Taxation of Commission Payments to Non-Residents

1. Provisions under the Income-tax Act, 1961 (the ‘Act’)

Indian exporters and/or businessmen avail services of foreign agents for a variety of purposes, such as securing export orders, sourcing of raw materials and plant & machinery, participation in exhibitions, buying or selling of properties and so on. When a non-resident receives commission for rendering such services outside India, from an Indian payer, whether it is taxable in India? Whether resident payer needs to deduct tax at source u/s.195 of the Act?

We will discuss various issues arising in this context such as:

• Whether taxability of the commission income received by a non-resident depends upon the nature of the underlying transaction?

• Whether commission income of a non-resident agent is taxable u/s.5 or u/s.9(1)(i), being source of income in India or u/s.9(1)(vii) as Fees for Technical Services (FTS)?

• What is the impact of withdrawal of CBDT Circulars (No. 23 of 1969 and 786 of 2000) dealing with taxability of commission income of foreign agents of Indian exporters?

• Whether the payment of commission to non-resident agent be taxed as ‘Other Income’ under Article 21 of a Tax Treaty relating to Other Income?

Let us first examine provisions of the Act in this regard.

(i) Section 5 r.w. Section 9 of the Act deals with this situation. Section 5 defines the scope of total income according to which, income of a nonresident is taxed in India if it is received, accrue or arise or deemed to be received, accrue or arise in India. Section 9 of the Act deals with Income deemed to accrue or arise in India. Inter alia it covers any income accruing or arising to a non-resident, directly or indirectly, through or from (i) any business connection (BC) in India and (ii) any asset or source of income in India.

(ii) Explanation to 2 to section 9(1)(i) defines the term ‘business connection’ (BC). The analysis of the said Explanation would show that any business activity in India carried out by a broker, general commission agent or any other agent having an independent status in his ordinary course of business will not constitute a BC in India and conversely that of a dependent agent will constitute a BC.

Thus, commission income of a foreign agent will not be taxed in India unless that agent has a BC in India. In absence of a BC, can it be construed that ‘source’ of commission income is in India as the payer is a tax resident of India?

(iii) In this connection, it is interesting to note the relevant contents of the CBDT Circular 23 of 1969 (since withdrawn), which is as follows:

“. . . . . . (4) Foreign agents of Indian exporters — A foreign agent of Indian exporter operates in his own country and no part of his income arises in India. His commission is usually remitted directly to him and is, therefore, not received by him or on his behalf in India. Such an agent is not liable to income-tax in India on the commission.” (Emphasis supplied)

The above position was reaffirmed by the CBDT vide its Circular No. 163, dated 29-5-1975.

(iv) In this connection, it is interesting to note the observations of the AAR in case of SPAHI Projects (P.) Ltd. (2009) 183 Taxman 92 (AAR), wherein it held that “irrespective of the existence or otherwise of the business connection of ‘Z’, in India, since no business operations are carried out in India by ‘Z’, the attribution in terms clause (a) of the Explanation 1 is not possible and, therefore, no income can be deemed to accrue or arise in India merely because ‘Z’ promotes the business of the applicant in South Africa.”

Here the AAR held that even if it is assumed that there exists a BC in India, only so much of income as is attributable to that BC in India would be taxable in India as provided in Explanation 1 to section 9(1) of the Act, which reads as follows:

“Explanation 1 — For the purposes of this clause

— (a) In the case of a business of which all the operations are not carried out in India, the income of the business deemed under this clause to accrue or arise in India shall be only such part of the income as is reasonably attributable to the operations carried out in India;”

Therefore, in a case where there exists a BC, but commission is paid in respect of services which are rendered outside India only, then no income can be said to accrue or arise in India.

(v) The Supreme Court in the case of Carborandum Co. v. CIT, (1977) 108 ITR 335, has held that “the carrying on of activities or operations in India is essential to make the non-resident have business connection in India in order that he may be liable to tax in respect of the income attributable to that business connection”.

(vi) In case of CIT v. Toshoku Ltd., (1980) 125 ITR 525 the Apex Court, while dealing with the issue of taxation in India of commission paid to a nonresident agent, held that “the assessees did not at all carry on any business operations in the taxable territories and as such the receipt in India of the sale proceeds of tobacco remitted or caused to be remitted by purchasers from abroad, did not amount to an operation carried by the assessees in India as contemplated by clause (a) of the Explanation to section 9(1)(i). The impugned commission could not, therefore, be deemed to be income which had either accrued or arisen in India”.

1.1 Applicability of TDS provisions u/s.195 on commission paid to non-resident

The Income-tax Department vide its Circular No. 786, dated 7-2-2000 clarified that “the deduction of tax at source u/s.195 would arise if the payment of commission to the non-resident agent is chargeable to tax in India. In this regard attention to CBDT Circular No. 23, dated 23rd July, 1969 is drawn where the taxability of ‘Foreign Agents of Indian Exporters’ was considered along with certain other specific situations. It had been clarified then that where the non-resident agent operates outside the country, no part of his income arises in India. Further, since the payment is usually remitted directly abroad it cannot be held to have been received by or on behalf of the agent in India. Such payments were therefore held to be not taxable in India. The relevant sections, namely, section 5(2) and section 9 of the Income-tax Act, 1961 not having undergone any change in this regard, the clarification in Circular No. 23 still prevails. No tax is therefore deductible u/s.195”.

Many decisions wherein taxability of Commission paid to foreign agents was examined are rendered in the context of deductibility of tax at source u/s.195 of the Act.

The Tribunals, AAR and Courts in following cases held that provisions of section 195 of the Act are not applicable in case of commission payments to foreign agents of Indian entities as the said income is not taxable in India in the hands of the recipient.

(i) CIT v. Cooper Engineering Ltd., (1968) 68 ITR 457 (Bom.)

(ii) CIT v. Toshoku Ltd., (1980) 125 ITR 525 (SC)

(iii) Ceat International S.A. v. CIT, (1999) 237 ITR 859 (Bom.)

(iv) Indopel Garments Pvt. Ltd. v. DCIT, (2001) 72 TTJ 702

(v) Ind. Telesoft (2004) 267 ITR 725 (AAR)

(vi) DCIT v. Ardeshir B. Cursetjee & Sons Ltd., (2008) 24 SOT 48 (Mum.) (URO)

(vii) Jt. CIT v. George Williamsons (Assam) Ltd., (2009) 116 ITD 328 (Gau.)

(viii)    Dr. Reddy Laboratories Ltd. v. ITO, (1996) 58 ITD 104 (Hyd.)

(ix)    SOL Pharmaceutical Ltd. v. ITO, (2002) 83 ITD 72 (Hyd.)

(x)    Eon Technology (P) Ltd. v. DCIT, (2011) 11 tax-mann.com 53 (Del.)

(xi)    ACIT v. Meru Impex, (2011) 16 Taxmann.com 219 (Mumbai ITAT)

(xii)    ITO v. Asiatic Colour Chem Ltd., (2010) 41 SOT 21 (Ahd.) (URO)

(xiii)    ACIT v. Tamil Nadu Newsprints and Papers Limited, (2011 TII 215 ITAT Mad.-Intl.)

(xiv)    DCIT v. Divi’s Laboratories Ltd., (2011 TII 182 ITAT Hyd.-Intl.)/(2011) 12 taxmann.com 103

(xv)    ADIT (IT) v. Wizcraft International Entertain-ment (P.) Ltd., (2011) 43 SOT 470 (Mum.)

(xvi)    DCIT v. Mainetti (India) (P.) Ltd., (2011) 12 tax-mann.com 60 (Chennai)

All controversies arising in respect of interpretation of section 195 regarding non-deduction of tax at source were put to rest by with decision of the Supreme Court in the case of GE India Technology Centre P. Ltd. v. CIT, (2010) 327 ITR 456 wherein the Apex Court following Vijay Ship Breaking Corporation v. CIT, (2009) 314 ITR 309 (SC) held that “The payer is bound to deduct tax at source only if the tax is assessable in India. If tax is not so assessable, there is no question of tax at source being deducted”.

The decision of GE India Technology Centre P. Ltd. (supra) assumes special significance as it explained the decision of the Supreme Court in case of Transmission Corporation of A. P. Ltd. v. CIT,(1999) 239 ITR 587 (SC) in proper perspective. The said decision is often invoked by the Income-tax Department to fasten TDS obligation on the payer on a gross basis and even when the income is not chargeable to tax in the hands of the recipient thereof. The Apex Court stated that in the case of decision of the Transmission Corporation (supra), the issue was of deciding on what amount of tax is to be deducted at source, as the payment was in respect of a composite contract. The said composite contract not only comprised supply of plant, machinery and equipment in India, but also comprised the installation and commissioning of the same in India.

With the above-mentioned correct interpretation of the decision in the case of Transmission Corporation (supra), the Apex Court set aside the decision of the Karnataka High Court in the case of CIT v. Samsung Electronics Co. Ltd. (2010) 320 ITR 209 wherein it was held that resident payer is obliged to deduct tax at source in any type of payment to a non-resident be it on account of buying/purchasing/ acquiring a packaged software product and as such a commercial transaction or even in the nature of a royalty payment. Applying the ratio of this decision the Income-tax Department used to disallow any payment to a non-resident where tax was not withheld, irrespective of the fact that the corresponding income was not chargeable to tax in the hands of a non-resident.

The CBDT vide circular 7/2009 [F. No. 500/135/2007-FTD-I], dated 22-10-2009 withdrew all three Circulars, namely, (i) 23 dated 23-7-1969 (ii) 163 dated 29-5-1975 and (iii) 786 dated 7-2-2000 which is giving rise to many controversies.

1.2    What is the impact of withdrawal of CBDT Circulars mentioned above?

Even though the above Circulars stand withdrawn, principles contained therein still hold the ground. Circular 23 of 1969 provided certain clarification regarding taxability in India in respect of certain transactions by a non-resident with an Indian resident, for example, sale of goods to India by a non-resident exporter, commission income of foreign agents of Indian exporters, purchasing of goods by a non-resident from India, sale of goods by non-resident in India either directly or through agents, etc. The Circular clarified about various situations that would not result in any business connection in India. One of the clarifications pertained to commission income earned by foreign agents of Indian exporters where the Circular clearly stated that no income shall deem to accrue or arise in India. In essence the said Circular interpreted provisions of section 9 of the Act whereby the underlying principles propounded were that the commission income of a foreign agent cannot be taxed in India if there exists no business connection in India and the income is not received in India. The subsequent amendments to section 9 of the Act, which relates to clarification of business connection in case of dependent/independent agent and taxability of Fees for Technical Services, do not alter the legal position. Therefore, even post withdrawal of impugned CBDT Circulars, commission earned by foreign agents of Indian exporters would not be taxable in India provided all services are rendered outside India (i.e., the foreign agent does not have any BC in India) and the income is not received in India.

This position has been upheld in DCIT v. Divi’s Laboratories Ltd., 2011 TII 182 ITAT Hyd.-Intl./(2011) 12 taxmann.com 103, wherein the Tribunal held as follows:

“We have considered the submissions of both the parties and perused the relevant material available on record. The moot question that arises out of these appeals is whether the payment of commission made to the overseas agents without deduction of tax is attracted disallowance u/s.40(a)(ia) of the Act or not. Whether the payment in dispute made by way of cheque or demand draft by posting the same in India would amount to payment in India and consequently whether mere payment would be said to arise or accrue in India or not? First we will take up the issue whether the payment of commission to overseas agents without deduction of tax is attracted disallowance u/s.40(a)(ia) of the Act or not. We find that the CBDT by its recent Circular No. 7, dated 22-10-2009 withdrawn its earlier Circular Nos. 23, dated 23-7-2009, 163 dated 29-5-1975 and 786, dated 7-2-2000. The earlier Circulars issued by the CBDT have clearly demonstrated the illustrations to explain that such commission payments can be paid without deduction of tax. Thus, the main thrust in such a situation is whether the commission made to overseas agents, who are non-resident entities, and who render services only at such particular place, is assessable to tax. Section 195 of the Act very clearly speaks that unless the income is liable to be taxed in India, there is no obligation to deduct tax. Now, in order to determine whether the income could be deemed to be accrued or arisen in India, section 9 of the Act is the basis. This section, in our opinion, does not provide scope for taxing such payment, because the basic criteria provided in the section is about genesis or accruing or arising in India, by virtue of connection with the property in India, control and management vested in India, which are not satisfied in the present cases. Under these circumstances, withdrawal of earlier Circulars issued by the CBDT has no assistance to the Department, in any way, in disallowing such expenditure. It appears that an overseas agent of Indian exporter operates in his own country and no part of his income arises in India and his commission is usually remitted directly to him by way of TT or posting of cheques/demand drafts in India and therefore the same is not received by him or on his behalf in India and such an overseas agent is not liable to income-tax in India on these commission payments. This view is fortified by the judgment of Apex Court in the case of Toshoku Ltd. (supra).”

Thus, in respect of payment of commission to non-resident agent by a resident in respect of services rendered outside India, it is clear that withdrawal of the aforesaid CBDT Circulars would not affect the existing settled position in law that the same would not be taxable in India.

1.3    Can the withdrawal of aforesaid CBDT Circulars have retrospective effect?

In Satellite Television Asia Region Advertising Sales BV v. ADIT, (2010 TII 58 ITAT Mum.-Intl.) the Mumbai Bench, in the context of payment for sale of advertising time, held that though the Circular No. 23, dated 23rd July, 1969 was withdrawn on 22nd October, 2009, the withdrawal is prospective in nature. Since for the year under consideration, the Circular was in force, the Circular was still applicable to the case under consideration.

The Mumbai ITAT reiterated the same view in the case of DDIT v. Siemens Aktiengesellschaft, 2010 TII 09 ITAT Mum.-Intl.

1.4    Can commission paid to an individual be classified as salaries?

Can a commission payment be classified as salaries if the same is paid to a non-resident individual who represents an Indian entity was a question examined by the Mumbai Tribunal in case of ACIT v. Meru Impex, (2011) 16 Taxmann.com 219. In this case the Assessing Officer held that the appointment as agent to represent the assessee before foreign buyer was sham and not genuine; and that even assuming said payment to be genuine, the same was in nature of salary. However, the Tribunal ruled that the said payment cannot be classified as salaries in absence of employer-employee relationship.

1.5    Can commission be classified as fees for technical services?

In the case of Wallace Pharmaceuticals P. Ltd. (2005) 278 ITR 97 (AAR), on the facts of the case the AAR held that “though Penser is a tax resident of USA, it has rendered consultancy services in India and as the consultancy fee payable in respect of services utilised is not in connection with a business or profession carried on by the applicant outside India for the purposes of making or earning any income from any source outside India, the consultancy fee would be deemed income of Penser in India. In addition to the monthly consultancy fee under the agreement, Penser is also entitled to 10% commission on the orders procured by it. The commission will also be deemed income arising to Penser in India.”

It appears that since the commission was linked to monthly consultancy fees, the AAR considered it at par with the consultancy fees, notwithstanding the fact that services, inter alia, included promotion of Wallace’s products in the USA. Ironically, provisions of India-US DTAA were not considered/applied in this case. If the provisions of India-US DTAA were considered, probably the conclusion of the AAR would have been different due to existence of ‘Make Available’ clause in Article 12(4)(b) of the DTAA. Also if Penser had no PE in India, it would also not be taxable under Article 7 of the DTAA.

The AAR in case of SPAHI Projects (P.) Ltd. (2009)183 Taxman 92 (AAR) held that there could possibly be no controversy that the non-resident will not be rendering services of a managerial, technical or consultancy nature and, therefore, the liability to tax cannot be fastened on it by invoking the provisions dealing with fee for technical services.

However, in case of DCIT v. Mainetti (India) (P.) Ltd., (2011) 12 taxmann.com 60 the Chennai Tribunal held that “No doubt technical service would definitely include managerial services. However, canvassing of orders abroad could not be regarded as managerial services, nor could it be said to be for any consultation. Thus, definitely technical services as per Explanation 2 to section 9(1)(vii) of the Act would have no application.”

2.    Taxability under a tax treaty

Under the provisions of a tax treaty, the income is taxed under different sub-heads with each having a separate set of distributive rules and definition. For example, profits from operation of ships and aircrafts, royalties and Fees for Technical Services (FTS) are dealt by separate articles though essentially they are all part and parcel of business activities. Under domestic tax law, they are all taxed under the same head of business profits. Therefore, difficulty arises about characterisation of income under a treaty scenario.

Under a tax treaty, business profits earned by an enterprise resident of one country are taxed only in its country of residence unless it has a Permanent Establishment (PE) in the source country. However, royalties and FTS can be taxed in a source country even if there is no PE.

Another difference is that whereas business profits are taxed on a net basis (that too only to the extent they are attributable to the PE in the source country), royalties and FTS are taxed on gross basis, albeit at a concessional rate.

In the treaty context the following situations arise:

2.1    Commission income treated as business income

Ideally, commission income should be classified as business income as it is neither royalty nor fees for technical services. In such a scenario, taxability in India would depend upon whether the foreign agent has a PE in India or not. If the foreign agent has a PE in India, then commission income which is attributable to it would be subject to tax in India. Usually, foreign agents of Indian exporters operate outside India and therefore there will not be a PE in India. In such a scenario, commission earned by them would not be taxed in India.

In SPAHI Projects (P.) Ltd. (supra), the AAR held that income received by the non-resident on account of commission paid by the resident is not chargeable to tax in India by virtue of Article 7 of the India-South Africa Tax Treaty and therefore the payer is not obliged to deduct tax at source u/s.195 of the Act.

2.2    Can commission paid to a non-resident be classified as Professional Fees?

In case of ACIT v. Meru Impex (supra) the assessee claimed benefit of Article 15 of the India-USA Tax Treaty which provides that income of a USA tax resident from the performance in India of professional services or other independent activities of a similar character shall be taxable only in the USA as the non-resident agent did not have a fixed base in India, nor did his stay in India exceeded 90 days. Incidentally India-USA treaty requires two conditions to be satisfied to claim exemption from tax in the State of source, which are:

(i)    non-existence of fixed base, and
(ii)    stay of 90 days or less in the relevant taxable year, in the State of Source.

The assessee relied on the term ‘other independent activities of a similar character’ to classify commission income into professional income and claimed exemption in India. However, the Mumbai Tribunal rightly observed that though the definition of ‘Professional Services’ is not exhaustive, it contemplates existence of professional skill and performance of such professional skill for which they receive payments. In absence of relevant details, the matter was remanded back to the AO for fresh determination. Interestingly, the CIT (Appeals) had granted benefit of Article 15 to the NR agent on the ground that he did not have a fixed base in India.

2.3    Can commission paid to a non-resident be classified as ‘Other Income’ falling under Article 21?

Almost every tax treaty contains a residuary clause, namely, ‘Other Income’ which gives right of taxation to both the countries (as per majority of Indian tax treaties). This Article covers income not dealt with in any other Articles of the concerned tax treaty.

In Rajiv Malhotra’s case (2006) 284 ITR 564 (AAR) the overseas agent rendered services abroad in respect of an exhibition to be organised in India. On the facts of the case, the AAR held that “though the agent rendered services abroad and pursued and solicited exhibitors there, the right of the agent to receive the commission arose in India only when the exhibitor participated in the Food and Wine Show to be held in India and made full payment to the applicant in India. The commission income would, therefore, be taxable in India, as income arising from a ‘source of income’ in India in view of the specific provisions of section 5(2)(b) read with section 9(1) of the Income-tax Act, 1961. The facts that the agent rendered services abroad in the form of pursuing and soliciting participants and that the commission was to be remitted to him abroad were wholly irrelevant for the purpose of determining the situs of the income”.

Surprisingly, AAR applied Article 23 on ‘Other Income’ to commission income instead of Article 7 on Business Profits and held that “paragraph 3 of Article 23 of the Agreement for the Avoidance of Double Taxation between India and the French Republic was at par with the provisions of section 5(2) read with section 9(1) and did not grant any further benefit”.

In our humble opinion, with due respect, this decision needs reconsideration. In any case, being advance ruling, it is case specific and therefore it does not render any binding precedent.

2.4    Taxability of commission paid to a non-resident for events held in India

CBDT Circular Nos. 23 of 1969 and 786, dated 7-2-2000 dealt with commission paid to foreign agents of Indian exporters. Therefore, a question often arises as to their applicability to payment of commission otherwise than for exports. However, in the case of ADIT(IT) v. Wizcraft International Entertainment Pvt. Ltd., (2011) 43 SOT 470 (Mum.), the Mumbai Tribunal held that “Though, the above Circular (i.e., Circular No. 786, dated 7-2-2000) is issued in the context of commission paid to foreign agent of Indian exporters, it applies with equal force to commission paid to agents for services rendered outside India”.

In this case one Mr. Colin Davie, a resident of UK earned commission from co-ordinating an entertainment event which was performed in India. The Mumbai Tribunal held that no income is deemed to accrue or arise in India in view of the fact that the services were rendered outside India. The Tribunal also rejected the argument of the Income-tax Department that the income of Mr. Davie be taxed under Article 18 of the India-UK Tax Treaty (dealing with income of ‘Artists and Athletes’) as Mr. Davie neither took part in events during the dates of engagements, nor did he exercise any personal activities in India. It further observed that the income of Mr. Davie by way of commission does not relate to the services of entertainer/artiste. The Tribunal held that the commission income was in the nature of Business Income and was not taxable in India in absence of a PE.

3.    Whether written agreement is crucial to establish commission payment and to get deduction thereof

In ACIT v. Meru Impex, (2011) 16 taxmann.com 219, the Mumbai Tribunal held that “if the services rendered are established, then the assessee would be entitled to claim deduction on account of commission paid. The existence or non-existence of written agreement would not be fatal to claim deduction on account of expenditure on account of commission. Therefore, the finding of the Assessing Officer with regard to the agreement being a sham document cannot be sustained and in any event, they are irrelevant”.

4.  Conclusion

The law on taxability of commission income of foreign agents of Indian exporters does not seem to have altered with withdrawal of the CBDT Circulars. In view of the clear provisions of the Act as well as decisions of Tribunals, Courts and AAR one can conclude that carrying on of business operation in India is crucial to result in a BC and in case of foreign agents where services are rendered outside India, commission cannot be said to be accruing or arising in India [refer the Supreme Court’s observations in case of Carborandum Co. at para 1.1 (v) (supra)]. In fact, even in a case where the event had taken place in India [refer the decision of the Mumbai Tribunal in the case of Wizcraft International Entertainment Pvt. Ltd. at para 2.4 (supra)], no income was deemed to accrue in India as long as services were rendered outside India.

The AAR has recently rendered a Ruling dated 22.02.2012, in the case of SKF Boilers and Driers Pvt. Ltd. (AAR No. 983-983 of 2010), wherein the AAR has held that such Export Commission is taxable in India u/s 5(2)(b) r/w Section 9(1)(i) of the Act. As the Applicant was not present and the Ruling was rendered in absentia, the correct position in Law as discussed above and the catena of decisions favourable to the Assessee (listed in Para 1.1 above) could not be presented and considered by the AAR, which followed its own Ruling in Rajiv Malhotra [284 ITR 564 (AAR) refer Para No. 2.3 above] but ignored its Ruling in SPAHI Projects (P.) Ltd. [2009] 183 TAXMAN 92 (AAR) discussed in Para Nos. 1(iv) and 1.5 above. In our humble opinion, if the correct position in Law and the relevant favourable case laws were presented and considered by the AAR, the Ruling could have been different.

As far as applicability of provisions of section 195 are concerned, the Supreme Court [in the case of GE India Technology, para 1.1 (supra)] has held that they are applicable only if income is chargeable to tax. The taxpayer can refrain from deducting tax at source if according to him the income is not chargeable to tax in India in the hands of the non-residents.