You must pay taxes. But there’s no law that says you gotta leave a tip. ~Morgan Stanley advertisement (according to quotegarden)
Attraction of Income Tax
An Indian resident’s total income includes their worldwide income “from whatever source derived.” Thus, a resident’s income need not be received in India to be subject to the income tax. An Indian resident’s total income includes income received in India, income “accruing or arising in India,” and income “accruing or arising outside India.”[1] The total income of a person who is not ordinarily resident in India does not include foreign source income unless the income is derived from an Indian company.[2]
The Indian government taxes some types of income based on the source of the income. Of particular importance to users of LPO services is the source-based taxation of income from a business connection in India. A nonresident’s total income includes income received in India and income “accruing or arising” in India.[3] Income is deemed to accrue or arise in India when it comes directly or indirectly from any business connection in India.[4]
Under Indian domestic tax law, some payments to nonresidents are subject to a non-final withholding tax. Income from sources other than royalties are subject to withholding at the current rates in force.[5] Any person in India who has a business connection with a nonresident or from whom the nonresident receives income directly or indirectly is considered to be an agent of the nonresident.[6]
An agent is treated as a “representative assessee” of the nonresident and must deduct the tax at the source and pay that amount to the Government.[7] However, India does not require withholding from remittances from a branch to a foreign parent.
Tax Treaty Protection
Under India’s Double Taxation Avoidance Agreements (DTAA), the business profits of a nonresident may only be taxed in India if the profits are attributable to a permanent establishment in India. India’s DTAAs are more similar to the U.N. Model Double Taxation Convention rather than the OECD’s.
The definition of “permanent establishment” (PE) under India’s DTAAs is generally consistent with the definition found in the UN Model Convention. Included in the definition of PE is a person, other than an independent agent, who has the authority to, and does habitually conclude contracts in the name of the nonresident person. Also included is a person authorized to, and who habitually does, keep a stock of goods for the nonresident and regularly delivers the goods on behalf of the nonresident.[8]
Business income is taxable in India if the income is attributable to a permanent establishment in India. A nonresident person may be taxed in India even if the nonresident does not have a physical presence in India. For instance, the Income Tax Appellate Tribunal has held that nonresident companies operating reservation systems servicing Indian residents are subject to the income tax under Indian treaty law (and domestic law).[9]
India’s domestic tax law applies to nonresidents when the domestic tax law is more beneficial to the taxpayer.[10]
Recent Treaty Based Decision Impacting BPOs / Transfer Pricing Issue
In a landmark Supreme Court decision in summer of 2007 that impacted many captive LPO providers, the Court substantively agreed with the conclusion of the 2006 Authority for Advance Ruling’s determination that Morgan Stanley’s Indian BPO subsidiary constituted a permanent establishment, though the Court’s and Authority’s analysis diverged.[11]
The Court’s analysis of the permanent establishment issue focused on the oversight/quality control employees of Morgan Stanley deployed to its Indian subsidiary. However, the inevitable question of determination of taxable income of the subsidiary whether in its own right or as a permanent establishment is answerable via a transfer pricing functional analysis.
The Court ruled that the Transaction Net Margin Method was an appropriate method for determining the arm’s length price between the associated parties.
Within the Fall Transfer Pricing course we will analyze the facts, reasoning, and criticisms of this case.
Lexis’ Practical Guide to U.S. Transfer Pricing, 28 chapters from 30 expert contributors led by international tax Professor William Byrnes, is designed to help multinationals cope with the U.S. transfer pricing rules and procedures, taking into account the international norms established by the Organisation for Economic Co-operation and Development (OECD). It is also designed for use by tax administrators, both those belonging to the U.S. Internal Revenue Service and those belonging to the tax administrations of other countries, and tax professionals in and out of government, corporate executives, and their non-tax advisors, both American and foreign. Fifty co-authors contribute subject matter expertise on technical issues faced by tax and risk management counsel.
[1] Income Tax Act § 5(1).
[2] Income Tax Act § 5(1) (flush language).
[3] Income Tax Act § 5(2).
[4] Income Tax Act § 9(1)(i).
[5] Income Tax Act § 195(1) and. § 194(J).
[6] Income Tax Act § 163(1)(b), (c).
[7] Income Tax Act §§ 161, 190.
[8] See e.g. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, India-Austria, Nov. 8, 1999, India Income Tax Department, art. 5.
[9] Galileo International Inc. v. DCIT, ITA No. 1733/Del/2001; 2473 to 2475/Del/2000; 820 to 823/Del of 2005 (Nov. 30, 2007).
[10] Income Tax Act § 90(2).
[11] Civil Appeal No. 2914 of 2007 arising out of S.L.P. (C) No. 12907 of 2006, M/s DIT (International Taxation), Mumbai v. M/s Morgan Stanley & Co. Inc., with Civil Appeal No. 2915 of 2007 arising out of S.L.P. (C) No. 16163 of 2006, M/s Morgan Stanley & Co. Inc. vs. Director of Income Tax, Mumbai. See Jefferson VanderWolk’s interesting commentary at 47 TNI AUGUST 13, 2007, P. 631. Email me for copies of the decision and lecture notes thereto.
William Byrnes' Tax, Wealth, and Risk Intelligence 