International Tax Alert - PKF

International Tax Alert

Issue seven Summer 2011

Chairman’s Note Welcome to the June 2011 edition of the PKF International Tax Alert (ITA), an online publication that summarises the latest key tax changes from selected countries around the world. In this seventh edition, there are contributions from PKF member firms’ tax experts in 25 countries. The ITA is issued three times per year and can be downloaded from the PKF International website at www.pkf.com

Belgium

3

Chris Peeters explains the special tax measures for shipping

Chile

5

6

9

10

Kai Schöneberger heralds the arrival of the E-Balance Sheet for electronic transmission of tax Accounting 1 // PKF International Tax Alert

19

20

Phillip Dearden introduces the new Isle of Man Foundation

Japan

20

Eiko Nakamoto reviews Japan’s latest tax treaty reforms

11

Malaysia

22

Lee Yiing Ting outlines the latest changes to income tax and indirect taxes

Regina Brejchov outlines the 2011 tax changes

Germany

15

Ireland

Isle of Man

Nicholas Stavrinides describes the new definition of securities exempted from taxation

Czech Republic

India

Sarah Murphy outlines the Finance Act 2011 changes for companies investing in Ireland

Uribe Cristobal explains the major changes to Colombian tax law

Cyprus

14

S Harihan reports on the latest tax court judgements

Edmund Chan sets out the latest changes to Chinese tax law

Colombia

Hungary Vadkerti Krisztián reports on recent developments in corporate income tax

Antonio Melys outlines the new audit process for transfer pricing

China

Jon Hills, Chairman PKF International Tax Committee

13

Mexico

24

Veronica Barba explains the changes to the maquila system for non-residents

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Issue 7 June 2011

Netherlands

26

Jan Roeland discusses the new Dutch Tax Agenda

New Zealand

29

30

40

USA

42

Doug Mueller outlines the opportunities for US subsidiary and parent companies to reduce their tax liabilities using the IC-DISC

31

José Parada Ramos considers the potential impact of the changes to participation exemption provisions

Romania

USA Leo Parmegiani explains the recent developments in foreign bank account reporting (FBAR)

Silvia Raquel Aguero summarises the country’s tax structure

Portugal

38

Jon Hills reviews the latest tax developments

John Dillon picks out the highlights of the 2011 Budget Overview

Paraguay

UK

USA

43

Mike Devereux II promotes the benefits of the Research Tax Credits

32

News in Brief

45

Florentina Susnea sets out the latest changes to corporate tax, income tax and social security contributions

Slovak Republic

35

Richard Budd highlights three points of the 2011 tax law

South Africa

36

Eugene du Plessis on the forthcoming closure of the Voluntary Disclosure Programme (VDP)

2 // PKF International Tax Alert

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Issue 7 June 2011

Belgium Update Maritime Tax Measures

case, the other results remain subject to the common corporate income tax system.

In this article we highlight the aspects of the Belgian special tax measures relating to shipping.

Consequences of the Tonnage Tax System

Principles of the Tonnage Tax System

The qualifying profits of the taxable period are assessed on a daily basis per vessel and per 100 net tons and are not influenced by the real results derived from the exploitation.

Belgian resident companies or Belgian permanent establishments of foreign companies (taxable in Belgium taking into account the double taxation treaty) may opt for the ”tonnage tax” system when calculating their taxable profit. The tonnage tax system applies to the following: ■

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Profit derived from sea-going vessels under the flag of Belgium or another EU member state derived from the transport of persons or goods on international maritime routes, and on routes from and to installations at sea that are intended for the exploitation or exploration of raw materials. The requirement to fly a Member State’s flag does not need to be met if the conditions set out in the Community Guidelines are met. Under certain conditions, profits from sea-going vessels under the Belgian flag which perform towage or dredging activities.

“Exploitation” is defined as: ■

Activities by the owner, co-owner or bareboat charterer of a sea-going vessel which is predominantly managed in Belgium and is not given in bareboat charter

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Provided these activities are significantly smaller than the exploitation as meant in the precedent paragraph: ■

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The calculation of the daily taxable profit is as follows: ■

1,00 EUR for up to 1,000 net tons

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0.60 EUR for between 1,000 net tons and 10,000 net tons

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0.05 EUR for over 40,000 net tons (only applicable if certain conditions are met).

Capital gains or losses at the moment of the alienation of the vessels are also deemed to be included in the profit, calculated on the tonnage basis. Tax losses or other deductible items originating from a period during which the profits were not calculated based on the tonnage or originating from an activity outside the scope of the tonnage tax system, cannot be offset against the profits calculated under the tonnage tax system.

commercial exploitation of a sea-going vessel of another owner etc exploitation of a sea-going vessel via a time or a voyage charter.

As indicated above, the tonnage tax system is optional. A formal request has to be submitted to the Belgian Ruling Commission. If the request is granted, the “tonnage tax” system will apply for a period of ten years, with an automatic renewal every ten years. When a company has different activities, the request can be introduced for the determination of the taxable profit of the branch of activity that exploits the sea-going vessels. In that 3 // PKF International Tax Alert

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Issue 7 June 2011

Belgium Update continued

Other Belgian tax measures Shipping companies are not likely to opt for the tonnage tax system if the company has already been active in Belgium and has accumulated substantial losses which cannot be offset against profits calculated under the tonnage tax system. For these companies, other measures have been introduced to encourage the Belgian maritime sector. These include a special amortisation scheme, an exemption from capital gains on the realisation of sea-going vessels, and an investment deduction.

Conclusion If certain conditions are met, the taxable profit derived from the exploitation of sea-going vessels can be based on the tonnage of the vessels concerned. This leads to a very low effective tax rate. When taking into account the other favourable tax measures, we conclude that Belgium has implemented attractive tax incentives to the maritime shipping sector, even if shipping companies do not wish to opt for the tonnage tax system.

For more details please contact: Chris Peeters or Kathleen Van Elsacker PKF Belgium T: +32 (0)2 242 11 41 F: +32 (0)2 242 03 45 E: [email protected] or [email protected]


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Issue 7 June 2011

Chile Update New audit process for transfer pricing

The Director of the IRS has recently announced that the Service has begun an audit process on these types of operations. He has explained that Article 38 of the Income

Article 38 of the Income Tax Law sets out the regulations on transfer pricing which have not been changed since 2002.

Tax Law is a facility for the IRS to assess the value of an operation as if it had been made between non-related parties. To do this, the methods based on the OECD

The regulations are intended to give the Internal Revenue Service (IRS) the power to justifiably object to transfer pricing if they have the documentation that, according to reasoning,

model will be applied, considering its advantages and disadvantages according to the case. Tax auditors are being trained on the subject and have recently finished a course on the new Chapter IX of the OECD Transfer

analysis and logical consistency, allows them to assign another value to the transfer or the prices received or paid

Pricing Guide on entrepreneurial groups’ reorganisations.

between related companies, according to the terms of the The IRS has not given specific instructions on how taxpayers

law, if one of the companies is established abroad.

can demonstrate that prices have been fixed properly from For tax purposes, the IRS has pointed out that the above

the tax point of view. However, regardless of which method has been applied, reliable documentation that provides

prices shall be called “transfer pricing” and includes

supporting evidence under a tax audit shall be crucially

concepts such as the purchase and sales of goods, the

important to prove that its price is not out of the line with

provision of services and technology transfer as well as

the regular market prices between non-related parties.

the authorisation for the temporary use of licences and trademarks. Broadly speaking, transfer pricing are those

For more details please contact:

paid or received for the transfer of goods or services between companies which are part of a multinational group. Immediately after the last legal regulations on transfer pricing had been passed, the IRS published instructions clarifying its approach on the topic and giving examples of several

Antonio Melys Tax Division Director PKF Chile Auditores Consultores Ltda T: +56 2 650 43 00 E: amelys@pkfchile

cases and procedures to determine whether the operation has been carried out under the principle internationally known as “arm’s length”.


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Issue 7 June 2011

China Update Corporate Income Taxes (CIT) treatment on asset transfer income and certain other income derived by enterprises (SAT Announcement [2010] No.19) On 27 October 2010, the State Administration of Taxation (SAT) issued SAT Announcement [2010] No. 19 (Announcement 19) clarifying CIT treatment on certain income including asset transfer income derived by enterprises. According to Announcement 19, when an enterprise has income from transfer of property (including various types

State Admission of Taxation (SAT) clarifies various CIT issues on cross-border transactions

of assets, equities and debts, etc), debt restructuring, donations and irrecoverable debts, regardless of whether

SAT Announcement [2011] No.24 (Announcement 24) was

they are monetary or non-monetary, such income should be

issued on 28 March 2011 to supplement the content of

treated as one-off income and calculated into the taxable

Guoshuihan [2009] 698. The purpose of this announcement

income of the year when such income is recognised.

is to control treaty shopping and tax avoidance by nonresident companies. The following five clauses are covered

Announcement 19 shall become effective on the 30th day after the issuance day. For the aforesaid income which has

in the Announcement 24: ■

Income is recognised as taxable income on the seller

adopted the five-year average amortisation method during

side for a direct transfer of equity settled by instalments

the period from 1 January 2008 to the date of

when 1) share transfer agreement becomes effective

implementation of Announcement 19, the remaining

and 2) share alteration registration is completed.

balance which has not been included in CIT calculation shall be recognised as the taxable income of the current year (i.e.

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Public share exemption defined as share transaction without pre-agreed transaction parties, volume and price.

the year of 2010) and complete the CIT payment. ■

An explanation that “effective controlling party” refers

Taxpayers who generated aforesaid income should consider

to the party that transfers the PRC equity indirectly;

the impact of Announcement 19 and change the practice

“effective tax” refers to the effective tax on the specific

accordingly.

transaction; “exempt tax” refers to those cases where the transaction is not subject to the income tax. ■

When multiple offshore parties indirectly transfer their equities, one representative party can complete tax filing on behalf of all parties.

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For a deal involving multiple PRC target companies, the Issue 7 June 2011

China Update continued

seller can select one representative tax authority among PRC target companies for combined filing. The selected

Expanding the scope of companies which can adopt "VAT exempt, offset and refund" method

tax authority will co-ordinate among other authorities in determining whether it is a tax case. If the transaction

SAT Announcement [2011] No. 18 (Announcement 18)

is deemed to be taxable, filing shall need to be prepared

was issued on 23 March 2011 to clarify the scope of “VAT

separately at the different locations of the PRC target

exempt, offset and refund” method. If companies are

companies.

engaged in the design of integrated circuits, software and animation (the Companies) or recognised as non-small

Announcement 24 also confirms the CIT treatments for

scale High and New Technology Enterprises (the HNTEs)

certain PRC-sourced income derived by non-residents:

for more than two years, they can adopt the "VAT exempt,

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offset and refund" method under the following conditions:

Timing to withhold tax on passive income including interest, rent and royalties, etc.

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■

■

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PRC-sourced guarantee income would be treated as

companies for Companies and HNTEs but were

interest in the nature and subject to the CIT.

originally designed by Companies and HNTEs

Transfer of land-use right is calculated as tax basis and

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Export of goods labelled as Companies and HNTEs’

shall be withheld and settled when paid in full.

brand where the goods were produced by overseas

Finance rental income and rental income of immovable

manufacturers

properties. ■

Export of goods that are manufactured by other

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Export of equipment manufactured by other companies but embedded with software developed and designed

Withholding deadline for the equity investment income.

by the Companies and the HNTEs Announcement 24 became effective on 1 April 2011.

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Requirements on re-certification of Representative Offices (ROs) of foreign enterprises SAT issued a new Circular 27 to regularise the requirement on re-certification of ROs.

Other situations are regulated by the SAT.

Announcement 18 became effective on 1 May 2011.

Issues related to the verification of the calculation basis on income derived from the alienation of shares for Individual Income Tax (IIT) purposes (SAT Announcement [2010] No. 27)

Based on the new circular, the local registration authorities should commence the work of renewal of registration

On 14 December 2010, the SAT issued SAT Announcement

forms, representative certificates, as well as the submission

[2010] No. 27 (Announcement 27) clarifying the calculation

of annual reports from 1 March 2011 to 30 June 2011.

basis on income derived from selling shares of non-listed

The required annual report should include contents such

companies for IIT purposes.

as the ongoing legal existence of the foreign enterprise, the business activities of ROs, etc. The deadline for the

Announcement 27 specifies that income derived from selling

submission of annual report is no later than 31 August 2011

shares should not only be calculated based on the contract

if a deferral is needed.

price but should be based on fair market price for IIT purposes. When the reported transfer price is obviously lower than fair


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Issue 7 June 2011

China Update continued

market price without justifiable reason, the tax authority may determine the deemed transaction price and tax on such price.

Other Issues Potential impact of the new PRC social security law on foreign nationals working in China The Standing Committee of the National People’s Congress approved the People’s Republic of China (PRC) Social Security Law (the Law), which comes into effect on 1 July 2011. The Law regulates that participation in social securities by foreign nationals who are employed in China should make reference to the provisions of the Law. This means that foreigners working in China will be able to participate in the PRC social security system. However, it is uncertain whether foreign nationals should join the PRC social security system mandatorily. Based on the current PRC CIT and IIT, the statutory social security contributions made by the employer are deductible for CIT while the statutory social security contributions made by the employee are exempt from IIT. Therefore, in cases where foreign nationals make social security contributions, it is possible that the tax deduction treatment should be the same.

For more details please contact: Edmund Chan Partner PKF Consulting Inc T: +86-21-52929998 ext. 208 E: [email protected] W: www.pkfchina.com


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Issue 7 June 2011

Columbia Update Major 2011 tax changes

6

On 29 December 2010 the Government of Colombia signed the Law 1430 which established a number of changes to the tax regime. Below is a summary of the main changes.

1

Abolition of the 30% deduction for investment in fixed assets

Since the taxable year 2011, taxpayers cannot use the special 30% deduction for investment in plant and machinery.

2

Credits no longer considered to be sources of national revenue (income)

Credits obtained outside Colombia by the financial corporations, financial cooperatives, finance companies, BANCOLDEX and the banks in accordance with the Colombian law in force are no longer considered to be sources of national revenue. Neither are credits for foreign trade operations carried out by referred entities.

3

Different treatment for some profits

The profits from trading in derivatives which are securities represented exclusively in shares listed on a stock exchange in Colombia together with indices or shares in funds or portfolios that reflect the collective behavior of such actions do not constitute income or capital gains. (Article 36-1 Subparagraph E.T.)

4

Tax deduction for financial movements

From tax year 2013, 50% of the tax paid in financial transactions, regardless of whether or not it has a causal relationship with the taxpayer's economic activity, will be deductible provided that is duly certified by the withholding agent (Art. 115 E.T.)

Surcharges for all electricity service users with 50% deduction for industrial users

The Law created a surcharge equivalent to 20% of the cost of providing the service which shall apply to industrial and residential users in strata 5 and 6 and to commercial users. Industrial users are entitled to deduct an income tax charge for the taxable year 2011 of 50% of the total value of the surcharge. (Art. 211 E.T.)

7

Foreign taxes paid

National taxpayers or foreigners with five or more years of continuous or discontinuous residence in the country who are liable to foreign source income tax in their country of origin are entitled to deduct the amount of the income tax paid in Colombia from the payment realised abroad on the same income provided that the discount does not exceed the tax payable for the same income in Colombia.

8

Withholding Tax

Payments for financial returns made to persons not resident or not domiciled in the country that arise from foreign loans obtained 12 month or more ago together with payments for interest or costs of rental fees originating from leases held directly or through leasing companies with foreign companies not resident in Colombia are subject to withholding tax at the rate of 14% on the value of the payment or crediting an account. Payments or credits on account arising from leases on ships, helicopters and / or aircraft and parts held directly or through leasing companies which are foreign companies not resident in Colombia will be subject to a fee withholding tax of 1%. (Art 408 E.T.). The interest or royalties from leasing or leasing-originated loans obtained abroad and leasing contracts signed before 31 December 2010 are not considered domestic source income and payments for these items are not subject to withholding tax. (Paragraph 408 Temporary Art E.T.).

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From 2014, the GMF rate will fall to 2 per thousand and be applied to the years 2014 and 2015.

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From 2016 the GMF rate will drop to 1 per thousand and be applied to the years 2016 and 2017.


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From 2018 the tax will be eliminated.

Cristobal Uribe Amezquita & Cia SA

Deduction of payments to guilds

T: +57 1 2087500

5

In 2011 the membership dues paid to guilds will be accepted as income tax deductible. (Art. 116 E.T.) 9 // PKF International Tax Alert

E: [email protected] W: amezquita.com.co All Regions

Issue 7 June 2011

Cyprus Update Tax Treaty Update: New Agreement with Germany

k) Rights of claim on bonds and debentures (but excluding related interest) l) Index participations only if they result in titles m) Repurchase agreements or Repos on titles n) Participations in companies (i.e. The Russian “OOO” or “ZAO”, the US “LLC” etc) which are subject to taxation on their corporate profits o) Units in open-end or closed-end collective investment schemes which have been established, registered and operate in line with specific legislation in the country of registration.

The new tax treaty replacing the old 1974 treaty between Cyprus and Germany was signed by the representatives of the countries on 18 February 2011. The treaty is the outcome of negotiations that began in 2005 and it will enter into force after the parties exchange instruments of ratification, widely expected to be at the beginning of 2012.

Definition of securities exempted from taxation Profits on disposal of securities are tax exempted, as per article 8(22).

Examples of such investment schemes include: i) Investment Trusts, Investment Funds, Mutual Funds, Unit Trusts, Real Estate Investment Trusts ii) International Collective Investment Schemes (ICIS) iii) Undertakings for Collective Investments in Transferable Securities or UCITS iv) Other similar investment entities.

In its circular, the Commissioner of Inland Revenue issued the following list of financial instruments which are to be considered and interpreted as securities in the tax legislation: a) b) c) d) e) f) g) h) i) j)

Ordinary shares Founder’s shares Preference shares Options on titles Debentures Bonds Short positions on titles Futures/forwards on titles Swaps on titles Depositary receipts on titles (i.e. ADRs/GDRs)


For more details please contact: Nicholas Stavrinides Director PKF Savvides & Co Ltd T: +357 2586 8000 E: [email protected]

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Issue 7 June 2011

Czech Republic Update Recent changes to the 2011 tax legislation

Corporate income tax

Personal income tax Tax allowance for tax payers is reduced only for year 2011 to 23, 640 CSK. Standard tax allowance was 24, 840 CSK. The reason for this reduction of 1,200 CSK is because the government decided to collect 100 CSK/monthly from each taxpayer for a “flood tax“. The threshold of the base for social and health insurance contribution was increased to 1,781, 280 CSK per annum. No social and health insurance contribution is required from people earning above this threshold. Pensions are tax-free if the amount does not exceed 288,000 CSK. In cases where the pensioner is employed or has another income and the sum exceeds 840,000 CSK per annum, the pension amount is taxable together with the other income. The deduction from the tax base of contributions paid to the pension insurance company (up to 12, 000 CSK p.a.) is also allowed when the pension insurance company is a company in EU.


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Tax rate of corporate income tax is 19% in 2011; tax rate for investments funds is 5%.

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There are new regulations for depreciation of photovoltaic solar power plants.

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Czech companies in liquidation are not allowed to pay dividends tax-free to mother company in EU. The tax needs to be witheld according to the double tax treaty.

Administration of taxes A completely new Act for the administration of taxes was introduced on 1 January 2011. Act Nr. 280/2009 Coll. - Tax Regulations replaced the Act of administration of taxes and fees (337/1992 Coll. as amended). The Act introduces new terminology in the tax administration, new regulations for the execution of tax and changes some deadlines.

Overview of important changes in the Czech Value Added Tax regime A number of amendments were made to the VAT regime by Act Nr. 47/2011Coll. which came into effect on 1 April 2011.

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Issue 7 June 2011

Czech Republic Update continued

1 The reverse charge to the recipient of the supply 5 Group registration In accordance with Article 199 of the EU VAT Directive, certain supplies are subject to the reverse mechanism whereby the customer, not the supplier, accounts for VAT. After the amendment becomes effective, this scheme will be used for new supplies of gold and also the supply of scrap and waste, including processing and trading of the greenhouse gas emissions. The implementation of this scheme for the provision of construction and assembly work is postponed until 1 January 2012. The scheme applies to supplies made between the payers in the country.

Due to the changes that occurred in 2010 and 2011 in the provisions relating to registration of the group, these changes are commented in the document issued by Ministry of Finance.

For more details please contact: Regina Brejchov PKF Czech Republic T: +420 226 220 010 F: +420 226 220 012

2 Changes in exercising the right to deduct

E: [email protected]

(VAT reclaim) There are some changes for claiming a deduction based on some principles derived from the established jurisprudence of the Court of Justice and the principles of 2009/162/ EU Directive. These are aimed at simplifying the application of the rules in practice and introduce some measures to comply with the principle of tax neutrality for taxable businesses. When customers reclaim VAT, they are responsible for: ■

using the correct tax rate on the invoice

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payment of VAT by the supplier

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checking that the supplier is a registered VAT payer

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including all required information (IC,DIC Nr. etc.) on the invoice

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ensuring that they only reclaim from invoices received during the VAT period relating to the VAT return. This came into effect on 1 April 2011.

3 Tax claims against debtors in insolvency proceedings This is a new provision allowing taxpayers under the statutory conditions of service to make tax claims against debtors in insolvency proceedings.

4 Exemption from tax on import of goods There has been a tightening of conditions for tax exemption on the import of goods to the State if the goods are subsequently delivered to a different Member State from the one in which the original importation of goods was made.


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Issue 7 June 2011

Germany Update Electronic transmission of Tax Accounting introduced for 2012 In the course of the amendment of the German Income Tax Act, a paradigm change in the communication between taxpayer and tax authorities has been introduced. For fiscal years beginning after 31 December 2011, taxpayers will have to file the content of their balance sheet and profit and loss statement for tax purposes via an electronic form called “E-Balance Sheet”. This may be a commercial balance sheet combined with a tax reconciliation statement or directly a tax balance sheet. The electronic mailing is based on the machine language XBRL (eXtensible Business Reporting Language). This instrument will enable the tax authorities to automatically determine the taxable income but also - due to an exhaustive interpretation on quality and quantity of information requested - to run complex cross-checks in case of a tax audit. The general regulations for filing annual tax returns are currently being specified by the German Federal Ministry of Finance (FMF). Due to this regulation the taxpayer will be forced to adjust his (tax) book keeping to the guidelines of FMF. To illustrate the scope of possible adjustments, one merely has to take into consideration that the statement (depending on the legal form) covers up to 416 to 550 potential positions just for the balance sheet. Additionally, 299 to 305 positions in the profit and loss statement are postulated. On top of that, master data like domicile of the company and name of partners have to be enclosed. Not all of these positions are mandatory but it is to be expected that the importance of these parts will grow over time.

In cases of non-participation and omission of sending the “E-Balance Sheet”, the tax authority is entitled to impose a penalty. The amount of the penalty depends on the individual case. Although the adjustment of book keeping systems will tie up resources in the beginning, opportunities will emerge for the taxpayer. The taxpayer can use the adjustment to implement a self-assessment approach to tax planning. The tax accounting may, for instance, provide an efficient basis to calculate deferred taxes. Moreover, the implementation in the book keeping system may be used as an opportunity to modernise an old fashioned chart of accounts. Intracompany information can be sent via XBRL to provide the parent company with very detailed management information. The final guidelines regarding the specific content of the “E-Balance Sheet” are expected in August 2011. Companies are well advised to deal with the topic well ahead of time to be able to have the new system up and running from 1 January 2012.

For more details please contact: Kai Schöneberger PKF Fasselt Schlage T: +49 203 30001 170 F: +49 203 30001 8 170 E: [email protected]

The resulting consequences are enormous. Almost every company is indirectly committed to extend its standard chart of accounts for fiscal purposes. For inbound investors who nearly always draw up accounts under both local GAAP and international reporting standards, this means an additional burden. In addition to this, many international investors have specific intra-company book keeping policy/guidelines and reporting requirements that may have to be adjusted. This will particularly affect corporate groups with German subsidiary companies using non-commercial but specific software.


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Issue 7 June 2011

Hungary Update Recent developments in corporate income taxation

Corporate income tax rate

Tax credit for donations to sport clubs and associations The Parliament adopted new legislation last July which allows companies to claim a tax saving worth 110% or 119% of the donations to certain sport clubs and associations. The tax credit is not yet available as the European Union also needs to approve it but we believe that the credit could become effective from 15 June 2011. The tax credit will be available on donations given to clubs and associations of five sports: football, handball, hockey, basketball and water polo. The credit may be up to 70% expense. A tax saving of at least 110% can therefore be claimed.

According to the already adopted corporate income tax act, the discount rate of 10% applicable to the tax base below 500 million HUF (approximately 1,850,000 EUR) will be extended to the whole tax base in 2013. However, the Government has announced that the discount rate will not be extended until 2015 and, therefore, the standard 19% rate will still apply above 500 million HUF.

For more details please contact: Vadkerti Krisztián PKF Hungary T: +36 1 391 4220 F: +36 1 391 4221 E: [email protected]

A similar tax saving scheme is already available for film production and performing arts sponsorship.


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Issue 7 June 2011

India Update Finance Act 2011 – amendments relevant to international taxation

or territory outside India, having regard to the lack of effective exchange of information. ■

The Finance Minister of India presented the Finance Budget in February 2011. Some of the amendments pertinent to international taxation introduced by Finance Act 2011 are summarised below:

Transfer Pricing ■

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Under the existing provisions of section 92C, if the variation between the arm’s length price determined by the assessing officer and the price at which the international transaction has actually been undertaken by the assessee does not exceed 5% of the latter, the price at which the international transaction took place shall be deemed to be the arm’s length price. As per the amended provisions, 5% has been substituted by “such percentage as may be notified by the Central Government”. The amended provisions are effective from FY 2011-12. The filing date for Income Tax Returns for corporate assesses whose accounts are required to be audited under the provisions of section 92E (Transfer pricing) has been extended to 30 November from 30 September. A new subsection (2A) has been introduced in section 92CA (Transfer pricing), and, as per the new subsection, “If any international transaction other than the international transaction referred by the Assessing Officer comes to the notice of the transfer pricing officer during the course of assessment proceedings, the same will be treated as international transaction referred by the Assessing Officer”. The same will take effect from 1 June 2011.

International Transactions ■

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Counter measures in respect of transactions with persons located in a notified jurisdictional area In order to discourage a transaction by a resident assessee with a person residing outside India or any jurisdiction which does not effectively exchange information with India, anti-avoidance measures have been introduced in new Section 94 A. The provisions are as follows: Enabling the Central Government to notify any country


If an assessee transacts with any person of the notified area then all the parties to the transaction shall be deemed to be the Associated Enterprises and the transaction shall be deemed to be international transaction and, accordingly, Transfer Pricing Regulations will apply. No deduction in respect of payment to Financial Institution will be allowed unless the assessee furnishes the authorisation, authorising the board or any other Income Tax Authority in this regard, to seek information from the financial institution.

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No deduction, in respect of expenses arising from the transaction with a person located in the notified area shall be allowed unless the assessee maintains prescribed documents and furnishes the prescribed information.

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If any sum is received from the notified area, the onus is on the assessee to explain the source of money, failure of which would lead to treating the same as income.

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Any payment made to a person of the notified area would be subject to tax deduction at rate applicable as per the Act or 30%, whichever is higher.

The amendment is effective from 1 June 2011.

Important Legal Judgments

1

Ruling on Bandwidth charges for IT company (INFOSYS TECHNOLOGIES LTD v DDIT, B'LORE ) FACTS AND ISSUES

1

In this case, the assessee was engaged in the business of software development. It claimed deduction on account of bandwidth charges paid to service providers such as AT&T and MCI Telecommunications for downlinking signals in the US for data communication. The assessee had also made payment of subscription charges to various international organisations for accessing web-based database of market data and client strategy details, etc. Also, it first claimed double taxation relief and thereafter computed surcharge on the amount of tax remaining after such relief.

2

The Income Tax Department rejected the contention of the assessee that the payments for bandwidth were not

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Issue 7 June 2011

India Update continued

‘royalty’ or ‘fees for technical services’. It contended that the assessee was liable to deduct tax at source in respect of the said amount, and since it had not done so, the amount should be disallowed as per Section 40(a).

the foreign entities is not liable to tax in India, the assessee was under no obligation to deduct tax u/s 195 and, hence, no disallowance of the amount is warranted u/s 40(a)(i).

3 3

Whether 'no deduction certificate' mandatory for claiming deduction?

Also, the contention that payment for access of the webbased database was ‘subscription charges’ was rejected and the Department classified it as 'fee for technical services', and hence asserted that tax should have been deducted at source in order to claim deduction of charges. The methodology adopted by the assessee for the computation of tax liability was also rejected and it was specified that first, surcharge needed to be computed, and thereafter, double taxation relief was to be allowed. The assessee went in appeal to the Tribunal.

The Tribunal relied on the decision of the Apex Court in GE India Technology Centre P. Ltd. v CIT (327 ITR 456) where it was held that the expression 'chargeable' under the provisions of the Act implies that the remittance has to be of a trading nature, whole or part of which is liable to tax in India and that if the income is not assessable, question of tax deductibility does not arise. Therefore, it was held that certificate u/s 195(2) was not mandatory for avoiding disallowance u/s 40(a)(i).

DECISION

Surcharge to be computed before DTA relief

1

Taxability of bandwidth charges as 'royalty' or 'FTS'

When an Indian company exports software to companies outside India using satellite communication facilities, the digital signals are converted into analog signals through earth stations and are transmitted to one of the geo-stationary satellites using the required bandwidth provided by VSNL. The signals beamed to the satellite are downlinked to the earth station in the US and sent to the client locations using the bandwidth and downlinking facility provided by the international service providers (AT& T, MCI Telecom). The payments made are for the use of bandwidth provided for downlinking the signals in the US and not in the nature of managerial, technical or consultancy services, nor is it for the right to use industrial, commercial or scientific equipment. Companies like AT&T and MCI Telecom only ensure that sufficient bandwidth is available on an ongoing basis to the ultimate users to uplink and downlink the signals. The sum paid as consideration for the said service are not taxable in India and hence tax need not be deducted on such charges.

2

Taxability of subscription charges

2

Ruling on taxability of payment for purchase of software (M/s CRANE SOFTWARE INTERNATIONAL LTD. VS DCIT, B'LORE) FACTS AND ISSUES

1

In this case, the assessee was in the business of providing software products for statistical analytics and engineering simulations to customers in different countries. It had purchased software, mainly from foreign companies, treated it as addition to the existing Block of Assets, and claimed depreciation allowance at 60%. It claimed that the software was purchased for its own use, similar to plant and machinery of manufacturing units, which was not meant for re-sale but to develop products and packages for generating income.

2

The payment was in the nature of an access fee to the Gartner database maintained outside India. The fee was payable even if no service was utilised. The question of imparting of any information did not arise. There was no literary, artistic or scientific work for the payment to be construed as 'royalty'. The server was indisputably located outside India and the rendering of services was an event outside the taxable territory of India. The service provider did not have a PE in India. By this reasoning, it was held that since the subscription paid to 16 // PKF International Tax Alert

ITAT has laid down an important rule in respect of computation of tax liability where double tax relief is available. It was held that first surcharge is to be computed and thereafter double taxation relief is to be allowed.

The Income Tax Department denied such claim. It held that the assessee had purchased a comprehensive software package with the right to sell to multiple customers and not any article or asset as claimed. The payments were therefore in the nature of royalties and the assessee should have deducted tax at source before making payments to nonresidents. Having failed to do so, the expenditure was disallowed.

3

Moreover, the assessee had incurred expenditure

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towards marketing of its software products in the European markets. The activities included market positioning, sourcing of a market database, market survey and research for its products. Although treated as deferred revenue expenditure in the books, it claimed the entire expenditure as deduction whereas the Department treated the expenditure as having been incurred for technical services and accordingly liable to TDS. Since no TDS had been deducted by the assessee, the Department disallowed the claim.

4

Lastly, the assessee had incurred expenses in connection with issue of Foreign Currency Convertible Bonds. As the Bonds were convertible, the Department treated the bond proceeds as increase in capital. Accordingly, the expenditure was disallowed for being capital in nature. DECISION

1

Purchase of software not royalty

The agreements were titled as 'software distribution and asset purchase agreement'. The agreements thereafter provide for procurement of products on outright purchase basis even though option is available for licence arrangement as well. There is no doubt that the assessee has exercised its option for purchases and the products were acquired as purchase of assets. The assessee was using those products to develop its own branded proprietary software packages. Therefore, it was concluded that payments made by the assessee against purchase of software cannot be held as 'royalty. Since no tax was deductible by the assessee in respect of the transaction, disallowance u/s 40(a)(i) was not warranted and to be deleted.

2

Taxability of marketing fee in India

Expenditure incurred for marketing of a software product in the competitive foreign market is in the nature of fee for technical services since promotion of these products in competitive markets requires technical expertise. Also, the launch of these products call for an elaborate marketing management network and a professional strategy. Therefore, the payment has rightly been treated as fee for technical services. However, in this case, the foreign companies (German and Singapore companies) rendering the services had no PE in India; payment is also effected outside India; services were rendered outside India; and the profits were generated in the hands of those companies outside India. As a result, tax liability in India does not arise and neither does the obligation 17 // PKF International Tax Alert

to deduct tax. Hence, the disallowance u/s 40(a)(i) was ordered to be deleted.

3

Allowability of expenditure incurred towards issuance of Foreign Currency Convertible Bonds (FCCB)

The expenditure on FCCB issue was held to be allowable since the expenditure was held to be not capital in nature. The funds collected through issue of FCCBs were in the nature of a liability and funding was in the nature of loan finance. The assessee company was bound to discharge the bonds on due dates. The assessee was paying interest to bond-holders. The bond funds would become equity only on exercise of the option of conversion by the bond holders. Therefore, the equity nature of funds was contingent on a future event of conversion. It cannot affect the nature of the funds in the present. If the funds are treated as equity capital, payment of interest would be ultra vires the law.

3

Applicability of indexation benefit to non-residents and interpretation of 'Non-discrimination' clause in DTAA (TRANSWORLD GARNET COMPANY LTD. v. DIT) FACTS AND ISSUES

1

In this case, the assessee, a Canadian company (CanCo) held 74% share in an Indian company (TGI). Shares of TGI were acquired by CanCo in various lots and at different points in time by remitting foreign currency. CanCo transferred shares of TGI to a partnership firm registered in India and made significant profits. There was no dispute that the shares were a long-term capital asset in the hands of CanCo and that income arising on transfer of shares was chargeable to tax in India. However, the method of calculation of the capital gain was in question.

2

CanCo computed capital gain by applying both the provisos of section 48. Firstly, by neutralising exchange fluctuation gain (worked out to Rs 140 million), and secondly, by considering indexation benefit (worked out to Rs 70 million). Since indexation benefit was more beneficial, CanCo claimed that resident taxpayers under comparable circumstances are provided benefit of indexation for the cost of acquisition, whereas non-residents are denied such benefit. Such treatment results in discrimination of a Canadian National vis-à-vis an Indian National, which is contrary to the provisions of Article 24(1) of the Treaty between India and Canada.

3

The Tax Department contended that the second proviso to

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section 48 of the Act provides that benefit of indexation is not available in respect of capital gains arising to a nonresident from transfer of shares or debentures of an Indian company. The non-residents stand protected from the vagaries of exchange fluctuation under the first proviso to section 48 of the Act. Hence, in terms of clear language of the second proviso to Section 48, no benefit of indexation can be granted. DECISION The Advance Authority Ruling (AAR) held that ‘Discrimination' is understood to be unequal treatment in identical situations. Differential treatment does not constitute discrimination unless it is arbitrary. Article 24(1) of DTAA seeks to prevent differentiation solely on the ground of nationality. Discrimination on account of nationality alone may be prohibited but a discrimination based on residence is permitted.

4

Ruling on whether payment for data processing support service constitutes royalty (STANDARD CHARTERED BANK v DDIT, MUMBAI) FACTS AND ISSUES

1 The assessee, a UK bank carrying on business in India, entered into an agreement with Sema Group, Singapore for the provision of data processing support to the assessee for its business in India. Sema had a Data Centre at Singapore which it agreed to make available for “exclusive use” by the assessee for a specified period. Broadly, the service rendered was that the raw data relating to branch transactions of the assessee was transmitted to Sema’s mainframe computer in Singapore for processing. 2 The raw data was processed by Sema’s staff as per the requirements of the assessee using the application software owned by the assessee. The output data was transmitted electronically to the assessee in India using the software provided by the assessee, which was not designed by Sema. 3

The AO & CIT (A) held the payments made by the assessee to Sema to be “royalty” u/s 9(1)(vi) & Article 12 of the DTAA on the grounds that (i) the provision of the computer facility to process the data was consideration for use of a “process” and (ii) the consideration was for “the use or right to use any industrial, commercial or scientific equipment”.

DECISION

1

Use of process: The activity of transmitting raw data to Sema, processing the data by Sema using software belonging to the assessee and the transmission of the processed data to the assessee did not, at any stage, involve the “use of any process” by the assessee so as to constitute “royalty” under Article 12(3)(a). The consideration received by Sema was for using the computer hardware which does not involve use or right to use a process.

2

Use of equipment: In order to constitute ‘user of equipment’, the customer should actually have domain or control over the equipment or, in other words, the equipment should be at its disposal. The customer should be in a position to use the equipment in its business activities. If a customer is given mere access to some infrastructural facilities of the service provider and where the service provider has all the control, disposition and possession of such infrastructure, and also the service provider operates such infrastructure on its own, then the customer cannot be said to have been assigned a right to use the equipment in the form of the infrastructure. In that case, the transaction partakes of the character of provision of services or facilities by the owner of the infrastructure in favour of the customer and hence cannot constitute 'royalty'.

3

Exclusive use: Although the 'Data Centre' was made available for the assessee’s “exclusive use”, the assessee had no right to access the computer hardware except for transmitting raw data for further processing. The assessee had no control over the computer hardware or physical access to it. The assessee could not come face to face with the equipment, operate it or control its functions in any manner. The assessee merely took advantage of a facility of use of sophisticated equipment installed and provided by another. Accordingly, the payment was not royalty under Article 12(3)(b) of the DTAA.

For more details please contact: S Harihan Partner PKF Sridhar & Santhanam T: + 91 44 2811 2895 F: +91 44 2811 2899 E: [email protected]


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Ireland Update Finance Act 2011 changes for companies investing in Ireland

Start-Up Companies

Interest Deductibility Measures were introduced to restrict interest deductibility for intra-group borrowings (trade interest) and interest as a charge. A tax deduction is no longer available for interest on funds borrowed from a group company where such funds are used to acquire assets (other than trading stock and qualifying intangible assets) from another connected company. Relief remains available where funds are used to acquire an asset that is leased in the course of a leasing trade, to acquire assets as part of an acquisition of a trade which was not previously within the charge to Irish tax and to refinance existing qualifying debt. Significant changes were introduced to the tax deductibility of non-trade interest in loans to or acquiring shares in other companies. Relief is restricted where the companies which use the borrowed monies are not within the charge to Irish tax and are in receipt of interest on those monies. Relief is restricted to the amount of interest earned by the Irish company. The above restrictions apply to loans made on or after 21 January 2011 other than such loans made in accordance with a binding written agreement made before that date.

Transfer Pricing The Transfer Pricing regime applies on or after 1 January 2011. It concerns the pricing of transactions between connected companies. The law applies to arrangements involving the supply or acquisition of goods, services, money or intangible assets between associated persons where the profits, gains, or losses arising from the arrangement are within the charge to tax as trading activities. ■

Securitisation Regime Changes have been introduced for qualifying financial services companies under the Section 110 regime. An extension has been made to qualifying assets which can be acquired by a Section 110 company to include (a) commodities and (b) plant and machinery which are subject to lease and (c) an extension of the application of the section to additional carbon offsets. Also, where a Total Return Swap arrangement is used to extract the profits from a S.110 company, the structure is now restricted so that a deduction will not now be available for payments made under a return agreement as defined in the legislation. Other domestic taxation measures include: Patent Royalty Exemption Patent royalty and dividend exemption is abolished in respect of qualifying patents. Income from a qualifying patent paid on or after 24 November 2010 is no longer tax exempt. Foreign Credit Companies are no longer permitted to allocate relevant trade charges in computing foreign credit due in respect of foreign tax paid on income. Mandatory Reporting A new mandatory reporting regime has been introduced in relation to certain tax transactions where the main benefit is to obtain a tax advantage.


Profits and losses shall be computed as if the arm’s length amount were receivable instead of the actual consideration.

Sarah Murphy PKF Tax Consulting Ltd

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Formal transfer pricing documentation is a requirement.

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Full exemption from Transfer Pricing provisions for small and medium sized entities (