• By ADMIN
• Posted 05 May, 2023
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Mitigating Risks of Litigation and Double Taxation on Fee for Technical Services (FTS)

In the Union Budget of 2023, the Indian government has increased the rate of tax deducted at source (TDS) on Fee for Technical Services (FTS) from 10% to 20% (excluding Surcharge and Cess). It is important to note that when FTS is paid outside India, it is generally taxable in India, regardless of the residential status of the recipient Non-Resident, unless certain conditions are met. The first condition is that the person making the payment must be a resident of India, and the FTS must be payable for services used in a business or profession carried out by such person outside India or for the purpose of making or earning any income from any source outside India. The second condition is that the person making the payment must be a non-resident, and the FTS must be payable for services used in a business or profession carried out by such person Outside India or for the purpose of making or earning any income from any source outside India.

Fees for Technical Services refers to any form of compensation (including a lump sum payment) for the provision of managerial, technical or consultancy services, including the engagement of technical or other personnel. However, this definition does not include consideration for any construction, assembly, mining or similar project undertaken by the recipient or payment that would be considered income of the recipient and subject to taxation under the "Salaries" head. But each DTAA which India had entered into might have different scope and meaning of it for taxing the same.

Tax treatment for FTS as per the provisions of Income-tax Act

If the non-resident recipient of fees for technical services (FTS) does not have a permanent establishment (PE) or fixed place of business in India that is effectively connected to the said income, then the said income would be subject to tax on a gross basis. This means that no deduction for expenses incurred would be allowed. The applicable tax rate would be 20%, along with applicable surcharge and cess.

If the non-resident has a permanent establishment (PE) or fixed place of business in India that is effectively connected to the fees for technical services (FTS) income, then the royalty or FTS received by the non-resident from the Indian government or an Indian concern under agreements entered into after 31st March, 2003, would be considered as business income and taxed accordingly. The taxable income would be arrived at by deducting permissible expenses as per the provisions of the Income Tax Act.

If a non-resident has a permanent establishment (PE) or fixed place of business in India that is effectively connected to the fees for technical services (FTS) income received from the government or Indian concern under agreements entered after 31st March, 2003, the income would be computed under the head "business income." In this case, income would be determined after reducing permissible expenses as per the provisions of the Income-tax Act. However, no deduction shall be allowed for expenditure that is not wholly and exclusively incurred for the business of the PE/fixed place of profession in India, or for the amount paid by the PE to its head office or any of its other offices, except for actual reimbursement of expenses. Additionally, the non-resident would be required to maintain books of accounts and get the accounts audited. The tax rate applicable under section 44DA of the Act is 40% (plus applicable surcharge and education cess).

India has entered into agreements with various countries to avoid double taxation on the same income earned by a non-resident individual in both India and their home country. These agreements are known as Double Taxation Avoidance Agreements (DTAAs). The purpose of these agreements is to prevent the same income from being taxed in both countries. Non-residents can take advantage of the provisions of the DTAA between India and their home country. In most cases, the provisions of the DTAA are beneficial to non-residents. If a beneficial provision is given in the DTAA, the non-residents can claim it, ignoring Indian Income-tax laws. However, to claim the benefits of the DTAA, the Non-Resident must provide a Tax Residence Certificate (TRC) issued by the authorities of their home country, certifying their residential status in that country. Failure to provide a TRC may result in the denial of DTAA benefits in India. In addition to it Form 10F also to be provided which contains other details of the non-residents which are not usually available in the TRC.

Taxability of FTS as per the provisions of DTAA

In most cases, the relevant article of the Double Taxation Avoidance Agreement (DTAA), typically Article 12 or 13, would establish a tax rate for fees for technical services (FTS), and/or fees for included services (FIS) that fall within its scope of coverage. If a non-resident recipient does not have a permanent establishment (PE) in India, any fees for technical or included services (FTS/FIS) they receive would be subject to gross taxation under the relevant provisions of the DTAA, similar to taxation provided in section 115A of the Income Tax Act. Many of the DTAA agreements that India had entered into generally establish a tax rate of 10%-15%. In this scenario, the taxpayer has the choice to apply the tax rate set out in the applicable DTAA or section 115A of the Act, whichever results in a more favorable.

If the fee for technical services (FTS) is attributable to a non-resident's permanent establishment (PE) in India, the taxable income would be calculated on a net basis according to the relevant articles of the DTAA. Typically, this would involve Article 5, which addresses the concept of PE, along with Article 7, which covers business profits. In such a scenario, the tax rate applicable would be 40%, along with any applicable surcharges and education cess. Determining profits that are attributable to a permanent establishment (PE) in India can be a complex process. It typically requires a detailed analysis of the functions performed, assets used, and risks assumed by the PE, known as a Functional Analysis and Risk Assessment (FAR Analysis).

If no clause for FTS found in DTAA,

In certain DTAA agreements, such as those with Bangladesh, Mauritius, UAE, and others, there may not be a specific clause pertaining to fees for technical or included services (FTS/FIS). Additionally, the definition of "royalty" in these agreements may not encompass FTS/FIS within its scope. When a DTAA does not include a provision recognizing or classifying income as fees for technical services (FTS), it is not an omission but rather a deliberate mutual agreement between the Countries. The intention behind this is typically to exclude FTS from taxation under the DTAA. Once the income chargeable to tax has been categorized under the DTAA, excluding FTS, the scope of taxing that income as FTS cannot be expanded by importing provisions from the Income-tax Act.

For most DTAA agreements between India and other countries, the agreed-upon rate of tax deducted at source (TDS) on fees for technical services (FTS) is 10%, which includes applicable surcharges and education cess. It is important to note that the rates agreed upon in DTAA agreements are always all-inclusive. On the other hand, the rates prescribed for TDS under the Income-tax Act are exclusive of applicable surcharges and education cess for non-residents and inclusive of all for residents.

Below are the rates of tax deducted at source (TDS) on fees for technical services (FTS) that have been agreed upon in various DTAA agreements entered into by India with other countries:

In most of the countries with which Government of India had agreed at 10% (all inclusive rate) which would be more beneficial than rate of tax prescribed under Income-tax act which is 20% plus applicable surcharge and cess.

Impact of Multilateral Instruments (MLI)

As per the provisions of the MLI, when the principal purpose is to get the treaty benefit by the non-resident in the entire transaction/arrangements, then the non-resident shall not get the benefit of the treaty. Further, one must check before analysing the MLI provisions as to whether both India and the other country had agreed to the relevant provisions of MLI and it in force. Further the provisions of Indian Incomed-tax Act, 1961 also has General Anti-Avoidance rule (GAAR) provisions which would deny the treaty benefits when the transactions/arrangements declared as impermissible.

“Make available” clause in DTAA

Certain DTAA that India has entered into, such as those with the United States, the United Kingdom, Canada, Australia, Finland, Singapore, and others, have a narrow or restrictive definition of the terms "fees for technical services" (FTS) or "fees for included services" (FIS). For example the FTS would be taxable in India when the non-resident “make available” technical knowledge, experience, skill know-how or processes, or consist of the development and transfer of a technical plan or technical design in the provision of services. In all other countries it is not so hence, the taxing rights also given to India by prescribing a particular rate of TDS on it.

Most Favoured Nation Clause (MFN)

The Most Favored Nation (MFN) clause in a Double Taxation Avoidance Agreement (DTAA) is a provision where participating states mutually agree to grant more favorable tax treatment to residents or contracting states, based on one party's acceptance of a preferential regime offered to a third state.

Tax Residence Certificate (TRC):

TRC is an important document which the home country’s tax authorities needs to issue to the name of the Non-residents to claim the benefits of DTAA provisions. In the absence of the same, the tax would be as per Indian Income-tax law. When tax is deducted as per the provisions of the DTAA the relevant tax credit would be given by the home country, if the same is deducted as per the provisions of the Income-tax due to non-submission of TRC, then it is doubtful as to whether the home country could provide credit for the taxes paid in India.

Foreign Tax Credits

Double taxation of the same income in both India and a Non-Resident's home country can lead to an undue financial burden on the taxpayer. To address this issue, India and various other countries have entered into Double Taxation Avoidance Agreements (DTAAs). Under these agreements, Non-Residents can claim foreign tax credits in their home country for the taxes paid in India (TDS/Tax). It is important for Non-Residents who have paid taxes in India to review the relevant DTAA between India and their home country to ensure that they can claim these foreign tax credits. The respective DTAA provides methods for eliminating double taxation. These methods should be followed to avoid the double taxation of income.

The following are the illustrative list of transactions in which the courts have treated certain transactions as FTS and others are not as FTS:-

1. Payment for trial tests conducted in France (so that after passing these tests, the diameter electrodes produced become acceptable in the international market) are towards “technical” services under the India- France DTAA.

2. Tests conducted by a foreign company (to evaluate whether coke produced by an Indian company is suitable for making anode for aluminium industry) and reporting the conclusions thereof constitute a “technical” service.

3. Services rendered in the context of examining and improving overall fuel efficiency of carbureted engine of two-wheelers (through modification of existing designs) is a “technical” service. Accordingly, payments made by an Indian company to a foreign company in this regard would qualify as “FTS” as defined in Article 12 of the India- Austria DTAA.

4. It was held that receipt from activities of inspection, verification, testing and certification services to various customers amounts to fees for technical services. The said services which applicant is rendering for a fee is a technical service rendered by carrying out tests and certifying that goods imported/exported confirmed to certain specifications, it would be chargeable to tax in India as 'fees for technical services' ('FTS') under section 9(1)(vii)(b). Also whether further payments received/receivable in connection with cost incurred and recovery of administrative cost are chargeable to tax as FTS under section 9(1)(vii).

5. The activity of trouble-shooting repair and maintenance of turbines which includes activities like inspection and boroscoping would be fees for technical services under Act. Since the test of 'making available technical knowledge' in terms of paragraph 4 of Article 12 of DTAA cannot be said to be satisfied, amount received by applicant namely Solar Turbines in respect of said activities is not taxable in India.

6. An assessee may carry on manufacturing or trading activities and can enter into a contract separately to furnish technical information for a fee to a third party. Fess received for such technical information received from third party is 'fee for technical services', as payment made is to acquire technical information.

7. It was held that where a company was giving training to the assessee's employees in making use of the inputs, experience, experimentation, assistance and advice rendered by them for taking a better and possible decision in order to achieve the desired objectives / goal, the same, would be in the nature of technical services which facilitate the assessee to take correct and suitable decisions. Therefore, the technical knowledge, experience, skill with regard to financial and risk management was made available in the form of advice or service to the assessee and would come under the ambit of FIS under Article 12 of India US DTAA.

8. The Delhi HC held that merely because the use of internet facilities requires sophisticated equipment does not mean that “technical services” are being rendered by an internet service provider.

9. Payments for clinical testing services provided by foreign companies in US and Canada would not be taxable in India as fees from technical services under Article 12 of DTAA as there was neither transfer of technical plan or technical design nor making available of technical knowledge, experience or know how to the assessee company.

10. Any technology or machinery is developed by human and put to operation automatically, wherein it operates without much of human interface or intervention, then usage of such technology cannot per se be held as rendering of 'technical services' as contemplated in Explanation 2 to section 9(1)(vii).

11. Fees for online advertising could not be considered as fees for technical services as there is no human element involved in rendering the services.

12. Fees for providing services in respect of design and engineering for laying pipelines, preparing welding procedure, reviewing work procedure and deputing expert manpower for site review are in nature of technical supervision and qualify as fees for technical services.

13. Services pertaining to registration and enforcement of intellectual property rights are “consultancy” services and accordingly, payments made for the same are in the nature of “FTS” as defined in section 9(1)(vii) of the Act.

14. Where the assessee company entered into an agreement with a foreign entity to identify potential customers and file a report regarding the market strategy and developmental studies would be in the nature of consultancy services taxable in India.

15. Transmission of data via technical gadgets without any human intervention won't amount to technical services.