HP Agrawal: Applicability of treaties on branches of foreign companies

For computing tax liability in India, should the treaty with branch country or that with the head-office country be applied?

The issue for consideration is when an Indian company enters into transactions with a branch of a foreign company, then, for computing tax liability in India, whether the treaty between India and branch-country will apply or the treaty between India and head office-country will apply.

Reference in this regard may be made to the decision of Authority for Advance Rulings (AAR) in the case of Shell Technology India P Ltd, 345 ITR 206. In the said case, an Indian company entered into an agreement with the branch office of a Netherland company which was based in Philippines.

In consideration for the services, the Indian company agreed to make payment to the Philippines branch of the Dutch company on a monthly operation fee basis. The Indian company took the matter to AAR to decide whether the payment made by the Indian company would fall in the category of “fee for technical services” in terms of Article 12 of India-Netherlands tax treaty.

It may be clarified that the real issue for consideration by AAR was whether the India-Netherlands tax treaty would be applicable or whether India-Philippines treaty will be applicable. Interestingly, the legal position is that if India-Netherlands treaty applies then the amount paid by the Indian company to the foreign company would not be taxable in India because of the concept of ‘make available’ prevailing in that treaty.

On the other hand, if India-Philippines tax treaty applies, the amount paid by the Indian company would be taxable in the hands of foreign company because the concept of ‘make available’ does not exist in India-Philippines tax treaty.

The Authority finally ruled that it is the India-Netherlands treaty that will apply because “since the services are rendered by the Netherland company though through its branch in Philippines, the DTAA between India and Philippines would not be applicable”.

However, it needs to be mentioned that the aforesaid ruling of the AAR does not provide any sound legal basis for the decision.

For the purpose of determining whether treaty with branch-country will apply or treaty with head office-country will apply, one has to look at the tax treaty between India and the branch-country as well as the domestic tax law of that country.

In terms of Article 1 of virtually all tax treaties, the tax treaty applies to persons who are ‘residents’ of one or both of the contracting states. The concept of ‘resident’ is dealt with in Article 4 of tax treaties. The treaties which have been designed on the OECD Model Convention contain an additional condition while defining the term “resident” as compared to the treaties which have been designed on UN Model.

While defining the term “resident” the additional condition as aforesaid provides that “This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capitals situated therein”.

Significance of the above condition is that where the treaty seeks to exclude a person from being treated as “resident” who is liable to tax in the Contracting State only in respect of income from sources in that State, a branch office may not qualify as a “resident” of the State where the branch is situated. In such cases, the branch shall be treated as “resident” of the State where the head office of the branch is situated. Therefore, the treaty with head office-country will apply.

Let us take example of an Israel company whose branch is situated in Germany. The India-Germany treaty contains the aforesaid additional condition; therefore, branch of Israel company shall not be treated as resident of Germany, i.e. the place where it is located. The treaty between India-Israel (i.e. head office-country) will apply.

However, in the reverse situation i.e. where the branch is in Israel and the head office is in Germany, branch would be treated as resident of Israel and accordingly, the treaty between India-Israel (i.e. branch country) would apply. This is so because the treaty between India and Israel does not contain the aforesaid additional condition.

The decision of the AAR in Shell Technology case (supra), though correct, has been rendered without referring to the above legal position. As per the decision of the AAR, wherever a transaction is entered into with the branch of a foreign company, the treaty with the head office-country would apply.

However, the correct legal position will depend upon the provisions contained in the domestic law and the treaty with the country where the branch is situated.

Therefore, it appears that until the decision in Shell Technology case (supra) is clarified it would open-up a pandora box of litigation for the foreign companies who make investment in India through their overseas branch.

email: hp.agrawal@sskmin.com