As Zenobia Aunty begins to type this column, she realises that she has completed a decade of interacting with her loyal readers. She raises her cup of tulsi tea to toast them. This is a time for reflection. While a decade may have passed since this column first rolled out, there are so many issues in tax land that remains unresolved.
For instance, litigation in the tax arena as regards the classification of payments on import of shrink-wrapped software continues. At the judicial level, the tax orders are largely in favour of the foreign recipient as the judiciary seeks to distinguish between a copyrighted article and exploitation of a copyright. Software licensing to the Indian payer is treated as a transaction of a copyrighted article and thus not a royalty payment.
However, at the lower levels, the going is tough for the foreign recipient or even the Indian payer. Faced with the prospect of being treated in default, the Indian payer seeks to withhold tax at source, even when it is technically not subject to tax under the tax treaty. To compound the problem , if the foreign recipient does not have a permanent account number ( PAN )), tax has to be withheld at the higher rate of 20%. It is also likely that the home country of the foreign recipient may not allow a foreign tax credit on the ground that the tax was wrongfully withheld in India.
Recently, professionals were a bit taken aback with a ruling given by the Delhi income tax tribunal, in the widely published case of Microsoft . While holding that the payments made by the Indian payer would be subject to withholding tax as the payment for licence of the software was royalty, the tribunal also went ahead to observe that reliance cannot be placed on the OECD commentary in interpreting a tax treaty and that a later provision in domestic laws would override tax treaty provisions. Thankfully, the Mumbai income tax tribunal followed suit with a few favourable decisions, upholding the distinction between a copyright and a copyrighted article. Yet, uncertainty continues to loom large.
Let us take another instance. Indian companies are often subcontracted work by their foreign parent and other overseas group entities. The Delhi income tax tribunal , in another instance, has held that the relationship of the US entities with its Indian subsidiary to which it had subcontracted or assigned software development or call centre services resulted in a permanent establishment in India.
More so, since the Indian subsidiary had not been remunerated on an arm's length basis, the Delhi income tax tribunal largely upheld the approach adopted by the tax department of attributing profits to such permanent establishment of the US entities based on a proportion of Indian assets to global assets.
Looks like foreign entities wanting to do business with India need to pay more detailed attention to these ongoing issues . While it may be time to ring out the old, in tax land, the existing issues never seem to die.
But one must also look forward at emerging business scenarios, for instance e-commerce or the even more nascent cloud computing. A prominent feature of business activities conducted via the internet is that it is impossible to pinpoint where that activity is taking place. The physical location of the business activity has traditionally been the crucial factor in determining where the permanent establishment is located and thus in which country the profits can get taxed.
In the context of a computer server, the OECD in its commentary has made several observations. If an enterprise that carries on a business through a website has the server (in another country) at its own disposal - it owns or leases and operates the server, it could result in a permanent establishment exposure in such other country. In most cases, it is likely, especially given the lack of usage of personnel manning the server that the all substantial assets and risks would be at the head office level and negligible profits alone could be attributed to the server created permanent establishment. But yes, attribution of profits would be a tricky matter.
If this were not enough, cloud computing will blur the boundaries further. However, it is likely that a cloud computing solution may help reduce the tax exposure arising through permanent establishment creation, as in essence it would mean that a foreign entity is merely using the services of the cloud computing provider and the cloud computing provider is not its dependent agent so as to constitute a permanent establishment.
As Zenobia Aunty looks back on the existing tax issues and foresees some new tax issues emerging she exclaims: There is never a dull moment in tax land.
Greater clarity is required over royalty payments to overseas companies on software licensing by the Indian payer
In subcontracted work, clearer guidelines are required for determining a permanent establishment in India
As regards emerging business scenarios, cloud computing will create more tax challenges
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