22 October 2018 Australian court rules deemed source provision in Indian DTA creates liability to income tax in Australia On 11 October 2018, Australia's Full Federal Court handed down its decision in Satyam Computer Services Limited v Commissioner of Taxation (now an amalgamated entity named Tech Mahindra Limited). The decision, unless successfully challenged in the High Court, provides authority for the Commissioner to apply the deemed source provision in the Indian Double Tax Agreement (DTA), and potentially DTAs more broadly, to create a liability to income tax in Australia absent a domestic tax provision first giving rise to that liability. The decision impacts engineering, software and other companies making outbound payments to India who have an Indian company in the group providing "technical services" (broadly defined) to Australian customers, including Australian affiliate entities. The case involves a DTA with unique features and should not be seen as changing the general approach to the interpretation and application of tax treaties. Impacted cases are very fact specific and businesses need to review their facts to understand their position in light of the Full Federal Court decision. This is particularly so for the engineering sector which tends to exhibit features which may be distinguished from that in Tech Mahindra. The Full Federal Court unanimously held that payments received by the applicant, a resident of India, from its Australian clients that are royalties for the purposes of the Indian DTA (but not under Australian law) are taken to have an Australian source for the purposes of section 6-5 of the Income Tax Assessment Act 1997 (ITAA'97) by application of Article 23 of the Indian DTA and the International Agreements Act (ITAA'53). As a consequence, the payment were considered to be assessable income under Australian law. The Court read the text of Article 23(1) of the Indian DTA as not ambiguous. Its "effect" is given paramountcy by section 4(2) as recognized and affirmed by section 3AA(2) of ITAA'53. The Court further concluded there is nothing in the context, object or purpose of the Indian DTA or ITAA'53 which permits it to be read down to conform with a generalized assertion about the "effect" of tax treaties drawn from outside the text of the Indian DTA. In the Court's view, Article 23 effectively deems income, profits or gains derived by a resident of one country which, under the agreement, may be taxed in the other country, to be income from sources in the latter country for the purposes of the domestic laws of both countries and Article 24 of the Indian DTA. The applicant is a resident of India for tax purposes and carries on a business providing computer technology services to customers. In the income years ended 30 June 2009, 30 June 2010 and 30 June 2011, the applicant had offices in Sydney and Melbourne through which it provided software products and information technology services to entities in Australia. The services provided by the applicant to entities in Australia were performed partly by employees located in Australia and partly by employees located in India. In a related earlier decision, Tech Mahindra Limited v Federal Commissioner of Taxation (2015) 101 ATR 755; [2015] FCA 1082 (Tech Mahindra), the Court held that the payments received by the applicant for the services provided by the employees located in India (the Indian services) were "royalties" as defined in Article 12(3)(g) of the Indian DTA and Australia was given the right to tax those payments under Article 12(2) of the Indian DTA. That decision was upheld on appeal and an application for special leave to appeal was refused by the High Court. The Court also held that the payments were deemed to have an Australian source by virtue of Article 23 of the Indian DTA and section 4(2) of the ITAA'53 and were therefore taxable as Australian source income under section 6-5(3)(a) of the ITAA'97. That conclusion was not challenged on appeal or considered by the Full Court in Tech Mahindra Limited v Federal Commissioner of Taxation (2016) 250 FCR 287. In this further decision, the applicant challenges that conclusion. At issue is whether, where Article 23 applies to an item of income, the item of income is deemed to have an Australian source for the purposes of the law of Australia "relating to its tax." The applicant argued:
The Full Federal Court rejected all submission points including that treaties only ever are "shields not swords." The judges accepted there was "no standalone taxing power" and "independent imposition of taxation arguments" before adding, "none of these generalisations establish the proposition that Article 23 does not operate according to its terms." The Australian Taxation Office (ATO) in a review will seek to assess fees paid by Australian customers to Indian companies for "technical services" as "income received by an Indian company for providing "technical services" to Australian customers as Australian sourced and subject to tax as ordinary income under Article 12(3)(g) of the India-Australia treaty."
Any business with an Indian company in the group providing "technical services" to Australian customers, including Australian affiliated entities, must be aware that the ATO will scrutinize these payments and may wish to review and where appropriate restructure these arrangements. The ATO is selecting businesses for risk review/audit based on the International Dealings Schedule to the Income Tax Return where Australian companies use Indian subsidiaries as a shared services support function. The payments to the related party in that case should not necessarily involve the transfer ("making available" for the purposes of the DTA) of intellectual property (IP) (e.g., engineering companies getting drafting done in India) but the ATO may select businesses for audit based merely on the existence of the outbound payment. This case essentially impacts any Australian company using an Indian provider of "technical services" including related parties or third parties. The payment for such services is potentially a "royalty" as defined under the Indian DTA if it involves the required dealing with IP. While there is no withholding tax requirement, the recipient's income can be deemed to be sourced and taxable in Australia. Businesses should therefore review contracts to see if there's a gross up clause that enables Indian service providers to recharge tax back to Australia customers.
Document ID: 2018-2101 |
