India-US DTAA

DTAA stands for Double Taxation Avoidance Agreement, which is an agreement between two countries that aims to eliminate the double taxation of income earned by individuals or entities in both countries. The DTAA provides a mechanism for foreign investors to avoid being taxed twice on the same income. It allows foreign investors to claim tax relief in their home country for the tax paid in India. The DTAA also helps to prevent tax evasion and promote transparency in tax matters.

The DTAA came into force on the 18 December 1990. It has been revised several times since then. The DTAA ensures that taxpayers who are residents of one country but earn income from the other country are not taxed twice on the same income. The agreement covers taxes on income and wealth and applies to residents of both countries.

Scope of India-US DTAA

Foreign investors in India can be categorized into different groups based on their investment objectives, the nature of their investment and the regulatory requirements they need to comply with. Here are some of the categories of foreign investors in India:

Residence-based Taxation

The DTAA provides clarity on the tax treatment of residents and non-residents in both countries. It ensures that individuals and businesses are not taxed twice on the same income.

Business Profits

The agreement provides guidelines for the taxation of business profits earned by companies in either country. It ensures that companies are taxed fairly based on their activities in each country.

Dividends, Interest, and Royalties

The DTAA provides rules for the taxation of dividends, interest, and royalties received by residents of either country. It ensures that these payments are taxed at a reasonable rate and not subject to double taxation.

Capital Gains

The agreement provides for the taxation of capital gains arising from the sale of assets, such as shares, real estate and other investments. It ensures that residents are taxed fairly and not subject to double taxation.

Exchange of Information

The agreement provides for the exchange of information between the tax authorities of both countries to prevent tax evasion and ensure compliance with tax laws.

Permanent Establishment

As per Article 5 of India-US DTAA, ‘Permanent Establishment’ refers to a fixed place of business through which an enterprise of one country carries on its business activities in the other country. It includes the following:
 

• a place of management,
• a branch,
• an office,
• a factory,
• a workshop,
• a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources,
• a warehouse, in relation to a person providing storage facilities for others,
• a farm, plantation or other place where agriculture, forestry, plantation, or related activities are carried on,
• a store or premises used as a sales outlet,
• an installation or structure used for the exploration or exploitation of natural resources, but only if, so used for a period of more than 120 days in any twelve-month period,
• a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more than 120 days in any twelve-month period,
• [Service PE] The furnishing of services, other than included services as defined in Article 12 (Royalties and Fees for Included Services), within India by an enterprise through employees or other personnel, but only if (& vice versa):
• activities of that nature continue within that State for a period or periods aggregating more than 90 days within any twelve-month period, or
• the services are performed within India for a related enterprise [within the meaning of Associated Enterprises as per paragraph 1 of Article 9 of India-US DTAA].
• Person acting in India on behalf of an enterprise of US shall be deemed to be a permanent establishment of that enterprise in India if (& vice versa):
• The person has, and habitually exercises in India, an authority to conclude contracts on behalf of the enterprise, unless their activities are limited to those mentioned in below paragraph (A to E) which, if exercised through a fixed place of business, would not make that fixed place of business a permanent establishment under the provisions of that paragraph.
• The person has no such authority but habitually maintains in India a stock of goods or merchandise from which they regularly deliver goods or merchandise on behalf of the enterprise, and some additional activities conducted in India on behalf of the enterprise have contributed to the sale of the goods or merchandise.
• The person habitually secures orders in India, wholly or almost wholly for the enterprise.

Note: The mere presence of a company's goods or merchandise in the other country does not, by itself, constitute a Permanent Establishment (PE).

The DTAA also considers certain activities as not constituting a PE, such as:

A.    The use of facilities solely for the purpose of storage, display, or occasional delivery of goods or merchandise belonging to the enterprise.

B.    The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or occasional delivery.

C.    The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise.

D.    The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise.

E.    The maintenance of a fixed place of business solely for the purpose of advertising, for the supply of information, for scientific research or for other activities which have a preparatory or auxiliary character, for the enterprise.

In case an enterprise has a Permanent Establishment in both India and US, the business profits will be taxed in both countries, but the DTAA provides relief from double taxation by allowing the taxpayer to claim a credit for the taxes paid in one country against the taxes payable in the other country.

Overall, the definition of Permanent Establishment under the India-US DTAA plays a crucial role in determining the tax liability of foreign enterprises doing business in India or US.

A summary of structure of entities covered in Permanent establishment is as follows:

Particulars	Indian Definition	US Definition	India-US DTAA Definition
Brief meaning	- Any fixed place of business serving the activities of an enterprise - Any entity engaged in any activity, relating to the production, storage, supply or distribution - Wider definition than Tax treaty	- Any fixed place of business serving the activities of an enterprise - entity perform clearly differentiated activities and the management of these is carried out in US - Wider definition than Tax treaty	- Any fixed place of business through which the business of an enterprise is wholly or partly carried on - Narrower definition than respective taxation
Example
Place of Management	Yes	Yes	Yes
Branch or office	Yes	Yes	Yes
Factory or workshop	Yes	Yes	Yes
Fixed place solely for the purpose of purchasing goods or merchandise	Yes	Yes	No
Fixed place solely for the purpose of maintenance of a stock of goods	Yes	Yes	No
Building site or construction	Yes (if Duration > 6 Months)	Yes (if Duration > 12 Months)	Yes (if Duration > 120 Days)

Withholding Tax as per Indian Tax laws

A brief Summary of withholding tax rates is as follows:

Nature of Income	Indian Income Tax Act	India-US DTAA*
Dividend	20%	15%/25%
Interest	20%	10%/15%
Royalty	20%	10%/15%
Fee for Technical Services	20%	Not covered under DTAA

*The rates as per income tax Act shall be increased by applicable surcharge (2%/5% - for companies and 10%/15%/25%/37% - for individuals) and cess (4%).

Note: Taxability of dividend is on gross basis and the amount of tax is deducted by the source country. Interest is also taxable on gross basis and the tax is withheld by the source country.

Benefits and Rates of Tax as per DTAA

Royalty

As per Article 12, "royalties" means –   

a.    Payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including cinematograph films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial, commercial or scientific experience, including gains derived from the alienation of any such right or property which are contingent on the productivity, use, or disposition thereof.

b.    Payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise.

In the case of royalties referred to in sub-paragraph (a) above earned in India by a resident of are taxable at a rate of 15% of the gross amount of the royalties and in the case of royalties referred to in sub-paragraph (b) above earned in India by a resident of are taxable at a rate of 10% of the gross amount of the royalties.

However, if such services are provided through a permanent establishment (PE), then the PE shall be taxed as per rates of income tax act (i.e., 40%)

Fees for Technical Services

The term " fees for technical services" is not specifically defined in the India-US Double Taxation Avoidance Agreement. However, "fees for included services" is taxable as per the India-US DTAA and as per Article 12, means payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services:

•    Are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in definition of royalty is received; or
•    Make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

Note: ‘Fees for included services’ does not cover amounts paid: for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in (a) of definition of royalty, for services that are ancillary and subsidiary to the rental of ships, aircraft, containers, or other equipment used in connection with the operation of ships or aircraft in international traffic, for teaching in or by educational institutions, for services for the personal use of the individual or individuals making the payments, or to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).

Fees for included services earned in India by a resident are taxable at a rate of 15% of the gross amount of the Fees for included services. Fees for included services, as defined in this Article, are ancillary and subsidiary to the enjoyment of the property for which payment is received under paragraph (b) of definition of Royalties this article are taxable at a rate of 10% of the gross amount of the fees for included services.

If such services are provided through a permanent establishment (PE), then the PE shall be taxed as per rates of income tax act (i.e., 40%)

Dividend Income

As per Article 10, ‘dividends’ refers to income from shares or other rights, not being debt-claims, participating in profits, income from other corporate rights which are subjected to the same taxation treatment as income from shares by the taxation laws of the country of which the company making the distribution is a resident; and income from arrangements, including debt obligations, carrying the right to participate in profits, to the extent so characterised under the laws of the country in which the income arises. Such dividends earned in India by a resident of US are taxable in India at:

a.    A rate of 15% if the beneficial owner is a US company, which owns at least 10% of the voting stock of the company paying the dividends and vice-versa.

b.    A rate of 25% of the gross amount of the dividends in all other cases.

Note: In respect of dividends paid by a United States entity which is a Real Estate Investment Trust (REIT): paragraph (a) above shall not apply. paragraph (b) shall only apply if the dividend is beneficially owned by an individual holding a less than 10 per cent interest in the REIT.

Interest

As per Article 11, the term ‘interest’ refers to income from debt-claims of every kind,

• Whether secured by mortgage,
• Whether carrying a right to participate in the debtor's profits,
• Income from Government securities, and
• Income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures.

Penalty charges for late payment shall not be regarded as interest for the purposes of the Convention. However, the term "interest" does not include income dealt with in Article 10 (Dividends). Such interests earned in India by a resident of US are taxable in India at:

(a)    a rate of 10% of the gross amount of the interest if such interest is paid on a loan granted by a bank carrying on a bona fide banking business or by a similar financial institution (including an insurance company), and

(b)    a rate of 15% of the gross amount of the interest in all other cases.

The above rates shall not apply to:

• Interest arising in India/US and derived and beneficially owned by government of the other country, a political sub-division or local authority thereof, the Reserve Bank of India, or the Federal Reserve Bank of the United States, as the case may be.
• Interest with respect to loans or credits extended or endorsed by the Export Import Bank of the United States or EXIM Bank of India.

The above rates and taxability are not applicable if such incomes are earned through a permanent establishment situated therein. Then the permanent establishment shall be taxed as per rates of income tax act (i.e., 40%)

Independent Personal Services

As per Article 15, the term "professional services” includes services performed in the exercise of independent scientific, literary, artistic, educational or teaching activities as well as in the exercise of the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants.

Income derived by a resident (individual or firm) of US and who earns income from the performance of professional services or other independent activities of a similar character shall be taxable in India only if any of the following conditions is satisfied:

• if they have a fixed base regularly available to them in India for the purpose of performing their activities and in that case, only so much of the income as is attributable to that fixed base may be taxed in India, or
• If their stay (or stay of one or more members of firm) in India is for a period amounting to or exceeding in the aggregate 90 days in the relevant taxable year.

Dependent Personal Services

As per Article 16, salaries, wages and other similar remuneration derived by a resident of a US in respect of an employment shall be taxable in India only if the employment is exercised in India and such income shall be taxable at the rates in force. Such salary can be taxed in US only after fulfilment of the following conditions:

• The recipient is present in India for a period or periods not exceeding in the aggregate 183 days in the fiscal year concerned,
• The remuneration is paid by, or on behalf of, an employer who is not a resident of India, and
• The remuneration is not borne by a permanent establishment or a fixed base which the employer has in India.

However, remuneration in respect of an employment exercised aboard a ship or aircraft operated in international traffic by a resident of US may be taxed in US (and vice-versa) and the article does not apply to remuneration covered under other articles of the India-US DTAA.

Tax on Capital Gains (Article 13)

Except as provided in Article 8 (Shipping and Air Transport) of India-US DTAA, each country, i.e., India or US, may tax capital gains in accordance with the provisions of its domestic law.

Comparison with the Other Tax Treaties

Treaty Partner	Dividends	Interest	Royalties	Fee for Technical Services	Capital Gain on Shares held in India
Canada	15% / 25%	15%	10%/15%	10%/15%	Capital gain arises in both India and Canada
France	10%	10%	10%	10%	Capital gain arises in India if more than 10% shares are held
Spain	15%	15%	10%/20%	20%	Capital gain arises in India if more than 10% shares are held
Australia	15%	15%	10%/15%	Not Covered under DTAA	Capital gain arises in India
US	15% / 25%	10%/15%	10%/15%	Not Covered under DTAA	Capital gain arises as per Indian/US Income tax Act
Germany	10%	10%	10%	10%	Capital gain arises in India
Netherlands	10%	10%	10%	10%	Capital gain arises in India if more than 25% shares are held
United Kingdom	10% / 15%	10% / 15%	10% / 15%	10% / 15%	Capital gain arises as per Indian/UK Income tax Act

Conclusion

Some issues specific to India-US DTAA are:

• eFunds Corporation vs. Asst. DIT: In the case of eFunds Corporation vs. Asst. DIT 45 DTR 345, it had been decided that Assessee from a US company, providing IT enabled services to its clients by assigning or sub-contracting execution of the contracts to its wholly owned Indian subsidiary EFI and supplying the relevant software and database to the latter free of charge has business connection in India, profits attributable to the PE are to be worked out by applying the proportion of Indian assets, including EFI’s assets, to the aggregate of global profits and reducing resultant figure by the assessed profits of EFI.
• Millennium Infocom Tech Ltd.: Payments made to non-residents on account of rentals for hosting of websites on servers are not in nature of interest of royalties or fee for technical services or other sum chargeable to tax in India.
• R&B Falcon Offshore Limited v Addl. CIT: Installation or structure used for exploration or exploitation of natural resources may constitute a PE provided it is used for either of activities for a period of more than 120 days for any 12-month period. According to the Tribunal, the word ‘used’ has been sufficiently explained in the Agreement requiring no further explanation and, for that matter, there is no scope of entering into the Income Tax Act, in as much as, the word ‘used’ has been used in conjunction of ‘an installation or structure for exploration or exploitation of natural resources and only if so used for a period of more than 120 days in 12-month period.’

This made it completely clear that the Agreement meant user of installation and structure for exploration or exploitation of natural resources and not merely being ready for use. Having had concluded the same, the Tribunal had reversed the findings of the Assessing Officer as well as the First Appellate Authority.