Karnataka High Court ruling wherein it was held that the payments made for payroll services to a Philippines entity were on account of business income and not taxable in India due to the absence of a permanent establishment (PE) in India.

Brief facts of the case

• Taxpayer is engaged in the business of information technology services. They had entered into a agreement with customer for rendering payroll related services;
• The services to be rendered by the Indian entity were outsourced to its Philippines counterpart. In addition, it had also outsourced certain human resource services to Philippines entity for the project;
• The Assessing Officer(‘AO’) held that the payments made to Philippines entity were in the nature of Fees for Technical Services (‘FTS’) and since the Indian entity had failed to withhold tax under Section 195 of the Income Tax Act, 1961 (‘ITA’), it was assessee-in-default in terms of Section 201(1);
• The CIT(A) confirmed AO’s order. The same was challenged before the Tribunal and it held that the payments made by the Indian entity were not chargeable to tax under the India-Philippines DTAA and thus no tax was required to be deducted. Hence, Revenue appealed before the Karnataka High Court (‘HC’).

Key excerpts from the ruling

• HC observes that as far as the Philippines entity is concerned, it works like a sub-contractor under the Indian entity and earns profit by rendering outsourced payroll services;
• Upholds tribunal’s order holding that the Philippines entity was not rendering any technical service and therefore, the income in the hands of the Philippines entity is a business income;
• Further observes that since the Philippines entity does not have a PE in India, HC opines that tribunal rightly held that as per Article 7(1) and Article 23 of the agreement, the business profit of the Philippines entity shall be taxable only in its State of residence;
• As regards to Tribunal’s finding that Double Taxation Avoidance Agreement (DTAA) does not define FTS, HC states that the question does not arise for consideration as Revenue itself has taken a specific contention that FTS was absent under the India-Philippines Treaty;
• Accordingly held that the payments received by the Philippines entity shall not be liable for TDS under Section 195 and thus the Indian entity cannot be deemed as ‘assessee-in-default’.