What is the tax impact involved in movement of goods within India!

In our today's business world, the businesses perform movement of material / goods within the Indian territories very commonly. Whether it is manufacturing concerns or construction companies or infrastructure / project companies; whether it is movement of raw materials or semi-finished / finished goods; and whether it is movement between branches or godown or to customers or even to job workers for certain repairs, material movement is a very common phenomenon. Business use all possible means of transport for the above - by rail, road, air, sea ferry etc. Basis the business requirements, the nature of transactions to be performed and the means used for material movement, the formalities / procedures would generally differ, but what remain more or less common in the impact of taxes.

But in a basic simple transaction where goods are to be moved from one place to another within the same country, how would TAXES impact? At this stage, lets keep in perspective the basic nature / requirements of TAXES - it generally involves : (i) a payout of money; and (ii) compliance with the prescribed procedures. 

Whenever there is a material movement, one has to first of all understand the stimulus for the same. Why is the material movement happening - is it under sale or transfer from one branch to another or transfer to sale depot, understanding the stimulus which triggers such material movement is a must - since the tax impact would differ significantly basis such stimulus. 

Whenever there is a sale or transfer in the ownership, it would typically have a levy of sales tax or Value Added Tax (VAT, as commonly known). The same is levied at the time of sale - generally, when the invoice is raised. Thus, it needs to be seen in a transaction involving material movement. However, if the material is moving from one branch to another branch and there is no sale / transfer of ownership, it would not be subject to VAT. The above might have certain tax registration and other compliance involved which we will talk about later. Also, lets be aware of the levy of EXCISE which would typically be levied on manufacture of goods and has to be discharged before the removal of finished goods from the respective factory. 

Now, after we have understood the stimulus and are aware of the general tax impact involved in the same, lets be clear about the modalities for the material movement i .e. understanding if the material movement involve transfer of goods to another Indian state (or sometimes to another Municipality) or would it be within the existing state where the goods would be currently present. To move the material within the state, the respective state Government would require certain forms etc to be filled and submitted by the respective mover. Generally, for movement within the state taxes would not be levied. However, we have seen in the past that taxes like LOCAL BODY TAX were levied by the respective state which were levied when goods moved from a certain municipal limits to another. 

Similarly, for inter-state movement of goods, there could be prescribed forms etc which has to be complied with by the mover. Generally a lot of Indian States prescribe their own specified WAYBILLS - which has to be filled by the purchaser of goods (the person who is responsible for bringing the goods into that respective state). At the time of entry of goods into the respective state, there could be ENTRY TAX which would differ depending on the commodity / goods involved and the same would have to be discharged in prescribed timelines to the respective state Government. Interestingly, we find that in inter-state sale, there is a levy of CENTRAL SALES TAX at a concessional rate (as compared to VAT in such state) which later on requires the transacting parties to issue the prescribed C forms etc. to the seller. Similarly, there could be transactions such as sales in course of inter-state movement which would later on require issuance of E1 or E2 forms. In case of transfer from one branch to another, it would require issuance of F Form. These forms are state specific and every Indian state has prescribed procedures to issue / get the same - sometimes, online or otherwise from the Department.

In order to execute the above, one will require prescribed tax registrations. Any taxpayer who wish to execute sale transaction in a particular state,   bring goods from one state to another (and issue C forms or E1 / E2 forms) or would like to deal in sensitive goods or would like to execute works contract in a state would require VAT and / or CST registration. It is important to include in such registrations details of all premises / places where goods would be lying or from where business of taxpayer would be performed.  Commonly, it happens that after a main registration, additional places of business are added.

One would experience that the manner in which the above mentioned procedures are implemented and administered by the respective state Governments,  it would be essential to obtain VAT / CST registration before any material movement.  During the material movement, one has to ensure that valid waybills, invoice and other details are available with the transporter / carriage. The prescribed procedures are complied with. Entry tax or other taxes, wherever applicable, are paid in time. Necessary returns are filed within time. Prescribed forms are generated and provided to the concerned parties. Every time,  the nature of transaction is understood clearly and necessary forms are procured and provided to carriage (even in case of branch transfers or job works, forms are required as we have seen above). Additional places of business are regularly updated. Whenever dealing with sensitive goods, prescribed procedures are followed.

It would flow as an imperative that non-compliance with any of the above requirements could have serious implications in terms of detention/seizure of goods, penalties and prosecution of people involved etc. Sometimes the stakes could get really high and implications very serious.

Thus, businesses must reckon that this area of material movement holds significant stake and exposure and thus, needs to be dealt with very professionally - as good or as bad as any other significant tax function. 

  

What are the 'tax things' we have to be mindful of in India!! asks a foreigner

In our today's times, one sees several businesses where foreign companies have made their presence felt and done some great business in India for a very long; and also some of the so-called 'sunrise sectors' where constantly the foreign or multinational companies are trying to catch up. Thus, it has an increasing amount of business interest fuelled by Administration's efforts to make India a great business place. However, amid all this Euphoria, has remained constant over a long time a perception that Indian taxes are highly complex - courtesy to several factors and developments. Therefore, emerges a very commonly asked question by the foreign businesses - What are the Tax Things that we have to be mindful of in India? 

Indian tax regime is a wide spectrum of several Direct and Indirect tax laws - governed by the different arms of Indian Federation i.e. the Union and the States. Thus, on one hand we see direct taxes such as Income tax and wealth tax levied and administered by the Centre/ Union, there are indirect taxes such as excise laws, customs and services tax which are again Centre/ Union levies. The Indian states levy taxes such as Vat or sales tax, professional tax and municipal taxes etc - which comes in their domain. Thus, the state levied taxes differ from state to state depending upon its policies. These taxes impact any and all foreign and /or indigenous business in several of the ways. 

The taxes have their inherent pay out costs - which could be very high at times; and also its compliances - which could be quite cumbersome to deal with. Like it happens everywhere, the taxes remain dynamic and they do change - sometimes for good, sometimes for not, depending on several factors. Thus, taxes cause business: a) a cost - in the form of payout to respective Governments, b) comply with statutory procedures and requirements and c) also make businesses fight disputes whenever emerges with the regulators. Not to mention, it also makes business predict the future and remain prepared to deal with the changes in taxes.

Talking specifically about the Indian Income tax, a foreign business, which has a presence in India but not in the form of an Indian incorporated company or firm or otherwise, would be subject to tax at 40% in respect of its Indian operations. However, if the foreign company incorporates a company or a firm in India and has effective management in India, then such Indian operations are subject to tax alike any other Indian company or firm - typically at tax rate of 30%. Closure of such companies or firms or any other business formed in India and winding up of operations would obviously involve procedures. However, having a business presence / permanent establishment in India or working in a globally prevalent model of 'consortium' would continue to have the tax exposure applicable to foreign businesses in India. There are several forms in which a foreign business can set up its base in India. Also, for businesses set up in prescribed sectors such as software, oil and gas, dredging etc, or for businesses set up in Indian backward states, tax exception are provided. 

Talking about the tax impact involved in payments to overseas and also repatriation of capital, then declaration and payment of dividends in India would involve an additional cost of 20% dividends distribution tax. Payment to overseas in form of royalty and fees for technical services, interest etc would be subject to tax withholding in India. If the PAN is obtained, then the beneficial rate of tax treaty, if any prescribed, can be availed. India has signed tax treaties with several of the countries and it grants benefits such as capital gains tax exemption, restricted definition of  royalty and fees for technical services etc under various treaties such as Mauritius, Cyprus, Singapore and others. Transactions between two associated parties would also need to be at arm's length from transfer pricing perspective. 

The employees deputed /seconded by the foreign company to its Indian business remain subject to tax in their individual capacity. Thy would have to bear the tax cost and also copy with tax filing and other prescribed requirements. Such individuals would also be eligible for tax treaty benefits if applicable.

The Indian indirect taxes such as exise - relevant for manufacturers and service tax - applicable on service providers (typically at 14% rate) comes to play in each and all business transactions performed by any enterprise. Sometimes, when the services are obtained from overseas service providers, the recipient has to discharge service tax on the same under a reverse charge mechanism. Customs, of course, is applicable at the time of import of goods into India. The Indian indirect tax laws follow a Harmonised System of Nomenclature or the HSN system of classification of goods which is as per the internationally accepted standards of classification of goods for excise or customs purposes, however classification of goods and services in various of the prescribed categories remain a matter of dispute - no different than rest of the world. There are some exemptions granted to specified businesses and business transactions under the Indian Indirect tax laws. The indirect taxes have its own prescribed rules for tax filings and other procedures etc

Talking about the state taxes, mostly it is Vat and/or octroi, entry tax and some municipal taxes - whose impact is mostly felt in the movement of goods from one Indian state to another or while selling goods. There could be professional tax etc levied on hiring of employees in few of the states. The state levied taxes have their own set of administration, filing requirements and other prescribed procedures. Indirect taxes, as per their basic nature can be passed on to the ultimate consumer. 

As we have seen, right from the basic decision of whether and in what for me to perform business to performance of business procedures and even later thereon, taxes do make a significant impact - sometimes as grave as Vodafone's tax situation in India. Even in big decisions involving stake sale, mergers, acquisition etc, tax impact could be huge.  

Thus, taxes requires a serious and effective consideration and ought to work in consonance with the business and legal teams to define the basic and ever changing strategies of any business. Since the stakes could be high and managers might have to face serious charges from the tax administrators, one has to constantly assess the tax risk/ position proactively and do necessary forecasting in here. 

Indian taxes could be uncertain, sometimes work in an irregular way or subject to dispute /litigation. Thus, a call / position would have its inherent risk and would have to pass the test of time. Thus, comes the need of outside experts to help with the proper advices.

Thus, when any business is trying to find out an answer to the question of what are the tax things one has to be mindful of, it ultimately need to alleviate it's tax function to work proactively with business and legal teams, where it's 'tax things' could be assessed well every single time and it makes an informed decision always. 

So what if i earn taxfree income, i still end up paying MAT!!

So what if i (the taxpayer) earn tax-free income, i still end up paying MAT! This expression is commonly found amid the Indian Taxpayers. The basic issue which leads to the above situation is that under the Indian Income-tax Act, 1961 (' the Act'), the taxpayers (who are Companies) are required to compute their taxes (a) as per the provisions of Minimum Alternate Tax ('MAT'); and (b) under the Normal Provisions of the Act, and pay resultant tax which is higher of the above two - (a) or (b). Interestingly, in addition to MAT which is applicable only on Companies, we see a new regime of Alternate Minimum Tax or AMT emerging which will be applicable on Taxpayers other than Companies.  

MAT has been specifically dealt with in Chapter XII-B of the Act. It says that the book profits which are shown in the profit and loss account of a company for a particular year has to be adjusted (by making additions / deletions) with certain prescribed list of items and tax is computed at 18.5% of such adjusted book profits. For instance, if a company has a net profit of INR 100 in its profit and loss account, then for MAT computation purposes, one has to take such base figure of INR 100, (+) add to it the amount of income-taxes paid by the company and a whole list of other prescribed items and also (-) reduce therefrom, such income which is exempt u/s 10 of Act and other such prescribed items. On the adjusted book profits, MAT will be computed by applying 18.5% on such adjusted profits. There is also a concept of MAT credit which exists in the Act. 

As regards the Normal Provisions of the Act, all provisions of the Act other than MAT or Chapter XII-B mean the normal provisions. Computation of tax under normal provisions of the Act in our example means taking the book profit of INR 100 as base figure and making additions / deletions to it of all the respective items as may be applicable as per the normal provisions of the Act. Thereafter, tax is computed at 30% on such profits. As mentioned earlier, the taxpayer will have to discharge the higher of (a) MAT computed at 18.5% on book profits; or (b) Normal Tax computed at 30% as per normal provisions of the Act. 

At this stage, lets look at the principal difference in MAT and normal provisions of the Act. MAT provisions are a relatively newer concept in the tax laws (introduced from 1987). It basically intends to bring to the ambit of tax such companies who earn/book profits (by following the Generally Accepted Accounting Norms) but gets it all exempt by taking benefit of the normal provisions of the Act. Thus, MAT has more proximity with book profits computed as per GAAP and allows very bare minimum adjustments in computation for tax purposes. Normal Provisions are relatively older set of provisions, despite having legislated by the same lawmakers (who govern MAT provisions) and under the same Income-tax Act, have numerous exemptions and tax benefits offered to taxpayers - may be driven by several economic, political and other considerations. The deductions, exemptions and other benefits provided under the normal provisions of the Act are typically not there in the MAT (few common exemptions are there such as certain income exempt u/s 10 of the Act are not subject to tax either in MAT or normal tax). By way of an example, one principal difference commonly found is that under the normal provisions, the taxpayer can claim significantly higher rate of depreciation and reduce its taxable income, however, under MAT, it is allowed a relatively lower amount of depreciation expense benefit.  

Thus, emerges an interesting and often complicated jugglery of the tax law, where a taxpayer has to make 2 computations of tax - (a) under MAT provisions; and (b) under normal provisions and then decide about the final tax (as we saw, higher of the two). It may often happen that the same taxpayer who would claim to draw a benefit under the normal provisions of the Act, get denied such benefit under MAT. Thereby, end up paying tax on a 'potentially' tax-free income. To go back to our example, while it would be possible for a taxpayer to get the whole amount of INR 100 exempt / tax-free under the normal provisions of the Act and would pay no taxes. However, it may still happen that on the same INR 100, the taxpayer might end up paying 20% tax since the benefit / deduction as available under the normal provisions is not available in MAT. Accordingly, MAT seems to take away a lot of benefits which are otherwise available to the taxpayers under the normal provisions of the Act. 

Now the MAT credit : whenever a taxpayer pays MAT, it is eligible to get MAT credit. MAT Credit is the excess of MAT paid over normal tax. In our example, if the taxpayer's tax liability as per MAT is INR 20 and tax liability as per normal tax is INR 10, it is eligible to claim MAT credit of INR 10 (excess of MAT over normal tax liability). The taxpayer can carry forward such MAT credit and set off against the normal tax liability, if any, which may arise in the future years. Thus, if in our example, if the taxpayer  has the tax liability of INR 20 under normal provisions in the immediate next year and MAT liability is INR 10, then it can claim set off MAT credit of INR 10 against its normal tax liability and thus pay only INR 10 (INR 20 normal tax reduced by INR 10 MAT credit). MAT credit can only be carried forward to for a period of 10 years and set off in the manner aforesaid against thy normal tax liability. Thus, MAT credit can serve as an effective way of reducing tax liability in the future years when there are normal profits expected. 

However complicated or harsh it may sound, the reality remains that MAT and / or AMT exists under the Indian tax laws and do operate as fully acceptable and constitutionally approved statue. Unsurprisingly, this kind of concept is also found in several other countries - for instance Mauritius, also by US Federal Government, to name a few. 

Going back to where we started - if a taxpayer earns tax free income (under normal provisions of the Act), will it have MAT thereon or is it possible to get it held as completely tax free.  

On this aspect, an interesting situation arose before the the Hon'ble Mumbai Tax Tribunal ('ITAT') in one of the recent case-laws of Shivalik Venture Pvt Ltd, concerning whether to pay MAT on an otherwise tax exempt income. In this case, during the year 2008-09, the taxpayer (Shivalik) transferred certain development rights to its subsidiary and earned some income therefrom. The taxpayer booked in its accounts such income as 'extraordinary income' and mentioned in its notes to accounts that such income is a capital receipt and the transaction is not regarded as transfer under the Act. Also, that such income is not includible in its net profits for MAT computation purposes.  

At the time of tax computation, the taxpayer, under the normal provisions of the Act, claimed such income as exempt. Also, under MAT, the taxpayer claimed that such income, by virtue of the specific disclosure given in its notes to accounts, would not form part of the 'book profits' for MAT computation and would therefore be tax free. To this, the Hon'ble Mumbai ITAT upheld the taxpayer's contentions and decided the case in favour of taxpayer. The Hon'ble ITAT based its judgement on the principle that the said income do not fall under the definition of 'income'. Also for MAT purposes, the profit arising to the taxpayer as per the GAAP would have to be adjusted by reading the notes to accounts and thereby, the book profits for MAT purposes would not include such income. 

In the aforesaid case-law, several of the judicial precedents were discussed and debated by the disputing parties : such as Rain Commodities Ltd v. DCIT (131 TTJ 514) wherein it was upheld that MAT would be levied on an otherwise tax exempt income. However, this case was distinguished basis that the taxpayer did not make a disclosure in its notes to accounts as done by Shivalik Ventures. Another case was Hon'ble Delhi High Court : Sain Processing & Weaving Mills (P) Ltd (325 ITR 565) where the taxpayer did not charge depreciation to its Profit & Loss account, but disclosed the same in the Notes forming part of accounts. However, while computing book profit under MAT, it claimed the amount of depreciation as deduction from the Net profit disclosed in the Profit and loss account and was allowed such benefit. Also, Hon'ble Pune ITAT : K.K. Nag Ltd Vs. Addl CIT (2012)(52 SOT 381) where the incremental liability towards leave encashment was not debited to the taxpayer's Profit and Loss account, but otherwise disclosed in Notes to Accounts. The Hon'ble Tribunal upheld that the said liability would have to be deducted while determining “Book Profits” for MAT purposes. On similar lines, the decision of Visakhapatnam ITAT : Hindustan Shipyard Ltd Vs. DCIT (6 ITR (Trib) 407). 

As one can experience, the fight to claim an income exempt under the normal provisions of the Act and thereafter being made to pay MAT thereon is an ongoing and one of the most complicated and burning dispute in the Indian tax laws. It has several complications around it and as we have seen above no straight and time tested answers /ways to deal with. Thus, calls for the taxpayers to deal with the problem in a proactive and smarter way and change the convention to - While i earn tax free income, i might not have to pay MAT thereon as well. 

The Beauty of Cenvat Credit in Indirect Taxes

Cenvat Credit has been an age old concept prevalent in the Indian Indirect Tax regime. As the name suggest, it simply means credit of indirect taxes such as Excise Duty and Service Tax paid at the time of procurement of ‘inputs’ be allowed (as set off) against the taxes payable on output goods and / or services. The underlying premise of Indirect Taxes has been that in a value chain, tax is levied only on the component of value addition made by the respective producer / service provider. This concept is also found even in the State VAT laws where the Seller is allowed to set off the VAT paid at the time of procurement, with the VAT it is liable to pay at the time of sale of goods to its buyer.

To take an example, if a (manufacturing or service provider) firm procure raw materials / services worth INR 100 and pays Excise Duty and / or Service tax thereon at INR 20 (thereby, paying a total of INR 120) to the seller. After making the respective value-addition, such firm would sell the same product/services at INR 150 and charging Excise Duty and / or Service tax thereon at INR 40. On the Rs. 40 which the firm has collected from its Buyer on sale, it claim set-off of INR 20 paid by it at the time of its own procurement and thereby, just pay INR 20 to the Government Authorities in prescribed manner. Not INR 40 this time. The same series of events qua taxes would follow with the next leg of transaction involving our firm as seller and its respective buyer and so on. Lets always keep in perspective the underlying nature of Indirect Taxes – the burden is passed to the buyer.

As we can see in our example, as the value addition happens at different stages in the value chain of goods / services, the respective sellers and buyer in their different capacities pays taxes (on inputs at the time of procurement through seller and later as recovery of taxes on the value addition made by them upon sale of their output goods / services). For governing the set-off of taxes paid on inputs against the taxes levied on output goods / services, the prescribed regulation in Indian Central Laws is Cenvat Credit Rules, 2004.

The concept despite being old, has evolved over the years and the Lawmakers have tried to make the concept progressive with the changing times. In the good old days, credit of service tax paid on input services was allowed only for payment of service tax on output services, similarly, excise duty paid on inputs and capital goods was allowed only for payment of excise duty on final products. From 2004-05 onwards, major step has been taken integrating tax on goods and services and both manufacturer of goods and provider of output services under excise and service tax are allowed to take credit of excise duty and service tax across goods and services. The current talk on Goods and Service Tax or GST is another step in the direction of providing credit for all the taxes that are still left out from credit mechanism in the current regime. But what is the legislation on the concept? Let’s see:

The regulation simply state that a manufacturer / producer of (any) final product or a provider of an output services is eligible to claim credit of: (a) Excise Duty including additional excise; (b) Service tax, and education cess thereon which is paid on: (i) Input and/or Capital Goods received in factory of manufacturer or Output Service Provider; and (ii) Input Services received by manufacturer or output service provider.

An ‘Input’ is defined to mean all goods used in factory by manufacturer or goods used for providing any output service. It also include specified accessories etc and goods used in steam generation, however, it excludes items such as (i) Petrol; (ii) goods used for construction / execution of works contract; (iii) motor vehicles; (iv) food consumed by employees and others including the goods having no relation whatsoever with the manufacture of final output / product. Likewise, ‘Input Services’ would mean any service: (I) used by output service provider for providing output service; (II) used by manufacturer directly or indirectly in or in relation to the manufacture of final product and its clearance upto place of removal. It includes services such as advertisement, auditing, credit rating, recruitment and quality control, mobile phones, sales commission etc but exclude service portion in work contracts, renting of cars services, club membership of employees and others. Similarly, ‘Capital Goods’ would mean: a) goods falling in prescribed chapters (82, 84, 85 and others of 1^st schedule of Excise Tariff Act); b) pollution control equipment, c) storage tanks, d) Moduls, Jigs etc which are used in factory of manufacturer (but not in office) or for providing output service. It also include Motor Vehicles used by courier agency, firms providing rent a cab facility and other prescribed.

Cenvat credit may be utilized for payment of service tax on any output service but only to the extent it is available on last day of the month / quarter. Balance if left unutilized, can be carried forward to future years. In case of mergers etc., the balance can be transferred. Credit of tax / duty can be claimed only against tax / duty, similarly, credit of education and higher education cess can be claimed against such pay-outs. In case of capital goods received in the premises of output service provider, 50% of duty paid on such goods can be allowed as credit in the same year, balance can be taken in any subsequent year. Credit shall not be allowed on that part of capital goods in respect of which output service provider claim depreciation u/s 32 of the Income-tax Act, 1961.

Cenvat credit shall be taken by the output service provider on the basis of invoices, supplementary invoices, bill of entry or any other prescribed document. The records must be kept for 6 to 7 years. The outer limit of taking credit currently is one year of date of receipt of invoice or date of payment of service tax in cases of reverse charge. Thus, ensure that vendor invoices are received well in time and booked in the accounting system in a regular way. 

Credit is allowed on inputs when it is used in the output goods and/or services which are taxable. If inputs are procured to produce exempt goods and/or services, no credit of taxes shall be allowed and such respective portion of total accumulated credit would have to be reversed. Thus, separate accounts would have to be maintained for exempt and taxable items. If separate accounts are not kept, then taxpayer would have to pay tax at 7% of the value of exempt services or reverse from total, credit entitlement in the ratio of exempt and total turnover as per last year, intimating the authorities.

Refund of Cenvat Credit is allowed on export and to units set up in specified areas. There is also a concept of Input Service distributor as per Rule 2(m) dealing with the manner in which an office of a manufacturer or output service provider receive invoices and thereafter issues bills, invoices etc for distribution of such credit – typically in cases wherein Head Office receive bills for services used in factory etc.

An idea of ‘Revenue neutrality’ as upheld by Hon’ble Courts in several Courts also come into play in the Indirect taxes disputes. Where the Tax Authorities alleges levy of any particular taxes upon discharge of which Cenvat credit is available to the taxpayer, it would automatically allow credit to taxpayer and sometimes lead to revenue neutral position for the Authorities.

In view of the very nature of the concept, the manner in which the respective tax laws are written and administered by the Authorities, lack of clarity on several areas, different views taken by Judicial Authorities, this is highly prone to litigation. As we have seen, the concept of Cenvat Credit has a beautiful underlying rationale, it involve compliances and has its own set of (often complicated) procedures and disputes. However, it is a reality in today’s business world and calls for a proactive and skilful handling of the subject. Thus there is a need to have a robust accounting system in place which can properly account for and track the necessary numbers and records such as invoices, knowledgeable people placed in the maker-checker mechanism of the entire system and above all, a culture of discipline and regular reviews to ensure that it turns out to be a success story.

Income Computation and Disclosure Standards (ICDS) - the newest tax legislation

The Indian Authorities have notified 10 ICDS recently - a brand new tax legislation. The same are standards which have to be followed by taxpayers from FY 2015-16 for computation of income under the heads of a). Profits and Gains of Business and Profession; and b). Income from other sources. Thus, computation of tax under Minimum Alternate Tax (MAT) remain unaffected by ICDS. There are also certain mandatory disclosure(s) of information which taxpayer(s) have to make now - may be in Return of Income or Tax Audit Report.

So, we all have the usual flak like for any new legislation - what are these ICDS? What are they going to do? Why is there a need to have these ICDS?  Why can't changes be made in existing Income tax Act or Rules to achieve what the regulators are trying to achieve? and so on...

ICDS basically intends to bring consistency in accounting of the taxpayers. The figures of revenue and expenses flow into tax records from the financial books of accounts, basis which (tax records), tax men raise the tax bill after giving effect to provisions of Income tax Act. Thus, ICDS is in some way an attempt of the regulators to reach out to the accounting and financial books of the taxpayers and make it consistent and perhaps more 'tax(men) friendly'! But what's the need to reach out to accounting of taxpayers? 

Lets take a reference from the History: In the good old days, Indian laws did allow the taxpayers to have a hybrid of accounting systems. Meaning thereby, the taxpayers could follow both cash and mercantile systems of accounting at the same time. And the taxpayers could thus follow cash system for revenue and mercantile system for expenses and arrive at a magical figure of profits upon which the tax men would raise a bill, of course, after giving effect to provisions of Income tax Act. This practise was cut short long back and only one system was allowed to be followed and that too consistently. Almost 2 decades back, section 145 was introduced in Income tax Act and powers were granted to the tax authorities to govern accounting of taxpayers. Thereupon, two tax accounting standards were prescribed and as much as I have experienced, those standards were seldom put to use. From earlier days till the recent past, the accounting world grew quite eventful - as they gear up for IFRS, new accounting standards, revised schedule VI and later,  a completely new Companies Act and now Ind-AS. 

The tax authorities could always realise that the way accounts were maintained by the Indian taxpayers lacked that great amount of consistency, offered several opportunities to taxpayers to perform irregular planning and so many colorful things could be done in the garb of accounting. This coupled with the recent changes as we have seen above. So, what if almost every taxpayer follow different accounting principles and generate varied numbers which form basis for tax computation. Quite a nightmare for tax men, isn't it! Thus, to bring consistency in taxpayer's accounting and thereby, arrive at a proper and regular base number of taxable profits in a dynamic world, the old stale standards are withdrawn and ICDS provided. This is quite evident from the developments that has taken place in respect of ICDS formulation and prescription in the last couple of years. 

In a nutshell, ICDS require taxpayers to make certain prescribed adjustments to its accounting and thereby arrive at the base profit / loss number, which will further be adjusted as per provisions of Income tax Act and the final taxable profits and tax will be determined. Once again, ICDS apply only on business income and income from other sources. ICDS does not require separate set of books to be maintained-just making certain adjustments to the accounting. ICDS does not supercede or extend the scope of Income tax Act. The terms not defined in ICDS shall be interpreted from Income tax Act and in case of conflict, Income tax Act provisions will prevail. In all likelihood, a settled tax position under the Income tax Act (basis the judicial precedents or otherwise) will not be affected by ICDS. However, any jurisprudence in the Income tax Act which has an(y) impact on taxpayer's accounting shall be superceded by ICDS. Additionally, there are disclosure requirements which taxpayer has to fulfill - whether it will be in Return or Tax Audit or in any other way is yet to be notified.

As we have seen, the power to govern accounting and make rules existed in Income tax Act and the Hon'ble Courts also recognised it clearly (decision of Woodward Governer). Thus, ICDS are prescribed in Income tax Act in exercise of such statutory power. For not following the ICDS, the taxpayer may be subject to Best Judgement Assessment and face consequences.

Currently, ICDS provided for - Changes in Accounting Policies, Inventory valuation, Borrowing Costs, Forex fluctuations, Government Grants, Securities, Provisions and Contingent Assets and Liabilities, Fixed Assets, Construction contracts and Revenue recognition. A few others such as leases, events after balance sheet date etc are drafted but not yet notified. As we can see, for the Indian Accounting Standards which have any bearing on income measurement and not purely disclosures, correspondingly the ICDS are provided. ICDS has similarities with existing accounting standards as well.

Out of the several changes which the ICDS prescribe, what comes to my mind are : prescription of reasonable certainty criteria for creation of provisions as against probable certainty and similarly, for creating contingent assets and liabilities, again reasonable certainty as against virtual certainty. Prescription of only Percentage of Completion Method (POCM) for Service providers under revenue recognition and prescription on of only POCM in construction contracts as against completed contract method. Non allowance of Marked to Market or expected losses to the taxpayers. Compulsory recognition of Government Grants in year of receipt. Removal of 'substantial period' criteria for capitalization of borrowing costs in value of qualifying assets. Recognition of inventories by service providers.

Does the above changes, in effect, lead to preponement of income and deferral of expenses, might be yes. It can also lead to certain situations where the taxpayer might have to recognise income in normal tax in one year and pay tax thereon; and again recognise same income in its books in next year and might pay MAT thereon. ICDS also does away the concept of Materiality, thereby, requiring the taxpayer capitalize purchase of all small value assets and also maintain records even for several small value items which may not have been required earlier.

Thus, ICDS require reconciliation with accounting standards and now Ind-AS. It also require maintenance of effective systems and controls to give necessary effect to accounting, the changes prescribed under ICDS. It also require maintenance of proper records to capture even the smallest and low value items; and above all,

a highly proactive and tireless approach of the  businesses to identify the effect of ICDS and comply with it efficiently...

The Tax Impact in Leasing

'Leasing' signify a very widespread way of doing business today. It is very commonly employed by businesses who cannot afford to make huge investment in assets in one go, particularly during start up or even otherwise as well. Such are called Lessees. On the other side - the Lessors find out investors for their assets who pays them value for their assets over an agreed time period (called as lease term), and usually an enhanced value inclusive of an interest. Thereby, enhancing purchasing power of consumers and increasing thy customer base. At the end of lease term, both parties decide the future course of action - whether to extend the lease, take the asset back, transfer the asset to Lessee only or any other. Through leasing, big assets or projects requiring huge capex investment can be easily funded and operationalized.

We find various types of Lessors doing business as such - could be strategic investors or professional asset leasing companies having love for particular assets or purely financial investors such as Banks who are only interested in generating returns from the whole set up. There are Lessees who take the assets on lease and operate such assets as per terms of lease and agreed structure between the parties.

Thus, we have seen that Leasing can be quite a complicated business which can have complex structures, terms of agreement, financing, the way it is accounted for in books (following the prescribed Accounting Standards); and yes, quite a big taxation impact!

Under the Indian tax laws, Leasing can have several tax implications from both Direct and Indirect tax sides. Interestingly, under the Indian tax laws, particularly Income tax, the lawmakers have been paying attention to leasing concept from olden days itself and we can see some clarifications emerging from the year 1943 as well. Under the Indirect tax laws also, we can see clearly prescribed implications arising on leasing under VAT and Service tax laws. Consequently, there has been a lot of litigation around the subject.

Let's firstly see the different types of structures that can emerge under this business, as the implications can vary significantly depending upon the structure that we have in place. Leases can be classified into Operating and Finance lease. The chief difference between the two is that in case of Finance Lease, substantial risks and rewards are transferred by lessor to lessee - just like Banks finances a Car purchase under a lease structure. Typically, Finance lease term cover the entire life of the asset and the lessee virtually gains all rights of the owner and becomes the economic owner of the asset. Operating lease on the other hand is exactly opposite and akin to a normal lease structure that we can see in different forms in our routine lives. Thus, the presence / absence of certain vital factors in any arrangement would determine whether it is in the nature of Operating Lease or Finance Lease. 

Within the principal categories of lease as seen above, there can be Dry lease or Wet lease. Whereas, Dry lease signify providing only the asset on lease, Wet lease signify providing the asset on lease as well as the personnel to operationalise such asset. Something like providing a Ship along with the crew and staff as a complete package. Thus, Wet lease can be very close to becoming a 'Service' in real terms.

There are several structures such as Hire Purchase, installment systems, sale and leaseback transactions etc that possess very close proximity with Lease, of course with its underlying differences as well. Such transactions would be governed by their respective governing a laws. Now, let's see the tax impact on leases.

Under the Income tax, the lease payment can trigger the tax withholding implications straight. Providing asset on rent under dry lease or in a wet lease as a transaction much akin to service, it can clearly invoke tax withholding requirements. Even in international transactions, tax withholding requirement would emerge as payment of lease rental would partake the character of royalty and subject to tax as such. There are few tax treaties that provide specific exemptions / benefits. Such as Ireland which exempts lease of Aircraft or Israel which does not tax royalty paid on 'Equipment'. Wet leases as seen earlier can partake the character of service and become taxable or exempt accordingly.

Another vital aspect of leasing in Income tax is the tax impact of payments of lease rent, which the Lessee would make, particularly in Finance lease. In operating lease, it could be a simple deduction for renting of asset or leasehold rights.

In Finance lease, lease rent typically comprise of principal repayment (of loan) and also the interest. The question arise on the deductibility of principal component. Since the Lessee acquire ownership rights in the asset by virtue of making such payments, the lessee would like to capitalize the value of asset in its books and claim depreciation thereon. But, the legal owner of such asset remain the Lessor, hence the Taxmen may not allow depreciation to the Lessee. Also, it can be argued that such principal payment is in the nature of capital payments, therefore it cannot be allowed even otherwise. So Lessee has generally to substantiate that it is the owner of asset and can claim depreciation. Thus arise the litigation.

Whereas, the law provides depreciation in case of Hire Purchase to the Purchaser, it does not clearly provide for the Leasing. Basis a few case - laws (including the ones decided by Hon'ble Supreme Court), a position can be taken that in finance lease, lessee can claim the depreciation, but it is not very clear and settled. Though in the draft Direct Tax Code or the DTC, there was a provision that in case of Finance Lease, depreciation will be allowed to Lessee. Thus, it is left to the facts and circumstances to ultimately decide who will claim the benefit. Hence a matter of taking a position.

Talking about the Indirect taxes, Hire Purchase transactions and 'transfer of right to use the goods' are clearly included in definition of 'Sale' and thus subject to VAT or sales tax. What constitutes transfer of right to use the goods is also defined by certain case laws. Thus, if there is transfer of such right, it could have VAT, if not, it may be subject to Service tax. Thus, lessor has to charge such taxes at the time of invoicing the lessee and the lessee can claim input credit of the same, if eligible. In case of Financial leasing services and hire purchase, service tax shall be levied on the 10% component of the interest part included in the lease rent.

As we have seen the tax impact on leasing transactions can vary significantly depending on its nature, one has to look at the underlying structure, the intention of parties, the accounting aspect, tax impact and the cash flows to define the terms of lease agreement and arrive at a most suitable structure. The tax implications would arise thereon accordingly.

It is imperative that amid evolving laws, accounting practices and tax jurisprudence, Leasing is governed by several legal and other attributes and thereby, holds a substantial exposure arising from tax and other fronts. Therefore, the business must consciously an proactively make efforts towards reckoning the issues that can arise on account of the above and try to find out ways to resolve the same amicably. 

How to do a ‘Tax Review’ of the Agreements

An entity enters into several agreements during its lifetime. As a very normal course, before any transaction is executed / entered into, a draft agreement is prepared which captures the general understanding of the two (or more) contracting parties and after a typical phase of negotiation(s), it gets finalized. More and more organizations today are realizing that before a draft agreement is finalized, all the different departments and stake holders must review the same (not only the legal and operations department) and include their points therein. Whether it is a commercial, NGO, charitable or a Government concern, it is becoming imperative to get its draft agreements comprehensively reviewed from all before finalization.

Hence, emerges the need to get all such agreement(s) reviewed from the Tax person in an(y) organization. But as a Tax reviewer, how should a review of an agreement be done? Lets see how.

Let us first keep in perspective the general role / responsibilities of a Tax Person. The basic duty is to see that all the tax laws /requirements involved in any transaction gets complied with; this coupled with the endeavor to achieve cost savings for the entity. In a synopsis form, the Tax review would involve (i) understanding the nature of the document under review; (ii) understanding the tax implications that would be involved in the transaction, both in present and future; and (iii) a sanctity check. Thereafter, one could incorporate the tax clauses in such agreement(s); and finalize it in consonance with legal & business teams.  

It would be important to understand the nature of the document / draft agreement in hand, first. Chances would be that it could be a Master Agreement or could be a subsidiary document which would be governed by a Master Agreement; or even a term sheet which would be culminated into an agreement later on. The Tax clauses might vary on the basis of the nature of document under review. For example, if it is a subsidiary agreement governed by a Master Agreement and the Master Agreement captures all tax clauses properly, there may not be a need to include any tax clause in such subsidiary agreement. Similarly, it may be agreed to insert the tax clauses only in Side Letters and not main agreement. Hence, it is very important to understand the nature of the document under review.

Now, the tax implications. To understand the tax implications involved, the reviewer must obtain a clear understanding of the transaction contemplated by the entity. In typical situations, the transaction would involve a payment, a receipt or barter or might sometimes have no monetary terms. After the basic understanding of the transaction(s), one can draw a caricature of the typical tax laws / implications that would be involved in such transaction(s) and then could proceed further.

The Reviewer must be able to clearly understand what tax implications are involved in such agreement and know the responsibilities of each of contracting parties arising therefrom. The Reviewer must ensure that the contracting parties remain responsible for taxes and compliance of their respective parts on their own; and appropriate clauses must be built accordingly in the agreement.

One would also like to understand the status of the contracting parties involved – whether such are company, non-company, LLP, university), its nationality (Indian, foreign), whether legal entity (branch or head office etc), since the tax implications would vary accordingly. As an example, if the contracting entity is a non-company and thereby, not eligible to claim benefit under the respective Double Tax Avoidance Agreement, it might cause certain concerns and the tax clauses would accordingly change.

The reviewer must incorporate the clause(s) to ensure compliance with all the tax implications. For example, to comply with the tax withholding obligations at the time of payments, a clause must be there in the draft to clearly state that the payments will be subject to tax withholding (under the Indian Income-tax or Work Contract Tax ‘WCT’ under the respective state VAT laws). If taxes have to be grossed up, clauses for the same. Also, for providing / getting Form 16A or tax withholding certificates.

One must also understand if the transaction would have bearing of indirect taxes such as Excise, Service tax, VAT, Central Sales tax (in case of inter-state sale and subject to availability of C forms) or Customs. Whether such taxes would be included in the price agreed in the agreement, or would it be charged extra. The relevant clauses must be incorporated accordingly. In case of foreign party agreement(s), one must understand what taxes would the foreign party charge in its own country and whether the agreement prices are inclusive or exclusive of such foreign taxes.

If certain documents (PAN, valid invoices with all necessary details, tax withholding certificates, waybills in case of interstate movement of goods; in case of foreign parties, no-PE and Tax Residency Certificate (TRC)) are required from the other contracting party, and the duration of submission of such documents (no-PE and TRC every year, invoices every month etc.), the relevant clauses must be incorporated. In case of purchases or foreign imports, it must be clearly defined when the title of goods would be transferred to the purchaser (VAT implications could vary basis the place of transfer); also, the delivery terms (FOB, CIF etc.) and the roles of the respective parties (as to who would be responsible for custom clearance etc.).  

If the agreement is between unrelated parties, a clause must be incorporated in the agreement that the status of parties would remain as independent parties and one should not be deemed as agent or representative of the other. Similarly, a clause could be there stating that both parties will remain responsible for their own tax liabilities and compliance, on their own. However, if the agreement is between related parties, it must take into consideration the transfer pricing implications (domestic and / or foreign).

The reviewer must also look at the confidentiality/non-disclosure clause, it should not restrict the entity from sharing such agreement with tax / regulatory authority if required under assessment or other such proceeding. Tax indemnity must be clearly provided. It must clearly state the items against which tax indemnity is provided / availed and the beneficiaries of such tax indemnity.

The Tax Reviewer must also keep in perspective, the present tax obligations and the future ones as well; and build the tax clauses accordingly. For instance, if there is a change in tax rates expected or a new type of tax (such as GST in India) envisaged, the Reviewer must understand who will bear such higher / lower taxes and put clauses accordingly. Similarly, if the other contracting party does not charge taxes properly on its invoice or does not deposit the taxes, adequate safeguards must be built in the agreement, so that no liability / implications could arise therefrom.

In the Sanctity check of the draft, the Reviewer must ensure that the transaction, the terms around it and consideration are clearly defined, without any ambiguity. There must be consistency in agreement. For instance, rates quoted in main agreement (tax inclusive or exclusive) and in annexures are same. The contract for Supplies is not termed as Service or Works Contract. The Agreement, invoice to/from, payment to / from remain with same party and has same terms. Also, ensure that the agreement is as per the entity’s policies and not against it. The tax clauses appearing in the annexures of the draft should be considered as agreement / part of the agreement only. Wherever any complicated tax position is incorporated in an agreement by way of an example, one could use examples to explain it clearly and mitigate ambiguity therein. One must put accurate referencing of the clause numbers in agreement.

The Tax Reviewer must follow the basic rule of ensuring entity’s compliance with tax laws (not to have any excessive responsibilities by virtue of the agreement), achieving cost savings and accordingly put clauses in the draft with a clear language. After having incorporated all tax clauses, the reviewer must obtain a buy-out of the same from legal or commercial / business teams; chances are that the business teams would have agreed different terms with the other contracting parties and the clauses would thus have to be suitably amended in view of the business exigencies.

As discussed above, due to the vital stake which the Tax person would hold in the transaction(s) / agreement(s), more and more organizations must ensure an effective Tax Review of the agreements for better and efficient business.    

TDS.....is far from Tedious

The concept of Tax Withholding at Source has always been a very controversial topic in the tax laws. In India, the commonly used term for tax witholding is TDS. It simply means that the payer of certain incomes has to deduct tax at a prescribed percentage of the total amount, at the time of payment or booking the expense and pay such tax to the authorities. Thereby, paying the sum net of TDS to the destined recipient or sometimes, merely accounting for the expense and paying TDS thereon to the authorities. Interestingly, there is also a concept of Tax Collected at Source or TCS under the Indian tax laws. TDS or TCS is an age old concept in the Indian tax laws and comes with its complicated and often, costly compliances and controversies. Let's see how.

Interestingly, the very nature and existence of TDS under the laws can spark several controversies. The underlying rationale of this concept is that the law assumes a certain tax component in every payment / expense which any person or enterprise make / incur and it demands the payer to pay such tax amount to the authorities without any delay. Thus, for tax authorities, TDS yield revenue immediately without even the need to reach out to the ultimate taxpayer. What happens to the payer and payee who have to fulfill TDS obligations, lets see : The payer has to deduct and deposit TDS and file its returns in the prescribed manner. If the payer of such income does not fulfill it's obligations, he can be subject to additional taxes, interest, penalties etc. Vide TDS, the recipient of such income pays a certain portion from its total tax on his income at the time of earning of such income itself. At the year-end, there is a final assessment done of such person's (recipient) income and tax liability and after offsetting the TDS already deposited on his income, such person pays balance taxes or claim refund. 

But without questioning the sanctity or the existence of the TDS concept, the parties wants to meet their obligations. So, how to devise a system to comply with the requirements effectively. 

As we now know, TDS arise at the time of every payment or expense, however for ease of performance, the law requires TDS on all payments / expenses for a particular month to be deposited in the first week of next month. For a payment made or expense booked booked month of May, TDS thereon can be deposited till June 7. Thus, arise the need to account for all payments / expenses and keep a check thereon to accurately comply with TDS requirements. And thus, arise the need to have a robust accounting system in place, develop a culture of proper and systematic accounting and administration by the people responsible for such tasks and having an effective reviewer for a final check and on time compliance.

But is it really so complicated? Let us see : the number of transactions for any enterprise can vary from few to extremely huge, however, every payment or expense has to be examined to see what is its nature/categorisation for TDS and thereby applying accurate TDS rate thereon. It is important to remember that wrong rate of TDS can cause worries for both payer and recipient. While short deduction of TDS by payer can lead to penalties and interest on the shortfall, the excess deduction of TDS can have the destined recipient receiving lower amounts than expected. Thus, correct classification of payments for TDS and deduction of taxes at accurate rates is very important. The complications arise further when payment is made to a foreign party and the classification and TDS rate can be determined under Indian domestic tax laws or the tax treaty with such country, whichever is beneficial to the foreign recipient. The payer / recipient can also obtain a lower tax certificate from the tax authorities and TDS on their respective payments can be at lower prescribed rates. 

The TDS accumulated from payments made in a month has to be deposited with the authorities in the early next month. Thereafter, TDS return has to be filed by the payer and it has to be ensured that the deductee's name, registration number and other details are filled in accurately. If in the TDS return, the payer makes a mistake with the party's name, the credit of TDS will not go to the correct recipient. Then, the payer has to provide a TDS certificate to the recipients, basis which the recipient claim credit of TDS in their final tax computation and assessment. 

As we have seen above, there are several obligations cast on the payer, the non- compliance of which can lead to penalties, interest, litigation. In some cases, such as TDS deducted and deposited late, the penalties can be more serious and can implicate prosecution of persons responsible. Yes, its prosecution even in cases of delay in deposition of TDS even by one day. 

So, how to comply with the above. One robust accounting system is certainly the must have. The system must be designed comprehensive enough to capture all transactions taking place in an enterprise and that can generate reports at periodic intervals and enable the compliance teams perform compliances and also enable checker or reviewer to check the necessary details for corrections. 

Then, comes an effective and a well defined accounting and administrative function. The accountants must possess adequate knowledge of their function and how they have to comply with TDS. The data entry teams must ensure that TDS is accurately booked and in the name of correct recipient. If there is lower tax certificate, it's effect is correctly taken. The teams must ensure that the lower tax certificate is reviewed periodically and if it gets cancelled or expired, the recipient is informed and TDS deducted accurately. Whenever, any new transaction is entered into or in doubt, professional advice is sought. Delays in accounting of invoices and expenses must be avoided. Records are properly filed and kept. The funds are allocated for payment of TDS. Year end expenses / provisions are properly booked. Having a cultured and effective accounting and administration of TDS is a regular and long term process, but if there are cracks in the accounting then things can fall into cracks and go unnoticed. It can lead to serious repercussions, as we have seen earlier. 

As a natural process, errors are bound to happen in any function, so it will be there. Hence, the role of a final reviewer or checker, who has to be ultimately made responsible for checking the details and giving his go-ahead and thereby, carrying out all the compliances in time. 

After doing all the above, will there be a system that can lead to error free and litigation free TDS process from the payer's end, is a difficult question. The inherent nature of TDS process, the manner in which tax laws are framed and administered by the authorities and the way TDS impact any business generally makes it highly tough to have an error free process. 

However, as said earlier, better to invest in effective administration, compliance procedures and solving TDS controversies, than incurring cost in falling prey to those complications and finding solutions thereafter. 

What happens...when a foreign vendor says I will not bear the tax withholding cost in India:

What happens...when a foreign vendor says I will not bear the tax withholding cost in India:

Ours a small beautiful world today! Foreign suppliers, vendors, service providers, business partners are very commonly found in our increasingly interdependent world. Thus, here are several Indian entities buying goods, services, technologies from overseas (and generally better) suppliers and making payments for the same. Even paying dividends, interest, lease, return on capital etc. to foreign investors and lessors is not that uncommon.
Often, the business discussions between foreign and indigenous parties start on a very positive note and while the parties head towards successful closure, they start discussing 'commercials'. And Often, such discussions overlook a very critical component 'TAXES' while deciding 'commercials'. Lucky are those, who identify the implications of TAXES well within time and take suitable decisions.

What can be the implications of TAXES? The commonest of those remain withholding taxes or tax deducted at source or TDS as commonly said. Under the Indian Tax Laws, the Indian payer is required to withhold taxes on taxable income arising to the foreign entity by virtue of the payments made by the Indian payer. Apart from payments made by an Indian party for pure purchase of goods from foreign supplier, rest all type of payments (whether for revenue or capital purpose(s)) has the exposure of withholding taxes. The implications of withholding taxes are many, not only does it have financial impact, but also certain procedures.

Withholding taxes means, before making the payment to foreign vendor, the Indian party has to deduct a certain % therefrom (could be 10%, 15%, 20 or 25% or even 40%), depending upon the situation. The Indian party thereafter deposit such withheld (tax) amount to the Indian Government and issues a certificate to the foreign vendor, which entitles the foreign vendor claim credit of such taxes (withheld in India) in its respective country.

For example, while making a payment of USD 100 to an American vendor, if the Indian payer withhold 10% tax, then it will pay USD 90 to the vendor and deposit USD 10 with the Indian Government and issue a tax withholding certificate to the American Co. Thus, the American Co. receive USD 90 immediately in consideration of its services worth USD 100 and it receive certificate of USD 10 which it can claim from the USA Government by way of reduction in its taxes (may be at at the time of filing it's annual return).

The % at which taxes are withheld is governed by the tax deduction rates provided in Indian domestic tax laws on a particular type of payment and also by the rates provided in double tax avoidance treaty between India and the country of that vendor. Taxes are withheld at the rate which is lower out of rates provided in domestic law or treaty and which is beneficial to the taxpayer.  In our example, if the Indian payer is paying Dividends and rate of tax withholding provided for dividends under Indian domestic law is 20%, and rate of tax withholding under India-USA tax treaty is 10%, then Indian payer can withhold taxes at 10% (at lower of the two rates). Similar analysis will have to be done if Indian payer makes payment of royalties or interest or anything else (it differs with type/nature of payment made). Further, in order to apply the lower rate of tax, the US Co. will have to provide certain documents such as Indian Permanent Account Number ('PAN' obtained from Indian tax authorities), Tax residency Certificate ('TRC' provided by US or any other country's Tax Authorities). As said before, to claim credit of taxes withheld in India or for reduction in its tax liability, the US Co. will have to apply before the US tax authorities as per their laws and get such benefit.

Now, here comes the difficulty.  The financial and procedural aspects of tax withholding would seem to be putting foreign party in some dis-advantage and make the whole a long drawn process. Even getting prescribed documents would sound troblesome. However, without tax withholding, Indian payer cannot make the payment. Else, there could be serious penalties imposed on Indian payer.

So what would happen when foreign party refuse to have any tax withholding on its payments from India. In other words, the foreign company is asking Indian Co. to bear the cost of tax withholding and make payments net of taxes to foreign vendor. This means for a USD 100 payment, Indian payer will have to bear additional cost of USD 11.11 to comply with tax withholding requirement of 10%. Higher the tax rate (such as 20% or 40% depending on nature of payment or availability of required documents), higher the incremental cost to Indian payer. So what happens in such situation?

First it boils down to commercials. If it is commercially viable for Indian payer to absorb the incremental cost of taxes (and thereby increase its overall project cost), then it must negotiate, else it may have to leave the deal there and then. Though, the Indian party can ask the foreign payee to bear half of the cost, so that both parties share equal burden of it. It's both's business after all!

But if both parties try to find a solution, there are many options to choose one from. Firstly, withholding taxes are a reality found in every part of the world and not alien to India alone, thus, the parties must recognise and accept it as a vital component of business and be open to finding solutions around it.

It calls for a proper analysis of domestic tax laws and relevant tax treaty. There are several tax exemptions and benefits provided in the law(s) itself whose benefits can be availed and taxes could be reduced to NIL naturally. If the standard laws do not provide for any such benefit, then there are ways (provided in the law itself) in which parties can approach tax authorities and ask their permission for applying lower tax rates (by way of 197 certificate or advance ruling). The tax authorities of the two countries involved can also speak with each other to find solution to a particular tax problem (provisions of information exchange and Mutual Agreement Procedure are found in every tax treaty).

Even when taxes are withheld, for a foreign company to approach tax authorities of it's own country for claiming credit of taxes withheld is easier than it looks. Those authorities gave their consent (as a signatory to the tax treaty) to allow such credit and have simple and effective procedures through which benefit envisaged by their laws is provided. The foreign Co.  has to ask for it, that's it. Even in cases of non-treaty countries, credit mechanism is provided. Thus, money withheld as taxes is never sunk, contrary to the fond perception.

Another interesting solution in our above-mentioned example could be that while Indian party pays USD 100 net to the US Co., it deposit USD 11.11 to Indian Government from its own pocket and provide a tax withholding certificate to the US Co. Therafter,  the US Co can claim credit of such taxes from US tax authorities and after getting such benefit, it can refund back USD 11.11 to the Indian party. Putting no one to loss, except following certain procedures, that's all.

Now the documents required for lowering tax rate or making an exemption (such as PAN or TRC), they are not tough to obtain. By filing simple details with tax authorities (online or manual) these documents can be obtained in 2 weeks time. The apprehensions that having obtained such documents bring foreign Co. before eyes of tax authorities and they could be exposed to unnecessary tax filing and other requirements is baseless. Nothing happens merely due to having those documents in your name in any country. Its similar to the case that merely having a license to drive on road doesn't create any issue, it is the crime of rash driving which expose people towards penalties.

Thus, the resistance of foreign entities towards Indian tax withholding has more to do with a mindset of trying to find easier routes to doing business and baseless apprehensions, which one should not let deter the business realities. As we have seen, parties must discuss issues with openness and try to find solutions in real sense, which are not difficult to come by.

Whichever route one want to take or ultimately takes, as earlier said, better to be lucky to make or break it in time.