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The ‘Subject to Tax Rule’ is a treaty-based rule, which may override tax treaty benefits in existing treaties in respect of certain payments where those payments are not subject to a minimum level of tax in the recipient jurisdiction.
The proposal by the UN Subcommittee on tax matters for inclusion of a general “subject to tax” rule in the United Nations Model Double Taxation Convention between Developed and Developing Countries (UN Model Tax Convention) was published on 3 October 2022.
The proposal sets out the initial draft of “subject to tax” rule along with the Subcommittee’s suggestions regarding how to address certain issues where there were different views. The Subcommittee concluded that the priority is for the Committee to agree on the principles and drafting with respect to a new provision for the UN Model before considering any mechanisms for expedited implementation. The draft discusses the proposed scope for a “subject to tax” rule regarding taxation by the source state and taxation by the residence state.
The proposal was presented during the 25th Session of the Committee of Experts on International Cooperation in Tax Matter held between 18 October - 21 October 2022.
Categorization of payments to non-residents as Fees for Technical Services (‘FTS’) is an often-debated issue in India. Depending on the taxability of such payments for the non-resident in India, the liability to withhold tax at source (‘TDS’) arises for the payer of such services in India.
In a recent case of Sunsmart Technologies Pvt Ltd [TS-853-ITAT-2022], the taxpayer who was engaged in the business of providing software solutions and services, entered into a marketing services agreement with a Dubai based entity for marketing its software solution products in the middle east Asian countries. The taxpayer did not deduct TDS while making payment against such services to the Dubai entity. The tax department opined those services rendered by the Dubai entity were in the nature of FTS as per Explanation 2 to section 9 (1) (vii) of the Income Tax Act, 1961 (‘ITA’) and thus the taxpayer was liable to deduct TDS on such payments. The taxpayer contended that payments were made against marketing services as such and would thus not qualify as FTS. Taxpayer claimed that the payment was a commission paid for rendering marketing services outside India and did not qualify as FTS.
Based on the Marketing Services Agreement entered between the taxpayer and the Dubai entity, the Chennai Tax Tribunal held that the services rendered by the Dubai entity to the taxpayer constituted FTS as per Explanation 2 to section 9 (1) (vii) of ITA. The Tax Tribunal observed that Dubai entity provided pre-sale and post-sale product related services to the customers of the taxpayer in Dubai, which involved technical expertise and knowledge and therefore constituted FTS income of Dubai entity in India. Interestingly, neither the taxpayer nor the Tax Tribunal have deliberated the taxability of the payment under the India-UAE Double Taxation Avoidance Agreement (‘DTAA’), wherein the clause for taxation of payments in the nature of FTS is absent.
In the instant case of Redington Distribution Pte. Ltd [TS-908-ITAT-2022(CHNY)], the taxpayer is a Singapore based subsidiary of an Indian Company. The group provides leading supply chain solutions in Information Technology, Telecom and Consumer & Lifestyle products with operations in Asian and African markets. Pursuant to a Survey operation conducted by the tax department on the taxpayer, it was alleged that the taxpayer has a fixed place Permanent Establishment (‘PE’) in India on the basis that Indian Company’s employees’ i.e., referred to as ‘Dollar Team’, conducted taxpayer’s business in India which is USD business of Indian customers with SEZ units. It was also alleged by the tax department that taxpayer has a Dependent Agent PE (‘DAPE’) in India on the basis of statements of Sales Manager of ‘Dollar Team’ and of Singapore Operations Head, as per which right from appointing staff required for Singapore operations to carrying out various business activities in India, employees of Indian Company worked for the taxpayer.
The Chennai Tax Tribunal upheld the tax department’s allegations. The Tribunal referred to quotations issued by Indian Company for their USD business which has been issued in the name of Indian Company, but specifically stated that an order is to be placed on the taxpayer. To reach the conclusion, the Tribunal noted statements of Accounts Executive and Deputy Manager (Credit) who agreed that the ‘Dollar Team’ of Indian Company was responsible for USD business of Indian customers and that right from seeking orders, request for quote from the customer, vendor discussion, negotiation and conclusion of terms of sales, sending proforma invoices, shipment plan from the customer, payment follow-up etc. are carried out by ‘Dollar Team’ with an exception of preparation of packing list. Airway bill from taxpayer’s office. Tax Tribunal notes that there was continuous occupation of ‘Dollar Team’ of Indian Company and continuous conduct of taxpayers’ business from India.
On DAPE, the Tax Tribunal held that ‘Dollar Team’ of Indian Company acts as taxpayer’s agent for Indian customers with an authority to conclude contracts and such authority has been habitually exercised by them. Basis the same, the Tribunal upholds tax department’s findings on constitution of DAPE of taxpayer.
Secondment of expatriate employees is an often-litigated topic in India. Points of contention being:
In a recent decision of the Delhi High Court in the case of BOEING India Pvt Ltd [TS-790-HC-2022 (DEL)], the latter point was deliberated and opined in favour of the taxpayer. In doing so, the High Court relied upon the conclusion of the Lower Tax Tribunal that once it was concluded that the real employer of the seconded employees was Indian entity and not overseas entity, and salary TDS compliance is undertaken, there would be no implications in so far as TDS on foreign remittance is concerned, i.e., of the recharge of salaries to overseas entity.
The High Court has however, not gone into the factual aspects of how the Indian entity was the real employer of the seconded employees. For more details on the controversy involved, refer to our detailed article on this topic. Click here to read our article on "Secondment of employees to India – Recent jurisprudence on controversies".
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Martin Wörlein
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