TDS UNDER SECTION 195 IN POST-MLI SCENARIO

In our earlier articles of June, August and September, 2018, we had covered the various facets of TDS under section 195 of the Income-tax Act, 1961 (the Act), including some practical issues on the same. With the increase in global trade, TDS on payments to non-residents has gained importance in recent years. The year 2020 was unforgettable for various reasons – the ongoing pandemic and the lockdown that followed being one of them. However, the international tax landscape in India also underwent a significant change in 2020 with the Multilateral Instrument (MLI) coming into effect on 1st April, 2020. The MLI has modified various DTAAs. Further, the return to the classical system of taxing dividends and the abolishment of the Dividend Distribution Tax regime in the Finance Act, 2020 also extended the scope of TDS u/s 195 as dividend payments hitherto were not subject to such TDS by virtue of the exemption u/s 10(34).

Given the host of changes that the world, particularly the tax world, has undergone in 2020, this article attempts to analyse the impact of these changes on compliance u/s 195 especially for a practitioner who is certifying the taxability of foreign remittances in Form 15CB.

1. BACKGROUND

Section 195 requires tax to be deducted at the ‘rates in force’ in respect of interest or ‘other sum chargeable under the provisions of this Act’ in respect of payment to a non-resident. Further, section 2(37A), defining the term ‘rates in force’ in respect of income subject to TDS u/s 195 refers to the rate specified in the Finance Act of the relevant year, or the rate as per the respective DTAA in accordance with section 90. Therefore, TDS u/s 195 in theory results in the finality of the tax deducted on the income chargeable to tax in India in respect of a non-resident recipient as against the TDS under the other provisions of the Act, wherein TDS is only a form of collection of tax in advance and does not signify the final amount of tax payable in the hands of the deductee. This finality of the tax places a higher responsibility on a professional certifying the taxability u/s 195(6) in Form 15CB. Further, given the penal provisions for furnishing inaccurate information u/s 195, it is extremely important for a practitioner issuing Form 15CB to keep himself updated on the various changes in the international tax world. The ensuing paragraphs seek to address the practical issues arising on account of the recent changes in the international tax arena.

2. UNDERTAKING TDS COMPLIANCE BEFORE MLI

Before evaluating the impact of MLI on undertaking TDS compliances u/s 195, it may be worthwhile to briefly evaluate some of the best practices a professional would follow to avail the benefit under the DTAA before the MLI was effective.

While our earlier articles have covered most of these practices, in order to get a holistic view of the matter the same have been briefly covered below.

i. Tax Residency Certificate (TRC)
Section 90(4) provides that the benefit of a DTAA shall be available to a non-resident only in case such non-resident obtains a TRC from the tax authorities of the relevant country in which such person is a resident.

While the provision seeks to deny benefits of a DTAA to a non-resident who does not provide a valid TRC, the Ahmedabad Tribunal in the case of Skaps Industries India (P) Ltd. vs. ITO [2018] 94 taxmann.com 448 (Ahmedabad – Trib.) held that section 90(4) does not override the DTAA and, therefore, if the taxpayer can substantiate through any other document his eligibility to claim the benefit under the DTAA, the said benefit should be granted to him. One may refer to our article in the August, 2018 issue of this Journal for a detailed discussion on the ruling. In a recent decision, the Hyderabad Tribunal in the case of Sreenivasa Reddy Cheemalamarri vs. ITO [2020] TS-158-ITAT-2020 (Hyd.) has also followed the ruling of the Ahmedabad Tribunal in Skaps (Supra).

However, from the perspective of deduction u/s 195, it is always advisable to follow a conservative approach and therefore in a scenario where the recipient has not provided a valid TRC, the benefit under the DTAA may not be granted. The recipient would always have the option of filing a return of income and claiming refund and substantiating the eligibility to claim the benefit of the DTAA before the tax authorities, if required.

Further, if the TRC does not contain all the information as required in Rule 21AB of the Income-tax Rules, 1962 (Rules), one needs to also obtain a self-declaration from the recipient in Form 10F.

As TRC generally contains the residential status of the recipient as on the date of certificate or for a particular period, it is important that one obtains the TRC and Form 10F which is applicable for the period in which the transaction is undertaken.

ii. Declarations
In addition to the TRC, one generally also obtains the following declarations before certifying the taxability of the transaction u/s 195:
a.    Declaration that the recipient does not have a PE in India and if a PE exists, the income from the transaction is not attributable to such PE;
b.    Declaration that the main purpose of the transaction is not tax avoidance. However, one also needs to evaluate the transaction in detail and not merely rely on the declaration under GAAR as one needs to be fairly certain of the taxability before certifying the same;
c.    Declaration in respect of specific items of income that the recipient is the beneficial owner of the income and that it is not contractually or legally obligated to pass on the said income to any other person;
d.    Declaration that the Limitation of Benefits (LOB) clause, if any, in the DTAA has been met. Similar to the above declarations, one needs to evaluate the transaction in detail to ensure that the transaction or the recipient, as the case may be, satisfies the conditions mentioned in the LOB clause and not merely rely on the declaration.

3. IMPACT ON ACCOUNT OF MLI

i. Background of the MLI
Following the recommendations in the Base Erosion and Profit Shifting (BEPS) Project of the OECD in which discussion more than 100 countries participated, the MLI, a document which seeks to modify more than 3,000 bilateral tax treaties (modified tax treaties are called Covered Tax Agreements or CTAs), was released for ratification. India is one of the nearly 100 countries which are signatories to the MLI.

India signed the MLI on 7th June, 2017 and deposited the ratified document along with a list of its Reservations and Options on 25th June, 2019. Article 34(2) of the MLI provides that the MLI shall enter into force for a signatory on the first day of the month following the expiration of a period of three calendar months from the date of deposit of the ratified instrument. In the case of India, therefore, the MLI entered into force on 1st October, 2019.

Further, Article 35(1)(a) of the MLI provides that the MLI shall come into effect in respect of withholding taxes on the first day of the calendar year (or financial year in the case of India) that begins after the latest date on which the MLI enters into force for each of the Contracting Jurisdictions to the CTA. In other words, the MLI shall have an effect of modifying a particular DTAA on the first day of a calendar year (or financial year) beginning after the MLI has entered into force for both the countries which are signatory to the DTAA.

As the MLI has entered into force for India in October, 2019, it has come into effect and would result in the modification to the DTAA from 1st April, 2020 where the MLI has entered into force for the other signatory to the DTAA prior to 1st April, 2020 as well. The MLI had entered into force for many Indian treaty partners in 2019 or earlier and therefore the MLI has come into effect for those DTAAs from 1st April, 2020.

India has listed 93 of its existing DTAAs to be modified by the MLI. However, as the MLI works on a matching concept, the respective DTAA would be modified only if both the countries, signatories to the DTAA, have included the said DTAA in their final list of treaties to be modified. For example, while India has included the India-Germany DTAA in its final list, Germany has not and therefore the India-Germany DTAA will not be modified by the MLI. Some of the other notable Indian DTAAs which are not modified by the MLI are those with the USA, Brazil and Mauritius. Similarly, out of the 95 signatories to the MLI, as on date 59 countries have deposited the ratified document. Moreover, out of the 59 countries which have deposited the document, some of them have done so only recently and therefore it is important at the time of undertaking compliance of section 195 and dealing with a DTAA to verify whether the DTAA has been modified by the MLI and, if so, from which date. One can use the MLI Matching Database on the OECD website to know whether a particular DTAA has been modified and from which date.

Treaty Partner	Whether modified by MLI	Effective date for withholding taxes from when MLI modifies DTAA 1
Albania	Yes	1st April, 2021
Armenia	No	NA
Australia	Yes	1st April, 2020
Austria	Yes	1st April, 2020
Bangladesh	No	NA
Belarus	No	NA
Belgium	Yes	1st April, 2020
Bhutan	No	NA
Botswana	No	NA
Brazil	No	NA
Bulgaria	No	NA
Canada	Yes	1st April, 2020
China (People’s Republic of)	No	NA
Colombia	No	NA
Croatia	No	NA
Cyprus	Yes	1st April, 2021
Czech Republic	Yes	1st April, 2021
Denmark	Yes	1st April, 2020
Egypt	Yes	1st April, 2021
Estonia	Yes	1st April, 2022
Ethiopia	No	NA
Fiji	No	NA
Finland	Yes	1st April, 2020
France	Yes	1st April, 2020
Georgia	Yes	1st April, 2020
Germany	No	NA
Greece	No	NA
Hong Kong (China)	No	NA
Hungary	No	NA
Iceland	Yes	1st April, 2020
Indonesia	Yes	1st April, 2021
Iran	No	NA
Ireland	Yes	1st April, 2020
Israel	Yes	1st April, 2020
Italy	No	NA
Japan	Yes	1st April, 2020
Jordan	Yes	1st April, 2021
Kazakhstan	Yes	1st April, 2021
Kenya	No	NA
Korea	Yes	1st April, 2021
Kuwait	No	NA
Kyrgyz Republic	No	NA
Latvia	Yes	1st April, 2020
Libya	No	NA
Lithuania	Yes	1st April, 2020
Luxembourg	Yes	1st April, 2020
Macedonia	No	NA
Malaysia	No	NA
Malta	Yes	1st April, 2020
Mauritius	No	NA
Mexico	No	NA
Mongolia	No	NA
Montenegro	No	NA
Morocco	No	NA
Mozambique	No	NA
Myanmar	No	NA
Namibia	No	NA
Nepal	No	NA
Netherlands	Yes	1st April, 2020
New Zealand	Yes	1st April, 2020
Norway	Yes	1st April, 2020
Oman	Yes	1st April, 2021
Philippines	No	NA
Poland	Yes	1st April, 2020
Portugal	Yes	1st April, 2021
Qatar	Yes	1st April, 2020
Romania	No	NA
Russian Federation	Yes	1st April, 2020
Saudi Arabia	Yes	1st April, 2021
Serbia	Yes	1st April, 2020
Singapore	Yes	1st April, 2020
Slovak Republic	Yes	1st April, 2020
Slovenia	Yes	1st April, 2020
South Africa	No	NA
Spain	No	NA
Sri Lanka	No	NA
Sudan	No	NA
Sweden	Yes	1st April, 2020
Switzerland	Yes	1st April, 2020
Syria	No	NA
Tajikistan	No	NA
Tanzania	No	NA
Thailand	No	NA
Trinidad & Tobago	No	NA
Turkey	No	NA
Turkmenistan	No	NA
Uganda	No	NA
Ukraine	Yes	1st April, 2020
United Arab Emirates	Yes	1st April, 2020
United Kingdom	Yes	1st April, 2020
Uruguay	Yes	1st April, 2021
USA	No	NA
Uzbekistan	No	NA
Vietnam	No	NA
Zambia	No	NA

As highlighted earlier, the above list of DTAAs modified is only as on 15th January, 2021, therefore it is advisable to review the latest list and positions as on the date of the transaction.

The MLI has introduced various measures to combat tax avoidance in DTAAs. While some of the measures are objective, there are certain subjective measures as well and can lead to some ambiguity for a payer who is required to deduct TDS as one needs to evaluate various factual aspects of the income as well as the recipient, which may not always be available with the payer to conclude on the applicability of such measures to a particular payment.

While MLI is a vast subject, the ensuing paragraphs seek to evaluate the impact of the MLI on undertaking compliance u/s 195 and the challenges thereof. Accordingly, there may be some provisions of the MLI, for example, the clause relating to method to be employed for elimination of double taxation, which would not have an impact on TDS u/s 195 and therefore have not been covered in this article. Another similar example is the modification relating to dual resident entities (other than individuals), wherein the provisions of section 195 would not apply as payment to such a dual resident entity (thereby meaning a resident of India under the Act as well as the other country under its domestic tax law) would be considered as payment to a resident and not to a non-resident under the Act.

ii. Principal Purpose Test (PPT)
Article 7 of the MLI provides that ‘Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.’

Therefore, the PPT test acts as an anti-avoidance provision in a treaty scenario and seeks to deny a benefit under a DTAA if it is reasonable to conclude that obtaining the said benefit was one of the principal purposes of the arrangement or transaction. However, it may be highlighted that the PPT and GAAR, although having similar objectives, operate differently. Further, the PPT has a wider coverage as compared to GAAR and therefore a transaction which satisfies GAAR may not satisfy the PPT, resulting in denial of the benefit under the DTAA.

a. Issue 1: How does the PPT impact the compliance u/s 195
The first issue one needs to address is whether the PPT has any impact on the TDS u/s 195. As the PPT seeks to address the issue of eligibility of a taxpayer to obtain the benefit of a CTA, it would impact the tax to be deducted in cases where the DTAA benefit is claimed at the time of deduction.

In other words, if one is applying a DTAA (which has been modified by the MLI, thereby making it a CTA) on account of the beneficial provision under the DTAA at the time of undertaking TDS, one would need to ensure that the PPT test is satisfied to claim the benefit of the DTAA / CTA.

The second aspect that needs to be addressed in this issue is whether the payer needs to evaluate the applicability of the PPT at the time of deduction of tax u/s 195 or can one argue that the PPT needs to only be applied by the tax authorities at the time of assessment of the recipient of the income.

In order to address this aspect, one would need to refer to section 163(1)(c) which makes the payer an agent of the non-resident recipient. Moreover, as highlighted earlier, unlike the other TDS provisions in the Act, in most cases section 195 in theory results in the finality of the tax being paid to the government in the case of payment to a non-resident.

Therefore, the Act places a significant onerous responsibility on the payer to ensure that the due tax is duly deducted u/s 195 in the case of payments to a non-resident. Keeping this in mind, it is therefore necessary for the payer to apply the PPT while granting treaty benefits at the time of deduction of tax u/s 195.

b. Issue 2: How can one apply the PPT while undertaking compliances u/s 195
Once it is determined that the PPT needs to be evaluated at the time of application of section 195, the main issue which arises is that the PPT being a subjective intention-based test to determine treaty eligibility, how can one apply the same while undertaking compliance u/s 195 and what documentation should one obtain while certifying the taxability of the said transaction? As highlighted earlier, the major challenge in application of a subjective test at the time of withholding is that the payer and the professional certifying the taxability of the transaction u/s 195 are not aware of all the facts to conclude one way or another.

There are three views to address this issue.

View 1: Given the onerous responsibility tasked on the payer to collect the tax due on the transaction in the hands of the non-resident recipient and the subjective nature of the PPT, one can consider following a conservative approach by not providing any benefit under the DTAA at the time of deducting tax u/s 195 and asking the recipient to claim a refund of the excess tax deducted by filing a return of income. This would ensure that if any benefit under the DTAA is eventually claimed (by way of the recipient seeking a refund), the payer and the professional certifying the taxability are not responsible and the tax authorities can verify the subjective PPT in the hands of the recipient, who can provide the necessary information to satisfy the PPT directly to the tax authorities.

While this view is a conservative view, it may not always be practically possible as in many cases the recipient may not be willing to undertake additional compliance of filing a return of income, especially in a scenario where there is no tax payable under the DTAA.

View 2: Another conservative view is to approach the tax authorities to adjudicate on the issue by following the provisions of section 195(2) or section 197. This would eliminate any risk that the payer or the professional may undertake. However, this may not always be practically possible as there would be a delay in the remittance and this process is time-consuming, especially in scenarios where the payer makes many remittances to various parties during the year as this would entail approaching the tax authorities before every remittance.

View 3: Alternatively, as is the case with other declarations such as a ‘No PE declaration’ or a beneficial ownership declaration, one can take a declaration that obtaining the benefit under the DTAA is not one of the principal purposes of the arrangement or the transaction.

As per this view, the question arises whether such a declaration is to be obtained from the payer or from the recipient. The PPT needs to be tested qua the transaction as well as qua the arrangement. While the payer would in most cases be aware whether the principal purpose of a transaction is to avail DTAA benefits, an arrangement being a wider term may not entail the payer in necessarily being aware of all the details. Therefore, one must ensure that the declaration is to be obtained from the recipient of the income which is claiming the DTAA benefits.

This view is a practical one and follows the doctrine of impossibility, whereby in the absence of facts to the contrary it is not possible for a professional to certify that the transaction is designed to avoid tax and, therefore, the benefit of the DTAA should not be granted. While the payer would be aware whether the principal purpose of the transaction (not necessarily the arrangement) is to obtain benefit of the DTAA, in the absence of any facts provided to the professional, it is not possible for a professional to suspect otherwise.

Further, the Supreme Court in the case of GE India Technology Centre (P) Ltd. vs. CIT [2010] 193 Taxman 234 (SC) held, ‘(7)….where a person responsible for deduction is fairly certain then he can make his own determination as to whether the tax was deductible at source and, if so, what should be the amount thereof.’

Therefore, where the payer is ‘fairly certain’ having regard to the facts and circumstances about the taxability of a particular transaction, one need not approach the tax authorities.

However, it is advisable for a professional certifying the taxability of the transaction to question the nature of the transaction from an anti-avoidance perspective before taking the declaration or management representation. For example, if the transaction is towards payment of dividend by an Indian company to a Mauritian company, if such Mauritian company was set up at the time when the DDT regime was applicable, it may give credence to the fact that the investment through Mauritius was not made with the principal purpose of obtaining the DTAA rate on dividends paid.

In other words, the professional would need to question and evaluate, to the extent practically possible, as to why a particular transaction was undertaken in a particular manner and with adequate documentation to substantiate such reasoning. Such an evaluation may be required as unlike an audit report, where one provides an ‘opinion’ on a particular aspect, Form 15CB requires a professional to ‘certify’ the taxability after examination of relevant documents and books of accounts.

iii. Holding period for dividends
Article 8(1) of the MLI provides that, ‘Provisions of a Covered Tax Agreement that exempt dividends paid by a company which is a resident of a Contracting Jurisdiction from tax or that limit the rate at which such dividends may be taxed, provided that the beneficial owner or the recipient is a company which is a resident of the other Contracting Jurisdiction and which owns, holds or controls more than a certain amount of the capital, shares, stock, voting power, voting rights or similar ownership interests of the company paying the dividend, shall apply only if the ownership conditions described in those provisions are met throughout a 365-day period that includes the day of the payment of the dividends….’

Accordingly, Article 8(1) of the MLI restricts the participation exemption or benefit granted to a holding company receiving dividends to cases where the shares have been held by the holding company for at least 365 days, including the date of payment of dividends. Such provision, therefore, denies the benefit of the lower tax rate to a company shareholder who has acquired the shares for a short period only to meet the minimum holding requirement for availing such benefit.

This provision, being an objective factual test to avail the benefit of lower tax rate on dividends under the DTAA, can be examined by the professional certifying the tax u/s 195 as this information, being information regarding the shareholding of the Indian payer company, is readily available with the payer company.

However, it may be highlighted that the provision requires the holding period to be maintained for any period which includes the date on which the dividend is paid and not necessarily the period preceding the date of payment of dividend.

For example, Sing Co acquires 50% of the shares of I Co on 1st January, 2021. The dividend is declared by I Co on 30th June, 2021. In this case, while the 365-day holding period has not been met on the day of payment or declaration of dividend, the holding period requirement under Article 8(1) of the MLI would still be satisfied if Sing Co continued holding the said shares till 31st December, 2021 and would still be eligible for the lower rate of tax.

This gives rise to an issue to be addressed as to whether the lower rate of tax under Article 10(2)(a) of the India-Singapore DTAA should be considered at the time of undertaking the TDS compliance at the time of payment of dividend.

In our view, as on the date of the dividend payment the number of days threshold has not been met, the benefit of the lower rate of tax under Article 10(2)(a) of the DTAA should not be granted and TDS should be deducted in accordance with Article 10(2)(b) of the DTAA. In such a scenario, Sing Co can always file its return of income claiming a refund of the excess tax deducted once it satisfies the holding period criterion.

iv. Permanent Establishment (PE)
The MLI has extended the scope of the definition of a PE under a DTAA to include the following:
a.     A dependent agent who does not conclude contracts on behalf of the non-resident will still constitute a PE of the non-resident if such agent habitually plays a principal role in the conclusion of contracts of the non-resident.
b.     The exemption from the constitution of a PE provided to certain activities undertaken in a Source State through a fixed place of business would not be available if the activities along with activities undertaken by a closely-related enterprise in the Source State are not preparatory or auxiliary in nature.
c.     In the case of a construction or installation PE, the number of days threshold that needs to be met will include connected activities undertaken by closely-related enterprises as well.

Now the question arises, how does a professional identify the applicability of the extended scope of the definition of PE in remittances to non-residents and whether a mere declaration that a PE is not constituted would be sufficient.

With regard to point (a) above, for the extended scope of PE in respect of the transaction itself, one should be able to identify the facts of the said transaction before certifying the taxability thereof and a mere declaration on this aspect may not be sufficient.

Similarly, with regard to points (b) and (c) above, one may be able to analyse the applicability of the MLI in case of transactions undertaken by the non-resident recipient himself in India as they would relate to the transaction the taxability of which is to be certified. However, with regard to the activities undertaken by the closely-related enterprises, one may be able to follow the doctrine of impossibility and obtain a declaration from the recipient provided one has gone through all the relevant documents related to the transaction itself.

4. STEP-BY-STEP EVALUATION
Having understood the impact of the MLI on the compliances to be undertaken u/s 195, the table below provides a brief guidance on the step-by-step process that a professional needs to follow before certifying
the transaction in Form 15CB once it is determined that the DTAA is more beneficial than the taxability under the Act:

Step number	Particulars
1	Obtain TRC from recipient (check whether TRC is a valid TRC for the period in which the transaction is undertaken)
2	Obtain Form 10F if TRC does not contain information as required in Rule 21AB of the Rules (check whether Form 10F is for the period in which the transaction is undertaken)
3	Check whether GAAR provisions apply to the said transaction and obtain suitable declaration
4	Check whether any specific LOB clause in the DTAA applies. If so, whether the conditions for LOB have been met and obtain suitable declaration
5	Check whether DTAA modified by MLI as on date of transaction (follow steps 6 to 7 if MLI modifies DTAA)
6	Check whether the conditions of PPT are satisfied and obtain suitable declaration
7	In case of dividend income earned by a company, verify if the holding period for the shares is met as on date of transaction
8	Check if the transaction constitutes a PE for the recipient in India or if income from the transaction can be attributable to the profits of any PE of the recipient in India and obtain suitable declaration (in case MLI modifies DTAA, the declaration should include the modified definition of PE)
9	In case of dividend, interest, royalty or income from fees for technical services, check if the recipient is the beneficial owner or if the beneficial owner is a resident of the same country in which the recipient is a resident and obtain suitable declaration

5. CONCLUSION
The introduction of the MLI has added complexities to the process of undertaking compliance u/s 195. A professional who is certifying the taxability would now need to evaluate various other aspects in relation to the transaction to satisfy himself, with documentary evidence, that the various provisions of the MLI have been duly complied with. Further, merely obtaining declarations may not be sufficient as one needs to be fairly certain, after going through the relevant documents, of the taxability of the transaction u/s 195 before certifying the same.

1   The effective date for withholding taxes has been provided
from an Indian
perspective and may vary in the other jurisdiction