H P Agrawal: Tax on fees for technical services

FOREIGN ENTERPRISES

In case of foreign tie-ups, it is generally believed that royalty and fees for technical services accruing to a foreign enterprise will be taxed on a receipt basis. Article 12 of the Tax Treaties dealing with royalty or fees provides that the aforesaid income will be taxed when paid to a resident of the other State.

Thus, where royalty is to be paid by an Indian company to a foreign company, the same shall be taxed in the hands of the foreign company, when it is actually paid by the Indian company.

In a recent case before the Authority for Advance Rulings 267 ITR 727), it was argued that unless the royalty or fees are paid and received by a foreign company, the amounts cannot be taxed in India.

Therefore, the stage of deducting tax at source will arise only when a payment is made. Thus in a case where the Indian company merely makes a provision in its books of accounts for payment of royalty or fees, the Indian company is not obliged to deduct tax at source.

The Authority for Advance Rulings, after analysing the provisions of Article 12 of Tax Trea-ties, held that taxability of royalty or fees in the foreign country will depend on the actual payment made by the Indian company.

As far as liability to tax that income in India is concerned, it was observed that "it is clear that the provisions of Article 12 do not provide that taxability of such royalties or fees in India shall be on cash or receipt basis. Indeed, even according to Article 12, such royalties or fees will be taxable according to Indian laws."

The Authority further held that provisions of Section 195 are clear. "The deduction of tax need not necessarily be at the time of making actual remittance of the said sums; it has to be at the time of making a mere provision thereof in the books of accounts of the applicant," it said.

This provision should also be looked at from another angle. Section 40 (a)(i) provides that where royalty or fees for technical services is payable outside India or in India to a non-resident or a foreign company, the allowance of expenditure is subject to fulfilment of the condition that wherever tax is deductible at source the same should be deducted and paid during the previous year or before the expiry of time prescribed under Section 200 (1) of the Act.

In other words, if the tax is not deducted at source or after deduction is not paid in time, then the amount on which tax is deductible at source will not be allowed as a deduction in the previous year. But if tax is deducted and paid in the subsequent year, then the deduction may be allowed in the subsequent year.

Similarly, if the provision for royalty or fees for technical services is made in March 2004 for example, the payer cannot claim a deduction of royalty or fees for technical services in assessment year 2004-2005, unless the payer deducts the tax at source in March 2004 and pays the same to the central government before May 31, 2004.

It will thus appear that the ruling pronounced by the Authority is also in consonance with the provisions of Section 40 (a) (i) of the Act. It appears that no useful purpose will be served by merely making a provision in the accounts without deducting tax at source or without paying the same within the prescribed time.

agar@nda.vsnl.net.in