Proper Drafting Of Pacts Can Avoid & #8216;Tax On Tax & #8217;

In certain cases, the Indian party to a collaboration agreement undertakes to pay income-tax payable by the foreign counterpart in India. The tax so paid by the Indian party becomes the income of the foreign party, on which income-tax is again payable in India. Thus, the Indian party not only pays tax on one-time income of the non-resident, it has to pay tax on tax also.

However, with effect from assessment year 1984-85 a new provision [Section 10(6A)] has been inserted in the Income Tax Act providing that where income tax is paid by an Indian concern on behalf of a foreign company, the tax so paid shall not constitute income of the foreign company.

In other words, the Indian concern shall not be required to pay tax on tax. The aforesaid provision is however applicable only to foreign companies in respect of income by way of royalty or fees for technical services.

Besides the provisions of Section 10(6A), a further new section, namely 195A, has been inserted with effect from June 1, 1987 providing for grossing up of the amount for the purpose of deduction of tax at source.

Where the person who is responsible for making payment undertakes to bear the tax liability of the payee, the amount on which tax is to be deducted at source shall be so increased that after deduction of tax at the prescribed rate, the balance payable is the same figure which is payable as per the agreement with that party.

Provisions of Section 10(6A) and Section 195A may be interpreted as being overlapping. For example, if the tax on fees for technical services is payable, under the terms of the agreement, by the Indian concern, the tax so paid shall not be included in the income of the foreign company.

However, Section 195A provides that where tax is payable by the Indian concern, the income by way of fees for technical services shall be increased to such an amount as would, after deduction of tax thereon, be equal to the net amount payable under the agreement.

Thus where Rs 100 is payable as fees for technical services (which is chargeable to tax @ 20 per cent), the figure of payment will be increased to Rs 125 so that after paying tax @ 20 per cent on Rs 125, the net amount payable to the foreign company remains at Rs 100.

On the other hand, as per Section 10(6A), the tax paid by the Indian concern shall not be treated as income of the foreign company. Thus, where Rs 100 is payable to the foreign company, the Indian concern need not gross up the said amount to Rs 125, but pay Rs 100 to the foreign company and Rs 20 to the Indian income tax department.

It would therefore, imply that if the provisions of Section 195A are to be applied, the actual cost to the Indian concern will be Rs 125. But if the provisions of Section 10(6A) are considered as applicable, the cost to the Indian concern will be only Rs 120.

Therefore, as far as agreements for royalty and fees for technical services are concerned, it will be helpful if the agreement is so worded that the same is covered under Section 10(6A) rather than making a