The bad business of taxing agents

Make 'doing business' in India easier by cleaning up how 'business connections' of foreign companies are taxed

The finance minister in his Budget speech said "doing business" in India must be seen as easy, friendly and mutually beneficial, through improved communication that removes any apprehension or distrust in the minds of investors, including fears about undue regulatory burdens or application of tax laws. These fears need to be addressed urgently. Internationally, too, India's reputation is not very strong on this count. A World Bank report in June 2012 ranked India at 132 out of 185 countries in its "Ease of Doing Business" rankings.

To make "doing business" in India easier, one of the desirable steps would be to re-examine some of the income tax provisions concerning taxation of income from "business connections" in respect of non-residents. Application of tax laws becomes coercive, time-consuming, litigious and unproductive if they are not simple, or if they are based on too many presumptions and require too much documentation. The same World Bank report has also given details regarding hours per year spent preparing tax returns under the sub-head "Paying Taxes". In the case of India, "Time (hours per year)" taken in preparing a return is shown at 243. In Singapore, it takes 82 hours. In the UK, France and the US it takes 110, 132 and 175 hours, respectively. Of course, there are many countries where the time taken is much more. However, it does not take into account the time spent in tax compliance and the proceedings before different authorities. Include all that and the time spent paying taxes in India would be colossal.

The only purpose of any tax legislation is to collect revenue by law and under a procedure. It should not be required to delve too far into the semantics of words and phrases used in the Act and, wherever possible, should be settled through a simple process. Making the application of tax laws simple leads to better tax collection. Presumptive taxation is one of the effective ways to attain that objective - especially where vertical equity may not be a consideration, such as in collecting tax from non-residents.

For the sake of illustration, if a foreign company wants to sell its product in India, it may do so directly to a client in India on a principal-to-principal basis, and no income tax is payable in India on the profits earned by it from that sale. But if it appoints an agent in India, it may be headed for a long and argumentative handling of his tax liability in India.

Under the Income Tax Act, all income accruing or arising, whether directly or indirectly, through or from any business connection in India is taxable. If a person in India habitually exercises authority to conclude a contract on behalf of the company or maintains stocks in India for delivery of goods and merchandise or secures orders for it, the business connection is established and profit will attract tax. But it will not be taxable if the agent is of independent status, acts in the ordinary course of his business and does not work mainly or wholly on behalf of the non-resident. Where such income becomes taxable, it has to be further ascertained as to what is the proportion of operations in India over the total global operations of the non-resident to earn that profit. None of these is applicable if the non-resident is engaged in purchase of goods for export purposes.

Will the independence of the agency be judged on an overall basis or on year-to-year basis? In his ordinary course of business, the agent may have acted only for one foreign company in a particular year for lack of business from other principals; or it may be his first year of business even though he is an independent agent. With what accuracy can the proportion of operations in India over global operations be determined, especially if the foreign company is a manufacturing company? Is this not highly presumptive?

According to an earlier Central Board of Direct Taxes (CBDT) circular, where a non-resident had an agent in India but made sales directly to Indian customers, the commission paid by the resident to his agent was not taxable if the agent neither performed nor undertook to perform any service directly or indirectly in respect of the sales. But if sales were secured through the services of an agent in India, the income was taxable but limited to profit attributable to the agent's services if the non-resident's principal business activities were wholly channelled through the agent. In both situations, the contract was to be made outside India on a principal-to-principal basis. How profound, if any, was the difference between "having an agent" and "securing the services of an agent"?

In fact, if the foreign company appoints an agent in India and pays taxable commission to him, there is gain in foreign exchange and in employment opportunities that would not have happened had it sold goods directly. If the agent maintains godowns, warehouses and cold storages to stock their goods and merchandise, construction activities would increase. The man-hours engaged in litigation would be deployed for more productive purposes. More income tax officers would be available for working on tax evasion. All these benefits far outweigh the small addition to tax revenue in such contentious cases.

Therefore, it may be more prudent to do away with such provisions. No income tax need be levied where a foreign company sells its goods and merchandise in India directly or through any agent where there is no value-addition done in India. Alternatively, if such transactions need to be taxed at all, it should be done by prescribing a presumptive income tax rate on sales or otherwise by levying an additional duty on imports. Similar benefits may be secured for the sale of Indian goods and merchandise in foreign countries. Then, trading in India and, for that matter, in the world would be much more easy, friendly and mutually beneficial.

The author is a former Chief Commissioner of Income Tax. These views are his own ak@kurotax.co.in