International Taxation – BasicsAtul Khurana
Why should a Chartered Accountant be aware of International Taxation Laws?
In context of ICAI’s vision; The profession of Chartered Accountancy is touching international heights in the area of Auditing and Taxation. Our Institute is working relentlessly for making Indian Chartered Accountants, A Global Professional. Now what makes a Chartered Accountant different from other professionals is their adaptability towards new and tough areas. As you know very well, Taxation is the most dynamic and wide area as compared to auditing and the increasing globalization is making Indian Taxation Authorities to take a few steps more towards taxing the international transactions, so when it comes to tax the international transactions there is a need of a Chartered Accountant.
“Where there is a Tax, There is a Chartered Accountant!!!”
It is not wrong to mention that it is impossible for the taxation department to regulate this huge tax regime without the support of Chartered Accountants or I can say, Government introduces the Taxation Laws and the Chartered Accountants implements the same. Now it is a duty of each and every professional that he should be aware of these laws, doesn’t matter whether he is working in the area of taxation or auditing or company law because everything is interlinked. You can’t focus on one thing till the time you are aware about its corresponding law.
Being a part of this community of em9888erging professionals, I just want to contribute my part for educating the students and those members who left untouched by this subject. Those students who has chosen International Taxation as elective subject, it is going to be a revision for them and for others; it will be a great knowledge. Yes, Trust me, A Great Knowledge.
So let us start:
International Tax is best regarded as the body of legal provisions of different countries that covers the tax aspects of cross – border transactions. It is concerned with Direct Taxes and Indirect Taxes – Kevin Holmes
International taxation in a simple language means the study of Taxation beyond the National Level. Though we all are very much aware about our Indian Taxation Laws pertaining to domestic transactions but as time is demanding something more so, there is a need to study the taxation at another level.
International taxation: A different law???
This can be a doubt in the mind of anybody who wants to study all aspects of international taxation. So, let me clarify this:
- There is no any different law for studying international taxation.
- There are no any separate courts for the matters related to international taxation.
- The Income Tax Act, 1961 specifies certain separate provisions for the taxability of foreign transactions.
So now if I say what makes International Taxation a different law?
So the answer is:
International Taxation is a combination of:
- Transfer Pricing (TP) Provisions
- Tax Treaties
- Double Taxation Avoidance Agreements (DTAA)
- Non Resident Taxation
- Taxation of E-Commerce Companies
We are going to study everything in detail and in as much as possible simplified manner that you will start loving taxation.
The topic for today is Transfer Pricing.
Transfer pricing as a concept traditionally began with the amount charged by one segment of an enterprise for a product or service that it supplied to another segment of the same enterprise.
For example: Division A of M/s A ltd. Transferring goods to Division B of the same company.
Where is the problem?
With the evolution of MNC concept, segments of the enterprise started spreading as independent entities operating in various parts of the globe. Accordingly, the term has evolved to mean price which is charged between two or more entities of a MNC [associated enterprises (AEs)].
You can understand it in a way that it is quite obvious that when you give/sell some goods to your relative then definitely the price you charge is not the fair price of the product.
Same is the case here,
Now try to understand with an example how these MNC’s were trying to shift their profits to the low taxation countries and were avoiding the tax payments.
By increasing the costs of purchases from related parties, X Ltd has reduced its taxable profits in said jurisdiction.
You might be thinking that it is not illegal or it is tax management as it is at the discretion of the company to choose the price at which they want to transfer the goods to their own division.
But No, it is not called Tax Management rather it comers under the scope of Tax Evasion.
Let us understand how:
The Income Tax Act, 1961 specifies that when a tax payer manages the tax within the four corners of the law then it is known as tax management but by not transferring the goods at Arm Length’s Price (Fair value at which the goods are sold to unassociated person) the MNC’s are doing their business beyond the law and therefore these transactions cannot be said to be within the 4 corners of the law and hence It becomes the part of tax evasion.
Why Transfer Pricing Provisions in the Income Tax Act, 1961?
Post the globalization/ liberalization in 1991, there was introduction of MNC’s on very large scale in India and the manner of working of those MNC’s put the Income Tax Department in doubt regarding the real profits of those companies. The department presumed that due to breaking of Arm Length’s Price principle, the companies were transferring their share of profit to their divisions located in other countries. This presumption ultimately laid to the evolution of the transfer pricing regulations in India.
Therfore, The Finance Act, 2001 introduced Transfer Pricing Regulations for curbing tax avoidance and manipulation of intra-group transactions by abusing transfer pricing.
Specifically, the memorandum to the Finance Act, 2001 stated that:
“The increasing participation of multinational groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multinational group. The profits derived by such enterprises carrying on business in India can be controlled by the multinational group, by manipulating the prices charged and paid in such intra-group transactions, thereby, leading to erosion of tax revenues. With a view to provide a statutory framework which can lead to computation of reasonable, fair and equitable profits and tax in India, in the case of such multinational enterprises, new provisions are proposed to be introduced in the Income-tax Act.”
Accordingly, sections 92 to 92F had been included in Chapter X of the Income-tax Act, 1961, through the Finance Act, 2001, providing for a transfer pricing mechanism based on computation of income from cross-border transactions.
The following conditions must be satisfied in order to attract the special provisions of Chapter X relating to avoidance of tax:
- There must be an international transaction;
- Such international transaction should be between two or more associated enterprises either or both of whom are non-residents;
- Such international transaction should be in the nature of:
(a) purchase, sale or lease of tangible or intangible property; or
(b) provision of service; or
(c) lending or borrowing money; or
(d) any other transaction having a bearing on the profits, income, losses or assets of such enterprise.
- Further, such transaction may also involve allocation or apportionment of, or any contribution to any cost or expenses incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of the associated enterprises on the basis of mutual agreement or arrangement between such associated enterprises.
- Such international transaction must be done at arm’s length price and if such international transaction has been done at less than the arm’s length price, it shall require determination of income or apportionment of cost or expense on the basis of arm’s length price.
- The above adjustment should either result in an increase of income or decrease of loss returned by the assessee. In other words, the adjustment should not have the effect of reducing the income chargeable to tax or increasing the loss.
Case Study which led to the taxation of the MNC’s not doing business on ALP principles:
Mazagaon Dock Ltd v. CIT (Supreme Court),12 May, 1958
Facts of the case:
Under Section 42(2) Of the Indian Income-tax Act, 1922, ” Where a person not resident or not ordinarily resident in the taxable territories carried on business with a person resident in the taxable territories, and it appears to the Income-tax Officer that owing to the close connection between such persons the course of business is so arranged that the business done by the resident person with the person not resident or not ordinarily resident produces to the resident either no profits or less than the ordinary profits which might be expected to arise in that business, the profits derived therefrom, or which may reasonably be deemed to have been derived therefrom, shall be chargeable to income-tax in the name of the resident person who shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax The appellant, a private limited company carrying on business as marine engineers and ship repairers had its registered office in Bombay and was resident and ordinarily resident in India, but its entire share capital was beneficially owned by two non-resident companies whose business consisted in plying ships for hire. Under an agreement between them the ships plied for hire by the non- resident companies were to be repaired by the appellant company at cost, charging no profits. The Income-tax Officer made an assessment on the appellant company under Section 42 (2) of the Indian Income-tax Act, 1922.
It was contended for the appellant (1) that Section 42(2) imposed a charge only on a business carried on by a non-resident and that therefore no tax could be imposed on the business of the appellant, and (2) that it was a condition for the levy of a charge under that subsection that the non-resident must carry on business with the resident and that in the instant case it was not satisfied, as all that the non-resident companies did was only to get their ships repaired by the appellant company: Held, (1) that the business which is the subject-matter of taxation under Section 42(2) Of the Indian Income-tax Act, 1922, is that of the resident and not of a non-resident. The expression 849 ” derived therefrom ” in that sub-section refers to the business of the resident. (2)that a person can be said to carry on a business with another if the dealings between them form concerted and organised activities of a business character. Where, as in the instant case, the nonresident companies got their ships repaired by the appellant, not as they might by any other repairer but under a special agreement that repairs should be done by the appellant at cost, the non- resident companies must be held to have carried on business with the appellant within the meaning of Section 42(2) Of the Act, even though the non-resident companies might have derived no profits from the dealings with the appellant.
The concept of transfer pricing was considered by the Supreme Court with reference to section 42 of the Indian Income-tax Act, 1922, when the law relating to transfer pricing was in its rudimentary stage. The question before the Supreme Court was whether the transaction between the non-resident British companies and the Indian company were at arm’s length. If not, whether it is covered within the scope set out under section 42(2) of the Indian Income-tax Act, 1922. It was observed that section 42 states that it is not the question of the non- residents carrying on business in the abstract but of their carrying on business with the resident. The arrangement has to be looked into and decided on the taxability. The Apex court rejected the contentions of the Indian company and held that profits, if any foregone, must be taxed. The court expressed the view that the fact, that the dealings were such as to yield no profit, was immaterial.
That was the 1st time when this kind of business arrangement was taxed after the order of Apex Court.
So, this much for today. Tomorrow we will discuss about the practical situations that how the profits are shifted to evade the tax.
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