Tax management has assumed significant importance in boardroom discussions. Not only are tax laws mired in complexity, but they also account for a significant cost for companies. Risk management, therefore, becomes critical given the onerous compliances and the potential implications that could result if tax positions are not carefully assessed and managed.
With globalisation and digitalisation taking center stage in the world economy, interactions between countries have increased multifold. The humongous magnitude of cross-border transactions brings its own set of cross-border tax issues which one needs to be mindful of with the help of international tax risk management.
The following paragraphs highlight some of the key international tax issues and the role each of them plays in risk management:
- Can a non-resident be subjected to tax in India?
In simple terms, a non-resident is liable to tax in India if they earn income from India. Whilst certain streams of income (such as dividends, interest, royalties, technical fees) are taxable in India if the payer is in India (without the non-resident having a physical presence in India), the business income of a non-resident is typically taxable in India only if the non-resident has a physical presence in India.
The distinction of whether the non-resident carries on “business with India” or “business in India” is of importance as a tax liability in India would arise in the case of the latter and not the former. For example, a non-resident exporting their goods to India may not be taxable in India whereas a non-resident who sells goods in India through its branch or subsidiary or agents in India could potentially be liable to be taxed in India.
- Withholding taxes
According to the Indian tax laws, any sum payable to a non-resident which is chargeable to tax in India is liable for deduction of tax at source (‘TDS’). Thus, two things are very important to be determined–
(i) whether the sum payable to the non-resident is chargeable to tax in India; and (ii) the applicable rate of TDS.
Both these issues are critical, and their assessment requires evaluation of several parameters such as:
- What is the nature of the income?
- Is it taxable under the Indian tax laws?
- Is it taxable under the relevant tax treaty?
- If not taxable or taxable at a concessional rate in accordance with the tax treaty, is the non-resident eligible for treaty benefits? This eligibility, in turn, is determined on the basis of whether the person can be regarded as a ‘resident’ of their home country to access treaty benefits, whether they can be regarded as a ‘beneficial owner’ of income, whether they hold a valid Tax Residency Certificate to claim treaty benefits, whether anti-avoidance provisions can apply to deny treaty benefits, et al.
Any failure to deduct taxes appropriately as required by law could have severe ramifications; not only would the expense be disallowed for tax purposes, recovery of taxes along with interest and penalty obligation would also fall on the payer. In some cases, prosecution proceedings could also be initiated against the payer.
- Transfer pricing regulations
The concept of transfer pricing requires that transactions between related parties ought to be at an arm’s length price. The law requires a taxpayer to maintain transfer pricing reports which substantiate that the transactions with related parties are carried out on an arm’s length basis. There is also a requirement that all cross-border related party transactions be audited, and a report thereof be furnished to the tax authorities along with the tax return.
Any compliance failure in this regard attracts sizable penalty exposure. Also, if it is found that the transfer price is at variance with the arm’s length price, an adjustment to the taxable income is made by the tax authorities, which leads to additional tax and interest demands. Therefore, in transfer pricing methods, a need to maintain robust transfer pricing documentation cannot be overemphasised as this goes a long way in contesting any alleged adjustments which may be made on this count.
- Mergers and acquisitions (‘M&A’)
Whilst the cross-border M&A activity is an interesting space to watch, the risk of any potential India tax liability arising out of an offshore M&A transaction cannot be undermined. In this regard, the Vodafone issue is perhaps the most discussed tax controversy in India and has garnered attention from investors all across the globe. Overturning a favorable Supreme Court judgment, the Indian Government retrospectively amended the law from the year 1961 by “clarifying” that offshore share transfer deals were always intended to be taxed in India if those shares derived their value substantially from underlying assets in India. More on this topic can be read here.
Therefore, any offshore M&A deal cannot be brushed off simply because it is entered between two non-residents. If India linkage is established in the deal basis and the prescribed parameters, the buyer as well as the seller would need to discharge their respective obligations under the Indian tax laws; viz, deduction of withholding tax by the buyer, offering capital gains tax to India by the seller, filing of tax returns, etc.
- Taxability of digital economy
With increasing digitalisation and emerging business models such as online marketplaces, online advertisement services, Over-the-top platforms, etc., non-residents can earn huge profits from a source country through online means, without having a physical presence in a particular country. Multinational forums such as the OECD and UN are doing a commendable job in developing new rules to tax such digital business models as the existing international tax framework is not equipped to tax such new-age business models. Whilst a consensus on a unified approach to taxing the digital economy is expected to be reached by the end of 2021, several countries (including India) have enacted unilateral measures to tax these businesses. For instance, India has introduced equalisation levy provisions which tax cross-border e-commerce transactions. The Indian law also provides that a non-resident which has a “significant economic presence” in India is liable to be taxed in India based on the prescribed parameters.
Given the above, one needs to be mindful of the above provisions as well, since non-compliance with regard to any part of them could invite serious consequences and long drawn out litigation, which is best avoided.
The above discussion encapsulates only the key focus areas which one needs to be mindful of as far as risk management in international tax is concerned by following the international tax regulations. The importance of having a well-defined tax strategy with adequate safeguards in terms of a factual as well as legal position cannot be undermined.
Blog submitted by Dinesh Kanabar, CEO – Dhruva Advisors