The Bombay High Court has prescribed a ground rule for calculating tax on profits of companies operating in India without a permanent establishment or a branch office, including those that do not maintain country-wise accounts.
The court's decision, which comes as a part of the ruling in a case related to Singapore-based Sony Entertainment Television (SET), can put to end several controversies related to such companies.
The court has ruled that tax authorities could work out the income of such companies at 10 per cent of gross receipts meant for remittance overseas or the income filed for return, whichever is higher. The income then could be taxed at a prescribed rate of 55 per cent, which is the case at present. There are several methods, including the arm's-length pricing and tax rates prevailing in the double taxation treaties.
Gross receipts are calculated by excluding the amount retained by the advertising agent and the Indian agent of the non-resident foreign telecasting company, SET, as their commission or charges. SET operates in India through a permanent establishment.
In addition, the judgement also said in case a country had a Double Taxation Avoidance Agreement (DTAA) with India, the authorities should accord priority to the tax rates provided for in the treaty instead of following the arm's-length pricing rule. The method should be adopted if DTAA is more favourable to the assessee, it said. This is because the arm's-length pricing is not the only criterion for taxation on profits earned by foreign companies from their operations in India.
Experts said even with a DTAA, it is up to the discretion of tax officials to use the arm's-length pricing under the transfer pricing rules or apply tax rates prescribed in the treaty. However, this ruling could set a precedent for other cases. At present, India has a DTAA with 65 countries and there are country-specific rates of taxation on dividends, interest and royalties and all such cases could benefit from the SET ruling.
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The arm's-length pricing is the method used for taxation on financial transactions of foreign companies with their Indian affiliates at market prices as would have been done with any other entity other than their own arms.
A tax expert said the ruling could generate new issues for foreign telecasting companies, business process outsourcing firms, travel portals, among other foreign companies. A case in point is the tax demand raised for Hong Kong-based Star TV.
The court held that if the company had once made a payment to its Indian PE at the arm's-length pricing, then no further tax could be charged on the companies. At present, over and above the arm's-length pricing, the tax authorities also impose a presumptive rate of taxation for those with PEs as well.