Supreme Court confirms liability to deduct tax on offshore salary paid to non-resident employees for services rendered in India

Transcription

1 Supreme Court confirms liability to deduct tax on offshore salary paid to non-resident employees for services rendered in India CIT vs Eli Lilly and Company (India) Pvt. Ltd (Supreme Court) While disposing off a batch of appeals by the Revenue Department ( the department ) in cases of Eli Lilly and Company, Mitsui and Co and Ericsson Communications, the Supreme Court delivering a landmark decision, has held that salaries paid offshore (in the home country) to a non-resident employee ( expatriate ) for rendering services in India, should also be liable for withholding tax. The Income tax Act, 1961 ( the Act ) fastens a liability on the expatriate to pay tax on salaries in respect of services rendered in India, irrespective of the place of receipt of such salary. But the contentious issue was when the expatriates were paid Indian salary by the Indian entity to which they were seconded and tax was deducted on such Indian salary, whether or not salary paid in their country of residence by their foreign principal employer ( home salary ) should also be included for deduction of tax or not. The Supreme Court confirmed that such an obligation exists as per section 192 of the Act. Background and facts of the case The common issue in the batch of cases was that the expatriates were seconded to the Indian joint venture ( JV ) or Indian branch office ( BO ) by the Foreign Enterprise ( FE ). The JV/BO had deducted tax at source on the salary payable in India ( Indian salary ) as per section 192 of the Act, but did not deduct tax on the home salary paid to expatriates. The department took a position that as per section 192 of the Act, the JV/BO should have deducted tax on the home salary as well and remitted it to the Indian Government. The department also initiated penal proceedings for non-deduction of tax at source. The tribunal and the High Court ruled in favour of the JV/BO and the department appealed to the Supreme Court. Feedback Expert Speak 1. MNCs liable to deduct taxes on expat employee salaries 2. SC's withholding tax order won't set precedent 3. Will slowdown impact tax collections? 4. Works contracts and GST 5. M&A in tough times: The RKHS-Sodexo deal breaks a myth Awards 1. BMR s M&A practice in India League Table 2. BMR is India Transfer Pricing Firm of the Year at ITR s Asia Awards BMR is Tier 1 Firm in ITR's World Tax Guide 2009 Events UPCOMING EVENTS 1. Interactive workshop on Successful EPC Contracting - Fiscal and Legal Challenges, April 16-18, New Delhi 2. Asia Tax Executives Forum, May 13-14, 2009 in Singapore 3. Joint meeting of the USA and India branches of the International Fiscal Association, May 27-29, 2009, Fairmont, Washington RECENT EVENTS 1. Gazing into the crystal ball M&A in the IT/ITES industry in Taxand Global Conference 2009, in Miami, USA 3. USIBC roundtable discussion, Washington 4. BMR Singapore hosts Tax Network Group Bobby Parikh, Mumbai Phone: ID: bobby.parikh@bmradvisors.com

2 Key questions before the Supreme Court Whether the JV/BO is liable to deduct Indian tax on home salary and whether provisions dealing with deduction of tax at source, which are in nature of machinery provisions for collection of taxes, are independent of the charging provisions, which determines chargebility of income under the head Salaries in the hands of the expatriates. Arguments of the Revenue Section 192 of the Act imposes obligation of deducting tax on any person responsible for paying salary to deduct tax at source and therefore, every person responsible for paying salary taxable in India should withhold and remit the tax to the Government, irrespective of the place of payment of such salary. Section 192 of the Act imposes a joint and several obligation on all persons, who are responsible for paying any income chargeable under the head salaries to an employee in India. The obligation of JV/BO has to be interpreted coextensively and in respect to the entire salary income of expatriate since the entire salary is deemed to accrue or arise in India in respect of services rendered in India as per section 9(1)(ii) of the Act. Imposition of penalty under section 271C is in nature of civil liability and the bonafide misunderstanding of law, does not satisfy the test of reasonable cause. Mukesh Butani, New Delhi Phone: ID: mukesh.butani@bmradvisors.com Rajeev Dimri, New Delhi Phone: ID: rajeev.dimri@bmradvisors.com Abhishek Goenka, Bangalore Phone: ID: abhishek.goenka@bmradvisors.com Ravi K, Chennai Phone: ID: k.ravi@bmradvisors.com Gagan Malik, Singapore Phone: ID: gagan.malik@bmradvisors.com Special: What s so great about the BMR work environment? Arguments of the tax payer The provisions for deduction of tax at source have no extra territorial operation and hence cannot apply to payment made abroad by a person located outside India. The FE and BO are to be treated as separate and independent entities for the purpose of applicability of section 192 of the Act and the BO has deducted and remitted the tax on the Indian salary, for which it is responsible for paying to the expatriate. Though the expatriates were seconded to the JV/BO as employees, they continued to remain on the rolls of FE. As per section 192(2) of the Act, when an employee is in employment with more than one employer, he has an option to declare the salary received from one employer to the other and only if declared, the other employer shall be liable to consider the salary paid by the first employer while deducting tax at source. In the absence of such an option being exercised by the Contributors to this edition: Sriram Seshadri Ashka Dave

3 expatriates, the JV/BO is not liable for deduction of tax on the home salary. The obligation to deduct tax is on the person responsible for making payment and does not extend to deduction of tax out of salary paid by other person, which is not on account of or on behalf of the first person. Therefore, the JV/BO did not have any obligation to deduct tax at source, since the home salary was not paid on their behalf by the FE. The TDS provisions are in nature of machinery for easy collection and recovery of tax and these are independent of charging provisions. Each expatriate, subject to tax as per the charging provision, has paid the taxes due on the home salary as well Indian salary by way of advance tax or self assessment tax and therefore, there is no loss of revenue to the Government. The issue in the appeal being nascent, not been considered by the Apex court earlier, no penal consequences can be imposed. Industry Groups: Competencies: Publications: Key Personnel: Decision of the Supreme Court Where the home salary paid to the expatriates has any connection or nexus with his rendition of service in India, then such payment would constitute income which is deemed to accrue or arise to the expatriate in India in terms of section 9(1)(ii) of the Act. Section 9 is not only a machinery section but also provides chargeability of tax on incomes which are deemed to accrue or arise in India. The TDS provisions have extra territorial operation in respect of subject matters permissible under Article 245 of the Constitution and the provisions are enforceable within the area where the Act extends through the machinery provided under it. The provisions relating to deduction of tax at source, which are in nature of machinery provisions to enable collection and recovery of tax forms an integrated code with the charging provisions which determines charge to tax in the hands of expatriates. If the services of employment are rendered in India, the place of receipt or actual accrual of salary is immaterial. Section 192(1) of the Act has to be read with section 9(1)(ii) of the Act. Where the home salary is paid and it is found that no services have been performed outside India, such payment shall be deemed to accrue or arise in India and the JV/BO is statutorily obliged to deduct tax under section 192(1) of the Act. The Assessing Officer ( AO ) has been directed to verify whether the expatriate has paid the tax due on home salary and if so, then the AO should not proceed under section 201(1) of the Act and if not, the AO should proceed under section 201(1) of the Act to recover the shortfall

4 in the tax payment. The AO has also been directed to examine whether interest has been paid / recovered for the period between the date on which the tax was deductible till the date on which the tax was actually paid. If the interest has not been paid, the AO has been directed to take steps under section 201(1A) of the Act. As far as levy of penalty is concerned, the Court held that the nondeduction of tax at source has occurred on account of a controversial addition. It was a nascent issue, not been considered by the Supreme Court earlier. The JV/BO was under the bonafide belief that it was not under any obligation to deduct tax at source from home salary and the expatriates had also paid the advance tax / self assessment tax. Hence, there was a reasonable cause for default in deducting tax at source and therefore, penalty should not be levied. The Apex Court has also clarified that the decision is confined strictly to deductibility of tax from the income chargeable under the head salaries under section 192(1) of the Act, which unlike other sections in Chapter XVII-B required such deduction on estimated income chargeable under head salary and at the time of payment of salary. BMR comments and analysis This is a landmark decision as it provides clarity on the requirement to deduct tax on payment of home salary to expatriate employees rendering services in India. This decision has the potential of encouraging the Revenue to intensely examine expatriate taxation issues in assessments of Indian entities housing expatriates. It may also encourage the Revenue to examine closely the number of days of services rendered in India and also whether the expatriate has rendered any service at all to the foreign employer, while determining the component of income taxable in India. Such an observation would highlight service PE exposure. One of the challenges for the Indian entity to whom an expatriate is seconded has been availability of adequate salary details to compute the tax component on home salary. It is now imperative that the tax aspect is adequately addressed at the time of seconding the expatriate to an Indian entity and proper database is built for exchange of all information about compensation of the expatriate. The other challenge is that some companies pay a meager allowance in India to the expatriate, aimed at compensating the bare living expenses in India, while retaining sizeable portions of the salary as home salary. In

5 such a case, administering withholding tax in India for tax arising on the home salary would be a challenge, given the small amount of compensation payable in India. The other historical challenges have been the differences in the definition of salary, the difference in tax years, more than two tax jurisdictions coming in to play, etc and all these have contributed and added to the burden of tax administration of expatriates. This decision may also set the companies to examine the possibility of cross-charging home salary to Indian books, as taxes are withheld in India without backing claim of expenses. Some companies have been following the practice that home salary is borne by the foreign employer and Indian salary is borne by the Indian entity and the deduction of each portion of the salary was claimed only by respective entities. Consequently, the non-deduction of tax on home salary did not attract disallowance of expense in the hands of the Indian entity under section 40(a)(i) of the Act. But as a consequence of this decision, some companies may take home salary expense as well in their books, to the extent the salary is paid for services rendered in India, on which tax has also been deducted at source. However, adequate thought would be needed where Indian entity is a permanent establishment because cross-charging home salaries of all expatriates as a policy, would take away the short stay exemption for some of the employees, whose stay is less than the threshold 183 days for treaty exemption purposes. Hence, adequate care and reflection would be needed in finalizing the tax policies related to expatriates in India. Also, the Apex Court has (Para 23) observed that the scheme of tax deduction provisions apply not only to the amount paid, which bears the character of income such as salaries, dividends, interest on securities etc, but the said provisions also apply to gross sums, the whole of which may not be income or profits in the hands of the recipient, such as payment to contactor and sub contactor. This has the potential of being interpreted to mean that all re-imbursements would also be subject to withholding tax. It is interesting to note that the Supreme Court has clarified that the decision is applicable only to withholding tax pertaining to salary income and it will not be applicable for the Vodafone case. However, the observations of the Supreme Court on extraterritorial operation of the Act may be relied upon by the department in Vodafone case.

6 AWARDS AND RECOGNITION BMR s M&A practice among top 25 in India League Table BMR has been ranked among the top M&A practices in India in the recently concluded annual India League Table survey 2008 conducted by Thomson Reuters. BMR is India Transfer Pricing Firm of the Year at ITR s Asia Awards 2008 BMR has emerged as the India Transfer Pricing Firm of the year at the International Tax Review s Asia Awards BMR received this award for the second consecutive year and was chosen over three of the Big 4 Firms. BMR is Tier 1 Firm in ITR's World Tax Guide 2009 In the latest World Tax Guide 2009 brought out by the international Tax Review, BMR has been ranked a Tier 1 Firm. This ranking is based on a rigorous process that involves research among all participating Firms, and interviews with their representatives. EVENTS UPCOMING EVENTS Interactive workshop on Successful EPC Contracting - Fiscal and Legal Challenges, April 16-18, New Delhi BMR Advisors, in collaboration with Infraline, will host the fifth conference and interactive workshop on Successful EPC Contracting - Fiscal and Legal Challenges" from April 16-18, 2009, at The Imperial hotel, New Delhi. Asia Tax Executives Forum, May 13-14, 2009 in Singapore The International Tax Review, supported by the Asia-Pacific member Firms of the Taxand network, will organize the fourth Asia Tax Executives Forum 2009 on May 13-14, 2009 at Shangri La hotel in Singapore.

7 Joint meeting of the USA and India branches of the International Fiscal Association, May 27-29, 2009, Fairmont, Washington The US and India branches of IFA will hold the second joint conference on May 27-29, 2009, in Washington DC, USA. Mukesh Butani and Shefali Goradia, Partners at BMR Advisors will be key panelists at the conference. RECENT EVENTS Gazing into the crystal ball M&A in the IT/ITES industry in 2009, Mumbai The National Association for Software and Services Companies, Nasscom, organized the India Leadership Forum 2009 on February 11-13, 2009 in Mumbai. Bobby Parikh, Managing Partner, BMR was invited as a key speaker at the conference. For more details, please click here Taxand Global Conference 2009, Miami The 2009 Global Taxand Conference was held at The Westin Diplomat Resort and Spa in Miami, Florida, from February 18 to 20, The conference, hosted by Alvarez & Marsal Taxand, LLC, the US member Firm of Taxand, featured informative speakers and engaging plenary sessions addressing the clients' latest tax issues. USIBC roundtable discussion, Washington US India Business Council, supported by BMR, organized a roundtable discussion at US Chamber of Commerce, Washington USA, on February 17, BMR Singapore hosts Tax Network Group BMR Singapore was recently invited to organize a session on India tax update Recent challenges for Tax Network Group in Singapore. The session witnessed impressive participation from many multinational organizations. The session was very well-received and elicited encouraging feedback from participants.

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