The premise of present study involves an enterprise formed and operating in a jurisdiction outside India. For the sake of convenience, we assume the foreign territory is Bangladesh, and Enterprise, let’s call it E has manufacturing operations there. E wants to sell its merchandise in India through a Branch Office, let’s call it B, in Kolkata. Since, E exports goods from Bangladesh to B in India, there can various tax implications including customs and income tax. However, for present study we restrict our focus to income tax implications.
In the present study the author is posed with two queries:
Taxability of Income earned in India
Companies incorporated outside India and engaged in manufacturing or trading activities are allowed to set up Branch Office with specific approval of the RBI. A Branch office is not allowed to carry out manufacturing or processing activities in India, directly or indirectly.
A person who resides outsides India is technically known as “non-resident”. The residential status of an individual does not depend upon the nationality or domicile of that person, but it depends upon the presence of the person in India during the previous year. The case of a company having a branch office in India and registered in Bangladesh during the previous year shall be treated as resident in India as explained herein below.
According to section 5 of the Income Tax Act, a foreign Company is liable to pay tax which accrues or arises or is deemed to accrue or arise in India. As per Section 9 of the said Act, income may be deemed to accrue or arise in India even though it may actually accrue or arise outside India.
Since the Company is a foreign company having its presence in India, it is treated as having a Permanent Establishment in India under Article 5 of the Double Taxation Avoidance Agreements entered into by India with Bangladesh and also section 5 of the Income Tax Act, 1961 read with section 9 of the said Act. If the said non-resident or foreign company carries on business in India through a branch who habitually exercises an authority to conclude contracts or regularly delivers goods or merchandise or habitually secures orders on behalf of the non-resident principal, it creates a business connection/ permanent establishment in India. In such a case, the profits of the foreign company having branch office in India is attributable to the business activities carried out in India by the Permanent Establishment and becomes taxable in India under Article 7 of the Double Taxation Avoidance Agreements.
Incidence of taxation in respect of the instant non-resident foreign company would be entirely covered by the Income Tax Circular Vide memo no. 5/2004, dated 28-09-2004 and also in the DTAA (Bangladesh) Article 7 which states that “the profits of an enterprise shall be taxable in the contracting state (Bangladesh) unless the enterprise carries on business in other contracting state (India) through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, then so much of the profit as is attributable to that permanent establishment shall be taxable in that contracting state (India)”.
The object of a Double Taxation Avoidance Agreement is to provide for the tax claims of two governments both legitimately interested in taxing a particular source of income either by assigning to one of the two the whole claim or else by prescribing the basis on which tax claims is to be shared between them. Here it is important to highlight hat Section 90 of the Act provides an assessee to opt for the provisions of the Act or the tax treaty, whichever is more beneficial.
In any case where the amount of profit attributable to a permanent establishment is incapable of determination thereof presents exceptional difficulties; the profits will be attributable to that permanent establishment (India) may be computed on a reasonable basis. Rate of Tax for Foreign Companies having Branch Office in India under Income Tax Act, 1961: -
Transfer Pricing Implication
Transfer pricing generally refers to prices of transaction between ‘associated enterprises’ which may take place under conditions different from those taking place between independent enterprises. It refers to the value attached to transfer of goods, services and technologically between related entities.
In the matter of transfer pricing provision, it is important to under “International Transaction” as defined by Section 92B(1). “International Transaction” means a transaction between two or more Associated Enterprises, either or both of whom are non-residents, in the nature of purchase, sale, export, import, etc. or provision for services going by this definition. It is pertinent to note that Section 92F(iii) defines “Enterprise” as a person (including a permanent establishment of such person) who is engaged in any activity relating to production, storage, supply, distribution etc. whether such activity or business is carried on directly or through one or more of its units at the same place or at a different place or places. In this regard The Hon’ble Delhi Income Tax Appellate Tribunal (ITAT) in Aithent Technologies Pvt. Ltd. vs. DCIT vide bearing no. ITA No. 6446/Del/2012 considered that the definition of “international transaction” u/s 92B(1) in juxtaposition to the definition of “enterprise” u/s 92F(iii). The position which prima facie appears is that since a Branch office who is selling or purchasing goods is an enterprise having a permanent establishment, all the transaction between the branch office and head office be subjected to the transfer pricing provisions.
As per section 92(1) of Income Tax Act,1961 any income arising from an international transaction shall be computed to the arm’s length price. The arm’s length price principle is applied both in context of transfer pricing and attribution of profits. A functional hypothesis underlying the application of the arm’s length price principle is found in almost all tax treaties.
In view of the above, if a branch office of a foreign company is having a transaction with the head office that will be covered under the definition of “international transactions” under section 92B of the Income Tax Act,1961. This is because the Indian branch will be liable to pay tax in India in respect of its Indian operations. It has been clarified that the allowances for any expenses or interests will also be come under arm’s length price principle read with transfer pricing.
B is engaged in import, export with its head office, E in Bangladesh. Therefore, the transaction between the branch office (India) and the head office (Bangladesh) are required to be computed in the Arm’s Length Price for the purpose of Transfer Pricing under the Income Tax Act, 1961.
Thus, if an Associated Enterprise in India sells any goods or renderes any services to its Enterprise in Bangladesh for Rs. 30,00,000/- whereas the arm’s length price is Rs. 50,00,000/- then the income of the Indian enterprise shall be determined with reference to the arm’s length price of such goods/provision of such services i.e. it shall be 50,00,000/-.
At this moment various principles relating to determination of arm’s length price might be relevant. However, for present purposes we shall restrict our discussion. The arm’s length in transfer pricing principle states that the amount that is charged by one party to the other party in the transaction must be the same as if the parties were not related. For example, the arm’s length price must be the same as what the price would be on the open market.
When dealing in commodities, arm’s length in transfer pricing is rather straightforward, and can be as easy as researching comparable transactions. However, if the transaction deals with trademarked goods or services, then settling on an arm’s length price can be more complicated.
If an international transaction includes only outgoings such as expenses, interest, allowances or other then these are also decided or valued on the basis of Arm’s Length Price [Section 92(1)]. Income includes losses and it will be net of expenses as decide in case of UOI v. A Sanyasi Rao (1996) 219 ITR 330(SC).
The Arm’s length price is determined in relation to an international transaction undertaken on or after 01.04.2015 as per the notification vide memo no.57/2016 dated 14.07.2016 the Central Government notifies that the price at which international transaction has been undertaken does not exceed 1% of the latter in respect of wholesale trading and 3% of the latter in all other cases. The price at which the international transaction has actually been undertaken shall be deemed to be the Arm’s length price for the assessment year 2016-17 and onwards.