We live in a dynamic era where services can be availed from any part of the world using the internet. Businesses today can avail services from professionals or freelancers, who are residents of other countries. But how does one go about making payments to them? Even with a credit card, making payments is not just about ‘one click’ – there are tax matters that you must consider as well. This article will guide you on what you should do before making payments to professionals or freelancers outside India (including what DTAA is all about). What we describe here is just the tip of the iceberg and we advise you to seek professional opinion before you enter into cross border transactions.
In this article we shall as an example consider legal services or technical services provided by a Lawyer resident in the United States of America to an Indian company. Please note that our analysis is based on the Double Taxation Avoidance Agreement (DTAA) between India and USA. Given that DTAAs are entered into with each country separately, the conclusions of this article would not be the same even if similar services are procured from a resident of a different country.
At the first instance, it has to be checked if the services consumed in India are subject to tax in India. The Income Tax Law provides guidelines on what income is or is not subject to tax in India. As you might have guessed correctly, most payments to non-residents are subject to tax in India except where the income clearly does not arise from a source in India.
Legal fee falls under the definition of ‘fee for technical or managerial services’. The norm is that the fee shall be subject to tax in India when the service is used by a resident (in our case the India company); the only exception being that if the service is used in a business or profession outside India, it shall not be taxed in India.
Thus, if the Indian company utilises the services of a lawyer in the USA for its business in South Africa, it shall not be subject to tax in India. However, if the same services are used for its business in India, it will be subject to tax in India.
Does this mean the lawyer in the USA should end up paying taxes in India? As absurd as it may sound, it is true! Thankfully, we have DTAAs to our rescue. DTAAs are agreements signed up between two countries to avoid such absurdities. DTAAs provide the safety net & they will prevail over local tax laws to the extent they are more beneficial to the taxpayer. Thus, in addition to the Income Tax laws of India we also need to refer to the DTAA between India and USA to see if it provides any relaxation on the payment of legal fee.
DTAA and tax relief
A precursor to relief under DTAA is that the service provider, in our case the lawyer resident in USA, should have a Tax Residency Certificate (TRC). This certificate is issued by the tax authorities of the recipient’s country of residence, in our example, USA. If the TRC is not available, the Indian Company cannot apply DTAA provisions, and hence the domestic tax law shall be applicable.
Assuming that the lawyer has a TRC, we have to analyse the provisions of the DTAA to identify the correct Article under which the transaction falls. In our instance case, the transaction falls under Article 15 “Independent Personal Services” of the India-USA tax treaty. The extract is as below:
- Income derived by a person who is an individual or firm of individuals (other than a company) who is a resident of a Contracting State (i.e. USA) from the performance in the other Contracting State(India) of professional services or other independent activities of a similar character shall be taxable only in the first-mentioned State (i.e. USA) except in the following circumstances when such income may also be taxed in the other Contracting State
- if such person has a fixed base regularly available to him in the other Contracting State (i.e. India) for the purpose of performing his activities; in that case, only so much of the income as is attributable to that fixed base may be taxed in that other State (i.e. India); or
- if the person’s stay in the other Contracting State (i.e. India) is for a period or periods amounting to or exceeding in the aggregate 90 days in the relevant taxable year
- The term “professional services” includes independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, surgeons, lawyers, engineers, architects, dentists and accountants.
In the instant case, we can take benefit under Article 15 and no tax shall be payable in India. If the lawyer was not eligible for benefit under DTAA, the said payment would be subject to tax in India.
The payer of any service fee to non-residents has to verify if the said payment would be subject to tax in India. In addition to the Income Tax laws of India, the DTAA between India and the country of residence of the recipient has to be verified. Relief under DTAA can be given only if the TRC is made available. In its absence, the payment would be subject to tax in India and it shall be the responsibility of the payer to withhold such tax before any payment is made.