ICAI released Technical Guide on Royalty and Fees for Technical Services

The Committee on International Taxation of the Institute of Chartered Accountants of India releases fifth edition of Technical Guide on Royalty and Fees for Technical Services, covering all the recent notifications, judicial updates and reporting requirements.

Takes into consideration recent developments such as SC ruling in Engineering Analysis and CBDT Circular on MFN clause and its impact on determining taxability of royalty/FTS.

Its also Provides illustrative list of income qualifying as royalty/FTS as well as income excluded from definition of royalty/FTS, relying on catena of ruling.

The Technical Guide also highlights peculiarities in definition of royalty/FTS in specific DTAAs entered into by India with a diagrammatic explanation for characterisation of income as royalty/FTS, tests enshrined under the Act and classification of software payments to determine the taxability.

Broad Scheme of Taxation in India

Taxability as per provisions of the Act

1. Every person is liable to pay income tax in respect of his total income, in accordance with the provisions of the Act.

2. For determination of taxability, the Act in general, follows a combination of the “source” and “residence” rules. Accordingly, as a starting point, it is essential to examine the residential status of the assessee. The scheme for determination of the same is provided in section 6 of the Act.

3. There are different tests laid down for determining the residential status of individuals, companies, etc. The same would largely depend on factors such as duration of stay in India (for individuals), country of incorporation coupled with existence of “control and management” of the affairs in India or place of effective management (for companies), etc. As per provisions of section 5 of the Act, “income” would be liable to tax in India if it is –

• Received or deemed to be received in India; or
• Accrues or arises in India; or
• Is deemed to accrue or arise in India; or
• Accrues or arises outside India (the same would be taxable only in the hands of a “resident” assessee).

4. Further, the Act contains certain deeming provisions which lay down the circumstances under which income shall be “deemed to accrue or arise” in India, and hence taxable in India.

Taxability as per provisions of the DTAA

The Central Government of India has entered into agreements with the governments of various countries in order to grant relief of tax ,or avoid double taxation or exchange of information or recovery of Income Tax, (Sec 90).This is subject to the caveat that there should be no opportunities created for non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements aimed at obtaining reliefs provided in this agreement for the indirect benefit of residents of any other country or territory), in case of taxpayers to whom such agreement applies. Such agreements are termed as Double Tax Avoidance Agreement (DTAA), being contracts of taxing rights between contracting states and for cooperation between tax administrations for various actions. It must be noted that devoid of enabling provisions under the domestic laws of the contracting states, the residents of the contracting states do not get the right to access the beneficial provisions of the treaty, as they are not parties to the said sovereign contracts. As per section 90(2) of the Act, a person resident of a particular country with whom India has entered into a DTAA can claim the beneficial provisions of such DTAA in relation to transactions which are taxable under the Income-tax Act, 1961. Accordingly, as per section 90(2) of the Act, the provisions of DTAA would override the provisions of the Act and in the event of conflict between the provisions of DTAA and the Act, the more beneficial one would prevail. The interplay between the provisions of the DTAA and the Act as explained by the Indian judiciary are discussed in Annexure F.

The interplay between domestic law and DTAA depends on the constitutional provisions of the concerned country. For example, the United States of America expressly provides that their domestic law or the tax treaty whichever is later in time will prevail. There are certain other countries where parliament is involved in the negotiation process, directly or indirectly, then the provisions of the treaty will prevail. In countries like India where treaty is negotiated by executive, instrument has to be issued for incorporation of tax treaties in domestic law. This has mandated introduction of section 90(2) in the Act to provide an option to the assessee and making it clear that depending on the choice of taxpayer-provisions of domestic law or tax treaty will prevail.

In India, a person has to be eligible to claim the beneficial provisions of such DTAA. As per section 90(4) of the Act, a person would be eligible to claim the beneficial provisions of the DTAA if he has obtained a Tax Residency Certificate from the government of the country of which he is a resident. Further, as per subsection (5) of section 90 read with Rule 21AB of the Income-tax Rules, 1962, the taxpayer also has to provide a self-declaration in Form 10F.

India has entered into comprehensive DTAAs with more than 89 countries for the avoidance of double taxation.

Accordingly, while examining taxability under the provisions of the Act, it is also necessary to examine taxability under the provisions of the applicable DTAA. This facilitates optimization of the overall tax position in India.

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