Credit of foreign tax problems with India regarding technical service fees (see also WITS no 1/2014)

WebJournal on International Taxation in Sweden, WITS, no 2/2014.

December 2014

In WITS no 1/2014 I reported on various tax problems that Swedish companies have been running into when providing (technical) services to customers in Brazil, China and India.

Concerning India I wrote that Sweden's treaty with this country under Article 12 subparagraph 2 allows the services to be taxed also in the contracting state where they arise but that the tax shall be limited to 10 percent of the gross payment. Sweden may also tax but under the elimination of double taxation article, no 24, but must provide a credit for the 10 percent Indian tax that has been levied.

The meaning of what is meant by a service fee is taken care of in Article 12 subparagraph 3.b. Of the treaty which reads as follows: ” The term 'fees for technical services' means payment of any kind in consideration for the rendering of any managerial, technical or consultancy services including the provision of services by technical or other personnel...”

Moreover, which I, however, did not mention, was that Article 12 subparagraph 5 also has a source rule determining where a technical service fee is deemed to arise. The answer hereto is that a service fee has its source or is deemed to arise in the state where the payor of the fee is resident, Article 12 subparagraph 5. Consequently, when ever an Indian company makes a payment to Sweden for services rendered India may claim its 10 percent tax that income.

But, as I also wrote, this is not the whole story. In this specific case, one must also observe a special and extremely unusual provision tucked away in the special protocol of the Sweden-India treaty, a so called ”most-favoured-nation” clause applying to both dividends, interest payments as well as to royalties and technical service fees. It reads as follows:

”If India according to any treaty, agreement or protocol between India and a third State, which is a member of the OECD, reduces its source taxation under articles 10 (dividends), 11 (interest) or 12 (royalty and technical services fees) on dividends, interest or royalties and technical services fees to a lower level or limits its field of application of these incomes, the same level of tax or field of application in that treaty, agreement or protocol shall apply also according to this treaty.”

And quoting again my earlier report, ”India has indeed, since it made its treaty with Sweden (1997), concluded a treaty (with Finland amended in 2010) under which India, as source state, reduces its tax on technical services fees to nil. This, consequently, shall then apply also visavi Sweden according to our most-favoured-nation clause. India must correct this situation by reimbursing the Swedish companies involved and the 10 percent credit that has been granted by Sweden should be repaid to the Swedish treasury.”

After having been brought to attention by a Finnish reader of this blog for which I am most grateful, it turns out after further analysis of the Finland-India treaty that my information about the tax rate on service fees in that treaty is incorrect. (And my Finnish friend also reports that Nokia is entangled in very big tax problems concerning payments of service fees received from India.) Thus, the Finland-India treaty also provides for a ten percent source tax to be charged on services. Our Swedish most favoured nation-clause can therefore not be invoked visavi India on account of this rule.

But on the other hand and more importantly regarding the Finland – India treaty is that the scope for applying this source tax has been limited when determining where a service fee arises.

Thus, the relevant part of Article 12 subparagraph 5 of the Finland-India treaty reads as follows:

...fees for technical services shall be deemed to arise in a Contracting State when the payer is that State itself, a political sub-division, a local authority, or a resident of that State. Where, however,the fees for technical services relate to services performed within a Contracting State, then such ... fees for technical services shall be deemed to arise in the State in which ... the services are performed.

Consequently, and comparing the treaties concluded by India, on the one hand with Sweden and on the other hand with Finland, service fees with regard to Sweden are considered to arise only in the state in which the payor is resident. With regard, however, to the treaty concluded by India with Finland, and presuming reasonably that the payment for the services can be considered to arise in one state only, the second sentence of the above paragraph requires an additional condition to be fullfilled for triggering the source tax.And that is that the service has been performed in the state from where the payment is made. Consequently, for example, a payment made by an Indian company to a Finnish company for technical services performed not in India but in Finland  is considered to arise in Finland which thus prevents India from levying tax on the payment. Only if the Finnish company performs the services in India may India tax.

Interpreting the text as giving India the right to tax by applying the nexus rule of residence of the payor does not make sense as it would provide that the payment – a thought which has been dismissed above - has a source in both states. And suggesting that Finland would be completely deprived of its taxing right would indeed be quite absurd as Finland as the state of residence of the tax payor, the Finnish company, always preserves the right to tax under subparagraph 1 of Article 12 (and the obligation to provide a credit for the Indian tax.) For the purpose in this example of determining Finlands right to tax, the question where the income arises is thus irrelevant.

The nexus rule of performance must thus, as already mentioned, be interpreted as excluding the performance state from taxing the payment for the service to the extent that the services have been performed in the state of residence of the tax payor, Finland in this case.

This, in consequence, gives rise to the practical problem of establishing where the services have been performed. In many cases one would imagine, especially in the digital service providing 'industry', that such services will have been performed only in the residence state of the tax payer. In other cases the services may be performed wholly in the source state or sometimes of course in both states. In this latter case it will be up to the service providing company to determine and prove to the tax authorities how the income shall been apportioned for tax purposes.

In conclusion therefor, Swedish companies that have been subjected to tax in India for services performed in Sweden should claim repayment of that tax under our most favoured nation clause with reference to India's tax treaty with Finland. It is suggested that one should do so through the Swedish competent authority.

India's tax treaty with Portugal

With regard again to our most favoured nation-clause with India it is also of interest to study India's treaties with other OECD member states. When doing so one will find that India's treaty with Portugal also is of interest with regard to our most-favoured-nation clause with India and its application to service fees.

In article 12 subparagraphs 4 and 5 of the India - Portugal treaty one will thus find the following text determining the meaning of the term technical (or included) services which focuses not on the source of the payment but on the character of the service:

4. For the purposes of this Article, fees for included services means payments of any kind, other than those mentioned in Articles 14 and 15 of this Convention, to any person in consideration of the rendering of any technical or consultancy services (including through the provisions of services of technical or other personnel) if such services :

  (a)  are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received, or

  (b)  make available technical knowledge, experience, skill, know-how or processes or consist of the development and transfer of a technical plan or technical design which enables the person acquiring the services to apply the technology contained therein.

5. Notwithstanding paragraph 4, fees for included services does not include payments :

  (a)  for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property;

  (b)  for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international craft;

  (c)  for teaching in or by educational institutions;

  (d)  for services for the personal use of the individual or individuals making the payment;

  (e)  to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 14;

  (f)  for services rendered in connection with an installation or structure used for the exploration or exploitation of natural resources referred to in paragraph 2(g) of Article 5;

  (g)  for services referred to in paragraph 3 of Article 5.

Of greatest interest is perhaps subparagraph 5 itemizing services which are not covered by article 12 most importantly (under (a)) services performed in the source state which are linked to the sale of property.

Also in these cases Sweden can invoke its most favoured nation-clause with India. Or in other words, if, for instance, a Swedish company has performed services in India for an Indian customer and if the services are linked to the sale of property to that same customer, then the services may not be taxed in India.

As I mentioned in my earlier article most favoured nation clauses are difficult for ordinary tax payers to keep track of. (And I haven't gone through all of the technical services provisions of India's treaties made after the treaty with Sweden!) It would therefore be appropriate for the competent authority of either Sweden or India to make information available in these matters.

To be noted is that the (10 percent) tax on services to be charged by the source state never applies when Sweden is the source state. This is because such taxation does not exist under Swedish national tax law. Thus, when an Indian company supplies services to Swedish customers, also when they are performed in Sweden, there will be no Swedish tax on the income (unless the Indian company has a permanennt establishment in Sweden). But this is due to Sweden's own and selfimposed principle regarding national law visavi treaty law that tax cannot be imposed under a treaty where there is no tax under Swedish law. So the treaty as far as tax on services is concerned is not reciprocal.

But, as I was indeed born in India, a country which is therefore one of my personal most favoured nations, I don't mind this little irregularity in our treaty!

peter.sundgren@gmail.com