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Description

FINAL COURSE STUDY MATERIAL

Direct Tax Laws Assessment Year 2009-10 [Relevant for students appearing for May 2009 and November 2009 examinations]

Volume – 2

BOARD OF STUDIES THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

This study material has been prepared by the faculty of the Board of Studies

The objective of the study material is to provide teaching material to the students to enable them to obtain knowledge and skills in the subject

Students should also supplement their study by reference to the recommended text book(s)

In case students need any clarifications or have any suggestions to make for further improvement of the material contained herein they may write to the Director of Studies

All care has been taken to provide interpretations and discussions in a manner useful for the students

However,

the study material has not been specifically discussed by the Council of the Institute or any of its Committees and the views expressed herein may not be taken to necessarily represent the views of the Council or any of its Committees

Permission of the Institute is essential for reproduction of any portion of this material

The Institute of Chartered Accountants of India

All rights reserved

No part of this book may be reproduced,

Website

ISBN No

Published by

The Publication Department on behalf of CA

Devarajan,

Additional Director of Studies (SG),

The Institute of Chartered Accountants of India,

A-94/4,

Sector – 58,

Noida-201 301,

Typeset and designed at Board of Studies

Printed by

Sahitya Bhawan Publications,

Hospital Road,

Agra 282 003

December/ 2008/6500 Copies

PREFACE Direct tax laws and Indirect tax laws are important elements of the core competence areas of the Chartered Accountants

A thorough knowledge of direct tax laws and indirect tax laws is,

necessary for the students of the CA Final course

In the new Final course,

“Direct Tax Laws” constitutes Paper–7

Students are expected to acquire advanced knowledge of the provisions of direct tax laws after undergoing this course and apply such knowledge to various situations in actual practice

The first part of this study material deals with income-tax

There are 29 chapters under income-tax

The inter-relationship between accounting and taxation is discussed in chapter 12

The concept and significance of “ethics” in taxation has been discussed in the chapter of “Tax Planning”

The second part of this study material is on wealth-tax

There are 3 chapters under wealth-tax

The subject matter in this study material is based on the law as amended by the Finance Act,

In this study material,

efforts have been made to present the complex direct tax laws in a lucid manner

The latest amendments have been given in italics

Chapters are organised in a logical sequence to facilitate easy understanding

Another helpful feature in this study material is the addition of selfexamination questions at the end of each chapter,

which will be useful to test understanding of the provisions discussed in the chapter

Answers have been given in respect of those questions which are based on judicial decisions or involving legal interpretations

The taxation laws in our country undergo many amendments

In order to help the students to update their knowledge relating to the statutory developments in the field of direct and indirect taxes,

the Board of Studies brings out,

a “Supplementary Study Paper” containing all the amendments in direct and indirect taxes

This is an essential read for all our students

Another important publication,

“Select cases in Direct and Indirect Taxes – An essential reading for the final course”,

is meant for updating the knowledge regarding judicial decisions

A word of advice to the students – please make it a habit of referring to the bare acts as often as possible

This will not only facilitate the process of understanding the law and the sequence of sections in these Acts,

but will also equip them with the professional expertise that is expected

Study Material of Direct Tax Laws is made in two volumes for ease of handling by the students

Volume – 1 contains Chapters 1 – 14 of Income Tax,

and Volume – 2 contains Chapters 15 – 29 of Income Tax and Chapters 1 – 3 of Wealth Tax

Finally,

we would welcome suggestions to make this study material more useful to the students

In case of any doubt,

students are welcome to write to the Director of Studies,

The Institute of Chartered Accountants of India,

A-94/4,

Sector-58 Noida – 201 301

SYLLABUS PAPER – 7 : DIRECT TAX LAWS (One paper ─ Three hours – 100 Marks) Level of Knowledge: Advanced knowledge Objectives: (a)

To gain advanced knowledge of the provisions of direct tax laws,

To acquire the ability to apply the knowledge of the provisions of direct tax laws to various situations in actual practice

Contents: I

The Income-tax Act,

The Wealth-tax Act,

While covering the direct tax laws,

students should familiarise themselves with considerations relevant to tax management

These may include tax considerations with regard to specific management decisions,

foreign collaboration agreements,

inter-relationship of taxation and accounting,

with special reference to relevant accounting standards and other precautions to be observed to maximise tax relief

Further,

they should have a basic understanding about the ethical considerations in tax management and compliance with taxation laws

Note – If new legislations are enacted in place of the existing legislations relating to income tax and wealth tax,

the syllabus will accordingly include such new legislations in the place of the existing legislations with effect from the date to be notified by the Institute

Volume – 2 INCOME TAX CONTENTS CHAPTERS 1 – 14 of Income Tax are in Volume – 1

CHAPTER 15 : DOUBLE TAXATION RELIEF 15

Concept of Double Taxation Relief

Types of relief

Double taxation relief provisions under the Act

Taxation of business process outsourcing units in India

Concept of Permanent Establishment

Taxing Foreign Income

……………………………………………………………15

Meaning of important terms

Treaty overrides Domestic Law ………………………………………………………15

CHAPTER 16 : TRANSFER PRICING AND OTHER PROVISIONS TO CHECK AVOIDANCE OF TAX 16

Meaning of the term “Arm’s Length Principle”

Significance of Arm’s Length Principle

Practical difficulties in application of ALP

Guidelines for applying the ALP

Methods for calculating arm’s length price

Applying the ALP to Intangibles

Applying the ALP to Intra-group services

The Indian Scenario

Transfer of income to non-residents

Transactions in securities

CHAPTER 17 : FOREIGN COLLABORATION 17

Introduction

Tax liability based on residential status

Choice of place where income is to be received

Choice of method of accounting

Choice of form of business organisation

Taxability of different kinds of income

Tax treatment of payments made for expenses,

Other factors

Assessment of foreign collaborators

Deduction of tax at source from non-resident’s income

CHAPTER 18 : BUSINESS RESTRUCTURING 18

Introduction

Forms of business restructuring

Amalgamation

Demerger

Conversion of sole proprietary business into company

Conversion of partnership firm into company

Slump sale

Buy Back of Shares

Capital Reduction

Redemption of preference shares

Conversion of debentures into shares

CHAPTER 19 : TAXATION OF E-COMMERCE TRANSACTIONS 19

What is e-commerce

Issues and problems in taxing e-commerce transactions

How business is transacted through e-commerce

Permanent establishment in e-commerce situations

Determination of the nature of income

Conclusion

CHAPTER 20 : INCOME TAX AUTHORITIES 20

Appointment and control

Jurisdiction of Income-tax Authorities

Powers of Income-tax Authorities

CHAPTER 21 : ASSESSMENT PROCEDURE 21

Return of income

Compulsory filing of return of income

Interest for default in furnishing return of income

Option to furnish return of income to employer

Income-tax return through computer readable media

Return of loss

Belated return

Return of income of charitable trusts and institutions

Return of income of political parties

Mandatory filing of returns by scientific research associations,

Mandatory filing of returns by universities,

Revised return

Particulars required to be furnished with the return

Particulars to be furnished with return of income in the case of an assessee engaged in business or profession

Defective return

Permanent account number (PAN)

Scheme for submission of returns through tax return preparers

Power of CBDT to dispense with furnishing documents etc

with the return and filing of return in electronic form

Authorised signatories to the return of income

Self assessment

Inquiry before assessment

Audit under section 142

Power of Assessing Officer to make a reference to the valuation officer

Assessment

Power of Joint Commissioner to issue directions in certain cases

Valuation of inventory

Income escaping assessment

Sanction for issue of notice

Time limit for completion of assessment /reassessment

Limitation period for completion of assessment / reassessment

Assessment procedure in case of search or requisition

Rectification of mistakes

Other amendments

Notice of demand

Intimation of loss

CHAPTER 22 : SETTLEMENT OF TAX CASES 22

Settlement Commission

Definition of ‘Case’

Application for settlement of cases

Procedure on receipt of application

Power of Settlement Commission to order provisional attachment to protect revenue

Re-opening of completed proceedings

Jurisdiction and powers of the Settlement Commission

Power to grant immunity from prosecution and penalty

Abatement of proceeding before the Settlement Commission

Order of Settlement Commission to be conclusive

Recovery of settled amount

Bar on subsequent application for settlement

Proceedings to be judicial proceedings

Order to be conclusive

CHAPTER 23 : ADVANCE RULINGS 23

Introduction

Definitions

Authority for Advance Rulings

Vacancies,

Application for advance ruling

Procedure on receipt of application

Applicability of advance ruling

Advance ruling to be void in certain circumstances

Powers of the Authority

Procedure of Authority

CHAPTER 24 : APPEALS AND REVISION 24

Appealable orders before Commissioner (Appeals)

Appeals to the Appellate Tribunal

Effect to the decision of the Supreme Court and of the NTT

Appeal to High Court

Appeal to the Supreme Court

Provision for avoiding repetitive appeals

Revision by the Commissioner

CHAPTER 25 : PENALTIES 25

Introduction

Penalties

Penalty not leviable in certain cases

Extension of scope of concealed income

Penalty in respect of searches initiated under section 132 on or after 1

Penalty in the case of firm

Procedure for assessment of penalties

Reduction or waiver of penalty and interest

Power of Commissioner to grant immunity from penalty ……………………… 25

Time limits for imposition of penalty

CHAPTER 26 : OFFENCES AND PROSECUTION 26

Summary of offences and prosecution

Power of commissioner to grant immunity from prosecution …………………… 26

Presumption with regard to assets,

Presumption as to culpable mental state

Prosecution to be made at the instance of the Chief Commissioner or Commissioner

Proof of entries in records or documents

Disclosure of particulars by public servants

CHAPTER 27 : MISCELLANEOUS PROVISIONS 27

Mode of taking or accepting loans and deposits

Mode of repayment of certain deposits

Special Bearer Bonds

Transfers to defraud revenue void

Provisional attachment to protect the interest of the revenue

Service of notice

Authentication of notice and other documents ……………………………………

Submission of statements by producers of films

Annual Information Return

Publication of information

Appearance by registered valuers

Appearance by authorised representative

Rounding off of income,

Receipt

Indemnity

Power to tender immunity from prosecution

Cognizance of offences and bar of suits in Civil Courts

Certain laws not to apply

Return of income,

Notice deemed to invalid in certain circumstances …………………………… 27

Presumption as to assets,

Concessions for encouraging participation in the business of prospecting for,

Act to have effect pending legislative provisions for charge of tax

Schedules to the Income-tax Act

CHAPTER 28 : DEDUCTION,

COLLECTION AND RECOVERY OF TAX 28

Deduction and collection of tax at source and advance payment

Direct Payment

Deduction of tax at source

Certification for deduction at lower rate

No deduction in certain cases

Miscellaneous provisions

Tax collection at source

Advance payment of tax

Scheme of mandatory interest

Collection and recovery of tax

Refunds

CHAPTER 29 : ASSESSMENT OF VARIOUS ENTITIES 29

Assessment of individuals

Assessment of Hindu Undivided Families

Assessment of local authority

Assessment of firms and their partners

Assessment of companies

Assessment of co-operative societies

Assessment of mutual concerns

Liability in special cases

WEALTH TAX CHAPTER 1 : LEVY OF WEATH TAX 1

Levy of wealth tax

Applicability

Definitions

Deductibility of tax liabilities

Chargeability

Deemed wealth

Exemptions

CHAPTER 2 : VALUATION UNDER WEALTH TAX ACT 2

Valuation of assets

Valuation of assets other than cash

Valuation of immovable property

Global method of valuation of business

Interest in firm or association of persons

Life interest

Jewellery

Other assets

CHAPTER 3 : ASSESSMENT PROCEDURE 3

Administration

Assessment procedure

Assessment in special cases

Penalties

Settlement of cases

Appeals and revision

Collection and refund

Prosecution

Search and seizure

Miscellaneous provisions

the effect of taxation is one of the important considerations for any trade and investment decision in other countries

One of the most significant results of globalisation is the visible impact of one country’s domestic tax policies on the economy of another country

This has led to the need for continuously assessing the tax regimes of various countries and bringing about necessary reforms

Where a taxpayer is resident in one country but has a source of income situated in another country it gives rise to possible double taxation

This arises from the two basic rules that enables the country of residence as well as the country where the source of income exists to impose tax namely,

(i) the source rule and (ii) the residence rule

The source rule holds that income is to be taxed in the country in which it originates irrespective of whether the income accrues to a resident or a non-resident whereas the residence rule stipulates that the power to tax should rest with the country in which the taxpayer resides

If both rules apply simultaneously to a business entity and it were to suffer tax at both ends,

the cost of operating on an international scale would become prohibitive and would deter the process of globalisation

It is from this point of view that Double Taxation Avoidance Agreements (DTAA) become very significant

DTAAs lay down the rules for taxation of the income by the source country and the residence country

Such rules are laid for various categories of income,

Each such category is dealt with by separate article in the DTAA

Double taxation means taxing the same income twice in the hands of an assessee

In India,

a person is taxed on the basis of his residential status

Likewise,

it may so happen that he is taxed on this basis or some other basis in another country on the same income

However,

it is a universally accepted principle that the same income should not be subjected to tax twice

In order to take care of such situations,

Income Tax

the Governments of two countries can enter into an agreement to provide relief against double taxation by mutually working out the basis on which the relief is to be granted

India has entered into agreements for relief against or avoidance of double taxation with about 50 countries which include Sri Lanka,

Switzerland,

Sweden,

Denmark,

Federal Republic of Germany,

Greece,

Bilateral Relief may be granted in either one of the following methods: (a) Exemption method,

by which a particular income is taxed in only one of the two countries

an income is taxable in both countries in accordance with their respective tax laws read with the double taxation avoidance agreement

However,

the country of residence of the tax payer allows him credit for the tax charged thereon in the country of source

In India,

double taxation relief is provided by a combination of the two methods

income on which income tax has been paid both in India and in the other country

(ii) income-tax chargeable under this Act and under the corresponding law in force in that country to promote mutual economic relations,

(b) the avoidance of double taxation of income under the Income-tax Act and under the corresponding law in force in the other country

(c) exchange of information for the prevention of evasion or avoidance of income tax chargeable under this Act or under the corresponding law in force in that country or investigation of cases of such evasion or avoidance

Double Taxation Relief

(d) recovery of income tax under the Income-tax Act,

This section also empowers the Central Government to make much provisions as may be necessary for implementing the agreement

These provisions shall be made by notification in the Official Gazette

Under section 90 of the Income-tax Act,

the Government of India can enter into agreements with governments of other countries for granting of relief in respect of income on which tax is payable,

avoidance of double taxation of income under the laws of India as well as the laws of the other country,

for exchange of information for prevention of tax evasion or avoidance and for the recovery of income-tax

The position of law is that the double taxation avoidance treaties entered into by the Government of India override the domestic law

This has been clarified by the CBDT vide circular no

which provides that a specific provision of the DTAA will prevail over the general provisions of the Income-tax Act

Therefore,

where a DTAA provides for a particular mode of computation of income,

this mode will take precedence over the Income-tax Act

However,

where there is no specific provision in the treaty,

then the Income-tax Act will apply

The Hon’ble Supreme Court had an occasion to examine the DTAA entered into with the Government of Mauritius in the case of Union of India v

Azadi Bachao Andolan (2003) 132 Taxman 373

Under the DTAA,

capital gains accruing in India to a resident of Mauritius is not liable to tax in India subject to certain exceptions

This was clarified by the CBDT by Circular No

Subsequently,

the issue of ‘treaty shopping’ by non-resident foreign companies to avoid capital gains tax on transfer of shares in Indian companies arose

In order to clarify the situation,

The Delhi High Court in Shiva Kant Jha v

Union of India (2002) 256 ITR 536 held that Circular No

The Court observed that the CBDT could not issue any instruction which would be ultra vires the provisions of the Income-tax Act,

Circular No

having directed the income-tax authorities to accept certificate of residence issued by the authorities of Mauritius as sufficient evidence as regards residential status and beneficial ownership in Mauritius,

would be ultra vires the powers of the CBDT

The Court held that the ITO was entitled to lift the corporate veil in order to see whether a

Income Tax

company was actually resident of Mauritius or not or whether the company was paying income-tax in Mauritius or not and this function of the ITO was quasi judicial

Any attempt by the CBDT to interfere with the exercise of this quasi judicial power was contrary to the intendment of the Income-tax Act

The Court held that ‘treaty shopping’ by which the resident of a third country takes advantage of a fiscal treaty between States was illegal and thus necessarily forbidden

The Supreme Court reversed the above decision of the Delhi High Court and made wideranging observations on many matters including tax planning considerations

The Court held that the judicial consensus in India has been that section 90 is specifically intended to enable and empower the Central Government to issue a notification for implementation of the terms of a DTAA

Therefore,

the provisions of such an agreement would operate even if inconsistent with the provisions of the Income-tax Act

Circular 789 is a circular within the meaning of section 90,

it must have the legal consequences contemplated by section 90(2)

In other words,

the circular shall prevail even if it is inconsistent with the provisions of the Income-tax Act,

insofar as assessees covered by the provisions of DTAA are concerned

The Court observed that many developed countries tolerate or encourage “treaty shopping”,

unless it leads to significant loss of tax revenue

The Court cannot judge the legality of “treaty shopping” merely because one section of thought considers it improper

The court cannot characterize the act of incorporation under the Mauritian law as a sham or a device actuated by improper motives

The Court held that the impugned circular was issued under section 119 and hence valid

The Supreme Court recognized that the Treaties are negotiated and entered into at political level and have several considerations as their bases

This was an important principle to be kept in mind in the interpretation of the provisions of an international treaty

The Court observed that if it was intended that a national of a Third State should be precluded from the benefits of a DTAA,

then a suitable limitation to that effect must find place in the DTAA itself

In the absence of a limitation specifically provided in the DTAA,

the same cannot be read into it

The Supreme Court observed that not only is the principle in IRC v

Duke of Westminister (1936) AC 1 alive and kicking in England,

but it also seems to have acquired judicial benediction of the Constitutional Bench in India,

notwithstanding the temporary turbulence created in the wake of McDowell &Co

CTO (1985) 154 ITR 148 (SC)

The Supreme Court held that if notwithstanding a series of legal steps taken by an assessee,

the intended legal result has not been achieved,

the Court might be justified in overlooking the intermediate steps,

but it would not be permissible for the Court to treat

Double Taxation Relief

the intervening legal steps as non-est based upon some hypothetical assessment of the ‘real motive’ of the assessee

Certain terms used in the DTAAs have not been defined either in the agreements or in the Income-tax Act

In order to address the problems arising due to conflicting interpretations of such terms,

sub-section (3) empowers the Central Government to define such terms by way of notification in the Official Gazette

However,

the charge of tax in respect of a foreign company at a rate higher than the rate at which a domestic company is chargeable,

shall not be regarded as less favourable charge or levy of tax in respect of such foreign company

Models of Treaties Tax treaties are generally based on certain models

The most common ones are : (i)

OECD model (Organisation of Economic Co-operation and Development)

models Double Taxation Convention,

by notification in the Official Gazette,

make the necessary provisions for adopting and implementing such agreement for (1)

grant of double taxation relief,

avoidance of double taxation of income,

(ii) In relation to any assessee to whom the said agreement applies,

the provisions of the Income-tax Act shall apply to the extent they are more beneficial to that assessee

(iii) Any term used but not defined in the Income tax Act or in the said agreement shall have the same meaning as assigned to it in the said notification,

unless the context requires otherwise,

and it is not inconsistent with the provisions of the Income tax Act or the said agreement

Income Tax

(iv) The charge of tax at a higher rate for a company incorporated in the specified territory outside India as compared to a domestic company would not be considered as less favourable charge or levy of tax in respect of such company

(v) For the purpose of this section,

the ‘specified association’ means any institution,

functioning under any law for the time being in force in India or the laws of the specified territory outside India and which may be notified as such by the Central Government and ‘specified territory’ means any area outside India which may be notified by the Central Government

relief would be granted under Section 91 provided all the following conditions are fulfilled: (a) The assessee is a resident in India during the previous year in respect of which the income is taxable

(b) The income accrues or arises to him outside India

(c) The income is not deemed to accrue or arise in India during the previous year

(d) The income in question has been subjected to income-tax in the foreign country in the hands of the assessee

(e) The assessee has paid tax on the income in the foreign country

There is no agreement for relief from double taxation between India and the other country where the income has accrued or arisen

In such a case,

the assessee shall be entitled to a deduction from the Indian income-tax payable by him

The deduction would be a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax in the said country,

or at the Indian rate of tax if both the rates are equal

Sub-section (2) provides that where a person who is resident in India in any previous year has any agricultural income in Pakistan in respect of which he has paid the income tax payable in that country,

he shall be entitled to a deduction from the Indian income-tax payable by him to the following extent: (i)

of the amount of tax paid in Pakistan on such income which is liable to tax under this Act,

Double Taxation Relief

(ii) of a sum calculated on that income at the Indian rate of tax,

Sub-section (3) provides for relief to a non-resident assessee in respect of his share in the income of a registered firm assessed as resident in India in any previous year,

provided all the following conditions are fulfilled – (i)

The share income from the firm should include income accruing or arising outside India during that previous year

(ii) Such income should not be deemed to accrue or arise in India

(iii) The income should accrue or arise in a country with which India has no agreement under section 90 for the relief or avoidance of double taxation

(iv) The assessee should have paid income-tax in respect of such income according to the law in force in that country

In such a case,

the assessee will be entitled to a deduction from the Indian income-tax payable by him

The deduction will be a sum calculated on such doubly taxed income so included,

at the Indian rate of tax or the rate of tax of the said country,

The provisions are briefed hereunder (a) A non-resident entity may outsource certain services to a resident Indian entity

If there is no business connection between the two,

the resident entity may not be a Permanent Establishment of the non-resident entity,

and the resident entity would have to be assessed to income-tax as a separate entity

In such a case,

the nonresident entity will not be liable under the Income-tax Act,

it is possible that the non-resident entity may have a business connection with the resident Indian entity

In such a case,

the resident Indian entity could be treated as the Permanent Establishment of the non-resident entity

(c) The non-resident entity or the foreign company will be liable to tax in India only if the IT enabled BPO unit in India constitutes its Permanent Establishment

(d) A non-resident or a foreign company is treated as having a Permanent Establishment in India if the said non-resident or foreign company carries on business in India through a branch,

or through an agent (other than an independent

Income Tax agent) who habitually exercises an authority to conclude contracts or regularly delivers goods or merchandise or habitually secures orders on behalf of the nonresident principal

In such a case,

the profits of the non-resident or foreign company attributable to the business activities carried out in India by the Permanent Establishment becomes taxable in India

(e) If a foreign enterprise carries on business in another country through a Permanent Establishment situated therein,

the profits of the enterprise may be taxed in the other country but only so much of them as is attributable to the Permanent Establishment

Profits are to be attributed to the Permanent Establishment as if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a Permanent Establishment

(g) In determining the profits of a Permanent Establishment there shall be allowed as deduction,

expenses which are incurred for the purposes of the Permanent Establishment including executive and general administrative expenses so incurred,

whether in the State in which the Permanent Establishment is situated or elsewhere

(h) The expenses that are deductible would have to be determined in accordance with the accepted principles of accountancy and the provisions of the Income-tax Act,

The profits to be attributed to a Permanent Establishment are those which that Permanent Establishment would have made if,

instead of dealing with its Head Office,

it had been dealing with an entirely separate enterprise under conditions and at prices prevailing in the ordinary market

This corresponds to the “arm’s length principle”

in determining the profits attributable to an IT-enabled BPO unit constituting a Permanent Establishment,

it will be necessary to determine the price of the services rendered by the Permanent Establishment to the Head office or by the Head office to the Permanent Establishment on the basis of “arm’s length principle”

it is important to determine the existence of a Permanent Establishment (‘PE’)

Article 5(1) of the DTAA provides that for the purpose of this convention the term ‘Permanent Establishment’ means a fixed place of business through which the business of an enterprise is wholly or partly carried on

The term ‘Enterprise’ has been defined in section 92F(iii) [See page16

Double Taxation Relief

According to Article 5(2),

which enumerates various instances of PE,

the term PE includes (a) a place of management

a quarry or other place of extraction of natural resources (but not exploration)

Permanent establishment means a fixed place of business through which the business of an enterprises is wholly or partly carried on

Every DTAA has a specific clause,

which will deal with an explanation of permanent establishment for the purpose of such DTAA

Business Income of a non resident will not be taxed in India,

unless such non-resident has a permanent establishment in India

Distinguishment of taxability of income under business connection and permanent establishment is explained here below :

Income of a Non-resident

Taxability under the Income Tax Act

Taxability under the DTAA

Governed by Sec

Governed by DTAA

With or without business connection

Only with permanent establishments

TAXING FOREIGN INCOME

Income earned outside India

Residential Status Test

Resident

Non-resident Not taxable

Agreement with foreign Country exists

No agreement with foreign country exits

90 & Sec

Taxability Test

Compute normal tax on total income

Non-taxable

Taxable

Compute the average tax on foreign income

“Indian rate of tax” means the rate determined by dividing the amount of Indian income-tax after deduction of any relief due under the provisions of the Act but From the total tax reduce before deduction of any double taxation relief due to the DTAA vs

Income Tax Act,

the tax paid in foreign country

Final Tax payable

average tax on foreign income whichever is lower

Final Tax payable

Double Taxation Relief 15

“Indian rate of tax” means the rate determined by dividing the amount of Indian income-tax after deduction of any relief due under the provisions of the Act but before deduction of any double taxation relief due to the assessee

(ii) “Rate of tax of the said country” means income-tax and super-tax actually paid in that country in accordance with the corresponding laws in force in the said country after deduction of all relief due,

but before deduction on account of double taxation relief due in the said country,

divided by the whole amount of income assessed in the said country

(iii) The expression “income-tax” in relation to any country includes any excess profits tax or business profits tax charged on the profits by the Government of any part of that country or a local authority in that country

What is double taxation relief

Explain the types of double taxation relief

State the models on which tax treaties are generally based

“Double taxation relief has now been extended to certain agreements adopted by the Government”

How are IT-enabled Business Process Outsourcing units in India taxed

? Are there any provisions in the Income-tax Act,

Explain briefly the concept of permanent establishment

Explain the meaning of the following terms (a) Indian rate of tax (b) Rate of tax of the said country

An individual resident in India ,

having income earned outside India in a country with which no agreement under section 90 exists asks you to explain whether the credit of

The Income-tax Act,

The Double Taxation Avoidance Agreement,

excludes the income earned by Mr

X from the purview of tax

X liable to pay tax on the income earned by him

Treaty Shopping is illegal and should be necessarily forbidden – Discuss the correctness of this statement

Mahesh is a resident both in India and Malaysia

He owns some immovable properties (Rubber Plantations) in Malaysia

During the previous year 2008-09,

he earned income from rubber estates in Malaysia

The Assessing Officer contended that the business income is assessable in India and brought the same to tax

Discuss the correctness of the contention of the Assessing Officer,

taking into consideration the following (i)

Mahesh has no permanent establishment in India in respect of the business of rubber plantations

(ii) Article 4 of the Double Taxation Avoidance Agreement between India and Malaysia provides that where an individual is a resident of both the Contracting States,

he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him

If he has a permanent home available to him in both Contracting States,

he shall be deemed to be resident of the Contracting State with which his personal and economic relations are closer

Answers 9

Section 90(2) makes it clear that where the Central Government has entered into a Double Taxation Avoidance Agreement,

then in respect of an assessee to whom such agreement applies,

the provisions of the Act shall apply to the extent they are more beneficial to the assessee

This means that where tax liability is imposed by the Act,

the Double Taxation Avoidance Agreement may be resorted to for reducing or avoiding the tax liability

The Supreme Court has held,

Kulandagan Chettiar (2004) 267 ITR 654,

that in case of any conflict between the provisions of the Double Taxation Avoidance Agreement and the Income-tax Act,

the provisions of the Double Taxation Avoidance Agreement would prevail over those of the Income-tax Act

not liable to pay tax on the income earned by him

Double Taxation Relief 15

Treaty shopping is a process by which a resident of a third country takes advantage of a fiscal treaty between two countries

The Supreme Court in Union of India v

Azadi Bachao Andolan (2003) 132 Taxman 373,

observed that many developed countries tolerate or encourage “treaty shopping”,

unless it leads to significant loss of tax revenue

The Court cannot judge the legality of “treaty shopping” merely because one section of thought considers it improper

The Supreme Court recognized that the Treaties are negotiated and entered into at political level and have several considerations as their bases

This was an important principle to be kept in mind in the interpretation of the provisions of an international treaty

The Court observed that if it was intended that a national of a Third State should be precluded from the benefits of a DTAA,

then a suitable limitation to that effect must find place in the DTAA itself

In the absence of a limitation specifically provided in the DTAA,

the same cannot be read into it

The issue arising in this case is similar to the issue which has been settled by the Apex Court in CIT v

Kulandagan Chettiar (2004) 137 Taxman 460

In this case,

the Apex Court observed the following (1) Section 90(2) of the Income-tax Act,

the provisions of the DTAA would prevail over the provisions of the Act

(2) The tax liability arising in respect of a person residing in both the contracting States has to be determined with reference to that State with which his personal and economic relations are closer

The person shall be deemed to be a resident of that contracting State in which he has an habitual abode

(3) The immovable property in question (i

Rubber Plantations) is situated in Malaysia and income was derived from that property

Further,

there was no permanent establishment (PE) in India in regard to the business of rubber plantations

Therefore,

the business income from rubber plantations could not be taxed in India because of closer economic relations between the assessee and Malaysia,

being the place where (a) the property is located and (b) the PE has been set up

(4) If an assessee is deemed to be a resident of a contracting State where his personal and economic relations are closer,

the fact that he is a resident in India to be taxed in terms of sections 4 and 5 would become irrelevant,

since the DTAA prevails over sections 4 and 5

Therefore,

the contention of the Assessing Officer is not correct

In the present age of commercial globalisation,

it is a universal phenomena that Multinational Companies (MNCs) have branches/subsidiaries/divisions operating in more than one country

In such a situation,

it is a common event for MNCs to transfer goods produced by a branch in one tax jurisdiction to an associate branch operating in another tax jurisdiction

While doing so,

the MNC concerned has in mind the goal of minimizing tax burden and maximizing profits but the two tax jurisdictions/countries have also the consideration of maximizing their revenue while making laws that govern such transactions

It is an internationally accepted practice that such ‘transfer pricing’ should be governed by the Arm’s Length Principle (ALP) a