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CREDIT OF TAXES AND

WITHHOLDING TAXES-CROSS BORDER ISSUES

SUSHIL LAKHANI
PROFESSOR KLAUS VOGEL APPRECIATES THE
INDIAN JUDICIARY FOR DECISIONS ON
INTERNATIONAL TAXATION - ESPECIALLY THE
DELHI SPECIAL BENCH DECISION IN THE CASE
OF NOKIA, ERICCSON AND MOTOROLA

– ECONOMIC TIMES OF 7TH APRIL 2006


Cross Border Payments-Withholding Tax Issues

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Section 195 (1) – Scope of the section
 any person responsible for paying to a non-resident or
a foreign company
• Non resident to non resident covered.
• Payment by Branch to HO (ABN Amro Bank (280 ITR
(AT) 117)(Kol – SB))
 “sum chargeable to tax (other than Salaries)”
• Capital Gains – NR to NR trf of shares??
• Sec 195 vs Sec 196D?? (Int to FIIs)
• Interest – whether all interest or only interest chargeable to tax
covered??
• Gift??
• Gross Sum vs Income element
• FTS, Royalty etc
•Other than Sec 44D
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Section 195 (1) – Scope of the section
 Treaty vs Act
• meaning of “Liable to Tax” – Recent
developments
- Abdul Razak Meman (276 ITR 306)(AAR)
- GE Pension Trust (280 ITR 425) (AAR)
- Green Emirates Shipping and Travel (99 TTJ 988)
(Mum)
• Surcharge and Education Cess not to be included
when treaty applied .
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Section 195A – Grossing up of tax
 Deductibility of TDS borne by payer--S.40(a)(ii)??
Sec 40(a) (ii)
“any sum paid on account of any rate or tax levied on
the profits or gains of any business or profession or
assessed at a proportion of, or otherwise on the basis
of, any such profits or gains”

Incidental issues
Expenses whether disallowed u/s 40(a)(i), if TDS
partly deducted??
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Certificate by a CA for remittance:
Clause 1 – “name & address of beneficiary”
• “Beneficiary” – meaning of – “Beneficial Owner” or
“Recipient”?
 Clause 7– determination of a PE and profits of PE:
• Whether CA duty bound to ascertain the existence of
PE?
• Determination of “attributable to PE” ?

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Certificate by a CA for remittance:
Some Issues:
 Consequence of difference of opinion between a CA and AO
 Consequence of change in the view due to an amendment or
a judicial decision or circular subsequent to issue of
certificate.
 Determination of any “special relation” between payer and
payee.
 Tax residency certificate – if not available?
 Tax residency certificate—not sufficient -- dual residency?
 Validity period of tax residency certificate / undertaking /
declaration from the payee – for a year or for single
payment?
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Certificate by a CA for remittance:
Some Issues (Cont…):
 Whether CA certificate is an alternative to Order u/s 195(2)?
 “Non resident” status of the receiver – at what point of time
to be considered?
• at the time of signing of agreement or
• the prior financial year or
• making of remittance
 In absence of address in the agreement is the payer obliged to
determine the status of purchaser for purchase of capital
gains?

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SECTION 9(1)(i)--BUSINESS CONNECTION
 Taxable only if :
• relates to a source of income or asset in India; or
• if “business connection” under IT Act and “PE” under
the treaty exists.
 Taxable only to the extent “reasonably attributable”
to operations in India.
 Specific exclusions – Explanation 1(b); 1(c) & 1(d) of
Section 9(1)(i)
 Specific inclusions – Explanation 2 to Section 9(1)(i)
• treaty concept of dependent agent introduced in Act
• agent need not be in India but must Act in India.
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SECTION 9(1)(i)--BUSINESS CONNECTION
Section 9(1)(i) – Business Connection – Judicial
Interpretations
 CIT Vs. R.D. Aggarwal & Co. (56 ITR 20) & Circular 23
and 786 lay down certain tests.

 Business in India Vs. Business with India

 Difference between a BC and a PE


• BC is wider in scope than PE.

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SECTION 9(1)(i)--BUSINESS CONNECTION - Issues
 Source of Income outside India
• “Source” – meaning of (91 ITD 133(Del); 85 ITD 478(Del))
• Whether “Export” – a source outside India ??(262 ITR 513(Mad))
 “Service utilised” is where the income accrues (250 ITR 164(AP))
Query?
• Fees to Investment Advisor of non- resident FII--both are outside :
- No presence of adviser in India (250 ITR 194(AAR); 271 ITR 1 (AAR); 272
ITR 416 (AAR))
- Presence of adviser in India – Service PE clause
 Payment of commission to foreign agents (Circular 23 of 1969; 125
ITR 525(SC); contrary - 278 ITR 97(AAR))

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SECTION 9(1)(i)--BUSINESS CONNECTION - Issues
 Payments for supply and installation of equipment
• Payment of design and drawings alongwith equipment (259 ITR 248)(Del)-
Mitsui);
• Payment for installation and supervision of machinery supplied—not
taxable --as part of supply(262 ITR 110(AP)-Sundwiger) ;
Contrary Decisions:
• Proportionate amount relating to provision of certain subsidiary services in
course of supply taxable as PE existed.– Protocol of India – Japan Treaty
(271 ITR 193)(AAR)-IHH)
• Where consideration for supply and installation separately stated (279 ITR
165)(AAR)-Rotem)
• Finalisation and signing of deal by country manager in India amounts to
PE (268 ITR 156)(AAR)-Sutron)

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ROYALTIES
Royalty and FTS deemed to accrue or arise in India if payable by:

In all cases without exception


Government
In all cases, except where payable for any right, property
etc. or services utilized for the purpose of / in business or
Resident profession carried on by such person outside India, or
for the purposes of making or earning any income from
any source outside India

Only in cases where it is payable for any right, property


etc. or services utilized for the purpose of a business or
Non-resident profession carried on by such person in India, or for the
purposes of making or earning any income from any
source in India

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ROYALTIES
 For Agreements on or after 1 April 2003
• No PE in India
Section 115A of the Act
- Taxed on gross basis
- Lower rate for Central Government approved Agreements or those
relating to matter included in Industrial Policy
20% for agreements entered before 1 June 2005
10% for agreements entered on or after 1 June 2005
- Provisions earlier applicable only to foreign companies extended to all
non-resident entities w.e.f. AY 2004-05

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ROYALTIES
 For Agreements on or after 1 April 2003
• PE in India and Royalty / FTS effectively connected with
such PE
Section 44DA of the Act w.e.f. AY 2004-05
- Taxed on net basis at the rate applicable to Non Residents
- Amounts paid to Head Office / Other Offices not deductible (except
reimbursement of actual expenses)
• PE as defined in Section 92F(iiia) of the Act – fixed place
PE

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ROYALTIES
 Difference in definition of Royalty under Act and
Treaties
ACT TREATY(UN Model)
• Consideration for transfer Consideration for use or
of “all” of any rights right to use
• “Cinematographic films” “Cinematographic
specifically excluded films” included
• Services in relation to Services in relation to
transfer of any rights transfer if incidental will
covered get covered here else not
• Use of equipment in No Such exclusion. Use of
connection with exploration all sorts of equipment
of mineral Oil excluded covered.
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ROYALTIES
 Payment for Software
 Off- the -shelf Software ; (94 ITD 91 (Bang.-Samsung));
( TCS-SC-271 ITR 401)

 Customised Software; ( 88 ITD 134(Mum)—ISBC)

 Software along with Hardware (82 TTJ 163-Bang-


Lucent)

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ROYALTIES

 Payment for following whether “Royalty” ?


• Consideration for design and drawings (Indian Hotels
(Unreported)
• Payment for “Know how” and “Information”
• Payment for access to info base-not royalty (94 ITD 9 (Bang)-
Wipro)
• Payment for the use of satellite (78 TTJ 498 (Del)-Asiasat)

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ROYALTIES
Analysis of some treaties signed by India
 Excludes Ships and Aircrafts
• UK USA
 Exclude ICS equipment from ambit of Royalties
• Belgium / France / Greece / Israel / Netherlands / Sweden
 Excludes payment for use of Aircraft
• Ireland
 Includes proceeds from outright sale of copyrights etc. that are
contingent on its use by purchaser
• USA
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Fees For Technical Services (FTS)
 FTS receipt taxable in India regardless of situs and
mode of services – other than FTS utilised in a
business or source outside India.
 Consideration (includes lump sum consideration) for
rendering any:
• Managerial, technical or consultancy services
 Thrust is on ‘Services’
 Technical Services vs Technology driven services

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Fees For Technical Services (FTS)
 Excludes:
• Construction,
• Assembly,
• Mining,
• Any like project,
• Income chargeable as salaries,

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SOME ISSUES IN FTS
 Connectivity payments –standard facilities (80 TTJ 191 (Bang)-
Wipro)
 Payment for use of telephone, electricity etc i.e. standardised
products is not FTS (251 ITR 53)(Mad)-Skycell
 Payment for repairs
• Hardware (273 ITR 437)(AAR)-Airport Authority-Not FIS
• Software – Clause 12 (4) (a) of India USA Treaty – Ancillary and
subsidiary to royalty (273 ITR 437)(AAR)-Airport Authority
• Specialised repairs –FTS (79 TTJ 268) (Del)-Sahara
• General repairs-Not FTS (91 ITD 133)(Del)-Lufthansa
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Fees For Technical Services (FTS)
 Absence of specific Article on FTS
• Bangladesh, Brazil, Greece, Indonesia, Libya, Mauritius,
Nepal, Philippines, Sri Lanka, Syria, Thailand, UAE, UAR
 Concurrent Coverage under Independent Personal Services
(IPS)
• Japan, New Zealand

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Fees for Included Services (FIS) – “Make Available”
 Deals with Technical Services - but coverage is very
narrow.
 Services under FIS should be technical (Mckinsey (99 TTJ
857)); and
 Services should satisfy further conditions as per the MOU
of India –US Treaty

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Fees for Included Services (FIS) – “Make Available”
(Cont…)
 Associated with Service PE
 The words “make available” held to have the same
meaning as in India-USA Treaty even in absence of
the MOU (Raymonds Ltd. (80 TTJ 120))
 Caution! These treaties also have “Service PE” clause.

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Fees for Included Services (FIS) – “Make Available”
(Cont…)
 Case Laws
• Advisory service –not FIS (80 TTJ 806) (Cal)-Raymonds
• Preparation of project report-FIS?? (85 TTJ 794)(Del)-Sinar Mas
• Payment for strategic consultancy services-Not FIS (99 TTJ 857)(Mum)
Mckinsey
• Payment for testing charges-FIS (278 ITR 233)(AAR); (278 ITR 97)
(AAR)
 Analysis of few Treaties signed by India (FIS)
• Directly - Australia, Canada, Cyprus, Malta, Portugal, Finland,
Singapore, USA, UK
• Due to MFN Clause - Belgium, France, Israel, Kazakhstan, Spain,
Sweden—(Service PE missing)

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Reimbursement of expenses
 Reimbursement of incidental expenses in addition to payments of Fees for
Technical Services (FTS) / Royalty
 Reimbursement of cost of services of a third party engaged by the non-resident.
(278 ITR 97)(AAR) -Wallace
 Reimbursement of allocated cost (i.e. costs- sharing arrangements) (268 ITR 1)
(AAR)-Danfoss
 Payments for services rendered at cost. (273 ITR 67)(AAR)-Timkin
 Reimbursement of living allowance, etc of a person deputed to India by the non-
resident. (274 ITR 261)(Del)
 Direct payments by the non-resident of expenses and salaries of foreign
technicians. (233 ITR 751)(All)
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Reimbursement of expenses (Cont…)
GREY AREAS
 Reimbursement of expenses incurred by group company outside India on behalf of
Indian company
• If the services are taxable in India and
• If the services are not taxable in India
 Reimbursement of pre joint venture expenses like incorporation, registration fees
etc. incurred by a foreign joint venture partner.

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INTEREST AND SHIPPING INCOME

 Analysis of some treaties signed by India:


• “interest on deferred payment sales” included in the
definition – Indonesia, Philippines
• Penalty charges for later payment excluded – Singapore,
Indonesia
 Payment of usance interest is not a part of purchase
price (261 ITR 113) (Guj)

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INTEREST AND SHIPPING INCOME
 Payments for Shipping:
• Freight
• Payment to Shipping Agent (Circuar 742)
• Bare Boat lease (113 ITR 307)(SC)
• Wet Lease – is same as bare boat lease – sec 44B does not apply (4
SOT 18)
 Analysis of Treaties signed by India
• Profits taxable only in residence country – USA, Singapore
• Profits taxable where effective management is situated –
• Profits taxable in India for specified no of years – Netherland, Japan
• Profits taxable in Indian but at concessional rates -
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Cross Border Payments – Credit of Taxes

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EXEMPTION METHOD
 Full Exemption
 Exemption with progression – taken into account for rate
purposes
CREDIT METHOD
 Full credit – No restriction
 Ordinary credit – restricted to the extent of tax payable –
qua “Income”
 Underlying tax credit – except Mauritius & Singapore
Treaty only one way in Indian Treaties
 Tax sparing
 Sparing w.r.f. certain income
 Sparing w.r.f. tax payable (e.g. Mauritius)
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Underlying Tax Credit

Directly Via Mauritius

UK Parent / Home Company Income (Grossed up) 1,633Income (Grossed up) 1,633
Tax @ 30% (490)Tax @ 30% (490)
1,143 1,143
Underlying Tax Credit (633) Underlying Tax Credit
490 245
1,633 1,388
Offshore Intermediary Income (Grossed up) 1,633
Company Tax @ 15% (245)
1,388
Underlying Tax Credit (633)
245

Withholding Tax 1,633


NIL
1,633
Indian Host Company 1,633 1,633
Tax @ 30% (490)Tax @ 30% (490)
1,143 1,143
DDT @ 12.5% (143)DDT @ 12.5% (143)
1,000 1,000
Withholding Tax NILWithholding Tax NIL
1,000 1,000

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 General Principles
 Whenever exemption method is followed – the
expenses are also not deductible.
 Grossing up of Underlying Tax & Dividend

Distribution Tax.
 No Grossing up of Tax Sparing as no tax has

been paid.

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Case Studies for Group Discussion:

Case Study (a)

Facts:
“X” (Parent Company in India)

“Z” (100% Subsidiary in Mauritius)

“A” (50% Subsidiary in BVI)

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Case Study (a) Contd.
(i) What is the “Mauritius Tax payable” ??
As per (Article 23(3) of the India - Mauritius Treaty)
“Mauritius tax payable” shall be deemed to include any amount
which would have been payable as Mauritius tax for any year but
for an exemption or reduction of tax granted for that year or any
part thereof under:

(i) section 33, 34, 34A and 34B of the Mauritius Income – tax Act,
1974 (41 of 1974)

(ii) any other provision which may be subsequently be made granting


an exemption or reduction of tax which the competent authorities
of the contracting states agree to be for the purposes of economic
development.
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Case Study (a) Contd.
(ii) Will ‘X’ be entitled to a foreign tax credit in India for the
taxes payable (before Tax Sparing) in Mauritius ??

Article 23(3)(i) of India Mauritius Treaty – Section 33, 34, 34A and 34B of the
Mauritius Income Tax Act, 1974 have been deleted – Article 2(2) has
ambulatory approach – Similar taxes which are imposed after the date of
conventions are also covered.

 Therefore ‘X’ Should be entitled to credit of taxes payable in Mauritius


though the taxes are not paid because of Tax Sparing Clause in Article
23(3).

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Case Study (a) Contd.

(iii)Whether change in the character of income


makes a difference for credit??
The Residence State is obliged to give credit /
exempt on income so long as the source state has
taxed that item “in accordance with provision of
the convention.”
(Para 32 of OECD Commentary on
Article 23)

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Case Study (b)
Whether Exchange Rate fluctuation should be
considered for giving credit ??
Rate of exchange for conversion into rupees of
income expressed in foreign currency. (Rule 115 of
the Income Tax Rules 1962)
Telegraphic Transfer buying Rate of such currency as on
the specified date. (31 ITR 538 (Ch. D))

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Case Study (c)
Whether foreign tax credit can be denied on the
ground that the taxes are not paid by the foreign
deductor to the Govt. of foreign country ??
No ?? (104 ITR 233(Guj))

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Case studies on withholding of taxes

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Case Study 1:
1. Whether PH can claim refund or US Co will have to
claim refund?
• Circular 790 dated 20.04.2000
• Whether the two instances in the Circular are only
illustrative?
• 83 TTJ 458 (mum)(TELCO) – if assessee was not liable
to deduct tax it can claim refund if TDS certificate not
issued
1. Will the answer be different if the TDS certificate is issued?
• Yes. Not entitled to claim refund (82 TTJ 325(Del))
1. If the tax was borne by PH, whether that would make a
difference?
• No if certificate has been issued??
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Case Study 1: (Cont…)
4 What is the obligation of PH for issue of TDS Certificate.
• Certificate has to be issued within 30 days of credit of
deduction of tax (Rule 31)

5 Whether excess deduction u/s 195 in one quarter can be


adjusted against short deduction u/s 195 in next quarter?
• Yes
• Quarterly return to be filed in Form 27

6 Whether excess deduction u/s 195 can be adjusted against


payment of TDS u/s 194A to 194D?
• Yes
• No restrictions under the Act
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Case Study 2:
1. Whether payments for business information will
amount to FTS in India and hence liability to TDS?
• Non Technical Services – not FIS (99 TTJ 857-Mckinsey)

1. Whether application u/s. 195(2) mandatory?


• No
• Payer should apply only when he is unable to determine
the sum chargeable to tax

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Case Study 2:

3 Whether the AO was justified in disallowing the


payments u/s. 40(a)(i)?
• Yes?, if he is of the view that TDS was deductible (Sol
Pharma (83 ITD 72 (Hyd))
• Appeal can be filed against such an addition
- Fact that in the assessment of Exotic USA the income
was not taxable can of help in getting a favourable order
but that by itself not enough.

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Case Study 3:
1 Whether payment by a non resident to another non resident in
respect of shares in Indian company is chargeable to TDS?
• Yes; Difficult for the Department to enforce .

2 If Yes, Whether Canada Ltd. should consider the details of


different shareholders before deducting tax?
• Yes
• Indexation not available (Section 48)

3 What is the rate of tax applicable to :


• Resident Shareholders – No TDS
• Ismail (UAE) – (Green Emirates Vs.Meman)
Not deductible- As per India UAE Treaty gains taxable only in
UAE, hence not deductible.

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Case Study 3: (Cont…)
• Charlie (Mauritius) – Not deductible. As per India
Mauritius Treaty gains taxable only in Mauritius, hence
not deductible.
• Dinanath (NRI)
• Section 115E
•TDS on LTCG – 10%
•TDS on STCG – 10%
• Other non-residents (Assumed to be resident of USA)
- TDS on LTCG – 10%
- TDS on STCG – 10 %
• Sub account of foreign FII
• No TDS – Sec 196D (2)

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Case Study 4:
1. Whether tax is deductible on payment for purchase of
software?
• No --as purchase of software not royalty if copyrights not
transferred.
1. Assuming payment for purchase of software is royalty,
whether TDS is deductible when:
(a) Payment of Rs 5 Cr is made to Software Ltd – Yes
(b) Payment of Rs. 5 Cr is made to Singapore Ltd –Yes?
(c) Payment of Rs. 5 Cr is made by Singapore Ltd to
Software Ltd – Yes??
• Sec 9(1)(vi)(c) – “a person who is a non resident …for the
purpose of business or profession carried on by such person
in India”
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Case Study 5:

Contract to supply
‘A’ Ltd. Personnels ‘B’ Ltd. - HR Agency

Contract to appoint
persons at Project

Cost of persons +
10% of fees
In India

Outside India

Project of ‘A’ Ltd. Appointment of ‘C’ Inc. – Wholly owned


qualified persons
subsidiary

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Case Study 5:
1 Is TDS u/s 195 deductible on payments made by B
Ltd. to C Inc in respect of Cost of the person
employed and 10% fees?
• TDS deductible on both cost of the person and 10% fees
charged
• 278 ITR 97 (AAR)-Wallace and Timkin( 273 ITR 67
AAR)

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Case Study 6:
1 What will be the tax to be deducted at source for
payment of “Professional Fees” paid to Individual?
• Covered under S 9(1)(vii)
• Treaty--Specific Provision (IPS) overrides general
provision (FIS)
• Covered under IPS of India- USA Treaty
- Fixed base or
- 60 days in the source state
• If does not fit in “Professional Services” of IPS Article –
Article 5 (PE) applies.
• No TDS
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Case Study 7:
Whether payment for roaming charges is “royalty”? –
 No
 Service (E-Commerce report of OECD) vs use of
equipment
 Technical Services vs Technology driven services
(Wipro (80 TTJ 191 Bang); Skycell (251 ITR 53 Mad))

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