Plugging the TDS loophole on payments abroad.
The presence of multinational companies has led to increased cross-border transactions between Indian companies and their overseas affiliates. Amongst others, Indian companies make payments to their non-resident parent company or group companies towards allocation or sharing of common costs, recovery of expenses borne by the non-resident company on behalf of the Indian company, and so on.
With respect to transactions where an overseas company seeks reimbursement of third party expense from an Indian company, some taxpayers have been taking the position that a payment made to a non-resident company as reimbursement of expenses incurred on behalf of the Indian subsidiary is not subject to tax.
This position is based on the fact that there is no profit element in the reimbursement as it is made on a cost-to-cost basis without any mark-up. The view that reimbursements do not qualify as income for the purposes of taxation has been endorsed by the judiciary as well.
Notwithstanding this above principle, tax authorities have started analysing the underlying transaction between the parent-group companies and the third party vendor, leading to the reimbursement transaction with the Indian company. Recently, the Mumbai Tribunal in the case of M/s C.U. Inspections (I) Private Limited, dealt with one such matter wherein payment was made to a parent company towards training services availed by the assessee from an independent third party. Such training was provided to employees of the assessee by some trainers who were independent third party service providers and the payment for these services was made by the parent company.
The tribunal held that where the Indian subsidiary company incurs expense or avails any service from some third party abroad and the payment to such third party is made through its holding or related company abroad, the provision for deduction of tax at source applies as if the assessee has made the payment to such independent party dehors the making of payment through the holding company.
Based on this argument, it was concluded that the remission of payment to the parent company for making the payment to the independent third party trainers shall be construed as a direct payment by the assessee to the third party trainers and cannot be termed as reimbursement of expenses to the holding company. Accordingly, the withholding tax provisions would apply as if the payment was made directly to the trainers dehors the making of payment through the parent company.
The income factor
The same principle was observed by the Delhi Tribunal in the case of SPX India (Private) with similar facts wherein the tribunal dealt with the taxability of reimbursement made to the parent company towards share of expenses for an ISO environmental audit. It was held that an element of income was embedded in the receipt of the auditor and if the receipts were made through the parent company, it would not extinguish the element of income in the payments.
Such rulings have raised a very important issue; third party payments made through the parent company or other related group companies cannot be equated with reimbursements, and the taxability of the transaction has to be analysed as if the payment was made directly to the third party. Furthermore, the characterisation of the income has to be analysed. As an example, in case a payment is made towards royalty/fee for technical services, the beneficial owner of the income — whether the parent company or the third party — has to be evaluated. Based on this evaluation, the relevant tax treaty and corresponding documentation shall be looked into.
In sum, Indian companies now need to rethink before making reimbursement payments to their parent and/or related group companies without deducting appropriate taxes