The Authority for Advance Rulings (AAR) recently held that payments made to a foreign company, within the same group, for services availed from it, would be subject to withholding tax in India.

The AAR held that the payments made to the foreign group company by the Indian company were not an exact reimbursement. Thus, the Indian company was obliged to withhold tax at source, in India, prior to making the payments, as per the Indian tax laws. The ruling was limited to the question raised in the application and hence, the AAR did not examine the nature of the payments.

Indian companies commonly avail of certain services from a foreign group company. These services are as varied as market research, quality control, setting standards for employees and so on. In turn, the foreign company is reimbursed for the services provided by it. The reimbursement mechanism is, sometimes, based on a predetermined formula.

All companies within the group that have availed of these services, pay up their share. In this case, Danfoss Industries (Danfoss India), based in Chennai, availed services from a Singapore-based group company. Broadly, the services provided by Danfoss Singapore to its group companies included advice and assistance on market research and promotional activities, financial and management matters.

Danfoss India, made an application to the AAR, seeking a ruling on just one issue - whether the payments made to the Singapore company would be subject to withholding tax in India under section 195 of the Income-tax Act? The answer was sought in the light of the fact that the payments made were a reimbursement of a portion of the actual expenditure incurred by Danfoss Singapore and there was no income element embedded in the payments.

AAR members observed that the consideration payable to the Singapore company was based on a formula. However, several factors like the growth rate and market maturity of each individual group company were also taken into cognisance for the ultimate payment.

AAR held, 'There is no direct nexus between the actual costs incurred by Danfoss Singapore and the fees payable by each individual company that availed of its services. In the absence of an exact break-up, it wasn't possible to conclude that the payments were only a reimbursement."

Thus, Danfoss India was obliged to withhold tax at source prior to making payments.'

Advance rulings tend to have a persuasive effect and tax officers rely on the same in similar cases. In this context, Dinesh Kanabar, partner RSM and Co, points out, "this ruling should carry limited persuasive value and the nature of the payment must be analysed in each case."

"If the nature of any payments made to a foreign company is not fees for technical services (FTS) or even Royalty, as per tax treaty definitions, then if the foreign company does not have a permanent establishment (fixed place) in India, tax should not be withheld in India," he explains.

On the other hand, if the payments made by an Indian company to a foreign group company are not an exact reimbursement, and are in the nature of FTS or Royalty, it would be difficult for the foreign company to escape from tax in India.