What is Withholding Tax?
The Withholding Tax, also known as retention tax, is the obligation of a person (whether resident or non-resident) to deduct tax before payments, be it rent, salary, professional services, commission, contractual, etc., as per the rates prescribed in the Indian tax system.
This allows ease in collection and recovery of tax from foreign companies and non-residents. The provision is applicable to the payer of income under the Income Tax Act, 1961 (the “Act”).
What is Fee for Technical Services?
Section 9(1)(vii) - Explanation 2, of the Act suggests that any payment for rendering any managerial, technical or consultancy services, whether technical or other personnel is a Fee for Technical Services (FTS). While it is inclusive of payments of lump sum consideration, it does not include fees paid by recipient of a constructive activity or as part of an assembly, mining, or other similar projects or a fee categorized under the tax head “salaries”.
2017 United Nations Model Tax Convention, defines the term "fees for technical services" as any fee for service related to managerial, technical, or consulting service, unless payment is made:
- to an employee of the payer;
- for teaching in an educational institution or for teaching carried out by an educational institution; or
- to an individual for services intended for personal use.
In the matter of
GVK Industries Ltd. v ITO, the Supreme Court held that the terms managerial, technical, and consultancy are not defined in the Act. Therefore, the common and general meaning of these terms must be considered.
However, the definition of permanent establishment includes consultancy services that are within the ambit of technical services as used in common parlance and are matter of legal interpretation.
The general term “technical services” includes extensive services that require special technical knowledge or skills or knowledge related to the field of technology. According to the Oxford Condensed Dictionary, “technical services” means belonging to or relating to art, science, trade or profession, mechanical arts, and applied sciences. Since the administrative services of the assessee, viz. organization of logistics, etc., did not involve the use of technical skills or technical knowledge or the use of technical expertise in the provision of such services, they cannot be characterised as technical services.
Question of Taxability on FTS from UAE
To understand taxability on FTS under the India-UAE DTAA, we must review the case of
Deputy Commissioner of Income Tax (DCIT) v Kalpataru Power Transmission Ltd. (ITAT Ahmedabad), Income Tax Appellate Tribunal (ITAT), Ahmedabad.
The assessee is a domestic company engaged in engineering, procurement, and construction (EPC) contracts related to infrastructure facilities which include high-power transmission lines, transmission and distribution, railway electrification, laying of oil and gas pipelines, etc. In one of the EPC projects executed by the Ugandan branch office of the assessee, the assessee paid Oilstone Technologies Dubai Multi Commodities Center of UAE (Oilstone UAE) for tower design, including the designing of its foundation and structural drawing. No tax was deducted from such payment made to Oilstone UAE by the assessee on the grounds that it is an FTS and therefore not taxable in India.
Upon verification, the Assessing Officer found that tax was not deducted against certain payments made outside India. The assessee was issued a show cause notice by the Assessing Officer of TDS Division questioning why the assessee should not be treated as “assessee in default” under Section 201(1) and Section 201(1A) of the Act.
After receiving a response against the said show cause notice, the TDS Officer concluded that it was a case of royalty and not of FTS. Accordingly, the TDS Officer held that the assessee made payments to Oilstone UAE for various services as mentioned in Explanation 2 of Section 9(1)(vi) of the Income Tax Act, of 1961. For the payments were in the nature of royalty, the assessee had failed to deduct tax on such payment.
The assessee filed an appeal against the order before the Commissioner of Income Tax (Appeals) (CIT (Appeals)), challenging the additions/treatments made by the TDS Officer. Appeal was allowed by the forum. Aggrieved from the order of CIT (Appeals), the revenue department instead approached the Appellate Tribunal against the order of CIT(Appeals).
The Ld. CIT (Appeals) stated that it was a case where payments were made to Oilstone UAE for project specification study, preparation of tower plans, preparation of tower structure drawings, preparation of tower test data documents, etc., and various other services mentioned in the contract, service agreement and therefore, the same qualify as FTS and are not Royalty payments.
The matter reiterated the well settled law and held that in the absence of an FTS clause in the India-UAE Tax Treaty, payments made towards Fees for Technical Services cannot be taxed in India, unless the foreign company has a permanent establishment (PE) in India.
Further, as per
DCIT v. Kalpataru Power Transmission Ltd (KPTL), the Tribunal held that there was no pre-existing tower structure design or any data which was supplied to Kalpataru Power Transmission Ltd (KPTL) by the UAE entity. The UAE entity had to create a new design for the service course based on KPTL specifications. The Payments made to the UAE company were to carry out the services of project specification study, preparation of tower designs, preparation of structural drawings of the tower, preparation of tower test data documents, etc., and various other services as mentioned in the service arrangement. Therefore, such payments were in the nature of FTS and did not constitute Royalty merely as license payments.
Some other decisions have held that since the India-UAE tax treaty does not provide for payment for technical services, the payment for services rendered to a UAE entity in India can be taxed as business income provided the UAE entity has a Permanent Establishment (PE) in India under Article 7 of the India-UAE Tax Treaty. In the present case, the UAE entity had no PE in India, therefore services were not taxed as corporate income. Accordingly, KPTL was not required to deduct withholding tax from payments made to the UAE entity.
Conclusion
In the absence of the FTS clause in the discussed treaty, if the payment does not qualify as Fees for Technical Services, there is no requirement for the assessee to withhold taxes on such technical fee payments.
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