In an order that will have a bearing on all foreign companies dealing with Indian entities, the Authority for Advance Ruling (AAR) has held that payments made abroad by a foreign entity to another foreign company on behalf of an Indian entity, is not taxable in India.
The Indian entity in this case is Airport Authority of India (AAI), a public sector undertaking. The AAR, a quasi judicial body ruling on tax-related disputes, gave this verdict on an application filed by the AAI.
AAI was given a grant by the US government through the US Trade and Development Agency (USTDA) for conducting a feasibility study on Indian air traffic management requirements. The contract for conducting the feasibility study went to a US company, Innovative Solutions.
The USTDA had directly paid Innovative Solutions for undertaking the study after the AAI approved the performance of Innovative Solutions.
The question arising from the case is whether the amount disbursed in the US by USTDA to Innovative Solutions, a US company, is taxable in India.
The Indian tax authorities took a stand that it is liable to be taxed as the amount paid was made on behalf of the Indian entity AAI. The AAR ruled against taxing the grant in India for two reasons. First, in this case, the income did not arise in India because the AAI did not receive any money from the foreign company.
Secondly, the only task AAI performed in this case is approving the quality of the feasibility study and hence the transaction cannot be construed as royalty.
"This ruling would provide useful guidelines in examining the tax implications of cross-border transactions where payment is made by a third party," Punit Shah and Sanjay Sanghvi of RSM & Co said. "This judgement is in tune with the interpretations of Section 5 of the I-T Act as laid down by various high courts and the apex court of India," said Rajesh Chaturvedi of accounting firm Chaturvedi & Shah.
"This decision would act as a guideline for tax authorities and professionals while deciding on cross-border transactions involving third-party payments," said TP Ostwal, senior tax consultant.
The facts of the case are as follows: The USTDA had offered a grant to AAI for a feasibility study in India on India's air traffic management requirements. The AAI agreed to the proposal. The grant would be disbursed through Innovative Solutions, selected to carry out the feasibility study.
As provided in the contract between Innovative Solutions and AAI, the latter was bound to arrange for the grant funds, ie $0.45m was to be disbursed by the USTDA directly to the contractor in four periodic instalments. This is the consideration to the performance of Innovative Solutions regarding the feasibility study.
The contract provided that if taxes were to be paid in India, it will be borne by the AAI.
The AAR in its ruling pointed out that the US company had no permanent base in India, except engaging some Indian vendors to assist AAI and the US company's visiting experts. Hence, Section 5 (2) of I-T Act, which deals with income arising in India, does not apply in this case.
The I-T authorities have taken a stand that the amount is payable by AAI in pursuance of a contract between AAI and Innovative Solutions and hence income is deemed to arise in India. Thus, there is ground for taxing the company in India under Section 9 (1) (V) or 9 (1) (vii) of the I-T Act.
However, the AAR held that the AAI's role is limited to approving the quality of the feasibility study and thereby it stays out of the purview of these provisions in the I-T Act.
Hence, under domestic law there are no provisions to tax the transaction. The AAR also held that under the Indo-US Double Taxation Avoidance Agreement also, this transaction is not liable to be taxed in India.
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