(Note: The author Milind M. Korde is a student of Chartered Accountancy. This is a very informative article he has written on special issues pertaining to taxability of NRI transactions, and taxation of Online transactions. -Tejinder Singh Rawal)

The status conferred by the phrase 'Non-Resident' enjoys weighted privileges not only under the FERA and RBI's guidelines on foreign exchange control but also under the Income Tax Act . Add the word 'Indian' to it and enjoy the special status in Indian social life with the title of 'NRI'. For some 'non-resident' status is a key to 'Juke-box' whose music is sweet to listen and dance , some others hit the 'Jack-Pot' and for a one in thousand it is a 'Pandora's- Box'. It is a sure-shot passport to get name, fame, Dollars-Yens and attention of the taxman also.

An attempt has been made to discuss the tax consequences of the 'NON-RESIDENT' status under the Indian Income tax Act, 1961. In the paper only special issues are covered in the light of domestic tax law , various treaties - on the back ground of Authority for Advance Rulings , Court judgements , Model Tax Convention of the Organisation for Economic Co-operation and Development (OECD) and its Commentary. Before running through the following pages readers are requested to go through annexture to comprehend some important concepts to ease understanding of the paper.

VIDESHI SUBSIDIARY - SWADESHI TAX.

Opening up of the Indian economy and globalisation resulted not only in setting up of branches by the MNCs in India but also addition of foreign subsidiaries to the Indian conglomerates. The residential status of such foreign subsidiaries and consequent tax implication can be ascertained from the provisions of Sec. 5 and 6 of the Income Tax Act, 1961.

As per Section 6(3) of the act a foreign company is resident in India for tax purposes if during the year the control and management (C&M) of it's affairs is situated wholly in India - otherwise the company is a non- resident. As per the provisions of Section 5(2) a non-resident company is not liable to tax for the income which accrue or arise to it outside India unless it is received or deemed to be received in India.

But the important question is,where can control and management be deemed to be situated? When can the control and management be said to be situated wholly outside India? The phrase 'Control and Management' should not be confused with the carrying on of business or trading activity nor with the carrying of physical operations. It should not be taken on at par with the control of individual shareholder and neither it is situated at the place where shareholders meetings are held. After referring to the various court judgements one can safely infer that the control and management of the affairs of the company means de facto control and management and not merely right or power to control and management.

As a rule, the direction, management and control,' the head and seat and directing power', of a company's affairs is situated at the place where the director's meetings are held. It is not what directors have power to do, but what they do, that is important in determining the question of place where control and management is exercised. Some of the directors may reside abroad, where subsidiary is situated and it's activities are carried on, but the activities of such directors may be subject to control of those who are resident in India, it may be possible to escape from Indian tax. Only if no powers are delegated to the directors residing abroad and their actions are not subject to control of directors in India , control and management would not be situated wholly in India.

So it would be a smart decision for the Indian company thinking of setting up a wholly owned foreign subsidiary to appoint some of the persons as directors on board who are not based in India. A mere presence of such directors outside India is not enough to ensure that control and management is not situated wholly in India,these directors should have adequate powers and should take independent decisions outside India. This will save a Videshi subsidiary from Swadeshi tax.

TAXING YANKEES

Section 115AC of the Income Tax Act, 1961 and the guidelines issued by the Government of India ,Issue of FCCBs and Ordinary Shares Scheme,1993, in cohesion govern the taxation of American Depository Receipts i.e. ADRs. These guidelines throw light on the tax implication on a ADRholder at various point and form of holding which are mentioned below.

1. Trading in ADRs outside India among non-resident investors: As per these guidelines all such transactions will be exempt from tax in India.
2. Redemption of ADRs into underlying shares : At the time of such redemption there are no tax implications. After redemption of ADRs into underlying shares, if the non-resident continues to hold such shares .he will not be denied benefits under section 115AC.
3. Capital gains on sale of underlying shares : Capital gain arising on the transfer of such shares in India will be liable for tax in the hands of non-resident investors. The nature of such capital gain, whether short term or long term,will depend upon the period of holding of such shares. Period of holding of such shares will be counted from the date of advice of redemption by overseas depository to the Indian custodian .If shares are held for less than 12 months then it is a short term capital gain otherwise its a long term capital gain. For computation of the capital gains cost of acquisition of such shares is taken as market price of shares on BSE or NSE on the date of the advice. As per the provisions of sec 115AC such long term capital gains are taxed at a concessional rate of 10% and short term capital gains are taxed at normal rates. By Finance Act, 1999 a new sub section (5) has been inserted in the section 115AC so as to extend benefits of sec. 115AC even to the shares in the amalgamated company or the resulting company in case of demerger ,which are received by the investors by virtue of their shareholding in the Indian company offering ADRs.
4. Distribution of additional ADRs etc. : Distribution of additional ADRs or equity shares or rights in respect of ADRs is not taxable in India. However it is uncertain whether capital gain arising on transfer of such rights is taxable or not .It is expected that the proper authority will soon clear the ambiguity.
5. Application of Tax Treaty : While the fiduciary ownership of ADRs is with the overseas depository the tax treaty applicable to such depository will also govern the individual investor.After redemption till the time such shares are sold the treaty applicable to individual investor will be applicable.

SHORT STAY, SWEET STAY.

Till the recent past winds of the uncertainty about the tax implication of short stay in India were roaring in the ears of the non-residents employed by the foreign employers.But in a recent landmark decision,the AAR has settled the dust by exempting from Indian taxes the remuneration of an American citizen who was deputed in India for a short period.

In this particular decision, the applicant was a US resident employed by Whirlpool Corporation (WC),a US company.It has a 100 per cent subsidiary - Whirlpool India Holdings Ltd - which was also incorporated in the America.This subsidiary company has a branch in India and the applicant was posted as vice-president at this branch. Under the terms of his contract, his salary was payable outside India, in the USA.Certain emoluments in India such as suitable residential accommodation, chauffeur driven car,electricity and water charges,and other bills were paid for by Whirlpool Corporation.Expenses borne in India by subsidiary company were reimbursed by WC by periodic remittances.

In his application the applicant had asked if he would be liable to pay taxes in India.The three member bench of the AAR analysed Article 16 of the Indo-US double tax avoidance agreement (DTAA). Article 16 relates to 'dependent personal services'.Under its provisions,salaries,wages and other similar remuneration derived by the resident of the contracting state (country) in respect of employment shall be taxable only in that state (country of residence),unless employment is exercised in the other Contracting State(source country). If so it may be taxed in the source country. Thus if salary is derived by a US resident for employment exercised in India, it can be taxed in India.

But clause (2) of the this Article provides that such remuneration will be taxed in the country of residence (i.e. US) and not in the source country (i.e. India),if the recipient was present in the other state (India), for a period or periods not exceeding 182 days in relevant taxable year; and remuneration was paid by or on behalf of the employer who was not resident of the other state;and remuneration was not borne by a Permanent Establishment (PE) or fixed base which the employer has in the other state.

In this case applicant had stayed in India for 76 days only during 1997-98.AAR also held that the remuneration paid by the branch was reimbursed by WC and hence it couldn't be said that the burden of the remuneration was borne by PE or fixed place of business in India.Thus all the conditions of the Article 16(2) were met by the applicant,hence he was not liable to pay tax in India.

LONG & SHORT OF SHORT GAINS

A recent judgement of the Mumbai ITAT on taxation of short-term capital gains is the cause of the debate, can a short term capital gain in the hands of the NRI arising from the sale of foreign exchanged assets deserves special treatment under Section 115E or not.

Chapter XII-A of the Act contains provisions which confer the special treatment to the NRIs. Section 115C contains various definitions and Section 115E provides special rates of taxes on investment income and long-term capital gains. The crux of the matter is whether the short term capital gain accruing to NRI on transfer of foreign exchange asset qualifies the phrase 'investment income' as defined in the Sec. 115C(C) and hence liable for tax at concessional rate of tax under Section 115E.

In the case of Trishla Jain Vs. DCIT(Delhi ITAT) it was argued that as the shares were purchased in convertible foreign exchange sale proceeds of such shares qualify for the income from the foreign exchange assets and that too under the caption 'investment income' as defined under section 115C(C). Section 115C(C) of the Act defines 'investment income' as "any income derived other than dividend referred to in section 115-O from foreign exchange asset".The Delhi ITAT held the argument as right following a SC judgement in the case of Sevantilal Maneklal Seth Vs CIT (68 ITR 503,1967). It was held that the short term capital gain on transfer of shares held in Indian Company, which were purchased in foreign exchange qualify as the income from investment and hence taxed at special rate.It was held that the term investment income referred in sec.115E does not specifically exclude the short term capital gains and such exclusion cannot be presumed due to separate mention of the long term capital gain in the same section.It was also held that logically there is no difference between income arising from the asset and income arising from its sale proceeds.

However ,recently Mumbai ITAT in case of Sunderdas Haridas Vs CIT (67 ITD 89,1998) refused to include short term capital gains in the phrase 'investment income' on the ground that such exclusion is necessary to prevent short term movement of foreign exchange.The problem of double interpretation arose as the draftsmen failed to convey exact intent of the legislature in clear words.Where two or more interpretations are possible one that favours the assessees should be adopted so long as it doesn't violate the spirit of statue. This view was held by the SC in Keshav Mills Vs CIT. However in order to avoid unnecessary litigation it is in the interest of NRIs to obtained a ruling in advance in this matter.

BANKING ON COMMITMENT When a Bank extends a credit facility to its customers it does not make the immediate payments to the customers. It just earmarks the fund for the customers and supplies it as and when it is demanded by the customers. It is a normal business practice to recover 'commitment charges' at a fixed percentage on these earmarked funds.So the question is whether these commitment charges are taxable in the hands of the bank and whether these charges are in the nature of 'interest' charged by the bank.

As per the definition of 'Interest' given in the section 2(23A) of the Income Tax Act interest includes charges in respect of any credit facility which has not been utilised.Hence the commitment charges are in the nature of interest. Section 9(1)(v) of the Act governs the place of accrual of interest income. As per the provisions where interest is paid by the resident it accrues in India except where interest is payable in respect of moneys borrowed and used outside India for the purpose of his business or profession carried on by him outside India or for earning income from any source outside India. Similarly where interest is paid by a non-resident it accrues in India provided money borrowed by non-resident is used in the business or profession carried on by such person in India.

These charges are levied in the normal course of banking hence these receipts are taxable income in the hands of the foreign banks as 'business income' irrespective of the fact whether these charges assumes the character of 'interest' or not .

While discussing the taxation of commitment charges from the point of view of the foreign bank it is interesting to study incidence of the tax under different DTAAs. Let us test these charges against Indo-US and Indo-Japan treaties. Before we study the incidence of the tax under different treaties,it is important to note that a foreign bank,as per the provisions of sec 90(2) of the Income Tax Act, is entitled to apply for the provisions of the Act or the provisions of the DTAA with country of which bank is resident whichever is more beneficial to it.

Under Indo-US Treaty :Under Indo-US treaty the definition of the 'interest' is given in the Article 11(4). However the definition of the 'interest' given in the said Article does not provide for the commitment charges.Hence a US resident bank will not have to pay taxes in India @ 10% as prescribed under the Article 11(2) of Indo-US DTAA. This conclusion makes it necessary to make analysis of Article 7 of the DTAA which covers 'Business Income'.

This Article provides that the income of the US resident will be taxed in India only if the resident has a PE in India.It further provides that the income to the extent it is attributable to such PE will only be taxed.If the American bank has a branch in India ,i.e. a PE,then income attributable to such branch will be taxed in accordance with the domestic law @ 48%. However if such bank has no PE in India then commitment charges received from the Indian customers will not be taxable.

Where commitment charges are directly earned by the American bank (and not through its branch in India) then also such charges will not be taxed for the reason that they are not attributable to the branch in India.But the onus of the proof is on the concerned bank.

An American bank is taxed @ 48% while an Indian Company @ 35% only. Article 14(2) of the treaty allows such discrimination as long as the difference between the rate of tax does not exceed 15 percentage points. Hence in the given circumstances American Bank has no resort to non-discrimination clause and hence can not demand taxation @ 35%.

Under Indo-Japan Treaty : Under the Article 11(5) of the treaty the definition of 'interest' does not include commitment charges. Likewise Article 7 of the Indo-Japan treaty ,governing 'business income',provides that the income of the Japanese Bank can be taxed in India only if these banks have PE (i.e. branches) in India and to the extent such income is attributable to such branches.

Article 24(2) of the Indo-Japan treaty relating to the non-discrimination clause provides that the taxation of such branches in India should not be less favourably levied than that levied on the enterprises carrying on the same activity. Thus Japanese Banks can invoke the non-discrimination clause irrespective of the difference in the rate of taxation. And these banks may demand that they should be taxed at same rate as Indian Banks i.e. @ 35%.

However AAR has held that such discrimination is not available on basis of being national of Japan but on being a resident outside India.

SOFT - WAR(E) CALLED ERP

Indian Income Tax Act is crystal clear about the tax sops available to the software exporters but on the flip side it is equally silent about the tax consequences of payment for import of software. Some of the foreign suppliers of software have established branches in India and others are operating from their home country or have authorised distributors in India. Hence under domestic law such payments can be taxed either as business profits or royalty.

1. Business Profits :Under business profits, income earned by non-resident through business connection in India is taxable in India.But CBDT has clarified that mere supply of 'goods' by a foreign supplier,subject to certain conditions,does not amount to business connection and hence payment for such supplies is not taxable in India. Such payment for acquiring computer software qualify for such exemption or not depends on whether computer software amount to 'goods' and how such software are acquired - on an outright basis or licence or right-to-use basis.Computer software is a dutiable good under the Customs Act hence import of computer software on outright basis (i.e. with full rights) can be taken on par with import of any other goods which in general does not make the supplier taxable in India.
2. Royalty :On a plain reading of the definition of 'Royalty' given in the sec. 9(1)(vi)explanation 2 it is clear that the payment for rights in respect of the computer software is not specifically covered, but includes consideration for transfer of all or any rights in respect of copyright or literary work. Computer software are protected under the Copyright Act. Under the Copyright Act the term 'literary work' includes computer programmes, tables and compilations, including computer data base.Hence any transfer of right or licence to use a software is also likely to be covered as royalty.It should be noted that the payment for transfer of rights not only in part but also in full is covered under definition of royalty,hence it is equally likely that the payment for sale of software on an outright basis would be taxed as royalty inspite of the general exemption available to the foreign suppliers.