Factoring Withholding Tax into the Transfer Pricing of Services.

Posted on Updated on

This note considers the UK Transfer Pricing implications of Withholding Tax charged on fees for technical services, using India as an example.

WHT is relevant to international companies doing business with associated or independent enterprises in India, even if they don’t have a presence or permanent establishment there. India isn’t the only State which applies a WHT on fees for services, China is another and there are many more. It is a one-way street from the UK viewpoint because UK domestic law does not award a taxing right if the positions were reversed.

It’s a complex area, with many variables, and the application of the rules is dependent on the specific facts & circumstances of each case. The circumstances under which WHT might actually lead to a TP adjustment may be limited, but they can’t be ignored.

The UK has tax treaties with around 140 countries and 25 of these include an article that permits the other state to charge a Withholding Tax (WHT) on royalties or fees for technical or management services provided by a UK business to customers in those states, or vice-versa.

Some countries, India for example, also have a WHT written into their taxing statute in addition to the treaty provision. It is also one of the largest of such countries and so a good example to illustrate the potential Transfer Pricing (TP) consequences of WHT.

Article 13 of the UK/India Double Taxation Convention (DTC) deals with royalties and fees for technical services (FTS).

It provides that “royalties and fees for technical services arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.

However, such royalties and fees for technical services may also be taxed in the Contracting State in which they arise and according to the law of that State.”

The DTC defines FTS as payments for the rendering of any technical or consultancy services which are ancillary and subsidiary to any payment in the nature of a royalty or which ‘make available’ technical knowledge, experience, skill, or knowhow or process, or consist of the development and transfer of a technical plan or design.

Therefore services under the DTC result in FTS if they are connected with royalty payments or “make available” technical knowledge, experience etc. Technical knowledge is `made available’ when, as a result, the person acquiring the services can apply the technology in similar circumstances. The mere fact that the services have some technical aspects does not necessarily mean that technical knowledge etc is made available.

So, according to the DTC, FTS from one state to the other can be taxed in both the UK and India. The DTC tax charge is capped and shall not exceed 10% or 15% of the gross amount of the royalties/FTS, depending on the specific facts and circumstances of the transaction.

These provisions don’t apply if the services provider carries on business in the other Contracting State through a permanent establishment there.

Where the parties to the transaction are connected and the fees exceed the arm’s length amount, the DTC applies only to the arm’s length amount and the excess remains taxable according to the law of each Contracting State.

India’s Income Tax Act also provides for the deduction of taxes at the source of payments of FTS made by an Indian business to an overseas service provider. UK domestic law does not award a taxing right if the positions are reversed.

The rate can be up to 25%. It does not matter whether the service is rendered in India or outside India, so long as it is utilised in India. Royalty/FTS income is deemed to accrue or arise in India and is therefore taxable in India whether or not the non-resident has any business connection or PE in India.

“Fees for technical services” for the purposes of India’s Tax Act means any consideration for the rendering of any managerial, technical or consultancy services, including the provision of services of technical or other personnel. Fees for legal services, marketing and business promotion activities paid by an Indian company to a foreign company are also construed as FTS under the Indian Income Tax Provisions.

Where the DTC and Income Tax Act seek to apply different rates of WHT, the rate most favourable to the taxpayer is normally applied.

I say “normally” because to benefit from the normally lower DTC rate the service provider would be required to register with the Indian Tax Authorities to obtain a Permanent Account Number (PAN) for the Tax Deducted at Source and provide a Tax Residency Certificate (TRC) from the UK.

If the foreign company does not obtain a PAN and/or fails to provide a TRC then the maximum rate of WHT at 25% may have to be deducted.

So, WHT is relevant to international companies doing business with associated or independent enterprises in India, even if they don’t have a presence or permanent establishment there.

This note considers the UK TP implications of Indian WHT when the transacting parties are connected. The same considerations will be relevant where the transactions involve the UK and a number of other states, e.g. China.

Consider the situation where the arms length price for the provision of a technical service by a UK company to a French associate is cost plus 10%. Assume a cost of £100,000 so the amount invoiced is cost + 10%, i.e.£110,000. There is no WHT involved so the UK provider receives the full amount invoiced and everyone is happy (assuming no £/€ forex difficulties).

If the same service is provided by the UK company to an Indian Associate and £110,000 is actually invoiced, and the UK business has taken all reasonable steps to minimise the WHT, e.g. by obtaining a PAN and providing a TRC, the Indian Tax Authorities may require the treaty rate of a 15% WHT to be applied to the gross fee, i.e. resulting in £16,500 WHT (If the UK company hasn’t taken all such reasonable steps then the Indian Tax Authorities may require a WHT of 25% and HMRC may not accept a claim for double taxation relief (DTR)).

The UK company will most likely be entitled to DTR for the WHT suffered, although this would have to be in the form of deduction relief rather than credit relief as there would be insufficient Corporation Tax charged in the circumstances described against which to credit the WHT.

Therefore the UK company suffers an overall economic loss on the transaction of £6,500 (i.e. the original £10,000 profit less the £16,500 WHT).

Independent parties transacting at arm’s length would not normally do business if the outcome results in an economic loss for the provider, so a TP adjustment would be required in our example.

If the UK company had grossed up the invoice to its Indian Associate the amount invoiced would increase to £129,411, giving a profit of £29,411 which, after allowing for deduction relief of £19,411 for the WHT suffered, leaves the arm’s length profit of £10,000. So no TP adjustment would be necessary.

The UK company may not actually invoice its Indian Associate for the services rendered, but it should still make a TP adjustment in its UK Corporation Tax computations, to achieve the £10,000 profit corresponding to the second scenario above.

However, one also must consider the transaction from the viewpoint of the Indian Associate. If they could have obtained the same services locally at a lesser cost than charged by their UK associate then a UK TP adjustment may not be appropriate. This might be the case for low value or routine services. However, if the service provided by the UK company is highly specialist, perhaps requiring a level of knowledge and expertise that can’t be sourced elsewhere, then there would be no local alternative.

So, the correct treatment of WHT for TP purposes depends on the facts and circumstances of each case. If there is no actual invoiced charge between the UK service provider and the Indian recipient then there should be a TP adjustment in the UK tax computations. If an invoice is issued which doesn’t take into account the WHT then the UK service provider should expect a call from HMRC. All dependent of course on the nature of the services provided.

Therefore extra caution is required when a UK business provides services to an associated business located in a country that applies a WHT to the fee. There are treaty and local tax provisions to be considered. You can’t always assume that the “right” Transfer Price for one state is also the right price for the same transaction with another state.

India isn’t the only State which applies a WHT on fees for services, China is another, and there are many more. It is a one-way street from the UK viewpoint because UK domestic law does not award a taxing right if the positions were reversed.

It’s a complex area, with many variables, and the application of the rules is dependent on the specific facts & circumstances of each case. The circumstances under which WHT might actually lead to a TP adjustment may be limited, but they can’t be ignored.

Sources:
UK/India Double Taxation Convention
India Briefing August 2013
Taxmantra Sept 2013
TaxGuru Feb 2014
Nishith Desai Associates Tax Hotline December 2013
Indian Taxpayers Information Series no 44 July 2013

………………………………………………………………………………………………………………………………………………………….

I try to make the contents of this website as useful, reliable and factual as possible but any opinions that slip through are solely my own. They do not represent the views of my employer or any other person I’m connected with.

The purpose of the site is to inform and educate readers with general guidance and useful tips. It provides only an overview of the regulations and guidance in force at the date of publication and is not a substitute for professional advice. It is not designed to provide professional advice or financial advice and should not be relied on as such.

You should not base any action on the contents of this website without first obtaining specific professional advice from appropriately qualified Transfer Pricing experts. They can establish the full facts and circumstances of your business – I can’t.

Therefore, no responsibility for loss occasioned by any person acting or refraining from action as a result of this Website can be accepted by the author.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s