j) of the India-UK tax treaty, which was more beneficial to the Taxpayer, would override a general provision. Since the personnel carried out the work for less than 6 months in India, the UK-based company did not have a PE in India. Consequently, the Taxpayer was not required to withhold tax in India.
India- Netherlands tax treaty
The payments made to the Netherlands-based company for engineering services should not be treated as "fees for technical services" (FTS) under Art. 12 of the India- Netherlands tax treaty as the said services were provided for the inspection of the material required for execution of the Indian project. Though such services could be taken as technical in nature, it could not be said that any technical knowledge, experience, etc. was made available to the Taxpayer (Note: Generally, in order for such services to be taxable in India, there should have been a transfer of knowledge or skill to the party in India). Accordingly, the payment was covered by Art. 7 of the India-Netherlands tax treaty and in the absence of a PE in India, the said amount was not chargeable to tax in India. Hence, the tax was not required to be deducted at source and consequently no disallowance was warranted.
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