Conceptual Statement of Problems and Solutions.
Non-residents of India do business “with or within” India, & earn incomes. We need to examine whether & when they are liable to tax in India. One may say that the tax liability in the cases of “with or within” is a settled issue. So why discuss it! The discussion below will show that this position needs to be, and is being reconsidered.
1. FII & India.
A foreign institutional investor (FII) having its registered office in Mauritius has outsourced several functions to researchers, custodians, brokers, banks etc. The FII has no PE in India. Its 100% sales & purchases of shares & securities are within India. Should any part of its business profits be taxable in India
2. Internet Gaming.
In USA, land based casino, poker etc. ‘games’ are legally allowed. However, about internet gaming there are controversies. We ignore the controversies about legality of internet gaming.
There are companies registered in tax havens like Antigua and Gibraltar. They have servers in some tax havens. They allow people from all over the world to play casino & poker games on their computers. Almost 90% of their revenue is from U.S.A. They have no physical presence & no agents in U.S.A. No PE in U.S.A. These internet gaming companies were getting gross revenues worth a few billion dollars every year & were not paying any direct or indirect taxes in U.S.A.
Can the U.S. Government levy any income-tax (direct tax) or entertainment tax (indirect tax) on the companies!
The U. S. Government has recently passed a new law providing that as far as regulating the industry is concerned, the Government will have a jurisdiction even if any one out of - the viewer, player or the service provider - is within the U.S. And it has prohibited all banks & financial institutions from handling any payments for the internet gaming companies. The Government has acquired a way of enforcing its regulations where - if International tax principles were to be applied, it has no jurisdiction.
3. TV Broadcasting Company. Simple issue.
When a foreign television (TV) broadcasting channel broadcasts TV programmes targeted at India, is its income taxable in India! The channel has no PE in India, and operates from a place on earth outside India – say Singapore or Hong Kong; and also outside Indian sky – its satellite orbit is outside the sky of India.
Can it be said that it is operating with India; or within India!
4. Tax Planning by electronic service providers (internet, television, mobile etc.). More Details as compared to illustration (3) above.
For determining tax jurisdiction, there are two connecting factors; and the assessee can avoid both.
Residence : When the registered office is established in a tax haven, the company is prima facie, a resident of that tax haven. If it takes a few precautions, it will not be deemed to be a resident of any other country levying income-tax. It escapes residence based income-tax.
Source : By having no physical presence in any tax levying country, the company can avoid having any PE in any tax levying country. It escapes source based income-tax. Where some functions demand a physical presence in a particular company, that function can be outsourced. If the function is sensitive, it may be outsourced to a subsidiary.
Thus both the connecting factors & hence total income-tax are avoided. The ease with which this can be achieved, raises several questions. Some of them are :
4.1. Is it okay to accept the registered office as the primary determinant of residence! Is it okay even in the case of a tax haven!
4.2. Is it okay to insist on the fixed place of business for considering location of source! (COS).
4.3. Can a company’s income be taxed without it having a registered office & without having a PE in a country!
4.4 Can tax be levied because: The consumer is located on the country; or because the payment is made from a particular country!
5. COC Vs. COS- More issues :
Above referred company may produce television programmes, advertisement films for their customers, and feature films in India- Bollywood; and U.S.A. – Hollywood. It may take advertisements from Asia, Europe & the Americas – twenty five different countries. It may telecast the programmes and the advertisements from several earth stations around the earth. Several different Satellites having different countries as their foot prints may be used. The programmes may be telecasted in fifty different countries.
This is a truly Global company. It will earn revenue from several sources: The TV viewers are one smaller part of its source of revenue. The revenue may be in the forms of: subscription by the viewers, advertisement from companies within the country of the viewers; and advertisements from other countries.
Which country may tax which part of its income!
In India, FII and television companies’ taxation have raised major controversies. There is an urgent need for a fair & clear system of tax allocation between countries.
1. “Only that income of a non-Resident can be taxed in India which consists of -The taxable net profit earned in India out of value addition made in India by the assessee.”
The Country of Source & Country of Residence get the right to levy Income-tax. The tax will be allocated as per the DTA between them.
2. “The Country of Consumption or Market gets the right to levy consumption tax or indirect tax.”
In Other words :
Where an assessee has done some value addition in India; and that value addition has caused net profits earned by the assessee; then the net profits can be taxed in India. The value addition made by the market cannot be taxed.
This principle can be applied even without the concept of a PE. It does not come in conflict with the PE concept. It is a step towards the root of principles of international taxation; a step towards simplification.
1. Income-tax is a tax on income. Since it is a truism, people often forget it.
Let us see the important aspects of this statement.
1.1. Income-tax is levied on net profits and not on sales. Governments are too happy to collect a withholding tax on turnover and take it as a final tax. This is contrary to elementary principles of taxation.
1.2. While considering the tax liability one has to consider the actions etc. of only the earner of the income (the assessee) and not the “payer” of income (buyer of goods or services).
Let us illustrate this issue.
i. A hotel provides services to its guest. For the guest, the stay at the hotel may be a business trip or a vacation. The distinction in the customer’s purpose will determine whether the customer will get the deduction of the expense in computing his income or not. However, this distinction will not affect the taxability of the income for the hotel.
ii. A manufacturer of machinery sells machinery. When a whole-seller buys the machine, it is stock-in-trade for him. When a factory owner buys the machine, it is a fixed asset for him. In both cases, the tax treatment would be different for the buyer. But the machinery manufacturer’s income is not affected by the use of the machine in the hands of the buyer.
1.3. Income-tax does not depend upon the nature of business. And definitely not on means of communication used by the assessee.
Thus, a person may sell readymade garments or mobile phones or music cassettes. He may be a manufacturer or retailer. All these things make no difference. Once his net income is computed, it will bear the same rate of tax.
Whether a person sells his goods or services in a retail shop, by catalogues, on television marketing channel or on the internet website should not make any difference either in the taxability or in sharing of tax jurisdiction by different Governments. The means of communication for attracting customers; for transacting business and for delivery of goods have no impact on taxation.
The concept of neutrality is a separate issue. Here, what is highlighted is: tax is on income. Not on business. Nor on means of communication.
2. There are two connecting factors (also called Nexus) for Income tax jurisdiction :
2.1 In case of Assessee, the Residence;
2.2 In case of Income, the Source.
The same principle is stated in two more manners below:
An assessee is liable to tax based on his residence in India; and an income is taxable based on its source in India. If income is sourced in India, it will be taxable even if the assessee is a non-resident. Similarly, if the assessee is an Indian resident, his income will be taxable in India even if the income is foreign sourced income.
A Government has the right to tax global income of its residents. (Residential status of the assessee.) A Government has the right to tax all income sourced within its country even by non-residents. (Location of Source of Income.)
These two connecting factors when accepted by all Governments, by their very nature, create overlapping jurisdictions, hence double tax; and hence the need for Agreements for Avoidance of Double Tax.
3. Business Income :
It is accepted for Double Tax Avoidance Agreements (DTA) that for business income, the assessee’s source of income is located primarily where the assessee is resident. Thus, both the connecting factors- residence and source are situated in one country. Hence the Country of Residence COR gets the right to levy full tax on business income. For example, if an assessee exports goods to several countries without establishing offices in those countries, its income will be taxable only in COR. The countries importing the goods will not levy income-tax on the non-resident exporter.
4. Tax Sharing :
Under the DTA, the COS restricts its own tax rate. The COR levies full tax and gives credit for the TDS at COS. This is how the double tax is avoided. Of course there are several variations for avoiding double tax.
The above stated principles can be applied to all kinds of incomes earned from any activities. To put these fundamental principles into practice, some machinery provisions are required. Concepts of “Permanent Establishment”; and “Categorisation of Incomes” are the machinery provisions developed for applying the main principles. (It is possible that some one may call these principles as fundamental principles while I am calling them machinery provisions. These are different approaches to the same subject. My simple submission is that the machinery principles are instruments to implement the main principles.)
1. PE :
When the business assessee sets up office in another country so that the office amounts to a PE, then he will become taxable in the other country. When a NR has a PE in India, it is considered that he is doing business within India; or he has a source of income in India. Hence he is taxable in India.
It is recognised that taxing a non-resident’s income has practical problems of computation, proving the genuineness of income figures, and expenses. This practical, administrative problem has been tried to be solved by the mechanism of deducting tax at source –T.D.S.
Categorisation of Income :
Since different incomes will have different ways of determining the location of source; different categories have been listed. E.g. house property, interest, shipping, royalty, FTS, and business income. Having listed the different categories, no attempt is made to prescribe rules for determining the COS, nor the rules for attribution of profits between COS & COR.
Part II completed.
Principles of International Taxation Completed.
Next: Part III PE…..