Final Course

Study Material
(Modules 1 to 4)

Paper 4
Direct Tax Laws &
International Taxation
[Direct Tax Laws as amended by the Finance Act, 2025]
Assessment Year 2026-27

Module – 4
(Relevant for May 2026, September 2026 and
January 2027 examinations)

BOARD OF STUDIES (ACADEMIC)

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

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This Study Material has been prepared by the faculty of the Board of Studies (Academic).
The objective of the Study Material is to provide teaching material to the students to enable
them to obtain knowledge in the subject. In case students need any clarification or have any
suggestion for further improvement of the material contained herein, they may write to the Joint
Director, Board of Studies (Academic).
All care has been taken to provide interpretations and discussions in a manner useful for the
students. However, the Study Material has not been specifically discussed by the Council of the
Institute or any of its committees and the views expressed herein may not be taken to necessarily
represent the views of the Council or any of its Committees.
Permission of the Institute is essential for reproduction of any portion of this material.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in a retrieval system, or
transmitted, in any form, or by any means, electronic, mechanical, photocopying, recording, or
otherwise, without prior permission, in writing, from the publisher.

Basic draft of this publication was prepared by CA. (Dr.) Rashmi Goel.

Edition : September, 2025

Committee/Department : Board of Studies (Academic)

E-mail : bosnoida@[Link]

Website : [Link]

Price : ` /- (For All Modules)

ISBN No. : 978-93-48313-65-2

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The Institute of Chartered Accountants of India,
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CONTENTS

MODULE – 1
Chapter 1 : Basic Concepts
Chapter 2 : Incomes which do not form part of Total Income
Chapter 3 : Profits and Gains of Business or Profession
Chapter 4 : Capital Gains
Chapter 5 : Income from Other Sources
Chapter 6 : Income of Other Persons included in assessee’s Total Income
Chapter 7 : Aggregation of income, set-off or carry forward of Losses
Chapter 8 : Deductions from Gross Total Income
MODULE – 2
Chapter 9 : Assessment of Various Entities
Chapter 10: Assessment of Trusts and Institutions, Political Parties and Other Special Entities

Chapter 11 : Tax Planning, Tax Avoidance & Tax Evasion

Chapter 12 : Taxation of Digital Transactions
MODULE – 3
Chapter 13 : Deduction, Collection and Recovery of tax
Chapter 14 : Income-tax Authorities
Chapter 15 : Assessment Procedure
Chapter 16 : Appeals and Revision
Chapter 17 : Dispute Resolution
Chapter 18 : Miscellaneous Provisions
Chapter 19 : Provisions to Counteract Unethical Tax Practices
Chapter 20 : Tax Audit and Ethical Compliances

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MODULE – 4
Chapter 21 : Non-resident Taxation
Chapter 22 : Double Taxation Relief
Chapter 23 : Advance Rulings

Chapter 24 : Transfer Pricing

Chapter 25 : Fundamentals of BEPS
Chapter 26 : Application and Interpretation of Tax Treaties
Chapter 27 : Overview of Model Tax Conventions
Chapter 28 : Latest Developments in International Taxation

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DETAILED CONTENTS: MODULE - 4

CHAPTER 21 – NON RESIDENT TAXATION

Learning Outcomes ................................................................................................................... 21.1

Contents:
21.1 Introduction ........................................................................................................ 21.2
21.2 Residential status and scope of total income ....................................................... 21.2
21.3 Exempted income of Non-residents .................................................................... 21.62
21.4 Presumptive taxation for Non-residents .............................................................. 21.83

21.5 Capital gains taxation for Non-residents ............................................................. 21.99

21.6 Special provisions prescribed under Chapter XII-A ........................................... 21.103
21.7 Determination of tax in certain special cases [Chapter XII] ............................... 21.109

21.8 Special provisions relating to conversion of Indian branch of

a foreign bank into a subsidiary company [Chapter XII-BB] ............................... 21.121

21.9 Withholding tax provisions for Non-Residents ................................................... 21.126

21.10 Miscellaneous provisions ................................................................................. 21.149
Test Your Knowledge .................................................................................................. 21.154

CHAPTER 22 – DOUBLE TAXATION RELIEF

Learning Outcomes........................................................................................................ 22.1

Contents:

22.1 Concept of Double Taxation Relief ...................................................................... 22.2

22.2 Types of Relief.................................................................................................... 22.3
22.3 Double Taxation Relief provisions under the Income-tax Act, 1961 ...................... 22.4

22.4 Concept of Permanent Establishment ................................................................. 22.14

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22.5 Taxation of Business Process Outsourcing Units in India .................................... 22.16

Test Your Knowledge .................................................................................................... 22.18

CHAPTER 23 – ADVANCE RULINGS

Learning Outcomes........................................................................................................ 23.1

Contents:
23.1 Boards for Advance Rulings – An Introduction .................................................... 23.2
23.2 Constitution of Board for Advance Rulings [Section 245-OB] ................................ 23.2
23.3 Definition ........................................................................................................... 23.2
23.4 Vacancies, etc., not to invalidate proceedings [Section 245P] ............................. 23.5
23.5 Application for Advance Ruling [Section 245Q] ................................................... 23.5
23.6 Procedure on receipt of application [Section 245R] .............................................. 23.6
23.7 Advance Ruling to be void in certain circumstances [Section 245T] ...................... 23.7
23.8 Powers of the Board for Advance Rulings [Section 245U] .................................... 23.7
23.9 Appeal [Section 245W] ........................................................................................ 23.8
Test Your Knowledge ..................................................................................................... 23.9

CHAPTER 24 - TRANSFER PRICING

Learning Outcomes........................................................................................................ 24.1

Contents:

24.1 Introduction ........................................................................................................ 24.3

24.2 Meaning of the term “Arm’s Length Principle” ..................................................... 24.3

24.3 Significance of Arm’s Length Principle ................................................................ 24.4

24.4 Practical difficulties in application of ALP ............................................................. 24.5
24.5 The Indian Scenario ........................................................................................... 24.6

24.6 Transfer of income to Non-residents [Section 93] ............................................. 24.116

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24.7 Introduction of specific anti-avoidance measures in respect of transactions

with persons located in notified jurisdictional area [Section 94A] ....................... 24.118
24.8 Limitation of interest deduction in certain cases [Section 94B]........................... 24.121

Test Your Knowledge .................................................................................................. 24.128

CHAPTER 25- FUNDAMENTALS OF BEPS

Learning Outcomes........................................................................................................ 25.1

Contents:

25.1 Background ........................................................................................................ 25.2

25.2 Overview of BEPS .............................................................................................. 25.3
Action Plan 1 – Addressing the challenges of the digital economy ........................ 25.6
Action Plan 2 – Neutralise the effects of Hybrid Mismatch arrangements ............ 25.11
Action Plan 3 – Strengthen Controlled Foreign Company (CFC) Rules ............... 25.14
Action Plan 4 – Interest deductions and other financial payments....................... 25.15
Action Plan 5 – Counter harmful tax practices.................................................... 25.17
Action Plan 6 – Preventing treaty abuse ............................................................ 25.18
Action Plan 7– Prevent the artificial avoidance of PE status .............................. 25.20
Action Plan 8-10-Transfer Pricing Outcomes in line with Value Creation/
Intangibles/Risk and Capital and other high-risk transactions .............................. 25.22
Action Plan 11 – Measuring and monitoring BEPS .............................................. 25.24
Action Plan 12 – Disclosure of aggressive tax planning arrangements................. 25.25
Action Plan 13 – Re-examine transfer pricing documentation .............................. 25.26

Action Plan 14 – Making dispute resolution more effective ..................................25.29

Action Plan 15 – Developing a multilateral instrument ........................................ 25.31
Summary ....................................................................................................................... 25.43

Test Your Knowledge .................................................................................................... 25.49

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CHAPTER 26 – APPLICATION AND INTERPRETATION OF TAX TREATIES

Learning Outcomes........................................................................................................ 26.1

Contents:
26.1 Introduction ........................................................................................................ 26.2
26.2 Double Taxation and Connecting Factors ............................................................ 26.3

26.3 Tax Treaties: An Overview .................................................................................. 26.5

26.4 Interpretation of Tax Treaties .............................................................................. 26.9
Test Your Knowledge .................................................................................................... 26.24

CHAPTER 27 – OVERVIEW OF MODEL TAX CONVENTIONS

Learning Outcomes........................................................................................................ 27.1

Contents:

27.1 Introduction ........................................................................................................ 27.2

27.2 Comparative Analysis of some of the Significant
Articles of OECD and UN Model Conventions ...................................................... 27.5
Summary ....................................................................................................................... 27.20

Test Your Knowledge .................................................................................................... 27.32

CHAPTER 28 – LATEST DEVELOPMENTS IN INTERNATIONAL TAXATION

Learning Outcomes........................................................................................................ 28.1

Contents:
28.1 Brief background of BEPS ................................................................................... 28.2
28.2 Establishment of inclusive framework (IF) ............................................................ 28.3
28.3 Introduction of Two-Pillar Solution (BEPS 2.0) ..................................................... 28.4

© The Institute of Chartered Accountants of India

CHAPTER 21

NON RESIDENT TAXATION

LEARNING OUTCOMES

After studying this Chapter, you will be able to –

 determine the residential status of Individuals, HUF, AOPs/ BOIs, Firms & Companies etc;
 examine the scope of income chargeable to tax in respect of different persons, after
ascertaining their residential status;
 examine when income arising in the hands of non-resident from a transaction is deemed to
accrue or arise in India;
 appreciate the circumstances when the presence of eligible fund manager in India would
not constitute business connection in India for an eligible investment fund;
 identify whether a particular income is exempt in the hands of a non-resident based on the
provisions of the Income-tax Act, 1961;
 compute the profits and gains for non-resident assessees from shipping business,
business of operation of cruise ships, business of operation of aircraft, business of civil
construction etc. in certain turnkey power projects applying the presumptive tax provisions
under the Income-tax Act, 1961;
 determine the quantum of head office expenditure allowable as deduction to non-residents;
 determine the tax payable by the non-residents on dividend, royalty and fees for technical
service applying the special provisions of Chapter XII;
 determine the tax payable by non-residents applying the special provisions relating to
certain incomes of non-residents prescribed under Chapter XII-A;
 examine the withholding tax provisions to determine the tax, if any, required to be deducted
at source on certain payments made to non-residents;
 compute the total income of non-residents and tax payable thereon, applying the general
provisions and special provisions applicable to non-residents under the Income-tax Act,
1961.

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21.1 INTRODUCTION
Taxation of cross-border transactions are generally based on the two concepts:
1. Residence based taxation
2. Source based taxation
Residence based taxation: The concept of residence-based taxation asserts that natural persons
or individuals are taxable in the country or tax jurisdiction in which they establish their residence or
domicile, regardless of the source of income. In case of companies, the place of incorporation or
the place of effective management is generally considered as its place of residence.
Source based taxation: According to this concept, a country considers certain income as taxable
income, if such income arises within its jurisdiction. Such income is taxed in the country of source
regardless of the residence of the taxpayer.

21.2 RESIDENTIAL STATUS AND SCOPE OF TOTAL

INCOME
(1) Residential Status [Section 6]
The incidence of tax on any assessee depends upon his residential status under the Act. For all
purposes of income-tax, taxpayers (individuals and HUF) are classified into three broad categories
on the basis of their residential status viz.
(1) Resident and ordinarily resident
(2) Resident but not ordinarily resident
(3) Non-resident
Taxpayers (other than individuals and HUF) are classified into two broad categories on the basis of
their residential status viz.
(1) Resident
(2) Non-resident
The residential status of an assessee must be ascertained with reference to each previous year. A
person who is resident and ordinarily resident in one year may become non-resident or resident
but not ordinarily resident in another year or vice versa.

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The provisions for determining the residential status of assessees are:

(1) Residential status of Individuals

Residential status on the basis of number of days of stay in India

Under section 6(1), an individual is said to be resident in India in any previous year, if he satisfies
any one of the following conditions:
(i) He has been in India during the relevant previous year for a total period of 182 days or
more, or
(ii) He has been in India during the 4 years immediately preceding the relevant previous year
for a total period of 365 days or more and has been in India for at least 60 days in the
relevant previous year.
If both the above conditions are not satisfied, the individual is a non-resident.

Notes:

(a) The term “stay in India” includes stay in the territorial waters of India (i.e., 12 nautical
miles into the sea from the Indian coastline). Even the stay in a ship or boat moored in
the territorial waters of India would be sufficient to make the individual resident in India.

(b) It is not necessary that the period of stay must be continuous or active nor is it essential
that the stay should be at the usual place of residence, business or employment of the
individual.

(c) For the purpose of counting the number of days stayed in India, both the date of
departure as well as the date of arrival are considered to be in India.
(d) The residence of an individual for income-tax purpose has nothing to do with citizenship,
place of birth or domicile. An individual can, therefore, be resident in more countries than
one even though he can have only one domicile.

Exceptions:
The following categories of individuals will be treated as resident in India only if the period of their
stay during the relevant previous year amounts to 182 days or more. The condition of presence in
India for 60 days or more in the relevant previous year is not applicable for such individuals.
(i) Indian citizen, who leaves India during the relevant previous year as a member of the
crew of an Indian ship or for purposes of employment outside India, or

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(ii) Indian citizen or person of Indian origin 1 who, being outside India comes on a visit to
India during the relevant previous year.

However, such person having total income, other than the income from foreign sources
[i.e., income which accrues or arises outside India (except income from a business
controlled from or profession set up in India) and which is not deemed to accrue or arise
in India], exceeding ` 15 lakhs during the previous year will be treated as resident in
India if -
- the period of his stay during the relevant previous year amounts to 182 days or
more, or
- he has been in India during the 4 years immediately preceding the previous year
for a total period of 365 days or more and has been in India for at least 120 days
in the previous year.

Note - Stay in India for 120 days in the relevant P.Y. is not a standalone condition. This
condition requires stay in India for 120 days in the relevant P.Y. + 365 days in the 4 years
immediately preceding the P.Y.

How to determine period of stay in India for an Indian citizen, being a crew member?
In case of foreign bound ships where the destination of the voyage is outside India, there is
uncertainty regarding the manner and the basis of determining the period of stay in India for an
Indian citizen, being a crew member.
To remove this uncertainty, Explanation 2 to section 6(1) provides that in the case of an individual,
being a citizen of India and a member of the crew of a foreign bound ship leaving India, the period
or periods of stay in India shall, in respect of such voyage, be determined in the prescribed
manner and subject to the prescribed conditions.

Accordingly, the CBDT has vide, Notification No. 70/2015 dated 17.8.2015, inserted Rule 126 in
the Income-tax Rules, 1962 to compute the period of stay in such cases.
According to Rule 126, for the purposes of section 6(1), in case of an individual, being a citizen of
India and a member of the crew of a ship, the period or periods of stay in India shall, in respect of
an eligible voyage, not include the following period:

1A person is said to be of Indian origin if he or either of his parents or either of his grandparents were born
in undivided India.

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Period to be excluded
Period commencing from Period ending on
the date entered into the Continuous And the date entered into the Continuous
Discharge Certificate in respect of Discharge Certificate in respect of signing off
joining the ship by the said individual for by that individual from the ship in respect of
the eligible voyage such voyage.
Meaning of certain terms:

Terms Meaning
(a) Continuous This term has the meaning assigned to it in the Merchant Shipping (Continuous
Discharge Discharge Certificate-cum Seafarer’s Identity Document) Rules, 2001 made
Certificate under the Merchant Shipping Act, 1958.
(b) Eligible A voyage undertaken by a ship engaged in the carriage of passengers or freight
voyage in international traffic where –
(i) for the voyage having originated from any port in India, has as its
destination any port outside India; and
(ii) for the voyage having originated from any port outside India, has as its
destination any port in India.

ILLUSTRATION 1
Mr. Ajay is an Indian citizen and a member of the crew of a Mauritius bound Indian ship engaged
in carriage of passengers in international traffic departing from Mumbai port on 16th July, 2025.
From the following details for the P.Y.2025-26, determine the residential status of Mr. Ajay for
A.Y.2026-27, assuming that his stay in India in the last 4 previous years (preceding P.Y.2025-26)
is 415 days and last seven previous years (preceding P.Y.2025-26) is 745 days:
Particulars Date
Date entered into the Continuous Discharge Certificate in respect of 16th July, 2025
joining the ship by Mr. Ajay
Date entered into the Continuous Discharge Certificate in respect of 19th January, 2026
signing off the ship by Mr. Ajay

SOLUTION
In this case, since Mr. Ajay is an Indian citizen and leaving India during P.Y. 2025-26 as a member
of the crew of an Indian ship, he would be resident in India, only if he stayed in India for 182 days
or more.

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The voyage is undertaken by an Indian ship engaged in the carriage of passengers in international
traffic, originating from a port in India (i.e., the Mumbai port) and having its destination at a port
outside India (i.e., the Mauritius port). Hence, the voyage is an eligible voyage for the purposes of
section 6(1).
Therefore, the period beginning from 16th July, 2025 and ending on 19th January, 2026, being the
dates entered into the Continuous Discharge Certificate in respect of joining the ship and signing
off from the ship by Mr. Ajay, an Indian citizen who is a member of the crew of the ship, has to be
excluded for computing the period of his stay in India. Accordingly, 188 days
[16+31+30+31+30+31+19] have to be excluded from the period of his stay in India. Consequently,
Mr. Ajay’s period of stay in India during the P.Y.2025-26 would be 177 days [i.e., 365 days – 188
days]. Since his period of stay in India during the P.Y.2025-26 is less than 182 days, he is a non-
resident for A.Y.2026-27.
Note - Since the residential status of Mr. Ajay is “non-resident” for A.Y.2026-27 consequent to his
number of days of stay in P.Y.2025-26 being less than 182 days, his period of stay in the earlier
previous years become irrelevant.
Deemed resident [Section 6(1A)]
An individual, being an Indian citizen, having total income, other than the income from foreign
sources [i.e., income which accrues or arises outside India (except income from a business
controlled from or profession set up in India) and which is not deemed to accrue or arise in India],
exceeding ` 15 lakhs during the previous year would be deemed to be resident in India in that
previous year, if he is not liable to pay tax in any other country or territory by reason of his domicile or
residence or any other criteria of similar nature.
However, this provision will not apply in case of an individual who is a resident of India in the
previous year as per section 6(1).
Meaning of “liable to tax” – Liable to tax, in relation to a person and with reference to a country,
means that there is an income-tax liability on such person under the law of that country for the time
being in force. It also includes a person who has subsequently been exempted from such liability
under the law of that country [Section 2(29A)].

Notes – (1) Only Indian citizen can be deemed resident. An individual who is not an Indian citizen
but a person of Indian Origin cannot be deemed resident u/s 6(1A).

(2) Stay in India is not necessary for being a deemed resident u/s 6(1A).

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Resident and ordinarily resident/ Resident but not ordinarily resident

Only individuals and HUF can be resident but not ordinarily resident in India. All other classes of
assessees can be either a resident or non-resident. An individual and HUF would be not-ordinarily
resident if they satisfy any one of the conditions specified under section 6(6).
(i) If such individual has been non-resident in India in any 9 out of the 10 previous years
preceding the relevant previous year, or
(ii) If such individual has during the 7 previous years preceding the relevant previous year
been in India for a period of 729 days or less, or
(iii) If such individual is an Indian citizen or person of Indian origin (who, being outside India,
comes on a visit to India in any previous year) having total income, other than the income
from foreign sources [i.e., income which accrues or arises outside India (other than
income derived from a business controlled in or profession set up in India) and which is
not deemed to accrue or arise in India], exceeding ` 15 lakhs during the previous year,
who has been in India for 120 days or more but less than 182 days during that previous
year, or
(iv) If such individual is an Indian citizen who is deemed to be resident in India under section
6(1A) [It may be noted that a deemed resident will always be a resident but not ordinarily
resident].
ILLUSTRATION 2
Chris Gayle, a West Indies cricket player visits India for 102 days in every financial year. This has
been his practice for the past 10 financial years.
(a) Find out his residential status for the A.Y. 2026-27.
(b) Would your answer change if the above facts relate to Srinath, an Indian citizen who
resides in West Indies and represents the West Indies cricket team?
(c) What would be your answer if Srinath had visited India for 120 days instead of 102 days
every year, including P.Y.2025-26?
SOLUTION
(a) Determination of Residential Status of Mr. Chris Gayle for the A.Y. 2026-27:
Period of stay during the P.Y. 2025-26 = 102 days

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Calculation of period of stay during 4 preceding previous years (102 days x 4=408 days)
P.Y. 2024-25 102 days
P.Y. 2023-24 102 days
P.Y. 2022-23 102 days
P.Y. 2021-22 102 days
Total 408 days

Mr. Chris Gayle has been in India for a period of more than 60 days during P.Y. 2025-26
and for a period of more than 365 days during the 4 immediately preceding previous years.
Therefore, since he satisfies one of the basic conditions under section 6(1), he is a resident
for the A.Y. 2026-27.
Computation of period of stay during 7 preceding previous years = 102 days x 7=714 days
2024-25 102 days
2023-24 102 days
2022-23 102 days
2021-22 102 days
2020-21 102 days
2019-20 102 days
2018-19 102 days
Total 714 days

Since his period of stay in India during the past 7 previous years is less than 730 days, he is
a not-ordinarily resident during the A.Y. 2026-27. (See Note below)
Therefore, Mr. Chris Gayle is a resident but not ordinarily resident during the previous year
2025-26 relevant to the A.Y. 2026-27.
Note: An individual, not being an Indian citizen, would be not-ordinarily resident person if
he satisfies any one of the conditions specified under section 6(6), i.e.,
(i) If such individual has been non-resident in India in any 9 out of the 10 previous
years preceding the relevant previous year, or
(ii) If such individual has during the 7 previous years preceding the relevant previous
year been in India for a period of 729 days or less.
In this case, since Mr. Chris Gayle satisfies condition (ii), he is a not-ordinary resident for
the A.Y. 2026-27.

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(b) If the above facts relate to Mr. Srinath, an Indian citizen, who residing in West Indies,
comes on a visit to India, he would be treated as non-resident in India for previous year
2025-26, irrespective of his total income (excluding income from foreign sources), since
his stay in India in the current financial year is, in any case, less than 120 days.
(c) In this case, if Mr. Srinath’s total income (excluding income from foreign sources)
exceeds ` 15 lakh, he would be treated as resident but not ordinarily resident in India for
P.Y.2025-26, since his stay in India is 120 days in the P.Y.2025-26 and 480 days (i.e.,
120 days x 4 years) in the immediately four preceding previous years.
If his total income (excluding income from foreign sources) does not exceed ` 15 lakh, he
would be treated as non-resident in India for the P.Y.2025-26, since his stay in India is
less than 182 days in the P.Y.2025-26.
(2) Residential status of HUF
Resident: A HUF would be resident in India if the control and management of its affairs is situated
wholly or partly in India.
Non-resident: If the control and management of the affairs is situated wholly outside India it would
become a non-resident.

Meaning of the term “control and management”

• The expression ‘control and management’ referred to under section 6 refers to the central
control and management and not to the carrying on of day-to-day business by servants,
employees or agents.
• Control and management means de facto control and management and not merely having the
right to control or manage.
• The business may be done from outside India and yet its control and management may be
wholly within India. Therefore, control and management of a business is said to be situated at
a place where the head and brain of the adventure is situated. Merely because the family has
a house in India, where some of the members reside in the previous year, does not constitute
that place as the seat of control and management of the affairs of the HUF unless important
decisions concerning the affairs of the HUF are taken at that place.

Resident and ordinarily resident/ Resident but not ordinarily resident

If Karta of resident HUF satisfies both the following additional conditions (as applicable in case of
individual) then, resident HUF will be “Resident and ordinarily resident” (ROR), otherwise it will be
“Resident but not ordinarily resident” (RNOR).

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Additional conditions:
1. Karta of resident HUF should be resident in at least 2 previous years out of 10 previous
years immediately preceding relevant previous year.
2. Stay of Karta during 7 previous years immediately preceding relevant previous year
should be 730 days or more.

Residential Status of a HUF

Is the control and management of its affairs situated

wholly or partly in India?

YES NO

Is Karta resident in India in any 2 PYs out of 10 PYs

preceding the relevant PY? HUF is Non-resident
+
Is his stay in India for 730 days or more during the 7 PYs
preceding the relevant PY?

YES NO

HUF is ROR HUF is RNOR

(3) Residential status of firms, AoPs and BoIs

Resident: A firm, AoP and BoI would be resident in India if the control and management of its
affairs is situated wholly or partly in India.
Non-resident: Where the control and management of the affairs is situated wholly outside India,
the firm, AoP and BoI would become a non-resident.

Note - The residential status of the partners/ members is immaterial while determining the
residential status of a Firm/AOP/BOI.

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The term “Non-resident” is defined under section 2(30) of the Income-tax Act, 1961 as a person
who is not a "resident". However, for the purposes of sections 92B, 93 and 168, non-resident
would include a person who is not ordinarily resident within the meaning of section 6(6).

(4) Residential status of local authorities and artificial juridical persons

Resident: Local authorities and artificial juridical persons would be resident in India if the control
and management of its affairs is situated wholly or partly in India.
Non-resident: Where the control and management of the affairs is situated wholly outside India,
they would become non-residents.
(5) Residential status of a Company
A company would be resident in India in any previous year, if-
(i) it is an Indian company; or
(ii) its place of effective management, in that year, is in India.

“Place of effective management “means a place where key management and commercial
decisions that are necessary for the conduct of the business of an entity as a whole are, in
substance made [Explanation to section 6(3)].

DETERMINATION OF RESIDENTIAL STATUS OF A COMPANY

Is the company an Indian Whether POEM of the The company is a

No company is in India in the No non-resident for the
company?
relevant P.Y.? relevant P.Y.

Yes Yes

The company is a resident

in India for the relevant P.Y.

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 21.12 INTERNATIONAL TAXATION

Guiding Principles for determination of Place of Effective management (‘POEM’) of a

Company, other than an Indian company – [Circular No. 6/2017, dated 24.01.2017 & Circular
No. 8/2017, dated 23-02-2017]:
Place of effective management' (POEM) is an internationally recognised test for determination of
residence of a company incorporated in a foreign jurisdiction. Most of the tax treaties entered into
by India recognises the concept of 'place of effective management' for determination of residence
of a company as a tie-breaker rule for avoidance of double taxation.
The CBDT has laid down the following guiding principles to be followed for determination of
POEM.
Concept of Substance over form
The determination of the POEM will depend upon the facts and circumstances of a given case.
The POEM concept is one of substance over form. It may be noted that an entity may have more
than one place of management, but it can have only one place of effective management at any
point of time. Since “residence” is to be determined for each year, POEM will also be required to
be determined on year to year basis.
Whether the company is engaged in active business outside India? - An important criterion
for determination of POEM
The process of determination of POEM would be primarily based on the fact as to whether or not
the company is engaged in active business outside India.
A company shall be said to be engaged in 'active business outside India'
- if passive income is not more than 50% of its total income, and
- less than 50% of its total asset are situated in India; and
- less than 50% of total number of employees are situated in India or are resident in India;
and
- the payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.
Meaning of certain terms:

Term Meaning
Income (a) As computed for tax purpose in accordance with the laws of the country
of incorporation; or
(b) As per books of account, where the laws of the country of incorporation
does not require such a computation.

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 NON RESIDENT TAXATION 21.13

Value of (a) In case of an individually The average of its value for tax
depreciable asset purposes in the country of incorporation
assets
of the company at the beginning and at
end of the previous year; and
(b) In case of pool of fixed The average of its value for tax
asset, being treated as a purposes in the country of incorporation
block for depreciation of the company at the beginning and at
end of the year;
(c) In case of any other asset Value as per books of account

Number of The average of the number of employees as at the beginning and at the end
of the year and shall include persons, who though not employed directly by
employees
the company, perform tasks similar to those performed by the employees.

Payroll This term includes the cost of salaries, wages, bonus, and all other
employee compensation including related pension and social costs borne by
the employer.
Passive It is the aggregate of, -
income (i) income from the transactions where both the purchase and sale of
goods is from/to its associated enterprises; and
(ii) income by way of royalty, dividend, capital gains, interest, or rental
income;
However, any income by way of interest shall not be considered to be
passive income in case of a company which is engaged in the business of
banking or is a public financial institution, and its activities are regulated as
such under the applicable laws of the country of incorporation

Place of Effective Management:

(i) In case of Companies engaged in Active Business outside India
POEM of a company engaged in active business shall be presumed to be outside India if the
majority of the board meeting are held outside India.
However, in case the Board is not exercising its powers of management and such powers are
being exercised by either the holding company or any other person, resident in India, then POEM
shall be considered to be in India.

For this purpose, merely because the Board of Directors (BOD) follows general and objective
principles of global policy of the group laid down by the parent entity which may be in the field of
Payroll functions, Accounting, Human resource (HR) functions, IT infrastructure and network
platforms, Supply chain functions, Routine banking operational procedures, and not being specific

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to any entity or group of entities per se; would not constitute a case of BoD of companies standing
aside.

CBDT Circular No. 25/2017, dated 23.10.2017 clarifies that so long as the Regional Headquarter
operates for subsidiaries/ group companies in a region within the general and objective principles
of global policy of the group laid down by the parent entity in the field of Payroll functions,
Accounting, HR functions, IT infrastructure and network platforms, Supply chain functions, Routine
banking operational procedures, and not being specific to any entity or group of entities per se; it
would, in itself, not constitute a case of BoD of companies standing aside and such activities of
Regional Headquarter in India alone will not be a basis for establishment of POEM for such
subsidiaries/ group companies.
It is further mentioned in the said Circular that the provisions of General Anti-Avoidance Rule
contained in Chapter X-A of the Income-tax Act, 1961 may get triggered in such cases where the
above clarification is found to be used for abusive/ aggressive tax planning.
For the purpose of determining whether the company is engaged in active business outside India,
the average of the data of the previous year and two years prior to that shall be considered. In
case the company has been in existence for a shorter period, then data of such period shall be
considered. Where the accounting year for tax purposes, in accordance with laws of country of
incorporation of the company, is different from the previous year, then, data of the accounting year
that ends during the relevant previous year and two accounting years preceding it shall be
considered.
It has been clarified that mere following of global policies laid down by the Indian holding company
would not constitute that Board is standing aside.
(ii) In case of Companies not engaged in active business outside India
The guidelines provide a two-stage process for determination of POEM in case of companies not
engaged in active business.
(a) First stage: Identifying the person(s) who actually make the key management and
commercial decisions for the conduct of the company as a whole.
(b) Second stage: Determine the place where these decisions are, in fact, being made.

The place where these management decisions are taken would be more important than the place
where such decisions are implemented. For the purpose of determination of POEM, it is the
substance which would be conclusive rather than the form.

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The conditions specified in the circular are depicted in the flow charts below:

The determination of POEM is based on the following categorization of

foreign companies:

Active Business Outside India (Business Test)

Companies fulfilling the test of Companies other than those

ABOI fulfilling the test of ABOI

• POEM outside India, if majority

Stage 1: Identification of persons who
BOD meetings are held outside India
actually make the key management and
• If de facto decision making commercial decision for conduct of the
authority is not BOD but Indian parent company’s business as a whole
or resident, POEM shall be in India
Stage 2: Determination of place where
these decisions are, in fact, made

What is ABOI test?

Its passive income* (wherever earned) is 50% or less of its

total income

A company is said to
be engaged in ABOI, if Less than 50% of its total assets situated in India
it fulfills the
cumulative
conditions of:
Less than 50% of the total number of employees are
situated in India or are residents in India

Payroll expenses incurred on such employees are less than 50%

of its total payroll expenditure

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* Passive income of a company shall be aggregate of:

(i) Income from the transactions where both the purchase and sale of goods is from/ to its
associated enterprises; and
(ii) income by way of royalty, dividend, capital gains, interest (except for banking
companies and public financial institutions) or rental income whether or not involving
associated enterprises.

Some of the guiding principles which may be taken into account for determining the POEM
are as follows:
(a) Location where the Board of Directors meet and makes decisions: This location may
be the place of effective management of a company provided, the Board –
(i) retains and exercises its authority to govern the company; and
(ii) does, in substance, make the key management and commercial decisions necessary
for the conduct of the company’s ‘business as a whole’.
It may be mentioned that mere formal holding of board meetings at a place would by itself
not be conclusive for determination of POEM being located at that place. If the key
decisions by the directors are in fact being taken in a place other than the place where
the formal meetings are held then such other place would be relevant for POEM.
As an example this may be the case where the board meetings are held in a location
distinct from the place where head office of the company is located or such location is
unconnected with the place where the predominant activity of the company is being
carried out.

If a Board has de facto delegated the authority to make the key management and
commercial decisions for the company to the senior management or any other person
including a shareholder, promoter, strategic or legal or financial advisor etc. and does
nothing more than routinely ratifying the decisions that have been made, the company’s
place of effective management will ordinarily be the place where these senior managers
or the other person make those decisions.

“Senior Management” in respect of a company means the person or persons who are
generally responsible for developing and formulating key strategies and policies for the
company and for ensuring or overseeing the execution and implementation of those

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strategies on a regular and on-going basis. While designation may vary, these persons may
include:
(i) Managing Director or Chief Executive Officer;
(ii) Financial Director or Chief Financial Officer;
(iii) Chief Operating Officer; and
(iv) The heads of various divisions or departments (for example, Chief Information or
Technology Officer, Director for Sales or Marketing).

(b) Location of Executive Committee in case powers are delegated by the Board: A
company’s board may delegate some or all of its authority to one or more committees such
as an executive committee consisting of key members of senior management. In these
situations, the location where the members of the executive committee are based and
where that committee develops and formulates the key strategies and policies for mere
formal approval by the full board will often be considered to be the company’s place of
effective management.
The delegation of authority may be either de jure (by means of a formal resolution or
Shareholder Agreement) or de facto (based upon the actual conduct of the board and the
executive committee).
(c) Location of Head Office: The location of a company’s head office will be a very important
factor in the determination of the company’s place of effective management because it often
represents the place where key company decisions are made. The following points need to
be considered for determining the location of the head office of the company: -
If the company’s senior management and their support staff are based in a single location
and that location is held out to the public as the company’s principal place of business or
headquarters then that location is the place where head office is located.
If the company is more decentralized (for example where various members of senior
management may operate, from time to time, at offices located in the various countries)
then the company’s head office would be the location where these senior managers,-
(i) are primarily or predominantly based; or
(ii) normally return to following travel to other locations; or

(iii) meet when formulating or deciding key strategies and policies for the company as a
whole.

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Members of the senior management may operate from different locations on a more or less
permanent basis and the members may participate in various meetings via telephone or
video conferencing rather than by being physically present at meetings in a particular
location. In such situation the head office would normally be the location, if any, where the
highest level of management (for example, the Managing Director and Financial Director)
and their direct support staff are located.
In situations where the senior management is so decentralized that it is not possible to
determine the company’s head office with a reasonable degree of certainty, the location of a
company’s head office would not be of much relevance in determining that company’s place
of effective management.

“Head Office” of a company would be the place where the company's senior management
and their direct support staff are located or, if they are located at more than one location,
the place where they are primarily or predominantly located. A company’s head office is not
necessarily the same as the place where the majority of its employees work or where its
board typically meets.

(d) Use of modern technology: The use of modern technology impacts the place of effective
management in many ways. It is no longer necessary for the persons taking decision to be
physically present at a particular location. Therefore, physical location of board meeting or
executive committee meeting or meeting of senior management may not be where the key
decisions are in substance being made. In such cases the place where the directors or the
persons taking the decisions or majority of them usually reside may also be a relevant
factor.
(e) Decision via circular resolution or round robin voting: In case of circular resolution or
round robin voting the factors like, the frequency with which it is used, the type of decisions
made in that manner and where the parties involved in those decisions are located etc. are
to be considered. It cannot be said that proposer of decision alone would be relevant but
based on past practices and general conduct; it would be required to determine the person
who has the authority and who exercises the authority to take decisions. The place of
location of such person would be more important.
(f) Decisions made by shareholders are not relevant factor in determination of POEM:
The decisions made by shareholder on matters which are reserved for shareholder decision
under the company laws are not relevant for determination of a company’s place of effective
management. Such decisions may include sale of all or substantially all of the company’s

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assets, the dissolution, liquidation or deregistration of the company, the modification of the
rights attaching to various classes of shares or the issue of a new class of shares etc.
These decisions typically affect the existence of the company itself or the rights of the
shareholders as such, rather than the conduct of the company’s business from a
management or commercial perspective and are therefore, generally not relevant for the
determination of a company’s place of effective management.
However, the shareholder’s involvement can, in certain situations, turn into that of effective
management. This may happen through a formal arrangement by way of shareholder
agreement etc. or may also happen by way of actual conduct. As an example if the
shareholders limit the authority of board and senior managers of a company and thereby
remove the company’s real authority to make decision then the shareholder guidance
transforms into usurpation and such undue influence may result in effective management
being exercised by the shareholder.
Therefore, whether the shareholder involvement is crossing the line into that of effective
management is one of fact and has to be determined on case-to-case basis only.
(g) Day to day routine operational decisions are not relevant for determination of POEM:
It may be clarified that day to day routine operational decisions undertaken by junior and
middle management shall not be relevant for the purpose of determination of POEM. The
operational decisions relate to the oversight of the day-to-day business operations and
activities of a company whereas the key management and commercial decision are
concerned with broader strategic and policy decision. For example, a decision to open a
major new manufacturing facility or to discontinue a major product line would be examples
of key commercial decisions affecting the company’s business as a whole. By contrast,
decisions by the plant manager appointed by senior management to run that facility,
concerning repairs and maintenance, the implementation of company-wide quality controls
and human resources policies, would be examples of routine operational decisions. In
certain situations, it may happen that person responsible for operational decision is the
same person who is responsible for the key management and commercial decision. In such
cases it will be necessary to distinguish the two type of decisions and thereafter assess the
location where the key management and commercial decisions are taken.
If the above factors do not lead to clear identification of POEM, then the final guidelines
provide that following secondary factors may be considered:

• Place where main and substantial activity of the company is carried out; or

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• Place where the accounting records of the company are kept.

It needs to be emphasized that the determination of POEM is to be based on all relevant
facts related to the management and control of the company, and is not to be determined
on the basis of isolated facts that by itself do not establish effective management, as
illustrated by the following examples:

(i) The fact that a foreign company is completely owned by an Indian company will not
be conclusive evidence that the conditions for establishing POEM in India have been
satisfied.
(ii) The fact that there exists a Permanent Establishment of a foreign entity in India
would itself not be conclusive evidence that the conditions for establishing POEM in
India have been satisfied.
(iii) The fact that one or some of the Directors of a foreign company reside in India will
not be conclusive evidence that the conditions for establishing POEM in India have
been satisfied.

(iv) The fact of, local management being situated in India in respect of activities carried
out by a foreign company in India will not, by itself, be conclusive evidence that the
conditions for establishing POEM have been satisfied.

(v) The existence in India of support functions that are preparatory and auxiliary in
character will not be conclusive evidence that the conditions for establishing POEM
in India have been satisfied.
It is reiterated that the above principles for determining the POEM are for guidance only. No single
principle will be decisive in itself. The above principles are not to be seen with reference to any
particular moment in time rather activities performed over a period of time, during the previous
year, need to be considered.
In other words, a “snapshot” approach is not to be adopted. Further, based on the facts and
circumstances if it is determined that during the previous year the POEM is in India and also
outside India then POEM shall be presumed to be in India if it has been mainly /predominantly in
India.
The CBDT also clarified that the Assessing Officer (AO) shall, before initiating any proceedings for
holding a company incorporated outside India, on the basis of its POEM, as being resident in India,
seek prior approval of the Principal Commissioner or the Commissioner, as the case may be.

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Further, in case the AO proposes to hold a company incorporated outside India, on the basis of its
POEM, as being resident in India then any such finding shall be given by the AO after seeking
prior approval of the collegium of three members consisting of the Principal Commissioners or the
Commissioners, as the case may be, to be constituted by the Principal Chief Commissioner of the
region concerned, in this regard. The collegium so constituted shall provide an opportunity of being
heard to the company before issuing any directions in the matter.
Example 1: Company A Co. is a sourcing entity, for an Indian multinational group, incorporated in
country X and is 100% subsidiary of Indian company (B Co.). The warehouses and stock in them
are the only assets of the company and are located in country X. All the employees of the
company are also in country X. The average income wise breakup of the company’s total income
for three years is, -
(i) 30% of income is from transaction where purchases are made from parties which are non-
associated enterprises and sold to associated enterprises.
(ii) 30% of income is from transaction where purchases are made from associated enterprises
and sold to associated enterprises.
(iii) 30% of income is from transaction where purchases are made from associated enterprises
and sold to non-associated enterprises. and
(iv) 10% of the income is by way of interest.
Interpretation: In this case, passive income is 40% of the total income of the company. The
passive income consists of, -
(i) 30% income from the transaction where both purchase and sale is from/to associated
enterprises; and
(ii) 10% income from interest.
The A Co. satisfies the first requirement of the test of active business outside India. Since no
assets or employees of A Co. are in India the other requirements of the test is also satisfied.
Therefore, company is engaged in active business outside India.

Example 2: The other facts remain same as that in Example 1 with the variation that A Co. has a
total of 50 employees. 47 employees, managing the warehouse, storekeeping, and accounts of the
company, are located in country X. The Managing Director (MD), Chief Executive Officer (CEO)
and sales head are resident in India. The total annual payroll expenditure on these 50 employees

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is of ` 5 crore. The annual payroll expenditure in respect of MD, CEO and sales head is of
` 3 crore.
Interpretation: Although the first limb of active business test is satisfied by A Co. as only 40% of
its total income is passive in nature. Further, more than 50% of the employees are also situated
outside India. All the assets are situated outside India. However, the payroll expenditure in respect
of the MD, the CEO and the sales head being employee’s resident in India exceeds 50% of the
total payroll expenditure. Therefore, A Co. is not engaged in active business outside India.
Example 3: The basic facts are same as in Example 1. Further facts are that all the directors of
the A Co. are Indian residents. During the relevant previous year 5 meetings of the Board of
Directors is held of which two were held in India and 3 outside India with two in country X and one
in country Y.
Interpretation: The A Co. is engaged in active business outside India as the facts indicated in
Example 1 establish. The majority of board meetings have been held outside India. Therefore, the
POEM of A Co. shall be presumed to be outside India.
Example 4:The facts are same as in Example 3 but it is established by the Assessing Officer that
although A Co.’s senior management team signs all the contracts, for all the contracts above ` 10
lakh the A Co. must submit its recommendation to B Co. and B Co. makes the decision whether or
not the contract may be accepted. It is also seen that during the previous year more than 99% of
the contracts are above ` 10 lakh and over past years also the same trend in respect of value
contribution of contracts above ` 10 lakh is seen.
Interpretation: These facts suggest that the effective management of the A Co. may have been
usurped by the parent company B Co. Therefore, POEM of A Co. may in such cases be not
presumed to be outside India even though A Co. is engaged in active business outside India and
majority of board meeting are held outside India.
Example 5: An Indian multinational group has a local holding company A Co. in country X. The A
Co. also has 100% downstream subsidiaries B Co. and C Co. in country X and D Co. in country Y.
The A Co. has income only by way of dividend and interest from investments made in its
subsidiaries. The Place of Effective Management of A Co. is in India and is exercised by ultimate
parent company of the group. The subsidiaries B, C and D are engaged in active business outside
India. The meetings of Board of Director of B Co., C Co. and D Co. are held in country X and Y
respectively.
Interpretation: Merely because the POEM of an intermediate holding company is in India, the
POEM of its subsidiaries shall not be taken to be in India. Each subsidiary has to be examined

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separately. As indicated in the facts since B Co., C Co., and D Co. are independently engaged in
active business outside India and majority of Board meetings of these companies are also held
outside India. The POEM of B Co., C Co., and D Co. shall be presumed to be outside India.
Further, the CBDT vide Circular no. 8/2017 dated 23.02.2017 also clarified that POEM
guidelines shall not apply to a company having turnover or gross receipts of ` 50 crores or
less in a financial year.

ILLUSTRATION 3
ABC Inc., a Swedish company headquartered at Stockholm, not having a permanent establishment
in India, has set up a liaison office in Mumbai in April, 2025 in compliance with RBI guidelines to
look after its day to day business operations in India, spread awareness about the company’s
products and explore further opportunities. The liaison office takes decisions relating to day to day
routine operations and performs support functions that are preparatory and auxiliary in nature. The
significant management and commercial decisions are, however, in substance made by the Board
of Directors at Sweden. Determine the residential status of ABC Inc. for A.Y. 2026-27.
SOLUTION
Section 6(3) provides that a company would be resident in India in any previous year, if-

(i) it is an Indian company; or

(ii) its place of effective management, in that year, is in India.
In this case, ABC Inc. is a foreign company. Therefore, it would be resident in India for
P.Y.2025-26 only if its place of effective management, in that year, is in India.
Explanation to section 6(3) defines “place of effective management” to mean a place where key
management and commercial decisions that are necessary for the conduct of the business of an
entity as a whole are, in substance made. In the case of ABC Inc., its place of effective
management for P.Y.2025-26 is not in India, since the significant management and commercial
decisions are, in substance, made by the Board of Directors outside India in Sweden.

ABC Inc. has only a liaison office in India through which it looks after its routine day to day
business operations in India. The place where decisions relating to day to day routine operations
are taken and support functions that are preparatory or auxiliary in nature are performed are not
relevant in determining the place of effective management.
Hence, ABC Inc., being a foreign company is a non-resident for A.Y.2026-27, since its place of
effective management is outside India in the P.Y.2025-26.

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Transition Mechanism for a company incorporated outside India and has not been assessed
to tax earlier [Chapter XII-BC – Section 115JH]
A transition mechanism has been provided in Chapter XII-BC comprising of section 115JH for a
company which is incorporated outside India, which has not been assessed to tax in India earlier
and has become resident in India for the first time due to application of POEM.
(a) Section 115JH empowers the Central Government to notify exception, modification and
adaptation subject to which, the provisions of the Act relating to computation of income,
treatment of unabsorbed depreciation, set-off or carry forward and set off of losses, special
provision relating to avoidance of tax and the collection and recovery of taxes shall apply in
a case where a foreign company is said to be resident in India due to its POEM being in
India for the first time and the said company has never been resident in India before.
(b) In a case where the determination regarding foreign company to be resident in India has
been made in the assessment proceedings relevant to any previous year, then, these
transition provisions would also cover any subsequent previous year, if the foreign company
is resident in India in that previous year and the previous year ends on or before the date
on which such assessment proceeding is completed. In effect, the transition provisions
would also cover any subsequent previous year upto the date of determination of POEM in
an assessment proceeding. However, once the transition is complete, then, normal
provisions of the Act would apply.
(c) In the notification issued by the Central Government, certain conditions including procedural
conditions subject to which these adaptations shall apply can be provided for and in case of
failure to comply with the conditions, the benefit of such notification would not be available
to the foreign company.
Accordingly, where in a previous year, any benefit, exemption or relief has been claimed
and granted to the foreign company in accordance with the notification, and subsequently,
there is failure to comply with any of the conditions specified therein, then –
(i) the benefit, exemption or relief shall be deemed to have been wrongly allowed.

(ii) the Assessing Officer may re-compute the total income of the assessee for the said
previous year and make the necessary amendment as if the exceptions,
modifications, and adaptations as per the notification does not apply; and

(iii) the provisions of section 154 shall, so far as may be, apply thereto and the period of
four years for rectification of mistake apparent from the record has to be reckoned

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from the end of the previous year in which the failure to comply with the condition
stipulated in the notification takes place.

(d) Every notification issued in exercise of this power by the Central Government shall be laid
before each house of the Parliament.
(e) Accordingly, in exercise of the power under section 115JH(1) of the Income-tax Act,
1961,the Central Government has, vide notification No. 29/2018, dated 22 nd June, 2018,
specified the exceptions, modifications and adaptions subject to which, the provisions of the
Act relating to computation of income, treatment of unabsorbed depreciation, set-off or carry
forward and set off of losses, special provision relating to avoidance of tax and the
collection and recovery of taxes shall apply in a case where a foreign company is said to be
resident in India in any previous year on account of its POEM being in India and the such
foreign company has not been resident in India before the said previous year.

Particulars Provisions

Determination of opening If the foreign company is assessed to tax in the

WDV foreign jurisdiction
Where depreciation is required to be taken into
account for the purpose of computation of its
taxable income, the WDV of the depreciable asset as
per the tax record in the foreign country on the 1st day of
the previous year shall be adopted as the opening WDV
for the said previous year.
Where WDV is not available as per tax records, the
WDV shall be calculated assuming that the asset was
installed, utilised and the depreciation was actually
allowed as per the provisions of the laws of that foreign
jurisdiction. The WDV so arrived at as on the 1st day of
the previous year shall be adopted to be the opening
WDV for the said previous year.

If the foreign company is not assessed to tax in the

foreign jurisdiction
WDV of the depreciable asset as appearing in the books
of account as on the 1st day of the previous year

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maintained in accordance with the laws of that foreign

jurisdiction shall be adopted as the opening WDV for the
said previous year.

Brought forward loss and If the foreign company is assessed to tax in the
unabsorbed depreciation foreign jurisdiction
Brought forward loss and unabsorbed depreciation as
per the tax record shall be determined year wise on the
1st day of the said previous year.
If the foreign company is not assessed to tax in the
foreign jurisdiction

Brought forward loss and unabsorbed depreciation as

per the books of account prepared in accordance with
the laws of that country shall be determined year wise
on the 1st day of the said previous year.

Other provisions
Such brought forward loss and unabsorbed depreciation
shall be deemed as loss and unabsorbed depreciation
brought forward as on the 1st day of the said previous
year and shall be allowed to be set off and carried
forward in accordance with the provisions of the Act for
the remaining period calculated from the year in which
they occurred for the first time taking that year as the first
year.
However, the losses and unabsorbed depreciation of the
foreign company shall be allowed to be set off only
against such income of the foreign company which has
become chargeable to tax in India on account of it
becoming resident in India due to application of POEM.

In cases where the brought forward loss and unabsorbed

depreciation originally adopted in India are revised or
modified in the foreign jurisdiction due to any action of the
tax or legal authority, the amount of the loss and

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unabsorbed depreciation shall be revised or modified for

the purposes of set off and carry forward in India.

Period of profit and loss The foreign company is required to prepare profit and
account and balance sheet loss account and balance sheet for the period starting
in cases where accounting from the date on which the accounting year immediately
year of foreign company following said accounting year begins, upto 31st March
does not end on of the year immediately preceding the period beginning
31 March
st with 1st April and ending on 31st March during which the
foreign company has become resident.
The foreign company is also required to prepare profit
and loss account and balance sheet for succeeding
periods of twelve months, beginning from 1st April and
ending on 31st March, till the year the foreign company
remains resident in India on account of its POEM.
Examples:
Example 1: If the accounting year of the foreign
company is a calendar year and the company becomes
resident in India during P.Y. 2025-26 for the first time
due to its POEM being in India, then, the company is
required to prepare profit and loss account and balance
sheet for the period 1st January, 2025 to 31st March,
2025. It is also required to prepare profit and loss
account and balance sheet for the period 1st April, 2025
to 31st March, 2026.
For the purpose of carry forward of loss and unabsorbed
depreciation in this case, since the period 1st January,
2025 to 31st March, 2025 is less than 6 months, it is to
be included in the accounting year immediately
preceding the accounting year in which the foreign
company is held to be resident in India for the first time.
Accordingly, the profit and loss and balance sheet of the
Fifteen (15) month period from 1st January, 2025 to 31st
March, 2026 is to be prepared.

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 21.28 INTERNATIONAL TAXATION

Example 2: If the accounting year of the foreign

company is from 1st July to 30th June and the company
becomes resident in India during P.Y. 2025-26 for the
first time due to its POEM being in India, then, the
company is required to prepare profit and loss account
and balance sheet for the period 1st July, 2024 to 31st
March, 2025. It is also required to prepare profit and
loss account and balance sheet for the period 1st April
2025 to 31st March 2026.
For the purpose of carry forward of loss and unabsorbed
depreciation in this case, since the period is more than
6 months, it is to be treated as a separate accounting
year.

The loss and unabsorbed depreciation as per tax record

or books of account, as the case may be, of the foreign
company shall, be allocated on proportionate basis.

Applicability of provisions Where more than one provision of Chapter XVII-B of

of Chapter XVII-B (TDS the Act applies to the foreign company as resident as
provisions) well as foreign company, the provision applicable to
the foreign company alone shall apply.
Compliance to those provisions of Chapter XVII-B of
the Act as are applicable to the foreign company prior
to it becoming Indian resident shall be considered
sufficient compliance to the provisions of said Chapter.
The provisions of section 195(2) relating to application
to Assessing Officer to determine the appropriate
proportion of sum chargeable to tax shall apply in such
manner so as to include payment to the foreign
company.

Availability of deduction The foreign company shall be entitled to relief or deduction

under section 90 or 91 of taxes paid in accordance with the provisions of section
(Foreign tax credit) 90 or section 91 of the Act.

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 NON RESIDENT TAXATION 21.29

Where income on which foreign tax has been paid or

deducted, is offered to tax in more than one year, credit
of foreign tax shall be allowed across those years in the
same proportion in which the income is offered to tax or
assessed to tax in India in respect of the income to
which it relates and shall be in accordance with the
provisions of rule 128 of the Income-tax Rules, 1962.

Non applicability of the The above exceptions, modifications and adaptations

notification shall not apply in respect of such income of the foreign
company which otherwise would have been chargeable
to tax in India, even if the foreign company had not
become Indian resident.

Applicability of the In a case where the foreign company is said to be

notification where foreign resident in India during a previous year, immediately
company becomes resident succeeding a previous year during which it is said to be
in the subsequent previous resident in India; the exceptions, modifications and
year also adaptations shall apply to the said previous year subject
to the condition that the WDV, the brought forward loss
and the unabsorbed depreciation to be adopted on the
1st day of the previous year shall be those which have
been arrived at on the last day of the preceding previous
year in accordance with the provisions of this
notification.

No effect on other Any transaction of the foreign company with any other
transactions person or entity under the Act shall not be altered only on
the ground that the foreign company has become Indian
resident.

Applicability of other Subject to the above exceptions, modifications and

provisions relating to adaptions specifically provided vide this notification, the
foreign company foreign company shall continue to be treated as a
foreign company even if it is said to be resident in India
and all the provisions of the Act shall apply accordingly.
Consequently, the provisions specifically applicable to—

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 21.30 INTERNATIONAL TAXATION

(i) a foreign company, shall continue to apply to it;

(ii) non-resident persons, shall not apply to it; and
(iii) the provisions specifically applicable to resident,
shall apply to it.

Applicability of tax rate on In case of conflict between the provision applicable to

foreign company the foreign company as resident and the provision
applicable to it as foreign company, the later shall
generally prevail.
Therefore, the rate of tax in case of foreign company
i.e., 35% shall remain the same, i.e., rate of income-tax
applicable to the foreign company even though
residency status of the foreign company changes from
non-resident to resident on the basis of POEM.

Applicability of notification This notification shall be deemed to have come into

force from 1st April 2017.

Meaning of foreign The place of incorporation of the foreign company.

jurisdiction

Applicability of rule 115 of The rate of exchange for conversion into rupees of
the Income-tax Rules, 1962. value expressed in foreign currency, wherever
applicable, shall be in accordance with provision of Rule
115 of the Income-tax Rules, 1962. [Rule 115 is given
as Annexure 1 at the end of this module]

Determination of Residential Status: A summary

Abbreviations used in the Flow Charts in pages 21.31 & 21.32

IC = Indian Citizen RPY = Relevant Previous Year
R = Resident NR = Non-resident
IPPYs = Immediately Preceding Previous Years AOP = Association of Persons
N & OR = Resident but Not Ordinarily Resident HUF = Hindu Undivided Family
ROR = Resident and Ordinarily Resident

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 NON RESIDENT TAXATION 21.31

Determination of Residential Status of Individual

Individual

Has he stayed in India <

Yes
60 days in the RPY? NR
No
Yes
Resident Has he stayed ≥ 182
days in the RPY?

No

Is he a NR in any 9 Is he an Indian Citizen who

IPPYs out of 10 left India during the RPY for Yes
Yes employment OR as Crew
NR
RNOR IPPYs?
Member of an Indian Ship?

No No No
No
Is he an Indian Citizen Is his total income,
Yes Has he stayed in India or a Person of Indian
Yes
other than income
for ≤ 729 days during Origin visiting India from foreign
the 7 IPPYs?
during the RPY? source > ` 15
lakhs?
No No
Yes
ROR
Has he stayed in Is his stay in India
Deemed resident [Section 6(1A)] An India for ≥ 365 during RPY ≥ 120
individual, being an Indian citizen, having Yes
days during the 4 days + his stay in
total income (other than the income from
foreign sources) > ` 15 lakhs during the IPPYs? 4 IPPYs ≥ 365
RPY would be deemed to be resident in days?
India in that PY, if he is not liable to pay tax
No
in any other country or territory by reason of Yes
his domicile or residence or any other criteria
of similar nature. A deemed resident u/s NR RNOR
6(1A) would always be a RNOR.
Note – If an individual is a resident in India
in the PY as per section 6(1), then, the
provision of deemed resident u/s 6(1A)
would not apply to him.

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 21.32 INTERNATIONAL TAXATION

Determination of Residential Status of HUF/ Firm/ AOP/ BOI/Local Authority/ Artificial

Juridical Person/Company

HUF/Firm/AOP/BOI/Local Authority/
Artificial Juridical Person Company

Control & Management

Yes
R Is it an Indian
Company?

No
Is it wholly or NR
partly in India? No

Yes
Yes Is the Place of
R Effective Management
in India?

Resident HUF No

NR
Is the Karta NR Yes
in any 9 PPY HUF is
out of 10 PPY? RNOR

No

Is the Karta’s Yes

stay in India ≤
729 days during
the 7 PPYs?

No

HUF is ROR

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 NON RESIDENT TAXATION 21.33

(2) Scope of Total Income [Section 5]

Section 5 provides the scope of total income which depends on the residential status of the
assessee. The scope of total income of an assessee depends upon the following three important
considerations:
(i) the residential status of the assessee;

(ii) the place of accrual or receipt of income, whether actual or deemed; and
(iii) the point of time at which the income had accrued to or was received by or on behalf of the
assessee.
The ambit of total income of the three classes of assessees would be as follows:
(1) Resident and ordinarily resident (ROR)
The total income of an ROR would, under section 5(1), consist of:
(i) income received or deemed to be received in India during the previous year;
(ii) income which accrues or arises or is deemed to accrue or arise in India during the previous
year; and
(iii) income which accrues or arises outside India even if it is not received or brought into India
during the previous year.
In simpler words, the global income of a ROR is chargeable to tax in India.
(2) Resident but not ordinarily resident (RNOR)
Under section 5(1), the total income of an RNOR would consist of –
(i) income received or deemed to be received in India during the previous year;
(ii) income which accrues or arises or is deemed to accrue or arise in India during the previous
year; and
(iii) income derived from a business controlled in or profession set up in India, even though it
accrues or arises outside India.
Note – All other income accruing or arising outside India which is not received or deemed to be
received or deemed to accrue or arise in India would not be included in his total income.

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(3) Non-resident
A non-resident’s total income under section 5(2) includes:
(i) income received or deemed to be received in India in the previous year; and
(ii) income which accrues or arises or is deemed to accrue or arise in India during the previous
year.

Note: All assessees, whether resident or not, are chargeable to tax in respect of their income
accrued, arisen, received or deemed to accrue, arise or to be received in India whereas a resident
alone (resident and ordinarily resident in the case of individuals and HUF) is chargeable to tax in
respect of income which accrues or arises outside India.

Clarification regarding liability to income-tax in India of a non-resident seafarer receiving

remuneration in NRE (Non-Resident External) account maintained with an Indian Bank
[Circular No.13/2017, dated 11.04.2017 and Circular No.17/2017, dated 26.04.2017]
Income by way of salary, received by non-resident seafarers, for services rendered outside India
on foreign ships, is being subjected to tax in India for the reason that the salary has been received
by the seafarer into the NRE bank account maintained in India by the seafarer. On receiving
representations in this regard, the CBDT examined the matter and noted that section 5(2)(a) of the
Income-tax Act, 1961 provides that only such income of a non-resident shall be subjected to tax in
India that is either received or is deemed to be received in India.
Accordingly, the CBDT has, vide this circular, clarified that salary accrued to a non-resident
seafarer for services rendered outside India on a foreign going ship (with Indian flag or foreign
flag) shall not be included in the total income merely because the said salary has been credited in
the NRE account maintained with an Indian bank by the seafarer.

.Summary of scope of Total Income

Particulars Resident Not Non-
and ordinarily Resident
Ordinarily Resident
Resident
Income received or deemed to be received in Yes Yes Yes
India whether earned in India or elsewhere
Income which accrues or arises or is deemed to Yes Yes Yes
accrue or arise in India during the previous year
whether received in India or elsewhere

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 NON RESIDENT TAXATION 21.35

Income which accrues or arises outside India and Yes Yes No

received outside India from a business controlled
from India
Income which accrues or arises outside India and Yes No No
received outside India in the previous year from
any other source
Income which accrues or arises outside India and No No No
received outside India during the year(s)
preceding the relevant previous year and remitted
to India during the relevant previous year

Meaning of “Income received or deemed to be received”

All assessees are liable to tax in respect of the income received or deemed to be received by them
in India during the previous year irrespective of -

(i) their residential status, and

(ii) the place of its accrual.
Income is to be included in the total income of the assessee immediately on its actual or deemed
receipt. The receipt of income refers to only the first occasion when the recipient gets the money
under his control. Therefore, when once an amount is received as income, remittance or
transmission of that amount from one place or person to another does not constitute receipt of
income in the hands of the subsequent recipient or at the place of subsequent receipt.

Income deemed to be received in India [Section 7]

Contribution in excess of 12% Contribution by the Amount transferred from

of salary to Recognised Central Government or unrecognised provident
provident fund or interest any other employer in fund to recognised
credited in excess of 9.5% p.a the P.Y. under a provident fund (being the
(Annual accretion to the credit pension scheme employer's contribution
of RPF) referred u/s 80CCD and interest thereon)

Meaning of income ‘accruing’ and ‘due’

Accrue refers to the right to receive income, whereas due refers to the right to enforce payment of
the same. For e.g. salary for work done in December will accrue throughout the month, day to day,
but will become due on the salary bill being passed on 31st December or 1st January.

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 21.36 INTERNATIONAL TAXATION

Similarly, on Government securities, interest payable on specified dates arise during the period of
holding, day to day, but will become due for payment on the specified dates.
Example:
Interest on Government securities is usually payable on specified dates, say on 1st January and
1 st July. In all such cases, the interest would be said to accrue from 1 st July to 31 st December
and on 1st January, it will fall due for payment.

It must be noted that income which has been taxed on accrual basis cannot be assessed again on
receipt basis, as it will amount to double taxation.
Explanation 1 to section 5 specifically provides that an item of income accruing or arising outside
India shall not be deemed to be received in India merely because it is taken into account in a
balance sheet prepared in India.
Further, Explanation 2 to section 5 makes it clear that once an item of income is included in the
assessee’s total income and subjected to tax on the ground of its accrual/ deemed accrual, it
cannot again be included in the person’s total income and subjected to tax either in the same or in
a subsequent year on the ground of its receipt - whether actual or deemed.
Income deemed to accrue or arise in India [Section 9]
Under section 9, certain types of income are deemed to accrue or arise in India even though they
may actually accrue or arise outside India.

Income deemed to accrue or arise in India

[Clause (i), (ii), (iii) & (iv) Section 9(1) ]

Income accruing or Salary Salary payable by

arising outside earned for the Government to Dividend paid
India, directly or services Indian Citizen for by Indian
indirectly through rendered in services rendered Company
or from India outside India Outside India

Any Business Any property/asset Transfer of

Connection in or source of capital asset
India income in India situated in India

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 NON RESIDENT TAXATION 21.37

Income deemed to accrue or arise in India

[Clause (v), (vi) (vii) & (viii) of Section 9(1)]

Interest, if Royalty, if Fees for technical Income arising

payable by payable by outside India, being
service, if payable by any sum of money
paid without
consideration, by a
person resident in
Person resident Government A non- India to a non-
in India resident corporate non-
resident or foreign
company or to a
If technical RNOR, where
Exceptions If money is aggregate of such
borrowed services or sum > ` 50,000
and used royalty
If the money for the services
If the money purpose of are utilised
borrowed and borrowed
and used or business or for the
used or technical profession purpose of
services or royalty technical
services or carried on business or
services are in India profession
utilised for the royalty
services are carried on
purpose of in India or
business or utilised for
making making
profession carried income
on outside India income from
any source from any
outside India source in
India

The categories of income which are deemed to accrue or arise in India are:
(1) Any income accruing or arising to an assessee in any place outside India whether
directly or indirectly
(i) through or from any business connection in India,
(ii) through or from any property in India,
(iii) through or from any asset or source of income in India or

(iv) through the transfer of a capital asset situated in India

would be deemed to accrue or arise in India [Section 9(1)(i)].

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(i) What is Business Connection?

‘Business connection’ shall include any business activity carried out through a person acting on
behalf of the non-resident [Explanation 2 to section 9(1)(i)]

For a business connection to be established, the person acting on behalf of the non-resident –

(a) must have an authority, which is habitually exercised in India, to conclude contracts on
behalf of the non-resident or

habitually concludes contracts or habitually plays the principal role leading to conclusion
of contracts by that non-resident and such contracts are

- in the name of the non-resident; or

- for the transfer of the ownership of, or for the granting of the right to use, property
owned by that non-resident or that non-resident has the right to use; or

- for the provision of services by that non-resident, or

(b) in a case, where he has no such authority, but habitually maintains in India a stock of
goods or merchandise from which he regularly delivers goods or merchandise on behalf
of the non-resident, or

(c) habitually secures orders in India, mainly or wholly for the non-resident.

Further, there may be situations when the person acting on behalf of the non-resident
secure order for other non-residents. In such situation, business connection for other non-
residents is established if,

i. such other non-resident controls the non-resident or

ii. such other non-resident is controlled by the non-resident or

iii. such other non-resident is subject to same control as that of non-resident.

In all the three situations, business connection is established, where a person habitually
secures orders in India, mainly or wholly for such non-residents.

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Mr. A acting on behalf of Mr. X, non-resident

Secures order for

Mr. X, non-resident Mr. Y, non-resident

Business connection Business Connection

directly established established, if

(i) Mr. X is controlled by Mr. Y or

(ii) Mr. Y is controlled by Mr. X or
(iii) Commonly controlled by Mr. Z, being the
person who controls Mr. X as well as Mr. Y.

Agents having independent status are not included in Business Connection: Business
connection, however, shall not be established, where the non-resident carries on business through
a broker, general commission agent or any other agent having an independent status, if such a
person is acting in the ordinary course of his business.

A broker, general commission agent or any other agent shall be deemed to have an independent
status where he does not work mainly or wholly for the non-resident.
Where a business is carried on in India through a person referred to in (a), (b) or (c) of (i) above,
only so much of income as is attributable to the operations carried out in India shall be deemed to
accrue or arise in India [Explanation 3 to Section 9(1)(i)].
Significant economic presence [Explanation 2A to section 9(1)(i)]
Significant economic presence of a non-resident in India shall also constitute business connection
in India.
Significant economic presence means-
Nature of transaction Condition
(a) in respect of any goods, services or property Aggregate of payments arising from such
carried out by a non-resident with any person transaction or transactions during the
in India including provision of download of previous year should exceed ` 2 crores.
data or software in India

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(b) systematic and continuous soliciting of The number of users should be atleast 3
business activities or engaging in interaction lakhs.
with users in India

The above transactions or activities shall constitute significant economic presence in India,
whether or not,—
(i) the agreement for such transactions or activities is entered in India;
(ii) the non-resident has a residence or place of business in India; or

(iii) the non-resident renders services in India:

However, transactions or activities of a non-resident in India which are confined to the
purchase of goods in India for the purpose of export shall not constitute significant
economic presence of such non-resident in India.
Further, where a business connection is established by reason of significant economic presence in
India, only so much of income as is attributable to the transactions or activities referred to in (a) or
(b) above shall be deemed to accrue or arise in India.
In the case of a non-resident the following shall not, however, be treated as business
connection in India [Explanation 1 to section 9(1)(i)]:
(a) In the case of a business, in respect of which all the operations are not carried out
in India [Explanation 1(a) to section 9(1)(i)]: In the case of a business, other than the
business having business connection in India on account of significant economic
presence, of which all the operations are not carried out in India, the income of the
business deemed to accrue or arise in India shall be only such part of income as is
reasonably attributable to the operations carried out in India. Therefore, it follows that
such part of income which cannot be reasonably attributed to the operations in India, is
not deemed to accrue or arise in India.

Income attributable to the operations carried out in India includes:

Income from sale of goods

Income from advt. targetting Income from sale of data
and services using data
customers residing in India collected from persons
collected from persons
or accessing advt. thro IPA residing in India or using
residing in India or using
located in India IPA located in India
IPA located in India

IPA – Internet Protocol Address

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 NON RESIDENT TAXATION 21.41

The above provisions would also apply to the income attributable to the transactions or
activities referred to in Explanation 2A to section 9(1)(i).
(b) Purchase of goods in India for export [Explanation 1(b) to section 9(1)(i)]: In the
case of a non-resident, no income shall be deemed to accrue or arise in India to him
through or from operations which are confined to the purchase of goods in India for the
purpose of export.
(c) Collection of news and views in India for transmission out of India [Explanation 1(c)
to section 9(1)(i)]: In the case of a non-resident, being a person engaged in the business
of running a news agency or of publishing newspapers, magazines or journals, no income
shall be deemed to accrue or arise in India to him through or from activities which are
confined to the collection of news and views in India for transmission out of India.
(d) Shooting of cinematograph films in India [Explanation 1(d) to section 9(1)(i)]: In the
case of a non-resident, no income shall be deemed to accrue or arise in India through or
from operations which are confined to the shooting of any cinematograph film in India, if
such non-resident is :
• an individual, who is not a citizen of India or
• a firm which does not have any partner who is a citizen of India or who is resident in
India; or
• a company which does not have any shareholder who is a citizen of India or who is
resident in India.
(e) Activities confined to display of rough diamonds in SNZs [Explanation 1(e) to section
9(1)(i)]: In case of a foreign company engaged in the business of mining of diamonds, no
income shall be deemed to accrue or arise in India to it through or from the activities
which are confined to display of uncut and unassorted diamonds in any special zone
notified by the Central Government in the Official Gazette in this behalf.
(ii) & (iii) Income from property, asset or source of income in India
Any income which arises from any property in India (movable, immovable, tangible and intangible
property) would be deemed to accrue or arise in India.
Examples:
• Hire charges or rent paid outside India for the use of the machinery or buildings situated in
India
• deposits with an Indian company for which interest is received outside India etc.

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(iv) Income through transfer of a capital asset situated in India

Capital gains arising through or from the transfer of a capital asset situated in India would be
deemed to accrue or arise in India in all cases irrespective of the fact whether
• The capital asset is movable or immovable, tangible or intangible;
• The place of registration of the document of transfer etc., is in India or outside; and
• The place of payment of the consideration for the transfer is within India or outside.
Accordingly, the expression “through” shall mean and include and shall be deemed to have always
meant and included “by means of”, “in consequence of” or “by reason of” [Explanation 4 to
section 9(1)(i)].
Further, an asset or a capital asset being any share or interest in a company or entity registered or
incorporated outside India shall be deemed to be and shall always be deemed to have been
situated in India, if the share or interest derives, directly or indirectly, its value substantially from
the assets located in India [Explanation 5 to section 9(1)(i)].

Cases where an asset or capital asset held by a non-resident is not deemed to be situated in
India
(1) An asset or capital asset, which is held by a non-resident by way of investment, directly
or indirectly, in Category-I or Category-II foreign portfolio investor under the Securities
and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 prior to their
repeal, made under the Securities and Exchange Board of India Act, 1992, shall not
deemed to be or deemed to have been situated in India [Second proviso to Explanation 5
to section 9(1)(i)]
(2) An asset or a capital asset, which is held by a non-resident by way of investment, directly
or indirectly, in Category-I foreign portfolio investor under the Securities and Exchange
Board of India (Foreign Portfolio Investors) Regulations, 2019, made under the Securities
and Exchange Board of India Act, 1992 shall also not deemed to be or deemed to have
been situated in India [Third proviso to Explanation 5 to section 9(1)(i)]
The CBDT has, vide Circular No. 28/2017, dated 07.11.2017, clarified that the provisions of
section 9(1)(i) read with Explanation 5, shall not apply in respect of income accruing or arising to a
non-resident on account of redemption or buyback of its share or interest held indirectly (i.e.
through upstream entities registered or incorporated outside India) in the specified funds (namely,
investment funds, venture capital company and venture capital funds) if such income accrues or

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arises from or in consequence of transfer of shares or securities held in India by the specified
funds and such income is chargeable to tax in India.

However, the above benefit shall be applicable only in those cases where the proceeds of
redemption or buyback arising to the non-resident do not exceed the pro-rata share of the non-
resident in the total consideration realized by the specified funds from the said transfer of shares
or securities in India. It is further clarified that a non-resident investing directly in the specified
funds shall continue to be taxed as per the extant provisions of the Act.

Declaration of dividend by a foreign company outside India does not have the effect of transfer
of any underlying assets located in India. Circular No. 4/2015, dated 26-03-2015, therefore,
clarifies that, the dividends declared and paid by a foreign company outside India in respect of
shares which derive their value substantially from assets situated in India would NOT be deemed
to be income accruing or arising in India by virtue of the provisions of section 9(1)(i).

Explanation 6 to section 9(1)(i) provides that the share or interest in a company or entity registered
or incorporated outside India, shall be deemed to derive its value substantially from the assets
(whether tangible or intangible) located in India, if on the specified date, the value of Indian assets, -
• exceeds the amount of ` 10 crore; and
• represents at least 50% of the value of all the assets owned by the company or entity, as
the case may be;
Meaning of certain terms:
Term Meaning
Value of an asset The fair market value as on the specified date, of such asset
without reduction of liabilities, if any, in respect of the asset,
determined in prescribed manner.
Specified date The date on which the accounting period of the company or, as the
case may be, the entity ends preceding the date of transfer of a share
or an interest.
However, the date of transfer shall be the specified date of valuation,
in a case where the book value of the assets of the company or
entity on the date of transfer exceeds by at least 15%, the book
value of the assets as on the last balance sheet date preceding the
date of transfer.
Accounting period Each period of 12 months ending with 31st March.
However, where a company or an entity, referred to in Explanation 5,
regularly adopts a period of 12 months ending on a day other than
31st March for the purpose of—

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(a) complying with the provisions of the tax laws of the territory, of
which it is a resident, for tax purposes; or
(b) reporting to persons holding the share or interest,
then, the period of twelve months ending with the other day shall be the
accounting period of the company or, as the case may be, the entity:
First Accounting First accounting period of the company or, as the case may be, the
Period entity shall begin from the date of its registration or
incorporation and end with the 31st March or such other day, as
the case may be, following the date of such registration or
incorporation.
Later accounting Later accounting period shall be the successive periods of twelve
period months
Accounting period If the company or the entity ceases to exist before the end of
of an entity which accounting period, as aforesaid, then, the accounting period shall
ceases to exist end immediately before the company or, as the case may be, the
entity, ceases to exist.

Note - The manner of determination of fair market value of the assets of the foreign company is
given in Rule 11UB. Determination of income attributable to assets in India is given in Rule 11UC 2.
Explanation 7 to section 9(1)(i) provides that no income shall be deemed to accrue or arise to
a non-resident from transfer, outside India, of any share of, or interest in, a company or an entity,
registered or incorporated outside India, in the following cases;
(1) Foreign company or AND the transferor (whether individually or along with its
entity directly owns the associated enterprises), at any time in the twelve
assets situated in India months preceding the date of transfer, does not hold
• the right of management or control in relation to
foreign company or entity; or
• the voting power or share capital or interest
exceeding 5% of the total voting power or total
share capital or total interest, as the case may
be, of the foreign company or entity; or
(2) Foreign company or AND the transferor (whether individually or along with its
entity indirectly owns associated enterprises), at any time in the twelve
the assets situated in months preceding the date of transfer, does not hold
India • the right of management or control in relation to
foreign company or entity; or

2 For detailed reading of Rule 11UB and 11UC of the Income-tax Rules, 1962, students may visit
[Link]

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 NON RESIDENT TAXATION 21.45

• any right in, or in relation to, such foreign

company or entity which would entitle him to the
right of management or control in the company or
entity that directly owns the assets situated in
India; or
• such percentage of voting power or share capital
or interest in foreign company or entity which
results in holding of (either individually or along
with associated enterprises) a voting power or
share capital or interest exceeding 5% of the
total voting power or total share capital or total
interest, as the case may be, of the company or
entity that directly owns the assets situated in
India;

In effect, the exemption shall be available to the transferor of a share of, or interest in, a foreign
entity if he along with its associated enterprises, -
• neither holds the right of control or management,
• nor holds voting power or share capital or interest exceeding 5% of the total voting power or
total share capital or total interest,
in the foreign company or entity directly holding the Indian assets (direct holding company).
In case the transfer is of shares or interest in a foreign entity which does not hold the Indian assets
directly then the exemption shall be available to the transferor if he along with its associated
enterprises,-
• neither holds the right of management or control in relation to such company or the entity,
• nor holds any rights in such company which would entitle it to either exercise control or
management of the direct holding company or entity or entitle it to voting power or share
capital or total interest exceeding 5% in the direct holding company or entity.
Further, where all the assets owned, directly or indirectly, by a company or, as the case may be,
an entity registered or incorporated outside India, are not located in India, the income of the non-
resident transferor, from transfer outside India of a share of, or interest in the foreign company or
entity, deemed to accrue or arise in India under this clause, shall be only such part of the income
as is reasonably attributable to assets located in India and determined in the prescribed manner.

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“Associated enterprise”, in relation to another enterprise, means an enterprise—

• which participates, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise; or
• in respect of which one or more persons who participate, directly or indirectly, or through
one or more intermediaries, in its management or control or capital, are the same persons
who participate, directly or indirectly, or through one or more intermediaries, in the
management or control or capital of the other enterprise.
(2) Income from salaries earned in India [Section 9(1)(ii)]
Income, which falls under the head “Salaries”, deemed to accrue or arise in India, if it is earned in
India. Salary payable for service rendered in India would be treated as earned in India.
Further, any income under the head “Salaries” payable for rest period or leave period which is
preceded and succeeded by services rendered in India, and forms part of the service contract of
employment, shall be regarded as income earned in India.
(3) Income from salaries payable by the Government for services rendered outside India
[Section 9(1)(iii)]
Income from ‘Salaries’ which is payable by the Government to a citizen of India for services
rendered outside India would be deemed to accrue or arise in India.

However, allowances and perquisites paid or allowed outside India by the Government to an Indian
citizen for services rendered outside India is exempt, by virtue of section 10(7).

Note - Exemption under section 10(7) would be available to an assessee irrespective of the
regime under which he pays tax.

ILLUSTRATION 4
J, a citizen of India, employed in the Indian Embassy at Tokyo, Japan. He received salary and
allowances at Tokyo from the Government of India for the year ended 31.3.2026 for services
rendered by him in Tokyo. Besides, he was allowed perquisites by the Government. He is a non-
resident for the assessment year 2026-27. Examine the taxability of salary, allowances and
perquisites in the hands of J for the assessment year 2026-27.
SOLUTION
As per section 9(1)(iii), salaries payable by the Government to a citizen of India for services
rendered outside India shall be deemed to accrue or arise in India. As such, salary received by J is
chargeable to tax, even though he was a non-resident for A.Y. 2026-27.

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 NON RESIDENT TAXATION 21.47

As per section 10(7), all allowances or perquisites paid or allowed as such outside India by the
Government to a citizen of India for rendering services outside India is exempt from tax. Therefore,
the allowances and perquisites received by J are exempt as per section 10(7).
(4) Dividend paid by an Indian company outside India [Section 9(1)(iv)]
Dividend paid by an Indian company outside India is deemed to be accrue or arise in India and
would be taxable in India in the hands of non-resident shareholders.
(5) Interest [Section 9(1)(v)]
Under section 9(1)(v), an interest is deemed to accrue or arise in India if it is payable by -
(i) the Government;
(ii) a person who is a resident;
Exception: Where it is payable in respect of any debt incurred or money borrowed and
used, for the purposes of a business or profession carried on by him outside India or for
the purposes of making or earning any income from any source outside India, it will not
be deemed to accrue or arise in India.
(iii) a person who is a non-resident only when it is payable in respect of any debt incurred or
moneys borrowed and used, for the purpose of a business or profession carried on by
such person in India.

Example: If a non-resident ‘A’ borrows money from a non-resident ‘B’ and invests the
same in shares of an Indian company, interest payable by ‘A’ to ‘B’ will not be deemed to
accrue or arise in India.

Meaning of interest: Interest means interest payable in any manner in respect of any
moneys borrowed or debt incurred (including a deposit, claim or other similar right or
obligation) and includes any service fee or other charge in respect of the moneys
borrowed or debt incurred or in respect of any credit facility which has not been utilized.

Taxability of interest payable by the Permanent Establishment of a non-resident

engaged in banking business to the head office

In order to provide clarity and certainty, on the issue of taxability of interest payable by the
PE of a non-resident engaged in banking business to the head office, an Explanation has
been inserted in section 9(1)(v). Accordingly, in the case of a non-resident, being a
person engaged in the business of banking, any interest payable by the PE in India of

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such non-resident to the head office or any PE or any other part of such non-resident
outside India, shall be deemed to accrue or arise in India.
Such interest shall be chargeable to tax in addition to any income attributable to the PE in
India.
Further, the PE in India shall be deemed to be a person separate and independent of the
non-resident person of which it is a PE and the provisions of the Act relating to computation
of total income, determination of tax and collection and recovery would apply accordingly.
Also, the PE in India has to deduct tax at source on any interest payable to either the head
office or any other branch or PE, etc. of the non-resident outside India. Non-deduction
would result in disallowance of interest claimed as expenditure by the PE and may also
attract levy of interest and penalty in accordance with relevant provisions of the Act.

Permanent establishment includes a fixed place of business through which the business
of the enterprise is wholly or partly carried on.

(6) Royalty [Section 9(1)(vi)]

Royalty will be deemed to accrue or arise in India when it is payable by -
(i) the Government;
(ii) a person who is a resident in India
Exception: Where it is payable for the transfer of any right or the use of any property or
information or for the utilization of services for the purposes of a business or profession
carried on by such person outside India or for the purposes of making or earning any
income from any source outside India, or
(iii) a non-resident only when the royalty is payable in respect of any right, property or
information used or services utilised for purposes of a business or profession carried on by
such person in India or for the purposes of making or earning any income from any source
in India.
Important points:
(A) Lumpsum royalty not deemed to accrue arise in India: Lumpsum royalty payments
made by a resident for the transfer of all or any rights (including the granting of a license) in
respect of computer software supplied by a non-resident manufacturer along with
computer hardware under any scheme approved by the government under the policy on
computer software export, software development and training, 1986 shall not be deemed to
accrue or arise in India.

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 NON RESIDENT TAXATION 21.49

(B) Meaning of Computer software: “Computer software” means any computer programme
recorded on any disc, tape, perforated media or other information storage device and
includes any such programme or any customised electronic data.
(C) Meaning of Royalty: The term ‘royalty’ means consideration (including any lumpsum con-
sideration but excluding any consideration which would be the income of the recipient
chargeable under the head ‘capital gains’) for:
(i) the transfer of all or any rights (including the granting of license) in respect of a
patent, invention, model, design, secret formula or process or trade mark or similar
property;
(ii) the imparting of any information concerning the working of, or the use of, a patent,
invention, model, design, secret formula or process or trade mark or similar property;
(iii) the use of any patent, invention, model, design, secret formula or process or trade
mark or similar property;
(iv) the imparting of any information concerning technical, industrial, commercial or
scientific knowledge, experience or skill;
(v) the use or right to use any industrial, commercial or scientific equipment but not
including the amounts referred to in section 44BB;
(vi) the transfer of all or any rights (including the granting of license) in respect of any
copyright, literary, artistic or scientific work including films or video tapes for use in
connection with television or tapes for use in connection with radio broadcasting.
Note - Consideration for sale, distribution or exhibition of cinematographic films is
covered within the scope of royalty.
(vii) the rendering of any service in connection with the activities listed above.
The definition of ‘royalty’ for this purpose is wide enough to cover both industrial royalties
as well as copyright royalties. The definition specially excludes income which should be
chargeable to tax under the head ‘capital gains’.
(D) Consideration for use or right to use of computer software is royalty within the
meaning of section 9(1)(vi)
The consideration for use or right to use of computer software is royalty by clarifying that,
transfer of all or any rights in respect of any right, property or information includes and
has always included transfer of all or any right for use or right to use a computer software

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 21.50 INTERNATIONAL TAXATION

(including granting of a license) irrespective of the medium through which such right is
transferred [Explanation 4].

Consequently, the provisions of tax deduction at source under section 194J and
section 195 would be attracted in respect of consideration for use or right to use
computer software since the same falls within the definition of royalty as per the
provisions of the Income-tax Act, 1961.
The Central Government has, vide Notification No. 21/2012 dated 13.6.2012 to be effective
from 1st July, 2012, exempted certain software payments from the applicability of tax
deduction under section 194J. Accordingly, where payment is made by the transferee for
acquisition of software from a resident-transferor, the provisions of section 194J would not
be attracted if –

(1) the software is acquired in a subsequent transfer without any modification by the
transferor;
(2) tax has been deducted either under section 194J or under section 195 on payment
for any previous transfer of such software; and
(3) the transferee obtains a declaration from the transferor that tax has been so
deducted along with the PAN of the transferor.

The issue of whether the amounts paid by resident Indian end-users/ distributors to non-
resident computer software manufacturers/ suppliers, as consideration for the use/resale of
the computer software through End-User Licence Agreement (EULAs) /distribution
agreements, be considered as payment of royalty for the use of copyright in the computer
software came up before the Supreme Court in Engineering Analysis Centre of Excellence
P. Ltd v. CIT and Another (2021) ITR 471.
The Apex Court observed that as per the definition given in Explanation 2(v) to section
9(1)(vi) of the Income-tax Act, 1961, “royalty” means consideration for, inter alia, the
transfer of all or any rights (including the granting of a licence), in respect of any copyright,
literary, artistic or scientific work. As per Explanation 4 thereto, such transfer of all or any
rights includes transfer of all or any right for use or right to use a computer software
(including the granting of a licence). As per the meaning of royalties as assigned in the
DTAA with Singapore, “royalty” means payment of any kind received as consideration for
“the use of, or the right to use, any copyright” of a literary, artistic or scientific work. The
meaning of royalty in India’s DTAA with other countries like Australia, Canada, France,
Italy, USA, Netherlands, Sweden, Taiwan, Japan, China etc. is also similar if not identical.

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 NON RESIDENT TAXATION 21.51

The definition of the royalties under the DTAA does not include transfer of right for use or
right to use a computer software.
The scope of definition of royalties under the Act is wider as compared to the definition of
royalties under India’s DTAA with these countries.
The Apex Court observed the following four categories of cases, in which the distribution
agreements and end-user licence agreements did not create any interest or right to such
distributors or end-users, which could amount to the use of or right to use any copyright:
(i) where computer software is purchased directly by an end-user, resident in India,
from a foreign, non-resident supplier or manufacturer.
(ii) where resident Indian companies acting as distributors or resellers, purchase
computer software from foreign, non-resident suppliers or manufacturers and then,
resell the same to resident Indian end-users.
(iii) where the distributor happens to be a foreign, non-resident vendor, who, after
purchasing software from a foreign, non-resident seller, resells the same to resident
Indian distributors or end-users.
(iv) where computer software is affixed onto hardware and is sold as an integrated
unit/equipment by foreign, non-resident suppliers to resident Indian distributors or
end-users.
Therefore, in the specified cases mentioned above, the Apex Court held that the amount
paid by resident Indian end-users or distributors to non-resident computer software
manufacturers or suppliers, as consideration for the resale or use of the computer software
through end-user licence agreements or distribution agreements, is not royalty.
Consequently, the consideration paid to the non-resident computer software manufacturers
or suppliers would not be chargeable to tax India. Hence, no tax is required to be deducted
at source u/s 195.

(E) Consideration in respect of any right, property or information – Is it royalty?

Royalty includes and has always included consideration in respect of any right, property
or information, whether or not,
(a) the possession or control of such right, property or information is with the payer;

(b) such right, property or information is used directly by the payer;

(c) the location of such right, property or information is in India [Explanation 5].

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 21.52 INTERNATIONAL TAXATION

(F) Meaning of Process

The term “process” includes and shall be deemed to have always included transmission by
satellite (including up-linking, amplification, conversion for down-linking of any signal),
cable, optic fibre or by any other similar technology, whether or not such process is secret
[Explanation 6].
(7) Fees for technical services [Section 9(1)(vii)]
Any fees for technical services will be deemed to accrue or arise in India if they are payable by -

(i) the Government.

(ii) a person who is resident in India
Exception: Where the fees is payable in respect of technical services utilised in a
business or profession carried on by such person outside India or for the purpose of
making or earning any income from any source outside India.
(iii) a person who is a non-resident, only where the fees are payable in respect of services utilised
in a business or profession carried on by the non-resident in India or where such services are
utilised for the purpose of making or earning any income from any source in India.
Fees for technical services mean any consideration (including any lumpsum consideration) for
the rendering of any managerial, technical or consultancy services (including providing the
services of technical or other personnel). However, it does not include consideration for any
construction, assembly, mining or like project undertaken by the recipient or consideration which
would be income of the recipient chargeable under the head ‘Salaries’.

Income deemed to accrue or arise in India to a non-resident by way of interest, royalty and fee
for technical services to be taxed irrespective of territorial nexus [Explanation to section 9]

Income by way of interest, royalty or fee for technical services which is deemed to accrue or arise
in India by virtue of clauses (v), (vi) and (vii) of section 9(1), shall be included in the total income of
the non-resident, whether or not –

(i) the non-resident has a residence or place of business or business connection in India; or
(ii) the non-resident has rendered services in India.
In effect, the income by way of fee for technical services, interest or royalty, from services utilized
in India would be deemed to accrue or arise in India in case of a non-resident and be included in
his total income, whether or not such services were rendered in India.

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 NON RESIDENT TAXATION 21.53

ILLUSTRATION 5
Miss Vivitha, Resident, paid a sum of 5000 USD to Mr. Kulasekhara, a management consultant
practising in Colombo, specializing in project financing. The payment was made in Colombo.
Mr. Kulasekhara is a non-resident. The consultancy is related to a project in India with possible
Ceylonese collaboration. Is this payment chargeable to tax in India in the hands of
Mr. Kulasekhara?
SOLUTION
A non-resident is chargeable to tax in respect of income received outside India only if such income
accrues or arises or is deemed to accrue or arise to him in India.
The income deemed to accrue or arise in India under section 9 comprises, inter alia, income by
way of fees for technical services, which includes any consideration for rendering of any
managerial, technical or consultancy services. Therefore, payment to a management consultant
relating to project financing is covered within the scope of “fees for technical services”.
The Explanation to section 9(2) clarifies that income by way of, inter alia, fees for technical
services, would be deemed to accrue or arise in India in case of a non-resident and be included in
his total income, whether or not such services were rendered in India or whether or not the non-
resident has a residence or place of business or business connection in India.
In the instant case, since the services were utilized in India, the payment received by
Mr. Kulasekhara, a non-resident, in Colombo is chargeable to tax in his hands in India, as it is
deemed to accrue or arise in India.
(8) Any sum of money paid by a resident Indian to a non-corporate non-resident or
foreign company or to a resident but not ordinarily resident in India [Section 9(1)(viii)]
Income arising outside India, being any sum of money paid without consideration, by a Indian
resident person to a non-corporate non-resident or foreign company or to a RNOR would be
deemed to accrue or arise in India if the same is chargeable to tax under section 56(2)(x) i.e., if
the aggregate of such sum received by a non-corporate non-resident or foreign company exceeds
` 50,000.

It may be noted that this deeming provision applies to only sum of money paid outside India to a
non-corporate non-resident or foreign company or to a RNOR, and not in respect of property,
movable or immovable, transferred outside India without consideration or for inadequate
consideration to a non-corporate non-resident or foreign company or to a RNOR.

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ILLUSTRATION 6
Compute the total income in the hands of an individual, aged 55 years, being a resident and
ordinarily resident, resident but not ordinarily resident, and non-resident for the A.Y. 2026-27 if he
has shifted out of the default tax regime and pays tax under normal provisions of the Act:

Particulars Amount (`)

Interest on UK Development Bonds, 50% of interest received in India 10,000
Income from a business in Chennai (50% is received in India) 20,000
Short term capital gains on sale of shares of an Indian company received in 20,000
London
Dividend from British company received in London 5,000
Long term capital gains on sale of plant at Germany, 50% of profits are 40,000
received in India
Income earned from business in Germany which is controlled from Delhi 70,000
(` 40,000 is received in India)
Profits from a business in Delhi but managed entirely from London 15,000
Income from house property in London deposited in an Indian Bank at London, 50,000
brought to India (Computed)
Interest on debentures in an Indian company received in London 12,000
Fees for technical services rendered in India but received in London 8,000
Profits from a business in Bombay managed from London 26,000
Pension for services rendered in India but received in London (Computed) 4,000
Income from property situated in Pakistan, received there (Computed) 16,000
Past foreign untaxed income brought to India during the previous year 5,000
Income from agricultural land in Nepal received there and then brought to India 18,000
Income from profession in Kenya which was set up in India, received there but 5,000
spent in India
Gift received on the occasion of his wedding 20,000
Interest on savings bank deposit in State Bank of India 12,000
Income from a business in Russia, controlled from Russia 20,000
Dividend from Reliance Petroleum Limited, an Indian Company 5,000
Agricultural income from a land in Rajasthan 15,000

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 NON RESIDENT TAXATION 21.55

SOLUTION
Computation of total income for the A.Y. 2026-27

Particulars Resident Resident Non-

and but not resident
ordinarily ordinarily
resident resident
`
` `
Interest on UK Development Bonds, 50% of interest 10,000 5,000 5,000
received in India
Income from a business in Chennai (50% is received in 20,000 20,000 20,000
India)
Short term capital gains on sale of shares of an Indian 20,000 20,000 20,000
company received in London
Dividend from British company received in London 5,000 - -
Long term capital gain on sale of plant at Germany, 40,000 20,000 20,000
50% of profits are received in India
Income earned from business in Germany which is 70,000 70,000 40,000
controlled from Delhi, out of which
` 40,000 is received in India
Profits from a business in Delhi but managed entirely 15,000 15,000 15,000
from London
Income from property in London deposited in a Bank at 50,000 - -
London, later on remitted to India
Interest on debentures in an Indian company received 12,000 12,000 12,000
in London
Fees for technical services rendered in India but 8,000 8,000 8,000
received in London
Profits from a business in Bombay managed from 26,000 26,000 26,000
London
Pension for services rendered in India but received in 4,000 4,000 4,000
London
Income from property situated in Pakistan, received 16,000 - -
there
Past foreign untaxed income brought to India during - - -
the previous year

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Income from agricultural land in Nepal received there 18,000 - -

and then brought to India
Income from profession in Kenya which was set up in India, 5,000 5,000 -
received there but spent in India
Gift received on the occasion of his wedding [not - - -
taxable]
Interest on savings bank deposit in SBI 12,000 12,000 12,000
Income from a business in Russia, controlled from 20,000 - -
Russia
Dividend from Reliance Petroleum Limited, an Indian 5,000 5,000 5,000
Company
Agricultural income from a land in Rajasthan [Exempt - - -
under section 10(1)]
Gross Total Income 3,56,000 2,22,000 1,87,000
Less: Deduction u/s 80TTA
[Interest on savings bank account subject to a 10,000 10,000 10,000
maximum of ` 10,000]
Total Income 3,46,000 2,12,000 1,77,000

(3) Presence of Eligible Fund Manager in India not to constitute Business

Connection in India of such Eligible Investment Fund on behalf of which he
undertakes Fund Management Activity [Section 9A]
(i) Fund Management Activity through an eligible fund manager not to constitute
business connection [Section 9A(1)]: In the case of an eligible investment fund, the fund
management activity carried out through an eligible fund manager acting on behalf of such
fund shall not constitute business connection in India of the said fund, subject to fulfillment
of certain conditions.

(ii) Location of Fund Manager in India not to affect residential status of an eligible
investment fund [Section 9A(2)]: An eligible investment fund shall not be said to be
resident in India merely because the eligible fund manager undertaking fund management
activities on its behalf, is located in India.
(iii) Conditions to be fulfilled by an Eligible Investment Fund [Section 9A(3)]: The eligible
investment fund means a fund established or incorporated or registered outside India,

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which collects funds from its members for investing it for their benefit. Further, it should
fulfill the following conditions:

(a) the fund should not be a person resident in India;

(b) the fund should be a resident of a country or a specified territory with which an
agreement referred to in section 90(1) or section 90A(1) has been entered into or
should be established or incorporated or registered, outside India in a country or a
specified territory notified by the Central Government in this behalf;
(c) the aggregate participation or investment in the fund, directly by persons being
resident in India should not exceed 5% of the corpus of the fund as on 1st April and
1st October of the previous year;
However, for the purposes of calculation of aggregate participation or investment in
the fund, any contribution made by the eligible fund manager during the first 3 years
of operation of the fund, not exceeding ` 25 crore, would not be taken into account.
Further, if the aggregate participation or investment in the fund exceeds 5% as
on 1st April and 1st October of the previous year, the condition mentioned
above will be deemed to be satisfied if the fund reduces its aggregate
participation or investment to 5% or less within 4 months from 1st April or 1st
October of such previous year, as the case may be.
(d) the fund and its activities should be subject to applicable investor protection
regulations in the country or specified territory where it is established or incorporated
or is a resident;
(e) the fund should have a minimum of 25 members who are, directly or indirectly, not
connected persons;
(f) any member of the fund along with connected persons shall not have any
participation interest, directly or indirectly, in the fund exceeding 10%;
(g) the aggregate participation interest, directly or indirectly, of ten or less members
along with their connected persons in the fund, shall be less than 50%;
(h) the investment by the fund in any entity shall not exceed 20% of the corpus of the
fund;
(i) no investment shall be made by the fund in its associate entity;

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(j) the monthly average of the corpus of the fund shall not be less than ` 100 crore. If
the fund has been established or incorporated in the previous year, the corpus of
fund should not be less than ` 100 crore at the end of a period of twelve months
from the last day of the month of its establishment or incorporation;
However, this condition shall not be applicable to a fund which has been wound up in
the previous year.
(k) the fund shall not carry on or control and manage, directly or indirectly, any business
in India;
(l) the fund should neither be engaged in any activity which constitutes a business
connection in India nor should have any person acting on its behalf whose activities
constitute a business connection in India other than the activities undertaken by the
eligible fund manager on its behalf.
(m) the remuneration paid by the fund to an eligible fund manager in respect of fund
management activity undertaken on its behalf should not be less than the amount
calculated in the prescribed manner.
(iv) Certain conditions not to apply to investment fund set up by the Government or the
Central Bank of a foreign State or a Sovereign Fund or other notified fund [Proviso to
Section 9A(3)]: The following conditions would, however, not be applicable in case of an
investment fund set up by the Government or the Central Bank of a foreign State or a
sovereign fund or such other fund notified by the Central Government [i.e., an investment
fund set up by a Category-I or Category-II Foreign Portfolio Investor registered under the
SEBI (Foreign Portfolio Investors) Regulations, 2014, made under the SEBI Act, 1992 and
an investment fund set up by a Category-I foreign portfolio investor registered under the
SEBI (Foreign Portfolio Investors) Regulations, 2019, made under the SEBI Act, 1992]:
(e) the fund should have a minimum of 25 members who are, directly or indirectly, not
connected persons;
(f) any member of the fund along with connected persons shall not have any
participation interest, directly or indirectly, in the fund exceeding 10%;
(g) the aggregate participation interest, directly or indirectly, of ten or less members
along with their connected persons in the fund, shall be less than 50%.

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(v) Eligible Fund Manager [Section 9A(4)]: The eligible fund manager, in respect of an
eligible investment fund, means any person who is engaged in the activity of fund
management and fulfills the following conditions:
(a) the person should not be an employee of the eligible investment fund or a connected
person of the fund;

(b) the person should be registered as a fund manager or investment advisor in

accordance with the specified regulations;

The CBDT has, vide Circular No.8/2019 dated 10.5.2019, clarified that a fund
manager includes an Asset Management Company (AMC) approved by SEBI under
the SEBI (Mutual Funds) Regulations, 1996. This is because AMCs are engaged in
the activity of fund management of Mutual Funds and hence are, in substance, Fund
Managers.

(c) the person should be acting in the ordinary course of his business as a fund
manager;
(d) the person along with his connected persons shall not be entitled, directly or
indirectly, to more than 20% of the profits accruing or arising to the eligible
investment fund from the transactions carried out by the fund through such fund
manager.
(vi) Furnishing of Statement in prescribed form [Section 9A(5)]: Every eligible investment
fund shall, in respect of its activities in a financial year, furnish within 90 days from the
end of the financial year, a statement in the prescribed form to the prescribed income-tax
authority. The statement should contain information relating to –
(a) the fulfillment of the above conditions; and
(b) such other relevant information or document which may be prescribed.
If any eligible investment fund fails to furnish such statement or information or document
within 90 days from the end of the financial year, the income-tax authority prescribed
under the said sub-section may direct that such fund shall pay, by way of penalty, a sum
of ` 5,00,000 [Section 271FAB].
(vii) Non-applicability of special taxation regime under section 9A [Section 9A(6)/(7)]:
This special taxation regime would not have any impact on taxability of any income of the
eligible investment fund which would have been chargeable to tax irrespective of whether

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the activity of the eligible fund manager constituted business connection in India of such
fund or not.

Further, the said regime shall not have any effect on the scope of total income or
determination of total income in the case of the eligible fund manager.
(viii) CBDT to prescribe guidelines for the manner of application of the provisions of this
section.
(ix) Certain conditions not to apply or apply with modification to investment fund and
its fund manager, if such fund manager is located in an IFSC and has commenced
its operation on or before 31.3.2030 [Section 9A(8A)]: The Central Government may,
by notification, specify that any one or more of the conditions specified in point (iii) and (v)
above would not be applicable or applicable with such modifications, as may be specified in
such notification in case of an eligible investment fund and its eligible fund manager, if such
fund manager is located in an IFSC as defined in section 80LA and has commenced its
operation on or before 31.3.2030:

Accordingly, the Central Government has, vide Notification No. 59/2022 dated 6.6.2022,
specified that in case of –
I. An eligible investment fund -
(i) the following conditions mentioned under section 9A(3) would not be
applicable
(e) the fund should have a minimum of 25 members who are, directly or
indirectly, not connected persons;
(f) any member of the fund along with connected persons shall not have
any participation interest, directly or indirectly, in the fund exceeding
10%;
(g) the aggregate participation interest, directly or indirectly, of ten or
less members along with their connected persons in the fund, shall
be less than 50%.
(ii) the condition mentioned above in clause (k) of section 9A(3) would apply
after the following modification -

“the fund shall not carry on, or participate in, the day to day operations of
any person in India and for this purpose the monitoring mechanism to

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protect the investment in such person including the right to appoint directors
or executive director shall not be considered as participation in day to day
operations of such person in India”
II. Eligible fund manager –
The condition specified in section 9A(4)(b) would apply after the following
modification:
“the person is registered as a portfolio manager or an investment advisor in
accordance with the IFSC Authority (Capital Market Intermediaries) Regulation
2021 as notified under the IFSC Authority Act, 2019 or such other regulations
made under the IFSC Authority Act, 2019”.
(x) Meaning of certain terms:
Term Meaning
Associate An entity in which a director or a trustee or a partner or a member or a fund
manager of the investment fund or a director or a trustee or a partner or a
member of the fund manager of such fund, holds, either individually or
collectively, share or interest, being more than 15% of its share capital or
interest, as the case may be.
Corpus The total amount of funds raised for the purpose of investment by the
eligible investment fund as on a particular date.
Connected Any person who is connected directly or indirectly to another person and
person
includes,—
(a) any relative of the person, if such person is an individual;
(b) any director of the company or any relative of such director, if the
person is a company;
(c) any partner or member of a firm or association of persons or body of
individuals or any relative of such partner or member, if the person is
a firm or association of persons or body of individuals;
(d) any member of the Hindu undivided family or any relative of such
member, if the person is a Hindu undivided family;
(e) any individual who has a substantial interest in the business of the
person or any relative of such individual;
(f) a company, firm or an association of persons or a body of individuals,
whether incorporated or not, or a Hindu undivided family having a

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substantial interest in the business of the person or any director,

partner, or member of the company, firm or association of persons or
body of individuals or family, or any relative of such director, partner
or member;
(g) a company, firm or association of persons or body of individuals,
whether incorporated or not, or a Hindu undivided family, whose
director, partner, or member has a substantial interest in the business
of the person, or family or any relative of such director, partner or
member;
(h) any other person who carries on a business, if -
(i) the person being an individual, or any relative of such person,
has a substantial interest in the business of that other person;
or
(ii) the person being a company, firm, association of persons,
body of individuals, whether incorporated or not, or a Hindu
undivided family, or any director, partner or member of such
company, firm or association of persons or body of individuals
or family, or any relative of such director, partner or member,
has a substantial interest in the business of that other person;

21.3 EXEMPTED INCOME OF NON RESIDENTS

Section 10 of the Income-tax Act, 1961 exempts from tax various incomes including the following
in the hands of a non-resident:
(1) Interest on moneys standing to the credit of individual in his NRE A/c
[Section 10(4)(ii)]

As per section 10(4)(ii), in the case of an individual, any income by way of interest on moneys
standing to his credit in a Non-resident (External) Account (NRE A/c) in any bank in India in
accordance with the Foreign Exchange Management Act, 1999 (FEMA, 1999), and the rules made
thereunder, would be exempt, provided such individual;
 is a person resident outside India, as defined in FEMA, 1999, or
 is a person who has been permitted by the Reserve Bank of India to maintain such account.

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The benefit of exemption under section 10(4)(ii) will be available to joint account holders, subject
to fulfilment of other conditions contained in that section by each of the individual joint account
holders.
Example: Mrs. Neena Kansal, is resident of Singapore since year 2000. She holds an NRE
account with Bank of Baroda, New Delhi Branch. Interest of ` 10,000 was credited to such account
during financial year 2025-26. Such interest income earned by her shall be exempt from income-
tax while she files her tax return for A.Y 2026-27.
(2) Interest income of a non-corporate non-resident or foreign company on specified off-
shore Rupee Denominated Bonds issued by an Indian company or business trust
[Section 10(4C)]

Interest payable by an Indian company or business trust to a non-corporate non-resident or a

foreign company in respect of money borrowed from a source outside India by way of issue of
rupee denominated bond during the period from 17.9.2018 to 31.3.2019 would be exempt.
(3) Income of a specified fund on transfer of certain asset [Section 10(4D)]

Following income accrued or arising to or received by specified fund would be exempt -

- any income from transfer of a capital asset, being a bond of an Indian Company or a
public sector company (sold by the Government and purchased by the specified fund in
foreign currency), GDR or rupee denominated bond of an Indian company or derivative or
any other notified security, on a recognized stock exchange located in any IFSC and
where the consideration is paid or payable in convertible foreign exchange or

- any income from transfer of securities (other than shares in a company resident in India)
or
- any income from securities issued by a non-resident (not being a permanent
establishment of a non-resident in India) and where such income otherwise does not
accrue or arise in India or
- any income from a securitisation trust which is chargeable under the head "Profits and
gains of business or profession",
to the extent such income accrued or arisen to, or is received is attributable to units held by non-
resident (not being the permanent establishment of a non-resident in India) or is attributable to the
investment division of offshore banking unit, as the case may be, computed in the prescribed
manner.

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Condition for exemption - The income attributable to units held by non-resident (not being the
permanent establishment of a non-resident in India) in a specified fund would not be exempt under
section 10(4D) unless the specified fund furnish the annual statement of exempt income on or
before the due date u/s 139(1).
The income of a specified fund attributable to an eligible investment division would not be exempt
under section 10(4D) unless it furnishes the annual statement of exempt income and the report of
audit on or before the said due date. [Notification no. 64/2022 dated 16.6.2022].
Meaning of certain terms:
[Link]. Term Meaning
1 Securities Securities includes
(i) shares, scrips, stocks, bonds, debentures, debenture stock
or other marketable securities of a like nature in or of any
incorporated company or a pooled investment vehicle or
other body corporate;
(ii) derivative;
(iii) units or any other instrument issued by any collective
investment scheme to the investors in such schemes;
(iv) security receipt;
(v) units or any other such instrument issued to the investors
under any mutual fund scheme;
It does not include any unit linked insurance policy or scrips
or any such instrument or unit which provides a combined
benefit risk on the life of the persons and investment by such
persons and issued by an insurer
(vi) units or any other instrument issued by any pooled
investment vehicle;
(vii) any certificate or instrument, issued to an investor by any
issuer being a special purpose distinct entity which
possesses any debt or receivable, including mortgage debt,
assigned to such entity, and acknowledging beneficial
interest of such investor in such debt or receivable, including
mortgage debt, as the case may be;
(viii) Government securities;
(ix) such other instruments as may be declared by the Central
Government to be securities; and
(x) rights or interest in securities
It shall also include such other securities or instruments as may be
notified by the Central Government.

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2 Investment An investment division of a banking unit of a non-resident located

division of in an IFSC, as referred to in section 80LA(1A) and which has
offshore commenced its operations on or before 31.3.2030.
banking unit
3 Specified fund (i) A fund established or incorporated in India in the form of a
trust or a company or a LLP or a body corporate, –
(I) (a) which has been granted a certificate of registration
as a Category III Alternative Investment Fund and
is regulated under the SEBI (Alternative
Investment Fund) Regulation, 2012, made under
the SEBI Act, 1992 or regulated under the IFSC
Authority (Fund Management) Regulations, 2022 made
under the IFSC Authority Act, 2019;
(b) which has been granted a certificate as a retail
scheme or an Exchange Traded Fund and satisfies
the conditions laid down for such schemes or
funds under the IFSC Authority (Fund
Management) Regulations, 2022, made under the
IFSC Authority Act, 2019;
(II) which is located in any IFSC; and
(III) of which all the units are held by non-residents other
than units held by a sponsor or manager
However, this condition would not apply where any unit
holder or holders, being non-resident during the
previous year when such unit or units were issued,
becomes resident under section 6(1) or (1A) in any
previous year subsequent to that year, if the aggregate
value and number of the units held by such resident unit
holder or holders do not exceed 5% of the total units
issued and fulfill such other conditions as may be
prescribed.
(ii) investment division of an offshore banking unit, which has
been
(I) granted a certificate of registration as a Category-I
foreign portfolio investor under the SEBI (Foreign
Portfolio Investors) Regulations, 2019 made under the
SEBI Act, 1992 and which has commenced its
operations on or before 31.3.2030; and
(II) fulfils such conditions including maintenance of
separate accounts for its investment division, as may be
prescribed.

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4 Trust A trust established under the Indian Trust Act, 1882 or under any
other law for the time being in force.
5 Unit Unit means beneficial interest of an investor in the fund and shall
include shares or partnership interests.
6 Manager Any person or entity who is appointed by the Alternative Investment
Fund to manage its investment by whatever name called. Manager
may also be same as the sponsor of the Fund.
7 Sponsor Any person or persons who set up the Alternative Investment Fund
and includes promoter in case of a company and designated
partner in case of LLP.

(4) Income of a non-resident as a result of transfer of non-deliverable forward contracts/

offshore derivative instruments/ over the counter derivatives entered into with an
offshore banking unit of an IFSC [Section 10(4E)]

Any income accrued or arisen to, or received by a non-resident as a result of

- transfer of non-deliverable forward contracts or offshore derivative instruments or over-
the-counter derivatives, or

- distribution of income on offshore derivative instruments or over-the-counter

derivatives,
entered into with an offshore banking unit of an IFSC as referred to in section 80LA(1A) or any
Foreign Portfolio Investor being a unit of an IFSC, which fulfils prescribed conditions would be
exempt.
Accordingly, Rule 21AK specifies the following conditions to be fulfilled for claiming such
exemption -
• the non-deliverable forward contract or offshore derivative instruments or over-the-
counter derivatives is entered into by the non-resident with an offshore banking unit of an
IFSC which holds a valid certificate of registration granted under IFSC Authority
(Banking) Regulations, 2020 by the IFSC Authority or any Foreign Portfolio Investor
being a unit of an IFSC; and
• such contract or instrument or derivative is not entered into by the non-resident through or on
behalf of its permanent establishment in India [The offshore banking unit (i.e., a banking
branch unit located in an IFSC) or the Foreign Portfolio Investor has to ensure that this
condition is complied with].

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Meaning of Certain terms:

Term Meaning
Non-deliverable forward A contract for the difference between an exchange rate agreed
contract before and the actual spot rate at maturity, with the spot rate
being taken as the domestic rate or a market determined rate
and such contract being settled with a single payment in a
foreign currency.
Offshore banking unit A banking branch Unit located in an IFSC, as referred to in
section 80LA(1A).
Offshore derivative Any instrument, by whatever name called, which is issued
instrument overseas by a foreign portfolio investor against securities held by
it in India, as its underlying [Regulation 2(1)(o) of the SEBI
Foreign Portfolio Investor Regulations, 2019];
Over-the-counter A derivative contract that is not traded on an exchange but
derivatives instead is privately negotiated between a purchaser and a seller.
Foreign Portfolio Investor A person registered under the SEBI (Foreign Portfolio
Investors) Regulations, 2019 made under the SEBI Act, 1992

(5) Income of a non-resident by way of royalty or interest, on account of lease of an

aircraft or a ship in a previous year, paid by a unit of an IFSC [Section 10(4F)]

Income of a non-resident by way of royalty or interest, on account of lease of an aircraft or a ship

in a previous year, paid by a unit of an IFSC referred to in section 80LA(1A), if the unit has
commenced its operations on or before 31.3.2030 would be exempt.
"Aircraft", here, means an aircraft or a helicopter, or an engine of an aircraft or a helicopter, or any
part thereof.
“Ship” means a ship or an ocean vessel, engine of a ship or ocean vessel, or any part thereof.
(6) Income received by a non-resident in an account maintained with an offshore banking
unit in any IFSC [Section 10(4G)]

Any income received by a non-resident from

- portfolio of securities or financial products or funds, managed or administered by any
portfolio manager on behalf of such non-resident, or
- such activity carried out by such person as may be notified by the Central Government,
in an account maintained with an Offshore Banking Unit in any IFSC, as referred to in section
80LA(1A) would be exempt, to the extent such income accrues or arises outside India and is not
deemed to accrue or arise in India.

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(7) Income received by a non-resident or a Unit of an IFSC [Section 10(4H)]

Any income of a non-resident or a Unit of IFSC, as referred to in section 80LA(1A) engaged

primarily in the business of leasing of an aircraft or a ship, by way of capital gains on transfer of
equity shares of domestic company, being a Unit of an IFSC, as referred to in section 80LA(1A),
engaged primarily in the business of lease of an aircraft or a ship which has commenced
operations on or before 31.3.2030 would be exempt.
The exemption from capital gains on transfer of equity shares of such domestic company is
available for a period of ten assessment years -

(i) from A.Y. relevant to the P.Y. in which the domestic company has commenced its
operations or
(ii) from A.Y. 2024-25, where the period of 10 [Link]. under (i) above ends before 1.4.2034.
"Aircraft" means an aircraft or a helicopter, or an engine of an aircraft or a helicopter, or any part
thereof.
“Ship” means a ship or an ocean vessel, engine of a ship or ocean vessel, or any part
thereof.
(8) Remuneration received by individuals, who are not citizens of India [Section 10(6)]

(i) Remuneration received by officials of Embassies etc. of Foreign States [Section

10(6)(ii)]: The remuneration received by an individual, who is not a citizen of India, for
services as an official by whatever name called of an embassy, high commission, legation,
commission, consulate or trade representation of foreign state, or a member of staff of any
of these official, for service in such capacity is exempt.
Conditions
(a) The remuneration received by our corresponding Government officials resident in
such foreign countries should be exempt.

(b) The above-mentioned member of the staff of such officials should be the subjects
of the respective countries and should not be engaged in any other business or
profession or employment in India.
Examples:
• Mr. A, a citizen of India but resident of USA since year 2012, was appointed as a
senior official of the US embassy in India. He earned a remuneration of ` 10 lakhs
during F.Y. 2025-26. Being an Individual who is a citizen of India, though

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fulfilling other conditions of the section, such remuneration shall not be

exempt in his hands for A.Y. 2026-27.
• Mr. Vikram Kohli, an Indian born person but currently a resident and Citizen of USA,
was appointed as a senior official of the US embassy in India. He earned a
remuneration of ` 10 lakhs during F.Y. 2025-26. Being an Individual who is not a
citizen of India and also fulfilling other conditions of the section, such
remuneration shall be exempt in his hands for A.Y. 2026-27, subject to
fulfilment of conditions.
• Mr. Frank D’Souza, an Irish Citizen but currently the resident of USA, was appointed
as a senior official of the US embassy in India. He earned a remuneration of ` 10
lakhs during F.Y. 2025-26. Being an Individual who is not a citizen of India, such
remuneration shall be exempt in his hands for A.Y. 2026-27, subject to
fulfilment of the conditions.

(ii) Remuneration received for services rendered in India by a Foreign National employed
by foreign enterprise [Section 10(6)(vi)]: The remuneration received by a foreign national
as an employee of a foreign enterprises, for services rendered by him during his stay in
India is exempt from tax.
Conditions
(a) The foreign enterprise is not engaged in any business or trade in India:

(b) The employee’s stay in India does not exceed in the aggregate a period of 90 days in
such previous year, and
(c) The remuneration is not liable to be deducted from the income of the employer
chargeable under the Income-tax Act, 1961.
Examples:
• Mr. A, citizen of India but resident of USA since year 2012, was appointed in India in
October, 2024 as an employee of a US enterprise. Such US enterprise is not
engaged in any business in India. A’s job requires him to visit his US office every
twenty five (25) days for reporting purposes.
During F.Y. 2025-26, Mr. A earned a remuneration of ` 10 lakhs for his India related
assignment and his stay in India in aggregate was 85 days. Further, such US enterprise
has not claimed any deduction of such remuneration under the Income-tax Act, 1961.
Being an Individual who is a citizen of India, such remuneration shall not be exempt
in his hands for A.Y. 2026-27 under this section i.e., section 10(6)(vi), though he may
get exemption under any other provision of the Income-tax Act, 1961, subject to
fulfilment of conditions stipulated thereunder.

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• In the above case, let’s consider that Mr. A is a citizen of USA. All other facts
remaining same, his remuneration shall be exempt from tax in his hands for
A.Y. 2026-27 under this section.
• Let’s take another variation, Mr. A is a citizen of USA but the remuneration paid to
him is borne by the permanent establishment of such US enterprise in India. ` 10
lakhs paid to A is cross charged by the US enterprise to its Indian permanent
establishment (PE).
In this case, the remuneration shall not be exempt from taxation in the hands
of Mr. A as the same is getting deducted from the income of the Indian PE of
such foreign enterprise.

(iii) Salary received by a non-citizen for services rendered in connection with

employment on foreign ship [Section 10(6)(viii)]: Any income chargeable under the head
“Salaries” received by or due to, non-citizen of India who is also a non-resident as
remuneration for services rendered in connection with his employment on a foreign ship is
exempt provided his total stay in India does not exceed 90 days during the previous year.
(iv) Remuneration received by Foreign Government employees during their stay in India
for specified training [Section 10(6)(xi)]: Any remuneration received by employee of the
Government of a foreign state from their respective Government during his stay in India, is
exempt from tax, if remuneration is received in connection with training in any establishment
or office of or in any undertaking owned by,-
(a) the Government; or
(b) any company owned by the Central Government or any State Government or partly
by the Central Government and partly by one or more State Government; or
(c) any company which is subsidiary of a company referred to in (b) above, or
(d) any statutory corporation; or
(e) any society registered under Societies Registration Act, 1860 or under any law and
wholly financed by the Central Government or any State Government(s) or partly by
the Central Government and partly by one or more State Governments.
It may be carefully noted that exemption is available under section 10(6) only to an
individual who is not a citizen of India.
(9) Income of a foreign company from lease rentals of cruise ships received from a
specified company [Section 10(15B)]
Any income of a foreign company from lease rentals, by whatever name called, of cruise ships
received from specified company which operates such ship or ships in India, would be exempt.

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The income would be exempt, where such foreign company and the specified company are
subsidiaries of the same holding company, and such income is received or accrues or arises in
India for any assessment year on or before 1.4.2030.
Meaning of Certain terms:
Term Meaning
Specified company Any company, other than a domestic company which operates
cruise ships in India and opts to pay tax in accordance with the
provisions of section 44BBC
Holding company, in relation A company of which such companies are subsidiary
to a foreign company or a companies
specified company
Subsidiary company or A company in which the holding company exercises or controls
subsidiary, in relation to a more than one-half of the total share capital either at its own or
holding company together with one or more of its subsidiary companies

(10) Income accruing or arising to or received by a unit holder from a specified fund or on
transfer of units in a specified fund [Section 10(23FBC)]
(i) Nature of income exempted: Any income accruing or arising to or received by a unit
holder from a specified fund or on transfer of units in a specified fund would be exempt.
(ii) Meaning of specified Fund:
(a) A fund established or incorporated in India in the form of a trust or a company or a
LLP or a body corporate, –
- (a) which has been granted a certificate of registration as a Category III
Alternative Investment Fund and is regulated under the SEBI
(Alternative Investment Fund) Regulation, 2012, made under the
SEBI Act, 1992 or regulated under the IFSC Authority (Fund
Management) Regulations, 2022 made under the IFSC Authority Act,
2019;
(b) which has been granted a certificate as a retail scheme or an
Exchange Traded Fund and satisfies the conditions laid down for
such schemes or funds under the IFSC Authority (Fund Management)
Regulations, 2022, made under the IFSC Authority Act, 2019;
- which is located in any IFSC and
- of which all the units are held by non-residents other than units held by a
sponsor or manager

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However, this condition would not apply where any unit holder or holders,
being non-resident during the previous year when such unit or units were
issued, becomes resident under section 6(1) or (1A) in any previous year
subsequent to that year, if the aggregate value and number of the units held
by such resident unit holder or holders do not exceed 5% of the total units
issued and fulfill such other conditions as may be prescribed
(b) Investment division of an offshore banking unit, which has been
- granted a certificate of registration as a Category-I foreign portfolio investor
under the SEBI (Foreign Portfolio Investors) Regulations, 2019 made under
the SEBI Act, 1992 and which has commenced its operations on or before
31.3.2030; and
- fulfils such conditions including maintenance of separate accounts for its
investment division, as may be prescribed;
(iii) Meaning of Unit: It means beneficial interest of an investor in the fund and shall include
shares or partnership interests.

(11) Certain incomes of wholly owned subsidiary of Abu Dhabi Investment Authority,
Sovereign Wealth Fund and specified pension fund [Section 10(23FE)]
(i) Nature of income exempted: Any income of a specified person in the nature of
- dividend,
- interest
- any sum referred to in section 56(2)(xii) i.e. any specified sum received by a unit
holder from a business trust during the previous year, with respect to a unit held by
him at any time during the previous year or
- long-term capital gains (whether or not such capital gains are deemed as short-
term capital gains under section 50AA)
arising from an investment made by it in India, whether in the form of debt or share capital
or unit would be exempt, if such investment –
(a) is made on or after 1st April, 2020 but on or before 31st March, 2030; and
(b) is held for at least three years.
(ii) Eligible investment: Such investment should be in
(a) a business trust; or

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(b) a company or enterprise or an entity carrying on the business of developing, or

operating and maintaining, or developing, operating and maintaining any
infrastructure facility as defined in Explanation to section 80-IA(4)(i) or such other
business as notified by the Central Government in this behalf; or

(c) a Category-I or Category-II AIF regulated under the SEBI (Alternative Investment
Fund) Regulations, 2012, made under the SEBI Act, 1992, having not less than
50% investment in one or more of the company or enterprise or entity referred to in
(b) or (d) or (e) or in an Infrastructure Investment Trust; or

(d) a domestic company, set up and registered on or after 1.4.2021, having minimum
75% investments in one or more of the companies or enterprises or entities
referred to in (b); or

(e) a non-banking financial company registered as an Infrastructure Finance Company

as referred to in notification number RBI/2009-10/316 issued by the RBI or in an
Infrastructure Debt Fund, a non-banking finance company, as referred to in the
Infrastructure Debt Fund - NBFC (Reserve Bank) Directions, 2011, issued by the
RBI, having minimum 90% lending to one or more of the companies or enterprises
or entities referred to in (b).

The Central Government may prescribe the method of calculation of "50%" referred to in
(c) or "75%" referred to in (d) or "90%" referred to in (e).

(iii) Power of CBDT to issue guidelines: In case any difficulty arises regarding interpretation
or implementation of the provisions of this clause, the CBDT may issue guidelines for the
purpose of removing the difficulty with the approval of the Central Government.

Every guideline issued by the CBDT has to be laid before each House of Parliament, and
shall be binding on the income-tax authorities and specified person.

(iv) Taxability on failure to satisfy the conditions: Where any income has not been
included in the total income of the specified person due to the aforesaid provisions, and
subsequently during any previous year the specified person fails to satisfy any of the
conditions mentioned so that the said income would not have been eligible for such non-
inclusion, such income shall be chargeable to income-tax as the income of the specified
person of that previous year.

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(v) Proportionate exemption of income attributable to investment in Category-I or

Category-II AIF, domestic companies or NBFC referred to in (c), (d) or (e) of (ii)
above if they are not having 100% investment in specified companies or entities:
(a) In case a Category-I or Category-II AIF referred to in (c) of (ii) above has
investment of less than 100% in one or more of the companies or enterprises or
entities referred to in (b) or (d) or (e) of (ii) above or in an Infrastructure Investment
Trust referred to in (c) of (ii) above, income accrued or arisen or received or
attributable to such investment, directly or indirectly, which is exempt under this
section shall be calculated proportionately to that investment made in one or more
of the companies or enterprises or entities referred to in (b) or (d) or (e) of (ii)
above or in the Infrastructure Investment Trust referred to in (c) of (ii) above, in
such manner as may be prescribed.
(b) In case a domestic company referred to in (d) of (ii) above has investment of less
than 100% in one or more of the companies or enterprises or entities referred to in
(b) of (ii) above, income accrued or arisen or received or attributable to such
investment, directly or indirectly, which is exempt under this section shall be
calculated proportionately to that investment made in one or more of the
companies or enterprises or entities referred to in (b) of (ii) above, in such manner
as may be prescribed.
(c) In case a non-banking finance company registered as an Infrastructure Finance
Company or Infrastructure Debt Fund referred to in (e) of (ii) above has lending of
less than 100% in one or more of the companies or enterprises or entities referred to
in (b) of (ii) above, income accrued or arisen or received or attributable to such
lending, directly or indirectly, which is exempt under this section shall be calculated
proportionately to the lending made in one or more of the companies or enterprises
or entities referred to in (b) of (ii) above, in such manner as may be prescribed.
(vi) Non applicability of exemption under section: In case a sovereign wealth fund or
pension fund has loans or borrowings, directly or indirectly, for the purposes of making
investment in India, such fund shall be deemed to be not eligible for exemption under this
section.
In order to address the concern with regard to the term “indirect borrowings” which have not
been defined in the section and the consequent eligibility or otherwise of the exemption to
the specified fund, where the loan and borrowings have been taken by the specified fund or
its holding or any other entity in the chain of holding or any associate thereof, the CBDT
has, vide Circular No. 19/2021 dated 26.10.2021, issued the guidelines and clarified the
following:

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 NON RESIDENT TAXATION 21.75

- if the loans and borrowings have been taken by the specified fund or any of its group
concern, specifically for the purposes of making investment by the specified fund in
India, such fund shall not be eligible for exemption under section 10(23FE); and
- if the loans and borrowings have been taken by the specified fund or any of its group
concern, not specifically for the purposes of making investment in India, it shall not
be presumed that the investment in India has been made out of such loans and
borrowings and such specified fund shall be eligible for exemption under section
10(23FE), subject to the fulfilment of all other stipulated conditions, provided that the
source of the investment in India is not from such loans and borrowings.
(vii) Meaning of certain terms:
S. Term Meaning
No.
(i) Investee A business trust, or a company, or an enterprise, or an
entity, or a Category I or Category II AIF, or an
Infrastructure Investment Trust or a domestic company,
or an Infrastructure Finance Company or an
Infrastructure Debt Fund referred to in (e) of (ii) above,
in which the sovereign wealth fund or the pension fund,
as the case may be, has made the investment, directly
or indirectly, under the provisions of this section.
(ii) Loan and borrowing (a) Any loan taken or borrowing by a sovereign wealth
fund from, or any deposit or investment made in a
sovereign wealth fund by, any person other than
the Government of the country in which the
sovereign wealth fund is set up;
(b) Any loan taken or borrowing by a pension fund from
or any deposit or investment made in a pension fund
by, any person. However, it shall not include the
deposit or investment which represents statutory
obligations and defined contributions of one or more
funds or plans established for providing retirement,
social security, employment, disability, death benefits
or any similar compensation to the participants or
beneficiaries of such funds or plans, as the case may
be.

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(viii) Meaning of specified person:

Specified Person

A wholly owned A sovereign wealth A pension fund Public Investment

subsidiary of the Abu fund Fund of the
Dhabi Investment Government of the
Authority Kingdom of Saudi
Arabia and its
It should be created or subsidiary
It should be wholly owned and
controlled, directly or established under the law
It should be a resident indirectly, by the Government of a foreign country
of the United Arab of a foreign country including the laws made by
Emirates any of its political
It should be set up and constituents being a
province, State or local the Public
regulated under the law of Investment
such foreign country body, by whatever name
It makes investment, called Fund of the
directly or indirectly, out Government of
of the fund owned by the The earnings of the fund are the Kingdom of
credited either to the account It should not be liable to tax Saudi Arabia
Government of the Abu
of the Government of that in such foreign country or if
Dhabi
foreign country or to any liable to tax, exemption
other account designated by from taxation for all its
that Government so that no income has been provided a wholly owned
portion of the earnings inures by such foreign country subsidiary of the
any benefit to any private Public
person Investment Fund
It satisfies other of the
The asset of the said fund prescribed conditions Government of
vests in the Government of the Kingdom of
such foreign country upon Saudi Arabia,
dissolution which is a
It does not participate in the resident of
day to day operations of Saudi Arabia
It does not participate in the investee but the monitoring
day to day operations of and makes
mechanism to protect the investment,
investee but the monitoring investment with the
mechanism to protect the directly or
* These two investee including the right indirectly, out of
investment with the investee to appoint directors or
conditions would including the right to appoint the fund owned
executive director shall not by the said
not apply to any directors or executive director be considered as
shall not be considered as Government.
participation in day to day
payment made to participation in the day to day operations of the investee
creditors or operations of the investee

depositors for loan It is specified by the

It is specified by the Central Central Government, by
taken or borrowing Government, by notification, notification, for this
for the purpose for this purpose and fulfils purpose and fulfills
conditions specified in such conditions specified in
other than for notification such notification
making investment
in India

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 NON RESIDENT TAXATION 21.77

Exempted Income of Non-Residents

Section Income Available to

10(4)(ii) Interest on money standing to the credit in a Individual resident outside India
Non-resident (External) account of an (under FEMA Act) or an individual
Individual in any bank in India as per the who has been permitted to
FEMA Act, 1999. maintain said account by RBI
10(4C) Interest payable by an Indian company or A non-corporate non-resident or
business trust in respect of moneys foreign company
borrowed from a source outside India by way
of issue of rupee denominated bond during
the period from 17.9.2018 to 31.3.2019
10(4D) Income accrued or arising to or received by A specified fund
specified fund -
(i) on transfer of a capital asset, being a
bond of an Indian Company or a public
sector company (sold by the
Government and purchased by the
specified fund in foreign currency),
GDR or rupee denominated bond of an
Indian company or derivative or any
other notified security, on a recognized
stock exchange located in any IFSC
and where the consideration for such
transfer is paid or payable in
convertible foreign exchange; or
(ii) on transfer of securities (other than
shares in a company resident in India); or
(iii) from securities issued by a non-
resident (not being a permanent
establishment of a non-resident in
India) and where such income
otherwise does not accrue or arise in
India; or
(iv) from a securitisation trust which is
chargeable under the head "Profits and
gains of business or profession",
to the extent such income accrued or arisen
to, or is received, is attributable to units held
by non-resident (not being the permanent
establishment of a non-resident in India) or
is attributable to the investment division of

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 21.78 INTERNATIONAL TAXATION

offshore banking unit, as the case may be,

computed in the prescribed manner.
10(4E) Any income accrued or arisen to, or Non-resident
received by a non-resident as a result of
- transfer of non-deliverable forward
contracts or offshore derivative
instruments or over-the-counter
derivatives, or
- distribution of income on offshore
derivative instruments or over-the-
counter derivatives,
entered into with an offshore banking unit of
an IFSC as referred to in section 80LA(1A)
or any Foreign Portfolio Investor being a
unit of an IFSC, which fulfils prescribed
conditions.
10(4F) Any income of a non-resident by way of Non-resident
royalty or interest, on account of lease of an
aircraft or a ship in a previous year, paid by
a unit of an IFSC referred to in section
80LA(1A), if the unit has commenced its
operation on or before 31.3.2030.
"Aircraft", here, means an aircraft or a
helicopter, or an engine of an aircraft or a
helicopter, or any part thereof.
“Ship” means a ship or an ocean vessel,
engine of a ship or ocean vessel, or any
part thereof.
10(4G) Any income received by a non-resident from Non-resident
- portfolio of securities or financial
products or funds, managed or
administered by any portfolio manager
on behalf of such non-resident, or
- such activity carried out by such person
as may be notified by the Central
Government,
in an account maintained with an Offshore
Banking Unit in any IFSC, as referred to in
section 80LA(1A), to the extent such
income accrues or arises outside India and
is not deemed to accrue or arise in India.

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 NON RESIDENT TAXATION 21.79

10(4H) Any income by way of capital gains on - Non-resident or

transfer of equity shares of domestic - a Unit of IFSC, as referred to
company, being a Unit of an IFSC, as in section 80LA(1A) engaged
referred to in section 80LA(1A), engaged primarily in the business of
primarily in the business of lease of an leasing of an aircraft or a ship
aircraft or a ship which has commenced
operations on or before 31.3.2030.
The exemption from capital gains on transfer
of equity shares of such domestic company
is available for a period of ten assessment
years -
(i) from A.Y. relevant to the P.Y. in which
the domestic company has commenced
its operations or
(ii) from A.Y. 2024-25, where the period of
10 [Link]. under (i) above ends before
1.4.2034.
10(6)(ii) Remuneration received by Foreign Individual (not being a citizen of
Diplomats/Consulate and their staff (Subject India)
to conditions)
10(6)(vi) Remuneration received as an employee of a Individual Salaried Employee (not
foreign enterprise for services rendered by being a citizen of India) of a
him during his stay in India, if: foreign enterprise
a) Foreign enterprise is not engaged in
any trade or business in India;
b) His stay in India does not exceed in the
aggregate a period of 90 days in such
previous year; and
c) Such remuneration is not liable to
deducted from the income of employer
chargeable under this Act
10(6)(viii) Salary received by or due for services Individual Salaried Employee
rendered in connection with his employment (Non-resident who is not a citizen
on a foreign ship if his total stay in India does of India) of a foreign ship
not exceed 90 days in the previous year.
10(6)(xi) Remuneration received as an employee of Individual Salaried Employee (not
the Government of a foreign state during his being a citizen of India) of
stay in India in connection with his training in Government of foreign state
any Government Office/ Statutory
Undertaking/ corporation/ registered society
etc.

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10(6BB) Tax paid by Indian company, engaged in the Government of foreign State or
business of operation of aircraft, which has foreign enterprise (i.e., a person
acquired an aircraft or an aircraft engine on who is a non-resident)
lease, under an approved (by Central
Government) agreement entered into
between 1-4-1997 and 31-3-1999, or after
31-3-2007, on lease rental/income derived
(other than payment for providing spares or
services in connection with the operation of
leased aircraft) by the Government of a
Foreign State or foreign enterprise.
10(6C) Royalty income or fees for technical services Foreign company (notified by the
under an agreement with the Central Central Government)
Government for providing services in or
outside India in projects connected with
security of India
10(6D) Royalty income from or fees from technical Non-corporate non-resident or
services rendered in or outside India to, the foreign company
National Technical Research Organisation
(NTRO)
10(15)(iiia) Interest on deposits made by a foreign bank Bank incorporated outside India
with a scheduled bank with approval of RBI. and authorised to perform Central
Banking functions in that country.
10(15)(iv)(fa) Interest payable by scheduled bank on a) Non-resident
deposits in foreign currency where b) Individual or HUF being a
acceptance of such deposits is duly resident but not ordinary
approved by RBI. resident
[Scheduled bank does not include co-operative
bank]
10(15)(viii) Interest on deposit on or after 01.04.2005 in
an Offshore Banking Unit
10(15)(ix) Interest payable by a unit located in an IFSC Non-resident
in respect of monies borrowed by it on or
after 1.9.2019
10(15A) Lease rental paid by Indian company, Government of foreign State or
engaged in the business of operation of foreign enterprise (i.e., a person
aircraft, to acquire an aircraft or an aircraft who is a non-resident)
engine on lease (other than payment for
providing spares or services in connection
with the operation of leased aircraft) under

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 NON RESIDENT TAXATION 21.81

an approved (by Central Government)

agreement not entered into between
1-4-1997 and 31-3-1999, or after 31-3-2007.
10(15B) Any income of a foreign company from lease Foreign Company
rentals of cruise ships, received from a
specified company which operates such
ship/ ships in India provided such foreign
company and the specified company are
subsidiaries of the same holding company.
Such exemption is available upto
A.Y. 2030-31.
10(23BBB) Income of European Economic Community European Economic Community
derived in India from interest, dividends or
capital gains from investment out of its funds
under notified scheme of Central
Government.
10(23BBC) Income of SAARC Fund for Regional SAARC Fund for Regional
Projects set up by Colombo Declaration. Projects.
10(23FBC) Any income accruing or arising to or Unit holder of specified fund
received by a unit holder from a specified
fund or on transfer of units in a specified
fund
10(23FE) Dividend, interest, any sum referred to in Specified person, being
section 56(2)(xii) or long-term capital gains (i) a wholly owned subsidiary of
(whether or not such capital gains are the Abu Dhabi Investment
deemed as short-term capital gains under Authority
section 50AA) arising to specified person (ii) a sovereign wealth fund
from an investment made by it in India,
whether in the form of debt or share capital (iii) Pension fund satisfying the
or unit, if such investment prescribed conditions.
(iv) Public Investment Fund of
(i) is made between 1.4.2020 and
the Government of the
31.3.2030;
Kingdom of Saudi Arabia
(ii) is held for at least 3 years and its wholly owned
(iii) is in subsidiary
(a) a business trust,
(b) a company/ enterprise/entity in
developing/ operating/maintaining
an infrastructure facility or
(c) a SEBI Category I or II AIF
having not less than 50%

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investment in one or more of the

company or enterprise or entity
referred to in (b) or in (d) or in
(e) or in an Infrastructure
Investment Trust or
(d) a domestic company, set up and
registered on or after 1.4.2021,
having minimum 75%
investments in one or more of the
companies or enterprises or
entities referred to in (b) or
(e) a NBFC registered as an
Infrastructure Finance Company
or in an Infrastructure Debt Fund,
having minimum 90% lending to
one or more of the companies or
enterprises or entities referred to
in (b)

10(23FF) Income of the nature of capital gains on Non-resident or specified fund

account of transfer of share of a company
resident in India, by the resultant fund or a
specified fund to the extent attributable to
units held by non-resident (not being a PE of
a non-resident in India) in such manner as
may be prescribed, and such shares were
transferred from the original fund, or from its
wholly owned special purpose vehicle, to the
resultant fund in relocation, and where
capital gains on such shares were not
chargeable to tax if that relocation had not
taken place.
Income would be exempt only when the
specified fund furnishes an annual statement
of exempt income in the prescribed form
electronically under digital signature on or
before the due date specified u/s 139(1).
Where such form is not filed by the specified
fund, the exempt income would be NIL.
Further, such annual statement in prescribed
form has to be certified by an accountant
before the specified date [one month prior to
the due date u/s 139(1)] and such

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accountant has to furnish by that date, the

certificate in the prescribed form
electronically under digital signature.
10(34B) Any income by way of dividends from a Unit of any IFSC engaged in the
company being a unit of any IFSC primarily business of leasing of an aircraft
engaged in the business of leasing of an or a ship.
aircraft or a ship.
10(48) Income received in India in Indian currency Foreign company on account of
on account of sale of Crude oil or any other sale of crude oil, any other goods
goods or rendering of services, as may be or rendering of services. It should
notified by the Central Government in this not be engaged in any other
behalf, to any person in India. Foreign activity in India.
company and agreement should be notified
by the Central Government in national
interest.
10(48A) Income accruing or arsing on account of Foreign company on account of
storage of crude oil in a facility in India and storage of crude oil in a facility in
sale of crude oil therefrom to any person India and sale of crude oil
resident in India. Foreign company and therefrom.
agreement should be notified by the Central
Government in national interest.
10(48B) Income from sale of leftover stock of crude Foreign company from sale of
oil from facility in India after the expiry of leftover stock of crude oil from the
agreement or arrangement referred to in facility in India.
section 10(48A) or on termination of the said
agreement or arrangement, in accordance
with the terms mentioned therein, as the
case may be, subject to such conditions, as
may be notified by the Central Government.

21.4 PRESUMPTIVE TAXATION FOR NON RESIDENTS

Section 28 details the income chargeable to tax under the head “Profits and Gains of Business or
Profession”. Certain provisions have been incorporated in the Income-tax Act, 1961, whereby the
“Profits and gains of business or profession” of certain non-resident assessee is computed on the
basis of certain percentage of the amount accrued or arisen and received in India.

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(1) Special provision for computing the profits and gains of shipping business other
than cruise shipping in the case of non-residents [Section 44B]

Section 44B is a non-obstante clause. Accordingly, sections

28 to 43A are not applicable in the case of a non-resident
engaged in the business of operation of ships (other than
cruise ships referred to in section 44BBC).

Profits and gains of a non-resident engaged in the business of operation of ships (other than cruise ships
referred to in section 44BBC) would be@7.5% of the aggregate of the following amounts

Amounts paid or payable, whether in or out of India, Amounts received or deemed to be received in India
to the assessee or to any person on his behalf on by or on behalf of the assessee on account of the
account of carriage of passengers, livestock, mail or carriage of passengers, livestock mail or goods
goods shipped at any port in India shipped at any port outside India

The amounts referred above would include demurrage charges or handling charges or any other
amount of similar nature.
The amounts paid or payable or the amounts received or deemed to be received will also include the
amount paid or payable or received or deemed to be received by way of demurrage charges or
handling charges or any other amount of similar nature [CIT v. Japan Lines Ltd. 260 ITR 656(Mad)].
Thus 7.5% of the gross amounts mentioned above would be liable to tax and no deduction would be
allowed for any expenditure, (i.e. the provisions of section 28 to 43A are not to be taken into account)
however carried forward losses would be allowed to be set off from such income.
Analysis of section 44B and section 172:

Section 44B Section 172

Presumptive tax provisions for non-residents engaged in Complete code for taxation of
shipping business (other than other than cruise ships occasional shipping business of non-
referred to in section 44BBC). residents, including assessment and
It does not, however, contain any procedure for collection of tax.
assessment and collection of tax.
Manner of computation of presumptive Income:
Notwithstanding anything to the contrary contained Where a ship carries passengers,
in sections 28 to 43A, in the case of an assessee, being livestock, mail, or goods shipped at a
a non-resident, engaged in the business of operation of port in India, a sum equal to 7.5% of
ships (other than cruise ships referred to in section - the amount paid or payable on
44BBC), a sum equal to 7.5% of the aggregate of the - account of such carriage to the owner

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- amount paid or payable (whether in or outside India) to or the charterer or to any person on
the non-resident or to any other person on his behalf on his behalf, whether that amount is
account of the carriage of passengers, livestock, mail or paid or payable in or out of India,
goods shipped at any Indian port and shall be deemed to be income
- the amount received or deemed to be received in India accruing in India to the owner or
on account of the carriage of passengers, livestock, mail charterer on account of such carriage.
or goods shipped at any port outside India.
shall be deemed to be the profits and gains of such
business chargeable to tax under the head "Profits and
gains of business or profession".

Other provisions of section 172

(i) Furnish a return of the amount paid to the owner: Section 172(3) imposes an obligation on
the master of the ship to prepare and furnish to the Assessing Officer a return of the full
amount paid or payable to the owner or charterer or any person on this behalf, on account of
the carriage of all passengers, livestock, mail or goods shipped at any port in India since the
last arrival of the ship thereat. Such return is, ordinarily, to be furnished by the master of the
ship before the departure, from that port in India, of the ship.

A return may, however, be filed by the person authorized by the master of the ship within
30 days of the departure of the ship from the port, if:
(a) the Assessing Officer is satisfied that it is not possible for the master of the ship to
furnish the return required by section 172(3) before the departure of the ship from
the port; and
(b) the master of the ship has made satisfactory arrangement for the filing of the return
and payment of tax by any other person on this behalf.
(ii) Assessment [Section 172(4)]: This section provides for a summary procedure of
assessment. On receipt of the return filed by the master of the ship or by any person on this
behalf, the Assessing Officer has to determine the tax payable on the taxable income. By
virtue of the provisions of section 172(2), the taxable income is a sum equal to 7.5% of the
amount paid or payable on account of carriage of passengers etc. to the owner or charterer
or to any person on his behalf, whether that amount is paid or payable in or out of India.
The tax payable on such taxable income is to be calculated at the rate or rates in force
applicable to the total income of a foreign company. The master of the ship is liable for
payment of such tax.

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(iii) Time limit for passing the assessment order [Section 172(4A)/(5)]: It is incumbent on
the Assessing Officer to pass the order of assessment within 9 months from the end of
the financial year in which the return of income under section 172(3) is filed.
For the purpose of determining the tax payable, Assessing Officer is empowered to call
for such accounts and documents as he may require.

(iv) Grant of port of clearance to the ship [Section 172(6)]: A port clearance shall not be
granted to the ship until the Collector of customs or other authorized officer, is satisfied
that the tax assessable under section 172 has been duly paid or that satisfactory
arrangements have been made for the payment thereof.
(v) Option to pay tax as per normal provisions of the Income-tax Act, 1961 on the
income chargeable to tax under section 172 [Section 172(7)]: The owner or charterer
has the option to claim before the expiry of the assessment year relevant to the previous
year in which the date of departure of the ship from the Indian port falls, that an
assessment in respect of his total income for the previous year and the tax payable on
the basis thereof be determined in accordance with the other provisions of this Act. In
such a case, any payment made under section 172 is to be treated as a payment in
advance of the tax leviable for that assessment year and the difference between the sum
so paid and the amount of tax found payable by him on such assessment is to be paid by
him or refunded to him, as the case may be.

The sum chargeable to tax under this section shall include amounts payable by way of demurrage
charge or handling charge or any other amount of similar nature [Section 172(8)].
Section 172 vis-à-vis section 44B
In case the assessee is covered under section 172, 7.5% of the amount paid or payable on account of
the carriage of the passengers, livestock, mail or goods to the owner or the chartered or to any person
on his behalf is deemed as his income and tax is levied on such income at a rate applicable to a foreign
company i.e., 35% plus surcharge, if any, and plus health and education cess @4%.
Under the provisions of section 172(7), the non-resident owner or charterer is allowed an option to
be assessed on his total income of the previous year in accordance with other provisions of the Act
i.e., as per section 44B.
When such option is exercised, a regular assessment is made. In such a case, the tax already
paid under the provisions of section 172(4) by the non-resident owner or charterer would be
treated as tax paid in advance for that assessment year before determining the amount of tax

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finally due. The difference between the sum so paid and the amount of tax payable by him on such
assessment shall be paid by the assessee or refunded to him (See Note below).

In that case, the non-resident assessee is liable to pay interest under sections 234B and 234C and
also entitled to receive interest under section 244A of the Income-tax Act, 1961 as the case may
be. [Circular No. 9/2001, dated 9-7-2001]
Note –Refund may arise in case of non-corporate non-residents, since they are liable to pay tax at a rate
lower than the rate of 35% (plus surcharge, if any, and cess@4%) applicable to a foreign company.

The Supreme Court, in A.S. Glittre v CIT (1997) 225 ITR 739 (SC), held that the assessment made
under section 172(4) shall be an ‘adhoc’ assessment and it will be superseded if a regular
assessment is opted as per the provisions of the Act.
ILLUSTRATION 7
Sea Port Shipping Line, a non-resident foreign company, is engaged in the business of carriage of
goods shipped at Mumbai port. During the previous year ended on 31.3.2026, it had collected
freight of ` 100 lakhs, demurrages of ` 20 lakhs and handling charges of ` 10 lakhs. The
expenses of operating its fleet during the year for the Indian Ports were ` 110 lakhs. Compute its
income applying the presumptive provisions under section 44B.
SOLUTION
Section 44B provides that in the case of an assessee, being a non-resident, engaged in the
business of operation of ships, a sum equal to 7.5% of the aggregate of the following amounts
would be deemed to be the profits and gains of such business chargeable to tax under the head
“Profits and gains of business or profession”.
(i) The amount paid or payable, whether within India or outside, to the assessee or to any
person on his behalf on account of the carriage of passengers, livestock, mail or goods
shipped at any port in India; and
(ii) The amount received or deemed to be received in India by the assessee himself or by
any other person on behalf of or on account of the carriage of passengers, livestock, mail
or goods shipped at any port outside India.
The above amounts will include demurrage charges and handling charges.
These provisions for computation of income from the shipping business in case of non-residents
would apply notwithstanding anything to the contrary contained in the provisions of sections 28 to
43A of the Income-tax Act, 1961.

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 21.88 INTERNATIONAL TAXATION

Therefore, in this case, M/s. Sea Port Shipping Line is required to pay tax in India on the basis of
presumptive scheme as per the provisions of section 44B. The assessee shall not be entitled to
set off any of the expenses incurred for earning of such income. Therefore, the Shipping Line is
required to pay tax on deemed profit of ` 9.75 lakhs (7.50% on the total receipts of ` 130 lakhs).
The tax payable would be reduced by the amount of tax paid under section 172(4).
(2) Special provision for computing profits and gains in connection with the business of
exploration etc. of mineral oils [Section 44BB]

Section 44BB is a non-obstante clause. Accordingly, sections 28 to 41 and section 43 and 43A are
not applicable in the case of a non-resident engaged in the business of providing services of
facilities in connection with, or supplying plant and machinery on hire used, or to be used in the
prospecting for, or extraction or production of, mineral oils.
(i) Eligible assessee: Section 44BB provides for determination of income of taxpayer being
a non-resident engaged in the business of providing services and facilities in connection
with, or supplying plant and machinery on hire used or to be used in the prospecting for,
or extraction or production of mineral oils.
(ii) Presumptive rate: In such case, the profits and gains shall be deemed to be equal to
10% of the following amounts:

• paid or payable to the taxpayer or to any person on his behalf whether in or out of
India, on account of the provision of such services or facilities or supply of plant &
machinery for the aforesaid purposes in India; and
• received or deemed to be received in India by or on behalf of the assesse on
account of such service or facilities or supply of plant and machinery used or to be
used in prospecting for, or extraction or production of mineral oils outside India.
(iii) Non-applicability of presumptive taxation under section 44BB: The provisions of
section 44BB shall not apply to any income to which the provisions of section 42 or
section 44DA, 115A or 293A apply for the purpose of computing profit or gains or any
other income referred to in these sections.
Section Provision
42 Special provision for deductions in the case of business for prospecting,
etc., for mineral oil
44DA Special provisions for computing income by way of royalties, etc., in case of
non-residents.

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 NON RESIDENT TAXATION 21.89

115A Tax on royalty and fees for technical services

293A Power to make exemption, etc., in relation to participation in the business of

prospecting for, extraction, etc., of mineral oils.

(iv) Option to claim lower profits: An assessee may claim lower income than the
presumptive rate of 10%, if he keeps and maintains books of account under section
44AA(2) and get them audited and furnish a report of such audit under section 44AB. The
assessment in all such cases shall be done by the Assessing Officer under section
143(3).
(v) No set-off of unabsorbed depreciation and brought forward loss: Where an assessee
declares profits and gains of business @10% for any previous year in accordance with
the presumptive provisions under this section, no set off of unabsorbed depreciation and
brought forward loss would be allowed to the assessee for such previous year.

(vi) Meaning of certain terms: For the purposes of this section,-

(a) “Plant” includes ships, aircraft, vehicles, drilling units, scientific apparatus and
equipment, used for the purposes of the said business;
(b) “Mineral oil” includes petroleum and natural gas.

Note - If the income of a non-resident is in the nature of fees for technical services, it shall be
taxable under the provisions of either section 44DA or section 115A irrespective of the business to
which it relates. Section 44BB would apply only in a case where consideration is for services and
other facilities relating to exploration activity which are not in the nature of technical services..
(3) Special provision for computing profits and gains of the business of operation of
aircraft in the case of non-residents [Section 44BBA]

Section 44BBA is a non-obstante clause. Accordingly, sections 28 to

43A are not applicable in the case of a non-resident engaged in the
business of operation of aircraft.

(i) Eligible assessee: Section 44BBA provides presumptive rate in case of a non-resident
engaged in the business of operation of aircraft.

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 21.90 INTERNATIONAL TAXATION

(ii) Presumptive rate: Income from such business is calculated at a flat rate of 5% of the
following:

(a) amount paid or payable, in or out of India, to the tax payer or to any person on his
behalf on account or carriage of passenger, livestock, mail or goods from any
place in India and

(b) amount received or deemed to be received in India by or on behalf of the taxpayer

on account of carriage of passenger, livestock, mail or goods from any place
outside India.
ILLUSTRATION 8
Mr. Q, a non-resident, operates an aircraft between Singapore and Chennai. He received the
following amounts while carrying on the business of operation of aircrafts for the year ended
31.3.2026:
(i) ` 2 crores in India on account of carriage of passengers from Chennai.
(ii) ` 1 crore in India on account of carriage of goods from Chennai.
(iii) ` 3 crores in India on account of carriage of passengers from Singapore.
(iv) ` 1 crore in Singapore on account of carriage of passengers from Chennai.
The total expenditure incurred by Mr. Q for the purposes of the business during the year ending
31.3.2026 was ` 6.75 crores.
Compute the income of Mr. Q chargeable to tax in India under the head “Profits and gains of
business or profession” for the assessment year 2026-27.
What would be your answer in case the business was carried on by a foreign company, Q Airlines
(P) Ltd?
SOLUTION
Section 44BBA says for computing profits and gains of the business of operation of aircraft in the
case of non-residents a sum equal to 5% of the aggregate of the following amounts -
(a) paid or payable, whether in or out of India, to the assessee or to any person on his behalf
on account of the carriage of passengers, livestock, mail or goods from any place in
India; and
(b) received or deemed to be received in India by or on behalf of the assessee on account of
the carriage of passengers, livestock, mail or goods from any place outside India.

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 NON RESIDENT TAXATION 21.91

Keeping in view the provisions of section 44BBA, the income of Mr. Q chargeable to tax in India
under the head "Profits and gains of business or profession" is worked out hereunder -

Particulars `
Amount received in India on account of carriage of passengers from Chennai 2,00,00,000
Amount received in India on account of carriage of goods from Chennai 1,00,00,000
Amount received in India on account of carriage of passengers from Singapore 3,00,00,000
Amount received in Singapore on account of carriage of passengers from 1,00,00,000
Chennai
7,00,00,000
Income from business under section 44BBA at 5% of ` 7,00,00,000 is ` 35,00,000, which is the
income of Mr. Q chargeable to tax in India under the head “Profits and gains of business or
profession” for the A.Y. 2026-27.
In case the assessee is a foreign company, say, Q Airlines (P) Ltd, the answer would be the same
since section 44BBA does not distinguish corporate and non-corporate taxpayers who operate
aircraft provided their residential status is that of non-resident.
(4) Special provision for computing profits and gains of foreign companies engaged in
the business of civil construction etc. in certain turnkey power projects [Section
44BBB]

(i) Eligible assessee: A foreign company engaged in the business

of civil construction or the business of erection of plant or machinery
or testing or commissioning thereof in connection with a turnkey power
project approved by the Central Government in this behalf.
(ii) Presumptive rate: A sum equal to 10% of the amount paid or payable (whether in or out
of India) to the said assessee or to any person on his behalf on account of such civil
construction, erection, testing or commissioning shall be deemed to be the profits and
gains of such business chargeable to tax under the head 'profits and gains of business or
profession'.
(iii) Option to claim lower profits: An assessee may claim lower income than the
presumptive rate of 10%, if he keeps and maintains books of account under section
44AA(2) and get them audited and furnish a report of such audit under section 44AB. The
assessment in all such cases shall be done by the Assessing Officer under section
143(3).

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 21.92 INTERNATIONAL TAXATION

(iv) No set-off of unabsorbed depreciation and brought forward loss: Where an assessee
declares profits and gains of business @10% for any previous year in accordance with
the presumptive provisions under this section, no set off of unabsorbed depreciation and
brought forward loss would be allowed to the assessee for such previous year.
(5) Special provision for computing profits and gains of business of operation of cruise
ships in case of non-residents [Section 44BBC]

(i) Eligible Assessee: A non-resident engaged in the business of operation of cruise ships
subject to prescribed conditions.
(ii) Presumptive rate: The profits and gains shall be deemed to be equal to 20% of the
following amounts:
• paid or payable to the eligible assessee or to any person on his behalf on account of
the carriage of passengers; and

• received or deemed to be received by or on behalf of the assesse on account of the

carriage of passengers.
The lease rentals paid by a foreign company which opts for presumptive regime under section
44BBC, would be exempt in the hands of the recipient company under section 10(15B), if such
company is a foreign company and both these foreign companies are subsidiaries of the same
holding company. This exemption would be available upto A.Y. 2030-31.
The CBDT has, vide Notification No. 9/2025 dated 21.01.2025 inserted Rule 6GB. Rule 6GB
specified the conditions for non-resident, engaged in the business of operation of cruise ships for
section 44BBC.
For the purposes of section 44BBC, an assessee, being a non-resident, engaged in the business
of operation of cruise ships has to –
(i) operate a passenger ship having a carrying capacity of more than 200 passengers or length
of 75 meters or more, for leisure and recreational purposes and having appropriate dining
and cabin facilities for passengers;
(ii) operate such ship on scheduled voyage or shore excursion touching at least two sea ports
of India or same sea ports of India twice;
(iii) operate such ship primarily for carrying passengers and not for carrying cargo; and
(iv) operate such ship as per the procedure and guidelines if any, issued by the Ministry of
Tourism or Ministry of Shipping.”

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 NON RESIDENT TAXATION 21.93

(6) Special provision for computing profits and gains of non-residents engaged in
business of providing services or technology for setting up an electronics
manufacturing facility or in connection with manufacturing or producing electronic
goods, article or thing in India [Section 44BBD]

(i) Eligible assessee: A non-resident engaged in the business of providing services or

technology in India, for setting up an electronics manufacturing facility or in connection
with manufacturing or producing electronic goods, article or thing in India -
a. to a resident company which is establishing or operating electronics manufacturing
facility or a connected facility for manufacturing or producing electronics goods,
article or thing in India, under a scheme notified by the Central Government in the
Ministry of Electronics and Information Technology; and
b. the resident company satisfies the conditions prescribed in this behalf.
(ii) Presumptive rate: The profits and gains shall be deemed to be equal to 25% of the
following amounts:
• paid or payable to the non-resident assessee or to any person on his behalf on
account of providing services or technology; and

• received or deemed to be received by non-resident assessee or on behalf of the

non-resident assessee on account of providing services or technology.
(iii) Non-applicability of section 44DA or section 115A: The provisions of section 44DA or
section 115A do not apply in respect of income covered by this section.
(iv) No set-off of unabsorbed depreciation and brought forward loss: Where an assessee
declares profits and gains of business @25% for any previous year in accordance with
the presumptive provisions under this section, no set off of unabsorbed depreciation and
brought forward loss would be allowed to the assessee for such previous year.

© The Institute of Chartered Accountants of India

 SUMMARY OF PRESUMPTIVE PROVISIONS APPLICABLE TO NON RESIDENTS

Particulars 44B 44BBA 44BB 44BBB 44BBC 44BBD

Nature of Shipping Operation of Business of providing Business of civil Business of Business of providing
business business aircraft services or facilities in construction or the operation of services or technology
21.94

other than connection with, or business of cruise ships in India, for setting up
cruise ship supplying P & M on hire erection of P&M or an electronics
business u/s used, or to be used, in the testing or manufacturing facility
44BBC prospecting for, or commissioning or in connection with
extraction or production of thereof, in manufacturing or
mineral oils connection with producing electronic
turnkey power goods, article or thing

© The Institute of Chartered Accountants of India

projects approved in India
by the Central
Government.

Eligible Non-resident Non-resident Non-resident Only Foreign Co. Non-resident Non-resident

assessee

Presumptive 7.5% of 5% of 10% of specified sum 10% of specified 20% of specified 25% of specified sum
INTERNATIONAL TAXATION

income specified specified sum sum sum

sum

Specified (i) Amount paid or payable (i) Amount paid or Amount paid or (i) Amount (i) Amount paid or
sum on account of carriage payable on account payable on a/c of paid or payable to the
of passengers, of the provision of such civil payable on non-resident
livestock, mail or goods such services or construction, account of assessee or to
shipped at/ from any facilities for the erection, testing or carriage of any person on his
port/place in India; and aforesaid purposes in commissioning passengers; behalf on account
India; and and of providing
(ii) Amount received or
deemed to be received (ii) Amount received or (ii) Amount services or
in India on account of deemed to be received or technology; and
 the carriage of received in India on deemed to (ii) Amount received
passengers, livestock account of the be received or deemed to be
mail or goods shipped provisions of services on account received by non-
at/ from any port/place or facilities for the of carriage resident
outside India aforesaid purpose of assessee or on
outside India. passengers behalf of the non-
resident
assessee on
account of
providing services
or technology

Option to Not available Lower profits may be claimed u/s 44BB and u/s Not available Not available.

© The Institute of Chartered Accountants of India

declare lower 44BBB provided the assessee maintains books No set off of
profits of account u/s 44AA and gets them audited u/s unabsorbed
44AB. depreciation and
No set off of unabsorbed depreciation and brought forward loss
brought forward loss would be allowed to the would be allowed to
assessee in the previous year in which he/it the assessee in the
declares profits and gains @10% in previous year in which
NON RESIDENT TAXATION

accordance with the presumptive provisions of he/it declares profits

section 44BB/ 44BBB. and gains @25% in
accordance with the
presumptive provisions
of section 44BBD.
21.95
 21.96 INTERNATIONAL TAXATION

(6) Deduction in respect of head office expenses in case of non-residents [Section 44C]

In case of a non-resident, head office expenditure is allowed in accordance with the provisions of
section 44C. This section is a non-obstante provision, and anything contrary contained in sections
28 to 43A is not applicable.
Deduction in respect of head office expenditure is restricted to the least of the following:
(a) an amount equal to 5% of “adjusted total income” or in case adjusted total income is a
loss, 5% of the “average adjusted total income”; or
(b) the amount of so much of the expenditure in the nature of head office expenditure incurred
by the assessee as is attributable to the business or profession of the assessee in India.
Meaning of certain terms:
Term Meaning
Adjusted total Total income computed in accordance with the provisions of the Act without
income giving effect to the following :-
 Allowance under this section
 Unabsorbed depreciation allowance under section 32(2).
 Expenditure incurred by a company for the purpose of promoting family
planning amongst its employees under first proviso to section 36(1)(ix).
 Business loss brought forward under section 72(1).
 Speculation loss brought forward under section 73(2).
 Loss under the head Capital Gain under section 74(1).
 Loss from certain specified source brought forward under Section
74A(3).
 Deduction under Chapter VI-A.
Average (a) The total income of the assessee, assessable for each of the three
adjusted total assessment years immediately preceding the relevant assessment
income year, one third of the aggregate amount of the adjusted total income in
respect of previous years relevant to the aforesaid three assessment
years is average adjusted total income.
(b) When the total income of the assessee is assessable only for two of the
aforesaid three assessment years, one half of the aggregate amount
of the adjusted total income in respect of the previous year’s relevant to
the aforesaid two assessment years is taken on average adjusted total
income.
(c) Where the total income of the assessee is assessable only for one of
the aforesaid three assessment years, the amount of the adjusted
total income in respect of the previous year relevant to that assessment
year is average adjusted total income.

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 NON RESIDENT TAXATION 21.97

Head office Executive and general administration expenditure incurred by the assessee
expenditure outside India, including expenditure incurred in respect of:
a. rent, rates, taxes, repairs or insurance of any premises outside India
used for the purpose of the business or profession.
b. salary, wages, annuity, pension, fees, bonus, commission, gratuity,
perquisites or profit in lieu of or in addition to salary, whether paid or
allowed to any employee or other person employed in, or managing the
affairs of, any office outside India;
c. traveling by any employee or other person employed in, or managing the
affairs, of any office outside India; and
d. such other matters connected with executive and general administrative
as may be prescribed.

Deduction of Head Office expenditure in case of Non-residents while computing Profit

and gains from business or profession

Lower of

5% of adjusted Total Income Amount of Head Office expenditure incurred by

the Non-resident attributable to the business or
profession in India

Meaning of Adjusted Total Income Meaning of Head Office expenditure

Total Income, without giving effect to: Executive and general administration expenditure
(i) Head Office expenditure incurred by the NR outside India, including:
(ii) Unabsorbed depreciation (a) Rent, rates, taxes, repairs or insurance of
(iii) Capital expenditure on family any premises outside India used for
planning business or profession
(iv) Losses carry forward: (b) Salary, wages, perquisites etc. to any
- Business loss u/s 72(1) employee or other person managing the
affairs of any office outside India
- Speculative business Loss (c) Travelling expenditure by any employee or
u/s 73(2) other person managing the affairs of any
- LTCL/STCL u/s 74(1) office outside India
- Loss from owning and (d) Such other executive and general
maintaining race horses u/s administration expenditure prescribed
74A(3)
(v) Deductions under Chapter
VI-A from GTI

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 21.98 INTERNATIONAL TAXATION

ILLUSTRATION 9
The net result of the business carried on by a branch of foreign company in India for the year
ended 31.03.2026 was a loss of ` 100 lakhs after charge of head office expenses of ` 200 lakhs
allocated to the branch. Explain with reasons the income to be declared by the branch in its return
for the assessment year 2026-27.
SOLUTION
Section 44C restricts the allowability of the head office expenses to the extent of lower of an
amount equal to 5% of the adjusted total income or the amount actually incurred as is attributable
to the business of the assessee in India.
For the purpose of computing the adjusted total income, the head office expenses of ` 200 Lakhs
charged to the profit and loss account have to be added back.
The amount of income to be declared by the assessee for A.Y. 2026-27 will be as under:
Particulars `
Net loss for the year ended on 31.03.2026 (100 lakhs)
Add: Amount of head office expenses to be considered separately as per section 200 lakhs
44C
Adjusted total income 100 lakhs
Less: Head Office expenses allowable under section 44C is the lower of -
(i) ` 5 lakhs, being 5% of ` 100 lakhs, or
(ii) ` 200 lakhs. 5 lakhs
Income to be declared in return 95 lakhs

(7) Special provision for computing income by way of royalties etc. in case of non-
residents [Section 44DA]

(i) Eligible Assessee: Section 44DA provides the method of computation of income by way
of royalty or fees for technical services arising from the agreement made by the non-
resident with the Indian company or Government of India after 31.03.2003 where:
(a) such non-resident carries business/profession in India through permanent
establishment or fixed place of profession; and

(b) the right, property, or contract in respect of which the royalty or fees for technical
services are paid is effectively connected with such permanent establishment or
fixed place of service.

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 NON RESIDENT TAXATION 21.99

(ii) Expenses not allowed as deduction: While computing the income chargeable to tax
under this section, the following expenses are not allowed as deduction:

- expenditure or allowance incurred which is not wholly and exclusively for such
permanent establishment or fixed place of service in India
- amount paid (otherwise than reimbursement of actual expenses) by the permanent
establishment to head office or to any of its other offices.
(iii) Non-applicability of section 44BB: The provisions of section 44BB do not apply in
respect of income covered by this section.
(iv) Mandatory requirement to maintain books of account and get them audited: Under
this section, the non-resident is mandatorily required to keep and maintain the books of
account under section 44AA and get them audited before the date one month prior to the
due date for furnishing the return of income under section 139(1) and furnish by that date
a report of such audit.
Assessee Due date of filing return Specified date of tax
of income u/s 139(1) audit u/s 44AB
(i) In case of an assessee 30th November of the A.Y. 31 October of the A.Y.
st

who is required to furnish

report referred to in
section 92E
(ii) In case of other 31st October of the A.Y. 30th September of the A.Y.
assessees computing
income u/s 44DA

21.5 CAPITAL GAINS TAXATION FOR NON RESIDENTS

Any person including a foreign company or non-corporate non-resident is liable to capital gains tax
in India, if there is a transfer of a property (capital asset) in India which results in profit or gain. The
provisions relating to non-residents in respect of capital gains taxation are discussed in detail in
Chapter 4: Capital Gains in Module 1.
First Proviso to Section 48 read with Rule 115A:-
In case of non-residents who invest foreign exchange to acquire capital assets, exchange rate
fluctuation benefit is allowed while computing the capital gains arising from the transfer of shares
or debentures of an Indian company as per first proviso to section 48.

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 21.100 INTERNATIONAL TAXATION

The same is to be computed in the following manner:

♦ The cost of acquisition, the expenditure incurred wholly and exclusively in connection with
the transfer and the full value of the consideration are to be converted into the same foreign
currency with which such shares or debentures were acquired.
♦ The resulting capital gains shall be reconverted into Indian currency.
The aforesaid manner of computation of capital gains shall be applied for every purchase and sale
of shares or debentures in an Indian company.
Rule 115A of the Income-tax Rules, 1962 provides that the average of the telegraphic transfer
buying rate and telegraphic transfer selling rate of the foreign currency initially utilized in purchase
of the capital asset as on the date specified in column (3) in the table below, shall be considered to
convert rupees into foreign currency for the purpose of computation of capital gains.
(1) (2) (3)
S. No. Item Date
(a) Cost of acquisition of capital asset Date of acquisition of capital asset
(b) Expenditure incurred wholly and exclusively in Date of transfer of capital asset
connection with transfer of capital asset
(c) Full value of consideration received or accruing Date of transfer of capital asset
as a result of transfer of a capital asset

For reconverting capital gains computed in the foreign currency initially utilized in the purchase
of the capital asset into rupees, the telegraphic transfer buying rate of such currency, as on the
date of transfer of the capital asset, is to be considered.
Meaning of certain terms
Term Meaning
Telegraphic The rate or rates of exchange adopted by the State Bank of India for buying
transfer foreign currency having regard to the guidelines specified from time to time by
buying rate the RBI for buying foreign currency where such currency, made available to
that bank through a telegraphic transfer.
Telegraphic The rate of exchange adopted by the State Bank of India for selling foreign
transfer currency where such currency is made available by that bank through
selling rate telegraphic transfer.

However, the benefit of currency fluctuation would not be available in respect of capital gains
arising from the transfer of the following long term capital assets referred to in section 112A –
(i) equity share in a company on which STT is paid both at the time of acquisition and transfer
(ii) unit of equity oriented fund or unit of business trust on which STT is paid at the time of transfer.

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 NON RESIDENT TAXATION 21.101

Other Important Points:

a. It is also provided that the aforesaid manner of computation of capital gains shall be
applicable in respect of capital gains accruing or arising from every re-investment thereafter
in and sale of shares in or debentures of an Indian company.
b. The shares and debentures (whether listed or non-listed) of Indian companies only are
covered under first proviso to section 48. Indian company shall include Government
company. However, bonds of Central Government/State Government and RBI are not
covered for this purpose.
c. If the total income of an assessee includes any income chargeable under the head ‘Capital
Gains’ arising from transfer of a capital asset being an equity share in a company or unit of
an equity oriented fund or unit of a business trust, then, tax on short term capital gains shall
be payable at the rates specified in section 111A if transaction of sale of such security has
been entered on or after October 1, 2004 on which STT is chargeable; and tax on long-term
capital gains shall be payable on such securities as per section 112A, if STT has been paid
both at the time of acquisition and transfer of equity share or at the time of transfer of unit of
equity oriented fund or unit of business trust.
d. Tax rates on long term capital gains arising to non-residents
S. No. Long-term capital asset (LTCA) Rate of tax
(i) Unlisted securities or shares of a closely 12.5% without foreign currency
held company fluctuation
(ii) Other Assets (other than taxable u/s 12.5%
112A)

e. Section 50CA provides that where the consideration received or accruing as a result of
transfer of a capital asset, being share of a company other than a quoted share, is less than
the fair market value of such share determined in such manner as may be prescribed, such
fair market value shall be deemed to be the full value of consideration received or accruing
as a result of such transfer.
This provision would, however, not be applicable to any consideration received or accruing as a
result of transfer by such class of persons and subject to such conditions as may be prescribed.

f. Section 50D provides that, in case where the consideration received or accruing as a result
of the transfer of a capital asset by an assessee is not ascertainable or cannot be
determined, then, for the purpose of computing income chargeable to tax as capital gains,

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 21.102 INTERNATIONAL TAXATION

the fair market value of the said asset on the date of transfer shall be deemed to be the full
value of consideration received or accruing as a result of such transfer.
ILLUSTRATION 10
Mr. A, a non-resident Indian, remits US $ 40,000 to India on 16.09.2006. The amount is partly
utilised on 3.10.2006 for purchasing 10,000 equity shares in A Ltd, an Indian Company, at the rate
of ` 12 per share. These shares are sold for ` 48 per share on 30.03.2026. Fair market value of
these shares on 31.01.2018 was ` 35 per share.
The telegraphic transfer buying and selling rate of US dollars adopted by the State Bank of India is
as follows:-
Date Buying Rate (1 US$) Selling Rate (1 US $)
16.09.2006 18 20
3.10.2006 19 21
30.3.2026 59 61
Compute the capital gain chargeable to tax for the A.Y. 2026-27 on the assumption that –
(a) These shares have not been sold through a recognised stock exchange
(b) These shares have been purchased and sold through a recognised stock exchange.
Ignore the provisions of Chapter XII-A
SOLUTION
(a) Where the shares are not sold through recognised stock exchange
Particulars US $
Sale consideration (` 4,80,000/60) 8000
Less: Cost of Acquisition (1,20,000/20) 6000
Long term capital gain 2000

Long-term capital gain converted into $ 2000 x ` 59 = ` 1,18,000

(b) Where the shares are purchased and sold through a recognised stock exchange
Particulars `
Sale consideration 4,80,000
Less: Cost of Acquisition
Higher of the following
Cost of acquisition 1,20,000

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 NON RESIDENT TAXATION 21.103

Lower of Fair market value as on 31.1.2018 and Full value

of consideration (i.e., lower of ` 3,50,000 and ` 4,80,000) 3,50,000 3,50,000
Long term capital gain 1,30,000

Long term capital gains upto ` 1,25,000 would be exempt. Long term capital gains
exceeding ` 1,25,000, i.e., ` 5,000 is taxable @12.5% under section 112A.
Rupee Denominated Bonds of an Indian company

As a measure to enable Indian companies to raise funds from outside India, the RBI has permitted
them to issue rupee denominated bonds outside India. Accordingly, in case of non-resident
assesses, any gains arising on account of appreciation of rupee between the date of purchase and
the date of redemption of rupee denominated bond of an Indian company held by him against
foreign currency in which investment is made shall not be included in computation of full value of
consideration. This would provide relief to the non-resident investor who bears the risk of currency
fluctuation [Fifth Proviso to Section 48].

21.6 SPECIAL PROVISIONS PRESCRIBED UNDER

CHAPTER XII-A
Chapter XII-A, introduced in the Income-tax Act 1961 with effect from June 01, 1983, contains
seven sections viz. 115C, 115D, 115E ,115F,115G,115H and115-I. The provisions of this Chapter
are applicable to a non-resident Indian who derives investment income from a foreign exchange
asset and/ or long term capital gains in respect thereof.
(1) Definitions [Section 115C]

Terms Meaning
(a) Convertible foreign Foreign exchange which is for the time being treated by the
exchange Reserve Bank of India as convertible foreign exchange for the
purposes of the Foreign Exchange Management Act, 1999, and
any rules made thereunder.
(b) Foreign exchange asset Any specified asset which the assessee has acquired or
purchased with, or subscribed to in, convertible foreign exchange.
(c) Investment income Any income derived from a foreign exchange asset.
(d) Long-term capital gains Income chargeable under the head “Capital gains” relating to a
capital asset, being a foreign exchange asset which is not a short-
term capital asset.

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(e) Non-resident Indian An individual, being a citizen of India or a person of Indian origin
who is not a “resident.
A person shall be deemed to be of Indian origin if he, or either of
his parents or any of his grandparents, was born in undivided
India
(f) Specified asset Any of the following assets, namely:
(i) Shares in an Indian company;
(ii) Debentures issued by an Indian company which is not a
private company
(iii) Deposits in an Indian Company which is not a private
company
(iv) Any security of the Central Government
(v) Any other asset which the Central Government may notify

(2) Special provisions relating to taxation of investment income and long-term capital
gains of a non-resident [Sections 115D to 115F]

(i) Taxation on gross basis [Section 115D(1)]: Section 115D deals with the computation of
total income of non-residents. In computing the investment income of non-resident Indian,
no deduction is to be allowed under any provision of the Act in respect of any expenditure
or allowance thereabout.

(ii) No deduction allowed [Section 115D(2)]: No deduction under Chapter VI-A shall be
allowed and indexation benefit will not be available, where the gross total income of a non-
resident Indian consists only of investment income or/and long term capital gain.

However, where the gross total income includes investment incomes or/and long term
capital gain, the deduction under Chapter VI-A shall be allowed only on that portion of gross
total income which does not include the investment income and long term capital gain.

(iii) Tax rate on investment income and long term capital gains [Section 115E]: Under
section 115E, tax payable by non-resident Indian shall be aggregate of –

(a) income-tax on Investment income at 20%;

(b) income-tax on long term capital gains from transfer of specified assets (i.e.,
purchased in foreign currency) at 12.5%

(c) income-tax on his other total income

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 NON RESIDENT TAXATION 21.105

Investment Income

20% + Surcharge (if applicable) + Health and Education Cess@4%

Long-term Capital Gain on Foreign Exchange Assets

12.5% + Surcharge (if applicable) + Health and Education Cess@4%

(iv) Exemption for long-term capital gains [Section 115F]

Where a non-resident Indian has long term capital gain from transfer of a foreign
exchange asset and has within a period of six months after the date of such transfer,
invested the whole or part of the net consideration in any specified asset then
(a) If the cost of the new asset is not less than the net consideration in respect of the
original asset, the whole of the capital gains shall not be charged to tax under
section 45
(b) If the cost of the new asset is less than the net consideration in respect of the
original asset, the amount as calculated below shall not be charged to tax under
section 45
Cost of acquisition of new asset
Capital Gains x
Net Consideration
Important points:
1. Net consideration means the full value of consideration from transfer less
expenditure incurred wholly and exclusively in connection with transfer.
2. Where the new asset is transferred or converted into money within a period of 3
years from the date of its acquisition, the amount of capital gains arising from the
transfer of original asset not charged to tax earlier shall be deemed to be the income
under the head “Capital Gains ‘’ relating to long term capital assets. The same shall
be charged to tax in the previous year in which new asset is transferred or converted
into money.
ILLUSTRATION 11
A non-resident Indian acquired shares in an Indian company, A Ltd., on 1.1.2009 for ` 1,00,000 in
foreign currency. These shares are sold by him on 1.1.2026 for ` 3,00,000. He invests ` 3,00,000
in shares on 31.03.2026 and these shares are sold by him on 30.06.2026 for ` 3,50,000. Discuss
the tax implications. Ignore the effect of first proviso to section 48.

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SOLUTION
Computation of Long term Capital Gain for Assessment Year 2026-27
Particulars Amount (`)
Sale consideration 3,00,000
Less: Cost of Acquisition 1,00,000
Long term capital gain 2,00,000
Less: Exemption under section 115F 2,00,000
Exempt long-term capital gain NIL

Capital Gain for Assessment year 2027-28:

1. LTCG of ` 2,00,000 which was exempt in A.Y.2026-27 becomes taxable this year.
2. STCG of ` 50,000 is also taxable this year.
ILLUSTRATION 12
Mr. John, a non-resident Indian, purchased unlisted shares of an Indian Company at a cost of
` 70,000 on 01.07.2010 in foreign currency. Mr. John sold the said shares for a consideration of
` 2,50,000 on 01.08.2025 and the expenditure incurred wholly or exclusively in connection with the
transfer is ` 10,000. Compute the taxable capital gain if he deposited in specified assets
` 1,50,000 out of sale consideration. Ignore the effect of first proviso to section 48.
SOLUTION
Particulars Amount (`)
Sale Consideration 2,50,000
Less: Transfer Expenses 10,000
Net Consideration 2,40,000
Less: Cost of Acquisition 70,000
Long-term capital gain 1,70,000
Less: Exemption u/s 115F 1,06,250*
Taxable long-term capital gain 63,750

* 1,70,000 × 1,50,000
= ` 1,06,250
2,40,000

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(v) Option not to file income-tax return [Section 115G]

A non-resident Indian need not furnish a return of income under section 139(1) if he
satisfies the following two conditions:-
(a) His total income consists only of investment income or income by way of long-term
capital gains or both; and
(b) Tax deductible at source has been deducted from such income.
(vi) Continuance of benefits after the non-resident becomes a resident [Section 115H]
(a) Where a person who is an NRI in any previous year becomes assessable as a resident
in any subsequent year, then he may furnish a declaration in writing along with the
return of income under section 139 for the year in which he is so assessable.
(b) The declaration shall be to the effect that the provisions of this chapter shall
continue to apply to him in respect of the investment income derived from foreign
exchange assets being debentures, deposits, securities of Central Government
and such other notified assets as specified under section 115C.
(c) If he does so, the provisions of this chapter shall continue to apply to him in
relation to such income for that assessment year and every subsequent year until
the transfer or conversion into money of such assets.
(vii) Option to opt out of Chapter XII-A [Section 115-I]
This section gives an option to a non-resident Indian to elect that he should not be
governed by the special provisions of Chapter XII-A for any particular assessment year by
furnishing his return of income for that assessment year under section 139 declaring
therein that the provisions of Chapter XII-A shall not apply to him for that assessment
year. In case where such an option is exercised by a non-resident Indian, his total income
for that assessment year would be charged to tax under the general provisions of the Act.

A Quick Recap
Meaning of Foreign Exchange Asset (FEA)

Specified asset Acquired/purchased/ subscribed to in convertible foreign exchange

Shares in Debentures issued by Deposits with an Any security Other assets

an Indian an Indian Co. (other Indian Co. (other of the CG notified by the CG
Company than a Pvt. Co.) than a Pvt. Co.)

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Special Provisions relating to certain incomes of non-resident individual, being a

citizen of India or person of Indian Origin

Investment LTCG relating Other Income

Income from to FEA, being a
FEA LTCA

Rate of tax 20% 12.5% As per other

provisions of the
Act

Deduction for
expenses or Not allowable Allowable Allowable
allowance

Deduction
under
Not allowable Not allowable Allowable
Chapter
VI-A

Exemption Allowable
u/s 115F
If entire net If part of net
consideration is consideration is
invested in specified invested in specified
asset (new asset) asset (new asset)

Entire LTCG would be Proportionate LTCG

exempt would be exempt

In case of transfer of new asset/conversion into money within 3

years of acquisition

Exempted LTCG deemed to be income chargeable to tax in the

year of transfer

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21.7 DETERMINATION OF TAX IN CERTAIN SPECIAL

CASES [CHAPTER XII]
Sections 111A, 112 and 112A have already been discussed in detail in Chapter 4: Capital Gains in
Module 1. The special provisions contained in other sections under Chapter XII are discussed hereunder -
(1) Special provisions for computing tax on income by way of royalty, fees for technical
service, interest etc. [Section 115A]
(i) Tax on dividend and interest in case of non-corporate non-residents and foreign
companies:
Where the total income of a foreign company or a Rate of
non-corporate non- resident includes any income by way of Tax
(1) - Dividends received from a unit in an IFSC, referred to in section 10%
80LA(1A)
- Dividend other than mentioned above 20%
(2) Interest received from the Government or an Indian concern on monies 20%
borrowed or debt incurred by the Government /Indian concern in foreign
currency, other than 3 and 4 mentioned below
(3) Interest received from an infrastructure debt fund referred to in section 10(47) 5%
(4) Interest referred to in section 194LC received from an Indian company
or business trust –
- in respect of monies borrowed by an Indian company or business
trust in foreign currency from sources outside India
• Under a loan agreement between 1.7.2012 and 30.6.2023 or
• by way of issue of long-term infrastructure bonds between
1.7.2012 and 30.9.2014 or
5%
• by way of issue of long-term bonds including long term
infrastructure bond between 1.10.2014 and 30.6.2023
as approved by the Central Government
- in respect of monies borrowed from sources outside India by way
of rupee denominated bond on or before 30.6.2023
- in respect of monies borrowed by it from a source outside India by
way of issue of any long-term bond or rupee denominated bond 4%
between 1.4.2020 and 30.6.2023, which is listed only on a
recognised stock exchange located in any IFSC
- in respect of monies borrowed by it from a source outside India by
way of issue of any long-term bond or rupee denominated bond on 9%
or after 1.7.2023, which is listed only on a recognised stock
exchange located in any IFSC

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to the extent to which such interest does not exceed the interest
calculated at the rate approved by the Central Government
(5) Distributed income referred to in section 194LBA(2), being interest
income of a business trust from a SPV, distributed by business trust to 5%
its non-resident unit holders
(6) Income received in respect of units purchased in foreign currency of a 20%
mutual fund specified under section 10(23D) or of the Unit Trust of India
(ii) Tax on royalty or fees for technical services in case of non-residents
Where the total income of a foreign company or a non- Applicable Rate of Tax
corporate non-resident includes any income by way of
royalty or fees for technical services (FTS) other than the
income referred to in section 44DA
(1) Received from the Government in pursuance of an 20% of such royalty or
agreement made by the non-resident/foreign company FTS. However, if DTAA
with the Government provides for a rate lower
(2) Received from the Indian concern in pursuance of an than 20%, then, the
agreement made by the non-resident/foreign company provisions of DTAA
with the Indian concern and the agreement is approved by would apply.
the Central Government or where it relates to industrial
policy of Government of India, the agreement in
accordance with that policy.

Important Points:
1. Special rate of tax is applicable on the above mentioned incomes. The remaining income of
the assessee will be chargeable to tax at normal rates applicable to assessee.

2. No deduction in respect of any expenditure or allowance shall be allowed to the assessee

under sections 28 to 44C and section 57 in computing the above income.
3. Deduction under Chapter VI-A is not available in respect of dividend and interest referred to in (i)
above. However, this condition would not be applicable to deduction allowed to a unit of an
International Financial Services Centre (IFSC) under section 80LA i.e. a unit of an IFSC can
claim deduction under section 80LA against dividend and interest referred to in (i) above.
4. It shall not be necessary for the assessee to furnish a return of income if the following
conditions are satisfied:
(a) The total income consists of only the interest or dividend income referred to in (i)
above or royalty or fees for technical services referred to in (ii) above; and
(b) Tax deductible at source has been deducted from such income and the rate of such
deduction is not less than the rate specified in (i) or the rate of 20% specified in (ii).

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 NON RESIDENT TAXATION 21.111

A Quick Recap
Tax treatment of Royalty & Fees for technical service received from
Government/Indian concern in pursuance of approved agreement

Is right, property or contract effectively connected with PE/Fixed Place of

Profession (FPP) in India?
Yes No

Royalty & FTS would be computed as per sec 44DA under Rate of tax@20% u/s
the head “PGBP” as per the provisions of the Income-tax 115A on gross
Act, 1961; and normal rates of tax would apply royalty/FTS would apply

No deduction of any
expenditure or
allowance is allowable
u/s 28 to 44C or u/s 57
Accounts & Audit Deduction of
expenditure
Deduction under Chap
VI-A permissible

Books of Books of No deduction No deduction Exemption

account to account to be in respect of in respect of from filing
be audited & Audit expenses not amount paid return of
maintained Report to be incurred (other than income u/s
as per furnished by wholly & reimbursement 139(1) if tax
section one month exclusively in of actual has been
44AA prior to the due relation to PE/ expenses) by deducted
date of return Fixed place of PE/Fixed @20%#
of income profession in place of
India profession to
HO & other
offices
# If tax has been deducted at a rate lower than 20% by availing the beneficial provisions of DTAA, then, no

exemption would be available from filing return of income.

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 21.112 INTERNATIONAL TAXATION

(2) Special provision for computing tax on income from units purchased in foreign
currency or capital gains arising from their transfer in case of offshore fund [Section
115AB]

Where the total income of an overseas financial organisation (Offshore Fund) includes the
following incomes namely-
(i) Income received in respect of units purchased in foreign currency or
(ii) by way of long-term capital gains arising from the transfer of units of a mutual fund
specified under section 10(23D) or units of UTI purchased in foreign currency,
then, the income tax payable shall be the aggregate of the following:
(a) At the rate of 10% on income in respect of units purchased in foreign currency
(b) At the rate of 12.5% of income by way of long-term capital gain
(c) the amount of income-tax with which the Offshore Fund would have been chargeable had
its total income been reduced by the amount of long-term capital gains and income received
referred to above.
Important Points:
(i) The benefit of indexation shall not be available in the computation of long- term capital
gains.
(ii) No deduction shall be allowed to the assessee under sections 28 to 44C or section 57(i)/(iii)
or under Chapter VI-A in computing the above income.

(iii) Where the gross total income of the Overseas Financial Organisation consists of other
incomes, then, the deduction under Chapter VI- A will be available in respect of other
incomes. The normal provisions of the Income-tax Act, 1961 will apply for computation of
other income.
(iv) “Overseas Financial Organisation’’ means any fund, institution, association or body,
whether incorporated or not, established under the laws of a country outside India, which
has entered into an arrangement for investment in India with any public sector bank or
public financial institution or a mutual fund specified under section 10(23D). Such
arrangement should be approved by the Securities and Exchange Board of India.

(v) It may be noted that short term capital gains on units of equity oriented fund are taxable
@20% under section 111A provided securities transaction tax has been paid on the sale of
such units.

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(vi) It may be noted that capital gain on transfer of unit of specified mutual fund (mutual fund
where not more than 35% of its total proceeds is invested in the equity shares of domestic
companies) is a short term capital gain [Section 50AA].

(3) Special provision for computing tax on income from bonds or Global Depository
Receipts purchased in foreign currency or capital gains arising from their transfer
[Section 115AC]

(i) Eligible assessee and special rate of tax: According to section 115AC(1), where the total
income of an assessee, being a non-resident includes:
(a) income by way of interest on bonds of an Indian company issued in accordance
with such scheme as the Central Government may notify or on bonds of a public
sector company sold by the Government, and purchased by him in foreign
currency; or
(b) income by way of dividends on Global Depository Receipts –
(1) issued in accordance with such scheme as the Central Government may
specify against the initial issue of shares of an Indian company and
purchased by him in foreign currency through an approved intermediary; or
(2) issued against the shares of a public sector company sold by the
Government and purchased by him in foreign currency through an approved
intermediary; or
(3) issue or re-issued in accordance with such scheme as the Central
Government may specify against the existing shares of an Indian company
purchased by him in foreign currency through an approved intermediary; or
(c) income by way of long-term capital gains arising from the transfer of above bonds
or GDRs,
then, the income tax payable shall be the aggregate of the following:
(I) At the rate of 10% in respect of interest or dividend referred to in (a) and (b) above
(II) At the rate of 12.5% in respect of long-term capital gain from the transfer of above
bonds or GDRs
(III) the amount of income-tax with which the non -resident would have been chargeable
had its total income been reduced by the amount of long-term capital gains and
income received referred to above.

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(ii) Deductions not allowable [Section 115AC(2)]: Where the gross total income of the
non-resident consists only the aforesaid interest or dividend income referred to in (a) and
(b) of (i) above, no deduction shall be allowed to him under section 28 to 44C or section
57(i) or 57(iii) or under Chapter VIA.
Deduction under Chapter VI-A is also not allowable against long term capital gains
arising from transfer of bonds or GDRs.
Where the gross total income of the non-resident consists of incomes other than interest,
dividend and long term capital gains referred to in (a), (b) and (c) of (i) above, then, the
deduction under Chapter VI-A will be available in respect of other incomes.
(iii) Non-availability of indexation benefit and computation of capital gains in foreign
currency [Section 115AC(3)]: The indexation benefit and benefit of computation of
capital gains in foreign currency, shall not be available for the computation of long-term
capital gains arising out of the transfer of long term asset, being bonds or GDRs.
(iv) Filing of Return of Income not required [Section 115AC(4)]: It shall not be necessary
for a non-resident to furnish under section 139(1), a return of income if his total income in
respect of which he is assessable under the Act during the previous year consisted only
of aforesaid interest or dividend income, and the tax deductible at source under the
provisions of Chapter XVII-B has been deducted from such income.
(v) Concessional tax treatment for GDR/Bonds acquired in course of Amalgamation
[Section 115AC(5)]: Where the assessee acquired GDR or bonds in an amalgamated or
resulting company by virtue of his holding GDR or bonds in the amalgamating or
demerged company, in accordance with the provisions of 115AC(1), the concessional tax
treatment would apply to such GDR or bonds.
(vi) Meaning of Global Depository Receipts: "Global Depository Receipts" means any
instrument in the form of a depository receipt or certificate (by whatever name called)
created by the Overseas Depository Bank outside India or in an IFSC and issued to
investors against the issue of —
(a) ordinary shares of issuing company, being a company listed on a recognized stock
exchange in India;

(b) foreign currency convertible bonds of issuing company; or

(c) ordinary shares of issuing company, being a company incorporated outside India, if
such depository receipt or certificate is listed and traded on any IFSC.

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(4) Special provisions for computing tax on income of Specified Fund or Foreign
Institutional Investors from securities or capital gains arising from their transfer
[Section 115AD]
(i) Special rate of tax: Where the total income of a Specified Fund or Foreign Institutional
Investor includes the income referred to in column (2), the same would be subject to tax at
the rate mentioned in column (3):
(1) (2) (3)
S. Income Rate of Tax
No.
(a) Income received in respect of securities other than 20% in case of FII,
income on units referred to in section 115AB i.e., units 10% in case of specified fund
of Mutual Fund specified u/s 10(23D) or UTI
(b) Income by way of Short term capital gains arising from 30%
the transfer of securities (other than Short term capital
gains u/s 111A)
(c) Income by way of Short term capital gains u/s 111A 20%
(d) Income by way of Long term capital gains arising 12.5%
from the transfer of securities (other than Long term
capital gains u/s 112A)
(e) Income by way of long term capital gains u/s 112A 12.5%
exceeding ` 1.25 lakh
(f) Other income of Specified Fund or FII At normal rates of tax

In case of specified fund, the provision of this section would apply only to the extent of
income that is attributable to units held by non-resident (not being a permanent
establishment of a non-resident in India) calculated in the prescribed manner.
The specified fund has to furnish an annual statement of income eligible for concessional
taxation electronically under digital signature on or before the due date u/s 139(1), which
is duly verified in the manner indicated therein.
The income of a specified fund attributable to the units held by a non-resident (not being
the permanent establishment of a non-resident in India), would not be eligible for tax
rates specified under section 115AD unless it furnishes the annual statement of income
eligible for concessional taxation on or before the said due date. [Notification no. 64/2022
dated 16.6.2022]
Where the specified fund is investment division of an offshore banking unit, the provisions of
this section would apply to the extent of income that is attributable to the investment division

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of offshore banking units [granted certificate of registration as a Category-I foreign portfolio

investor under the SEBI (Foreign Portfolio Investors) Regulations, 2019 made under the SEBI
Act, 1992, and fulfills the prescribed conditions, including maintenance of separate accounts
for its investment division] calculated in the prescribed manner.
The eligible investment division has to furnish an annual statement of income, eligible for
taxation under section 115AD(1B) in the prescribed form electronically under digital
signature on or before the due date specified u/s 139(1).
The income of an eligible investment division would not be eligible for tax rates specified
under section 115AD unless the eligible investment division furnishes an annual
statement of income eligible for taxation under section 115AD(1B) on or before the said
due date [Notification no. 64/2022 dated 16.6.2022].
(ii) Surcharge:
Under normal provisions of the Act
Surcharge applicable on tax on total income of individuals/AoPs 3/BoIs/ Artificial Juridical
Persons (having any income under section 115AD and such person has shifted out of the
default tax regime and opted to pay tax under the normal provisions of the Act) for payment
of advance tax for A.Y.2026-27 –
Rate of Example
Particulars surcharge Components of total Applicable rate of
on income- income surcharge
tax
(i) Where the total 10% Example:
income > ` 50 • Capital gains on Surcharge would
lakhs but ≤ ` 1 securities referred to be levied@10% on
crore in section 115AD(1)(b) income-tax
` 60 lakhs; and computed on total
• Other income ` 35 income of ` 95
lakhs; lakhs.
(ii) Where total 15% Example:
income > ` 1 • Capital gains on Surcharge would
crore but ≤ securities referred to be levied@15% on
` 2 crore in section 115AD(1)(b) income-tax
` 1.20 crore; and computed on total
income of

3 AoPs(other than AoP consisting of only companies as its members)

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 NON RESIDENT TAXATION 21.117

• Other income ` 60 ` 1.80 crore.

lakhs;
(iii) Where total 25% Example:
income • Dividend ` 1.05 crore Surcharge would
[excluding • Capital gains on be levied:
dividend and securities referred to @15% on income-
STCG/LTCG on in section 115AD(1)(b) tax leviable on
securities ` 1.05 crore; and dividend of ` 1.05
referred to in • Other income ` 2.1 crore and capital
section crores; gains of ` 1.05
115AD(1)(b)] > crore refered to in
` 2 crore but ≤ section 115AD;
` 5 crore and
Rate of Not @25% on income-
surcharge on exceeding tax computed on
the income-tax 15% other income of
payable on ` 2.1 crores
dividend and the included in total
portion of income
income
chargeable to
tax u/s
115AD(1)(b)
(iv) Where total 37% Example:
income • Dividend ` 1.05 crore Surcharge would
[excluding • Capital gains on be levied -
dividend and securities referred to @15% on income-
STCG/ LTCG on in section 115AD(1)(b) tax leviable on
securities ` 1.70 crore; and dividend of ` 1.05
referred to in • Other income ` 6 crore and capital
section crore gains of ` 1.70 crore
115AD(1)(b)] > referred to in section
` 5 crore 115AD; and
Rate of Not @37% on income-
surcharge on exceeding tax computed on
the income-tax 15% other income of
payable on ` 6 crore included
dividend and in total income.
the portion of
income
chargeable to
tax u/s
115AD(1)(b)

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(v) Where total 15% Example:

income
• Dividend ` 1.05 crore Surcharge would
[including
• Capital gains on be levied@15% on
dividend and
securities referred to tax on total income
STCG/ LTCG on
in section 115AD(1)(b) of
securities
` 3.75 crore.
referred to in ` 1.10 crore; and
115AD(1)(b)] > • Other income
` 2 crore in ` 1.60 crore;
cases not
covered under
(iii) and (iv)
above

Surcharge and health and education cess would not be applicable to specified fund in
respect of income received from securities referred to in section 115AD(1)(a).
Note – In case of default tax regime, the maximum rate of surcharge would be 25%
(instead of 37%).
In case of an AoP consisting of only companies as its members, the rate of surcharge
would be 10%, where the total income > ` 50 lakhs but ≤ ` 1 crore and 15%, where the
total income > ` 1 crore.
(iii) No deduction is allowed [Section 115AD(2)]: Where the gross total income of the
specified fund or Foreign Institutional Investor comprises only of the aforesaid interest or
dividend income from securities, no deduction shall be allowed to it under sections 28 to
44C or section 57(i) or 57(iii) or under Chapter VI-A.
Deduction under Chapter VI-A is also not allowable in case of short term capital gain or long
term capital gain arising from transfer of securities.
Where the gross total income of the specified fund or Foreign Institutional Investor consists
of incomes other than income referred to in (a) to (e) of table in (i) above, then, the
deduction under Chapter VI-A will be available in respect of other incomes. However, the
provisions of AMT under section 115JEE would not apply to specified fund.
(iv) First and second provisos to section 48 shall not apply [Section 115AD(3)]:The benefit
of computation of capital gains in foreign currency and the benefit of indexation would not
be available for the computation of capital gains arising on transfer of securities.

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(v) Meaning of certain terms

S. Term Meaning
No.
1 Investment An investment division of a banking unit of a non-resident located
division of in an IFSC, as referred to in section 80LA(1A) and which has
offshore commenced its operations on or before 31.3.2030
banking unit
2 Specified (i) A fund established or incorporated in India in the form of a
fund trust or a company or a LLP or a body corporate,–
(I) (a) which has been granted a certificate of registration
as a Category III Alternative Investment Fund and
is regulated under the SEBI (Alternative Investment
Fund) Regulations, 2012, made under the SEBI
Act, 1992 or IFSC Authority Act, 2019;
(b) which has been granted a certificate as a retail
scheme or an Exchange Traded Fund and satisfies
the conditions laid down for such schemes or funds
under the IFSC Authority (Fund Management)
Regulations, 2022, made under the IFSC Authority
Act, 2019;
(II) which is located in any IFSC and
(III) of which all the units are held by non-residents other
than units held by a sponsor or manager;
However, this condition would not apply where any unit
holder or holders, being non-resident during the
previous year when such unit or units were issued,
becomes resident under section 6(1) or (1A) in any
previous year subsequent to that year, if the aggregate
value and number of the units held by such resident
unit holder or holders do not exceed 5% of the total
units issued and fulfill such other conditions as may be
prescribed.
(ii) investment division of an offshore banking unit, which has
been
(a) granted a certificate of registration as a Category-I
foreign portfolio investor under the SEBI (Foreign
Portfolio Investors) Regulations, 2019 made under the
SEBI Act, 1992 and which has commenced its
operations on or before 31.3.2030; and
(b) fulfils such conditions including maintenance of
separate accounts for its investment division, as may
be prescribed.

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(5) Special provision for computing tax on non-resident sportsmen or sports

associations [Section 115BBA]

(i) Eligible assessee and special rate of tax: Where the total income of an assessee,
referred to in column (2) includes income referred to in column (3) of the table below, such
income would be chargeable to tax@20%.

Assessee Income
(1) (2) (3)
(a) A sportsman Any income received or receivable by way of—
(including an (i) participation in India in any game (other than a game the
athlete), who is winnings wherefrom are taxable under section 115BB,
not a citizen of being winning from crossword puzzles, races including
India and is a horse races, card games and other games of any sort of
non-resident gambling or betting) or sport; or
(ii) advertisement; or
(iii) contribution of articles relating to any game or sport in
India in newspapers, magazines or journals;
(b) A non-resident Any amount guaranteed to be paid or payable to such
sports association or institution in relation to any game (other than a
association or game the winnings wherefrom are taxable under section
institution 115BB) or sport played in India
(c) An entertainer Any income received or receivable from his performance in
who is not a India
citizen of India
and is a non-
resident

(ii) Deduction of expenditure not permissible: No deduction in respect of any expenditure

or allowance shall be allowed under any provision of this Act in computing the income
referred to in (a) or (b) or (c) in the table given above.
(iii) Filing of return of income not required: The assessee is not required to furnish under
section 139(1) a return of his income if—
(a) his total income in respect of which he is assessable under this Act during the
previous year consisted only of income referred to in (a) or (b) or (c) above; and
(b) the tax deductible at source under the provisions of Chapter XVII-B has been
deducted from such income.

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ILLUSTRATION 13
During the financial year 2025-26, Nadal, a tennis professional and a Spanish citizen participated
in India in a Tennis Tournament and won prize money of ` 15 lakhs. He contributed articles on the
tournament in a local newspaper for which amount of ` 1 lakh is payable to him. He also earned
` 5 lakhs from a Soft Drink company for appearance in a T.V. advertisement. Although his
expenses in India were met by the sponsors, he had to incur ` 3 lakhs towards his travel costs to
India. He was a non-resident for tax purposes in India.
What would be his tax liability in India for A.Y. 2026-27? Is he required to file his return of income?
SOLUTION
Under section 115BBA, all the three items of receipts in India viz. prize money of ` 15 lakhs,
amount received from newspaper of ` 1 lakh and amount received towards TV advertisement of
` 5 lakhs - are chargeable to tax. No expenditure is allowable as deduction against such receipts.
The rate of tax chargeable under section 115BBA is 20%, plus health and education cess @4%.
The total tax liability works out to ` 4,36,800 being 20.8% of ` 21 lakhs. Thus, Nadal will be liable
to tax on the income earned in India
He is not required to file his return of income if -

(a) his total income during the previous year consists only of income arising under section
115BBA; and
(b) the tax deductible at source under the provisions of Chapter XVII-B have been deducted
from such incomes.

21.8 SPECIAL PROVISIONS RELATING TO CONVERSION

OF INDIAN BRANCH OF A FOREIGN BANK INTO A
SUBSIDIARY COMPANY [CHAPTER XII-BB]
(1) Conversion of an Indian branch of foreign company into subsidiary Indian company
[Section 115JG(1)]

(i) The provisions of this section apply to a foreign company engaged in banking business in
India through its branch situated in India, which is converted into an Indian subsidiary
company in accordance with the scheme framed by RBI.

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(ii) If the conditions notified by the Central Government in this behalf are satisfied, then
capital gains arising from such conversion would not be chargeable to tax in the
assessment year relevant to the previous year in which such conversion takes place.
(iii) Also, the provisions of the Act relating to computation of income of foreign company and
Indian subsidiary company would apply with such exceptions, modifications and
adaptations as specified in the notification.
(iv) Further, the benefit of set-off of unabsorbed depreciation, set-off or carry forward and set-
off of losses, tax credit in respect of tax paid on deemed income relating to certain
companies available under the Act shall apply with such exceptions, modifications and
adaptations as specified in the notification.
Accordingly, the Central Government has, vide Notification no. 85/2018, specified the conditions to
be fulfilled –
(1) For Capital Gains exemption:
Where a foreign company is engaged in the business of banking through its Indian branch and
converts such Indian branch into its Indian subsidiary company in accordance with the scheme
framed by RBI, the capital gains arising from such conversion would not be chargeable to tax, if -
(a) the Indian branch amalgamates with the Indian subsidiary company in accordance with
the scheme of amalgamation approved by the shareholders of the foreign company and
the Indian subsidiary company and sanctioned by the RBI 4
(b) all the assets and liabilities of the Indian branch immediately before conversion would
become the assets and liabilities of the Indian subsidiary company;
(c) the asset and liabilities of the Indian branch are transferred to the Indian subsidiary
company at values appearing in the books of account of the Indian branch immediately
before its conversion.
Note - Any change in the value of assets consequent to their revaluation would not be
considered while determining the value of the assets.

(d) the foreign bank or its nominee shall hold the whole of the share capital of the Indian
subsidiary company during the period beginning from the date of conversion and ending
on the last day of the previous year in which the conversion took place and continue to

4under paragraph 20(h) of the Framework for setting up of wholly owned subsidiaries by foreign banks in
India issued by the Reserve Bank of India vide Press release number 2013-2014/936 dated
6th November, 2013

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hold the shares of Indian subsidiary company carrying not less than 51% of the voting
power for a period of five years immediately succeeding the said previous year;

(e) the foreign company does not receive any consideration or benefit, directly or indirectly,
in any form or manner, other than by way of allotment of shares in the Indian subsidiary
company.

(2) Application of the provisions of the Income-tax Act, 1961 with modifications/
exceptions
The provisions of the Income-tax Act, 1961 relating to unabsorbed depreciation, set off or carry
forward and set off of losses, tax credit in respect of tax paid on deemed income relating to certain
companies and the computation of income in case of foreign company and Indian subsidiary
company shall apply with following modifications, exceptions and adaptation –
Purpose Modification/exception/adaptation
(a) Allowance of The aggregate deduction, in respect of depreciation on buildings,
depreciation under machinery, plant or furniture, being tangible assets, or know-
section 32 how, patents, copyrights, trademarks, licenses, franchises or any
other business or commercial rights of similar nature, being
intangible assets, allowable to the Indian branch and the Indian
subsidiary company shall not exceed in any previous year the
deduction calculated at the prescribed rates as if the conversion
had not taken place.
Such deduction would be apportioned between the Indian branch
and the Indian subsidiary company in the ratio of the number of
days for which the assets were used by them;
(b) Set-off and c/f of loss The accumulated loss and the unabsorbed depreciation of the
and depreciation Indian branch would be deemed to be the loss or allowance for
depreciation of the Indian subsidiary company for the previous
year in which conversion was effected; and provisions of the
Income-tax Act, 1961, relating to set off and carry forward of loss
and allowance for depreciation shall apply accordingly.
(c) Determination of The actual cost of the block of assets in the case of the Indian
actual cost u/s 43(1) subsidiary company shall be the written down value of the block
of assets as in the case of the Indian branch on the date of its
conversion into the Indian subsidiary company
The actual cost of any capital asset on which deduction has
been allowed or is allowable under section 35AD, shall be
treated as 'nil' in the case of the Indian subsidiary company if the
capital asset became the property of the Indian subsidiary
company as a result of conversion of the Indian branch.

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(d) Cost of acquisition of Where the capital asset other than those referred to in (c) above
other capital assets became the property of the Indian subsidiary company as a
result of conversion of the Indian branch, the cost of acquisition
of the asset for the purposes of computation of capital gains
shall be deemed to be the cost for which the Indian branch
acquired it or, as the case may be, the cost for which previous
owner has acquired it.
(e) Tax credit The tax credit of the Indian branch shall be deemed to be the tax
credit of the Indian subsidiary company for the purpose of the
previous year in which conversion was effected; and the
provisions of section 115JAA of the Income-tax Act, 1961 shall
apply accordingly.
(f) Amortisation of VRS The provisions of 35DDA of the Act shall be, as far as may be,
Expenditure apply to the Indian subsidiary company, as they would have
applied to the Indian branch, if the conversion had not taken
place
(g) Deemed credit The credit balance in the provision for bad and doubtful debts
balance in provision account made under section 36(1)(viia) of the Indian branch on
for bad and doubtful the date of conversion shall be deemed to be the credit balance
debts of the Indian subsidiary company and the provisions of section
36 of the Income-tax Act, 1961, shall apply accordingly
(h) Non-applicability of The provisions of section 56(2)(x) shall not apply to the
section 56(2)(x) transaction of receipt of shares in the Indian subsidiary company
by the foreign company or its nominee in consequence of the
conversion of the Indian branch into the Indian subsidiary
company.

Meaning of certain terms:

Term Meaning
Accumulated loss So much of the loss of the Indian branch before its conversion into
Indian subsidiary company under the head “Profits and gains of
business or profession” (not being a loss sustained in a speculation
business) which such Indian branch would have been entitled to
carry forward and set off under the provisions of section 72, if the
conversion had not taken place.
Unabsorbed depreciation So much of the allowance for depreciation of the Indian branch
before its conversion into Indian subsidiary company, which
remains to be allowed and which would have been allowed to the
Indian branch under the provisions of the Act, if the conversion had
not taken place.
Previous owner In relation to any capital asset owned by the Indian subsidiary
company means the last previous owner of the capital asset who

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acquired it by a mode of acquisition other than those referred in

section 49(1)(i)/(ii)/(iii)/(iv) or section 115JG(1).
Tax credit So much of the tax credit of the Indian branch before conversion
into Indian subsidiary company which such Indian branch would
have been entitled to carry forward and set off under the provisions
of section 115JAA of the Act, if the conversion had not taken place.
Date of conversion The date, which the Reserve Bank of India appoints for the vesting
of undertaking of the Indian branch in Indian subsidiary company 5

(2) Consequences of failure to comply with the specified conditions [Section 115JG(2)]

If the conditions specified in the scheme of RBI or notification issued by the Central Government
are not complied with, then, all the provisions of the Act would apply to the foreign company and
Indian subsidiary company without any benefit, exemption or relief under this section.
(3) Consequences of subsequent failure to comply with the conditions [Section
115JG(3)]

(i) If the benefit, exemption or relief has been granted to the foreign company or Indian
subsidiary company in any previous year and thereafter, there is a failure to comply with
any of the conditions specified in the scheme or notification, then, such benefit, exemption
or relief shall be deemed to have been wrongly allowed.

(ii) In such a case, the Assessing Officer is empowered to re-compute the total income of the
assessee for the said previous year and make the necessary amendment. This power is
notwithstanding anything contained in the Income-tax Act, 1961.

(iii) The provisions of rectification under section 154, would, accordingly, apply and the four
year period within which such rectification should be made has to be reckoned from the end
of the previous year in which the failure to comply with such conditions has taken place.

(iv) Every notification under issued under this section shall be laid before each House of
Parliament.

5under paragraph 20(i) of the Framework for setting up of wholly owned subsidiaries by foreign banks in
India issued by the Reserve Bank of India vide press release number 2013-2014/936 dated 6th day of
November, 2013.

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21.9 WITHHOLDING TAX PROVISIONS FOR NON-

RESIDENTS

(1) Salary payable in foreign currency [Section 192]

By virtue of section 9(1)(ii), salary is deemed to accrue or arise in India, if services are rendered in
India. Therefore, if a non-resident renders services in India, the salary income would be
chargeable to tax in India and the person responsible for paying the salary income i.e., the
employer, has to deduct withholding tax in accordance with the provisions of section 192, at the
rates in force for the financial year in which the payment is made where the employee exercises
option to opt out of new tax regime under section 115BAC.
(i) Tax on non-monetary perquisites paid by employer [Section 192(1A)] – In case of
non-monetary perquisite, employer can opt to pay tax on whole or part of such income
without making any deduction therefrom at the time tax was otherwise deductible.

Such tax will have to be calculated at the average rate applicable to aggregate salary
income of the employee and payment of tax will have to be made every month along with
tax deducted at source on monetary payment of salary, allowances etc. [Section 192(1)].
(ii) Meaning of Average rate of income-tax – Average rate of income-tax means the rate
arrived at by dividing the amount of income-tax calculated on the total income, by such
total income.
(iii) Deferment of TDS on perquisite of specified security or sweat equity shares
provided by an eligible start-up [Section 192(1C)] - An employer, being an eligible
start up referred to in section 80-IAC, responsible for paying any income to the assessee
by way of perquisite being any specified security or sweat equity shares allotted or
transferred free of cost or at concessional rate to the assessee, has to deduct or pay, as
the case may be, tax on the value of such perquisite provided to its employee within 14
days from the earliest of the following dates –
- after the expiry of 48 months from the end of the relevant assessment year; or
- from the date of the sale of such specified security or sweat equity share by the
assessee; or
- from the date of the assessee ceasing to be the employee of the employer who
allotted such shares

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Such tax has to deducted or paid for the financial year in which said specified security or
sweat equity share is allotted or transferred.
(iv) Calculation of TDS where salary is payable in foreign currency [Section 192(6)] -
Section 192(6) deals with the provisions of withholding tax in case of salary payable in
foreign currency. In case, where salary is payable in foreign currency, the amount of tax
deducted is to be calculated after converting the salary payable into Indian currency at
the telegraphic transfer buying rate as adopted by State Bank of India on the last day of
the month immediately preceding the month in which the salary is due, or is paid in
advance or in arrears [Rule 26 read with Rule 115].
Students may note that the Rule 26 and Rule 115 have been given as Annexure – 1 at the
end of this module.

(2) Payments to non-resident sportsmen or sports association [Section 194E]

(i) Applicability
This section provides for deduction of tax at source in respect of any income referred to in
section 115BBA payable to a non-resident sportsman (including an athlete) or an
entertainer who is not a citizen of India or a non-resident sports association or institution.
(ii) Rate of TDS
Deduction of tax at source @20% (plus surcharge, if applicable, and health and
education cess@4%) should be made by the person responsible for making the payment.
Health and education cess @4% on TDS rate of 20% would be leviable, since payment is
made to a non-resident.
(iii) Time of deduction of tax
Such tax deduction should be at the time of credit of such income to the account of the
payee or at the time of payment thereof in cash or by issue of a cheque or draft or by any
other mode, whichever is earlier.
(iv) Income referred to in section 115BBA
(i) income received or receivable by a non-resident sportsman (including an athlete),
who is not a citizen of India, by way of-

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(a) participation in any game or sport in India (However, games like crossword
puzzles, horse races etc. taxable under section 115BB are not included
herein); or
(b) advertisement; or
(c) contribution of articles relating to any game or sport in India in newspapers,
magazines or journals.
(ii) Guarantee amount paid or payable to a non-resident sports association or
institution in relation to any game or sport played in India. However, games like
crossword puzzles, horse races etc. taxable under section 115BB are not included
herein.
(iii) income received or receivable by a non-resident entertainer (who is not a citizen of
India) from his performance in India.

Note: The issue as to whether the non-resident match referees and umpires in the games played
in India fall within the meaning of “sportsmen” to attract taxability under the provisions of section
115BBA, and consequently attract the TDS provisions under section 194E in the hands of the
payer was taken up by the Calcutta High Court in Indcomv. CIT (TDS) (2011) 335 ITR 485.
In order to attract the provisions of the section 194E, the person should be a non-resident
sportsperson or non-resident sports association or institution whose income is taxable as per the
provisions of section 115BBA.
Umpires and match referees can be described as professionals or technical persons who render
professional or technical services, but they cannot be said to be either non-resident sportsmen
(including an athlete) or non-resident sports association or institution so as to attract the provisions
of section 115BBA and consequently, the provisions of tax deduction at source under section 194E
are can not be attracted.

The Calcutta High Court held that although the payments made to non-resident umpires and the
match referees are “income” which has accrued and arisen in India, the same are not taxable
under the provisions of section 115BBA and thus, the assessee is not liable to deduct tax under
section 194E.
It may be noted that since income has accrued and arisen in India to the non-resident umpires and
match referees, the TDS provisions under section 195 would be attracted and tax would be
deductible at the rates in force.

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Board of Control for Cricket in Sri Lanka v. DIT (International Taxation) & Pilcom v. CIT
(2020) 425 ITR 312 (SC)
The International Cricket Council (ICC), having its headquarters in London, is the organisation
which makes and alters the rules of the game of cricket, sets the different levels and minimum
standards at which the game is to be played in each country to get its recognition, the different
formats of the game, e. g. test cricket, first class cricket, limited overs competition and so on. It
has affiliates from similar organisations in countries, all over the world. It controls, supervises and
regulates the game of cricket in every respect.
At a special meeting of the ICC held in London in the year 1993, India, Pakistan and Sri Lanka
were chosen to co-host the world cup. A joint management committee of these three countries,
[(Pak-Indo-Lanka) joint management committee (PILCOM)] was formed to conduct this world cup
cricket tournament. Bank accounts were opened by PILCOM in London to be operated jointly by
the India and Pakistan Cricket Boards. In this account were deposited moneys from sponsorships,
TV rights, etc. The Board of Control for Cricket in India (BCCI) appointed its own committee,
INDCOM, for discharge of its functions. INDCOM had its bank account at Calcutta. From the bank
account of PILCOM at London certain amounts were transferred to the bank accounts of the host
countries for the purpose of payment of fees to umpires and referees, defraying administrative
expenses and payment of prize money. PILCOM paid £ 43,50,000 which included £ 19,55,000 as
guarantee money to eleven cricket associations.
The payments of £ 8,85,000 representing guarantee money paid to the Boards of Australia,
England, New Zealand, Sri Lanka and Kenya with whom Double Taxation Avoidance Agreements
exist, and of £ 7,10,000 representing guarantee money paid to the Boards of Pakistan, West
Indies, Zimbabwe and Holland were in the nature of guarantee money paid to non-resident sports
associations. The payments were not made by the assessee in India but through its bank accounts
at London or elsewhere. The non-resident sports associations had participated in the event, where
cricket teams of these associations had played various matches in the country. Though the
payments were described as guarantee money, they were intricately connected with the event
where various cricket teams were scheduled to play and did participate in the event. The source of
income was in the playing of the matches in India.
The mandate under section 115BBA(1)(b) is that if the total income of a non-resident sports
association includes the amount guaranteed to be paid or payable to it in relation to any game or
sports played in India, the amount of Income-tax calculated in terms of the section shall become
payable. The expression “in relation to” emphasises the connection between the game or sport
played in India on the one hand and the guarantee money paid or payable to the non-resident

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sports association on the other. Once the connection is established, the liability under the
provision must arise. To the extent the payments represented amounts which could not be subject
matter of charge under the provisions of the Act, appropriate benefit had already been extended to
the assessee.
The payments made to the non-resident sports associations represented their income which
accrued or arose or was deemed to have accrued or arisen in India. Consequently, the assessee
was liable to deduct tax at source in terms of section 194E.

ILLUSTRATION 14
Smith, a foreign national and a cricketer came to India as a member of Australian cricket team in
the year ended 31st March, 2026. He earned ` 5 lakhs for participation in matches in India. He also
earned ` 1 lakh for an advertisement of a product on TV. He contributed articles in a newspaper
for which he earned ` 10,000. When he stayed in India, he also won a prize of
` 20,000 from horse racing in Mumbai. He has no other income in India during the year.
(i) Compute tax liability of Smith for Assessment Year 2026-27.
(ii) Are the income specified above subject to deduction of tax at source?
(iii) Is he liable to file his return of income for Assessment Year 2026-27?
(iv) What would have been his tax liability, had he been a match referee instead of a cricketer
and pays tax under the default tax regime under section 115BAC?
SOLUTION
(i) Computation of tax liability of Smith for the A.Y.2026-27

Particulars ` `
Income taxable under section 115BBA
Income from participation in matches in India 5,00,000
Advertisement of product on TV 1,00,000
Contribution of articles in newspaper 10,000
Income taxable under section 115BB
Income from horse races 20,000
Total income 6,30,000
Tax@ 20% under section 115BBA on ` 6,10,000 1,22,000

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Tax@ 30% under section 115BB on income of ` 20,000

from horse races 6,000
1,28,000
Add: Health and Education cess@4% 5,120
Total tax liability of Smith for the A.Y.2026-27 1,33,120

(ii) Yes, the above income is subject to tax deduction at source.

Income referred to in section 115BBA (i.e., ` 6,10,000, in this case) is subject to tax
deduction at source@ 20% under section 194E.
Income referred to in section 115BB (i.e.,` 20,000, in this case) is subject to tax
deduction at source@30% under section 194BB.
Since Smith is a non-resident, the amount of tax to be deducted calculated at the
prescribed rates mentioned above, would be increased by health and education
cess@4%.
(iii) Section 115BBA provides that if the total income of the non-resident sportsman comprises
of only income referred to in that section and tax deductible at source has been fully
deducted, it shall not be necessary for him to file his return of income. However, in this
case, Mr. Smith has income from horse races as well. Therefore, he cannot avail the benefit
of exemption from filing of return of income as contained in section 115BBA. Hence, he
would be liable to file his return of income for A.Y.2026-27.
(iv) The Calcutta High Court in Indcom v. CIT (TDS)(2011) 335 ITR 485 has held that ‘match
referee’ would not fall within the meaning of “sportsmen” to attract the provisions of section
[Link], although the payments made to non-resident ‘match referee’ are “income”
which has accrued and arisen in India, the same are not taxable under the provisions of
section 115BBA. They are subject to the normal rates of tax under section 115BAC.
Particulars `
Tax@30% under section 115BB on winnings of ` 20,000 from horse races 6,000
Tax on ` 6,10,000 at normal rate of tax
Upto ` 4,00,000 Nil
4,00,000 – 6,10,000 @5% 10,500 10,500
16,500
Add: Health and Education cess@4% 660
Total tax liability 17,160

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(3) Income by way of interest from Infrastructure Debt Fund [Section 194LB]

(i) Special rate of tax on interest received by non-residents from notified infrastructure
debt funds
Interest income received by a non-corporate non-resident or a foreign company from
notified infrastructure debt funds set up in accordance with the prescribed guidelines would
be subject to tax at a concessional rate of 5% under section 115A on the gross amount of
such interest income as compared to tax @20% on other interest income of non-resident.
The concessional rate of tax is expected to give a fillip to infrastructure and encourage
inflow of long-term foreign funds to the infrastructure sector.
(ii) Rate of TDS
Accordingly, tax would be deductible @5% plus surcharge, if applicable, plus health and
education cess @4% on interest paid/credited by such fund to a non-resident/foreign
company.
(iii) Time of deduction
The person responsible for making the payment shall, at the time of credit of such
income to the account of the payee or at the time of payment thereof in cash or by
issue of a cheque or draft or by any other mode, whichever is earlier, deduct income-tax.
(4) Income by way of interest from an Indian company or business trust [Section 194LC]
(i) Concessional rate of tax on interest on foreign currency borrowings by an Indian
company or business trust
Interest paid by an Indian company or business trust to a foreign company or a non-
corporate non-resident would be subject to tax at a concessional rate on gross interest (as
against the rate of 20% of gross interest applicable in respect of other interest received by a
non-corporate non-resident or foreign company from Government or an Indian concern on
money borrowed or debt incurred by it in foreign currency)

Tax is deductible at concessional rate of 5% on the following interest paid by an Indian

company or business trust to a foreign company or a non-corporate non-resident -
(a) in respect of borrowing made in foreign currency from sources outside India
- under a loan agreement at any time between 1.7.2012 and 30.6.2023 or

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- by way of issue of long-term infrastructure bonds during the period between

1.7.2012 and 30.9.2014 or

- by way of issue of any long-term bond, including long-term infrastructure bond

during the period between 1.10.2014 and 30.6.2023
as approved by the Central Government in this behalf.

(b) in respect of monies borrowed by it from a source outside India by way of issue of
rupee denominated bond on or before 30.6.2023.
Tax is deductible at concessional rate of 4% in respect of monies borrowed by an Indian
company or business trust from a source outside India by way of issue of any long-term
bond or rupee denominated bond between 1.4.2020 and 30.6.2023, which is listed only on
a recognised stock exchange located in any IFSC.
Tax is deductible at concessional rate of 9% in respect of monies borrowed by an Indian
company or business trust from a source outside India by way of issuance of any long-term
bond or rupee denominated bond on or after 1.7.2023, which is listed only on a recognised
stock exchange located in any IFSC.
The interest to the extent the same does not exceed the interest calculated at the rate
approved by the Central Government, taking into consideration the terms of the loan or the
bond and its repayment, will be subject to tax at a concessional rate of 5%, 4% or 9%, as
the case may be, plus surcharge, wherever applicable, plus health and education cess
@4%.

Note - Interest payable by an Indian company or a business trust to a non-resident,

including a foreign company, in respect of rupee denominated bond issued outside India
during the period from 17.9.2018 to 31.3.2019 shall be exempt from tax, and
consequently, no tax shall be deducted on the payment of interest in respect of the said
bond under section 194LC.

(ii) Non-applicability of higher rate of TDS under section 206AA for non-furnishing of
PAN
Section 206AA provides that any person whose receipts are subject to deduction of tax at
source i.e., the deductee, shall mandatorily furnish his PAN to the deductor failing which
the deductor has to deduct tax at source at higher of the following rates –
(i) the rate prescribed in the Act;

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(ii) at the rate in force i.e., the rate mentioned in the Finance Act; or
(iii) at the rate of 20%

Levy of higher rate of TDS under section 206AA in the absence of PAN would not be
attracted in respect of payment of interest on long-term bonds, as referred to in section
194LC, to a non-corporate non-resident or to a foreign company and other payment
subject to prescribed conditions.
For the purpose of reducing the compliance burden, Rule 37BC provides for relaxation to
a non-corporate non-resident or a foreign company not having PAN in respect of payment
in the nature of interest, royalty, fees for technical services, dividends and payments on
transfer of any capital asset, subject to the deductee furnishing the following details and
documents to the deductor, namely:-

a. name, e-mail id, contact number;

b. address in the country or specified territory outside India of which the deductee is
a resident;

c. a certificate of his being resident in any country or specified territory outside India
from the Government of that country or specified territory if the law of that country
or specified territory provides for issuance of such certificate;

d. Tax Identification Number of the deductee in the country or specified territory of his
residence and in case no such number is available, then a unique number on the
basis of which the deductee is identified by the Government of that country or the
specified territory of which he claims to be a resident.

(5) Other sums (payable to non-residents) [Section 195]

(i) Applicability
Any person responsible for paying interest (other than interest referred to in section
194LB or section 194LC) or any other sum chargeable to tax (other than salaries) to a
non-corporate non-resident or to a foreign company is liable to deduct tax at source at the
rates prescribed by the relevant Finance Act. Such persons are also required to furnish
the information relating to payment of any sum in such form and manner as may be
prescribed by the CBDT.
Payee to be a non-resident - In order to subject an item of income to deduction of tax
under this section the payee must be a non-corporate non-resident or a foreign company.

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Payer may be a resident or non-resident - Under section 195(1), the obligation to

deduct tax at source from interest and other payments to a non-resident, which are
chargeable to tax in India, is on “any person responsible for paying to a non-resident or to
a foreign company”.
The words “any person” used in section 195(1) is intended to include both residents and
non-residents. Therefore, a non-resident person is also required to deduct tax at source
before making payment to another non-resident, if the payment represents income of the
payee non-resident, chargeable to tax in India. Therefore, if the income of the payee non-
resident is chargeable to tax, then tax has to be deducted at source, whether the payment
is made by a resident or a non-resident.
Explanation 2 clarifies that the obligation to comply with section 195(1) and to make
deduction thereunder applies and shall be deemed to have always applied and extends
and shall be deemed to have always extended to all persons, resident or non-resident,
whether or not the non-resident has:-
(a) a residence or place of business or business connection in India; or
(b) any other presence in any manner whatsoever in India.
(ii) Time of deduction
The tax is to be deducted at source at the time of credit of such income to the account of
the payee or at the time of payment thereof in cash or by the issue of a cheque or draft or
by any other mode, whichever is earlier.
Where any interest or other sum as aforesaid is credited to any account, whether called
“Interest payable account” or “Suspense account” or by any other name, in the books of
account of the person liable to pay such income, such crediting shall be deemed to be
credit of such income to the account of the payee.
However, in the case of interest payable by the Government or a public sector bank
within the meaning of section 10(23D) or a public financial institution within the meaning
of section 10(23D), deduction of tax shall be made only at the time of payment thereof in
cash or by the issue of a cheque or draft or by any other mode.

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(iii) Payments subject to tax deduction

The statutory obligation imposed under this section would apply for the purpose of
deduction of tax at source from any sum being income assessable to tax (other than
salary income) in the hands of the non-resident non-corporate/foreign company.
Payment to a non-resident by way of royalties and payments for technical services
rendered in India are common examples of sums chargeable under the said provisions of
the Act to which the liability for deduction of tax at source would apply.
(iv) Certificate of non-deduction of tax at source
(a) Under section 195(3), any person entitled to receive any interest or other sum on
which income-tax has to be deducted under section 195(1) may make an
application in the prescribed form to the Assessing Officer for grant of certificate
authorizing him to receive such interest or other sum without deduction of tax
thereunder.
(b) Where any such certificate is granted, every person responsible for paying such
interest or other sum to the person to whom certificate is granted make payment of
such interest or other sum without deduction of tax at source under section 195(1),
so long as the certificate in force.

(c) Such certificate shall remain in force till the expiry of the period specified therein.
However, if it is cancelled by the Assessing Officer before the expiry of such
period, the certificate shall remain in force till such cancellation.
(d) The CBDT is empowered to make rules specifying the cases in which, and the
circumstances under which, an application may be made for the grant of certificate.
While doing so, it should take into account the convenience of the assessees and
the interests of the revenue.
(e) Such Rules would provide for the conditions subject to which such certificate may
be granted and any other matter connected therewith.

(v) Person responsible for paying any sum to non-resident to furnish prescribed
information
Section 195(6) provides that the person responsible for paying any sum, whether or not
chargeable to tax under the provisions of the Act, to a non-corporate non-resident or to a

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foreign company, shall be required to furnish the information relating to payment of such
sum in the prescribed form and prescribed manner.

(vi) Specified class or classes of persons, making payment to the non-resident, to

mandatorily make application to Assessing Officer to determine the appropriate
proportion of sum chargeable to tax

(a) Under section 195(1), any person responsible for paying to a non-corporate non-
resident or to a foreign company, any interest or any other sum chargeable under
the provisions of the Act (other than salary), has to deduct tax at source at the
rates in force.
(b) Under section 195(2), where the person responsible for paying any such sum
chargeable to tax under the Act (other than salary) to a non-resident, considers that
the whole of such sum would not be income chargeable in the hands of the recipient,
he may make an application in such form and manner to the Assessing Officer, to
determine in such manner, as may be prescribed, the appropriate proportion of such
sum so chargeable. When the Assessing Officer so determines, the appropriate
proportion, tax shall be deducted under section 195(1) only on that proportion of the
sum which is so chargeable.
(c) Section 195(7) provides that, notwithstanding anything contained in sections 195(1)
and 195(2), the CBDT may, by notification in the Official Gazette, specify a class of
persons or cases, where the person responsible for paying to a non-corporate non-
resident or to a foreign company, any sum, whether or not chargeable under the
provisions of this Act, shall make an application in the prescribed form and manner
to the Assessing Officer, to determine in the prescribed manner, the appropriate
proportion of sum chargeable to tax. Where the Assessing Officer determines the
appropriate proportion of the sum chargeable, tax shall be deducted under sub-
section (1) on that proportion of the sum which is so chargeable.
(d) Consequently, where the CBDT specifies a class of persons or cases, the person
responsible for making payment to a non-corporate non-resident or a foreign
company in such cases has to mandatorily make an application in the prescribed
form and manner to the Assessing Officer, whether or not such payment is
chargeable under the provisions of the Act.
Accordingly, the CBDT has inserted Rule 29BA to specify the following form and manner
of making application to the Assessing Officer and manner for determining the
appropriate fraction on which tax is deductible at source:

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Sub-rule Provision
(1) Form and manner of making application:
An application by a person for determination of appropriate proportion of
sum chargeable in the case of non-resident recipient under section
195(2)/(7) has to be made in Form 15E electronically –
(i) under digital signature; or
(ii) through electronic verification code.
(2) Determination of appropriate proportion of sum chargeable to tax
after examining the taxability of the amount as per the Act and the
relevant DTAA:
The Assessing Officer has to examine whether the sum being paid or
credited is chargeable to tax under the provisions of the Act read with the
relevant DTAA, if any. If the sum is chargeable to tax, he has to
determine the appropriate proportion of such sum chargeable to tax.
(3) Issuance of certificate determining appropriate proportion of sum
chargeable to tax:
The Assessing Officer has to examine the application and on being
satisfied that the whole of such sum would not be the income chargeable
in case of the recipient, he may issue a certificate determining appropriate
proportion of such sum chargeable under the provision of the Act, for the
purposes of tax deduction under section 195(1).
(4) Information to be considered while examining the application:
While examining the application, the Assessing Officer has to take into
consideration, following information in relation to the recipient:-
(i) tax payable on estimated income of the previous year relevant to
the assessment year
(ii) tax payable on the assessed or returned or estimated income, as
the case may be, of preceding four previous years
(iii) existing liability under the Income-tax Act, 1961
(iv) advance tax payment, tax deducted at source and tax collected at
source for the assessment year relevant to the previous year till the date
of making application in Form 15E.
(5) Validity of the certificate:
The certificate would be valid only for the payment to non-resident named
therein and for such period of the previous year as may be specified in
the certificate, unless it is cancelled by the Assessing Officer at any time
before the expiry of the specified period.
(6) Application for fresh certificate:
An application for a fresh certificate may be made, if the assessee so
desires, -

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- after the expiry of the period of validity of the earlier certificate or

- within three months before the expiry thereof.
(7) Procedures, formats and standards to be laid down for ensuring
secure capture and transmission of data and uploading of
documents:
The PDGIT (Systems) or the DGIT (Systems), as the case may be, has to
lay down procedures, formats and standards for ensuring secure capture
and transmission of data and uploading of documents. They would also
be responsible for evolving and implementing appropriate security,
archival and retrieval policies in relation to the furnishing of Form No 15E
and issuance of Certificate.

(vii) Refund for denying liability to deduct tax under section 195 [Section 239A]:
(a) Application for refund of tax - This section provides that where under an
agreement or other arrangement, in writing, the tax deductible on any income,
other than interest, under section 195 is to be borne by the person by whom the
income is payable, and such person having paid such tax to the credit of the
Central Government, claims that no tax was required to be deducted on such
income, he may file an application before the Assessing Officer for refund of such
tax in prescribed form 29D. The claim for refund of tax shall be accompanied by a
copy of an agreement or arrangement as applicable.
(b) Time limit for filing application - Such application may be filed within 30 days from
the date of payment of such tax.

(c) Passing of order by Assessing Officer - The Assessing Officer has to, by an order
in writing, allow or reject the application. However, no application would be rejected
unless an opportunity of being heard has been given to the applicant. The Assessing
Officer, may, before passing an order make such inquiry as he considers necessary.
(d) Time limit for passing order - The order has to be passed within 6 months from
the end of the month in which application for refund is received.
(viii) Procedure for refund of TDS under section 195 to the person deducting tax in cases
where tax is deducted at a higher rate prescribed in the DTAA
(I) The CBDT has, through Circular No.7/2011 dated 27.9.2011, modified Circular
No.07/2007, dated 23.10.2007 which laid down the procedure for refund of tax
deducted at source under section 195 of the Income-tax Act, 1961 to the person
deducting tax at source from the payment to a non-resident. The said Circular

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allowed refund to the person making payment under section 195 in the
circumstances indicated below where, after the deposit into Government account
of the tax deducted at source under section 195,
(a) the contract is cancelled, and no remittance is made to the non-resident;
(b) the remittance is duly made to the non-resident, but the contract is cancelled.
In such cases, the remitted amount has been returned to the person
responsible for deducting tax at source;
(c) the contract is cancelled after partial execution and no remittance is made to
the non-resident for the non-executed part;
(d) the contract is cancelled after partial execution and remittance related to non-
executed part is made to the non-resident. In such cases, the remitted amount
has been returned to the person responsible for deducting the tax at source or
no remittance is made but tax was deducted and deposited when the amount
was credited to the account of the non-resident;
(e) there occurs exemption of the remitted amount from tax either by amendment
in law or by notification under the provisions of Income-tax Act, 1961;
(f) an order is passed under section 154 or 248 or 264 of the Income-tax Act,
1961 reducing the tax deduction liability of a deductor under section 195;
(g) there occurs deduction of tax twice from the same income by mistake;
(h) there occurs payment of tax on account of grossing up which was not required
under the provisions of the Income-tax Act, 1961;
(i) there occurs payment of tax at a higher rate under the domestic law while a
lower rate is prescribed in the relevant double taxation avoidance treaty
entered into by India.
In the cases mentioned above, income does not either accrue to the non-resident
or it accrues but the excess amount in respect of which refund is claimed, is borne
by the deductor. The amount deducted as tax under section 195 and paid to the
credit of the Government therefore belongs to the deductor.
In the type of cases referred to in (a), the non-resident not having received any
payment would not apply for a refund. For cases covered in (b) to (i), no claim may
be made by the non-resident where he has no further dealings with the resident
deductor of tax or the tax is to be borne by the resident deductor. The resident

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deductor was therefore put to genuine hardship as he would not be able to recover
the amount deducted and deposited as tax.
In the type of cases referred to above, where no income has accrued to the non-
resident due to cancellation of contract or where income has accrued but no tax is
due on that income or tax is due at a lesser rate, the amount deposited to the
credit of Government to that extent under section 195, cannot be said to be "tax".
Therefore, the CBDT decided that this amount can be refunded to the person who
deducted it from the payment to the non-resident, under section 195.
Refund to the person making payment under section 195 is being allowed as
income does not accrue to the non-resident or if the income is accruing no tax is
due or tax is due at a lesser rate. The amount paid into the Government account in
such cases to that extent, is no longer "tax".
If a resident deductor is entitled for the refund of tax deposited under section 195,
then, it has to be refunded with interest under section 244A from the date of
payment of such tax [Circular No. 11/2016 dated 26.4.2016].
In case of refund being made to the person who made the payment under section
195, the Assessing Officer may, after giving intimation to the deductor, adjust it
against any existing tax liability of the deductor under the Income-tax Act, 1961, or
any other direct tax law. The balance amount, if any, should be refunded to the
person who made such payment under section 195.
A refund in terms of this circular should be granted only after obtaining an
undertaking that no certificate under section 203 of the Income-tax Act has been
issued to the non-resident. In cases where such a certificate has been issued, the
person making the refund claim under this circular should either obtain it or should
indemnify the Income-tax Department from any possible loss on account of any
separate claim of refund for the same amount by the non-resident. A refund in
terms of this circular should be granted only if the deductee has not filed return of
income and the time for filing of return of income has expired.
The refund as per this circular is, inter alia, permitted in respect of transactions
with non-residents, which have either not materialized or have been cancelled
subsequently. It, therefore, needs to be ensured by the Assessing Officer that they
disallow corresponding transaction amount, if claimed, as an expense in the case
of the person, being the deductor making refund claim. Besides, in all cases, the
Assessing Officer should also ensure that in the case of a deductor making the

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claim of refund, the corresponding disallowance of expense amount representing

TDS refunded is made.
(II) The said Circular, however, did not cover a situation where tax is deducted at a
rate prescribed in the relevant DTAA which is higher than the rate prescribed in the
Income-tax Act, 1961. Since the law requires deduction of tax at a rate prescribed
in the relevant DTAA or under the Income-tax Act, 1961, whichever is lower, there
is a possibility that in such cases excess tax is deducted relying on the provisions
of relevant DTAA.
(III) Accordingly, in order to remove the genuine hardship faced by the resident
deductor, the CBDT has modified Circular No. 07/2007, dated 23-10-2007 to the
effect that the beneficial provisions under the said Circular allowing refund of tax
deducted at source under section 195 to the person deducting tax at source shall
also apply to those cases where deduction of tax at a higher rate under the
relevant DTAA has been made while a lower rate is prescribed under the domestic
law.

(6) Income from units of mutual fund or specified company [Section 196A]

(i) Applicability and rate of TDS: The person responsible for paying to non-corporate non-
resident or a foreign company any income in respect of units of a mutual fund specified
under section 10(23D) or from the specified company referred to in section 10(35) shall
deduct tax @20% plus surcharge, wherever applicable, plus health and education
cess@4%.
However, where an agreement referred to in section 90(1) or section 90A(1) applies to
the payee and if the payee has furnished a tax residency certificate referred to in section
90(4) or section 90A(4), as the case may be, then, tax thereon shall be deducted @20%
or at the rate or rates of income-tax provided in such agreement for such income,
whichever is lower.
(ii) Time of deduction: Tax shall be deducted at the time of credit of such income to the
account of the payee or at the time of payment thereof by any mode, whichever is earlier.

Where any such income is credited to any account, whether called “Suspense account” or
by any other name, in the books of account of the person liable to pay such income, such
crediting shall be deemed to be credit of such income to the account of the payee and the
provisions of this section will apply accordingly.

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(iii) Non-applicability in certain cases: No deduction of tax is to be made from any income
payable in respect of units of the Unit Trust of India to a non-resident Indian or a non-
resident Hindu undivided family, where the units have been acquired from the Unit Trust
of India out of the funds in a Non-resident (External) Account maintained with any bank in
India or by remittance of funds in foreign currency, in accordance, in either case, with the
provisions of the Foreign Exchange Management Act, 1999 (42 of 1999), and the rules
made thereunder.
(iv) Meaning of non-resident: An individual, being a citizen of India or a person of Indian
origin who is not a “resident. A person would be deemed to be of Indian origin if he, or
either of his parents or any of his grandparents, was born in undivided India.
(7) Income from units [Section 196B]

The person responsible for making the following payment to an Offshore Fund shall deduct tax
at the time of credit of such income to the account of the payee or at the time of payment thereof
by any mode, whichever is earlier at the following rates:
- @10% plus surcharge, wherever applicable, plus health and education cess@4% in
respect of income in respect of units referred to in section 115AB(1)((i) i.e., income
received in respect of units of a mutual fund specified under section 10(23D) or units of UTI
purchased in foreign currency; or
- @12.5% plus surcharge, wherever applicable, plus health and education cess @4% in
respect of long-term capital gains arising from the transfer of such units referred to in
section 115AB.
(8) Income from foreign currency bonds or shares of Indian company [Section 196C]

The person responsible for making the following payments to a non-resident has to deduct tax
at the time of credit of such income to the account of the payee or at the time of payment thereof
by any mode, whichever is earlier at the following rates:
- @10% plus surcharge, wherever applicable, plus health and education cess@4% in
respect of income by way of interest or dividend from bonds or Global Depository
Receipts referred to in section 115AC or
- @12.5% plus surcharge, wherever applicable, plus health and education cess@4% in
respect of long-term capital gains arising from the transfer of such bonds or Global
Depository Receipts.

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(9) Income of foreign institutional investors and specified funds from securities [Section
196D]

(i) Applicability and rate of TDS: The person responsible for making the payment in
respect of securities referred to in section 115AD(1)(a)
- to a Foreign Institutional Investor has to deduct tax @20% or
- to a specified fund referred to in section 10(4D) has to be deduct tax @10%

plus surcharge, wherever applicable, plus health and education cess@4% at the time of
credit of such income to the account of the payee or at the time of payment thereof by
any mode, whichever is earlier.
However, where an agreement referred to in section 90(1) or section 90A(1) applies to
the Foreign Institutional Investor and if the FII has furnished a tax residency certificate
referred to in section 90(4) or section 90A(4), as the case may be, then, tax thereon shall
be deducted @20% or at the rate or rates of income-tax provided in such agreement for
such income, whichever is lower.
Note – The enhanced rate of surcharge@25% and 37% of tax payable are not applicable
in case of tax deductible u/s 196D on dividend income.
Surcharge and health and education cess would not be applicable to specified fund in
respect of income received from securities referred to in section 115AD(1)(a)
(ii) Non-applicability of TDS: No deduction shall be made in respect of
- income exempt under section 10(4D) in the hands of specified fund; or
- income , by way of capital gains arising from the transfer of securities referred to in
section 115AD, payable to a Foreign Institutional Investor.
The summary of withholding tax provisions relating to non-residents is given below. These
provisions are discussed in detail in the following chapters mentioned in Column (4):
Section Nature of payment Rate of TDS Chapter
(1) (2) (3) (4)
192 Salary Concessional rate u/s 13: Deduction,
115BAC/ normal slab Collection and
rates if the individual Recovery of Tax
has exercised the (Module 3)
option to shift out of
the default tax regime

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192A Premature withdrawal from EPF, 10%

aggregating to ` 50,000 or more
194B Income by way of winnings from 30%
lotteries, crossword puzzles, card
games and other games of any
sort or from gambling or betting
of any form or nature whatsoever,
where amt in respect of single
transaction > ` 10,000.
194BA Income by way of winnings 30%
from any online game
194BB Income by way of winnings from 30%
horse races, where amt in
respect of single transaction >
` 10,000.
194G Commission etc. on the sale of 2%
lottery tickets, where amount
payable to a person > ` 20,000
194N On withdrawal of cash in excess 2% on amount
of ` 1 crore exceeding ` 1 crore
Where the recipient is a co-
operative society, the higher
threshold limit of ` 3 crores is
applicable for withdrawals
In case the recipient has not filed - @2% of the sum,
ROI for all the 3 immediately where cash
preceding P.Y.s, for which time withdrawal > ` 20
limit u/s 139(1) has expired, the lakhs ≤ ` 1 crore
sum shall be the amt or agg. of (` 3 crores,
amts, in cash > ` 20 lakh during where the
the P.Y. recipient is a
co-operative
society)
- @5% of the sum,
where cash
withdrawal
exceeds ` 1
crore (` 3 crores,
where the
recipient is a co-
operative society)

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194T Distribution of any sum by a firm 10%

in the nature of salary,
remuneration, commission, bonus
or interest to a partner of the firm,
where amt or aggregate of amts
paid to a partner of firm >
` 20,000.
Distribution of any interest 5%
income, received or receivable by
a business trust from a SPV, to
its unit holders.
Distribution of any dividend 10%
income, received or receivable by
business trust from a SPV
exercising option to pay tax at
194LBA(2) concessional rate under section
115BAA, to its unit holders
However, if the SPV is not
exercising the option to pay tax at
concessional rate under section
115BAA, dividend income would 10: Assessment of
be exempt in the hands of unit Trusts, Political
holders and tax would not be Parties and other
deductible at source. Special Entities
(Module 2)
194LBA(3) Distribution of any income
received from renting or leasing
or letting out any real estate
asset directly owned by the
business trust, to its unit holders.
194LBB Investment fund paying income to At the rates in force
a unit holder [other than income
which is exempt under section
10(23FBB)].
194LBC(2) Income in respect of investment
made in a securitisation trust
(specified in Explanation to
section 115TCA)
194E Income referred to under section 20%
115BBA payable to non-resident 21: Non Resident
sportsmen/sports association or Taxation
an entertainer (Module 4)

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194LB Interest payable by infrastructure 5%

debt fund to a non-corporate non-
resident or foreign company
Interest payable by an Indian 5%
Company or a business trust to a
non-corporate non-resident or
foreign company
- in respect of money borrowed
in foreign currency from a
source outside India
• under a loan agreement
between 1.7.2012 and
30.6.2023 or
• by way of issue of long-
term infrastructure bonds
during the period between
1.7.2012 and 30.9.2014
• by way of issue of long
term bonds (including long
term infrastructure bond)
between 1.10.2014 and
30.6.2023
194LC as approved by Central
Government or
- in respect of money borrowed
from source outside India by
way of rupee denominated
bond on or before 30.6.2023
Interest payable by an Indian 4%
company or a business trust to a
non-corporate non-resident or
foreign company, in respect of
monies borrowed by it from a
source outside India by way of
issue of any long-term bond or
rupee denominated bond
between 1.4.2020 and 30.6.2023,
which is listed only on a
recognised stock exchange
located in any International
Financial Services Centre

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Interest payable by an Indian 9%

company or a business trust to a
non-corporate non-resident or
foreign company, in respect of
monies borrowed by it from a
source outside India by way of
issue of any long-term bond or
rupee denominated bond on or
after 1.7.2023, which is listed
only on a recognised stock
exchange located in any
International Financial Services
Centre
Interest payable by an Indian Nil
company or a business trust to a (Since such interest
non-resident, including a foreign is exempt u/s 10(4C),
company, in respect of rupee no tax is deductible
denominated bond issued outside u/s 194LC)
India during the period from
17.9.2018 to 31.3.2019
195 Any other sum payable to a non- At the rates in force
resident
196A Income on units of a mutual fund 20%
specified under section 10(23D)
or from the specified company
referred to in section 10(35)
payable to non-corporate non-
resident or foreign company.
Where a DTAA applies to the
payee and if the payee has
furnished a TRC then, tax
thereon shall be deducted
@20% or at the rate or rates of
income-tax provided in such
agreement for such income,
whichever is lower.
196B Income from units of a mutual 10% in respect of
fund or UTI purchased in foreign income from units
currency (including long term 12.5% in respect of
capital gain on transfer of such long term capital gain
units) payable to an Offshore on transfer of such
Fund units

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196C Income by way of interest or 10% in respect of

dividend on bonds of an Indian interest or dividend
company or public sector company from bonds or GDRs
sold by the Government and
purchased by a non-resident in
12.5% in respect of
foreign currency or GDRs referred
long-term capital
to in section 115AC (including long
gains on transfer of
term capital gain on transfer of
such bonds or GDRs
such bonds or GDRs) payable to a
non-resident
196D Income of foreign Institutional 20%
Investors from securities (not
being capital gain arising from
such securities).
Where a DTAA applies to the
payee and if the payee has
furnished a TRC then, tax
thereon shall be deducted
@20% or at the rate or rates of
income-tax provided in such
agreement for such income,
whichever is lower.
Income of specified fund from 10%
securities [not being income
exempt u/s 10(4D)]

Note: In all the above cases, the rate of tax would be increased by surcharge, wherever
applicable, and health and education cess @4% except in case of deduction u/s 196D on income
of a specified fund.

21.10 MISCELLANEOUS PROVISIONS

(1) Recovery of tax in respect of non-resident from his assets [Section 173]
In a case where the person entitled to the income arising from any business connection in India or
from any property in India or through or from any asset or source of income in India or through the
transfer of a capital asset situated in India is a non-resident, the tax chargeable thereon, whether
in his name or in the name of his agent who is liable as a representative assessee, may be
recovered by deduction under any of the provisions of Chapter XVII-B. Further, any arrears of tax
may be recovered also in accordance with the provisions of the Income-tax Act from any assets of

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the non- resident which are, or may at any time come, within India. These provisions are without
prejudice to the provisions of section 161(1) or of section 167.

(2) Recovery against the assessee’s property in foreign countries [Section 228A]
Where an assessee is in default or is deemed to be in default in making a payment of tax, the Tax
Recovery Officer may, if the assessee is a resident of a country (being a country with which the
Central Government has entered into an agreement for the recovery of income tax under this Act
and the corresponding law in force in that country) or has any property in that country, forward to
the CBDT a certificate drawn up by him under section 222. Thereafter, the CBDT may take such
action thereon as it may deem appropriate having regard to the terms of the agreement with such
country.
Similarly, the Government of the other country or any authority under that Government may send
to the CBDT a certificate of recovery of any tax due under such corresponding law from a person
having property in India and the CBDT may forward such certificate to Tax Recovery Officer
having jurisdiction over the resident or within whose jurisdiction such property is situated, for
recovery of such tax. Tax Recovery Officer can proceed to recover the amount specified in the
Certificate by –
(a) attachment and sale of assesses movable or immovable property
(b) arrest of the assessee and his detention in prison.
(c) appointing a receiver for the management of assesses movable and immovable property.
He shall thereafter remit the sum so recovered to the CBDT.

(3) Submission of statement by a non-resident having liaison office [Section 285]

(i) A non-resident can operate in India through a branch or a liaison office set up after
getting the approval of the Reserve Bank of India. Since the branch constitutes a
permanent establishment of the non-resident, it has to file its return of income.
(ii) Such a non-resident is required to file a statement in the prescribed form [Form No.49C]
to the Assessing Officer having jurisdiction, within eight months from the end of such
financial year, a statement providing the details in respect of activities carried out by the
liaison office in India during the financial year.
(iii) This requirement has to be complied with by every person, being a non-resident having a
liaison office in India set up in accordance with the guidelines issued by the RBI under the
Foreign Exchange Management Act, 1999.

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(iv) The statement is to be verified by a Chartered Accountant or by the Authorized Signatory

i.e., the person authorized by the non-resident in this behalf.

(4) Furnishing of information or documents by an Indian Concern [Section 285A]

(i) There shall be a reporting obligation on the Indian concern through or in which the Indian
assets are held by a foreign company or entity.

(ii) For the purposes of determination of any income accruing or arising in India under
section 9(1)(i), an Indian concern has to furnish, within the prescribed period to the
prescribed income-tax authority, the information or documents, in prescribed manner, if -
- any share of, or interest in, a company or an entity registered or incorporated outside
India derives, directly or indirectly, its value substantially from the assets located in
India, as referred to in Explanation 5 to section 9(1)(i), and
- such company or, entity, holds, directly or indirectly, such assets in India through, or
in, the Indian concern.
(iii) The information has to be furnished in Form No.49D electronically within a period of 90
days from the end of the financial year in which the transfer of such share or interest
referred to above takes place. However, if the share or the interest has the effect of
directly or indirectly transferring the rights of management or control in relation to the
Indian concern, the information has to be furnished in Form No.49D within a period of 90
days of the transaction.
(iv) If any Indian concern fails to furnish the information or documents, the income-tax
authority, as may be prescribed under the said section, may direct that such Indian
concern shall pay, by way of penalty under section 271GA,—
(a) @2% of the value of the transaction in respect of which such failure has taken
place, if such transaction had the effect of directly or indirectly transferring the
right of management or control in relation to the Indian concern;
(b) ` 5,00,000 in any other case.

Note – Rule 114DB prescribes the time limit and information or documents to be furnished under
section 285A 6.

6 For detailed reading of Rule 114DB of the Income-tax Rules, 1962, students may visit
[Link]

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(5) Statutory agent of non-residents [Section 163]

According to section 163, an agent, in relation to a non-resident person, includes any person in India:

(i) who is employed by or on behalf of the non-resident;

(ii) who is having any business connection with the non-resident;

(iii) from or through whom the non-resident is in receipt of any income, whether directly or
indirectly;

(iv) who is trustee of the non-resident; and

any other person who (whether resident or non-resident) has acquired a capital asset in India by
means of a transfer from the non-resident.

In the first four cases stated above, the person sought to be assessed as the agent of a non-
resident must necessarily be in India whereas it need not be so in the fifth case. Thus, a non-
resident may be treated as the agent of another non-resident. The appointment of the agent may
be made any time before or after the expiry of the relevant previous year. An agent of a non-
resident may be appointed under this section even if at the date of such appointment, the non-
resident is not alive.
According to the proviso to this section, where transactions are carried on in the ordinary course of
business through a broker in India and the broker does not deal directly with or on behalf of a non-
resident principal but deals with or through a non-resident broker and such non-resident broker
also carries on such transactions in the ordinary course of his business and not as a principal, the
broker in India cannot be treated as statutory agent in respect of the income arising to the non-
resident from such transactions. Thus, where bona fide hedging transactions take place through a
broker in India and a foreign broker acting for an undisclosed principal, the Indian broker cannot be
deemed to be agent of the foreign principal.
For the purposes of section 163(1), the expression “business connection” shall have the meaning
assigned to it in Explanation 2 to clause (i) of section 9(1) of the Income-tax Act, 1961.
[Explanation to section 163(1)]
Before a person can be treated as an agent of a non-resident he must be given a reasonable
opportunity of being heard by the Assessing Officer as to his liability to be so treated.

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In certain cases, the income received by one person can be assessed in the hands of another.
Persons who are liable to be assessed on behalf of other because of their association with the real
recipient of the income are known as representative assessees.

In respect of Income of a non-resident which is deemed to accrue or arise to him in India under
section 9(1), agent of a non-resident including a person who is treated as an agent under section
163 would be considered a representative assessee under section 160. As per the provisions of
section 161, every representative assessee, shall be subject to the same duties, responsibilities
and liabilities as the assessee and the taxes shall be levied upon and recovered from him in like
manner and to the same extent as it would be leviable upon and recoverable from the person
represented by him.

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TEST YOUR KNOWLEDGE

Questions
1. Peeyush, who returned to India on 12th June, 2025 for permanently residing in India after a
stay of about 20 years in U.K., provides the sources of his various incomes and seeks your
opinion to know about his liability to income tax thereon in India in A.Y. 2026-27 assuming
that he has exercised the option to shift out of the default tax regime under section
115BAC:
(i) Income of rent of the flat in London which was deposited in a bank there. The flat
was given on rent by him after his return to India since July, 2025.
(ii) Dividends on the shares of three German Companies which are being collected in
a bank account in London. He proposes to keep the dividend on shares in London
with the permission of the Reserve Bank of India.
(iii) He has got two sons, one of whom is of 12 years and other 19 years. Both his sons
are staying in London and not returning to India with him. Each of his sons is
having income of ` 75,000 in U.K. in foreign currency (not received in India) and of
` 20,000 in India.
(iv) During the preceding accounting year when he was a non-resident, he had sold
1000 shares which were acquired by him in British Pound Sterling and the sale
proceeds were repatriated. The profit in terms of British Pound Sterling on sale of
these 1000 shares was 175% of the cost at ` 37,500 while in terms of Indian
Rupee it was ` 50,000.
2. Mr. David, a citizen of India, serving in the Ministry of External Affairs in India, was
transferred to Indian Embassy in Canada on 31.03.2025. He did not visit India any time
during the previous year 2025-26. He has received the following income for the Financial
Year 2025-26:
[Link]. Particulars `
(i) Salary (Computed) 5,00,000
(ii) Foreign Allowance 4,00,000
(iii) Interest on fixed deposit from bank in India 1,00,000
(iv) Income from agriculture in Country X 2,00,000
(v) Income from house property in Country X 2,50,000
Compute his gross total income for Assessment Year 2026-27.

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3. Mr. A, a citizen of India, left for USA for the purposes of employment on 1.5.2025. He has
not visited India thereafter. Mr. A borrows money from his friend Mr. B, who also left India
for employment purpose one week before Mr. A's departure, to the extent of ` 10 lakhs and
buys shares in X Ltd., an Indian company. Discuss the taxability of the interest charged
@10% in B's hands, if the said interest has been received in New York.
4. JJ Limited, a company incorporated in Australia has entered into an agreement with KK
Limited, an Indian company for rendering technical services to the latter for setting up a
fertilizer plant in Orissa. As per the agreement, JJ Limited rendered both off-shore services
and on-shore services to KK Limited at fee of ` 1 crore and ` 1.5 crore, respectively. JJ
Limited is of the view that it is not liable to tax in India in respect of fee of ` 1 crore as it is
for rendering services outside India. Discuss the correctness of the view of JJ Limited.
5. Examine with reasons whether the following transactions attract income-tax in India, in the
hands of recipients under section 9 of Income-tax Act, 1961:
(i) A non-resident German company, which did not have a permanent establishment in
India, entered into an agreement for execution of electrical work in India. Separate
payments were made towards drawings & designs, which were described as
"Engineering Fee". The assessee contended that such business profits should be
taxable in Germany as there is no business connection within the meaning of section
9(1)(i) of the Income-tax Act, 1961.
(ii) A firm of solicitors in Mumbai engaged a barrister in UK for arguing a case before
Supreme Court of India. A payment of 5000 pounds was made as per terms of
professional engagement.
(iii) Amount paid by Government of India for use of a patent developed by Mr. A, who is
a non-resident.
(iv) Sai Engineering, a non-resident foreign company entered into a collaboration
agreement on 25/6/2025, with an Indian Company and was in receipt of interest on
8% debentures for ` 20 lakhs, issued by Indian Company, in consideration of
providing technical know-how utilised in its business in Mumbai during previous year
2025-26.
6. Z, an American tourist, comes to India for the first time on June 17, 2025. He leaves India
on September 29, 2025. Determine his residential status for the assessment year
2026-27.

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Would your answer change if he is a person of Indian origin and his total income from
Indian sources for A.Y.2026-27 is ` 16 lakhs?
7. M/s. Global Airlines incorporated as a company in USA operated its flights to India and
vice versa during the year 2025-26 (April, 2025 to March, 2026) and collected charges of
` 125 lakhs for carriage of passengers and cargo out of which ` 65 lakhs were received
in New York in U.S Dollars for the passenger fare booked from New York to Mumbai. The
total expenses for the year on operation of such flights were ` 95 lakhs. Compute the
income chargeable to tax of the foreign airlines.
8. Atlant Italy, a company incorporated in France, was engaged in manufacture, trade and
supply equipment and services for GSM Cellular Radio Telephones Systems. It supplied
hardware and software to various entities in India. Software licensed by assessee
embodied the process which is required to control and manage the specific set of
activities involved in the business use of its customers, and also made available to its
customers, who used it to carry out their business activities. The Assessing Officer
contended that the consideration for supply of software embedded in hardware is 'royalty'
under section 9(1)(vi).
Examine the correctness of the action of the Assessing Officer assuming that the
software that was loaded on the hardware and embedded in the system does not have
any independent existence.
9. Singtel Ltd. is a company incorporated in Singapore and 55% of its shares are held by
Godavari (P) Ltd., an Indian company. Singtel Ltd. has its presence in India also. The
details relating to Singtel Ltd. for the P.Y.2025-26, are as under:

Particulars India Singapore

Fixed assets at depreciated values for tax purposes 120 80
(` in crores)
Intangible assets (` in crores) 50 200
Other assets (value as per books of account) (` in crores) 40 120
Income from trading operations (` in crores) 25 50
The above figure includes:
(i) Income from transactions where purchases are from 2 4
associated enterprises and sales are to unrelated parties
(ii) Income from transactions where sales are to associated 3 5
enterprises and purchases are from unrelated parties

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(iii) Income from transactions where both purchases and sales 5 10

are from/to associated enterprises
Interest and dividend from investments (` in crores) 20 15
Number of employees (Residents in respective countries) 70 90
Payroll expenses on employees (` in crores) 8 12

Determine the residential status of Singtel Ltd. for A.Y.2026-27, if during the F.Y.2025-26,
eight board meetings were held – 3 in India and 5 in Singapore.
10. STYLE Inc., a notified Foreign Institutional Investor (FII), derived the following incomes for
the financial year 2025-26:-
(1) Dividend from listed shares of Indian companies – ` 6,20,000
(2) Interest on securities – ` 17,32,000 (Expenses of ` 26,000 has been incurred to
earn such income)
(3) Income from sale of securities and shares:
(i) Bonds of J Ltd.
[Date of purchase 5 May, 2018; Date of sale 7 March, 2026]
Sale proceeds : ` 47,00,000
Cost of purchase : ` 32,00,000
Cost Inflation Index: F.Y.2018-19:280; F.Y.2025-26:376
(ii) Listed Shares of E Ltd.
[Date of purchase – 2 May, 2025; Date of sale – 9 February, 2026]
Sale Consideration ` 12,40,000
Purchase cost ` 7,80,000
[STT paid both at the time of purchase and sale]
(iii) Unlisted equity shares of M Ltd.
[Date of purchase – 1 July, 2025; Date of sale – 7 March, 2026]
Sale Consideration ` 8,40,000
Purchase cost ` 3,72,000
Compute the total income and tax liability of the FII, STYLE Inc., for the A.Y. 2026-27 as
per section 115AD, assuming that no other income is derived by STYLE Inc. during the
F.Y.2025-26.

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Answers
1. Peeyush returned to India on 12 th June 2025 for permanently residing in India after
staying in UK for 20 years. During the P.Y.2025-26, he stays in India for 293 days. Since
he has stayed in India for a period of 182 days or more during the previous year 2025-26,
he would be a resident in India for the A.Y.2026-27. However, he would be a resident but
not ordinarily resident, assuming that he was a non-resident in nine out of ten previous
years preceding P.Y.2025-26 his stay in India during the seven previous years is less
than 730 days. The residential status of Peeyush for A.Y.2026-27 is, therefore, Resident
but Not Ordinarily Resident.
As per section 5(1), only income which is received/ deemed to be received/ accrued or
arisen/ deemed to accrue or arise in India is taxable in case of a Resident but not
Ordinarily Resident. Income which accrues or arises outside India shall not be included
in his total income, unless it is derived from a business controlled in, or a profession set
up in India.
(i) Rental income from a flat in London which was deposited in a bank there shall not
be taxable in the case of a resident but not ordinarily resident, since both the
accrual and receipt of income are outside India.
(ii) Dividends from shares of three German Companies, collected in a bank account in
London, would also not be taxable in the case of a resident but not ordinarily
resident since both the accrual and receipt of income are outside India.
(iii) As per section 64(1A), all income accruing or arising to a minor child is includible
in the hands of the parent, after providing for deduction of ` 1,500 per child under
section 10(32).
Accordingly, income of ` 20,000 accruing to his minor son, aged 12 years, in India
is includible in the income of Peeyush, after providing deduction of ` 1,500.
Therefore, ` 18,500 is includible in the income of Peeyush. Income accruing to the
minor child outside India (which is also received outside India) is not includible in
the income of Peeyush.
Since the other son is major, his income is not includible in the income of Peeyush.
(iv) Repatriation of sale proceeds of 1000 shares sold in the preceding accounting
year, when Peeyush was a non-resident, is not taxable in the A.Y.2026-27 since it
is not the income of the P.Y.2025-26.

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Consequently, only the income includible under section 64(1A) would form part of
the total income of Mr. Peeyush for A.Y.2026-27. Since his total income (i.e.,
` 18,500) is less than the basic exemption limit, there would be no liability to
income-tax for A.Y.2026-27.
2. As per section 6(1), Mr. David is a non-resident for the A.Y. 2026-27, since he was not
present in India at any time during the previous year 2025-26.
As per section 5(2), a non-resident is chargeable to tax in India only in respect of
following incomes:
(i) Income received or deemed to be received in India; and
(ii) Income accruing or arising or deemed to accrue or arise in India.
In view of the above provisions, income from agriculture in Country X and income from
house property in Country X would not be chargeable to tax in the hands of David,
assuming that the same were received in Country X.
Income from ‘Salaries’ payable by the Government to a citizen of India for services
rendered outside India is deemed to accrue or arise in India as per section 9(1)(iii).
Hence, such income is taxable in the hands of Mr. David, even though he is a non-
resident. However, allowances or perquisites paid or allowed as such outside India by the
Government to a citizen of India for rendering service outside India is exempt under
section 10(7). Hence, foreign allowance of ` 4,00,000 is exempt under section 10(7).
Gross Total Income of Mr. David for A.Y. 2026-27
Particulars `
Salaries 5,00,000
Income from other sources (Interest on fixed deposit in India) 1,00,000
Gross Total Income 6,00,000

3. An individual is said to be resident in India in any previous year, if he -

(i) has been in India during that year for a total period of 182 days or more, or
(ii) has been in India during the four years immediately preceding that year for a total
period of 365 days or more and has been in India for at least 60 days in that year.
In the case of an Indian citizen leaving India for the purposes of employment outside
India during the previous year, the period of stay during the previous year in condition (ii)
above, to qualify as a resident, would be 182 days instead of 60 days.

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In this case, Mr. A is an Indian citizen who left India for employment outside India on
01.05.2025. Mr. A has been in India only from 1.4.2025 to 01.05.2025 i.e. for 31 days.
Since his stay in India during the previous year 2025-26 is only 31 days, he does not
satisfy the minimum criterion of 182 days stay in India for being a resident. Hence, his
residential status for A.Y. 2026-27 is non-resident. Mr. B, who left India one week before
A’s departure, is also a non-resident for the same reasons.
Section 9(1)(v) provides that income by way of interest payable by a non-resident in
respect of any debt incurred, or moneys borrowed and used, for the purposes of a
business or profession carried on by such person in India shall be deemed to accrue or
arise in India.
Therefore, interest payable by a non-resident in respect of any debt incurred, or moneys
borrowed and used, for the purpose of making or earning any income from any source
other than a business or profession carried on by him in India, shall not be deemed to
accrue or arise in India. Therefore, interest payable by Mr. A on money borrowed from
Mr. B to invest in shares of an Indian company shall not be deemed to accrue or arise in
India and hence, is not taxable in India in the hands of Mr. B.
4. The Explanation below section 9(2) clarifies that income by way of, inter alia, fees for
technical services from services utilized in India would be deemed to accrue or arise in
India under section 9(1)(vii) in case of a non-resident and be included in his total income,
whether or not such services were rendered in India.
In this case, the technical services rendered by the foreign company, JJ Ltd., were for
setting up a fertilizer plant in Orissa. Therefore, the services were utilized in India.
Consequently, as per the Explanation below section 9(2), the fee of ` 2.5 crore for
technical services rendered by JJ Ltd. (both off-shore and on-shore services) to KK Ltd. is
deemed to accrue or arise in India and includible in the total income of JJ Ltd.
Therefore, the view of JJ Ltd. that it is not liable to tax in India in respect of fee of ` 1
crore (as it is for rendering services outside India) is not correct.
5. (i) Fees for technical services is taxable under section 9(1)(vii). In this case, the
separate payments made towards drawings and designs (described as
“engineering fee”) are in the nature of fee for technical services and, therefore, it is
taxable in India by virtue of section 9(1)(vii), since the services are utilized for
execution of electrical work in India [Aeg Aktiengesllschaft v. CIT (2004) 267 ITR
209 (Kar.)].
As per Explanation below section 9(2), where income is deemed to accrue or arise
in India under section 9(1)(vii), such income shall be included in the total income of

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the non-resident German company, regardless of whether it has a residence or

place of business or business connection in India.
(ii) As per section 9(1)(i), all income accruing or arising, whether directly or indirectly,
through or from any business connection in India is deemed to accrue or arise in
India.
In this case, there was a professional connection between the firm of solicitors in
Mumbai and the barrister in UK. The expression “business” includes not only trade
and manufacture; it includes, within its scope, “profession” as well. Therefore, the
existence of professional connection amounts to existence of “business
connection” under section 9(1)(i). It was so held by the Supreme Court in Barendra
Prasad Roy v. ITO (1981) 129 ITR 295.
Hence, the amount of 5,000 pounds paid to the barrister in UK as per the terms of
the professional engagement constitutes income which is deemed to accrue or
arise in India under section 9(1)(i). Hence, it is taxable in India.
(iii) As per section 9(1)(vi), income by way of royalty payable by the Government of
India is deemed to accrue or arise in India. “Royalty” means consideration for,
inter alia, use of patent. Therefore, the amount paid by Government of India for
use of patent developed by Mr. A, a non-resident, is deemed to accrue or arise in
India. Hence, it is taxable in India in the hands of Mr. A.
(iv) ` 20 lakhs, being the value of debentures issued by an Indian company in
consideration of providing technical know-how for use in its business in India, is in
the nature of fee for technical services, deemed to accrue or arise in India to Sai
Engineering, a non-resident foreign company, under section 9(1)(vii). Hence, it is
taxable in India.
Further, as per section 9(1)(v), income by way of interest payable by a person who
is a resident of India is deemed to accrue or arise in India. Therefore, interest
income from debentures of an Indian company is deemed to accrue or arise in
India in the hands of Sai Engineering by virtue of section 9(1)(v). Hence, it is
taxable in India.
Note – Since the question specifically requires the candidates to examine the taxability of
the above transactions under section 9, the provisions of double taxation avoidance
agreement, if any, applicable in the above cases, have not been taken into consideration.

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6. Previous year 2025-26: 105 [14+31+31+29]

Previous year 2024-25: Nil
Previous year 2023-24: Nil
Previous year 2022-23: Nil
Previous year 2021-22: Nil
He is non-resident for the assessment year 2026-27 as he does not satisfy either of the
basic conditions.
Even if he is a person of Indian origin whose total income from Indian sources exceeds
` 15 lakhs, he would still be a non-resident for A.Y.2026-27. For becoming a resident but
not ordinarily resident, he should have stayed in India for atleast 120 days in the previous
year 2025-26 and 365 days in four immediately preceding previous years. Since his stay
in India in the P.Y.2025-26 is less than 120 days, he would be non-resident in India for
A.Y.2026-27.
7. As per section 44BBA, in case of a non-resident engaged in the business of operation of
aircraft, 5% of the following amounts would be deemed to be the profits and gains from
such business:
(a) paid or payable, whether in or out of India, to the assessee or to any person on his
behalf on account of the carriage of passengers, livestock, mail or goods from any
place in India; and
(b) received or deemed to be received in India by or on behalf of the assessee on
account of the carriage of passengers, livestock, mail or goods from any place
outside India.
In the present case, the income chargeable to tax of M/s Global Airlines applying the
provisions of section 44BBA are as follows:
Fare booked from India to Fare booked from New
Particulars outside India whether York to Mumbai and
received in India or not (`) received outside India (`)
Fare 60,00,000 65,00,000
(1,25,00,000 – 65,00,000)
Deemed income @5% u/s 3,00,000 Nil (since the amount not
44BBA (60,00,000 × 5%) received in India)

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8. The issue under consideration in this case is whether consideration for supply of software
embedded in hardware would tantamount to ‘royalty’ for attracting deemed accrual of
income under section 9(1)(vi).
As per section 9(1)(vi), income by way of royalty payable by a person who is a resident in
India would be deemed to accrue or arise in India. However, where it is payable for the
transfer of any right or the use of any property or information or for the utilization of services
for the purposes of a business or profession carried on by such person outside India or for
the purposes of making or earning any income from any source outside India, the amount
payable by way royalty would not be deemed to accrue or arise in India, in the hands of
non-resident.
For this purpose, ‘royalty’ includes transfer of all or any right for use or right to use a
computer software irrespective of the medium through which such right is transferred.
The facts of the case are similar to the facts in CIT v. Alcatel Lucent Canada (2015) 372
ITR 476, wherein the above issue came up before the Delhi High Court. The Court
observed that the software supply is an integral part of GSM mobile telephone system and
is used by the cellular operators for providing cellular services to its customers. Where
payment is made for hardware in which the software is embedded and the software does
not have independent functional existence, no amount could be attributed as ‘royalty’ for
software in terms of section 9(1)(vi).
In this case, since the software that was loaded on the hardware and embedded in the
system does not have any independent existence, there could not be any independent use
of such software. Therefore, the rationale of the Delhi High Court ruling can be applied to
the case on hand. Accordingly, the action of the Assessing Officer in treating the
consideration for supply of software embedded in hardware as royalty under section 9(1)(vi)
is not correct.
9. The residential status of a foreign company is determined on the basis of place of effective
management (POEM) of the company.
For determining the POEM of a foreign company, the important criteria is whether the
company is engaged in active business outside India or not.
A company shall be said to be engaged in “Active Business Outside India” (ABOI) for
POEM, if
- the passive income is not more than 50% of its total income; and
- less than 50% of its total assets are situated in India; and

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- less than 50% of total number of employees are situated in India or are resident in
India; and
- the payroll expenses incurred on such employees is less than 50% of its total payroll
expenditure.
Singtel Ltd. shall be regarded as a company engaged in active business outside India for
P.Y.2025-26 for POEM purpose only if it satisfies all the four conditions cumulatively.
Condition 1: The passive income of Singtel Ltd. should not be more than 50% of its total
income
Total income of Singtel Ltd. during the P.Y. 2025-26 is ` 110 crores [(` 25 crores + ` 50
crores) + (` 20 crores + ` 15 crores)]
Passive income is the aggregate of, -
(i) income from the transactions where both the purchase and sale of goods is from/to
its associated enterprises; and
(ii) income by way of royalty, dividend, capital gains, interest or rental income;
Passive Income of Singtel Ltd. is ` 50 crores, being sum total of :
(i) ` 15 crores, income from transactions where both purchases and sales are from/to
associated enterprises (` 5 crores in India and ` 10 crores in Singapore)
(ii) ` 35 crores, being interest and dividend from investment (` 20 crores in India and
` 15 crores in Singapore)
Percentage of passive income to total income = ` 50 crore/ ` 110 crore x 100 = 45.45%
Since passive income of Singtel Ltd. is 45.45%, which is not more than 50% of
its total income, the first condition is satisfied.
Condition 2: Singtel Ltd. should have less than 50% of its total assets situated in India
Value of total assets of Singtel Ltd. during the P.Y. 2025-26 is ` 610 crores [` 210 crores,
in India + ` 400 crores, in Singapore]
Value of total assets of Singtel Ltd. in India during the P.Y. 2025-26 is ` 210 crores
Percentage of assets situated in India to total assets = ` 210 crores/` 610 crores x 100
= 34.43%
Since the value of assets of Singtel Ltd. situated in India is less than 50% of its total
assets, the second condition for ABOI test is satisfied.

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Condition 3: Less than 50% of the total number of employees of Singtel Ltd. should
be situated in India or should be resident in India
Number of employees situated in India or are resident in India is 70
Total number of employees of Singtel Ltd. is 160 [70 + 90]
Percentage of employees situated in India or are resident in India to total number of
employees is 70/160 x 100 = 43.75%
Since employees situated in India or are residents in India of Singtel Ltd. are less than
50% of its total employees, the third condition for ABOI test is satisfied.
Condition 4: The payroll expenses incurred on employees situated in India or
resident in India should be less than 50% of its total payroll expenditure
Payroll expenses on employees employed in and resident of India = ` 8 crores.
Total payroll expenses = ` 20 crores (` 8 crores + ` 12 crores)
Percentage of payroll expenses of employees situated in India or are resident in
India to the total payroll expenses = 8 x 100/20 = 40%

Since the payroll expenses incurred on employees situated in India or resident in India is
less than 50% of its total payroll expenditure, the fourth condition for ABOI test is also
satisfied.
Thus, since Singtel Ltd. has satisfied all the four conditions, the company would be said
to be engaged in “active business outside India” during the P.Y. 2025-26.
POEM of a company engaged in active business outside India shall be presumed to be
outside India, if the majority of the board meetings are held outside India.
Since Singtel Ltd. is engaged in active business outside India in the P.Y. 2025-26 and
majority of its board meetings i.e., 5 out of 8, were held outside India, POEM of Singtel
Ltd. would be outside India.
Therefore, Singtel Ltd. would be non-resident in India for the P.Y. 2025-26.
10. Computation of total income of STYLE Inc., a notified FII, for A.Y.2026-27
Particulars ` `
Dividend income 6,20,000
Interest on securities [No deduction is allowable in respect of
expenses incurred in respect thereof] 17,32,000 23,52,000

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Long-term capital gains on sale of bonds of J Ltd.

Sale consideration 47,00,000
Less: Cost of acquisition 32,00,000 15,00,000
[Benefit of indexation is not allowable]
Short-term capital gains on sale of STT paid equity shares of
E Ltd.
Sale consideration 12,40,000
Less: Cost of acquisition 7,80,000 4,60,000
Short-term capital gains on sale on unlisted equity shares of
M Ltd.
Sale consideration 8,40,000
Less: Cost of acquisition 3,72,000 4,68,000
Total Income 47,80,000

Computation of tax liability of STYLE Inc. for A.Y.2026-27

Particulars `
Tax@20% on interest on securities and dividend =20% x ` 23,52,000 4,70,400
Tax@12.5% on long-term capital gains on sale of bonds of J Ltd. = 12.5% x 1,87,500
` 15,00,000
Tax @ 20% on short-term capital gains on sale of listed equity shares of E
Ltd., in respect of which STT has been paid = 20% of ` 4,60,000 92,000
Tax @ 30% on short-term capital gains on sale of unlisted equity shares of
M Ltd. = 30% of ` 4,68,000 1,40,400
8,90,300
Add: HEC@4% 35,612
Tax liability 9,25,912
Tax liability (rounded off) 9,25,910

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CHAPTER a 22
13
DOUBLE TAXATION
RELIEF
LEARNING OUTCOMES

After studying this chapter, you would be able to -

❑ appreciate the need for double taxation relief;
❑ appreciate the types of double taxation relief available;
❑ comprehend and apply the provisions relating to double taxation relief
contained in the Income-tax Act, 1961 and Income-tax Rules, 1962 in
problem solving and addressing related issues;
❑ comprehend the procedure for claiming deduction where there is no
double taxation avoidance agreement between India and the other
country where the income has been taxed and compute the amount of
deduction;
❑ appreciate the concept of Permanent Establishment under double
taxation avoidance agreements and its relevance.

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22.1 CONCEPT OF DOUBLE TAXATION RELIEF

In the present era of cross-border transactions across the globe, the effect of taxation is one of the
important considerations for any trade and investment decision in other countries. One of the most
significant results of globalisation is the visible impact of one country’s domestic tax policies on the
economy of another country. This has led to the need for continuously assessing the tax regimes
of various countries and bringing about necessary reforms.

Where a taxpayer is resident in one country but has a source of income situated in another country
it gives rise to possible double taxation. This arises from the two basic rules that enables the
country of residence as well as the country where the source of income exists to impose tax
namely, (i) the source rule and (ii) the residence rule.
The source rule holds that income is to be taxed in the
country in which it originates irrespective of whether the
income accrues to a resident or a non-resident.
The residence rule stipulates that the power to tax
should rest with the country in which the taxpayer
resides.
If both rules apply simultaneously to a business entity and it were to suffer tax at both ends, the
cost of operating on an international scale would become prohibitive and would deter the process
of globalisation. It is from this point of view that Double Taxation Avoidance Agreements (DTAA)
become very significant.
DTAAs lay down the allocation rules for taxation of the income by the source country and the
residence country. Such rules are laid for various categories of income, for example, interest,
dividend, royalties, capital gains, business income etc. Each such category is dealt with by
separate article in the DTAA.
Double taxation means taxing the same income twice in the hands of an assessee. A particular
income may be taxed in India in the hands of a person based on his/its residence. However, the
same income may be taxed in his/its hands in the Source Country also, as per the domestic laws
of that country. This gives rise to double taxation. It is a universally accepted principle that the
same income should not be subjected to tax twice. In order to take care of such situations, the
Income-tax Act, 1961 has provided for double taxation relief.

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22.2 TYPES OF RELIEF

Relief from double taxation can be provided in mainly two ways:

Relief
Bilateral Unilateral
(1) Under this method, the Governments of two countries can
enter into an agreement to provide relief against double
taxation by mutually working out the basis on which the
relief is to be granted. India has entered into agreements
for relief against or avoidance of double taxation with
almost 100 countries which include Sri Lanka, Switzerland, Sweden, Denmark, Japan,
Federal Republic of Germany, Greece, etc.
Bilateral Relief may be granted in either one of the following methods:

Exemption Method
• A particular income is taxed in only one of the
two countries.

• Income is taxable in both countries in

accordance with their respective tax laws read
with double taxation avoidance agreement.
Tax Credit Method
• The country of residence of the tax payer,
however, allows him credit for the tax charged
thereon in the country of source.

India follows credit method in majority of its DTAAs.

(2) This method provides for double taxation relief unilaterally
by a country to its resident for the taxes paid in the other
country, even where no DTAA has been entered into with
that country. India grants unilateral relief through credit

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method under section 91 to its residents for taxes paid in the country, with which India has
not signed DTAA.
India has introduced foreign tax credit rules under Rule 128 which allows for granting credit
to resident Indians for taxes paid in the other country.

22.3 DOUBLE TAXATION RELIEF PROVISIONS UNDER

THE INCOME TAX ACT, 1961
Sections 90, 90A and 91 of the Income-tax Act, 1961 provide for double taxation relief in
India.
(1) Agreement with foreign countries or specified territories outside India/ Adoption and
implementation of agreement of specified association in India with specified
association in specified territories outside India - Bilateral relief [Section 90/ 90A]
Both sections 90 and 90A provide for bilateral relief of double taxation. Section 90 empowers the
Central Government to enter into an agreement with foreign country or specified territory outside
India while section 90A empower the Central Government to make provisions for adopting and
implementing of any agreement entered by any specified association in India with any specified
association in the specified territory outside India.

(i) The objective of agreement under section 90 and 90A is

(a) for the granting of relief in respect of—
- income on which income-tax has been paid both in India and in that country or
specified territory; or
- income-tax chargeable under this Act and under the corresponding law in
force in that country or specified territory to promote mutual economic
relations, trade and investment; or
(b) for the avoidance of double taxation of income under this Act and under the
corresponding law in force in that country or specified territory, without creating
opportunities for non-taxation or reduced taxation through tax evasion or avoidance
(including through treaty-shopping arrangements aimed at obtaining reliefs provided
in the said agreement for the indirect benefit to residents of any other country or
territory); or

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(c) for exchange of information for the prevention of evasion or avoidance of income -tax
chargeable under this Act or under the corresponding law in force in that country or
specified territory or investigation of cases of such evasion or avoidance; or
(d) for recovery of income-tax under this Act and under the corresponding law in force in
that country or specified territory.
(ii) Where the agreement has been entered under section 90 or 90A for granting of relief of tax
or avoidance of double taxation, then, in relation to the assessee to whom such agreement
applies, the provisions of this Act shall apply to the extent they are more beneficial to that
assessee.
(iii) However, the provisions of Chapter X-A, General Anti-Avoidance Rule, shall apply to the
assessee even if such provisions are not beneficial to him.

(iv) The charge of tax in respect of a foreign company or a company incorporated in the
specified territory outside India at a rate higher than the rate at which a domestic company
is chargeable, shall not be regarded as less favourable charge or levy of tax in respect of
such company.
(v) Any term used in any agreement but not defined in the Act or in the agreement shall have
the same meaning as assigned to in the notification issued by the Central Government in
this behalf, unless the context otherwise requires and is not inconsistent with the
provisions of the Act or the agreement.
Accordingly, the Central Government has, vide Notification No.90/2008 dated 28.8.2008
and Notification No.91/2008 dated 28.8.2008, notified that where an agreement under
section 90A and 90 for granting of relief of tax or avoidance of double taxation provides that
any income of a resident of India may be taxed in the other country, then such income shall
be included in his total income chargeable to tax in India in accordance with the provisions
of the Income-tax Act, 1961, and relief shall be granted in accordance with the method for
elimination or avoidance of double taxation provided in such agreement.
(vi) Meaning of terms used in agreement

Particulars Meaning of the term

(1) Term used in any agreement under The term shall have the meaning
section 90(1) or 90A(1) and not defined assigned in the said notification and
in the agreement or the Act but assigned the meaning shall be deemed to
a meaning in the notification issued by have effect from the date on which

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the Central Government in the Official the agreement came into force.
Gazette, which is still in force.

(2) Term used in any agreement which is The term shall have the same
defined in the agreement itself. meaning assigned to it in the
agreement.

(3) Term used in any agreement, which is The term shall have the meaning
not defined in the said agreement, but assigned to it in the Income-tax Act,
defined in the Income-tax Act, 1961. 1961 and explanation, if any, given
to it by the Central Government.

(vii) The agreement under section 90 and 90A are intended to provide relief to the taxpayer, who
is resident of one of the Contracting States to the agreement. Such taxpayer can claim relief
by applying the beneficial provisions of either the treaty or the domestic law. However, in
many cases, taxpayers who were not residents of a Contracting State also resorted to
claiming the benefits under the agreement. In effect, third party residents claimed the
unintended treaty benefits.
Therefore, section 90(4) and 90A(4) provides that the non-resident to whom the agreement
referred to in section 90(1) or 90A(1) applies, shall be allowed to claim the relief under such
agreements if a Tax Residence Certificate (TRC) obtained by him from the Government of
that country or specified territory, is furnished declaring his residence of the country outside
India or the specified territory outside India, as the case may be.
(viii) A certificate issued by the Government of a foreign country or specified territory outside
India would constitute proof of tax residency, without any further conditions regarding
furnishing of “prescribed particulars” therein. In addition to such certificate, section
90(5)/90A(5) requires the assessee to provide such other documents and information, as
may be prescribed, for claiming the treaty benefits.

Documents and information, to be furnished by the assessee for claiming treaty

benefits, prescribed by CBDT vide Notification No. 57/2013 dated 01.08.2013:
(i) Status (individual, company, firm etc.) of the assessee;

(ii) Nationality (in case of an individual) or country or specified territory of incorporation

or registration (in case of others);
(iii) Assessee's tax identification number in the country or specified territory of residence
and in case there is no such number, then, a unique number on the basis of which

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the person is identified by the Government of the country or the specified territory of
which the assessee claims to be a resident;
(iv) Period for which the residential status, as mentioned in the certificate referred to in
section 90(4) or section 90A(4), is applicable; and
(v) Address of the assessee in the country or specified territory outside India, during the
period for which the certificate, as mentioned in (iv) above, is applicable.
However, the assessee may not be required to provide the information or any part thereof, if
the information or the part thereof, as the case may be, is already contained in the TRC
referred to in section 90(4) or section 90A(4).
The assessee shall keep and maintain such documents as are necessary to substantiate
the information provided. An income-tax authority may require the assessee to provide the
said documents in relation to a claim by the said assessee of any relief under an agreement
referred to in section 90(1) or section 90A(1), as the case may be.

(ix) Circular No. 333 dated 2.4.1982, issued by CBDT provides that a specific provision of the
DTAA will prevail over the general provisions of the Income-tax Act, 1961. However, where
there is no specific provision in the treaty, then the Income-tax Act will apply. Generally,
DTAA only provides for distribution of taxing rights between the residence and the source
state. The computation mechanism is usually not provided under DTAA and the same is
governed by the domestic tax law of each country.
(x) ‘Specified association’ under section 90A means any institution, association or body,
whether incorporated or not, functioning under any law for the time being in force in India or
the laws of the specified territory outside India and which may be notified as such by the
Central Government.
Tax treaties are generally based on certain models. The most common ones are:

Model Tax Conventions

OECD Model Tax Convention U.N. Model Tax Convention

These model tax conventions will be discussed in detail in Chapter 27 “Overview of Model Tax
Conventions”.

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ILLUSTRATION 1
Examine the correctness or otherwise of the following statement with reference to the provisions of
Income-tax Act, 1961.
The double taxation avoidance treaties entered into by the Government of India override the
domestic law.
SOLUTION
The statement is correct.
Section 90(2) provides that where a double taxation avoidance treaty is entered into by the
Government, the provisions of the Income-tax Act, 1961 would apply to the extent they are more
beneficial to the assessee.
In case of any conflict between the provisions of the double taxation avoidance agreement and the
Income-tax Act, 1961, the provisions of the DTAA would prevail over the Act in view of the
provisions of section 90(2), to the extent they are more beneficial to the assessee [ CIT v. P.V.A.L.
Kulandagan Chettiar (2004) 267 ITR 654 (SC)].
(2) Countries with which no agreement exists – Unilateral Agreements [Section 91]

In the case of income arising to an assessee in countries with which India does not have any
double taxation agreement, relief would be granted under section 91 provided all the following
conditions are fulfilled:
(a) The assessee is a resident in India during the previous year in respect of which the income
is taxable.
(b) The income accrues or arises to him outside India.
(c) The income is not deemed to accrue or arise in India during the previous year.
(d) The income in question has been subjected to income-tax in the foreign country in the
hands of the assessee.
(e) The assessee has paid tax on the income in the foreign country.
(f) There is no agreement for relief from double taxation between India and the other country
where the income has accrued or arisen.

In such a case, the assessee shall be entitled to a deduction from the Indian income -tax payable
by him. The deduction would be a sum calculated on such doubly taxed income at the Indian rate
of tax or the rate of tax in the said country, whichever is lower, or at the Indian rate of tax if both
the rates are equal.

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Meaning of important terms:

Term Meaning
Indian rate of The rate determined by dividing the amount of Indian income-tax after
tax deduction of any relief due under the provisions of the Act but before deduction
of any double taxation relief due to the assessee
Rate of tax of Income-tax and super-tax actually paid in that country in accordance with the
the said corresponding laws in force in the said country after deduction of all relief due,
country but before deduction on account of double taxation relief due in the said
country, divided by the whole amount of income assessed in the said country
Income-tax in It includes any excess profits tax or business profits tax charged on the profits
relation to by the Government of any part of that country or a local authority in that country
any country

ILLUSTRATION 2
Nandita, an individual resident retired employee of the Prasar Bharati aged 60 years, is a well -
known dramatist deriving income of ` 1,10,000 from theatrical works played abroad. Tax of
` 11,000 was deducted in the country where the plays were performed. India does not have any
Double Tax Avoidance Agreement under section 90 of the Income-tax Act, 1961, with that country.
Her income in India amounted to ` 6,10,000. In view of tax planning, she has deposited ` 1,50,000
in Public Provident Fund and paid contribution to approved Pension Fund of LIC ` 32,000. She
also contributed ` 28,000 to Central Government Health Scheme during the previous year and
gave payment of medical insurance premium of ` 26,000 to insure the health of her mother, a non-
resident aged 84 years, who is not dependent on her. Compute the tax liability of Nandita for the
Assessment year 2026-27, assuming that she opted out of the default tax regime under section
115BAC.
SOLUTION
Computation of tax liability of Nandita for the A.Y. 2026-27
under normal provisions of the Act

Particulars ` `
Indian Income 6,10,000
Foreign Income 1,10,000
Gross Total Income 7,20,000
Less: Deduction under section 80C
Deposit in PPF 1,50,000

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Under section 80CCC

Contribution to approved Pension Fund of LIC 32,000
1,82,000
Under section 80CCE
The aggregate deduction under section 80C, 80CCC and
80CCD(1) has to be restricted to ` 1,50,000 1,50,000
Under section 80D
Contribution to Central Government Health Scheme
` 28,000 is also allowable as deduction under section 80D.
Since she is a resident senior citizen, the deduction is
allowable to a maximum of ` 50,000 (See Note 1) 28,000
Medical insurance premium of ` 26,000 paid for mother aged
84 years. Since the mother is a non-resident in India, she will
not be entitled for the higher deduction of ` 50,000 eligible for
a senior citizen, who is resident in India. Hence, the deduction
will be restricted to maximum of ` 25,000. 25,000 2,03,000
Total Income 5,17,000
Tax on Total Income
Income-tax (See Note below) 13,400
Add: Health and Education Cess @4% 536
13,936
Average rate of tax in India 2.696%
(i.e. ` 13,936/ ` 5,17,000 × 100)
Average rate of tax in foreign country 10%
(i.e. ` 11,000/ ` 1,10,000 × 100)
Deduction under section 91 on ` 1,10,000 @ 2.696% (lower of
average Indian-tax rate or average foreign tax rate) 2,966
Tax payable in India (` 13,936 – ` 2,966) 10,970

Notes:
1. Section 80D allows a higher deduction of up to ` 50,000 in respect of the medical premium
paid to insure the heath of a senior citizen. Therefore, Nandita will be allowed deduction of
` 28,000 under section 80D, since she is a resident Indian of the age of 60 years.

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2. The basic exemption limit for senior citizens under the normal provisions of the Act is
` 3,00,000 and the age criterion for qualifying as a “senior citizen” for availing the higher
basic exemption limit is 60 years. Accordingly, Nandita is eligible for the higher basic
exemption limit of ` 3,00,000, since she is 60 years old.
3. An assessee shall be allowed deduction under section 91 provided all the following
conditions are fulfilled:-
(a) The assessee is a resident in India during the relevant previous year.
(b) The income accrues or arises to him outside India during that previous year.

(c) Such income is not deemed to accrue or arise in India during the previous year.
(d) The income in question has been subjected to income-tax in the foreign country in
the hands of the assessee and the assessee has paid tax on such income in the
foreign country.
(e) There is no agreement under section 90 for the relief or avoidance of double taxation
between India and the other country where the income has accrued or arisen.

In this case, since all the above conditions are satisfied, Nandita is eligible for deduction u/s 91.
(3) Foreign Tax Credit [Rule 128 of Income-tax Rules, 1962]
(i) Year of availability of credit for foreign tax paid
An assessee, being a resident shall be allowed a credit for the amount of any foreign tax
paid by him in a country or specified territory outside India, by way of deduction or
otherwise, in the year in which the income corresponding to such tax has been offered to
tax or assessed to tax in India, in the manner and to the extent as specified in this rule .
However, in a case where income on which foreign tax has been paid or deducted, is
offered to tax in more than one year, credit of foreign tax shall be allowed across those
years in the same proportion in which the income is offered to tax or assessed to tax in
India.
(ii) Meaning of “Foreign tax”:

Country/Specified Foreign Tax

Territory
(i) in respect of a country or the tax covered under the said agreement
specified territory outside
India with which India has

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entered into an agreement

for the relief or avoidance
of double taxation of
income in terms of section
90 or section 90A
(ii) in respect of any other the tax payable under the law in force in that country
country or specified or specified territory in the nature of income-tax
territory outside India referred to in section 91.
For this purpose, income-tax in relation to any
country includes any excess profits tax or business
profits tax charged on the profits by the Government
of any part of that country or a local authority in that
country.

(iii) Components of income-tax in respect of which FTC is available

Foreign Tax Credit (FTC) is available against the amount of tax, surcharge and cess
payable under the Income-tax Act, 1961. However, it is not available in respect of any sum
payable by way of interest, fee or penalty.
(iv) Manner of computing FTC
The credit of foreign tax would be the aggregate of the amounts of credit computed
separately for each source of income arising from a particular country or specified territory
outside India and shall be given effect to in the following manner:-
(a) the credit would be the lower of the tax payable under the Income-tax Act, 1961 on
such income and the foreign tax paid on such income.
However, where the foreign tax paid exceeds the amount of tax payable in
accordance with the provisions of the agreement for relief or avoidance of double
taxation, such excess has to be ignored.
(b) the credit would be determined by conversion of the currency of payment of foreign
tax at the telegraphic transfer buying rate on the last day of the month immediately
preceding the month in which such tax has been paid or deducted.
Note – Students are advised to refer to Rule 128 of Income-tax Rules, 1961 given as Annexure 2
at the end of this module.

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Summary

DT Relief under the Income-tax

Act, 1961

Bilateral Relief [Section 90/90A] Unilateral Relief [Section 91]

Agreement with foreign countries or specified

Countries with which no agreement exists
territories

• The Central Government may enter

into an agreement with the
Government of any country outside
India or specified territory or
specified assn outside India,— • Assessee, who is a resident in
• for the granting of relief in respect of Applicability India during the PY
doubly taxed income
• for the avoidance of double taxation
Objective
of income without creating
opportunities for non-taxation or
reduced taxation through tax evasion
or avoidance
• for exchange of information for the
prevention of evasion or avoidance of
income-tax
• for recovery of income-tax
• The income accrues or arises to
him outside India.
• Taxability of income would be detd • The income is not deemed to
Taxability based on DTAA or the Income-tax Act, accrue or arise in India during the
1961, whichever is more beneficial. PY.
• The income in question has been
Conditions subjected to income-tax in the
• The charge of tax in respect of a foreign foreign country in the hands of the
Charge of company at a rate higher than the rate assessee.
tax on at which a domestic company is • The assessee has paid tax on the
chargeable, shall not be regarded as income in the foreign country.
foreign
less favourable charge or levy of tax in • There is no agrmt for relief from
Company
respect of such foreign company. DT between India and the other
country where the income has
accrued or arisen.

• In order to claim DT relief, the non-

resident to whom such DTAA applies,
Tax has to obtain a TRC from the
Residency Government of that country or
specified territory. Computation • Doubly taxed income x Indian
Certificate • The non-resident to also provide rate of tax or Rate of tax in the
of Relief
(TRC) such other documents and said country, whichever is lower
information, as may be prescribed,
for claiming treaty benefits.

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22.4 CONCEPT OF PERMANENT ESTABLISHMENT

Under the Income-tax Act, 1961, the taxability of business profits is determined by existence
of business connection in India under section 9(1)(i). Under the DTAA, taxability of business
profits is determined by existence of a Permanent Establishment (PE) in India. It may be
noted that the scope of business connection under section 9(1)(i) is wider than that of a PE.
Article 5(1) of the DTAA usually provides that for the purpose of this convention, the term
‘Permanent Establishment’ means a fixed place of business through which the business of an
enterprise is wholly or partly carried on. The term PE is also defined under section 92F(iiia) to
include a fixed place of business through which the business of the enterprise is wholly or
partly carried on.
According to Article 5(2), the term PE includes

A place of
A mine, an oil or gas management
well, a quarry, or any
other place of A branch
extraction of natural
resources (not
exploration)

An office
A warehouse PE

A factory
A sales outlet

A workshop

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(1) Permanent establishment means a fixed place of business through which the business of an
enterprise is wholly or partly carried on.
(2) Every DTAA has a specific clause, which will deal with an explanation of permanent
establishment for the purpose of such DTAA.
(3) Business Income of a non-resident will not be taxed in India, unless such non-resident has
a permanent establishment in India.
(4) Taxability of income under business connection and permanent establishment is explained
here below:

Income of a Non-resident

Taxability under the Income-tax Taxability under the DTAA

Act, 1961

Governed by Sec. 9 Governed by DTAA

On the basis of business On the basis of permanent

connection establishment

(5) Liaison Office – Does it constitute a PE?

(i) Liaison Office engaged in remittance services - In Union of India v. UAE
Exchange Center (2020) 425 ITR 30, the Supreme Court held that an Indian liaison
office of a foreign enterprise engaged in remittance services would not constitute a
PE. In this case, no permission was given by RBI to the assessee to engage in
primary business activity and establish a business connection. The liaison office
downloads information (such as names and addresses of beneficiaries, amount to be
remitted, etc.) by accessing the main servers of assessee in UAE, prints
cheques/draft and dispatches them to the addresses of beneficiaries through courier.
The Supreme Court held that even if the activities of LO are regarded as business
activities, they were of preparatory or auxiliary character.

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(ii) Liaison Office as Communication Channel - In DIT (International Taxation) v.

Samsung Heavy Industries Ltd. (2020) 426 ITR 1 (SC), the project office was set up
solely as an auxiliary office meant to act as liaison office between ONGC and the
assessee. No expenditure relating to execution of contract was incurred by the
project office. Only two persons were working in the project office and they were not
qualified to perform any core activity of the assessee. Therefore, the Supreme Court
held that the project office is not a fixed place of business through which core
business of assessee is carried on, and hence, the same would not constitute a PE.

Identifying new customers, marketing activities, price negotiation, discussion of

commercial issues, securing and processing orders have led to the liaison office
forming a PE.

22.5 TAXATION OF BUSINESS PROCESS OUTSOURCING

UNITS IN INDIA
The provisions containing taxation of IT-enabled business process outsourcing units are not
contained in the Income-tax Act, 1961 but are given in Circular No.5/2004 dated 28.9.2004 issued
by CBDT. The provisions are briefed hereunder –

(a) A non-resident entity may outsource certain services to a resident Indian entity. If there is
no business connection between the two, the resident entity may not be a Permanent
Establishment of the non-resident entity, and the resident entity would have to be assessed
to income-tax as a separate entity. In such a case, the non-resident entity will not be liable
under the Income-tax Act, 1961.

(b) However, it is possible that the non-resident entity may have a business connection with the
resident Indian entity. In such a case, the resident Indian entity could be treated as the
Permanent Establishment of the non-resident entity.

(c) The non-resident entity or the foreign company will be liable to tax in India only if the IT
enabled BPO unit in India constitutes its Permanent Establishment.

(d) A non-resident or a foreign company is treated as having a Permanent Establishment in

India if the said non-resident or foreign company carries on business in India through a

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branch, sales office etc. or through an agent (other than an independent agent) who
habitually exercises an authority to conclude contracts or regularly delivers goods or
merchandise or habitually secures orders on behalf of the non-resident principal. In such a
case, the profits of the non-resident or foreign company attributable to the business
activities carried out in India by the Permanent Establishment becomes taxable in India.

(e) If a foreign enterprise carries on business in another country through a Permanent

Establishment situated therein, the profits of the enterprise may be taxed in the other
country but only so much of them as is attributable to the Permanent Establishment.

(f) Profits are to be attributed to the Permanent Establishment as if it were a distinct and
separate enterprise engaged in the same or similar activities under the same or similar
conditions and dealing wholly independently with the enterprise of which it is a Permanent
Establishment.

(g) In determining the profits of a Permanent Establishment there shall be allowed as

deduction, expenses which are incurred for the purposes of the Permanent Establishment
including executive and general administrative expenses so incurred, whether in the State
in which the Permanent Establishment is situated or elsewhere.

(h) The expenses that are deductible would have to be determined in accordance with the
accepted principles of accountancy and the provisions of the Income-tax Act, 1961.

(i) The profits to be attributed to a Permanent Establishment are those which that Permanent
Establishment would have made if, instead of dealing with its Head Office, it had been
dealing with an entirely separate enterprise under conditions and at prices prevailing in the
ordinary market. This corresponds to the “arm’s length principle”.

(j) Hence, in determining the profits attributable to an IT-enabled BPO unit constituting a
Permanent Establishment, it will be necessary to determine the price of the services
rendered by the Permanent Establishment to the Head office or by the Head office to the
Permanent Establishment on the basis of “arm’s length principle”.

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TEST YOUR KNOWLEDGE

Questions
1. Cosmos Limited, a company incorporated in Mauritius, has a branch office in Hyderabad
opened in April, 2025. The Indian branch has filed return of income for assessment year
2026-27 disclosing income of ` 50 lakhs. It paid tax at the rate applicable to domestic
company i.e. 30% plus higher education cess@4% on the basis of paragraph 2 of Article 24
(Non-Discrimination) of the Double Taxation Avoidance Agreement between India and
Mauritius, which reads as follows:
"The taxation on a permanent establishment which an enterprise of a Contracting State has
in the other Contracting State shall not be less favourably levied in that other State than the
taxation levied on enterprises of that other State carrying on the same activities in the same
circumstances."
However, the Assessing Officer computed tax on the Indian branch at the rate applicable to
a foreign company i.e. 35% plus higher education cess@4%.
Is the action of the Assessing Officer in accordance with law?
2. Kalpesh Kumar, a resident individual, is a musician deriving income of ` 7,50,000 from
concerts performed outside India. Tax of ` 1,00,000 was deducted at source in the country
where the concerts were performed. India does not have any double tax avoidance
agreement with that country. His income in India amounted to ` 30,00,000. Compute net tax
liability of Kalpesh Kumar for the assessment year 2026-27 assuming he has deposited
` 1,50,000 in Public Provident Fund and paid medical insurance premium in respect of his
father, resident in India, aged 65 years, ` 52,000.
3. The following are the particulars of income earned by Miss Vivitha, a resident Indian aged
25, for the assessment year 2026-27:
(` In lakhs)
Income from playing snooker matches in country L 12.00
Tax paid in country L 1.80
Income from playing snooker tournaments in India 19.20
Life Insurance Premium paid 1.10
Medical Insurance Premium paid for her father (resident Indian) aged 62 0.54
years (paid through credit card)
Compute her total income and net tax liability for the assessment year 2026-27. There is no
Double Taxation Avoidance Agreement between India and country L.

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4. The concept of Permanent Establishment is one of the most important concepts in

determining the tax implications of cross border transactions. Examine the significance
thereof, when such transactions are governed by Double Taxation Avoidance Agreements
(DTAA).
5. An individual resident in India, having income earned outside India in a country with which
no agreement under section 90 exists, asks you to examine whether the credit for the tax
paid on the foreign income will be allowed against his income-tax liability in India.
6. The Income-tax Act, 1961 provides for taxation of a certain income earned in India by Mr. X,
a non-resident. The Double Taxation Avoidance Agreement, which applies to Mr. X provides
for taxation of such income in the country of residence. Is Mr. X liable to pay tax on such
income earned by him in India? Examine.

7. Arif is a resident of both India and another foreign country in the previous year 2025-26. He
owns immovable properties (including residential house) in both the countries. He earned
income of ` 50 lakhs from rubber estates in the foreign country during the financial year
2025-26. He also sold some house property situated in foreign country resulting in short -
term capital gain of ` 10 lakhs during the year. Arif has no permanent establishment of
business carried on in India. However, he has derived rental income of ` 6 lakhs from
property let out in India and he has a house in Lucknow where he stays during his visit to
India.
Article 4 of the Double Taxation Avoidance Agreement between India and the foreign
country where Arif is a resident, provides that “where an individual is a resident of both the
Contracting States, then, he shall be deemed to be resident of the Contracting State in
which he has permanent home available to him. If he has permanent home in both the
Contracting States, he shall be deemed to be a resident of the Contracting State with which
his personal and economic relations are closer (centre of vital interests)”.
You are required to examine with reasons whether the business income of Arif arising in
foreign country and the capital gains in respect of sale of the property situated in foreign
country can be taxed in India.
8. Mr. Kamesh, an individual resident in India aged 52 years, furnishes you the following
particulars of income earned in India, Country "X" and Country "Y" for the previous year
2025-26. India has not entered into double taxation avoidance agreement with these two
countries.

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 22.20 INTERNATIONAL TAXATION

Particulars `
Income from profession carried on in India 7,50,000
Agricultural income in Country "X" (gross) 50,000
Dividend from a company incorporated in Country "Y" (gross) 1,50,000
Royalty income from a literary book from Country "X" (gross) 6,00,000
Expenses incurred for earning royalty 50,000
Business loss in Country "Y" (Proprietary business) 65,000
Rent from a house situated in Country "Y" (gross) 2,40,000
Municipal tax paid in respect of the above house in Country “Y” (not 10,000
allowed as deduction in country “Y”)

Note: Business loss in Country "Y" not eligible for set off against other incomes as per law
of that country.
The rates of tax in Country "X" and Country "Y" are 10% and 20%, respectively.
Compute total income and net tax liability of Mr. Kamesh in India for Assessment Year
2026-27, assuming that he opted out of the default tax regime under section 115BAC.
9. Mr. Anil, aged 49 years, a resident individual furnishes the following particulars of income
earned by him in India and Country N for the previous year 2025-26. India does not have a
double taxation avoidance agreement (DTAA) with Country N.
Particulars Amount (`)
Income from profession carried on in Mumbai 8,50,000
Agricultural Income in Country N 1,30,000
Dividend from a company incorporated in Country N (gross) 85,000
Royalty income from a literary book from Country N (gross) 6,25,000
Expenses incurred for earning royalty 75,000
Business loss in Country N 1,10,000

The domestic tax laws of Country N does not permit set-off of business loss against any
other income. The rate of income-tax in Country N is 18%. Compute total income and net
tax liability of Mr. Anil in India for A.Y. 2026-27, assuming that he satisfies all conditions for
the purpose of section 91 and he opted out of the default tax regime under section 115BAC.

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10. Mr. Ravi, an individual resident in India aged 45 years, furnishes you the following
particulars of income earned in India, Foreign Countries "S" and "T" for the previous year
2025-26.
Particulars `
Indian Income:
Income from business carried on in Mumbai 4,40,000
Interest on savings bank with ICICI Bank 42,000
Income earned in Foreign Country “S” [Rate of tax – 16%]:
Agricultural income in Country "S" 94,000
Royalty income from a book on art from Country "S" (Gross) 7,80,000
Expenses incurred for earning royalty 50,000
Income earned in Foreign Country “T” [Rate of tax – 20%]:
Dividend from a company incorporated in Country "T" (Gross) 2,65,000
Rent from a house situated in Country "T" (Gross) 3,30,000
Municipal tax paid in respect of the above house (not allowed as deduction in 10,000
Country “T”)

Compute the total income and net tax liability of Mr. Ravi in India for A.Y. 2026-27 assuming
that India has not entered into double taxation avoidance agreement with Countries S & T.

Answers
1. Under section 90(2), where the Central Government has entered into an agreement for
avoidance of double taxation with the Government of any country outside India or specified
territory outside India, as the case may be, then, in relation to the assessee to whom such
agreement applies, the provisions of the Income-tax Act, 1961 shall apply to the extent they
are more beneficial to the assessee. Thus, in view of paragraph 2 of Article 24 (Non -
discrimination of the DTAA, it appears that the Indian branch of Cosmos Limited,
incorporated in Mauritius, is liable to tax in India at the rate applicable to domestic company
(30%), which is lower than the rate of tax applicable to a foreign company (35%).
However, Explanation 1 to section 90 clarifies that the charge of tax in respect of a foreign
company at a rate higher than the rate at which a domestic company is chargeable, shall
not be regarded as less favourable charge or levy of tax in respect of such foreign
company. Therefore, in view of this Explanation, the action of the Assessing Officer in
levying tax@35% on the Indian branch of Cosmos Ltd. is in accordance with law.

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2. Computation of net tax liability of Mr. Kalpesh for A.Y.2026-27

under the default tax regime under section 115BAC
(assuming that he pays tax under the default tax regime)
Particulars ` `
Indian Income 30,00,000
Foreign Income 7,50,000
Gross Total Income 37,50,000
Less: Deduction under VI-A [Not available under default tax Nil
regime]
Total Income 37,50,000
Tax on total income 7,05,000
Add: Health and Education cess @4% 28,200
7,33,200
Average rate of tax in India [i.e., ` 7,33,200 /` 37,50,000 x 100] 19.552%
Average rate of tax in foreign country
[i.e. ` 1,00,000/ ` 7,50,000 x 100] 13.333%
Doubly taxed income 7,50,000
Deduction under section 91 on ` 7,50,000 @13.333%
(lower of average Indian tax rate and foreign tax rate] 1,00,000
Net tax liability in India [` 7,33,200 – ` 1,00,000] 6,33,200

Computation of net tax liability of Mr. Kalpesh for A.Y.2026-27

under the normal provisions of the Act
(assuming that he has exercised the option to shift out of default tax regime)
Particulars ` `
Indian Income 30,00,000
Foreign Income 7,50,000
Gross Total Income 37,50,000
Less: Deduction under section 80C
PPF Contribution 1,50,000
Deduction under section 80D
Medical insurance premium of father, being a resident
senior citizen, restricted to 50,000
2,00,000
Total Income 35,50,000

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Tax on total income 8,77,500

Add: Health and Education cess @4% 35,100
9,12,600
Average rate of tax in India [i.e., ` 9,12,600 /` 35,50,000 x 100] 25.707%
Average rate of tax in foreign country
[i.e. ` 1,00,000/ ` 7,50,000 x 100] 13.333%
Doubly taxed income 7,50,000
Deduction under section 91 on ` 7,50,000 @13.333%
(lower of average Indian tax rate and foreign tax rate] 1,00,000
Net tax liability in India [` 9,12,600 – ` 1,00,000] 8,12,600

Note: An assessee shall be allowed deduction under section 91 provided all the following
conditions are fulfilled:-

(a) The assessee is a resident in India during the relevant previous year.
(b) The income accrues or arises to him outside India during that previous year.
(c) Such income is not deemed to accrue or arise in India during the previous year.

(d) The income in question has been subjected to income-tax in the foreign country in
the hands of the assessee and the assessee has paid tax on such income in the
foreign country.

(e) There is no agreement under section 90 for the relief or avoidance of double taxation
between India and the other country where the income has accrued or arisen.
In this case, Kalpesh Kumar is eligible for deduction under section 91 since all the above
conditions are fulfilled.
3. Computation of total income and net tax liability of Miss Vivitha for the A.Y. 202 6-27
under the default tax regime under section 115BAC
(assuming that she pays tax under the default tax regime)
Particulars ` `
Indian Income [Income from playing snooker tournaments in India] 19,20,000
Foreign Income [Income from playing snooker matches in country L] 12,00,000
Gross Total Income 31,20,000
Less: Deduction under Chapter VIA Nil
Total Income 31,20,000

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Tax on Total Income

Income-tax 5,16,000
Add: Health and education cess @4% 20,640
5,36,640
Average rate of tax in India 17.20%
(i.e. ` 5,36,640/` 31,20,000 × 100)
Average rate of tax in foreign country 15.00%
(i.e. ` 1,80,000/ `12,00,000 ×100)
Deduction under section 91 on ` 12 lakh @ 15% (lower of
average Indian-tax rate or average foreign tax rate) 1,80,000
Net tax liability in India (` 5,36,640 – ` 1,80,000) 3,56,640

Computation of total income and net tax liability of Miss Vivitha for the A.Y. 2026-27
under the normal provisions of the Act
(assuming that she has exercised the option to shift out of default tax regime)
Particulars ` `
Indian Income [Income from playing snooker tournaments in 19,20,000
India]
Foreign Income [Income from playing snooker matches in 12,00,000
country L]
Gross Total Income 31,20,000
Less: Deduction under Chapter VIA
Deduction under section 80C
Life insurance premium of ` 1,10,000 paid during the
previous year deduction, is within the overall limit of ` 1.5
lakh. Hence, fully allowable as deduction 1,10,000
Deduction under section 80D
Medical insurance premium of ` 54,000 paid for her
father aged 62 years. Since her father is a senior citizen,
the deduction is allowable to a maximum of ` 50,000.
Further, deduction is allowable where payment is made
by any mode other than cash. Here payment is made by
credit card hence, eligible for deduction. 50,000 1,60,000
Total Income 29,60,000
Tax on Total Income
Income-tax 7,00,500

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Add: Health and education cess @4% 28,020

7,28,520
Average rate of tax in India 24.61%
(i.e. ` 7,28,520/` 29,60,000 × 100)
Average rate of tax in foreign country 15.00%
(i.e. ` 1,80,000/ `12,00,000 ×100)
Deduction under section 91 on ` 12 lakh @ 15% (lower of
average Indian-tax rate or average foreign tax rate) 1,80,000
Net tax liability in India (` 7,28,520 – ` 1,80,000) 5,48,520

Note: Miss Vivitha shall be allowed deduction under section 91, since the following
conditions are fulfilled:-
(a) She is a resident in India during the relevant previous year.
(b) The income accrues or arises to her outside India during that previous year and such
income is not deemed to accrue or arise in India during the previous year.
(c) The income in question has been subjected to income-tax in the foreign country L in
her hands and she has paid tax on such income in the foreign country L.
(d) There is no agreement under section 90 for the relief or avoidance of double taxation
between India and country L where the income has accrued or arisen.
4. Double Taxation Avoidance Agreements (DTAAs) generally contain an Article providing that
business income is taxable in the country of residence, unless the enterprise has a
permanent establishment in the country of source, and such income can be attributed to the
permanent establishment.
As per section 92F(iiia), the term “Permanent Establishment” includes a fixed place of
business through which the business of an enterprise is wholly or partly carried on.

As per this definition, to constitute a permanent establishment, there must be a place of

business which is fixed and the business of the enterprise must be carried out wholly or
partly through this place.

Section 9(1)(i) requires existence of business connection for deeming business income to
accrue or arise in India. DTAAs, however, provide that business income is taxable only if
there is a permanent establishment in India. As per section 90(2), the provisions of the
Income-tax Act, 1961 or the DTAA, whichever is beneficial, shall apply. The PE concept is
narrower than the business connection concept. Therefore, in a case where the Indian

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Government has entered into DTAA with a country, unless and until the PE test is satisfied,
the business income would not be taxable in the source country.
However, in cases not covered by DTAAs, business income attributable to business
connection is taxable.
5. The assessee is a resident in India and accordingly, the income accruing or arising to him
globally is chargeable to tax in India. However, section 91 specifies that if a person resident
in India has paid tax in any country with which no agreement under section 90 exists, then,
for the purpose of relief or avoidance of double taxation, a deduction is allowed from the
Indian income-tax payable by him, of a sum calculated on such doubly taxed income at
Indian rate of tax or the rate of tax of such foreign country, whichever is lower, or at the
Indian rate of tax, if both the rates are equal. Accordingly, the assessee shall not be given
any credit of the tax paid on the income in other country, but shall be allowed a deduction
from the Indian income-tax payable by him as per section 91 read with Rule 128 on Foreign
Tax Credit.
6. Section 90(2) makes it clear that where the Central Government has entered into a Double
Taxation Avoidance Agreement with a country outside India, then in respect of an assessee
to whom such agreement applies, the provisions of the Act shall apply to the extent they are
more beneficial to the assessee. This means that where the DTAA has been entered, the
assessee can opt to be governed by the provisions of DTAA if the provisions are beneficial
in comparison to provisions of Act.
However, as per section 90(4), the assessee, in order to claim relief under the agreement,
has to obtain a certificate [Tax Residence Certificate (TRC)] from the Government of that
country, declaring the residence of the country outside India. Further, he also has to provide
the following information in Form No. 10F:
(i) Status (individual, company, firm etc.) of the assessee;
(ii) PAN of the assessee, if allotted;
(iii) Nationality (in case of an individual) or country or specified territory of incorporation
or registration (in case of others);

(iv) Assessee's tax identification number in the country or specified territory of residence
and in case there is no such number, then, a unique number on the basis of which
the person is identified by the Government of the country or the specified territory of
which the assessee claims to be a resident;

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(v) Period for which the residential status, as mentioned in the certificate referred to in
section 90(4) or section 90A(4), is applicable; and
(vi) Address of the assessee in the country or specified territory outside India, during the
period for which the certificate, as mentioned in (v) above, is applicable.
However, the assessee may not be required to provide the information or any part thereof, if
the information or the part thereof, as the case may be, is already contained in the TRC
referred to in section 90(4) or section 90A(4).
The Supreme Court has held, in CIT v. P.V.A.L. Kulandagan Chettiar (2004) 267 ITR 654,
that in case of any conflict between the provisions of the Double Taxation Avoidance
Agreement and the Income-tax Act, 1961, the provisions of the Double Taxation Avoidance
Agreement would prevail over those of the Income-tax Act, 1961. Mr. X is, therefore, not
liable to pay tax on the income earned by him in India provided he submits the Tax
Residence Certificate obtained from the government of the other country and provides such
other documents and information as may be prescribed.
7. Section 90(2) of the Income-tax Act, 1961 provides that where the Central Government has
entered into an agreement with the Government of any other country for granting relief of
tax or for avoidance of double taxation, then, in relation to the assessee to whom such
agreement applies, the provisions of the Income-tax Act, 1961 shall apply to the extent they
are more beneficial to that assessee.
In this case, Arif is resident of both India and the foreign country. Therefore, the DTAA
provides for a tie-breaker rule wherein if a person is resident of two countries, he shall be
deemed to be resident of the Contracting State in which he has permanent home available
to him. If he has permanent home in both the Contracting States, he shall be deemed to be
a resident of the Contracting State with which his personal and economic relations are
closer (centre of vital interests).
Arif has residential houses both in India and foreign country. Thus, he has a permanent
home in both the countries.
Arif owns rubber estates in a foreign country from which he derives business income.
However, Arif has no permanent establishment of his business in India. Therefore , his
personal and economic relations with foreign country are closer, since foreign country is the
place where –
(a) the property is located and
(b) the permanent establishment (PE) has been set-up

Therefore, he shall be deemed to be resident of the foreign country for A.Y. 2026-27.

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The fact of the case and issues arising therefrom are similar to that of CIT vs. P.V.A.L.
Kulandagan Chettiar (2004) 267 ITR 654, where the Supreme Court held that if an
assessee is deemed to be a resident of a Contracting State where his personal and
economic relations are closer, then in such a case, the fact that he is a resident in India to
be taxed in terms of sections 4 and 5 would become irrelevant, since the DTAA prevails
over sections 4 and 5. Accordingly, only the income accruing or arising or deemed to
accrue or arise in India shall be taxable in India in the hands of Arif.
However, as per section 90(4), in order to claim relief under the agreement, Arif has to
obtain a certificate [Tax Residency Certificate (TRC)] declaring his residence of the country
outside India from the Government of that country. Further, he also has to provide such
other documents and information, as may be prescribed.

Therefore, in this case, Arif is not liable to income tax in India for assessment year 2026-27
in respect of business income and capital gains arising in the foreign country provided he
furnishes the Tax Residency Certificate and provides such other documents and information
as may be prescribed.
8. Computation of total income of Mr. Kamesh for A.Y.2026-27
under normal provisions of the Act
Particulars ` `
Income from House Property [House situated in country Y]
Gross Annual Value 1 2,40,000
Less: Municipal taxes 10,000
Net Annual Value 2,30,000
Less: Deduction under section 24 – 30% of NAV 69,000
1,61,000
Profits and Gains of Business or Profession
Income from profession carried on in India 7,50,000
Royalty income from a literary book from Country X (after 5,50,000
deducting expenses of ` 50,000)
13,00,000
Less: Business loss in country Y set-off2 65,000
12,35,000

1 Rental Income has been taken as GAV in the absence of other information relating to fair rent, municipal value
etc.
2 As per section 70(1), inter-source set-off of income is permitted.

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 DOUBLE TAXATION RELIEF 22.29
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Income from Other Sources

Agricultural income in country X 50,000
Dividend from a company in country Y 1,50,000 2,00,000
Gross Total Income 15,96,000
Less: Deduction under Chapter VIA
Under section 80QQB – Royalty income of a resident
from literary work 3 3,00,000
Total Income 12,96,000

Note – Since adjusted total income (i.e., ` 15,96,000) does not exceed ` 20 lakhs, AMT
would not be attracted in this case.
Computation of net tax liability of Mr. Kamesh for A.Y.2026-27

Particulars `
Tax on total income [30% of ` 2,96,000 + ` 1,12,500] 2,01,300
Add: Health and Education cess@4% 8,052
2,09,352
Less: Deduction under section 91 (See Working Note below) 69,739
Net tax liability 1,39,613
Net tax liability (rounded off) 1,39,610
Working Note: Calculation of Rebate under section 91
` `
Average rate of tax in India [i.e., ` 2,09,352 / ` 12,96,000 x 100] 16.154%
Average rate of tax in country X 10%
Doubly taxed income pertaining to country X
Agricultural Income 50,000
Royalty Income [` 6,00,000 – ` 50,000 (Expenses) – ` 3,00,000
(deduction under section 80QQB)] 4 2,50,000
3,00,000
Deduction under section 91 on ` 3,00,000 @10% [being the lower 30,000
of average Indian tax rate (16.154%) and foreign tax rate (10%)]

3 It is assumed that the royalty earned outside India has been brought into India in convertible foreign
exchange within a period of six months from the end of the previous year.
4 Doubly taxed income includes only that part of income which is included in the assessee’s total income.

The amount deducted under Chapter VIA is not doubly taxed and hence, no relief is allowable in respect of
such amount – CIT v. Dr. R.N. Jhanji (1990) 185 ITR 586 (Raj.).

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 22.30 INTERNATIONAL TAXATION

Average rate of tax in country Y 20%

Doubly taxed income pertaining to country Y
Income from house property 1,61,000
Dividend 1,50,000
3,11,000
Less: Business loss set-off 65,000
2,46,000
Deduction u/s 91 on ` 2,46,000 @16.154% (being the lower of
average Indian tax rate (16.154%) and foreign tax rate (20%)] 39,739
Total rebate under section 91 (Country X + Country Y) 69,739

Note: Mr. Kamesh shall be allowed deduction u/s 91, since the following conditions are
fulfilled:-

(a) He is a resident in India during the relevant previous year (i.e., P.Y.20 25-26).

(b) The income in question accrues or arises to him outside India in foreign countries X
and Y during that previous year and such income is not deemed to accrue or arise in
India during the previous year.

(c) The income in question has been subjected to income-tax in the foreign countries X
and Y in his hands and it is presumed that he has paid tax on such income in those
countries.

(d) There is no agreement under section 90 for the relief or avoidance of double taxation
between India and Countries X and Y where the income has accrued or arisen.
9. Computation of total income of Mr. Anil for A.Y.2026-27
under normal provisions of the Act

Particulars ` `
Profits and Gains of Business or Profession
Income from profession carried on in India 8,50,000
Royalty income from a literary book in Country N (after 5,50,000
deducting expenses of ` 75,000)
14,00,000
Less: Business loss in Country N 1,10,000 12,90,000

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 DOUBLE TAXATION RELIEF 22.31
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Income from Other Sources

Agricultural income in Country N [Not exempt u/s 10(1)] 1,30,000
Dividend received from a company incorporated in Country N 85,000
2,15,000
Gross Total Income 15,05,000
Less: Deduction under Chapter VIA 3,00,000
Under section 80QQB – Royalty income of a resident from a
literary book5
Total Income 12,05,000

Note – Since adjusted total income (i.e., ` 15,05,000) does not exceed ` 20 lakhs, AMT
would not be attracted in this case.
Computation of net tax liability of Mr. Anil for A.Y.2026-27
Particulars `
Tax on total income [30% of ` 2,05,000 plus ` 1,12,500] 1,74,000
Add: Health and education cess @4% 6,960
Tax Liability 1,80,960
Calculation of Rebate under section 91:
Average rate of tax in India [i.e., ` 1,80,960 / ` 12,05,000 x 100] 15.017%
Average rate of tax in Country N 18%
Doubly taxed income pertaining to Country N `
Agricultural Income 1,30,000
Royalty Income [` 6,25,000 – ` 75,000 (Expenses) – ` 3,00,000 2,50,000
(deduction under section 80QQB)] 6
Dividend income 85,000
4,65,000
Less: Business Loss set off 1,10,000
3,55,000

5 It is assumed that the royalty earned outside India has been brought into India in convertible foreign
exchange within a period of six months from the end of the previous year.
6 Doubly taxed income includes only that part of income which is included in the assessee’s total income.

The amount deducted under Chapter VIA is not doubly taxed and hence, no relief is allowable in respect of
such amount – CIT v. Dr. R.N. Jhanji (1990) 185 ITR 586 (Raj.).

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 22.32 INTERNATIONAL TAXATION

Rebate under section 91 on ` 3,55,000 @ 15.017% [being the lower of 53,310

average Indian tax rate (15.017%) and foreign tax rate (18%)]
Net tax liability 1,27,650

10. Computation of total income of Mr. Ravi for A.Y.2026-27

under the default tax regime under section 115BAC
(assuming that he pays tax under the default tax regime)
Particulars ` `
Income from House Property [House situated in Country T]
Gross Annual Value 7 3,30,000
Less: Municipal taxes paid in Country T 10,000
Net Annual Value 3,20,000
Less: Deduction under section 24 – 30% of NAV 96,000
2,24,000
Profits and Gains of Business or Profession
Income from business carried on in India 4,40,000
Royalty income from a book on art in Country S (after deducting
expenses of ` 50,000) 7,30,000 11,70,000
Income from Other Sources
Interest on savings bank with ICICI Bank 42,000
Agricultural income in Country S [Not exempt] 94,000
Dividend from a company in Country T 2,65,000 4,01,000
Gross Total Income 17,95,000
Less: Deduction under Chapter VIA [Not available under default Nil
tax regime]
Total Income 17,95,000

Computation of tax liability of Mr. Ravi for A.Y.2026-27 under the default tax regime
Particulars `
Tax on total income 1,59,000
Add: Health and education cess @4% 6,360
1,65,360

7Rental income has been taken as GAV in the absence of other information relating to fair rent, municipal
value etc.

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 DOUBLE TAXATION RELIEF 22.33
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Less: Rebate under section 91 (See Working Note below) 1,20,954

Net tax liability 44,406
Net tax liability (Rounded off) 44,410
Calculation of Rebate under section 91:
Average rate of tax in India [i.e., ` 1,65,360 / ` 17,95,000 x 100] 9.212%
Average rate of tax in Country S 16%
Doubly taxed income pertaining to Country S `
Agricultural Income 94,000
Royalty Income [` 7,80,000 – ` 50,000 (Expenses)] 7,30,000
8,24,000
Rebate under section 91 on ` 8,24,000 @9.212% [being the 75,907
lower of average Indian tax rate (9.212%) and Country S tax
rate (16%)]
Average rate of tax in Country T 20%
Doubly taxed income pertaining to Country T
Income from house property 2,24,000
Dividend 2,65,000
4,89,000
Rebate under section 91 on ` 4,89,000 @9.212% [being the 45,047
lower of average Indian tax rate (9.212%) and Country T tax
rate (20%)]
Total rebate under section 91 (Country S + Country T) 1,20,954

Computation of total income of Mr. Ravi for A.Y.2026-27

under the normal provisions of the Act
(assuming that he has exercised the option to shift out of default tax regime)
Particulars ` `
Income from House Property [House situated in
Country T]
Gross Annual Value 8 3,30,000
Less: Municipal taxes paid in Country T 10,000
Net Annual Value 3,20,000

8Rental income has been taken as GAV in the absence of other information relating to fair rent, municipal value etc.

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 22.34 INTERNATIONAL TAXATION

Less: Deduction under section 24 – 30% of NAV 96,000

2,24,000
Profits and Gains of Business or Profession
Income from business carried on in India 4,40,000
Royalty income from a book of art in Country S (after deducting
expenses of ` 50,000) 7,30,000 11,70,000
Income from Other Sources
Interest on savings bank with ICICI Bank 42,000
Agricultural income in Country S [Not exempt] 94,000
Dividend from a company in Country T 2,65,000 4,01,000
Gross Total Income 17,95,000
Less: Deduction under Chapter VIA
Under section 80QQB – Royalty income of a resident
from a work of art 9 3,00,000
Under section 80TTA – Interest on savings bank 10,000
account, subject to a maximum of ` 10,000.
Total Income 14,85,000

Note – Since adjusted total income (i.e., ` 17,85,000) does not exceed ` 20 lakhs, AMT
would not be attracted in this case.
Computation of tax liability of Mr. Ravi for A.Y.2026-27
under the normal provisions of the Act
Particulars `
Tax on total income [30% of ` 4,85,000 + ` 1,12,500] 2,58,000
Add: Health and education cess @4% 10,320
2,68,320
Less: Rebate under section 91 (See Working Note below) 1,72,197
Tax Payable 96,123
Tax payable (rounded off) 96,120
Calculation of Rebate under section 91:
Average rate of tax in India [i.e., ` 2,68,320 / ` 14,85,000 x 100] 18.069%

9 It is assumed that the royalty earned outside India has been brought into India in convertible foreign
exchange within a period of six months from the end of the previous year.

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 DOUBLE TAXATION RELIEF 22.35
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Average rate of tax in Country S 16%

Doubly taxed income pertaining to Country S10 `
Agricultural Income 94,000
Royalty Income [` 7,80,000 – ` 50,000 (Expenses) – ` 3,00,000 4,30,000
(deduction under section 80QQB)]
5,24,000
Rebate under section 91 on ` 5,24,000 @16% [being the lower of 83,840
average Indian tax rate (18.069%) and Country S tax rate (16%)]
Average rate of tax in Country T 20%
Doubly taxed income pertaining to Country T
Income from house property 2,24,000
Dividend 2,65,000
4,89,000
Rebate under section 91 on ` 4,89,000 @18.069% (being the
lower of average Indian tax rate (18.069%) and Country T tax rate 88,357
(20%)]
Total rebate under section 91 (Country S + Country T) 1,72,197

Note: Mr. Ravi shall be allowed deduction under section 91, since the following conditions
are fulfilled:-
(a) He is a resident in India during the relevant previous year i.e., P.Y. 2025-26.
(b) The income in question accrues or arises to him outside India in foreign countries S
& T during that previous year and such income is not deemed to accrue or arise in
India during the previous year.
(c) The income in question has been subjected to income-tax in the foreign countries “S”
and “T” in his hands and it is presumed that he has paid tax on such income in those
countries.

(d) There is no agreement under section 90 for the relief or avoidance of double taxation
between India and Countries S and T where the income has accrued or arisen.

10Doublytaxed income includes only that part of income which is included in the assessee’s total income.
The amount deducted under Chapter VIA is not doubly taxed and hence, no relief is allowable in respect of
such amount – CIT v. Dr. R.N. Jhanji (1990) 185 ITR 586 (Raj.).

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India
CHAPTER a
23
13

ADVANCE RULINGS

LEARNING OUTCOMES
After studying this Chapter, you will be able to–

❑ comprehend the meaning and scope of the term “advance ruling” and
the need for obtaining advance ruling;

❑ understand the constitution of Board for Advance Rulings;

❑ appreciate the procedure for making an application to the Board for

Advance Rulings and the procedure to be followed by the Board on
receipt of application;
❑ know the circumstances when an advance ruling can be declared void.

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 23.2 INTERNATIONAL TAXATION

23.1 BOARDS FOR ADVANCE RULINGS – AN

INTRODUCTION
Three Boards for Advance Rulings have been constituted for giving advance rulings on or after
1.9.2021. Every such Board shall consist of two members, each being an officer not below the
rank of Chief Commissioner, as may be nominated by the Board. The ruling pronounced or order
passed by the Board for Advance Rulings is appealable before the High Court. The Finance Act,
2021 has empowered the Central Government to make a scheme by notification in the Official
Gazette for the purpose of giving advance ruling by Boards for Advance Rulings to impart greater
efficiency, transparency and accountability by eliminating interface between the Boards for
Advance Rulings and the applicants to the extent technologically feasible, by optimising utilisation
of resources and introducing dynamic jurisdiction.

23.2 CONSTITUTION OF BOARD FOR ADVANCE

RULINGS [SECTION 245-OB]
One or more Boards for Advance Rulings, as may be necessary, shall be constituted by the
Central Government for giving advance rulings under Chapter XIX-B with effect from a date
appointed by notification in the Official Gazette. Accordingly, the Central Government has, in
exercise of such powers, vide Notification No.96/2021 dated 1.9.2021, constituted three Boards for
Advance Rulings, for the purposes of giving advance rulings under Chapter XIX -B on or after
1.9.2021. Board for Advance Rulings – I and Board for Advance Rulings – II have their
headquarters in Delhi and Board for Advance Rulings – III has its headquarters in Mumbai.
Every such Board for Advance Ruling shall consist of two members, each being an officer not
below the rank of Chief Commissioner, as may be nominated by the Board.

23.3 DEFINITIONS
(1) Advance Ruling [Section 245N(a)]: The meaning of Advance Ruling is detailed hereunder:
Section Determination by the Board for Advance Rulings
245N(a)(i) in relation to a transaction which has been undertaken or is proposed to be
undertaken by a non-resident applicant.

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 ADVANCE RULINGS 23.3
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245N(a)(ii) in relation to the tax liability of a non-resident arising out of a transaction

which has been undertaken or is proposed to be undertaken by a resident
applicant with such non-resident and such determination shall include the
determination of any question of law or of fact specified in the application .
245N(a)(iia) in relation to the tax liability of a resident applicant, arising out of a
transaction which has been undertaken or is proposed to be undertaken by
such applicant and such determination shall include the determination of
any question of law or of fact specified in the application.
245N(a)(iii) in respect of an issue relating to computation of total income which is
pending before any Income-tax Authority or the Appellate Tribunal and such
determination or decision shall include the determination or decision of any
question of law or fact in relation to such computation of total income
specified in the application.
245N(a)(iv) or decision whether an arrangement, which is proposed to be undertaken by
any person being a resident or a non-resident, is an impermissible
avoidance arrangement as referred to in Chapter X-A or not.

(2) Applicant [Section 245N(b)(A)]: ‘Applicant’ means any person who –

(i) is a non-resident referred to in section 245N(a)(i) above; or
(ii) is a resident referred to in section 245N(a)(ii) above; or

(iii) is a resident referred to in section 245N(a)(iia) above falling within any such class or
category of persons as the Central Government may, by notification in the Official
Gazette, specify.
[A resident in relation to his tax liability arising out of one or more transactions
valuing ` 100 crore or more in total which has been undertaken or is proposed to be
undertaken would be an applicant – Notification No.73/2014 dated 28.11.2014]; or

(iv) is a resident falling within such class or category of persons as the Central
Government may, by notification in the Official Gazette, specify in this behalf
[Public sector company as defined under section 2(36A) of the Income -tax Act, 1961
would be an applicant – Notification No. 725(E) dated 3.8.2000]; or
(v) is referred to in section 245N(a)(iv) above; and
who makes an application for advance ruling under section 245Q(1).

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 23.4 INTERNATIONAL TAXATION

Who can be an applicant in relation to different clauses of section 245N(a)

defining advance ruling?
S. Applicant u/s Advance Ruling u/s 245N(a) means determination by the
No. 245N(b) AAR in relation to
(i) Non-resident (NR) a transaction which has been undertaken or is proposed to be
undertaken by him.
(ii) Resident the tax liability of a NR arising out of a transaction which has
been undertaken or is proposed to be undertaken by a
resident applicant with such NR and such determination shall
include the determination of any question of law or of fact
specified in the application.
(iii) Resident of class the tax liability of a resident applicant, arising out of a
or category of transaction which has been undertaken or is proposed to be
persons notified by undertaken by such applicant and such determination shall
Central include the determination of any question of law or of fact
Government specified in the application.
Note: The Central Government notified a resident, in relation to his tax liability
arising out of one or more transactions valuing ` 100 crore or more in total.
(iv) Resident of class or n issue relating to computation of total income which is
category of persons pending before any Income-tax Authority or the Appellate
notified by Central Tribunal and such determination or decision shall include the
Government determination or decision of any question of law or fact in
relation to such computation of total income specified in the
application.
Note: A public sector undertaking has been notified by the Central Government.
(v) Resident or NR whether an arrangement, which is proposed to be undertaken
by any person being a resident or a NR, is an impermissible
avoidance arrangement as referred to in Chapter X-A or not.

Restrictions on Appellate Authority: Section 245RR provides that where a resident

applicant has made an application to the Board for Advance Rulings in respect of an issue
for decision of Board for Advance Rulings, then, no Income-tax Authority or Tribunal shall
take any decision in respect of such issues. In other words, a resident assessee cannot
pursue both the remedies, i.e., an appeal or revision before Income -tax Authority/Appellate
Authority as well as an application for Advance Ruling to Board for Advance Rulings, in
respect of an issue.

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 ADVANCE RULINGS 23.5
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23.4 VACANCIES, ETC., NOT TO INVALIDATE

PROCEEDINGS [SECTION 245P]
A proceeding before, or pronouncement of advance ruling by, the Board for Advance Rulings
would not be questioned or would not be invalid on the ground merely of the existence of any
vacancy or defect in the constitution of the Board for Advance Rulings.

23.5 APPLICATION FOR ADVANCE RULING [SECTION 245Q]

Section 245Q(1) provides that an applicant desirous of obtaining an advance ruling may make
an application stating the question on which the advance ruling is sought in the prescribed form
and in the prescribed manner.

As per section 245Q(2), the application shall be made in quadruplicate and be accompanied by
a fee of ` 10,000 or such fee as may be prescribed, whichever is higher.
Rule 44E prescribes the fees mentioned in column (3) to be paid by the applicant mentioned in
column (1) in the cases of column (2).
Category of Category of case Fee
applicant
(1) (2) (3)
An applicant referred Amount of one or more transaction, entered into or ` 2 lakhs
to in sub-clauses (i) proposed to be undertaken, in respect of which ruling
or (ii) or (iia) of is sought does not exceed ` 100 crore.
clause (b) of section Amount of one or more transaction, entered into or ` 5 lakhs
245N proposed to be undertaken, in respect of which ruling
is sought exceeds ` 100 crore but does not exceed
` 300 crore.
Amount of one or more transaction, entered into or ` 10 lakhs
proposed to be undertaken, in respect of which ruling
is sought exceeds ` 300 crore.
Any other applicant In all cases ` 10,000

Rule 44E prescribes the form of application for obtaining an advance ruling. Every application
under Rule 44E shall be accompanied by the proof of payment of fees.

Section 245Q(3) provides that an applicant may withdraw an application within 30 days from the
date of the application.

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 23.6 INTERNATIONAL TAXATION

23.6 PROCEDURE ON RECEIPT OF APPLICATION

[SECTION 245R]
The Board, on receipt of an application, will send a copy to the Principal Commissioner or
Commissioner concerned and wherever considered necessary, also call upon the Principal
Commissioner or Commissioner to furnish relevant records. Such records will be returned to the
Principal Commissioner or Commissioner as soon as possible.
After examining the application and the records called for, the Board may either allow or reject
an application. However, the Board shall not allow an application where the question raised in
the application is:
Pending with is already pending before any income-tax authority, or Appellate Tribunal
income-tax or any court.
authorities/ However, a resident falling within any class or category of persons as notified
tribunal/court by the Central Government can seek for advance ruling even if question
raised is pending before any income-tax authority or Appellate Tribunal.
Determination of involves the determination of the fair market value of any property;
Fair Market Value
Transaction relates to a transaction or issue which is designed prima facie for
designed for avoidance of income-tax (except in case of a resident applicant falling
avoidance of within any class or category of persons as notified by the Central
income-tax Government or in the case of resident or a non-resident for determination
of whether an arrangement, which is proposed to be undertaken, is an
impermissible avoidance arrangement).

However, no application shall be rejected unless an opportunity has been given to the applicant of
being heard. Further, where an application is rejected, the reason for rejection shall be given in the
order. A copy of every order shall be sent to the applicant and to the PCIT/CIT.
Where an application is allowed, the Board would pronounce its advance ruling on that question
specified in the application, after examining such further material as may be placed before it by
the applicant or obtained by the Board. Where a request is received from an applicant, the
Board has to provide an opportunity of being heard, either in person or through a duly
authorised representative, before pronouncing its advance ruling.
Time limit for pronouncement of advance Ruling - The Board has to pronounce the advance
ruling within 6 months from the receipt of application by the Board. A copy of advance ruling
pronounced, duly signed by the Members and certified, has to be sent to the applicant and to the
PCIT/CIT, as soon as may be, after pronouncement.
Faceless Scheme for Advance Rulings - The Central Government is empowered to make a
scheme by notification in Official Gazette for the purpose of giving advance rulings so as to

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 ADVANCE RULINGS 23.7
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impart greater efficiency, transparency and accountability by:

(i) eliminating the interface between the Board for Advance Rulings and the applicant in the
course of proceedings to the extent technologically feasible;
(ii) optimising utilisation of the resources through economies of scale and functional
specialisation;
(iii) introducing a system with dynamic jurisdiction.
Applicability or non-applicability of other provisions of the Act [Section 245R(10)] - The
Central Government may, for the purpose of giving effect to the above scheme, by notification in
the Official Gazette, direct that any of the provisions of the Income -tax Act, 1961 would not
apply or would apply with such modification, exceptions and adaptations as specified.
Though no such direction can be issued by the Central Government after 31 st March, 2023, the
Central Government may amend any direction, issued on or before 31.3.2023, by notification.
Notification issued above to be laid before each House of Parliament [Section 245R(11)] -
Every such notification issued by the Central Government either under sub section (9) or (10) of
the section 245R has to be laid before each House of Parliament as soon as may be after issue
of such notification.

23.7 ADVANCE RULING TO BE VOID IN CERTAIN

CIRCUMSTANCES [SECTION 245T]
Where the Board for Advance Rulings finds, on a representation made to it by the PCIT/CIT or
otherwise, that an advance ruling pronounced has been obtained by the applicant by fraud or
misrepresentation of facts, the Board may, by order, declare such ruling to be void ab initio.
The provisions of the Income-tax Act, 1961 would apply (after excluding the period beginning
with the date of such advance ruling and ending with the date of order under this section) to the
applicant as if such advance ruling had never been made.
A copy of this order has to be sent to the applicant and the Principal Commissioner or
Commissioner.

23.8 POWERS OF THE BOARD FOR ADVANCE RULINGS

[SECTION 245U]
The Board for Advance Rulings shall have all the powers of the Civil Court in respect of discovery
and inspection, enforcing the attendance of any person, including any officer of a banking

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 23.8 INTERNATIONAL TAXATION

company and examining on oath, issuing commissions and compelling the production of books of
accounts and other documents. The Board shall be deemed to be a Civil Court for the purposes of
section 195 of the Code of Criminal Procedure, 1973 which provides for prosecution for contempt
of lawful authority of public servants, for offences against public justice. Every proceeding before
the Board shall be deemed to be a judicial proceeding under the Indian Penal Cod e.
However, the Board shall not be deemed to a Civil Court for the purpose of Chapter XXVI of the
Code of Criminal Procedure, 1973 containing the provisions as to offences affecting the
administration of justice.

23.9 APPEAL [SECTION 245W]

Appeal to High Court by applicant [Section 245W(1)] - The applicant who is aggrieved by any
ruling pronounced or order passed by the Board for Advance Rulings or the Assessing Officer,
on the directions of the Principal Commissioner or Commissioner, may appeal to the High Court
against such ruling or order of the Board of Advance Rulings. He has to do so within sixty days
from the date of the communication of that ruling or order, in the prescribed form and manner.
However, where the High Court is satisfied, on an application made by the appellant in this behalf,
that the appellant was prevented by sufficient cause from presenting the appeal within the 60 day
period as specified above, it may grant further period of 30 days for filing such appeal.
Appeal to High Court by Assessing Officer [Section 245W(2)] - For the purpose of appeal to
the High Court by the Assessing Officer, the Central Government is empowered to make a
scheme by notification in Official Gazette so as to impart greater efficiency, transparency and
accountability by:
(i) optimising utilisation of the resources through economies of scale and functional
specialisation;
(ii) introducing a team-based mechanism with dynamic jurisdiction.
Applicability or non-applicability of other provisions of the Act [Section 245W(3)] - The
Central Government may, for the purpose of giving effect to the above scheme, by notification in
the Official Gazette, direct that any provision of the Income-tax Act, 1961, would not apply or
would apply with such modification, exceptions and adaptations as specified.
No such direction can, however, be issued by the Central Government after 31 st March, 2023.
Notification issued above to be laid before each House of Parliament [Section 245W(4)] -Every
such notification issued by the Central Government either under section 245W(2)/(3) has to be laid
before each House of Parliament as soon as may be after issue of the said notification.

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 ADVANCE RULINGS 23.9
a

TEST YOUR KNOWLEDGE

Questions
1. Q, a non-resident, made an application to the Board for Advance Rulings on 3.4.2025 in
relation to a transaction proposed to be undertaken by him. On 1.5.2025, he decides to
withdraw the said application. Can he withdraw the application on 1.5.2025?
2. Examine when can an advance ruling pronounced by the Board for Advance Rulings be
declared void. What is the consequence?
3. The Board for Advance Rulings has the powers of compelling the production of books of
account – Examine the correctness or otherwise of this statement.
4. The term 'Advance Ruling' includes within its scope, a determination by the Board for
Advance Rulings only in relation to a transaction undertaken by a non -resident applicant.
Examine the correctness of this statement, with reference to the provisions of the Income -
tax Act 1961.
5. What is the remedy available to an applicant who is aggrieved by the ruling of Board for
Advance Rulings? Also, state the time limit within which he should exercise this remedy.

Answers
1. Section 245Q(3) of the Income-tax Act, 1961 provides that an applicant, who has sought for
an advance ruling, may withdraw the application within 30 days from the date of the
application. Since the 30 day period from the date of application by Q to the Board for
Advance Rulings has not lapsed, he can withdraw the application.
2. As per section 245T, an advance ruling can be declared to be void ab initio by the Board for
Advance Rulings if, on a representation made to it by the Principal Commissioner or
Commissioner or otherwise, it finds that the ruling has been obtained by fraud or
misrepresentation of facts. Thereafter, all the provisions of the Act will apply (after
excluding the period beginning with the date of such advance ruling and ending with the
date of order under this section) as if no such advance ruling has been made. A copy of
such order shall be sent to the applicant and the Principal Commissioner or Commissioner.
3. The statement is correct.

Under section 245U, the Board for Advance Rulings shall have all the powers vested in the
Civil Court under the Code of Civil Procedure, 1908 as are referred to in section 131.

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Accordingly, the Board for Advance Rulings shall have the same powers as are vested in a
court under the Code of Civil Procedure, 1908, when trying a suit in respect of the following
matters, namely -
(1) discovery and inspection;
(2) enforcing the attendance of any person, including any officer of a banking company
and examining him on oath;
(3) compelling the production of books of account and other documents; and
(4) issuing commissions.

Therefore, the Board for Advance Ruling has the powers of compelling the production of
books of account.
4. The statement is not correct. As per section 245N, advance ruling not only includes a
determination by the BAR in relation to a transaction which has been undertaken or is
proposed to be undertaken by a non-resident applicant, but also includes, inter alia,
determination by the BAR –

(i) in relation to the tax liability of a non-resident arising out of a transaction which has
been undertaken or is proposed to be undertaken by a resident applicant with such
non-resident and such determination shall include the determination of any question
of law or of fact specified in the application
(ii) in relation to the tax liability of a resident applicant, arising out of a transaction which
has been undertaken or is proposed to be undertaken by such applicant and such
determination shall include the determination of any question of law or of fact
specified in the application.
5. An applicant who is aggrieved by any ruling pronounced by the Board for Advance Rulings
may appeal to the High Court against such ruling of the Board of Advance Rulings. He has
to do so within sixty days from the date of the communication of that ruling, in the
prescribed form and manner.

However, where the High Court is satisfied, on an application made by the appellant in this
behalf, that the appellant was prevented by sufficient cause from presenting the appeal
within the 60 day period as specified above, it may grant further period of 30 days for filing
such appeal.

© The Institute of Chartered Accountants of India

CHAPTER 24

TRANSFER PRICING

LEARNING OUTCOMES

After studying this chapter, you would be able to -

 appreciate the need for incorporation of transfer pricing provisions in the

Income-tax Act, 1961;

 comprehend the meaning and significance of arm’s length principle and

the practical difficulties in application of arm’s length principle;

 appreciate the meaning and significance of the terms “associated

enterprise”, “international transaction” and “specified domestic
transaction”;

 determine the arm’s length price using different methods prescribed

under the income-tax law;

 appreciate the meaning of safe harbour and rules for safe harbor
incorporated in the income-tax law;

 appreciate the benefits of entering into advance pricing agreements;

 identify the cases where secondary adjustments have to be made;

 pinpoint the responsibilities of a person entering into an international
transaction to keep and maintain prescribed information and documents;

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 24.2 INTERNATIONAL TAXATION

 identify the circumstances when the Assessing Officer can invoke the
power to determine the arm’s length price;

 comprehend and appreciate the country-by-country reporting

requirements and related matters incorporated in the income-tax law in
compliance with BEPS Action Plan 13;

 appreciate the specific anti-avoidance measures incorporated in the

Income-tax Act, 1961 in respect of transactions with persons located in
notified jurisdictional areas;

 appreciate the provisions incorporated in the Income-tax Act, 1961

restricting interest deduction claimed by an entity in respect of
borrowings from an associated enterprise in line with BEPS Action
Plan 4.

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24.1 INTRODUCTION
In the present age of globalisation, Multinational Companies
(MNCs) have branches/subsidiaries/divisions operating in more
than one country. There is a possibility that two or more entities
belonging to the same multinational group can fix up their prices
for goods and services and allocate profits among the enterprises
within the group in such a way that there may be either no profit
or negligible profit in the jurisdiction which taxes such profits and
substantial profit in the jurisdiction where the tax liability is
minimum. This results in base erosion of the high tax jurisdiction by shifting the profits to the low
tax jurisdiction, thereby minimizing the taxes. This may adversely affect a country's share of due
revenue. The increasing participation of multinational groups in economic activities in India has
given rise to new and complex issues emerging from transactions entered into between two or
more enterprises belonging to the same multinational group.
In order to curb such tax avoidance measures, Arm’s Length Principle (ALP) is used internationally
to substitute the transfer price adopted by the MNCs to price the intra-group transfer of goods or
provision of services. Generally, the arm’s length price refers to the price an unrelated enterprise
would be willing to pay in comparable circumstances.
The OECD guidelines define the “Transfer prices” as the prices at which an enterprise transfers
physical goods and intangible property or provides services to associated enterprises. Two
enterprises are “associated enterprises” if one of the enterprises participates directly or indirectly
in the management, control or capital of the other or if both enterprises are under common control.
Since international transfer pricing involves more than one tax jurisdiction, any adjustment to the
transfer price in one jurisdiction requires a corresponding adjustment in the other jurisdiction. If a
corresponding adjustment is not made, double taxation will result.

24.2 MEANING OF “ARM’S LENGTH PRINCIPLE”

The Arm’s Length Price (ALP) of a transaction between two associated enterprises is the price that
would be paid if the transaction had taken place between two comparable independent and
unrelated parties.

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 24.4 INTERNATIONAL TAXATION

The Arm’s Length Principle, in the context of taxation, is explained in the OECD Model Tax
Convention as under:

“Where conditions are made or imposed between two associated

enterprises in their commercial or financial relations which differ
from those which would be made between independent
enterprises, then any profits which would, but for those
conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so
accrued, may be included in the profits of that enterprise and taxed accordingly.”

The OECD transfer pricing guidelines provides guidance on the application of the arm’s length
principle in order to arrive at the proper transfer pricing range between associated enterprises.
Market forces determine business relations between independent parties. The arm’s length
principle seeks to adjust the profits between two associated enterprises by comparing the same as
if the transaction is carried out between two independent enterprises. It treats each enterprise as a
separate independent entity rather than as inseparable parts of a single unified business.

24.3 SIGNIFICANCE OF ARM’S LENGTH PRINCIPLE

There are several reasons as to why the OECD member countries and other countries have
adopted the arm’s length principle.
Parity between MNCs and independent enterprises – A major reason is that the ALP provides
broad parity of tax treatment for MNCs and independent enterprises. Since the ALP puts
associated and independent enterprises on a more equal footing for tax purposes, it avoids the
creation of tax advantages and disadvantages that would otherwise distort the relative competitive
positions of these entities. The ALP, thus promotes the growth of international trade and
investment by removing these tax considerations from economic decisions.
Determines real taxable profits - The transfer price adopted by a multinational has a direct
bearing on the proportional profit it derives in each country in which it operates. If inadequate or
excessive consideration is paid for the transfer of goods, services or intangible property between
the members of an MNC group, the income calculated for each of those members will be
inconsistent with their relative economic contributions. An ‘arm’s length’ price is needed to
determine real taxable profits earned in each country. The arm’s length doctrine permits the taxing
authorities to rectify the accounts of the enterprise so as to reflect correctly the income that the
establishment would have earned if they were an independent enterprise.

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Reduction of artificial price distortion - If the ALP is not followed, an MNC will sell goods/
provide services to a controlled entity in a high tax jurisdiction at a high price (which exceeds the
market price) and to an entity in a low-tax jurisdiction or a tax haven at a low price (which is lower
than the market price). This would result in extreme price distortion of goods and services in the
international market.
Accurate measurement of economic contribution – The ALP provides accurate measurement
of the fair market value of the economic contribution units of an MNC. The focus of the ALP is to
ensure that the proper amount of income is attributed to where it is earned. This result in each unit
of the MNC earning a return commensurate with its economic contribution and risk assumed.

24.4 PRACTICAL DIFFICULTIES IN APPLICATION OF ALP

There are, however, certain practical difficulties in applying the ALP, which are described
hereunder:
True comparison difficult in certain cases – The commercial and financial conditions governing
a transaction between independent enterprises are, by and large, never similar to those existing
between associated enterprises. As a result, there cannot be a true comparison. The economies of
scale and integration of various business activities of the associated enterprise may not be truly
appreciated by arm’s length principle. Further, associated enterprises may enter into transactions
which independent enterprises may not enter into, like say, licensing of valuable intangible or
sharing the benefits of research. The owner of an intangible may be hesitant to enter into licensing
arrangements with independent enterprises for fear of the value of the intangible being degraded.
In contrast, he may be prepared to offer terms that are less restrictive to associated enterprises
because the use of the intangible can be closely monitored. Further, there is no risk to the overall
group’s profit from a transaction of this kind between members of an MNC group. In such
situations, where independent enterprises seldom undertake transactions of the type entered into
by associated enterprises, the ALP is difficult to apply because there is little or no direct evidence
of what conditions would have been established by independent enterprises.
Availability of data and reliability of available data – There may be difficulty in getting adequate
and reliable information and data in order to apply arm’s length principle. The information
regarding the comparable companies, their profit margins, the pricing charged by them in
independent and comparable circumstances may be difficult to obtain. Further, the differences in
the accounting of the data could result in difficulty as the reliable adjustments may not be possible
to be made.

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 24.6 INTERNATIONAL TAXATION

Absence of comparable market price for “intangible” transactions - The ALP reaches a
comparable uncontrolled market price that is reasonably reliable for standard transactions where
the price range is narrow and market price is certain. However, the ALP generally fails to achieve
a comparable market price for transactions involving intangibles because they are unique. The
unique nature of these transactions creates a very wide price range.
Administrative burden – Due to the subjectivity in selection of comparables and the methods, the
application of arm’s length principle results in administrative burden for the tax administration as
well as the taxpayers.

Time lag - Although an associated enterprise normally establishes the conditions for a transaction
at the time it is undertaken, at some point the enterprise may be required to demonstrate that
these are consistent with the arm’s length principle. The tax administration may also have to
engage in the verification process perhaps some years after the transactions have taken place. It
may result in substantial cost being incurred by the taxpayer and the tax administration. It is also
difficult to appreciate the business realities which prevailed at the time when the transactions were
entered into. This may lead to bias against the taxpayer.
In spite of the practical difficulties listed above, OECD member countries are of the view that the
ALP does provide a sound basis to appreciate the transfer pricing between associated enterprises.
It has so far provided acceptable solutions to both taxpayers and the tax administrations. The
experience gained so far should be effectively used to remove the practical difficulties and improve
the administration.

24.5 THE INDIAN SCENARIO

(1) Transfer pricing in relation to International Transactions
Finance Act, 2001 has introduced Chapter X to the Income-tax Act, 1961 with a view to provide a
statutory framework which can lead to computation of reasonable, fair and equitable profits and tax
in India so as to curb the pricing strategies adopted by the MNCs resulting in base erosion and
profit shifting.
These provisions are contained in sections 92 to 92F of the Income-tax Act, 1961. Rules 10A to 10E
have been inserted in the Income-tax Rules, 1962. These sections and rules of the Income-tax Act,
1961 and the Income-tax Rules, 1962, respectively, will affect all non-corporate and corporate
assessees who have dealings with non-residents for import or export of goods, properties or
services.

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The following conditions must be satisfied in order to attract the special provisions of Chapter X
relating to avoidance of tax:

(i) There must be an international transaction;

(ii) Such international transaction should be between two or more associated enterprises either
or both of whom are non-residents;

(iii) Such international transaction should be in the nature of:

(a) purchase, sale or lease of tangible or intangible property; or
(b) provision of service; or

(c) lending or borrowing money; or

(d) any other transaction having a bearing on the profits, income, losses or assets of
such enterprise.
(iv) Further, such transaction can also involve allocation or apportionment of, or any
contribution to any cost or expenses incurred or to be incurred in connection with a benefit,
service or facility provided or to be provided to any one or more of the associated
enterprises on the basis of mutual agreement or arrangement between such associated
enterprises.
(v) Such international transaction must be done at arm’s length price and if such international
transaction has been done at less than the arm’s length price, it shall require determination
of income or apportionment of cost or expense on the basis of arm’s length price.
(vi) The above adjustment should either result in an increase of income or decrease of loss
returned by the assessee. In other words, the adjustment should not have the effect of
reducing the income chargeable to tax or increasing the loss.
I. Computation of income from transaction with non-resident [Section 92]:
Section 92 provides that any income arising from an “international transaction” shall be computed
having regard to “the arm’s length price”. For this purpose, the allowance for any expense or
interest shall be determined on the basis of arm’s length price.
The section further provides that in an international transaction
between two or more ‘associated enterprises” when there is a
mutual agreement or arrangement for the allocation or
apportionment of, or any contribution to, any cost or expenses
in connection with a benefit, service or facility provided to any one or more of such enterprises, the

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 24.8 INTERNATIONAL TAXATION

allocation of cost, expenses etc. shall be determined having regard to arm’s length price of such
benefit, service or facility.

The objective of transfer pricing provisions is to protect the tax base of India and to ensure that
due to inter-company transactions, there is no reduction in the taxable profits or the taxes paid by
the Indian taxpayer.

It is, however, pertinent to note that the transfer pricing provisions would not be applicable if
substitution of the ALP has the effect of reducing the income chargeable to tax or increasing the
loss.

The Assessing Officer will have wide powers to determine what is an arm’s length price for such
transactions and make adjustments for computation of income. The keywords in section 92 are
(i) associated enterprises,
(ii) international transactions and
(iii) arm’s length price.
These terms are defined in sections 92A, 92B and 92C.
II. Associated Enterprises [Section 92A]: Section 92A(1) defines the associated
enterprises generally. Section 92A(2) provides 13 relationships between the enterprises which
constitutes deemed associated enterprises.
The term “associated enterprise” in relation to another enterprise is defined in section 92A(1).
Associated enterprises are those which are owned or controlled by the same or common entity/ person.
Associated Enterprises [Section 92A(1)]
Condition Example
(1) An enterprise which participates, Where A Ltd. directly participates in the management
directly or indirectly, or through of B Ltd. and B Ltd. directly participates in the
one or more intermediaries, in: management of C Ltd. In such situation, A Ltd. has
• management of the other direct participation in management of B Ltd. but has
enterprise, or an indirect participation in management of C Ltd.

• control of other enterprise, or

A B C
• capital of other enterprise
In such scenario, both B Ltd. and C Ltd. would be
associated enterprises of A Ltd.

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(2) If one or more persons Mr. A directly has control in A Ltd. and B Ltd. In such
participates, directly or indirectly, a scenario, both A Ltd. & B Ltd. are associated
or through one or more enterprises since there is a common person i.e., Mr.
intermediaries in: A, who controls both entities A Ltd. & B Ltd.
• management/control/capital
of the two different
enterprises
Then, those two enterprises are
AEs.

Two enterprises are deemed to be associated enterprises if they fall under any one or more of
the situations contained in section 92A(2). This section provides 13 such situations during
which associated enterprise relationship is deemed to be established. Two enterprises are
deemed to be associated enterprise if:

Deemed Associated Enterprises [Section 92A(2)]

Condition Situation Example
Enterprise One enterprise holds A Ltd. holds 33% of Voting Power in B Ltd. and
ownership 26% or more of the B Ltd. holds 80% Voting Power in C Ltd.
voting power, directly or
33% 80%
indirectly, in the other A B C
enterprise.
In above situation, A Ltd. holds 26% or more
voting power in B Ltd., directly and in C Ltd.
indirectly (i.e. through B Ltd.). Therefore, both
B Ltd. & C Ltd. are deemed associated
enterprises of A Ltd.
Substantial Any person or enterprise Mr. A holds 40% of voting power in both X Ltd.
voting power in holds 26% or more of and Y Ltd. where neither X Ltd. has any holding in
two entities by the voting power, Y Ltd. nor Y Ltd. has any holding in X Ltd.
common directly or indirectly, in
person each of two different Mr. A
enterprises. 40% 40%

X Ltd. Y Ltd.

In this situation, since Mr. A directly holds 40% of

voting power in both X Ltd. and Y Ltd., X Ltd. & Y
Ltd. will be deemed associated enterprises.

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 24.10 INTERNATIONAL TAXATION

Advancing of One enterprise advances Book Value of total assets of Y Ltd. is ` 100 crores. X
substantial loan to the other enterprise Ltd. advances loan of ` 60 crores to Y Ltd.
sum of money of an amount of 51% or
In this case, X Ltd. advances loan of ` 60 crores
more of the book value of
to Y Ltd, which is 60% of the book value of total
the total assets of other
assets of Y Ltd. Hence, X Ltd. & Y Ltd. are
enterprise
deemed associated enterprises.
Guaranteeing One enterprise P Inc. has total loan of 1 million dollars from XYZ
borrowings guarantees 10% or more Bank of America. Out of that, A Ltd., an Indian
of the total borrowings company, guarantees 20% of total borrowings in
of the other enterprise. case of any default made by P Inc. In such case,
since A Ltd. guarantees 20% of total borrowings
of P Inc., P Inc. and A Ltd. are deemed
associated enterprises.
Appointment of One enterprise appoints X Ltd. has 15 directors on its Board. Out of that, Y
majority more than half of the Ltd. has appointed 8 directors. In such case, X
directors of board of directors or Ltd. and Y Ltd. are deemed associated
other members of the enterprises.
enterprise governing board, or one
or more executive
directors or executive
members of the governing
board of other
enterprise.
Appointment of More than half of the Mr. A appointed 9 directors out of 15 directors of
majority directors or members of X Ltd. and appointed 2 executive directors on the
directors of two the governing board, or board of Y Ltd. In such case, since a common
different one or more of the person i.e. Mr. A appointed more than half of the
enterprises by executive directors or directors in X Ltd. and appointed 2 executive
same person(s) members of the governing directors in Y Ltd., both X Ltd. and Y Ltd. are
board of each of the two deemed associated enterprises.
enterprises are appointed
by the same person(s).
Dependence on The manufacture or processing of goods or articles or business carried out
intangibles by one enterprise is wholly dependent (i.e. 100%) on the know-how,
w.r.t which patents, copyrights, trade-marks, licenses, franchises or any other business
other or commercial rights of similar nature, or any data, documentation, drawing
enterprise has or specification relating to any patent, invention, model, design, secret
exclusive formula or process, of which the other entity is the owner or in respect of
rights which the other enterprise has exclusive rights.
Dependence on 90% or more of raw materials and consumables required for the
raw material manufacture or processing of goods or articles carried out by one enterprise,
supplied by are supplied by the other enterprise, or by persons specified by the other

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other enterprise, where the prices and other conditions relating to the supply are
enterprise influenced by such other enterprise.
Dependence on The goods or articles manufactured or processed by one enterprise, are
sale sold to the other enterprise or to persons specified by the other enterprise,
and the prices and other conditions relating thereto are influenced by such
other enterprise.
Control by Where one enterprise is Mr. A and Mr. B are relatives. Mr. A has control
common controlled by an over X Ltd. and Mr. B has control over Y Ltd.
individual individual, the other Therefore, both X Ltd. and Y Ltd. will be
enterprise is also deemed associated enterprises.
controlled by such
individual or his relative or
jointly by such individual
and his relatives.
Control by HUF Where one enterprise is
or member controlled by a HUF and Member of
thereof the other enterprise is HUF HUF/
Relative of
controlled by a member member of
of such HUF or by such HUF
relative of a member of
such HUF or jointly by Control Control
such member and his
relative.
A Ltd. B Ltd.

A Ltd & B Ltd are deemed associated enterprises

Interest in a Where one enterprise is a firm, AOPs or BOls, the other enterprise holds 10%
firm, AOPs or or more interest in firm/AOPs/BOIs.
BOIs
Mutual interest There exists b/w the two enterprises, any relationship of mutual interest,
relationship as may be prescribed.

The term “enterprise” is defined in section 92F(iii) to mean a

person (including its certain specified Permanent
Establishment) who is, or has been, or is proposed to be,
engaged in any activity,
- relating to the production, storage, supply, distribution, acquisition or control of articles or
goods, or know-how, patents, copy rights, trade-marks, licences, franchises or any other
business or commercial rights of similar nature or any data, documentation, drawing or
specification relating to any patent, invention, model, design, secret formula or process, of

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which the other enterprise is the owner or in respect of which the other enterprise has
exclusive rights, or
- the provision of services of any kind, or in carrying out any work in pursuance of a contract,
or in investment, or providing loan or in the business of acquiring, holding, underwriting or
dealing with shares, debentures or other securities of any other body corporate,
whether such activity or business is carried on, directly or through one or more of its units or
divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place
where the enterprise is located or at a different place or places.
“Permanent establishment” includes a fixed place of business through
which the business of the enterprise is wholly or partly carried on.
III. Definition of International Transaction [Section 92B]
 As per section 92B, an international transaction means:

(i) a transaction between two or more associated

enterprises, either or both of whom are non-
residents; and

(ii) transaction in the nature of:

(a) sale/purchase/lease of tangible property; or
(b) sale/purchase/lease of intangible property; or

(c) provision of services; or

(d) lending/borrowing money; or
(e) any other transaction having a bearing on profits, income, losses or assets of
such enterprises; or
(f) mutual agreement or arrangement between two or more associated enterprise
for the allocation or apportionment of, or any contribution to, any cost or
expense incurred or to be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of such enterprises.
 Where, in respect of a transaction entered into by an
enterprise with a person other than an associated
enterprise (hereinafter referred to as “other person”),

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♦ there exists a prior agreement in relation to the relevant transaction between the
other person and the associated enterprise or,

♦ where the terms of the relevant transaction are determined in substance between
such other person and the associated enterprise; and
♦ either the enterprise or the associated enterprise or both of them are non-residents,

then such transaction entered into between the enterprise and the other person shall be
deemed to be an international transaction entered into between two associated
enterprises, whether or not such other person is a non-resident.
Example:
If A Ltd., an Indian company, has entered into an agreement for sale of product X to Mr. B,
an unrelated party, on 1/6/2025 and Mr. B has entered into an agreement for sale of
product X with C Inc., a non-resident entity, which holds 27% of the voting power in A Ltd.,
on 30/5/2025, then, the transaction between A Ltd. and Mr. B shall be deemed to be an
international transaction entered into between two associated enterprises, irrespective of
whether or not Mr. B is a non-resident.

Mr. B C Inc.
A Ltd (Unrelated (Associated
party) Enterprise of
A Ltd.)

Agreement for sale of Agreement for sale of

Product X entered into on product X entered into on
1/6/2025 30/5/2025

Transaction between A Ltd. and Mr. B is deemed to be an international transaction

between associated enterprises, whether or not Mr. B is a non-resident.

Note – C Inc. is deemed to be an associated enterprise of A Ltd. since it holds 26% or more
of the voting power A Ltd.

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 The scope of “international transaction” shall include:

Transactions Amplification of scope of terms used
(1) Purchase, sale, transfer, Tangible property includes -
lease or use of tangible • building,
property
• transportation vehicle,
• machinery, equipment, tools, plant,
• furniture,
• commodity or
• any other article, product or thing;
(2) Purchase, sale, transfer, “Use of certain rights” refer to –
lease or use of intangible • land use,
property, including transfer
of ownership or the provision • copyrights, patents, trademarks, licences,
of use of certain rights franchises,
• customer list, marketing channel, brand,
commercial secret,
• know-how,
• industrial property right,
• exterior design or practical and new design or
• any other business or commercial rights of
similar nature.
(3) Capital financing • any type of long-term or short-term borrowing,
• lending or guarantee,
• purchase or sale of marketable securities or
• any type of advance, payments or deferred
payment or receivable or any other debt arising
during the course of business.
(4) Provision of services • provision of market research,
• market development,
• marketing management,
• administration,
• technical service,
• repairs,
• design,
• consultation,

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• agency,
• scientific research,
• legal or accounting service.
(5) Business restructuring or All such transactions are included in the definition of
reorganization entered into “international transaction”, whether or not it has
by an enterprise with an bearing on the profit, income, losses or assets of
associated enterprise such enterprises at the time of the transaction or at
any future date.

 The expression “intangible property” shall include:

Type of intangible Examples of each type of intangible asset
asset in relation to
(1) Marketing • Trademarks
• trade names
• brand names
• logos
(2) Technology • Process patents
• patent applications
• technical documentation such as laboratory notebooks
• technical know-how
(3) Artistic • literary works and copyrights
• musical compositions
• copyrights
• maps
• engravings
(4) Data processing • proprietary computer software
• software copyrights
• automated databases
• integrated circuit masks and masters
(5) Engineering • industrial design
• product patents
• trade secrets
• engineering drawing and schematics
• blueprints
• proprietary documentation

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(6) Customer • customer lists

• customer contracts
• customer relationship
• open purchase orders
(7) Contract • favourable supplier
• contracts,
• licence agreements
• franchise agreements
• non-compete agreements
(8) Human capital • trained and organised work force
• employment agreements
• union contracts
(9) Location • leasehold interest
• mineral exploitation rights
• easements
• air rights
• water rights
(10) Goodwill • institutional goodwill
• professional practice goodwill
• personal goodwill of professional
• celebrity goodwill
• general business going concern value
(11) methods, programmes, systems, procedures, campaigns, surveys, studies,
forecasts, estimates, or technical data;
(12) any other similar item that derives its value from its intellectual content rather than
its physical attributes.

 Transaction: The word “transaction” has been defined in section 92F to include an
arrangement, understanding or action in concert

(i) whether or not such arrangement, understanding or action is formal or in writing; or

(ii) whether or not such arrangement, understanding or action is intended to be
enforceable by legal proceedings.”

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Section 92F(v) provides an inclusive definition of the term “transaction”. Based on the
reading of the section, it is evident that it is not necessary that for a transaction undertaken
between two enterprises there needs to be a formal written agreement between them. It is
only relevant whether a transaction has been entered into in substance. The section also
negates the requirement as to the legal enforceability of agreement or understanding.
It may be noted that one of the parties to the international transaction should be a non-
resident. Therefore, transactions between a resident assessee (“A” Ltd.) and its foreign
branches or between its two or more foreign branches will not be considered as
international transactions. This is for the reason that when “A” Ltd. is a resident in India, all
its foreign branches will be deemed to be resident in India and transactions between Head
Office and branches or between branches inter se will be considered as transactions
between residents. Even otherwise there can be no avoidance of income in the transactions
between Indian Head Office and foreign branches.
On the other hand, if an Indian branch of a foreign company (“B” Ltd.) is having a
transaction with the Head Office, the same will be covered by the definition of international
transaction between associated enterprises. This is because the Indian branch (permanent
establishment of “B” Ltd.) will be liable to tax in India in respect of its Indian operations and,
therefore, any transaction between the Indian branches of “B” Ltd. with its head office in
foreign country or with any of the branches of “B” Ltd. outside India will be considered as an
international transaction and it will have to establish that the transaction is at an arm’s
length price. This will be the position even in respect of transactions between a parent
company (“A” Ltd.) and its foreign subsidiary and, therefore, such transactions will have to
comply with the provisions of transfer pricing regulations.

IV. Arm’s Length Price [Section 92C]: “Arm’s length price” is defined in section 92F(ii) to
mean price which is applied or proposed to be applied in a transaction between persons other than
associated enterprises in uncontrolled conditions.
Section 92C deals with the method for determining
arm’s length price and the factors which are to be
considered for applicability or non-applicability of a
particular method to a given situation. The factors
as well as methods incorporated in this section are
not exhaustive and the CBDT may prescribe further factors and methods. It provides that the arm’s
length price in relation to an international transaction would be determined by any of the following
methods, being the most appropriate method, having regard to the nature of transaction or class of

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transaction or class of associated persons or functions performed by such persons or such other
relevant factors as the CBDT may prescribe, namely -

(a) comparable uncontrolled price method;

(b) resale price method;
(c) cost plus method;

(d) profit split method;

(e) transactional net margin method;
(f) such other method as may be prescribed by the Board.

Accordingly, the CBDT has prescribed that the other method for determination of arm’s length
price in relation to an international transaction would be any method which takes into account the
price which has been charged or paid, or would have been charged or paid, for the same or similar
uncontrolled transaction, with or between non-associated enterprises, under similar circumstances,
considering all the relevant facts [Rule 10AB].

Transfer Pricing Methods

Traditional Transaction Transactional Profit

Methods Other Methods
Methods

Comparable Uncontrolled Price Profit Split Method Any other method as

Method provided in Rule 10AB

Resale Price Transactional Net

Method Margin Method

Cost Plus Method

Section 92C(2) provides that the most appropriate method out of the above methods has to be
applied for determination of arm’s length price, in the prescribed manner.

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Rule 10B(1) prescribed the manner to determine the arm’s length price under the five methods as
stated in above diagram in respect of any goods, property or services purchased or sold under any
international transaction.
(a) Comparable Uncontrolled Price Method

Adjustment to account
for differences between
the international
Under this method the The adjusted price as
transaction and
price charged or paid worked out will be
comparable
for property transferred considered as an arm’s
uncontrolled
or services provided length price in respect
transactions or
under any comparable of the property
between the
uncontrolled transferred or services
enterprises entering
transaction or provided in the
into such transactions
transactions should be international
which could materially
identifiable. transaction.
affect the price in the
open market can be
made.

ILLUSTRATION 1
US Ltd., a US company has a subsidiary, IND Ltd. in India. US Ltd. sells computer monitors to
IND Ltd. for resale in India. US Ltd. also sells computer monitors to CMI Ltd., another computer
reseller. It sells 50,000 computer monitors to IND. Ltd. at ` 11,000 per unit. The price fixed for
CMI Ltd. is ` 10,000 per unit. The warranty in case of sale of monitors by IND Ltd. is handled by
IND Ltd. However, for sale of monitors by CMI Ltd., US Ltd. is responsible for the warranty for 3
months. Both US Ltd. and IND Ltd. offer extended warranty at a standard rate of ` 1,000 per
annum. On these facts, how is the assessment of IND Ltd. going to be affected?
SOLUTION
US Ltd., the foreign company and IND Ltd., the Indian company are associated enterprises since
US Ltd. is the holding company of IND Ltd. US Ltd. sells computer monitors to IND Ltd. for resale
in India. US Ltd. also sells identical computer monitors to CMI Ltd., which is not an associated
enterprise. The price charged by US Ltd. for a similar product transferred in comparable
uncontrolled transaction is, therefore, identifiable. Therefore, Comparable Uncontrolled Price
(CUP) method for determining arm’s length price can be applied.
While applying CUP method, the price in comparable uncontrolled transaction needs to be
adjusted to account for difference, if any, between the international transaction (i.e. transaction
between US Ltd. and IND Ltd.) and uncontrolled transaction (i.e. transaction between US Ltd. and
CMI Ltd.) and the price so adjusted shall be the arm’s length price for the international transaction.

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For sale of monitors by CMI Ltd., US Ltd. is responsible for warranty for 3 months. The price
charged by US Ltd. to CMI Ltd. includes the charge for warranty for 3 months. Hence arm's length
price for computer monitors being sold by US Ltd. to IND Ltd. would be:
Particulars No. `
Sale price charged by US Ltd. to CMI Ltd. 10,000
Less: Cost of warranty included in the price charged to CMI Ltd.
(` 1,000 x 3 /12) 250
Arm's length price 9,750
Actual price paid by IND Ltd. to US Ltd. 11,000
Difference per unit 1,250
No. of units supplied by US Ltd. to IND Ltd. 50,000
Addition required to be made in the computation of
total income of IND Ltd. (` 1,250 × 50,000) 6,25,00,000

No deduction under Chapter VI-A would be allowable in respect of the enhanced income of ` 6.25
crores.
Note: It is assumed that IND Ltd. has not entered into an advance pricing agreement or opted to be
subject to Safe Harbour Rules.
(b) Resale Price Method

Under this method, the price at which property purchased or services obtained by the enterprise
from an associated enterprise is resold or are provided to an unrelated enterprise should be
identifiable.

The following adjustments can be made to such resale price.

- For normal gross profit margin
- For expenses incurred in connection with the purchase of property or obtaining of services.
- For functional and other differences, including differences in accounting practices which could
materially affect the gross profit margin in the open market.

The adjusted price as stated above will be considered as the arm’s length price in respect of the
purchase of the property or obtaining of the services by the enterprise from the associated
enterprise.

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ILLUSTRATION 2
Earth (P) Ltd., Calcutta is engaged in trading of electronic goods. It purchased goods from its
associated enterprise Sun Pte. Ltd., Singapore, and also from unrelated party, Oceania Ltd., UK.
For the F.Y.2025-26, the gross profit margin was 15% on the sale of goods of Sun Pte Ltd.,
whereas it was 20% in the case of Oceania Ltd. After-sales warranty of 6 months was provided by
Sun Pte Ltd. whereas Oceania Ltd. gave after-sales warranty of 1 year. The cost of warranty may
be taken as 2% of the sale price. The Sun Pte. Ltd.’s brand value is internationally known and the
benefit of the brand value can be taken as 1% of sale price. During the F.Y.2025-26, it sold goods
of Sun Pte Ltd. for ` 20 crores and of Oceania Ltd. for ` 15 crores. As regards transport cost of
the goods purchased, there was no difference between related and unrelated party. Compute the
ALP of the transaction between Earth (P) Ltd. and Sun Pte Ltd., Singapore by applying the Resale
Price Method, considering the facts of the case.
SOLUTION
As per section 92B, the transactions entered into between Earth (P) Ltd., an Indian company, and
Sun Pte. Ltd., Singapore, being associated enterprises, for purchase of electronic goods would be
international transaction.
Since Earth (P) Ltd. purchased similar electronic goods from Oceania Ltd., an unrelated entity, and
sold the same to unrelated parties, this transaction can be considered as uncontrolled transaction
and the gross profit margin of 20% earned on sale of such goods can be considered for the
purpose of determining the arm’s length price of the transactions between Earth (P) Ltd. and Sun
Pte. Ltd. However, functional adjustments need to be given effect to in arriving at the ALP.
Computation of ALP of transaction between Earth (P) Ltd. and Sun Pte. Ltd.
Particulars Amount (In `)
Resale price of goods purchased from Sun Pte. Ltd. 20,00,00,000
Less: Profit margin with reference to uncontrolled transaction between Earth 4,00,00,000
(P) Ltd. and Oceania Ltd. (20% on sale)
16,00,00,000
Add: Adjustment for benefit of brand value of Sun Pte. Ltd. [Sun Pte. Ltd has 20,00,000
its brand value internationally. Therefore, adjustment of benefit of brand value
has to be carried out to arrive at ALP (1% of sale price)]
Less: Adjustment of cost of warranty [Sun Pte. Ltd. provides warranty for 6
months whereas unrelated party has provided warranty of 12 months.
Therefore, adjustment for the cost of such warranty has to be carried out to
arrive at arm’s length price (2% of sale price x 6/12)] (20,00,000)
Arm’s length price 16,00,00,000

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(c) Cost Plus Method

The amount of a
normal gross profit
Under this method, mark-up to such costs
the direct and indirect arising from the The computed normal Costs referred to in
costs of production transfer or provision of gross profit mark-up first box should be
incurred by the the same or similar can be adjusted to increased by the
enterprise in respect property or services by take into account the adjusted profit mark-
of property the enterprise, or by functional and other up as stated in third
transferred or an unrelated differences which box and the price so
services provided to enterprise in could materially affect arrived at will be
an associated comparable such profit mark-up in considered as the
enterprise should be uncontrolled the open market. arm’s length price.
determined. transaction or
transactions should be
determined.

ILLUSTRATION 3
ABC Ltd., Canada holds 35% shares in LMN Ltd., India. LMN Ltd. develops software and does
both onsite and offsite consultancy services for the customers. LMN Ltd. during the year billed
ABC Ltd. Canada for 120 man-hours at the rate of ` 1,800 per man hour. The total cost (direct and
indirect) for executing this work amounted to ` 2,25,000.
However, LMN Ltd. billed XYZ Ltd., India at the rate of ` 2,800 per man hour for the similar level of
manpower and earned a Gross Profit of 50% on its cost.
The transactions of LMN Ltd. with ABC Ltd. and XYZ Ltd. are comparable, subject to the following
differences:
• While LMN Ltd. derives technology support from the ABC Ltd., there is no such support
from XYZ Ltd. The value of technology support received from ABC Ltd. may be put at 18%
of normal gross profits.
• As ABC Ltd. gives business in large volumes, LMN Ltd. offered to ABC Ltd., a quantity
discount which may be valued at 10% of normal gross profits.
• In the case of rendering services to ABC Ltd., LMN Ltd. neither runs any risk nor incurs any
marketing costs. On the other hand, in the case of services to XYZ Ltd., LMN Ltd. has to

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assume all the risk and costs associated with the marketing function which may be
estimated at 12% of the normal gross profits.

• LMN Ltd. offered one month credit to ABC Ltd. The cost of providing such credit may be valued
at 2% of the gross profits. No such credit was given to XYZ Ltd.
Compute the Arm's Length Price along with income to be increased under the Cost Plus Method.

SOLUTION

LMN Ltd, an Indian company and ABC Ltd., a Canadian company, are deemed to associated
enterprises as per section 92A(2), since ABC Ltd. holds shares carrying 35% of the voting power
(i.e., not less than 26% of voting power) in LMN Ltd. Further, the transaction of developing
software and providing consultancy services (both onsite and offsite) fall within the meaning of
“international transaction” under section 92B. Hence, transfer pricing provisions would be attracted
in this case.

Computation of Arm’s Length Price as per Cost Plus Method

Gross Profit mark-up on cost in case of XYZ Ltd. [an unrelated party] 50%
Less: Adjustments for functional and other differences
- Value of technology support [ABC Ltd. provides technology support, 9%
but XYZ Ltd. does not provide such support. Therefore, value of
technology support shall be adjusted] [18% of 50%, being gross
profit]
- Quantity discount to ABC Ltd. [Quantity discount is allowed to ABC 5%
Ltd. as it gives business in large volumes, but the same is not
provided to XYZ Ltd. Therefore, it shall be adjusted] [10% of 50%,
being gross profit]
- Risk and cost associated with marketing [LMN Ltd. has to bear all the 6%
risk and costs associated with the marketing function in case of XYZ
Ltd., while there is no such risk in case of services to ABC Ltd.
Therefore, market risk and cost shall be adjusted] [12% of 50%,
being gross profit] 20%
30%
Add: Cost of credit to ABC Ltd. [LMN Ltd has provided credit of 1 month to
ABC Ltd. but not to the unrelated party. Therefore, adjustment for the
cost of such credit has to be carried out to arrive at the ALP] [(2% of
50%, being gross profit] 1%
Arm’s length gross profit mark up to cost 31%

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Cost incurred by LMN Ltd. for executing ABC Ltd.’s work 2,25,000
Add: Adjusted gross profit (` 2,25,000 x 31%) 69,750
Arm’s length billed value 2,94,750
Less: Actual Billed Income from ABC Ltd. (` 1800 x 120 man hours) 2,16,000
Total Income of LMN Ltd to be increased by 78,750

(d) Profit Split Method

This is a method which may be applicable mainly in international transactions involving

transfer of unique intangibles or in multiple international transactions which are so inter-
related that they cannot be evaluated separately for the purpose of determining the arm’s
length price of any one transaction.

Under this method, combined net profit of the associated enterprises arising from the
international transactions in which they are engaged is first determined.

The relative contribution of each associated enterprise to the earning of such combined net
profit is then evaluated on the basis of the functions performed, assets employed and risks
assumed by each enterprise. This evaluation is to be made on the basis of reliable external
market data which can indicate how such contribution would be evaluated by unrelated
enterprises performing comparable functions in similar circumstances.

The combined net profit is then split amongst the enterprises in proportion to their relative
contributions. The profit thus apportioned to the assessee is taken into consideration to
arrive at an arm’s length price in relation to the international transaction.

In certain cases the combined net profit referred to in second box may, in the first instance,
be partially allocated to each enterprise so as to provide it with a basic return appropriate
for the type of international transaction in which it is engaged. This has to be determined
with reference to market returns achieved for similar types of transactions by independent
enterprises. Thereafter, the residual net profit remaining after such allocation may be split
amongst the enterprises as stated in third and fourth box. In such a case the aggregate of
net profit allocated in the first instance together with the residual profit apportioned should
be considered for arriving at the arm’s length price of the international transaction.

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(e) Transactional Net Margin Method

In this method, the net profit margin realised by the enterprise from an international transaction
entered into with an associated enterprise is computed having regard to costs incurred or sales
effected or assets employed or having regard to any other relevant base.

The net profit margin realised by the enterprise or by an unrelated enterprise from a comparable
uncontrolled transaction by applying the same base as computed above. This profit margin is
adjusted to take into account the differences which could materially affect the net profit margin in the
open market having regard to international transaction and comparable uncontrolled transactions or
having regard to the enterprise entering into such transactions.

If the net profit margin realised by the enterprise as in first box is established to be the same as the
net profit margin as in second box, then the same is taken into consideration to arrive at an arm’s
length price in relation to the international transaction.

ILLUSTRATION 4
Andes Inc. having its business in Malaysia has advanced a loan of MD 1,60,000 to Andes Ltd,
India. Book value of total assets of Andes Ltd was ` 125 lakhs. Andes Ltd provides software
backup support to Andes Inc. Andes Ltd has spent 50,000 man hours during the financial year
2025-26 for the services rendered to Andes Inc. The cost for Andes Ltd is MD 75/manhour. Andes
Ltd has billed Andes Inc. at MD 90.75/manhour.

Gama Ltd. in India which has a similar business model, provides software backup support to Olive
Inc. in Penang, Malaysia. Gama Ltd.'s cost and operating profits are as hereunder:
Particulars ` in lakhs
Direct costs 600
Indirect costs 200
Operating profits 200

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(1) Calculate Arm’s Length Price for the transaction between Andes Ltd. and Andes Inc. based
on the above data of Gama Ltd. using the Transactional Net Margin Method. Assume 1 MD
= ` 45.
(2) Explain, if there is any adjustment to be made to the total income of Andes Ltd.
Note: MD = Malaysia Dollars
SOLUTION
Two enterprises are deemed to be associated enterprises where one enterprise advances loan
constituting not less than 51% of the book value of the total assets of the other enterprise.
In this case, since Andes Inc., a foreign company, has advanced loan to Andes Ltd., an Indian
company, and such loan constitutes 57.6% [(` 45 x 1,60,000 x 100/1,25,00,000] of the book value
of total assets of Andes Ltd., Andes Inc and Andes Ltd. are deemed to be associated enterprises.
Since the transaction of provision of software backup support by Andes Ltd. to Andes Inc. is an
international transaction between associated enterprises the provisions of transfer pricing would
be attracted in this case.
Determination of Operating Margin of transaction of provision of software backup support
by Andes Ltd. to Andes Inc

Particulars `

Billing per manhour [MD 90.75/hour x ` 45] 4,083.75

Cost per man hour [MD 75/hour x ` 45] 3,375.00

Operating profit per manhour 708.75

Operating profits to cost (%) [708.75 x 100/3375] = 21%

Determination of Operating Margin of Comparable Uncontrolled transaction i.e., provision of

software backup support. by Gama Ltd. to Olive Inc.
Particulars ` in lakhs
Direct Cost 600
Indirect Cost 200
Total cost 800
Operating profits 200
Operating profits to cost (%) [200 x 100/800] = 25%

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(1) Computation of Arm’s Length Price of provision of software backup support provided
by Andes Ltd. to Andes Inc. by applying TNMM

Particulars `

Cost for Andes Ltd. (per man hour) [MD 75 x ` 45/MD] 3,375.00

Add: Arm’s length operating profit margin as % of cost (25% of ` 3,375) 843.75

Arm’s length price (per manhour) in ` 4,218.75

Arm’s length price of total manhours spent by Andes Ltd. for providing software backup
support to Andes Inc. [` 4,218.75 x 50,000 man hours] = ` 21,09,37,500

(2) Adjustment to be made to the total income of Andes Ltd.

Particulars `

Arm’s length price of total manhours spent by Andes Ltd. for providing 21,09,37,500
software backup support to Andes Inc.

Less: Amount actually billed [90.75 MD x ` 45/MD x 50,000 manhours] 20,41,87,500

Arm’s length adjustment to be made to the total income of Andes 67,50,000

Ltd.

(f) Other Method as may be prescribed by the CBDT

The Other method allows the use of ‘any method’ which takes into account

(i) the price which has been charged or paid or

(ii) would have been charged or paid for the same or similar uncontrolled transactions
with or between non-associated enterprises, under similar circumstances.

The various data which may possibly be used for comparability purposes under this method
could be third party quotations, valuation reports, tender/Bid documents, documents relating
to the negotiations, standard rate cards, commercial & economic business models; etc.

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Methods for computing ALP [Section 92C]

CUP Method Resale Price Cost Plus Profit Split Transactional Net
Method(RPM) Method (CPM) Method (PSM) Margin Method
(TNMM)

This method is This method is This method is This method is Compute Net Profit
applied where applied where generally applied where (NP) margin of the
there are item obtained applied where there is transfer of enterprise from
similar from AE is semi-finished unique intangibles International
transaction(s) resold to goods are sold or in multiple Transaction with AE
b/w unrelated party to AEs International having regard to cost
unconnected Transaction incurred/sales effected/
parties assets employed

Identify price Identify the Identify direct & Determine Compute the NP
in a Resale Price indirect cost of combined NP of margin realised by
comparable (RP) at which production the AEs arising out the enterprise or
uncontrolled the item is incurred for of International unrelated enterprise
transaction resold to property Transaction in a CUCT by
(CUCT) unrelated party transferred or applying the same
services base
provided to AE

Reduce the RP Determine Evaluate the Adjust NP margin

by the normal normal GP relative realised from CUCT
Gross Profit mark up to contribution of to a/c for differences
(GP) margin on such costs by each enterprise to affecting NP margin
CUCT & an unrelated the earning of in the OM
expenditure enter in CUCT combined NP on
incurred the basis of FAR
(customs duty)
w.r.t. purchase

Adjust the Adjust the price Adjust the Split the combined Compare NP margin
price for for functional & normal GP NP amongst the relative to
material other differences mark-up for enterprise in costs/sales/assets of
differences in materially functional and proportion to the AE with NP
terms of affecting GP other market returns; & margin of
contract, margin in open differences residual profits in uncontrolled party in
credit, market (OM) materially proportion to their comparable
transport etc. affecting GP relative transactions
mark-up in OM contribution

Adjusted price Adjusted price Total Costs ↑d ALP to be detd. Adjusted NP margin
is ALP is ALP by adjusted on the basis of taken into A/c to
mark up = ALP profit apportioned. arrive at ALP

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Determination of the most appropriate method: Rule 10C deals with the determination of most
appropriate method. Under this Rule, the method which is best suited to the facts and
circumstances and which provides the most reliable measure of an arm’s length price in relation to
the international transaction will be considered to be the most appropriate method.
For the purpose of selecting the most appropriate method, the following factors should be taken
into account.
(i) The nature and class of the international transaction;
(ii) The class, or classes of associated enterprises entering into the transaction and the
functions performed by them taking into account assets employed or to be employed and
risks assumed by such enterprises;
(iii) The availability, coverage and reliability of data necessary for application of the method;
(iv) The degree of comparability existing between the international transaction and the
uncontrolled transaction and between the enterprises entering into such transactions;
(v) The extent to which reliable and accurate adjustments can be made to account for
difference, if any, between the international transaction and the comparable uncontrolled
transaction or between the enterprises entering into such transactions;
(vi) The nature, extent and reliability of assumptions required to be made in application of a method.
Manner of computation of Arm’s length price (Applicable for international transactions and
specified domestic transactions undertaken on or after 1.4.2014) [Third proviso to section 92C(2)]
In case of an international transaction or specified domestic transaction 1 undertaken on or after
1.4.2014, where more than one price is determined by the most appropriate method, the ALP
would be computed in the prescribed manner specified in Rule 10CA.
Computation of arm’s length price in certain cases [Rule 10CA]

Determination of arm’s length price using one of the prescribed methods

As per range concept, if

prescribed conditions are
The price thus Whether a
Yes No satisfied (covered in later
determined is the arm’s single price sections),
length price is arrived
at? (or)
By applying Arithmetic Mean in
any other case

1 discussed later in this Chapter

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Rule 10CA(1) provides that where in respect of an international transaction or a specified domestic
transaction, the application of the most appropriate method referred to in section 92C(1) results in
determination of more than one price, then, the arm’s length price in respect of such international
transaction or specified domestic transaction has to be computed on the basis of the dataset
constructed by placing such prices in an ascending order as provided in Rule 10CA(2).

Application of multiple year data for construction of dataset

Multiple year data allowed only in cases where

determination of ALP is done using TNMM, RPM or CPM

Data to be used for analyzing the comparability of an uncontrolled transaction with an

international transaction
The data to be used for analyzing the comparability of an uncontrolled transaction with an
international transaction should relate to the financial year (current year) in which the international
transaction has been entered into.
In case the most appropriate method for determination of ALP of a transaction entered into on or
after 1.4.2014 is the resale price method or cost plus method or the transactional net margin
method, then, the data to be used for analyzing the comparability of an uncontrolled transaction
with an international transaction shall be –
(a) the data relating to the current year; or
(b) the data relating to the financial year immediately preceding the current year, if the data
relating to the current year is not available at the time of furnishing the return of income by
the assessee, for the assessment year relevant to the current year.
However, where the data relating to the current year is subsequently available at the time of
determination of arm’s length price of an international transaction during the course of any
assessment proceeding for the assessment year relevant to the current year, then, such data
shall be used for such determination irrespective of the fact that the data was not available at
the time of furnishing the return of income of the relevant assessment year.
For the data relating to the current year, where the comparable uncontrolled transaction has been
identified and the enterprise undertaking the said uncontrolled transaction, [not being the
enterprise undertaking the international transaction or the specified domestic transaction referred

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to in sub-rule (1)], has in either or both of the two financial years immediately preceding the current
year undertaken the same or similar comparable uncontrolled transaction then,-

(i) the most appropriate method used to determine the price of the comparable uncontrolled
transaction undertaken in the aforesaid period and the price in respect of such uncontrolled
transactions has to be determined; and

(ii) the weighted average of the prices, computed in accordance with the manner provided in
sub-rule (3), of the comparable uncontrolled transactions undertaken in the current year and
in the aforesaid period preceding it has to be included in the dataset instead of the price
referred to in sub-rule (1).
Further, where the comparable uncontrolled transaction has been identified on the basis of the
data relating to the financial year immediately preceding the current year and the enterprise
undertaking the said uncontrolled transaction, [not being the enterprise undertaking the
international transaction or the specified domestic transaction referred to in sub-rule (1)], has in
the financial year immediately preceding the said financial year undertaken the same or similar
comparable uncontrolled transaction then, -
(i) the price in respect of such uncontrolled transaction shall be determined by applying the
most appropriate method in a similar manner as it was applied to determine the price of the
comparable uncontrolled transaction undertaken in the financial year immediately preceding
the current year; and
(ii) the weighted average of the prices, computed in accordance with the manner provided in
sub-rule (3), of the comparable uncontrolled transactions undertaken in the aforesaid period
of two years shall be included in the dataset instead of the price referred to in sub-rule (1).
Also, in such cases, where the use of data relating to the current year for determination of ALP
subsequently at the time of assessment establishes that,-
(i) the enterprise has not undertaken same or similar uncontrolled transaction during the
current year; or

(ii) the uncontrolled transaction undertaken by an enterprise in the current year is not a
comparable uncontrolled transaction,
then, irrespective of the fact that such an enterprise had undertaken comparable uncontrolled
transaction in the financial year immediately preceding the current year or the financial year
immediately preceding such financial year, the price of comparable uncontrolled transaction or the

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weighted average of the prices of the uncontrolled transactions, as the case may be, undertaken
by such enterprise shall not be included in the dataset.
Rule 10CA(3) provides that where an enterprise has undertaken comparable uncontrolled
transactions in more than one financial year, then for the purposes of constructed the dataset, the
weighted average of the prices of such transactions would be computed in the following manner,
namely:-
Method used to Manner of computation of weighted average of the prices
determine the prices
(i) The resale price By assigning weights to the quantum of sales which has been
method considered for arriving at the respective prices
(ii) The cost plus method By assigning weights to the quantum of costs which has been
considered for arriving at the respective prices
(iii) The transactional net By assigning weights to the quantum of costs incurred or
margin method sales effected or assets employed or to be employed, or as
the case may be, any other base which has been considered
for arriving at the respective prices.

Range Concept: Rule 10CA(4) provides that where the most appropriate method applied is –
(i) a method other than the profit split method or a method prescribed by the CBDT under
section 92C(1)(d)/(f); and

(ii) the dataset constructed in accordance with sub-rule (2) consists of six or more entries,
an arm’s length range beginning from the thirty-fifth percentile of the dataset and ending on the
sixty-fifth percentile of the dataset would be constructed.
If the price at which the international transaction or the specified domestic transaction has actually
been undertaken is within the said range, then, the price at which such international transaction or
the specified domestic transaction has actually been undertaken would be deemed to be the arm’s
length price [Rule 10CA(5)].
If the price at which the international transaction or the specified domestic transaction has actually
been undertaken is outside the said arm's length range, the arm’s length price shall be taken to be
the median of the dataset [Rule 10CA(6)].

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• Most appropriate method selected is Comparable uncontrolled

When to apply range price method, resale price method, cost plus method or
concept? transactional net margin method and
• The dataset constructed has six or more entries.
• Arrange the values in the dataset in the ascending order.
• Where the actual transaction price falls within 35th and 65th
percentile of the dataset, the value of transaction will be accepted
How to apply?
to be arm's length price.
• Where the transfer price does not fall within the above range,
then median of dataset shall be taken as the Arm's Length price.

Range concept not applicable:

In a case where the provisions of Rule 10CA(4) are not applicable [i.e. most appropriate method is
profit split method or any other method or the dataset has less than 6 entries], the arm's length
price shall be the arithmetical mean of all the values included in the dataset. However, if the
variation between the arm's length price so determined and price at which the international
transaction or specified domestic transaction has actually been undertaken does not exceed such
percentage not exceeding 3% of the latter, as may be notified by the Central Government in the
Official Gazette in this behalf, the price at which the international transaction or specified domestic
transaction has actually been undertaken shall be deemed to be the arm's length price [Rule
10CA(7)].
Meaning of certain terms [Rule 10CA(8)]
Term Meaning
(a) the thirty-fifth percentile of a dataset The lowest value in the dataset such that at least
(having values arranged in an 35% of the values included in the dataset are
ascending order) equal to or less than such value.
However, if the number of values that are equal to
or less than the aforesaid value is a whole
number, then, the thirty-fifth percentile shall be the
arithmetic mean of such value and the value
immediately succeeding it in the dataset.
(b) the sixth-fifth percentile of a dataset The lowest value in the dataset such that at least
(having values arranged in an 65% of the values included in the dataset are
ascending order) equal to or less than such value.
However, if the number of values that are equal to
or less than the aforesaid value is a whole
number, then, the sixty-fifth percentile shall be the
arithmetic mean of such value and the value
immediately succeeding it in the dataset.

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(c) the median of the dataset (having The lowest value in the dataset such that at least
values arranged in an ascending 50% of the values included in the dataset are
order) equal to or less than such value.
However, if the number of values that are equal to
or less than the aforesaid value is a whole
number, then, the median shall be the arithmetic
mean of such value and the value immediately
succeeding it in the dataset.
Comparability Analysis
The comparability of the international transaction with an uncontrolled transaction is to be
judged with reference to the following factors:
(i) The specific characteristics of the property transferred or services provided in either
transaction;
(ii) The functions performed, taking into account assets employed or to be employed and the
risks assumed, by the respective parties to the transactions;
(iii) The contractual terms (whether or not such terms are formal or in writing) of the
transactions which lay down explicitly or implicitly how the responsibilities, risks and
benefits are to be divided between the respective parties to the transactions;
(iv) Conditions prevailing in the markets in which the respective parties to the transactions
operate, including the geographical location and size of the markets, the laws and
Government orders in force, costs of labour and capital in the markets, overall economic
development and level of competition and whether the markets are wholesale or retail.
As per Rule 10B(3), an uncontrolled transaction should be considered comparable to the
international controlled transaction only if there are no material differences (in terms of
functions, assets and risks) between the transactions being compared or the enterprises entering
into such transactions which would materially affect the prices or costs charged or paid in, or the
profit arising from, such transactions in the open market.
It, further, provides that in a case there are any such material differences, reasonably accurate
adjustments should be made to eliminate such material differences in order to compare the
controlled and the uncontrolled transactions.
Comparable uncontrolled transactions could be of two types - Internal or external.

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Comparable uncontrolled
transactions

Internal External
Comparables Comparables

(a) Internal comparables: These are the comparable transactions between one of the parties
to the controlled transaction, (taxpayer or the AE) and an independent third party. These
comparables are considered a good measure of comparability as it is likely that the
Functions, Assets, Risks analysis (FAR analysis) of the comparable transaction would be
similar to that of the controlled transaction due to the involvement of a common entity to the
said two transactions. Even though internal comparables may offer a higher degree of
comparability, there is a need of rigorous scrutiny like in external comparables and suitable
adjustments should be made, wherever necessary.
(b) External comparables: These are the comparable transactions between two independent
parties, neither of which is a party to the controlled transaction. Generally, the level of
comparability offered in the external comparables is not as precise as internal comparables;
however, this rule is not absolute. For instance, it may so happen that an entity offers a
certain variation of its product exclusively to its AE and a slightly different variation to
unrelated parties. In such a situation, preference should be given to external comparables
involving the identical product and identical contractual terms than accepting the internal
comparable.

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In the above example, Transaction between AE1 and AE2 are subject to transfer pricing. AE1 and
AE2 are parties to a controlled transaction. Transaction #1 and #2 are internal uncontrolled
transactions since it is entered by AEs with unrelated parties.
Transaction #3 is external uncontrolled transactions since it is entered between unrelated parties.
Process for identification and selection of external comparables:

Wherever internal comparables are available, preference should be given to internal comparables
in the process of determination of ALP. However, in the absence of the same, recourse has to be
taken to search for external comparables. The transfer pricing legislation in India does not
prescribe a particular process for selection of such comparables. However, various decisions of
the judicial authorities have provided guidance on how to carry out such process based on the
data available in public domain. The major steps involved in the search process are discussed
hereunder:
A database is a domain where information (financial and
non-financial) about companies is maintained in an
organised manner so as to facilitate easy search for data and also for the application of the
relevant filters. Some of the commonly used databases in India are as under:
(a) Capitaline Plus/ Capitaline TP: It contains digital database of over 35,000 companies. It
includes information of public, private, co-operative and joint sector companies, listed or
otherwise.
(b) Prowess: Prowess is a database of the financial performance of Indian companies. Audited
Annual Reports of companies and information submitted to the MCA; and in the case of
listed companies, company filings with stock exchanges and prices of securities listed on
the major stock exchanges are the sources of the database. The database contains
information on all listed companies and a larger set of unlisted companies.
(c) ACE TP Database: ACE TP database contains information, both financial and non-financial
of companies and sectors. It also contains information regarding equity and commodity and
derivative markets.
There are other available Indian and foreign databases also like Prowess Pro, Amadeus, Royalty
Stat, Compustat Global, Osiris, ktmine, Oriana, Bloomberg etc. which can be referred.

The application of the quantitative filters help in

filtering the companies available in the database
based on the similarity of the quantitative information

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between the tested party and the potential comparables. Some of the commonly used quantitative
filters are:

(a) Availability of financial data: The companies whose financial information for the relevant
period (financial year of the controlled transaction or the preceding two years as the case
may be) are not available in the public domain should not be considered in the
comparability analysis.
(b) Industry of the tested party: The appropriate industry head should be selected. For
instance, if the tested party operates in the seed segment, it should be ensured that various
industry heads which could include comparable companies should be chosen, i.e. seeds,
agriculture etc. Therefore, while applying this filter, the parameters should be fairly broad.
(c) Turnover filter: This is perhaps the most commonly used quantitative filter in the search
process. This is for the reason that companies which are operating in the same range of
turnover would have similar share in the market and thus are more likely to have somewhat
similar margins. On the other hand, companies with extremely high or low turnover would
not provide an effective base for comparison since their margins would not only reflect the
efficiency of their business but also the scale of the operations. The range of the filter is
very subjective and varies with the facts of each case.
(d) Net worth filter: Net worth of a company can be used to determine the creditworthiness of
the company. Negative net worth would indicate that the debts of the company have
surpassed its assets. Therefore, a company with consistent negative net worth should be
rejected in the comparability analysis since its margins would be adversely affected and it
would ordinarily be difficult to quantify and adjust the effect of its negative worth on the
margins. Companies with negative net worth are usually rejected in this filter.
(e) Export filter: The parameter of ‘geographic location of market’ has lead to adoption of
‘export turnover filter’ whereby Transfer Pricing Officers (‘TPOs’) insist that if the taxpayer is
an exporter then the comparables should also have export earnings of a certain degree.
The export activity levels, by itself, cannot be a valid filter unless it is established that the
market to which the exports are made are materially different from the domestic market.
(f) Employee expense filter: The employee expense ratio helps to analyse the level of
activities and intensity of employee dependence.
(g) Related party transactions: As already discussed, a transaction between two related
parties cannot be taken as a comparable uncontrolled transaction for the purpose of
benchmarking a controlled transaction. This filter finds its application on the same principle,

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i.e., if a potential comparable has substantial related party transactions, it can be inferred
that its margins are contaminated with transactions which are not entirely governed by the
market forces and thus such a company should be rejected in the search process.
(h) Consistently loss making companies: The companies which are incurring losses on a
consistent basis cannot be considered as good comparables as their profitability is
adversely impacted by factors which are not specific to the industry but to the entity.
However, loss in just one year would not be indicative of any extra ordinary factors
surrounding the company and therefore such a company should not be rejected on that
count alone.
The entities remaining after the application of the
quantitative filters are further narrowed down by
applying the qualitative filters. Some of the
commonly used qualitative filters are as under:
(a) Product filter: Although the industry filter excludes the companies not operating in the
same industry but at the same time there are entities producing a variety of products in the
same industry and therefore in order to reach a precise measure of comparability, the list of
companies should be further shortlisted to exclude the companies not dealing in the
same/similar products as that of the tested party. For instance, for a tested party trading in
seeds, the industry filter to be applied could be agri-trading. However, this filter might result
in companies engaged in various types of agricultural products such as fertilizers,
pesticides etc. In order to remedy this, product criteria would be applied to only select the
companies engaged in trading of seeds in the agriculture industry.
(b) Functional filter: The chosen companies must be further analyzed to select only those
companies which are functionally similar to the tested party. The functions could be in the
form of manufacturing of goods, rendering of services, trading in goods etc. Thus, the filter
to be applied depends on the functions performed by the tested party to find transactions
which are functionally similar.
(c) Ownership (Government or private): Generally, entities in the private sector exist for
generating profits. Government owned entities on the other hand, function to serve the
society and are not necessarily driven by the profit motive. Accordingly, such companies
should be included/ excluded based on their comparability analysis like the other private
companies.

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V. Reference to Transfer Pricing Officer [Section 92CA]: This section provides for a
procedure for reference to a Transfer Pricing Officer (TPO) of any issue relating to computation of
arm’s length price in an international transaction. The procedure is as under -
(1) The option to make reference to TPO is given to the
Assessing Officer. Where the assessee has entered into an
international transaction in any previous year and if
Assessing Officer considers it necessary or expedient to do so, he may refer the
computation of the arm’s length price in relation to the said international transaction to the
TPO. This option is not, however, available to the assessee.
(2) The Assessing Officer has to take the approval of the Principal Commissioner of Income-tax
(PCIT)/Commissioner of Income-tax (CIT) before making such a reference.

(3) Any Joint/Deputy/Assistant Commissioner of Income-tax, authorised by CBDT, can be

appointed as TPO.
(4) When such reference is made, TPO would serve a notice to the assessee requiring him to
produce on a date specified in the notice, any evidence on which the assessee relied in
support of the computation of arm’s length price made by him in relation to the international
transaction.

(5) The TPO can also determine the ALP of other international transactions identified
subsequently in the course of proceedings before him as if such transaction is an
international transaction referred to the TPO by the Assessing Officer under section
92CA(1) [Sub-section (2A)].
(6) Where in respect of an international transaction, the assessee has not furnished the report
under section 92E and such transaction comes to the notice of the TPO during the course
of proceeding before him, the transfer pricing provisions shall apply as if such transaction is
an international transaction referred to the TPO by the Assessing Officer under section
92CA(1) [Sub-section (2B)].

(7) The TPO has to pass an order determining the arm’s length price after considering the evidence,
documents, etc. produced by the assessee and after considering the material gathered by him.
He has to send a copy of his order to Assessing Officer as well as the assessee.

(8) The order of the Transfer Pricing Officer determining the arm’s length price of an
international transaction is binding on the Assessing Officer and the Assessing Officer shall
proceed to compute the total income in conformity with the arm’s length price determined by
the Transfer Pricing Officer [Sub-section (4)].

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(9) In order to provide sufficient time to the Assessing Officer to complete the assessment in a
case where reference is made to the Transfer Pricing Officer, section 92CA(3A) provides for
determination of arm’s length price of international transactions by the Transfer Pricing
Officer at least 60 days before the expiry of the time limit under section 153 or section 153B
for making an order of assessment by the Assessing Officer.
(10) In many cases, it becomes necessary to seek information from foreign jurisdictions for the
purpose of determining the arm's length price by the TPO. At times, proceedings before the
TPO may also be stayed by a court order.

Taking into consideration such cases, it has been provided that where assessment
proceedings are stayed by any court or where a reference for exchange of information has
been made by the competent authority under an agreement referred to in section 90 or 90A,
the time available to the Transfer Pricing Officer for making an order after excluding the
time for which assessment proceedings were stayed or the time taken for receipt of
information, as the case may be, is less than 60 days, then, such remaining period shall be
extended to 60 days.
(11) The TPO has power to rectify his order under section 154 if any mistake apparent from the
record is noticed. If such rectification is made, the Assessing Officer has to rectify the
assessment order to bring it in conformity with the same.
(12) The TPO can exercise all or any of the powers specified in clause (a) to (d) of section
131(1) or section 133(6) or section 133A for determination of arm’s length price once the
above reference is made to him.
(13) The Central Government may make a scheme, by way of notification for the purposes of
determination of the arm's length price, so as to impart greater efficiency, transparency and
accountability by –
(a) eliminating the interface between the Transfer Pricing Officer and the assessee or
any other person to the extent technologically feasible;
(b) optimising utilisation of the resources through economies of scale and functional
specialisation;
(c) introducing a team-based determination of arm's length price with dynamic
jurisdiction [Sub-section (8)].

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(14) The Central Government may, for the purpose of giving effect to the scheme made, direct
that any of the provisions of this Act would not apply or would apply with such exceptions,
modifications and adaptations as may be specified.
(15) Every notification so issued shall, as soon as may be after the notification is issued, be laid
before each House of Parliament [Sub-section (10)].

To reduce the compliance burden on the assessee as well as administrative burden on the
TPOs, the concept of block transfer pricing assessment has been introduced by the Finance
Act, 2025 which allows to apply the ALP determined in relation to an international
transaction for any previous year to the similar transaction for the two consecutive
previous years immediately following such previous year. The provisions related block
transfer pricing assessment are as follow:
(1) The ALP determined in relation to the international transaction under sub-section (3)
for any previous year shall apply to similar international transaction for the two
consecutive previous years immediately following such previous year, on fulfilment
of the following conditions:
(a) the assessee exercises an option or options to the above effect for the said
two consecutive previous years;
(b) such option or options are exercised in prescribed form, manner and within
prescribed period; and
(c) the TPO shall, within one month from the end of the month in which such
option or options are exercised, by an order in writing, declare that such
option or options are valid subject to the prescribed conditions.
However, these provisions shall not apply to any proceedings for assessment of
search cases [Sub-section (3B)].
(2) If the TPO has declared that option exercised by the assessee in sub-section (3B) in
relation to such transaction is valid for such previous year, no reference for
computation of the arm's length price in relation to an international transaction shall
be made.
Moreover, where any reference for an international transaction in respect of a
previous year, for which the option is declared valid under sub-section (3B) is made
before or after such declaration by the TPO, it will be treated as no reference is made
for such transaction [Provisos to sub-section (1)].

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(3) Where the TPO has declared an option exercised by the assessee as valid option
under sub-section (3B), he shall examine and determine the arm's length price in
relation to such similar transaction for two consecutive previous years immediately
following such previous year, in the order referred to in sub-section (3) and on
receipt of such order, the Assessing Officer shall proceed to recompute the total
income of the assessee for the said two consecutive previous years as per the
provisions of section 155(21) [Sub-section (4)].
(4) In case there is any difficulty in giving effect to the provisions of sub-section (3B)
and (4A), the Board may, with the previous approval of the Central Government, issue
guidelines for the purpose of removing such difficulty:
However, no such guideline shall be made after the expiration of two years from 1st
April, 2026.
VI. Safe Harbour Rules for determination of arm's length price in case of international
transactions [Section 92CB]

Section 92CB provides that determination of

- income referred to in section 9(1)(i); or
- arm’s length price under section 92C or Section 92CA
shall be subject to Safe Harbour rules. Section 92CB(2) empowers the CBDT to prescribe safe
harbour rules 2.
Safe Harbour means circumstances in which the income-tax authorities shall accept the transfer
price or income, deemed to accrue or arise under section 9(1)(i), as the case may be, declared by
the assessee.
Accordingly, the CBDT has, vide notification no. 124/2024 dated 29.11.2024, inserted Rules 10TI,
10TIA, 10TIB and 10TIC providing the safe harbour rules for income referred to in section 9(1)(i)
chargeable to tax under the head “Profits and gains of business or profession”.
Rule Rule heading Particulars
10TI Definitions:
Eligible assessee A foreign company engaged in the business of diamond
mining which has exercised an option for application of
safe harbour rules in accordance with rule 10TIA.

2.

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Eligible business A business of selling raw diamonds in any notified special

zone as referred to in clause (e) of Explanation 1 to section
9(1)(i).
Gross receipts Aggregate of –
(i) the amount paid or payable to the eligible assessee or
to any person on his behalf on account of sale of raw
diamonds by such eligible assessee and
(ii) the amount received or deemed to be received by the
eligible assessee or by any person on his behalf on
account of sale of raw diamonds by such eligible assessee.
Relevant previous The previous year relevant to the assessment year in which
year the option for safe harbour is exercised
Raw diamonds Diamonds that are, -
(i) uncut or unpolished;
(ii) unassorted;
(iii) unworked or simply sawn, cleaved or bruted;
(iv) not conflict diamonds as defined by the Kimberley
Process;
(v) accompanied by Kimberley Process Certificate issued
by the Kimberley Process authority in the exporting
country; and
(vi) falling under Tariff Heading 7102 of the First Schedule
to the Customs Tariff Act, 1975.
10TIA Safe harbour (1) If an eligible assessee declared income from an
eligible business in accordance with the
circumstances as specified in Rule 10TIA(2), the
option for safe harbour exercised by such eligible
assessee in any relevant previous year under rule
10TIB shall be accepted by the income-tax
authorities, unless such safe harbour is declared
invalid under Rule 10TIB(3).
(2) Circumstances in respect of the eligible business is -
The profits and gains of the eligible business
chargeable to tax under the head “Profits and gains of
business or profession” shall be 4% or more of the
gross receipts from such business.
(3) Where the eligible assessee has exercised the option
for safe harbour under rule 10TIB in respect of the
eligible business in any relevant previous year and
such option is not declared invalid –

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(a) any deduction allowable under the provisions of

sections 30 to 38 shall be deemed to have been
already given full effect to and no further
deduction under those sections shall be allowed;
(b) the written down value of any asset of such
business shall be deemed to have been
calculated as if the eligible assessee had
claimed and had been actually allowed the
deduction in respect of the depreciation for such
previous year;
(c) no set off of unabsorbed depreciation under section
32(2) or carried forward loss under section 72(1)
shall be allowed to such assessee; and
(d) no set off of loss from other business under
section 70(1) or other head under section
71(1)/(2) shall be allowed to such assessee for
income chargeable to tax under the head “Profits
and gains of business or profession” in respect
of such business.
(4) The provisions of sections 92D relating to
maintenance, keeping and furnishing of information
and document and section 92E for submission of
report from an accountant in respect of an
international transaction shall apply, if the eligible
assessee enters into such transaction while carrying
on the eligible business.
10TIB Procedure Furnishing of Form 3CEFC for exercising the option
The assessee has to furnish Form 3CEFC, complete in all
respects, to the Assessing Officer before furnishing the
return of income under section 139 for the relevant previous
year, for exercising the option of safe harbour.
If the assessee does not exercise option for safe harbour,
the income from eligible business shall be determined in
accordance with other provisions of the Act.
Circumstances when option exercised can be declared
invalid
The Assessing Officer may declare the option for safe
harbour as invalid by an order in writing, where the
assessee has -
(a) availed the safe harbour by furnishing incorrect facts;
or
(b) concealed facts related to his business.

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The Assessing Officer has to afford a reasonable

opportunity of being heard to the assessee before declaring
the option for safe harbour invalid.
Order by Assessing Officer to declare option invalid
The Assessing Officer has to serve a copy of the order to
declare option invalid to the assessee and the other
provisions of the Act shall apply accordingly.
10TIC Mutual Agreement The assessee is not entitled to invoke mutual agreement
Procedure not to procedure under an agreement for avoidance of double
apply taxation as referred to in section 90 or section 90A in
relation to an eligible business, if the assessee has
exercised the option for safe harbour under rule 10TIB in
respect of such business and such option is not declared
invalid.

Further, the CBDT has, vide notification no. 21/2025 dated 25.03.2025 prescribed Rule 10TD read
with Rule 10TA, Rule 10TB and Rule 10TC providing the safe harbour rules for determination of
arm’s length price under section 92C or section 92CA.
Where an eligible assessee has entered into an eligible international transaction and the option
exercised by the said assessee is not held to be invalid, the transfer price declared by the
assessee in respect of such transaction shall be accepted by the income-tax authorities, if it is in
accordance with the circumstances mentioned below:
S. Eligible
No. International Circumstances Definition
Transaction3
[Rule 10TC] [Rule 10TD] [Rule 10TA]
(1) (2) (3) (4)
(i) Provision of The operating profit margin “Software development services”
software declared by the eligible means,-
development assessee from the eligible (i) business application
services international transaction in software and information
relation to operating expense system development
incurred is- using known methods
and existing software
tools;

3 Eligible international transaction means an international transaction between the eligible assesee and its

associated enterprise, either or both of whom are non-residents, and which comprises of the transactions
described in column (2) of the above table.

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Not less Where the (ii) support for existing

than the value of systems;
prescribed international (iii) Converting or translating
percentage transaction computer languages;
entered (iv) adding user functionality
17% does not to application
exceed a sum programmes;
of ` 100 crore; (v) debugging of systems;
18% exceeds a sum (vi) adaptation of existing
of ` 100 crore software; or
but does not (vii) preparation of user
exceed ` 300 documentation.
crore.
It, however, does not include any
R&D services whether or not in
the nature of contract R&D
services.
(ii) Provision of The operating profit margin “Information technology enabled
information declared by the eligible services” means the following
technology assessee from the eligible business process outsourcing
enabled services international transaction in services provided mainly with the
relation to operating expense assistance or use of information
incurred is – technology, namely:‐
Not less Where the (i) back office operations
than the aggregate (ii) call centres or contact
prescribed value of such centre services
percentage transactions
(iii) data processing and data
entered into
mining
during the
previous year (iv) insurance claim
17% does not processing
exceed a sum (v) legal databases
of ` 100 crore; (vi) creation and
18% exceeds a sum maintenance of medical
of ` 100 crore transcription excluding
but does not medical advice
exceed ` 300 (vii) translation services
crore. (viii) payroll
(ix) remote maintenance
(x) revenue accounting
(xi) support centres
(xii) website services

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(xiii) data search integration

and analysis
(xiv) remote education
excluding education
content development
(xv) clinical database
management services
excluding clinical trials
It, however, does not include any
R & D services whether or not in
the nature of contract R & D
services.
(iii) Provision of The value of international “Knowledge process outsourcing
knowledge transaction does not exceed services” means the following
process ` 300 crore and the operating business process outsourcing
outsourcing profit margin declared by the services provided mainly with the
services eligible assessee from the assistance or use of information
eligible international technology requiring application
transaction in relation to of knowledge and advanced
operating expense is – analytical and technical skills,
Not less Employee namely:‐
than the Cost in (i) geographic information
prescribed relation to system
percentage the Operating (ii) human resources services
Expense
(iii) engineering and design
24% at least 60%; services
21% 40% or more (iv) animation or content
but less than development and
60%; management
18% does not (v) business analytics
exceed 40%.
(vi) financial analytics
(vii) market research
It, however, does not include any
R&D services whether or not in
the nature of contract R&D
services.
(iv) Advancing of The interest rate declared in “Intra-group loan" means loan
intra‐group loans relation to the eligible advanced to an associated
where the international transaction is enterprise being a non-resident,
amount of loan is not less than the one-year where the loan–
denominated in marginal cost of funds

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Indian Rupees lending rate of SBI as on 1st (i) is not advanced by an

(INR) April of the relevant previous enterprise, being a
year plus financial company
% Credit rating of including a bank or a
Associated financial institution or
Enterprise or its an enterprise engaged
equivalent in lending or borrowing
in the normal course of
1.75% Between AAA to A
business; and
3.25% BBB-, BBB, BBB+
(ii) does not include credit
4.75% Between BB to B line or any other loan
6.25% C to D facility which has no
fixed term for
4.25% Where no credit repayment;
rating is available
and the loan to AE
including loans to
all AEs in Indian
rupees does not
exceed ` 100 crore
in aggregate as on
31 st March of the
relevant P.Y.

(v) Advancing of The interest rate declared in

intra‐group loans relation to the eligible
where the international transaction is
amount of loan is not less than the reference
denominated in rate of the relevant foreign
foreign currency currency as on 30th
September of the relevant
previous year plus
(a) If amount of loan
advanced to the associated
enterprise including loans to
all associated enterprises
does not exceed a sum
equivalent to ` 250 crore in
the aggregate as on
31st March of the relevant
previous year:

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% Credit rating of
Associated
Enterprise or its
equivalent
1.50% Between AAA,
AA+, AA, AA-,
A+, A, A-
3.00% BBB+, BBB,
BBB-
4.00% BB+, BB, BB-,
B+, B, B-, C+, C,
C-, D
(b) If amount of loan
advanced to the associated
enterprise including loans to
all associated enterprises
exceeds a sum equivalent to
` 250 crore in the aggregate
as on 31st March of the
relevant previous year:

% Credit rating of
Associated
Enterprise or
its equivalent
1.50% AAA, AA+, AA,
AA-, A+, A, A-
3.00% BBB+, BBB,
BBB-
4.50% BB+, BB, BB-,
B+, B, B-
6.00% C+, C, C-, D or
where the credit
rating of the
associated
enterprise is not
available.

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(vi) Providing Where the The “Corporate guarantee” means

corporate amount commission explicit corporate guarantee
guarantee guaranteed- or fee extended by a company to its
declared in wholly owned subsidiary being a
relation to non‐resident in respect of any
the eligible short‐term or long-term
international borrowing.
transaction Explicit corporate guarantee,
is at the rate however, does not include–
not less
than - (i) letter of comfort;
does not (ii) implicit corporate
exceed ` 100 guarantee;
crores. (iii) performance
exceeds guarantee; or
` 100 crore (iv) any other guarantee
and the credit of similar nature.
rating of the 1% p.a. on
associated the amount
enterprise guaranteed
done by an
agency
registered
with the SEBI
is of
the adequate
to the highest
safety
(vii) Provision of The operating profit margin “Contract research and
contract R & D declared by the eligible development (R&D) services
services wholly assessee from the eligible wholly or partly relating to
or partly relating international transaction in software development” means the
to software relation to operating expense following, namely:‐
development incurred is not less than 24%, (i) R & D producing new
where the value of the theorems and algorithms
international transaction does in the field of theoretical
not exceed ` 300 crore. computer science;
(ii) development of information
technology at the level of
operating systems,
programming languages,
data management,
communications software

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and software development

tools;
(iii) development of Internet
technology;
(iv) research into methods of
designing, developing,
deploying or maintaining
software;
(v) software development that
produces advances in
generic approaches for
capturing, transmitting,
storing, retrieving,
manipulating or displaying
information;
(vi) experimental
development aimed at
filling technology
knowledge gaps as
necessary to develop a
software programme or
system;
(vii) R & D on software tools or
technologies in
specialized areas of
computing (image
processing, geographic
data presentation,
character recognition,
artificial intelligence and
such other areas); or
(viii) upgradation of existing
products where source
code has been made
available by the principal
except where the source
code has been made
available to carry out
routine functions like
debugging of the
software.

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(viii) Provision of The operating profit margin “Generic pharmaceutical drug”

contract R&D declared by the eligible means a drug that is comparable
services wholly assessee from the eligible to a drug already approved by the
or partly relating international transaction in regulatory authority in dosage
to generic relation to operating expense form, strength, route of
pharmaceutical incurred is not less than 24%, administration, quality and
drugs where the value of the performance characteristics, and
international transaction does intended use.
not exceed ` 300 crore.
(ix) Manufacture and The operating profit margin “Core auto components” means,
export of core declared by the eligible (i) engine and engine
auto components assessee from the eligible parts, including piston
international transaction in and piston rings,
relation to operating expense engine valves and
is not less than 12%. parts cooling systems
and parts and power
train components;
(ii) transmission and
steering parts,
including gears,
wheels, steering
systems, axles and
clutches;
(iii) suspension and braking
parts, including brake
and brake assemblies,
brake linings, shock
absorbers and leaf
springs; or
(iv) lithium ion batteries for
use in electric or
hybrid electric
vehicles.
(x) Manufacture and The operating profit margin “Non‐core auto components”
export of non- declared by the eligible mean auto components other than
core auto assessee from the eligible core auto components.
components international transaction in
relation to operating expense
is not less than 8.5%.
(xi) Receipt of low The entire value of the “Low value-adding intra group
value-adding international transaction, services” means services that are
intra group including a mark-up not performed by one or more

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services from exceeding 5%, does not members of a multinational

one or more exceed ` 10 crore. enterprise group on behalf of one
members of its However, the method of cost or more other members of the
group pooling, the exclusion of same multinational enterprise
shareholder costs and group and which,
duplicate costs from the cost (i) are in the nature of support
pool and the reasonableness services;
of the allocation keys used
for allocation of costs to the (ii) are not part of the core
assessee by the overseas business of the multinational
associated enterprise, is enterprise group, i.e., such
certified by an accountant. services neither constitute
the profit-earning activities
nor contribute to the
economically significant
activities of the multinational
enterprise group;
(iii) are not in the nature of
shareholder services or
duplicate services;
(iv) neither require the use of
unique and valuable
intangibles nor lead to the
creation of unique and
valuable intangibles;
(v) neither involve the
assumption or control of
significant risk by the service
provider nor give rise to the
creation of significant risk for
the service provider; and
(vi) do not have reliable external
comparable services that can
be used for determining their
arm’s length price,
However, it does not include the
following services, namely:
(i) research and development
services;

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(ii) manufacturing and production

services;
(iii) information technology
(software development)
services;
(iv) knowledge process
outsourcing services;
(v) business process outsourcing
services;
(vi) purchasing activities of raw
materials or other materials
that are used in the
manufacturing or production
process;
(vii) sales, marketing and
distribution activities;
(viii) financial transactions;
(ix) extraction, exploration, or
processing of natural
resources; and
(x) insurance and reinsurance;”
Meaning of certain terms:
Term Meaning
(i) Eligible “Eligible assessee” means a person who has exercised a valid
assessee option for application of safe harbor rules and
(i) is engaged in providing software development services or
information technology enabled services or knowledge
process outsourcing services, with insignificant risk, to a non-
resident associated enterprise;
(ii) has made any intra-group loan;
(iii) has provided a corporate guarantee;
(iv) is engaged in providing contract research and development
services wholly or partly relating to software development,
with insignificant risk, to a non-resident associated enterprise;
(v) is engaged in providing contract research and development
services wholly or partly relating to generic pharmaceutical
drugs, with insignificant risk, to a non-resident associated
enterprise;

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(vi) is engaged in the manufacture and export of core or non-core

auto components and where ninety per cent or more of total
turnover during the relevant previous year is in the nature of
original equipment manufacturer sales; or
(vii) is in receipt of low value-adding intra-group services from one
or more members of its group
(ii) Reference rate It means –
For US dollar 6-month Term Secured Overnight Financing
Rate (SOFR), currently administered by
Chicago Mercantile Exchange (CME), as
increased by 0.45%
For Euro 6-month Euro Inter Bank Offered Rate
(EURIBOR), currently administered by
European Money Markets Institute
For UK Pound 6-month Term Sterling Overnight Index
Sterling Average (SONIA), currently administered by
ICE Benchmark Administration/ Refinitiv, as
increased by 0.30%
For Japanese 6-month Tokyo Term Risk Free Rate (TORF),
Yen currently benchmarked by QUICK Benchmarks
Inc, as increased by 0.10%
For Australian 6-month Bank Bill Swap Rates (BBSW)
dollar currently administered by Australian Securities
Exchange
For Singapore 6-month Compounded Singapore Overnight
dollar Rate Average (SORA), currently administered
by Monetary Authority of Singapore, as
increased by 0.45%
(iii) Credit rating The credit rating assigned to the associated enterprise by a SEBI
and RBI accredited credit rating agency which is applicable for the
relevant previous year, so however that—
(i) where the associated enterprise has only one credit rating,
then such rating shall be taken as its credit rating; and
(ii) where the associated enterprise has a credit rating from
more than one such credit rating agency, then the least of
such ratings shall be taken as its credit rating
(iv) Operating The costs incurred in the previous year by the assessee in relation
expense to the international transaction during the course of its normal
operations including

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- costs relating to Employee Stock Option Plan or similar stock-

based compensation provided for by the associated enterprises
of the assessee to the employees of the assessee,
- reimbursement to associated enterprises of expenses incurred
by the associated enterprises on behalf of the assessee,
- amounts recovered from associated enterprises on account of
expenses incurred by the assessee on behalf of those
associated enterprises and which relate to normal operations of
the assessee and
- depreciation and amortisation expenses relating to the assets
used by the assessee,
but not including the following, namely:—
(i) interest expense;
(ii) provision for unascertained liabilities;
(iii) pre-operating expenses;
(iv) loss arising on account of foreign currency fluctuations;
(v) extraordinary expenses;
(vi) loss on transfer of assets or investments other than
assets, on which depreciation is included in the operating
expense;
(vii) expense on account of income-tax; and
(viii) other expenses not relating to normal operations of the
assessee:
However, reimbursement to associated enterprises of expenses
incurred by the associated enterprises on behalf of the assessee
shall be at cost.
Further, amounts recovered from associated enterprises on
account of expenses incurred by the assessee on behalf of the
associated enterprises and which relate to normal operations of
the assessee shall be at cost.
(v) Operating The revenue earned by the assessee in the previous year in
revenue relation to the international transaction during the course of its
normal operations including costs relating to Employee Stock
Option Plan or similar stock-based compensation provided for by
the associated enterprises of the assessee to the employees of
the assessee but not including the following, namely:—
(i) interest income;
(ii) income arising on account of foreign currency fluctuations;
(iii) income on transfer of assets or investments other than
assets, on which depreciation is included in the operating
expense;;

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(iv) refunds relating to income-tax;

(v) provisions written back;
(vi) extraordinary incomes; and
(vii) other incomes not relating to normal operations of the
assessee
(vi) Operating profit In relation to operating expense, “operating profit margin” means
margin the ratio of operating profit, being the operating revenue in excess
of operating expense, to the operating expense expressed in
terms of percentage
(vii) Accountant An accountant referred to in the Explanation below section 288(2)
of the Act and includes any person recognised for undertaking
cost certification by the Government of the country where the
associated enterprise is registered or incorporated or any of its
agencies, who fulfils the following conditions, namely:—
(I) if he is a member or partner in any entity engaged in
rendering accountancy or valuation services then,—
(i) the entity or its affiliates have presence in more than
two countries; and
(ii) the annual receipt of the entity in the year preceding
the year in which cost certification is undertaken
exceeds ` 10 crore;
(II) if he is pursuing the profession of accountancy individually or
is a valuer then,—
(i) his annual receipt in the year preceding the year in
which cost certification is undertaken, from the
exercise of profession, exceeds ` 1 crore; and
(ii) he has professional experience of not less than 10
years.
(viii) Employee cost It includes,—
(i) salaries and wages;
(ii) gratuities;
(iii) contribution to Provident Fund and other funds;
(iv) the value of perquisites as specified in clause (2) of section
17;
(v) employment related allowances, like medical allowance,
dearness allowance, travel allowance and any other
allowance;
(vi) bonus or commission by whatever name called;

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(vii) lump sum payments received at the time of termination of

service or superannuation or voluntary retirement, such as
gratuity, severance pay, leave encashment, voluntary
retrenchment benefits, commutation of pension and similar
payments;
(viii) expenses incurred on contractual employment of persons
performing tasks similar to those performed by the regular
employees;
(ix) outsourcing expenses, to the extent of employee cost,
wherever ascertainable, embedded in the total outsourcing
expenses:
However, where the extent of employee cost embedded in
the total outsourcing expenses is not ascertainable, 80% of
the total outsourcing expenses shall be deemed to be the
employee cost embedded in the total outsourcing expenses;
(x) recruitment expenses;
(xi) relocation expenses;
(xii) training expenses;
(xiii) staff welfare expenses; and
(xiv) any other expenses related to employees or the employment.
(ix) No tax or low A country or territory in which the maximum rate of income-tax is less
tax country or than 15%.
territory
(x) Relevant The previous year relevant to the assessment year in which the
previous year option for safe harbour is validly exercised.
Procedure [Rule 10TE] 4
Furnishing of Form 3CEFA
For exercising the option of safe harbor, the assessee has to furnish Form 3CEFA, complete in
all respects, to the Assessing Officer on or before the due date specified in section 139(1) for
furnishing the return of income for
- the relevant assessment year, in case the option is exercised only for that assessment
year or
- the first of the assessment years, in case the option is exercised for more than one
assessment year.
The return of income for the relevant assessment year or the first of the assessment years, as the
case may be, should be furnished on or before the date of submitting the Form 3CEFA.

4
For detailed reading of Rule 10TE of the Income-tax Rules, 1962, students may visit
[Link]

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The option for safe harbour validly exercised would continue to apply for the period specified in
the form or 3 years, whichever is less.
Verification by the Assessing Officer
Before treating the option for safe harbor by the assessee as validly exercised, the Assessing
Officer shall verify whether the assessee exercising the option is an eligible assessee and the
transaction in respect of which the option is exercised is an eligible international transaction.
Reference to Transfer Pricing Officer by the Assessing Officer in case of a doubt on validity
The Assessing Officer shall make a reference to the Transfer Pricing Officer for determination
of the eligibility of the assessee or the international transaction or both for the purposes of the
safe harbor, where he has doubts the valid exercise of the option for the safe harbour by an
assessee.
Time limit for reference to Transfer Pricing Officer by Assessing Officer
No reference shall be made to the Transfer Pricing Officer by the Assessing Officer after
the expiry of 2 months from the end of the month in which Form 3CEFA is received by him.
Documents or information required by the Transfer Pricing Officer
Transfer Pricing Office may issue a notice to the assessee to furnish such information or
documents or other evidence as he may consider necessary. The assessee has to furnish the
same within the specified time in such notice.
Circumstances when option declared to be Invalid
The Transfer Pricing Officer shall, by order in writing, declare the option exercised by the
assessee as invalid and cause a copy of the order has to be served on the assessee and the
Assessing Officer, if –
(i) the assessee does not furnish the information or documents or other evidence required by
the Transfer Pricing Officer
(ii) the Transfer Pricing Officer finds that the assessee is not an eligible assessee
(iii) the Transfer Pricing Officer finds that the international transaction in respect of which
option has been exercised is not an eligible international transaction.
Order by Transfer Pricing Officer
The Transfer Pricing Officer shall pass the order declaring the option exercised by the
assessee as invalid within a period of 2 months from the end of the month in which reference
from the Assessing Officer is received by him.
No order can be passed declaring the option exercised by the assessee invalid unless an
opportunity of being heard is given to him.
Filling of objections against the order of Transfer Pricing Officer by the assessee
If the assessee objects to the order of the Transfer Pricing Officer declaring the option to
be invalid, he may file his objections with the Commissioner to whom the Transfer Pricing
Officer is subordinate, within 15 days of receipt of the order of the Transfer Pricing
Officer.

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On receipt of objection, the Commissioner shall, after providing an opportunity of being heard
to the assessee, pass appropriate orders, within a period of 2 months from the end of the
month in which the objection filed by the assessee is received by him, in respect of the validity
or otherwise of the option exercised by the assessee. A copy of the said order has to be served
on the assessee and the Assessing Officer.
If the Assessing Officer or the Transfer Pricing Officer or the Commissioner, as the case may
be, does not make a reference or pass an order within the specified time, then, the option for
safe harbour exercised by the assessee shall be treated as valid.
Notes:
(1) The second proviso to section 92C(2) provides that if the variation between the arm’s
length price determined and the price at which the transaction has been undertaken
does not exceed such percentage, not exceeding 3%, as may be notified by the Central
Government in the Official Gazette, the price at which the transaction has actually been
undertaken shall be deemed to be the arm’s length price. However, no comparability
adjustment and allowance under the second proviso to section 92C(2) shall be made to
the transfer price declared by the eligible assessee and accepted under the Safe
Harbour Rules given above.
(2) Section 92D requiring every person who has entered into an international transaction to
keep and maintain the prescribed information and documents and section 92E requiring
such person to obtain a report from an accountant and furnish such report on or before
the specified date in prescribed form and manner, shall apply irrespective of the fact that
the assessee exercises his option for safe harbor in respect of such transaction.
(3) Safe harbor rules shall not be applicable in respect of eligible international transaction
entered into with an associated enterprise located in any country or territory notified
under section 94A as notified jurisdictional area or in a no tax or low tax country or
territory [Rule 10TF].
(4) The assessee would not be entitled to invoke mutual agreement procedure (MAP) under
a DTAA entered with a country outside India, if the transfer price in relation to eligible
international transaction declared by an eligible assessee is accepted by the income-tax
authority under safe harbour rules [Rule 10TG].
VII. Introduction of Advance Pricing Agreements [Sections 92CC & 92CD]
(1) An Advance Pricing Agreement (APA) is an agreement between a taxpayer and a taxing
authority on an appropriate transfer pricing methodology for a set of transactions over a
fixed period of time in future. They offer better assurance on transfer pricing methods and
provide certainty and unanimity of approach.
(2) Keeping in mind the benefits offered by the APAs,
sections 92CC and section 92CD have been introduced in the transfer pricing regime to
provide a framework for formulation of APAs between the tax payer and the income-tax
authorities.

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(3) Section 92CC enables the CBDT (with the approval of the Central Government), to enter
into an APA with any person determining the –

- arm's length price or specifying the manner in which the arm's length price is to be
determined, in relation to an international transaction to be entered into by that person;
- income referred to in section 9(1)(i), or specifying the manner in which said income is
to be determined, as is reasonably attributable to the operations carried out in India
by or on behalf of that person, being a non-resident.
(A) Purpose of APA: The APA shall relate to an international transaction to be entered
into by such person. The APA shall be entered into for the purpose of determination
of the
(a) arm’s length price or specifying the manner in which arm’s length price shall
be determined, in relation to such international transaction.
(b) income referred to in section 9(1)(i), or specifying the manner in which said
income is to be determined, as is reasonably attributable to the operations
carried out in India by or on behalf of that person, being a non-resident.
(B) Manner of determination of Arm’s Length Price in APA: The manner of
determination of arm’s length price or the income referred above may include
methods referred to in section 92C(1) or any other method provided by rules made
under the Act with necessary adjustments or variations.
(C) Provisions of APA to apply notwithstanding anything contained in sections
92C or 92CA: In case an APA has been entered, the arm’s length price in relation to
that transaction or the income referred to in section 9(1)(i) shall be determined in
accordance with that APA notwithstanding any contrary provisions contained in
section 92C or section 92CA i.e., the provisions of the APA shall override the
provisions of section 92C or section 92CA, which are normally applicable for
determination of arm’s length price.

(D) Validity of APA: The APA shall be valid for such period as specified in the
agreement, which shall in no case exceed five consecutive previous years.
(E) Binding nature of APA: The APA so entered into shall be binding on:
(a) the person in whose case, and in respect of the transaction in relation to
which, the APA has been entered into; and

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(b) the Principal Commissioner or Commissioner and the income-tax authorities

subordinate to him, in respect of the said person and the said transaction.

(F) Not binding of APA: The APA shall not be binding if there is any change in law or
facts having bearing on such APA.
(G) Conditions to declare APA as void ab initio: In case the Board finds that the APA
so entered into has been obtained by the person by way of fraud or
misrepresentation of facts, the Board is empowered to pass an order declaring any
such APA to be void ab initio, with the approval of Central Government.
(H) Consequences of declaration of an APA as void ab initio: As a result of
declaration of an APA as void ab initio:
(a) all the provisions of the Act shall apply to such person as if such APA had
never been entered into.
(b) The period beginning with the date of such APA and ending on the date of
order declaring the APA as void ab initio, shall be excluded for the purpose of
computation of any period of limitation under this Act (for example period of
limitation specified in the section 153, 153B etc.). This is irrespective of
anything contained in any other provision of the Act.

(c) In case the period of limitation after exclusion of the above mentioned period
is less than 60 days, such remaining period of limitation shall be extended to
60 days.
(I) If an application is made by a person for entering into an APA, then, the proceeding,
in respect of such person for the purpose of the Act, shall be deemed to be pending.
(J) Prescribed scheme for APA: The Board is empowered to prescribe a scheme
specifying the manner, form, procedure and any other matter generally in respect of
the APA 5.
Prescribed Advance Pricing Agreement Scheme for the purpose of section
92CC [Rule 10F to 10T]: In exercise of the powers conferred in section 92CC(9)

5 Rules prescribing the scheme to enter into an APA for the purpose of determining income referred to in

section 9(1)(i), or the manner in which said income is to be determined, as is reasonably attributable to the
operations carried out in India by or on behalf of that person, being a non-resident are yet to be notified by
the CBDT as on the date of release of the Study Material. These rules, when notified, will form part of the
webhosted Statutory Update.

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read with section 295 of the Income-tax Act, 1961, the CBDT has prescribed rules
specifying an Advance Pricing Agreement (APA) Scheme. Some of the important
provisions of the scheme are briefed hereunder –
(1) Persons eligible to apply [Rule 10G]: Any person who has undertaken an
international transaction or is contemplating to undertake an international
transaction, shall be eligible to enter into an agreement under these rules.
(2) Pre-filing Consultation [Rule 10H]:
(a) Any person proposing to enter into an agreement under these rules
may, by an application in writing, make a request for a pre-filing
consultation in the prescribed form to the Director General of Income-
tax (International Taxation).
(b) The pre-filing consultation shall, among other things,-
(i) determine the scope of the agreement;
(ii) identify transfer pricing issues;
(iii) determine the suitability of international transaction for the
agreement;
(iv) discuss broad terms of the agreement.
(c) The pre-filing consultation shall –
(i) not bind the Board or the person to enter into an agreement or
initiate the agreement process;
(ii) not be deemed to mean that the person has applied for entering
into an agreement.
(3) Application for advance pricing agreement [Rule 10-I]
(a) Any person who is eligible to enter into agreement may, if he desires to
enter into an agreement furnish an application in the prescribed form
along with proof of payment of requisite fee as specified, to the
Director General of Income-tax (International Taxation) in case of
unilateral agreement and to the competent authority in India in case of
bilateral or multilateral agreement.

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(b) The application may be filed at any time -

(i) before the first day of the previous year relevant to the first
assessment year for which the application is made, in respect of
transactions which are of a continuing nature from dealings that
are already occurring; or

(ii) before undertaking the transaction in respect of remaining

transactions.
ILLUSTRATION 5
XYZ (P) Ltd. has been supplying goods to its Associate Enterprise (AE) in
foreign country. It has applied for Advance Pricing Agreement (‘APA’) in
respect of the transactions with its AE. Application for APA was filed on 15th
March, 2025 and the APA was signed on 2nd June, 2025. Discuss from which
previous year APA would be applicable.
SOLUTION
XYZ (P) Ltd. has filed APA application in respect of transactions with its AE
which are of a continuing nature from dealings that are already occurring.
Since the application was filed on 15th March, 2025 i.e., before 1.4.2025, APA
would be applicable from P.Y. 2025-26.
(4) Applicable Fee: The application has to be accompanied by proof of payment
of fees as given below:
Amount of international taxation entered into or Fee
proposed to be undertaken in respect of which
agreement is proposed during the proposed period of
agreement
Amount ≤ ` 100 crores ` 10 lakhs
Amount > ` 100 crores but not exceeding ≤ ` 200 crores ` 15 lakhs
Amount > ` 200 crores ` 20 lakhs

(5) Withdrawal of application for agreement [Rule 10J]

The applicant may withdraw the application for agreement at any time before
the finalisation of the terms of the agreement. However, application fees paid
shall not be refunded on withdrawal of application by the applicant.

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(6) Approval of Central Government: The agreement shall be entered into by

the Board with the applicant after its approval by the Central Government.

(7) Terms of the agreement [Rule 10M]

(a) An agreement may among other things, include –
(i) the international transactions covered by the agreement;

(ii) the agreed transfer pricing methodology, if any;

(iii) determination of arm's length price, if any;
(iv) definition of any relevant term to be used in item (ii) or (iii);

(v) critical assumptions i.e., the factors and assumptions that are so
critical and significant that neither party entering into an
agreement will continue to be bound by the agreement, if any of
the factors or assumptions is changed;
(vi) rollback provision referred to in Rule 10MA;
(vii) the conditions, if any, other than provided in the Act or these
rules.
(b) The agreement shall not be binding on the Board or the assessee if
there is a change in any of critical assumptions or failure to meet
conditions subject to which the agreement has been entered into.
(c) The binding effect of agreement shall cease only if any party has given
due notice of the concerned other party or parties.
(d) In case there is a change in any of the critical assumptions or failure to
meet the conditions subject to which the agreement has been entered
into, the agreement can be revised or cancelled, as the case may be.
(8) Furnishing of Annual Compliance Report [Rule 10-O]: The assessee shall
furnish an annual compliance report in quadruplicate in the prescribed form to
Director General of Income-tax (International Taxation) for each year covered
in the agreement, within 30 days of the due date of filing income-tax return for
that year, or within 90 days of entering into an agreement, whichever is later.

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(9) Compliance Audit of the agreement [Rule 10P]:

(a) The Transfer Pricing Officer having the jurisdiction over the assessee
shall carry out the compliance audit of the agreement for each of the
year covered in the agreement. For this purpose, the Transfer Pricing
Officer may require –

(i) the assessee to substantiate compliance with the terms of the

agreement, including satisfaction of the critical assumptions,
correctness of the supporting data or information and
consistency of the application of the transfer pricing method;
(ii) the assessee to submit any information, or document, to
establish that the terms of the agreement has been complied
with.
(b) The compliance audit report shall be furnished by the Transfer Pricing
Officer within six months from the end of the month in which the Annual
Compliance Report is received by the Transfer Pricing Officer.
(10) Revision of an agreement [Rule 10Q]:
(a) An agreement, after being entered, may be revised by the Board either
suo moto or on request of the assessee or the competent authority in
India or the Director General of Income-tax (International Taxation), if –
(i) there is a change in critical assumptions or failure to meet a
condition subject to which the agreement has been entered into;
(ii) there is a change in law that modifies any matter covered by the
agreement but is not of the nature which renders the agreement
to be non-binding; or
(iii) there is a request from competent authority in the other country
requesting revision of agreement, in case of bilateral or
multilateral agreement.
(b) Except when the agreement is proposed to be revised on the request
of the assessee, the agreement shall not be revised unless an
opportunity of being heard has been provided to the assessee and the
assessee is in agreement with the proposed revision.

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(c) The revised agreement shall include the date till which the original
agreement is to apply and the date from which the revised agreement
is to apply.
(11) Cancellation of an agreement [Rule 10R]:
(a) An agreement shall be cancelled by the Board for any of the following
reasons:
(i) the compliance audit has resulted in the finding of failure on the
part of the assessee to comply with the terms of the agreement;
(ii) the assessee has failed to file the annual compliance report in
time;
(iii) the annual compliance report furnished by the assessee
contains material errors; or
(iv) the assessee is not in agreement with the revision proposed in
the agreement or the agreement is to be cancelled under rule
10RA(7);.
(b) The Board shall give an opportunity of being heard to the assessee,
before proceeding to cancel an application.
(c) The order of cancellation of the agreement shall be in writing and shall
provide reasons for cancellation and for non-acceptance of assessee's
submission, if any.
(d) The order of cancellation shall also specify the effective date of
cancellation of the agreement, where applicable.
(e) The order under the Act, declaring the agreement as void ab initio, on
account of fraud or misrepresentation of facts, shall be in writing and
shall provide reason for such declaration and for non-acceptance of
assessee's submission, if any.

(12) Mere filing of an application for an agreement under these rules shall not
prevent the operation of Chapter X of the Act for determination of arms' length
price under that Chapter till the agreement is entered into. [Rule 10T(1)].
(13) The negotiation between the competent authority in India and the competent
authority in the other country or countries, in case of bilateral or multilateral

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agreement, shall be carried out in accordance with the provisions of the tax
treaty between India and the other country or countries. [Rule 10T(2)].
(K) Provision for Roll back in APA Scheme [Section 92CC(9A)]
(a) In order to reduce current pending as well as future litigation, section
92CC(9A) provides roll back mechanism in the APA scheme

(b) Accordingly, the APA may, subject to such prescribed conditions, procedure
and manner, provide for determining the
- ALP or for specifying the manner in which ALP is to be determined in
relation to an international transaction entered into by the person
- income referred to in section 9(1)(i), or specifying the manner in which
the said income is to be determined, as is reasonably attributable to
the operations carried out in India by or on behalf of that person, being
a non-resident,
during any period not exceeding four previous years preceding the first of the
previous years for which the APA applies in respect of the international
transaction to be undertaken.
The CBDT has, vide Notification No.23/2015 dated 14.3.2015, in exercise of the powers
conferred by 92CC(9A) read with section 295, notified following conditions, procedure and
manner for determining the arm’s length price or for specifying the manner in which arm’s
length price is to be determined in relation to an international transaction:
Rule Particulars Conditions, Procedure & Manner of determination of ALP
10F(ba) Definition of A person who has made an application.
Applicant
10F(ha) Definition of Any previous year, falling within the period not exceeding four
Rollback year previous years, preceding the first of the five consecutive
previous years referred to in section 92CC(4).
10MA Roll back of The said rule provides the following:
the agreement
1. The agreement may provide for determining the arm’s
length price or specify the manner in which arm’s
length price shall be determined in relation to the
international transaction entered into by the person
during the rollback year (hereinafter referred as
“rollback provision”).

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2. Conditions for applying for rollback provisions:

The agreement shall contain rollback provision in
respect of an international transaction subject to the
following, namely:-
(i) the international transaction is same as the
international transaction to which the agreement
(other than the rollback provision) applies;
(ii) the return of income for the relevant rollback year
has been or is furnished by the applicant before
the due date as specified in Explanation 2 of
section 139(1).
(iii) the report in respect of the international
transaction had been furnished in accordance with
section 92E;
(iv) the applicability of rollback provision, in respect of
an international transaction, has been requested
by the applicant for all the rollback years in which
the said international transaction has been
undertaken by the applicant; and
(v) the applicant has made an application seeking
rollback in Form 3CEDA in accordance with sub-
rule (5);
3. Non-applicability of Rollback provision: Rollback
provision shall not be provided in respect of an
international transaction for a rollback year, if,-
(i) the determination of arm’s length price of the said
international transaction for the said year has
been subject matter of an appeal before the
Appellate Tribunal and the Appellate Tribunal has
passed an order disposing of such appeal at any
time before signing of the agreement; or
(ii) the application of rollback provision has the effect
of reducing the total income or increasing the loss,
as the case may be, of the applicant as declared
in the return of income of the said year.
4. Manner for determining arm length price to be the
same for rollback years and other previous years:
Where the rollback provision specifies the manner in
which arm’s length price shall be determined in relation
to an international transaction undertaken in any
rollback year then such manner shall be the same as

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the manner which has been agreed to be provided for

determination of arm’s length price of the same
international transaction to be undertaken in any
previous year to which the agreement applies, not
being a rollback year.
5. Time limit for filling application for rollback
provision: The applicant may furnish along with the
application for advance pricing agreement, the request
for rollback provision in Form No. 3CEDA with proof of
payment of an additional fee of ` 5 lakh.
10RA Procedure for Rule 10RA lays down the “Procedure for giving effect to
giving effect
rollback provision of an Agreement” as follows:
to rollback
provision of (i) The applicant shall furnish modified return of income
an Agreement referred to in section 92CD in respect of a rollback
year to which the agreement applies along with the
proof of payment of any additional tax arising as a
consequence of and computed in accordance with the
rollback provision.
(ii) The modified return in respect of rollback year shall be
furnished along with the modified return to be furnished
in respect of first of the previous years for which the
agreement has been requested for in the application.
(iii) If any appeal filed by the applicant is pending before
the Commissioner (Appeals), Appellate Tribunal or the
High Court for a rollback year, on the issue which is
the subject matter of the rollback provision for that
year, the said appeal to the extent of the subject
covered under the agreement shall be withdrawn by
the applicant before furnishing the modified return for
the said year.
(iv) If any appeal filed by the Assessing Officer or the
Principal Commissioner or Commissioner is pending
before the Appellate Tribunal or the High Court for a
rollback year, on the issue which is subject matter of the
rollback provision for that year, the said appeal to the
extent of the subject covered under the agreement, shall
be withdrawn by the Assessing Officer or the Principal
Commissioner or the Commissioner, as the case may be,
within three months of filing of modified return by the
applicant.
(v) The applicant, the Assessing Officer or the Principal
Commissioner or the Commissioner, shall inform the

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Dispute Resolution Panel or the Commissioner

(Appeals) or the Appellate Tribunal or the High Court,
as the case may be, the fact of an agreement
containing rollback provision having been entered into
along with a copy of the same as soon as it is
practicable to do so.
(vi) In case effect cannot be given to the rollback provision
of an agreement in accordance with this rule, for any
rollback year to which it applies, on account of failure
on the part of applicant, the agreement shall be
cancelled.

Subsequent to the notification of the rules, the CBDT has issued Circular No. 10/2015 dated
10.6.2015 adopting a Question and Answer format to clarify certain issues arising out of the
said Rules. The questions raised and answers to such questions as per the said Circular
are given hereunder:
Question 1
Under rule 10MA(2)(ii) there is a condition that the return of income for the relevant roll
back year has been or is furnished by the applicant before the due date specified in
Explanation 2 to section 139(1). It is not clear as to whether applicants who have filed
returns under section 139(4) or 139(5) of the Act would be eligible for roll back.
Answer
The return of income under section 139(5) can be filed only when a return under section
139(1) has already been filed. Therefore, the return of income filed under section 139(5) of
the Act, replaces the original return of income filed under section 139(1). Hence, if there is
a return which is filed under section 139(5) to revise the original return filed before the due
date specified in Explanation 2 to sub-section (1) of section 139, the applicant would be
entitled for rollback on this revised return of income.
However, rollback provisions will not be available in case of a return of income filed under
section 139(4) because it is a return which is not filed before the due date.
Note – A belated return filed under section 139(4) can also be revised under section 139(5).
In such a case, the revised return would replace the belated return. Therefore, an applicant
would not be entitled for roll back provisions on a revised return which replaces a belated
return.

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Question 2
Rule 10MA(2)(i) mandates that the rollback provision shall apply in respect of an
international transaction that is same as the international transaction to which the
agreement (other than the rollback provision) applies. It is not clear what is the meaning of
the word “same”. Further, it is not clear whether this restriction also applies to the
Functions, Assets, Risks (FAR) analysis.
Answer
The international transaction for which a rollback provision is to be allowed should be the
same as the one proposed to be undertaken in the future years and in respect of which the
agreement has been reached. There cannot be a situation where rollback is finalised for a
transaction which is not covered in the agreement for future years. The term same
international transaction implies that the transaction in the rollback year has to be of same
nature and undertaken with the same associated enterprise(s), as proposed to be
undertaken in the future years and in respect of which agreement has been reached. In the
context of FAR analysis, the restriction would operate to ensure that rollback provisions
would apply only if the FAR analysis of the rollback year does not differ materially from the
FAR validated for the purpose of reaching an agreement in respect of international
transactions to be undertaken in the future years for which the agreement applies.
The word “materially” is generally being defined in the Advance Pricing Agreements being
entered into by CBDT. According to this definition, the word “materially” will be interpreted
consistently with its ordinary definition and in a manner that a material change of facts and
circumstances would be understood as a change which could reasonably have resulted in
an agreement with significantly different terms and conditions.
Question 3
Rule 10MA(2)(iv) requires that the application for rollback provision, in respect of an
international transaction, has to be made by the applicant for all the rollback years in which
the said international transaction has been undertaken by the applicant. Clarification is
required as to whether rollback has to be requested for all four years or applicant can
choose the years out of the block of four years.
Answer
The applicant does not have the option to choose the years for which it wants to apply for
rollback. The applicant has to either apply for all the four years or not apply at all. However,
if the covered international transaction(s) did not exist in a rollback year or there is some

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disqualification in a rollback year, then the applicant can apply for rollback for less than four
years. Accordingly, if the covered international transaction(s) were not in existence during
any of the rollback years, the applicant can apply for rollback for the remaining years.
Similarly, if in any of the rollback years for the covered international transaction(s), the
applicant fails the test of the rollback conditions contained in various provisions, then it
would be denied the benefit of rollback for that rollback year. However, for other rollback
years, it can still apply for rollback.
Question 4
Rule 10MA(3) states that the rollback provision shall not be provided in respect of an
international transaction for a rollback year if the determination of arm’s length price of the
said international transaction for the said year has been the subject matter of an appeal
before the Appellate Tribunal and the Appellate Tribunal has passed an order disposing of
such appeal at any time before signing of the agreement. Further, Rule 10 RA(4) provides
that if any appeal filed by the applicant is pending before the Commissioner (Appeals),
Appellate Tribunal or the High Court for a rollback year, on the issue which is subject matter
of the rollback provision for that year, the said appeal to the extent of the subject covered
under the agreement shall be withdrawn by the applicant.
There is a need to clarify the phrase “Tribunal has passed an order disposing of such
appeal” and on the mismatch, if any, between Rule 10MA(3) and Rule 10RA(4).
Answer
The reason for not allowing rollback for the international transaction for which Appellate
Tribunal has passed an order disposing of an appeal is that the ITAT is the final fact finding
authority and hence, on factual issues, the matter has already reached finality in that year.
However, if the ITAT has not decided the matter and has only set aside the order for fresh
consideration of the matter by the lower authorities with full discretion at their disposal, the
matter shall not be treated as one having reached finality and hence, benefit of rollback can
still be given.
There is no mismatch between Rule 10MA(3) and Rule 10RA(4).

Question 5
Rule 10MA(3)(ii) provides that rollback provision shall not be provided in respect of an
international transaction for a rollback year if the application of rollback provision has the
effect of reducing the total income or increasing the loss, as the case may be, of the
applicant as declared in the return of income of the said year. It may be clarified whether

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the rollback provisions in such situations can be applied in a manner so as to ensure that
the returned income or loss is accepted as the final income or loss after applying the
rollback provisions.
Answer
It is clarified that in case the terms of rollback provisions contain specific agreement
between the Board and the applicant that the agreed determination of ALP or the agreed
manner of determination of ALP is subject to the condition that the ALP would get modified
to the extent that it does not result in reducing the total income or increasing the total loss,
as the case may be, of the applicant as declared in the return of income of the said year,
the rollback provisions could be applied. For example, if the declared income is ` 100, the
income as adjusted by the TPO is ` 120, and the application of the rollback provisions
results in reducing the income to ` 90, then the rollback for that year would be determined
in a manner that the declared income ` 100 would be treated as the final income for that
year.
Question 6
Rule 10RA(7) states that in case effect cannot be given to the rollback provision of an
agreement in accordance with this rule, for any rollback year to which it applies, on account
of failure on the part of applicant, the agreement shall be cancelled. It is to be clarified as to
whether the entire agreement is to be cancelled or only that year for which roll back fails.
Answer

The procedure for giving effect to a rollback provision is laid down in Rule 10RA. Sub-rules
(2), (3), (4) and (6) of the Rule specify the actions to be taken by the applicant in order that
effect may be given to the rollback provision. If the applicant does not carry out such
actions for any of the rollback years, the entire agreement shall be cancelled.
This is because the rollback provision has been introduced for the benefit of the applicant
and is applicable at its option. Accordingly, if the rollback provision cannot be given effect to
for any of the rollback years on account of the applicant not taking the actions specified in
sub-rules (2), (3), (4) or (6), the entire agreement gets vitiated and will have to be
cancelled.

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Question 7
If there is a Mutual Agreement Procedure (MAP) application already pending for a rollback
year, what would be the stand of the APA authorities? Further, what would be the view of
the APA Authorities, if MAP has already been concluded for a rollback year?
Answer

If MAP has been already concluded for any of the international transactions in any of the
rollback year under APA, rollback provisions would not be allowed for those international
transactions for that year but could be allowed for other years or for other international
transactions for that year, subject to fulfilment of specified conditions in Rules 10MA and
10RA. However, if MAP request is pending for any of the rollback year under APA, upon the
option exercised by the applicant, either MAP or application for roll back shall be proceeded
with for such year.
Question 8
Rule 10MA(1) provides that the agreement may provide for determining ALP or manner of
determination of ALP. However, Rule 10MA(4) only specifies that the manner of determination
of ALP should be the same as in the APA term. Does that mean the ALP could be different?
Answer
Yes, the ALP could be different for different years. However, the manner of determination of
ALP (including choice of Method, comparability analysis and Tested Party) would be same.
Question 9
Will there be compliance audit for roll back? Would critical assumptions have to be
validated during compliance audit?
Answer

Since rollback provisions are for past years, ALP for the rollback years would be agreed
after full examination of all the facts, including validation of critical assumptions. Hence,
compliance audit for the rollback years would primarily be to check if the agreed price or
methodology has been applied in the modified return.
Question 10
Whether applicant has an option to withdraw its rollback application? Can the applicant
accept the rollback results without accepting the APA for the future years?

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Answer
The applicant has an option to withdraw its roll back application even while maintaining the
APA application for the future years. However, it is not possible to accept the rollback
results without accepting the APA for the future years. It may also be noted that the fee
specified in Rule 10MA(5) shall not be refunded even where a rollback application is
withdrawn.
Question 11
For already concluded APAs, will new APAs be signed for rollback or earlier APAs could be
revised?
Answer
The second proviso to Rule 10MA(5) provides for revision of APAs already concluded to
include rollback provisions.
Question 12
For already concluded APAs, where the modified return has already been filed for the first
year of the APA term, how will the time-limit for filing modified return for rollback years be
determined?
Answer
The time to file modified return for rollback years will start from the date of signing the
revised APA incorporating the rollback provisions.
Question 13
In case of merger of companies, where one or more of those companies are APA
applicants, how would the rollback provisions be allowed and to which company or
companies would it be allowed?
Answer
The agreement is between the Board and a person. The principle to be followed in case of
merger is that the person (company) who makes the APA application would only be entitled
to enter into the agreement and be entitled for the rollback provisions in respect of
international transactions undertaken by it in rollback years. Other persons (companies)
who have merged with this person (company) would not be eligible for the rollback
provisions.

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To illustrate, if A, B and C merge to form C and C is the APA applicant, then the agreement
can only be entered into with C and only C would be eligible for the rollback provisions. A
and B would not be eligible for the rollback provisions. To illustrate further, if A and B merge
to form a new company C and C is the APA applicant, then nobody would be eligible for
rollback provisions.
Question 14
In case of a demerger of an APA applicant or signatory into two or more companies
(persons), who would be eligible for the rollback provisions?
Answer
The same principle as mentioned in the previous answer, i.e., the person (company) who
makes an APA application or enters into an APA would only be entitled for the rollback
provisions, would continue to apply. To illustrate, if A has applied for or entered into an APA
and, subsequently, demerges into A and B, then only A will be eligible for rollback for
international transactions covered under the APA. As B was not in existence in rollback
years, availing or grant of rollback to B does not arise.
(4) Section 92CD provides for the following procedure for giving effect to an APA -
(i) In case a person has entered into an APA and prior to the date of entering into such
APA, he has furnished the return of income under the provisions of section 139 in
respect of any assessment year relevant to a previous year to which the APA
applies, then, such person shall, within a period of three months from the end of the
month in which the said agreement was entered into, furnish a modified return,
notwithstanding any contrary provision contained in section 139.
(ii) Such modified return shall be in accordance with and limited to the provisions of
such APA i.e., modifications can only be made on account of such APA in the return
to be filed.
(iii) All other provisions of this Act shall apply as if the modified return is a return
furnished under section 139, unless anything to the contrary is provided in this
section.
(iv) If the assessment or reassessment proceedings for an assessment year relevant to a
previous year to which the APA applies have been completed before the expiry of
period allowed for furnishing of modified return, the Assessing Officer shall, in a case
where modified return is filed in accordance with the provisions of this section, pass

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an order modifying the total income of the relevant assessment year determined in
such assessment or reassessment, as the case may be, having regard to and in
accordance with the APA, instead of proceeding to assess or reassess the total
income.
Such order for assessment or reassessment or re-computation of total income shall
be passed within a period of 1 year from the end of the financial year in which the
modified return was furnished. This shall apply notwithstanding the period of
limitation contained under section 153 or 153B or 144C.

The appeal against such order shall lie to Commissioner (Appeals) [Section 246A]
(v) Where the assessment or reassessment proceedings for an assessment year
relevant to the previous year to which the APA applies, are pending on the date of
filing of modified return, the Assessing Officer shall proceed to complete the
assessment or reassessment proceedings in accordance with the APA taking into
consideration the modified return so furnished.
In this case, the time period of completion of pending assessment or reassessment
mentioned under section 153 or 153B or 144C shall be extended by 12 months. This
shall apply notwithstanding the period of limitation contained under section 153 or
153B or 144C.
(vi) The assessment or reassessment proceedings for an assessment year shall be
deemed to have been completed where -
(a) an assessment or reassessment order has been passed; or
(b) no notice has been issued under section 143(2) till the expiry of the limitation
period provided under the said section.
VIII. Secondary Adjustment [Section 92CE]
(1) Meaning of Primary Adjustment and Secondary Adjustment
“Primary adjustment” to a transfer price means the determination of transfer price in
accordance with the arm’s length principle resulting in an increase in the total income or
reduction in the loss, as the case may be, of the assessee.
"Secondary adjustment" means an adjustment in the books of accounts of the assessee
and its associated enterprise to reflect that the actual allocation of profits between the
assessee and its associated enterprise are consistent with the transfer price determined as

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a result of primary adjustment, thereby removing the imbalance between cash account and
actual profit of the assessee.

(2) Forms of Secondary Adjustment - As per the OECD's Transfer Pricing Guidelines for
Multinational Enterprises and Tax Administrations (OECD transfer pricing guidelines),
secondary adjustment may take the form of constructive dividends, constructive equity
contributions, or constructive loans.
(3) Alignment of economic benefit of the transaction with the arm’s length position - The
provisions of secondary adjustment are internationally recognised and are already part of
the transfer pricing rules of many leading economies in the world. Whilst the approaches to
secondary adjustments by individual countries vary, they represent an internationally
recognised method to align the economic benefit of the transaction with the arm's length
position.
(4) Cases where secondary adjustment has to be made - In order to align the transfer
pricing provisions in line with OECD transfer pricing guidelines and international best
practices, section 92CE provides that the assessee shall be required to carry out secondary
adjustment where the primary adjustment to transfer price:
(a) has been made suo motu by the assessee in his return of income; or
(b) made by the Assessing Officer has been accepted by the assessee; or
(c) is determined by an advance pricing agreement entered into by the assessee under
section 92CC on or after the 1.4.2017; or
(d) is made as per the safe harbour rules framed under section 92CB; or
(e) is arising as a result of resolution of an assessment by way of the mutual agreement
procedure under an agreement entered into under section 90 or 90A for avoidance of
double taxation.
(5) No requirement of secondary adjustment in certain cases - Such secondary adjustment,
however, shall not be carried out if, the amount of primary adjustment made in the case of
an assessee in any previous year does not exceed ` 1 crore or the primary adjustment is
made in respect of A.Y.2016-17 or an earlier assessment year.
(6) Non-repatriation of excess money by the associated enterprise deemed to be an
advance - Where, as a result of primary adjustment to the transfer price, there is an
increase in the total income or reduction in the loss, as the case may be, of the assessee,
the excess money or part thereof, as the case may be, which is available with its associated

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enterprise, if not repatriated to India within the time as may be prescribed, shall be deemed
to be an advance made by the assessee to such associated enterprise and the interest on
such advance, shall be computed as the income of the assessee, in the prescribed manner.
Such excess money or part thereof may be repatriated from any of the associated
enterprises of the assessee which is not resident in India.

“Excess money” means the difference between the arm’s length price determined in
primary adjustment and the price at which the international transaction has actually taken
place.

Arms’
Actual value of
Length Price Excess
international
in primary Money
transaction
adjustment

(7) Time limit for repatriation of excess money or part thereof

Rule 10CB(1) prescribes the time limit for repatriation of excess money or part thereof i.e.,
on or before 90 days from the date given in column (3) in the cases mentioned in column
(2) of the table below. The period from which interest is chargeable on the excess money or
part thereof which is not repatriated in such cases is given in column (4).

Case Date Period

(1) (2) (3) (4)
(i) Where primary adjustments to transfer the due date of the due date of
price has been made suo-motu by the filing of return filing of return u/s
assessee in his return of income u/s 139(1) 139(1)
(ii) If primary adjustments to transfer price as the date of the the date of the
determined in the order of the Assessing said order said order
Officer or the appellate authority has been
accepted by the assessee
(iii) Where primary adjustment to transfer price
is determined by an advance pricing
agreement (APA) entered into by the
assessee under section 92CC in respect of
a previous year -

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• If the APA has been entered into on or the date of filing the due date of
before the due date of filing of return of return u/s filing of return u/s
for the relevant P.Y. 139(1) 139(1)
• If the APA has been entered into on or The end of the The end of the
after the due date of filing of return for month in which month in which
the relevant P.Y. the APA has the APA has
been entered been entered into
into
(iv) Where option has been exercised by the the due date of the due date of
assessee as per the safe harbour rules filing of return filing of return u/s
under section 92CB u/s 139(1) 139(1)
(v) Where the primary adjustment to the the date of giving the date of giving
transfer price is determined by a resolution effect by the effect by the A.O.
arrived at under Mutual Agreement A.O. under Rule under Rule 44H
Procedure under a DTAA has been entered 44H to such to such
into u/s 90 or 90A resolution resolution

(8) Rate of interest for the purpose of computation on interest on excess money or part
thereof, if not repatriated within the prescribed time
Rule 10CB(2) prescribes the rate at which the per annum interest income shall be
computed in case of failure to repatriate the excess money or part thereof within the above
time limit. The interest would be computed at the rates mentioned in column (3) in respect
of the cases mentioned in column (2) of the table below:
Case Rate
(1) (2) (3)
(i) Where the international At the one year marginal cost of fund lending
transaction is denominated in rate of SBI as on 1st April of the relevant
Indian rupee previous year + 3.25%
(ii) Where the international At six month London Interbank Offered Rate
transaction is denominated in (LIBOR) as on 30th September of the relevant
foreign currency previous year + 3.00%

Note – In case (ii) above, the rate of exchange for the calculation of the value of
international transaction denominated in foreign currency shall be the telegraphic transfer
buying rate of such currency on the last day of the previous year in which such international
transaction was undertaken.

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(9) Option to pay additional income-tax, if the excess money not repatriated: In a case
where the excess money or part thereof has not been repatriated within the prescribed time
as mentioned above, the assessee has the option to pay additional income-tax @
20.9664% (i.e., tax@18% plus surcharge@12% plus cess@4%) on such excess money or
part thereof, as the case may be.

Where additional income-tax is so paid by the assessee, he will not be required to make
secondary adjustment and compute interest from the date of payment of such tax. This
implies that he would, in any case, be required to compute interest upto the date of
payment of such additional tax.
The additional income-tax so paid by the assessee shall be treated as the final payment of
tax in respect of excess money or part thereof not repatriated and no further credit would be
allowed to the assessee or to any other person in respect of the amount of additional
income-tax so paid.
Further, no deduction in respect of the amount on which such additional income-tax has
been paid, would be allowed under any other provision of the Act.

ILLUSTRATION 6

On 1.4.2025, PQR Ltd., an Indian company, advanced a loan of ` 6 crores to XYZ Inc., a company
resident in Singapore. As on the date of loan, the book value of total assets in the books of XYZ
Inc. was ` 10 crores. XYZ Inc. paid the entire loan along with interest thereon on 31st August,
2025. During the Financial Year 2025-26, PQR Ltd. also entered into an agreement with XYZ Inc.
to provide 20,000 medical equipments at a cost of ` 7,400 per unit. The Assessing Officer treats
them as associate enterprises and wants to re-compute the income of PQR Ltd. at arms’ length
price. You are required to answer the following questions in this respect:
(1) Would PQR Ltd. and XYZ Inc. be treated as associate enterprises for the purpose of
transfer pricing adopted by the Assessing Officer? If yes, why?
(2) Calculate the arms length price of PQR Ltd. which sells the same equipment at the rate of
` 9,000 per unit to Y Ltd. and at the rate of ` 9,500 per unit to X LLP (both of them are
unrelated parties in respect of PQR Ltd.). PQR Ltd. is not a wholesale dealer.
(3) What are the options available to PQR Ltd. in respect of such increase in transfer price by
income tax authorities, if PQR Ltd. accepts such transfer price?

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SOLUTION

(1) Two enterprises are deemed to be associated enterprises as per section 92A(2)(c), if a loan
advanced by one enterprise to the other enterprise constitutes not less than 51% of the
book value of total assets of the other enterprise at any time during the previous year. Since
PQR Ltd., an Indian company, advanced loan of an amount of ` 6 crores to XYZ Inc., a
Singapore company, which is 60% of the book value of the total assets of XYZ Inc. (i.e.,
60% of ` 10 crores), PQR Ltd. and XYZ Inc. are deemed to be associated enterprises.
(2) PQR Ltd. sells equipment at the rate of ` 9,000 per unit to Y Ltd. and at ` 9,500 per unit to
X LLP, both of them being unrelated parties. Since the transactions can be considered as
comparable uncontrolled transactions for the purpose of determining the arm’s length price,
Comparable Uncontrolled Price (CUP) method would be most appropriate method.
Since two prices are determined by the most appropriate method, and data set comprises of
only two entries, the arm's length price shall be the arithmetical mean of both the values
included in the dataset.
Accordingly, arm’s length price would be ` 9,250 [(` 9,000 + ` 9,500)/2]. Since the
deviation between the arm’s length price and actual sale price of the equipment to XYZ
Inc. i.e., ` 7,400 per unit is 25%, which far exceeds the maximum percentage deviation
which can be notified by the Central Government 6, the arm’s length price would be
` 9,250 per unit and the total income would increase by ` 3.7 crores [i.e. ` 1,850
(` 9,250 – ` 7,400) x 20,000 units]
(3) On account of the primary adjustment of ` 3.7 crores (` 1850 x 20,000 units) made by the
Assessing Officer, in the total income of PQR Ltd. for A.Y.2026-27, secondary adjustment
has to be made under section 92CE, since –
(1) The company has accepted the primary adjustment made by the Assessing Officer;
(2) The primary adjustment is in respect of A.Y.2026-27; and
(3) The primary adjustment exceeds ` 100 lakhs.
Accordingly, the excess money i.e., ` 3.7 crores available with the XYZ Inc. has to be
repatriated to India within 90 days of the date of the order of the Assessing Officer.
In case of non-repatriation, ` 3.7 crores would be deemed as an advance made by the PQR
Ltd. to its associated enterprise, XYZ Inc. Interest would be calculated on such advance at

6 Which cannot exceed 3% in any case

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one year marginal cost of fund lending rate of SBI as on 1st April of the relevant previous
year + 3.25%, since the international transaction is denominated in Indian rupee.

Alternatively, PQR Ltd. can opt to pay additional income-tax @20.9664% (tax @18% plus
surcharge @12% plus cess@4%) on ` 3.7 crores, which amounts to ` 77,57,568.
IX. Records to be maintained [Section 92D]: A taxpayer undertaking international transaction
with the associated enterprise has to compute the income, expense or allocation of cost arising
from such international transaction having regard to the arm’s length price. To substantiate the
arm’s length price, the taxpayer is required to maintain the three tier documentation i.e. a Master
file, a local file as prescribed under section 92D of the Act and Country by country report as
prescribed under section 286 of the Act.
(1) Persons responsible for keeping and maintaining prescribed information and document -
Section 92D imposes responsibility on every person
(i) who enters into an international transaction to keep and maintain such information
and documents in respect thereof as may be prescribed;
(ii) being a constituent entity of an international group, to keep and maintain the
prescribed information and document in respect of an international group.

The constituent entity is required to keep and maintain the information and document
irrespective of the fact whether or not any international transaction is
undertaken by such constituent entity.
The constituent entity has to furnish the information and document to the authority
prescribed under section 286(1), i.e., Joint Director as designated by PDGIT
(Systems) or DGIT(Systems) in the prescribed manner, on or before prescribed date.
(2) Information and documents to be kept and maintained for prescribed period - The
CBDT is empowered to prescribe the period for which the information and documents shall
be kept and maintained.
(3) Assessing Officer & Commissioner (Appeals) empowered to require persons entering
into international transaction to furnish prescribed information and documents - The
Assessing Officer or the Commissioner (Appeals) may, in the course of any proceedings
under the Income-tax Act, require any person who has entered into an international
transaction to furnish any such prescribed information or documents within a period of
10 days from the date of receipt of a notice issued in this regard. The requisition period

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may, on request, be extended further for a period not exceeding thirty days by the
Assessing Officer or the Commissioner (Appeals).
Information to be kept and maintained under section 92D [Rule 10D]
Rule 10D (1) provides for the information and
documents to be kept and maintained by the
assessee under section 92D(1)(i). Under this Rule,
the following information and documents have to be maintained:
(i) A description of the ownership structure of the assessee enterprise with details of shares or
other ownership interest held therein by other enterprises;
(ii) A profile of the multinational group of which the assessee enterprise is a part along with the
name, address, legal status and country of tax residence of each of the enterprises
comprised in the group with whom international transactions have been entered into by the
assessee, and ownership linkages among them;
(iii) A broad description of the business of the assessee and the industry in which the assessee
operates, and the business of the associated enterprises with whom the assessee has
transacted;
(iv) The nature and terms (including prices) of international transactions entered into with each
associated enterprise, details of property transferred or services provided and the quantum
and the value of each such transaction or class of such transaction;
(v) A description of the functions performed, risks assumed and assets employed or to be employed
by the assessee and by the associated enterprises involved in the international transactions;
(vi) A record of the economic and market analyses, forecasts, budgets or any other financial
estimates prepared by the assessee for the business as a whole and for each division or
product separately, which may have a bearing on the international transactions entered into
by the assessee;
(vii) A record of uncontrolled transactions taken into account for analysing their comparability
with the international transactions entered into, including a record of the nature, terms and
conditions relating to any uncontrolled transaction with third parties which may be of
relevance to the pricing of the international transactions;
(viii) A record of the analysis performed to evaluate comparability of uncontrolled transactions
with the relevant international transaction;

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(ix) A description of the methods considered for determining the arm’s length price in relation to
each international transaction or class of transaction, the method selected as the most
appropriate method along with explanation as to why such method was so selected, and
how such method was applied in each case;
(x) A record of the actual working carried out for determining the arm’s length price, including
details of the comparable data and financial information used to apply the most appropriate
method, and adjustments, if any, which were made to account for differences between the
international transaction and the comparable uncontrolled transactions, or between the
enterprises entering into such transactions;
(xi) The assumptions, policies and price negotiations, if any, which have critically affected the
determination of the arm’s length price;
(xii) Details of the adjustments, if any, made to transfer prices to align them with arm’s length
prices determined under the Income-tax Rules and consequent adjustment made to the
total income for tax purposes;
(xiii) Any other information, data or documents, including information or data relating to the
associated enterprise, which may be relevant for determination of the arm’s length price.
Threshold limit for maintenance of prescribed information and documents [Rule 10D(2)]
Rule 10D(2) provides that in a case where the aggregate value of international transactions does
not exceed ` 1 crore, it will not be obligatory for the assessee
to maintain the above information and documents.
However, it is provided that in the above cases also the
assessee will have to substantiate that the income arising from the international transactions with
associated enterprises, as disclosed by the accounts, is in accordance with section 92. This will
mean that, even if the aggregate value of the international transactions is less than ` 1 crore, the
assessee will have to maintain adequate records and evidence to show that the international
transactions with associated enterprises are on the basis of arm’s length principle.
Information to be supported by authentic documents [Rule 10D(3)]
The information to be maintained by the assessee, is to be supported by authentic documents.
These documents may include the following:
(i) Official publications, reports, studies and data bases from the Government of the country of
residence of the associated enterprise, or of any other country;

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(ii) Reports of market research studies carried out and technical publications brought out by
institutions of national or international repute;

(iii) Price publications including stock exchange and commodity market quotations;
(iv) Published accounts and financial statements relating to the business affairs of the
associated enterprises;

(v) Agreements and contracts entered into with associated enterprises or with unrelated
enterprises in respect of transactions similar to the international transactions;
(vi) Letters and other correspondence documenting any terms negotiated between the
assessee and the associated enterprise;
(vii) Documents normally issued in connection with various transactions under the accounting
practices followed.

It is also provided that the information and documents to be maintained should be

contemporaneous and should exist latest by the specified date.
The date one month prior to the due date for furnishing the return of
income under section 139(1) for the relevant assessment year i.e., 31st
October of the relevant assessment year.
In the case of international transactions which continue to have effect over more than one financial
year, fresh documents will not be required to be maintained for each year if there are no significant
change which may affect the determination of arm’s length price.
The above information and documents are required to be maintained for a period of eight years
from the end of the relevant assessment year.
X. Audit Report [Section 92E]
Under section 92E, every person who enters into an international transaction during a previous
year is required to obtain a report from a chartered accountant and furnish such report on or
before the specified date in the prescribed form.
Rule 10E provides that the auditor’s report shall be in Form No.3CEB. It requires the auditor to
state that he has examined the accounts and records of the assessee relating to the international
transactions entered into by the assessee during the relevant year. He has also to give his opinion
whether the prescribed information and documents relating to the above transactions have been
kept by the assessee. Further, he has to state that the particulars stated in the Annexure to his
report are true and correct.

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In Part A of the Annexure, general information of the assessee (Name of the assessee, address,
PAN or Aadhaar No., nature of business etc.) is required to be reported.
In Part B of the Annexure, the particulars about the international transactions are required to be
stated. Broadly, these particulars include list of associated enterprises, particulars and description
of transactions in tangible property, intangible property, particulars in respect of lending or
borrowing of money, particulars of deemed international transaction etc.
In Part C of the Annexure, particulars related to list of associated enterprises with whom the
assessee has entered into specified domestic transactions, particulars in respect of transactions in
the nature of transfer or acquisition of goods or services, etc. are required to be reported.
“Specified date” means the date one month prior to the due date for furnishing the return of income
under section 139(1) for the relevant assessment year. The due date for filing of transfer pricing
report under section 92E in Form 3CEB is 31st October of the assessment year.
XI. Power of Assessing Officer: Section 92C(3) and (4) gives power to the Assessing Officer to
determine the arm’s length price under the following circumstances and also empowers the
Assessing Officer to re-compute total income of the assessee having regard to arm’s length price
determined by him. It also provides that deduction under section 10AA and Chapter VI-A shall not
be allowed from the additional income computed by him.

For example, if the total income declared by the assessee in his return of income is, say ` 7 lakhs and
the total income computed by the Assessing Officer applying the arm’s length principle is, say
` 9 lakhs, the difference of ` 2 lakhs will not qualify for deduction under section 10AA or Chapter VI-A.
The Assessing Officer may invoke the power to determine arm’s length price, if during the course
of any proceeding, he is of the opinion that, on the basis of material or information or documents in
his possession:
(a) The price charged or paid in an international transaction has not been determined in
accordance with section 92C(1) and (2); or
(b) Any information and documents relating to an international transaction has not been kept
and maintained by the assessee in accordance with the provisions contained in section
92D(1) and the rules made in this behalf (Rule 10D); or
(c) The information or data used in computation of the arm’s length price is not reliable or
correct; or
(d) The assessee has failed to furnish within the specified time, any information or documents
which he was required to furnish by a notice issued under section 92D(3).

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Before invoking the power to determine arm’s length price, an opportunity of being heard is to be
given to the assessee.
Second proviso to section 92C(4) provides that if the total income of an associated enterprise is
computed under this section on the determination of arm’s length price paid to another associated
enterprise, from which tax is deducted or deductible at source, the income of the other associated
enterprise shall not be recomputed on this count.

For example, if “A” Ltd. has paid royalty to “B” Ltd. (Non-Resident) @10% of sales and tax is
deducted at source, “B” Ltd. cannot claim refund if the Assessing Officer has determined 8% as
arm’s length price in the case of “A” Ltd. and disallowed 2% of the royalty amount.

Bright Line Test – To cater to the Indian market, MNC sets up subsidiaries in India. The Indian
subsidiaries act as a distributor/provider of goods/services and generally incurred certain
expenses for promoting the brand or product of the foreign company, which are popularly known
as Advertisement, marketing and sale promotion expenditure ("AMP expenses"). The intellectual
property rights ("IPR") in products/services and the brands lies with the parent entities. To test
that whether the transaction is at ALP or not and to determine the excess/non-routine advertising,
marketing and promotion (AMP) expenditure incurred by the taxpayer for building brand of its
associated enterprises in India, Revenue Authorities' sometimes adopt the Bright Line Test
("BLT"). The issue under consideration is whether bright line test can be used by the Assessing
Officer to determine the excess/non-routine advertising, marketing and promotion (AMP)
expenditure incurred by the taxpayer for building brand of its associated enterprises in India.
The Delhi High Court, in Bausch & Lomb Eyecare (India) (P.) Ltd. v. Addl. CIT [2016] 381 ITR 227,
held that advertisement expense is not an international transaction and there is no machinery
provision for computation of AMP expense adjustment.
In Sony Ericsson Mobile Communications India (P) Ltd v. CIT (2015) 374 ITR 118, the Delhi High
Court held that bright line test has no statutory mandate and a broad-brush approach is not
mandated or prescribed. It further opined that the exercise to separate “routine” and “non-routine”
advertising, marketing and promotion or brand building exercise by applying the bright line test of
non-comparables should not be sanctioned.
Applying the rationale of the above rulings of the High Court, the Revenue Authorities' are not
justified in adopting the “Bright Line Test” for disallowing or adjusting the advertisement
expenditure in computing arm’s length price.

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XII. Penalties
Stringent penalties are provided in various sections for non-compliance with the requirements
provided under the transfer pricing provisions. These are as under:
Penalty for failure to report any international transaction or any transaction deemed to be
an international transaction: Under section 270A, penalty@50% of tax payable on under-
reported income is leviable. However, the amount of under-reported income represented by any
addition made in conformity with the arm’s length price determined by the Transfer Pricing Officer
would not be included within the scope of under-reported income under section 270A, where the
assessee had maintained information and documents, as prescribed under section 92D, declared
the international transactions under Chapter X and disclosed all material facts relating to the
transaction.
Interestingly, clause (d) of section 270A(6) does not provide similar immunity from penalty if the
addition/disallowance is made by TPO in relation to a specified domestic transaction.
Further, failure to report any international transaction or any transaction deemed to be an
international transaction or specified domestic transaction to which the provisions of Chapter X
applies would constitute ‘misreporting of income’ under section 270A(9), in respect of which
penalty@200% would be attracted.
Penalty for failure to keep and maintain information and documentation [Section 271AA]: In
order to ensure compliance with the transfer pricing regulations, section 271AA provides that, the
Assessing Officer or Commissioner (Appeals) may direct the person entering into an international
transaction to pay a penalty@2% of the value of each international transaction entered into by him,
if the person:
(1) fails to keep and maintain any such document and information as required by section
92D(1) or section 92D(2);
(2) fails to report such international transaction which is required to be reported; or

(3) maintains or furnishes any incorrect information or document.

Penalty for failure to furnish information or document under section 92D [Section 271G]
Section 271G provides that if any person who has entered into an international transaction fails to
furnish any such information or document as required by Assessing Officer or TPO or
Commissioner (Appeals) within a period of 10 days from the date of receipt of a notice issued in
this regard, then such person shall be liable to a penalty up to 2% of the value of each
international transaction.

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Penalty for failure to furnish report under section 92E [Section 271BA]
If any person fails to furnish a report from an accountant, the Assessing Officer may direct that
such person shall pay, by way of penalty, a sum of ` 1 lakh.

Penalty for failure to comply with TP provisions : A Summary

Section Nature of default Penalty

270A(9) Failure to report any International transaction or 200% of the tax payable
deemed International transaction to which the on under-reported income
provision of Chapter X applies would constitute
‘misreporting of income’
271BA Failure to furnish a report from an accountant as ` 1 lakh
required under section 92E
271G Failure to furnish info or doc as required by 2% of the value of the
Assessing Officer or CIT(A) u/s 92D(3) within 10 international transaction for
days from the date of receipt of notice or extended each failure
period not exceeding 30 days, as the case may be.
271AA (1) Failure to keep and maintain any such 2% of the value of each
document and information as required by such international
section 92D(1)/(2); transaction
(2) Failure to report such international transaction
which is required to be reported; or
(3) Maintaining or furnishing any incorrect
information or document.
Notes:
• The penalty u/s 271AA is in addition and not in substitution of penalty u/s 271BA.
• If the assessee proves that there was reasonable cause for the failure, no penalty
would be leviable under section 271BA, 271G and 271AA.

(2) Furnishing of report in respect of international group in line with BEPS Action Plan –
Country by Country Report and Master File

(i) Transfer Pricing provisions under the Income-tax Act, 1961

Chapter X of the Income-tax Act, 1961 comprising sections 92 to 92F contain provisions relating to
transfer pricing regime.
Section 92D requires maintenance of prescribed information and document relating to the
international transaction and specified domestic transaction.

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(ii) Requirements as per OECD report on Action 13 of BEPS Action Plan

In order to tackle the base erosion and profit shifting by the MNCs, the OECD/G20 BEPS Action
Plan 13 report provides for:
(a) detailed transfer pricing documentation; and
(b) a template for country-by-country reporting of income, earnings, taxes paid and certain
measure of economic activity.
This measure is recommended to ensure that the MNEs are reporting the profits in the jurisdiction
where the economic activities are performed.
(iii) Three-tier structure mandated by BEPS
The BEPS report recommends that countries adopt a standardised approach to transfer pricing
documentation; it mandates the following three-tier structure:-

Document Information
(1) Master File Standardised information relevant for all multinational enterprises
(MNE) group members
(2) Local file Specific reference to material transactions of the local taxpayer
(3) Country-by- Information relating to the global allocation of the MNE's income
country report and taxes paid; and
Indicators of the location of economic activity within the MNE group.

(iv) Advantages of the three tier structure [as per BEPS Report]:
(a) Taxpayers will be required to articulate consistent transfer pricing positions;
(b) Tax administrations would get useful information to assess transfer pricing risks;
(c) Tax administrations would be able to make determinations about where their resources can
most effectively be deployed, and, in the event audits are called for, provide information to
commence and target audit enquiries.

(v) Country-by-country Report: Reporting Requirements of MNEs

The Country-by-Country (CbC) report has to be submitted by parent entity of an international
group to the prescribed authority in its country of residence. This report is to be based on
consolidated financial statement of the group.

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(a) MNEs have to report annually and for each tax jurisdiction in which they do business:
(1) the amount of revenue;
(2) profit before income tax; and
(3) income tax paid and accrued.
(b) MNEs have to report their total employment, capital, accumulated earnings and tangible
assets in each tax jurisdiction.
(c) MNEs have to identify each entity within the group doing business in a particular tax
jurisdiction and provide an indication of the business activities each entity engages in.

(vi) Master File: Objective & Features

(a) The master file would provide an overview of the MNE groups business, including:
(1) the nature of its global business operations,

(2) its overall transfer pricing policies, and

(3) its global allocation of income and economic activity
in order to assist tax administrations in evaluating the presence of significant transfer
pricing risk.
(b) The master file is intended to provide a high-level overview in order to place the MNE
group's transfer pricing practices in their global economic, legal, financial and tax context.

(c) The master file shall contain information which may not be restricted to transaction
undertaken by a particular entity situated in particular country.
(d) Thus, information in master file would be more comprehensive than the existing regular
transfer pricing documentation.
(e) The master file shall be furnished by each entity to the tax authority of the country in which
it operates.

(vii) Implementation of international consensus in India

India is one of the active members of BEPS initiative and part of international consensus. For the
purpose of implementing the international consensus, a specific reporting regime in respect of CbC
reporting and also the master file has been incorporated in the Income-tax Act, 1961.

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(viii) Elements relating to CbC reporting requirement and related matters which have been
incorporated in the Income-tax Act, 1961 [Section 286]

(a) Threshold limit for applicability of CbC reporting [Sub-section (7)]: The
reporting provision shall apply in respect of an international group for an accounting year, if
the total consolidated group revenue as reflected in the consolidated financial statement
(CFS) for the accounting year preceding such accounting year is above a threshold to be
prescribed i.e., ` 6,400 crore.

Where the total consolidated group revenue of the international group, as reflected in the
consolidated financial statement, is in foreign currency, the rate of exchange for the
calculation of the value in rupees of such total consolidated group revue shall be the
telegraphic transfer buying rate (TTBR) of such currency on the last day of the accounting
year preceding the accounting year [Rule 10DB(7)].
(b) Time limit for furnishing CbC report [Sub-section (2)]: The parent entity of an
international group or the alternate reporting entity, if it is resident in India shall be required
to furnish the report in respect of the group to the Joint Director, designated by the Principal
Director General of Income-tax (Systems) or the Director General of Income-tax (Systems), as
the case may be, for every reporting accounting year, within a period of twelve months from
the end of the said reporting accounting year for which the report is being furnished, in
Form No. 3CEAD.
(c) Details to be furnished by constituent entity resident in India [Sub-section (1)]:
Every constituent entity, resident in India, of an international group having parent entity that
is not resident in India, shall notify the Joint Director, designated by the Principal Director
General of Income-tax (Systems) or the Director General of Income-tax (Systems), as the
case may be, at least two months prior to the due date for furnishing CbC report –
(1) whether it is the alternate reporting entity of the international group; or
(2) the details of the parent entity or the alternate reporting entity, if any of the
international group, and the country of territory of which the said entities are resident.
The report shall be furnished in Form No.3CEAC.
(d) Details/ information to be included in CbC report [Sub-section (3)]: It should
contain aggregate information in respect of:
(1) the amount of revenue,
(2) profit and loss before income-tax,

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(3) amount of income-tax paid and accrued,

(4) details of stated capital, accumulated earnings, number of employees, tangible
assets other than cash or cash equivalent in respect of each country or territory
along with details of each constituent's incorporation country and residential status,
nature and details of main business activity or activities of each constituent entity
and any other information as may be prescribed.
This shall be based on the template provided in the OECD BEPS report on Action Plan 13.
(e) Furnishing of CbC report by resident constituent entity [Sub-section (4): A
constituent entity of an international group resident in India, other than the parent entity or
the alternate reporting entity, shall be required to furnish CbC report within the twelve
months from the end of the reporting accounting year to the Joint Director, designated by
the Principal Director General of Income-tax (Systems) or Director General of Income-tax
(Systems), if the parent entity of the group is resident of a country or territory,-
(1) in which it is not obligated to file report of the nature of CbC report;
(2) with which India does not have an arrangement for exchange of the CbC report; or
(3) there has been a systemic failure of the country or territory i.e., such country is not
exchanging information with India even though there is an agreement and this fact
has been intimated to the entity by the prescribed authority.
However, in case the parent entity of the constituent entity is resident of a country or
territory, where, there has been a systemic failure of the country or territory and the said
failure has been intimated to such constituent entity, the period for submission of the report
would be six months from the end of the month in which said systemic failure has
been intimated.
(f) Nomination of one constituent entity for furnishing CbC report [Proviso to sub-
section (4)]: If there are more than one such constituent entity of the group, resident in
India, other than the parent entity or the alternate reporting entity, then, the report shall be
furnished by any one constituent entity, if the group has nominated such entity on behalf of
all the constituent entities resident in India and information has been conveyed in writing on
behalf of the group to the prescribed authority in Form No. 3CEAE.

(g) No obligation to furnish CbC report in certain cases [Sub-section (5)]: If an

international group, having parent entity which is not resident in India, had designated an
alternate entity for filing its report with the tax jurisdiction in which the alternate entity is
resident and such alternate entity has furnished such report on or before the date specified

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by that country or territory, then, the entities of such group operating in India would not be
obliged to furnish report if -

- the report is required to be furnished under the law for the time being in force in the
said country or territory
- the report can be obtained under the agreement of exchange of such reports by
Indian tax authorities
- No systemic failure in respect of the said country or territory has been conveyed to
any constituent entity of the group that is resident in India
- the said country or territory has been informed in writing by the constituent entity that
it is the alternative reporting entity on behalf of the international group
- the same has been informed to the prescribed authority by the entity in accordance
with section 286(1).
(h) Entity to furnish documents and information called for [Sub-section (6)]: The
Joint Director, designated by the PDGIT (Systems) or DGIT (Systems) may call for such
document and information from the entity furnishing the report as it may specify in notice in
writing for the purpose of verifying the accuracy. The entity shall be required to make
submission within thirty days of receipt of notice or further period if extended by the
prescribed authority, but extension shall not be beyond a further period of 30 days.
(ix) Penalty for non-furnishing of the report by any reporting entity which is obligated to
furnish such report [Section 271GB(1) & (3)]

Period of delay/ default Penalty

(a) Not more than a month ` 5,000 per day
(b) beyond one month ` 15,000 per day for the period exceeding
one month
(c) Continuing default even after service ` 50,000 per day of continuing failure
of order levying penalty either under beginning from the date of service of order
(a) or under (b)
(x) Penalty for failure to produce information and documents within prescribed time
[Section 271GB(2) & (3)]

Default Penalty
(a) Failure to produce information ` 5,000 per day of continuing failure, from
and documents before the day immediately following the day on

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prescribed authority within the which the period for furnishing the
period allowed u/s 286(6) information and document expires.
(b) Continuing default even after ` 50,000 per day for the period of default
service of penalty order beyond the date of service of order.

(xi) Penalty for submission of inaccurate information in the CBC report [Section
271GB(4)]
If the reporting entity has provided any inaccurate information in the report, the penalty would be
` 5,00,000 if,-
(a) the entity has knowledge of the inaccuracy at the time of furnishing the report but does not
inform the prescribed authority; or
(b) the entity discovers the inaccuracy after the report is furnished and fails to inform the
prescribed authority and furnish correct report within a period of fifteen days of such
discovery; or
(c) the entity furnishes inaccurate information or document in response to notice of the
prescribed authority under section 286(6).

(xii) Non-levy of penalty if reasonable cause for failure is proved [Section 273B]
Section 273B provides for non-levy of penalty under various sections if the assessee proves that
there was reasonable cause for such failure. Section 271GB has been included within the scope of
section 273B. Therefore, the entity can offer reasonable cause defence for non-levy of penalties
mentioned above.
(xiii) Maintenance and furnishing of Master file: Consequent amendments in the Income-
tax Act, 1961

Section Provision
(1) 92D(1)(ii) Every person, being constituent entity of an international group, has to keep
and maintain the prescribed information and document in respect of the
international group. Constituent entity has to keep and maintain such
prescribed information and document irrespective of the fact whether or not
any international transaction is undertaken by such constituent entity.
The rules shall, thereafter, prescribe the information and document as
mandated for master file under OECD BEPS Action 13 report;
(2) 92D(4) The information and document shall also be furnished to the prescribed
authority u/s 286(1) within such period as may be prescribed and the manner
of furnishing may also be provided for in the rules

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(3) 271AA(2) For non-furnishing of the information and document to the prescribed
authority, a penalty of ` 5 lakh shall be leviable.
(4) 273B Reasonable cause defence against levy of penalty shall be available to the
entity.

(xiv) Maintenance and furnishing of information and documents by certain person

under section 92D [Rule 10DA]

Rule Particulars
10DA(1) Persons required to keep and maintain the information and documents:
Every person, being a constituent entity of an international group shall –
(i) if the consolidated group revenue of the international group, of which
such person is a constituent entity, as reflected in the consolidated
financial statement of the international group for the accounting year,
exceeds ` 500 crore; and
(ii) the aggregate value of international transactions –
(A) during the accounting year, as per the books of accounts,
exceeds ` 50 crore, or
(B) in respect of purchase, sale, transfer, lease or use of intangible
property during the accounting year, as per the books of
accounts, exceeds ` 10 crore
keep and maintain information and documents of the international group.
Note – The rate of exchange for the calculation of the value in rupees of the
consolidated group revenue in foreign currency shall be the telegraphic
transfer buying rate (TTBR) of such currency on the last day of the accounting
year. [Rule 10DA(7)]
Part A of Form No. 3CEAA (Master File), however, shall be furnished by
every person, being a constituent entity of an international group, whether or
not the above conditions are satisfied [Rule 10DA(3)].
Information and documents required to be kept and maintained:
The constituent entity shall keep and maintain the following information and
documents of the international group, namely:-
(a) a list of all entities of the international group along with their
addresses;
(b) a chart depicting the legal status of the constituent entity and
ownership structure of the entire international group;
(c) a description of the business of international group during the
accounting year including,-

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(I) the nature of the business or businesses;

(II) the important drivers of profits of such business or businesses;
(III) a description of the supply chain for the five largest products or
services of the international group in terms of revenue and any
other products including services amounting to more than five
per cent. of consolidated group revenue;
(IV) a list and brief description of important service arrangements
made among members of the international group, other than
those for research and development services;
(V) a description of the capabilities of the main service providers
within the international group;
(VI) details about the transfer pricing policies for allocating service
costs and determining prices to be paid for intra-group services;
(VII) a list and description of the major geographical markets for the
products and services offered by the international group;
(VIII) a description of the functions performed, assets employed and
risks assumed by the constituent entities of the international
group that contribute at least ten per cent. of the revenues or
assets or profits of such group; and
(IX) a description of the important business restructuring
transactions, acquisitions and divestments;
(d) a description of the overall strategy of the international group for the
development, ownership and exploitation of intangible property,
including location of principal research and development facilities and
their management;
(e) a list of all entities of the international group engaged in development
and management of intangible property along with their addresses;
(f) a list of all the important intangible property or groups of intangible
property owned by the international group along with the names and
addresses of the group entities that legally own such intangible property;
(g) a list and brief description of important agreements among members of
the international group related to intangible property, including cost
contribution arrangements, principal research service agreements and
license agreements;
(h) a detailed description of the transfer pricing policies of the international
group related to research and development and intangible property;
(i) a description of important transfers of interest in intangible property, if
any, among entities of the international group, including the name and

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address of the selling and buying entities and the compensation paid
for such transfers;
(j) a detailed description of the financing arrangements of the
international group, including the names and addresses of the top ten
unrelated lenders;
(k) a list of group entities that provide central financing functions, including
their place of operation and of effective management;
(l) a detailed description of the transfer pricing policies of the international
group related to financing arrangements among group entities;
(m) a copy of the annual consolidated financial statement of the
international group; and
(n) a list and brief description of the existing unilateral advance pricing
agreements and other tax rulings in respect of the international group
for allocation of income among countries.
10DA(2) Due date for furnishing report:
The information and document shall be furnished in Form No. 3CEAA to the
Joint Director as may be designated by PDGIT (Systems) or DGIT (Systems),
as the case may be, and it shall be furnished on or before the due date for
furnishing the return of income specified under section 139(1).
10DA(4)/ (5) Furnishing of report in case of more than one constituent entity:
Where there are more than one constituent entities of an international
group required to file the information and document under sub-rule (2),
then, the Form No 3CEAA may be furnished by any one constituent entity, if, -
(a) the international group has designated such entity for this purpose and
(b) the information has been conveyed to the Joint Director as may be
designated by PDGIT (Systems) or DGIT (Systems), as the case may
be, in Form No 3CEAB, in this behalf at least 30 days before the due
date of furnishing the Form No. 3CEAA.
10DA(6) Period for which such information and document to be kept or
maintained:
The information and documents shall be kept and maintained for a period of
eight years from the end of the relevant assessment year.

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(xv) Meaning of certain terms [Section 286(9)]

Term Meaning
(a) Accounting year
Case Accounting year
In a case A previous year
where the
parent entity is
resident in
India; or
In any other An annual accounting period, with respect to
which the parent entity of the international
group prepares its financial statements
under any law for the time being in force or
the applicable accounting standards of the
country or territory of which such entity is
resident.
(b) Agreement A combination of all of the following agreements, namely –
(i) an agreement referred to in section 90(1) or section
90A(1); or
(ii) an agreement for exchange of the CbC report referred to
in section 286(2) as may be notified by the Central
Government.
(c) Alternate Any constituent entity of the international group that has been
reporting entity designated by such group, in the place of the parent entity, to
furnish the CbC report in the country or territory in which the said
constituent entity is resident on behalf of such group.
(d) Constituent entity (i) any separate entity of an international group that is
included in the consolidated financial statement of the said
group for financial reporting purposes, or may be so
included for the said purpose, if the equity share of any
entity of the international group were to be listed on a stock
exchange;
(ii) any such entity that is excluded from the consolidated
financial statement of the international group solely on the
basis of size or materiality; or
(iii) any permanent establishment of any separate business
entity of the international group included in sub clause (i) or
sub clause (ii), if such business unit prepares a separate
financial statement for such permanent establishment for
financial reporting, regulatory, tax reporting or internal
management control purposes

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(e) Group This includes a parent entity and all the entities in respect of
which, for the reason of ownership or control, a consolidated
financial statement for financial reporting purposes,—
(i) is required to be prepared under any law for the time being
in force or the accounting standards of the country or
territory of which the parent entity is resident; or
(ii) would have been required to be prepared had the equity
shares of any of the enterprises were listed on a stock
exchange in the country or territory of which the parent
entity is resident.
(f) Consolidated The financial statement of an international group in which the
financial assets, liabilities, income, expenses and cash flows of the
statement parent entity and the constituent entities are presented as
those of a single economic entity
(g) International Any group that includes,—
group (i) two or more enterprises which are resident of different
countries or territories; or
(ii) an enterprise, being a resident of one country or territory,
which carries on any business through a permanent
establishment in other countries or territories;
(h) Parent entity A constituent entity, of an international group holding, directly or
indirectly, an interest in one or more of the other constituent
entities of the international group, such that,—
(i) it is required to prepare a consolidated financial statement
under any law for the time being in force or the accounting
standards of the country or territory of which the entity is
resident; or
(ii) it would have been required to prepare a consolidated
financial statement had the equity shares of any of the
enterprises were listed on a stock exchange,
and, there is no other constituent entity of such group which,
due to ownership of any interest, directly or indirectly, in the
first mentioned constituent entity, is required to prepare a
consolidated financial statement, under the circumstances
referred to in sub clause (i) or sub clause (ii), that includes
the separate financial statement of the first mentioned
constituent entity.
(i) Permanent Meaning assigned to it in clause (iiia) of section 92F i.e.,
establishment includes a fixed place of business through which the business of
the enterprise is wholly or partly carried on.

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(j) Reporting The accounting year in respect of which the financial and
accounting year operational results are required to be reflected in the report to be
furnished every year by the parent entity or the alternate
reporting entity, resident in India, in respect of the international
group of which it is a constituent under section 286(2) or by a
constituent entity of an international group referred to in section
286(4).
(k) Reporting entity The constituent entity including the parent entity or the
alternate reporting entity, that is required to furnish a report
referred to in section 286(2).
(l) Systemic failure Systemic failure, with respect to a country or territory, means
that the country or territory has an agreement with India
providing for exchange of report of the nature referred to in
section 286(2), but—
(i) in violation of the said agreement, it has suspended
automatic exchange; or
(ii) has persistently failed to automatically provide to India the
report in its possession in respect of any international group
having a constituent entity resident in India

(3) Transfer pricing for Specified Domestic Transactions

(i) Income from domestic related party transactions to be subject to transfer pricing
[Section 92(2A)]: Section 92 provides that any income arising from an international
transaction shall be computed having regard to the arm’s length price. Even in case of
certain domestic transaction, the tax arbitrage takes place due to differences in tax rates.
For example, if the entity has two units – one in DTA and other in non-DTA, the entity can
undertake the transfer of goods at price which results in lower profits in taxable unit and
higher profits in non-taxable unit. In order to ensure objectivity in determination of income
from domestic related party transactions and determination of reasonableness of
expenditure between related domestic parties, the provisions of section 92 have been
extended to include within its ambit the specified domestic transactions. Section 92(2A)
provides that, any allowance for an expenditure or interest or allocation of any cost or
expense or any income in relation to the specified domestic transaction shall be computed
having regard to the arm’s length price. However, as per section 92(3), the provisions of
this section would not apply if such allowance for expense or interest under section 92(2A)
has the effect of reducing the income chargeable to tax or increasing the loss, as the case
may be.

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(ii) Meaning of “specified domestic transaction” [Section 92BA]: Section 92BA provides
the meaning of “specified domestic transaction”. As per section 92BA, for the purpose of
sections 92, 92C (Computation of arm’s length price), 92D (Maintenance and keeping of
information and documents) and 92E (Furnishing of report from an accountant), in case of
an assessee the specified domestic transaction shall mean any of the following
transactions, not being an international transaction, namely,-
(1) any transaction referred to in section 80A i.e., inter-unit transfer of goods and
services by an undertaking or unit or enterprise or eligible business to other business
carried on by the assessee or vice versa, for consideration not corresponding to the
market value on the date of transfer;
(2) any transfer of goods or services referred to in section 80-IA(8) i.e., inter-unit transfer
of goods or services between eligible business and other business, where the
consideration for transfer does not correspond with the market value of goods and
services;
(3) any business transacted between the assessee carrying on eligible business and
other person as referred to section 80-IA(10);
(4) any transaction, referred to in any other section under Chapter VI-A or section 10AA,
to which provisions of section 80-IA(8) or section 80-IA(10) are applicable; or
(5) any business transacted between a company opting for section 115BAB and person
with whom the company has close connection; or

(6) any business transacted between a co-operative society opting for section 115BAE and
person with whom the co-operative society has close connection; or
(7) any other transaction as may be prescribed,
However, the above mentioned transactions shall not be treated as specified domestic
transaction in case the aggregate of such transactions entered into by the assessee in the
previous year does not exceed a sum of ` 20 crore.

(iii) Arm’s length price and income of a specified domestic transaction to be computed in
the same manner as applicable to an international transaction [Sections 92 & 92C]: In
order to determine the arm’s length price in respect of the specified domestic transaction,
the provisions of section 92 and 92C shall apply to the specified domestic transaction as
they apply to the international transaction. Accordingly, the methods of computation of

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arm’s length price for an international transaction would be applicable to a specified

domestic transaction also.

(iv) Persons entering into a specified domestic transaction to maintain information and
documents and furnish report of an accountant [Section 92D & 92E]: With a view to
create a legally enforceable obligation on assessees entering into a specified domestic
transaction to maintain proper documentation and obtain and furnish report of a Chartered
Accountant on or before the specified date, the provisions of section 92D and 92E have
been made applicable to a specified domestic transaction as they apply to an international
transaction.
(v) Reference to Transfer Pricing Officer for computation of arm’s length price of
specified domestic transaction [Section 92CA]: According to section 92CA, where any
person has entered into an international transaction or a specified domestic transaction in
any previous year, the Assessing Officer can with the previous approval of the Principal
Commissioner or Commissioner, if he considers necessary or expedient to do so, refer the
computation of the arm’s length price of such transaction to the Transfer Pricing Officer
(TPO).
When such reference is made, TPO can call upon the assessee to produce evidence in
support of the computation of arm’s length price made by him in respect of such
transaction.
The TPO can also determine the ALP of other specified domestic transactions identified
subsequently in the course of proceedings before him as if such transaction is a specified
domestic transaction referred to the TPO by the Assessing Officer under section 92CA(1).
Where in respect of a specified domestic transaction, the assessee has not furnished the
report under section 92E and such transaction comes to the notice of the TPO during the
course of proceeding before him, the transfer pricing provisions shall apply as if such
transaction is a specified domestic transaction referred to the TPO by the Assessing Officer
under section 92CA(1).
The TPO has to pass an order determining the arm’s length price in respect of the specified
domestic transaction after considering the evidence, documents, etc. produced by the
assessee and after considering the material gathered by him. He has to send a copy of his
order to the Assessing Officer as well as the assessee.
Block Transfer pricing assessment scheme is also applicable on specified domestic
transactions which allows to apply the ALP determined in relation to a specified

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domestic transaction for any previous year to the similar transaction for the two
consecutive previous year immediately following such previous year.

(vi) Penalty provisions to apply to specified domestic transactions as they apply to an

international transaction [Sections 271AA, 271BA & 271G]: The penalty provisions
under sections 271AA, 271BA and 271G shall apply to the specified domestic transaction
as they apply to an international transaction defined under section 92B.
Failure to furnish the report under section 92E from an accountant would attract penalty of
` 1,00,000 under section 271BA.
In addition,
(i) in case of failure to keep and maintain information, document as required under
section 92D(1) or 92D(2); or

(ii) failure to report such specified domestic transaction which is required to be reported; or
(iii) maintain or furnishes incorrect information or document
penalty under section 271AA at 2% of the value of each transaction would be attracted.

Penalty@2% of value of specified domestic transaction would be attracted under section

271G for failure to furnish the prescribed information or document as required under section
92D(3) within the period of 10 days from the date of receipt of notice or the extended period
not exceeding another 30 days, as the case may be.
(vii) Market value to be the arm’s length price of goods or services in a specified domestic
transaction [Section 80A & 80-IA(8)]: As per the provisions of section 80A(6), in a case
where the goods or services held for the purpose of the undertaking or unit or enterprise or
eligible business are transferred to any other business carried on by the assessee or where
any goods or services held for the purposes of any other business carried on by the
assessee are transferred to the undertaking or unit or enterprise or eligible business and
the consideration for transfer as recorded in the accounts does not correspond to the
market value of such goods or services as on the date of transfer, then, for the purpose of
any deduction under Chapter VI-A, profits and gains of such undertaking or unit or
enterprise or eligible business shall be determined at the market value of such goods or
services as on the date of transfer.
Clause (iii) of Explanation to section 80A(6) clarifies that “market value” in relation to any
goods or services sold, supplied or acquired, means the arm’s length price as defined under
section 92F of such goods or services, if it is a specified domestic transaction referred to in

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section 92BA i.e., the aggregate value of all such transaction specified in section 92BA
exceeds ` 20 crore.

Therefore, in case the transfer of goods and services between undertaking or unit or
enterprise or eligible business and any other business of the assessee takes place at the
arm’s length price, such arm’s length price shall be the market value for the purpose of
section 80A(6), and no further adjustment would be required in respect of the same, if the
transaction is a specified domestic transaction.

(viii) Similarly, for the purpose of section 80-IA(8), the market value, in relation to any goods or
services transferred between the eligible business and any other business carried on by the
assessee, shall mean -

(1) the price that such goods or services would ordinarily fetch in the open market; or

(2) the arm’s length price as defined under section 92F, where the transfer of such
goods or services is a specified domestic transaction referred to in section 92BA.

(ix) Profit from transactions between an assessee carrying on “eligible business” and
other assessees to be determined as per arm’s length price [Section 80-IA(10)]:
Under section 80-IA(10), the Assessing Officer is empowered to make an adjustment while
computing the profit and gains of the eligible business on the basis of the reasonable profit
that can be derived from the transaction, in case the transaction between the assessee
carrying on the eligible business under section 80-IA and any other person is so arranged
that the transaction produces excessive profits to the eligible business.

It has been provided that if the aforesaid arrangement between the assessee carrying on
the eligible business and any other person is a specified domestic transaction referred to in
section 92BA, then, the amount of profit of such transaction shall be determined having
regard to arm’s length price as defined under section 92F and not as per the reasonable
profit from such transaction.

(x) Transfer Pricing Rules made applicable to Specified Domestic Transactions

The transfer pricing provisions have been extended to Specified Domestic Transactions.
Accordingly, the transfer pricing rules prescribed for international transactions have been
suitably amended to make the same applicable for specified domestic transactions, as well.

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Rule Particulars Amendment

No.
10A Meaning of Definition of “associated enterprise” and
expressions used in “enterprise” included
computation of
“Associated Enterprise” shall -
Arm’s length price
(i) have the same meaning as assigned to it in
section 92A; and
(ii) in relation to a specified domestic transaction
entered into by an assessee, include -
(A) other units or undertakings or businesses of
such assessee in respect of a transaction
referred to in section 80A or section 80-
IA(8);
(B) any other person referred to in section
80-IA(10) in respect of a transaction referred
to therein;
(C) other units, undertakings, enterprises or
business of such assessee, or other person
referred to in section 80-IA(10) or in respect
of a transaction referred to in section 10AA
or the transactions referred to in Chapter VI-
A to which the provisions of section 80-IA(8)
or section 80-IA(10) are applicable;
“Enterprise” shall have the same meaning as
assigned to it in clause (iii) of section 92F and shall, for
the purposes of a specified domestic transaction,
include a unit, or an enterprise, or an undertaking or a
business of a person who undertakes such transaction.
10AB Other methods of This Rule provides that for the purpose of section
determination of 92C(1)(f), the other method for determination of the
ALP arm’s length price in relation to an international
transaction shall be any method which takes into
account the price which has been charged or paid or
would have been charged or paid, for the same or
similar uncontrolled transaction, with or between non-
associated enterprises, under similar circumstances,
considering all the relevant facts.
This Rule has been made applicable to specified
domestic transactions as well.

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10B Determination of The methods for determination of arm’s length price

ALP under section specified in this Rule for the purpose of section 92C(2)
92C in relation to an international transaction shall also be
made applicable in respect of specified domestic
transactions.
10C Most appropriate Sub-rule (1) provides that, for the purposes of section
method 92C(1), the most appropriate method shall be the
method which is best suited to the facts and
circumstances of each particular international
transaction, and which provides the most reliable
measure of an arm’s length price in relation to an
international transaction.
Sub-rule (2) specifies the factors to be taken into
account in selecting the most appropriate method. This
Rule is made applicable in respect of a specified
domestic transaction as well.
10D Information and Sub-rule (1) requires every person who has entered
documents to be into an international transaction or specified domestic
kept and maintained transaction to maintain the requisite information and
under section 92D documents as detailed thereunder. As per sub-rule (2),
maintenance of information and documents shall not
apply where the aggregate value of international
transactions does not exceed ` 1 crore. However, sub-
rule (1) shall be applicable for every specified domestic
transaction irrespective of its value.
10E Report from an This rule provides for submission of audit report from a
accountant to be chartered accountant by every person who has entered
furnished under into an international transaction. This provision would
section 92E also apply to a person entered into a specified
domestic transaction as well.

(xi) Safe Harbour Rules notified for Specified Domestic Transactions [Rule 10TH to Rule
10THD]
Section 92CB provides that determination of
- income referred to in section 9(1)(i); or

- arm’s length price under section 92C or Section 92CA

shall be subject to Safe Harbour rules. Section 92CB(2) empowers the CBDT to prescribe
safe harbour rules.

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Safe Harbour means circumstances in which the income-tax authorities shall accept the
transfer price or income, deemed to accrue or arise under section 9(1)(i), as the case may
be, declared by the assessee.
Accordingly, the CBDT has, in exercise of the powers conferred by section 92CB and 92D,
read with section 295, inserted Rules 10TH, 10THA, 10THB, 10THC & 10THD providing the
safe harbour rules for specified domestic transactions.
Rule Rule heading Particulars
10TH Definitions:
Appropriate Meaning assigned to it in section 2(4) of the
Commission Electricity Act, 2003.
Appropriate Commission means the Central Regulatory
Commission referred to in sub-section (1) of section 76
or the State Regulatory Commission referred to in
section 82 or the Joint Commission referred to in
section 83, as the case may be, of the Electricity Act,
2003.
Government Meaning assigned to it in section 2(45) of the
Company Companies Act, 2013.
Government company means any company in which
not less than 51% of the paid-up share capital is held
by the Central Government, or by any State
Government or Governments, or partly by the Central
Government and partly by one or more State
Governments, and includes a company which is a
subsidiary company of such a Government company.
"Paid-up share capital" shall be construed as "total
voting power", where shares with differential voting
rights have been issued.
10THA Eligible assessee • A person who has exercised a valid option for
application of safe harbour Rules in accordance
with the provisions of Rule 10THC, AND
• is a Government company engaged in the
business of generation, supply, transmission or
distribution of electricity; or
• is a co-operative society engaged in the business
of procuring and marketing milk and milk products.

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10THB Eligible Specified A specified domestic transaction undertaken by an

Domestic eligible assessee and which comprises of:
Transaction
(i) supply of electricity; or
(ii) transmission of electricity; or
(iii) wheeling of electricity; or
(iv) purchase of milk or milk products by a co-
operative society from its members.
10THC Safe harbour (1) Where an eligible assessee has entered into an
eligible specified domestic transaction in any
previous year relevant to an assessment year and
the option exercised by the said assessee is treated
to be validly exercised under Rule 10THD, the
transfer price declared by the assessee in respect of
such transaction for that assessment year shall be
accepted by the income-tax authorities, if it is in
accordance with the circumstances specified in Rule
10THC(2).
(2) The following are the circumstances in respect
of the eligible specified domestic transaction.
S. Eligible Circumstances
specified
No.
domestic
Transaction
1 Supply of The tariff in respect
electricity, of supply of
transmission of electricity,
electricity, transmission of
wheeling of electricity, wheeling
electricity of electricity, as the
case may be, is
determined or the
methodology for
determination of the
tariff is approved by
the Appropriate
Commission in
accordance with the
provisions of the
Electricity Act, 2003.

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2 Purchase of milk The price of milk or

or milk products milk products is
by a co- determined at a
operative rate which is fixed
society from its on the basis of the
members quality of milk,
namely, fat content
and Solid Not Fat
(SNF) content of
milk; and –
(a) the said rate
is irrespective of,-
(i) the quantity
of milk
procured;
(ii) the
percentage
of shares
held by the
members in
the co-
operative
society;
(iii) the voting
power held
by the
members in
the society;
and
(b) such prices
are routinely
declared by the co-
operative society in
a transparent
manner and are
available in public
domain.
(3) No comparability adjustment and allowance
under the second proviso to section 92C(2) shall
be made to the transfer price declared by the
eligible assessee and accepted by the income-
tax authority.

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(4) The provisions of sections 92D relating to

maintenance and keeping of information and
document and section 92E for submission of
report from an accountant in respect of a
specified domestic transaction shall apply
irrespective of the fact that the assessee
exercises his option for safe harbour in respect
of such transaction.
10THD Procedure Furnishing of Form 3CEFB
The assessee has to furnish Form 3CEFB, complete in
all respects, to the Assessing Officer on or before the
due date for furnishing the return of income for the
relevant assessment year specified in Explanation 2 to
section 139(1), for exercising the option of safe harbour.
The return of income should be furnished on or before
the date of submitting the Form 3CEFB.
Verification by the Assessing Officer
Before treating the option for safe harbor by the
assessee as validly exercised, the Assessing Officer
has to verify whether the assessee exercising the
option is an eligible assessee and the transaction in
respect of which the option is exercised is an eligible
specified domestic transaction.
Furnishing of documents or information required
by the Assessing Officer
Assessing Officer may issue a notice to the assessee
to furnish such information or documents or other
evidence as he may consider necessary. The
assessee has to furnish the same within the specified
time in such notice.
Circumstances when option exercised can be
declared Invalid
The Assessing Officer has to, by order in writing,
declare the option exercised by the assessee as
invalid and cause a copy of the order to be served on
the assessee if –
(i) the assessee does not furnish the information or
documents or other evidence required by the
Assessing Officer

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(ii) the Assessing Officer finds that the assessee is

not an eligible assessee
(iii) the Assessing Officer finds that the specified
domestic transaction in respect of which option
has been exercised is not an eligible specified
domestic transaction
(iv) the tariff is not in accordance with the
circumstances specified in Rule 10THC.
Order by Assessing Officer
The Assessing Officer has to pass the order declaring
the option exercised by the assessee as invalid within
a period of 3 months from the end of the month in
which Form 3CEFB is received by him.
No order can be passed declaring the option
exercised by the assessee invalid unless an
opportunity of being heard is given to him.
Filling of objections against the order of
Assessing Officer by the assessee
If the assessee objects to the order of the Assessing
Officer declaring the option to be invalid, he may file
his objections with the Principal Commissioner or the
Commissioner or the Principal Director or the
Director, as the case may be, to whom the Assessing
Officer is subordinate, within 15 days of receipt of
the order of the Assessing Officer.
On receipt of objection, the Principal Commissioner or
Commissioner or Principal Director or Director, as the
case may be, shall, after providing an opportunity of
being heard to the assessee, pass appropriate order,
within a period of 2 months from the end of the
month in which the objection filed by the assessee is
received by him, in respect of the validity or otherwise
of the option exercised by the assessee. A copy of
the said order has to be served on the assessee and
the Assessing Officer.
If the Assessing Officer or the Principal Commissioner
or the Commissioner or the Principal Director or the
Director, as the case may be, does not pass an order
within the specified time, then the option for safe
harbour exercised by the assessee shall be treated
as valid.

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(xii) Information and documents to be kept and maintained under section 92D in case of
an eligible assessee referred to in Rule 10THA in respect of eligible specified
domestic transaction [Rule 10D(2A)]:
Section 92D(1)(i) provides that every person who has entered into an international
transaction or specified domestic transaction shall keep and maintain prescribed
information and document.
Rule 10D(1) provides for information and documents to be maintained under section 92D.
Sub-rule (2A) in Rule 10D provides that nothing contained in Rule 10D(1) in so far as it
relates to specified domestic transaction referred to in Rule 10THB, shall apply in the case
of an eligible assessee referred to in Rule 10THA.
The information and documents to be maintained by an eligible assessee referred to in Rule
10THA relating to an eligible specified domestic transaction referred to in Rule 10THB are
given in Rule 10D(2A) as follows:
Rule Eligible Information and documents to be kept and
Assessee maintained
10THA(i) A government (i) a description of the ownership structure of the
company assessee enterprise with details of shares or other
engaged in the ownership interest held therein by other enterprises;
business of (ii) a broad description of the business of the assessee
generation, and the industry in which the assessee operates, and
supply, of the business of the associated enterprises with
transmission whom the assessee has transacted;
or distribution
of electricity (iii) the nature and terms (including prices) of specified
domestic transactions entered into with each
associated enterprise and the quantum and value of
each such transaction or class of such transaction;
(iv) a record of proceedings, if any, before the
regulatory commission and orders of such
commission relating to the specified domestic
transaction;
(v) a record of the actual working carried out for
determining the transfer price of the specified
domestic transaction;
(vi) the assumptions, policies and price negotiations, if
any, which have critically affected the determination
of the transfer price; and

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(vii) any other information, data or document, including

information or data relating to the associated
enterprise, which may be relevant for determination
of the transfer price.
10THA(ii) A co-operative (i) a description of the ownership structure of the
society assessee co-operative society with details of shares or
engaged in the other ownership interest held therein by the members;
business of (ii) description of members including their addresses
procuring and and period of membership;
marketing milk
and milk (iii) the nature and terms (including prices) of specified
products domestic transactions entered into with each member
and the quantum and value of each such transaction
or class of such transaction;
(iv) a record of the actual working carried out for
determining the transfer price of the specified
domestic transaction;
(v) the assumptions, policies and price negotiations, if
any, which have critically affected the determination
of the transfer price;
(vi) the documentation regarding price being routinely
declared in transparent manner and being available
in public domain; and
(vii) any other information, data or document which may
be relevant for determination of the transfer price.
The above information should be supported by authentic documents. Both the
information and documents must be contemporaneous and should exist latest by the
specified date [i.e., the date one month prior to the due date of filing return under section
139(1)] i.e., 31st October of the assessment year. Such information and documents have
to be kept and maintained for a period of eight years from the end of the relevant
assessment year.

24.6 TRANSFER OF INCOME TO NON RESIDENTS

[SECTION 93]
A resident and ordinarily resident is subject to tax in India in respect of his global income whereas
in case of a non-resident, income accruing or arising outside India would not be taxable in his
hands in India if it is not deemed to accrue or arise in India and is not received in India. Thus, in
order to reduce his tax liability, a resident Indian may transfer the ownership in his foreign asset to
a non-resident, while continuing to enjoy the benefits of income derived therefrom. Section 93 hits

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at such transactions which are effected with a view to avoiding income-tax liability. For the purpose
of this section, the word “non-resident” also includes a person who is not-ordinarily resident.

In order to attract the provisions of this section, the following conditions must be satisfied:
(a) There should be a transfer of assets.
(b) The said transfer may be made either alone or in conjunction with associated operations.

(c) The transfer of assets is effected in such a manner that the income from transferred assets
becomes payable to a non-resident.
(d) As a consequence of the transfer, the transferor, either alone or in conjunction with
associated operations, has acquired any right, by virtue of which he gets the power to enjoy
the income from transferred assets, whether immediately or in future.
(e) Such income of the non-resident transferee would have been chargeable to tax in India, had
it been the income of the resident transferor.
(f) The Assessing Officer is satisfied that avoidance of liability to tax in India is the purpose of
the transfer.

In such a case, the income from transferred asset would be deemed to be the income of the
resident transferor and would, accordingly, be taxable in his hands. Therefore, where assets are
transferred to a body corporate outside India, in consideration of shares allotted by it to the
transferor, he (the transferor), will become assessable under this section in respect of the income
of the company derived by it from those assets. This section will not, however, apply to cases
where it is shown to the satisfaction of the Assessing Officer that (i) neither the transfer nor any
associated operation had for its purpose or for one of its purposes the avoidance of liability to
taxation or (ii) it is provided to the satisfaction of the Assessing Officer that the transfer was
effected for bona fide commercial purpose and with no intent to avoid tax.
Terms Meaning
(i) Associated The expression ‘associated operation,” in relation to a transfer, means an
operation operation of any kind effected by any person in relation to:
(i) any of the assets transferred;
(ii) any assets representing, whether directly or indirectly, any of the
assets transferred;
(iii) any income arising from such assets;
(iv) any assets representing, whether directly or indirectly, the
accumulation of income arising from such assets.

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(ii) Assets It includes property or rights of any kind.

(iii) Transfer In relation to rights, includes creation of those rights
(iv) Benefit It includes a payment of any kind.

For purposes of this section, a person is deemed to have the power to enjoy the income of a non-
resident if:
(i) the income, in fact, so dealt with by any person as to be calculated at some point of time to
enure for the benefit of the transferor, whether in the form of the income or otherwise;
(ii) the receipt or accrual of the income operates to increase value of any assets held by the
transferor or for his direct or indirect benefit;
(iii) the transferor receives or is entitled to receive at any time any benefit out of the income or
out of any money available for the purpose by reason of the effect or successive effects of
the associated operations on that income and the assets which represent that income;
(iv) the transferor is in a position to obtain for himself the beneficial enjoyment of the income by
exercising any power of appointment or power of revocation or otherwise, whether with or
without the consent of any other person, or
(v) the transferor is able to control, directly or indirectly, the application of the income in any
manner whatsoever.
However, in determining whether a person has the power to enjoy the income, due regard shall be
had to the substantial result and effect of the transfer and any associated operations; all benefits
which may at any time accrue to such person as a result of the transfer and any associated
operations must be taken into consideration irrespective of the nature or form of the benefits.
It may be noted that where an assessee has been charged to tax in respect of a sum deemed to
be his income under this section, the subsequent receipt of that sum by the assessee, whether as
income or in any other form, shall not be liable to tax in his hands at the time of receipt.

24.7 INTRODUCTION OF SPECIFIC ANTI AVOIDANCE

MEASURES IN RESPECT OF TRANSACTIONS WITH
PERSONS LOCATED IN NOTIFIED JURISDICTIONAL
AREA [SECTION 94A]
The objective of anti-avoidance measures is to discourage assessees from entering into
transactions with persons located in countries or territories which do not have effective information
exchange mechanism with India. The following are the anti-avoidance measures introduced -

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(i) The Central Government is empowered to notify any country or territory outside India as a
NJA (Notified Jurisdictional Area), having regard to the lack of effective exchange of
information with such country or territory.

Clarification on removal of Cyprus from the list of notified jurisdictional area under
section 94A of the Income-tax Act, 1961 – [Circular No. 15/2017, dated 21-04-2017]
Cyprus was specified as a "notified jurisdictional area" (NJA) under section 94A of the
Income-tax Act, 1961 vide Notification No. 86/2013 dated 01.11.2013. The said Notification
No. 86/2013 was subsequently rescinded vide Notification No. 114 dated 14.12.2016 and
Notification No. 119 dated 16.12.2016 with effect from the date of issue of the notification.

The CBDT has, vide this Circular, clarified that Notification No. 86/2013 has been rescinded
with effect from the date of issue of the said notification, thereby, removing Cyprus as a
notified jurisdictional area with retrospective effect from 01.11.2013.

(ii) A transaction where one of the parties thereto is a person located in a NJA would be
deemed to be an international transaction then all parties to the transaction to be deemed
as associated enterprises, and accordingly, all the provisions of transfer pricing to be
attracted in case of such a transaction. However, the benefit of permissible variation
between the ALP and the transfer price based on the rate notified by the Central
Government would not be available in respect of such transaction.
(iii) Such transaction may be in the nature of –
(1) purchase, sale or lease of tangible or intangible property or
(2) provision of service or
(3) lending or borrowing money or
(4) any other transaction having a bearing on the profits, income, losses or assets of the
assessee. It may include a mutual agreement or arrangement for allocation or
apportionment of, or contribution to, any cost or expense incurred or to be incurred in
connection with a benefit, service or facility provided or to be provided by or to the
assessee.
(iv) Person located in a NJA shall include a person who is a resident of the NJA and a person,
not being an individual, which is established in the NJA. It would also include a permanent
establishment of any other person in the NJA.
(v) Payments made to any financial institution located in a NJA would not be allowed as
deduction unless the assessee authorizes the CBDT or any other income-tax authority

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acting on its behalf to seek relevant information from the financial institution on behalf of the
assessee.
(vi) No deduction in respect of any other expenditure or allowance, including depreciation,
arising from the transaction with a person located in a NJA would be allowed unless the
assessee maintains the relevant documents and furnishes the prescribed information.
(vii) Any sum credited or received from a person located in a NJA to be deemed to be the
income of the recipient-assessee if he does not explain satisfactorily the source of such
money in the hands of such person or in the hands of the beneficial owner, if such person is
not the beneficial owner.
(viii) The rate of TDS in respect of any payment made to a person located in the NJA, on which
tax is deductible at source, will be the higher of the following rates –
(1) rates specified in the relevant provision of the Income-tax Act, 1961; or
(2) rate or rates in force; or
(3) 30%.
ILLUSTRATION 7
A Ltd., an Indian company, provides technical services to a company, XYZ Inc., located in a NJA for
a consideration of ` 40 lakhs in October, 2025. It charges ` 42 lakhs for similar services rendered to
PQR Inc., which is not located in a NJA. PQR Inc. is not an associated enterprise of A Ltd.
Discuss the tax implications under section 94A read with section 92C in respect of the above
transaction of provision of technical services by A Ltd. to XYZ Inc.
SOLUTION
Since XYZ Inc. is located in a NJA, the transaction of provision of technical services by the Indian
company, A Ltd., would be deemed to be an international transaction and XYZ Inc. and A Ltd.
would be deemed to be associated enterprises. Therefore, the provisions of transfer pricing would
be attracted in this case.
The price of ` 42 lakhs charged for similar services from PQR Inc, being an independent entity
located in a non-NJA country, can be taken into consideration for determining the arm’s length
price (ALP) under Comparable Uncontrolled Price (CUP) Method.
Since the ALP is more than the transfer price, the ALP of ` 42 lakhs would be considered as the
income arising from the international transaction between A Ltd. and XYZ Inc.
It may be noted that the benefit of permissible variation between the ALP and transfer price is not
available in respect of a transaction entered into with an entity in NJA.

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ILLUSTRATION 8
Mr. X, a non-resident individual, is due to receive interest of ` 5 lakhs during March 2026 from a
notified infrastructure debt fund eligible for exemption under section 10(47). He incurred
expenditure amounting to ` 10,000 for earning such income. Assuming that Mr. X is a resident of a
NJA, discuss the tax implications under section 94A, read with sections 115A and 194LB.
SOLUTION
The interest income received by Mr. X, a non-resident, from a notified infrastructure debt fund
would be subject to a concessional tax rate of 5% under section 115A on the gross amount of such
interest income. Therefore, the tax liability of Mr. X in respect of such income would be ` 26,000
(being 5% of ` 5 lakhs plus health and education cess@4%).
Under section 194LB, tax is deductible @5% (plus health and education cess@4%) on interest
paid by such fund to a non-resident. However, since X is a resident of a NJA, tax would be
deductible@30% (plus health and education cess@4%) as per section 94A, and not @5%
specified under section 194LB. This is on account of the provisions of section 94A(5), which
provides that “Notwithstanding anything contained in any other provision of this Act, where
a person located in a NJA is entitled to receive any sum or income or amount on which tax is
deductible under Chapter XVII-B, the tax shall be deducted at the highest of the following
rates, namely–
(a) at the rate or rates in force;
(b) at the rate specified in the relevant provision of the Act;
(c) at the rate of thirty per cent.”
Mr. X can, however, claim refund of excess tax deducted along with interest.

24.8 LIMITATION OF INTEREST DEDUCTION IN CERTAIN

CASES [SECTION 94B]
(1) Preference of debt over equity as a measure to finance businesses: Debt and equity
are the instruments through which a company is generally financed or capitalized. The
manner in which a company is capitalized has a major impact on the amount of taxable
profit as the tax laws of countries generally provide for a deduction in respect of interest
paid or payable while arriving at the taxable profit. However, the dividend paid on equity
contribution is not deductible. Therefore, the higher the level of debt in a company, and
thus, the amount of interest it pays, the lower will be its taxable income. Due to this reason,
debt is considered a more tax efficient method of finance than equity. Multinational groups

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are often able to structure their financing arrangements to maximize tax benefits through
intra-group financing. In this manner, the MNEs are able to claim the excessive deduction of
interest in the high tax jurisdiction and shift the profits to the low tax jurisdiction resulting in
base erosion and profit shifting.
(2) Tax Rules to prevent shifting of profits through excessive interest payments: In order
to address this issue, tax rules are in place in many countries to fix a ceiling limit on the
amount of interest deductible in computing a company's profit for tax purposes. Such rules
are designed to counter cross-border shifting of profit through excessive interest payments,
with the objective of protecting a country's tax base.
(3) Relevant Action Plan of BEPS: Under the initiative of the G-20 countries, the Organization
for Economic Co-operation and Development (OECD) in its Base Erosion and Profit Shifting
(BEPS) project had taken up the issue of base erosion and profit shifting by way of excess
interest deductions by the MNEs in Action Plan 4 and recommended certain measures in its
final report.
(4) Insertion of provision in the Income-tax Act, 1961 in line with BEPS Action Plan 4:
Section 94B has, accordingly, been inserted in the Income-tax Act, 1961, in line with the
recommendations of OECD BEPS Action Plan 4, to provide that interest expenses claimed
by an entity on loan borrowed from its associated enterprises shall not be deductible in
computation of income under the “Profits and gains of business or profession” to the extent
that it arises from excess interest.

Excess interest shall mean an amount of

- total interest paid or payable* in excess of 30% of its earnings before interest, taxes,
depreciation and amortization (EBITDA) of the borrower in the previous year or
- interest paid or payable to associated enterprise for that previous year
whichever is less.

*”Total interest paid or payable” to be interpreted as interest paid or payable to non-resident

associated enterprise as per the intent expressed in section 94B(1) and also the
Explanatory Memorandum to the Finance Bill, 2017.
(5) Applicability: The provision shall be applicable to an Indian company, or a permanent
establishment of a foreign company in India, being the borrower who incurs expenditure by
way of interest or similar nature in respect of any form of debt issued by a non-resident who
is an 'associated enterprise' of the borrower.

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However, the provision of this section would be applicable only where the expenditure by
way of interest or of similar nature exceeds ` 1 crore, in respect of any form of debt issued
by a non-resident, being an 'associated enterprise' of such borrower.
(6) Meaning of debt: Any loan, financial instrument, finance lease, financial derivative, or any
arrangement that gives rise to interest, discounts or other finance charges that are
deductible in the computation of income chargeable under the head “Profits and gains of
business or profession”.
(7) Provision of guarantee and deposit of matching amount deemed to be debt issued: Where
the debt is issued by a lender which is not associated but an associated enterprise either
- provides an implicit or explicit guarantee to such lender or
- deposits a corresponding and matching amount of funds with the lender,
such debt shall be deemed to have been issued by an associated enterprise.
(8) Carry forward of excess interest: The disallowed interest expense can be carried forward
upto eight assessment years immediately succeeding the assessment year for which the
disallowance was first made and claimed as deduction against the income computed under
the head "Profits and gains of business or profession” to the extent of maximum allowable
interest expenditure.
(9) Businesses excluded from applicability of the provisions of section 94B: The following
has been excluded from the applicability of the provisions of this section -
- an Indian company or permanent establishment of a foreign company which is
engaged in the business of banking and insurance or
- a Finance Company located in any IFSC
- such class of non-banking financial companies as may be notified by the Central
Government or
- interest paid in respect of a debt issued by a lender which is a permanent
establishment in India of a non-resident, being a person engaged in the business of
banking.
(10) Meaning of Finance Company: “Finance Company” as per Regulation 2(1)(e) of the IFSC
Authority (Finance Company) Regulations, 2021 means a financial institution separately
incorporated to deal in one or more of the permissible activities, provided
(i) It does not accept public deposit from resident and non-resident, as defined in these
regulations; and

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(ii) It is not registered with the Authority as a Banking Unit;

Accordingly, the CBDT vide notification no. 10/2025, dated 27.01.2025, inserted Rule
21ACA to provide that the Finance Company located in any IFSC shall only carry out one or
more of the following activities –
(i) lending in the form of loans, commitments and guarantees, credit enhancement,
securitisation, financial lease;
(ii) factoring and forfaiting of receivables; or
(iii) functions of Global or Regional Corporate Treasury Centre such as borrowings,
lending, hedging of currency or commodity risk or investments, cash management,
structured credit, intra group financing, financial budgeting and similar other such
treasury services and activities.

The interest being paid by such Finance Company, being the borrower, in respect of any
debt issued by a non-resident, shall be in foreign currency
(11) Meaning of non-banking financial company: A non-banking financial company” means -
(i) a financial institution which is a company;
(ii) a non-banking institution which is a company and which has as its principal business
the receiving of deposits, under any scheme or arrangement or in any other manner,
or lending in any manner;
(iii) such other non-banking institution or class of such institutions, as may be notified by
the Bank with the previous approval of the Central Government.

Johnson Matthey Public Limited Company vs. CIT (International Taxation) (2024) 465 ITR
649 (Delhi)

Issue: Whether the amount received as “Guarantee Fees” by a foreign company from its Indian
subsidiaries fall within the definition of “interest”?

Facts of the Case: The assessee was a tax resident of the United Kingdom and engaged in
manufacturing specialty chemicals. It entered into global corporate guarantee for the purpose of
securing loans taken by its Indian subsidiaries from foreign banks. It received guarantee charges
for extending such guarantee.

Relevant Provision: As per section 2(28A), "interest" means interest payable in any manner in
respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right

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or obligation) and includes any service fee or other charge in respect of the moneys borrowed or
debt incurred or in respect of any credit facility which has not been utilized. Article 12(5) of India-
UK DTAA defines “interest” to mean income from debt-claims of every kind, whether or not
secured by mortgage and whether or not carrying a right to participate in the debtor's profits, and
in particular, income from Government securities and income from bonds or debentures, including
premiums and prizes attaching to such securities, bonds or debentures but, subject to the
provisions of paragraph 9 of this Article, shall not include any item which is treated as a distribution
under the provisions of Article 11(Dividends) of this Convention.

Analysis and Decision: The High Court concur with the views of the Tribunal that the word
"interest" as defined in Article 12(5) of the Treaty and section 2(28A) of the Act, shall be
understood contextually. Article 12(5) of the DTAA and section 2(28A) of the Act extend the scope
of such payments. However, payment or re-payment pursuant to any loan to be qualified as
"interest", necessarily have to be within the context of loan and shall relate to the parties to the
privity of contract. In this context only, the expressions "claims of any kind", "service fee or other
charge" have to be understood. The word “interest” does not take into its fold any payments made
to stranger to the privity of loan transactions, though such payments have to be made incidentally
in relation to such loan.

Undoubtedly, assessee is a stranger to the privity of loan transactions in as much as the contract
of loan is a different from the contract of guarantee, as such in our considered opinion, the
expression of "debt claims of any kind" or "the service fee or other charge in respect of moneys
borrowed or debt incurred" does not stand extended to the payment of guarantee commission
received by the assessee in India.

The expression “interest” is defined to mean amounts payable in respect of any monies borrowed
or debts incurred. Undisputedly the appellant had not borrowed any monies. The debt, if any,
which could be said to have been incurred was clearly not one owed to the Indian subsidiaries.
The income that it received from its Indian subsidiaries was solely in consideration of any liability
that could possibly befall in case its Indian subsidiaries were to default in their repayment
obligations.

Accordingly, the High Court held that the guarantee fee would neither fall within the ambit of Article
12 of India-UK DTAA nor section 2(28A) of the Act.

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Limitation of interest deduction (Section 94B): A Summary

Is the borrower an Indian company or a PE of a Foreign company?

Yes No

Is the borrower a bank or Insurance company Yes Section 94B would not apply
or a Finance Company located in IFSC or
notified NBFC?
No
Is the lender a PE in India of a non-resident Yes
engaged in the business of banking?
No
Does the interest paid to NR AE exceed No
Rs` 1 crore?
Yes Meaning of Excess interest
Excess Interest not allowable as
deduction
Interest paid or payable to non-
resident associated enterprise* in
Disallowed interest can be carried forward excess of 30% of EBITDA or
for 8 AYs for deduction against PGBP Interest paid or payable to AE for
income to the extent of maximum that previous year, whichever is
allowable interest expenses lower
*“Total interest paid or payable” may be interpreted as interest paid or payable to non-resident
associated enterprise as per the intent expressed in section 94B(1) and also the Explanatory
Memorandum to the Finance Bill, 2017.

ILLUSTRATION 9

ND Ltd., an Indian Company, has borrowed ` 90 crores on 01-04-2025 from M/s. TM Inc, a
company incorporated in London, at an interest rate of 10% p.a. The said loan is repayable over a
period of 5 years. Further, this loan is guaranteed by M/s TY Inc. incorporated in UK. M/s. TD Inc,
a non-resident, holds shares carrying 40% of voting power both in M/s ND Ltd. and M/s TY Inc.
Net profit of M/s. ND Ltd. for P.Y. 2025-26 was ` 11 crores after debiting the above interest,
depreciation of ` 5 crores and income-tax of ` 4 crores.
Calculate the amount of interest to be allowed to be claimed under the head "Profits and gains of
business or profession" in the computation of M/s ND Ltd. giving appropriate reasons. Also explain
allowability of such disallowed interest, if any.

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SOLUTION

If an Indian company, being the borrower, incurs any expenditure by way of interest in respect of
any debt issued by its non-resident associated enterprise (AE) and such interest exceeds ` 1
crore, then, the interest paid or payable by such Indian company in excess of 30% of its earnings
before interest, taxes, depreciation and amortization (EBITDA) or interest paid or payable to
associated enterprise, whichever is lower, shall not be allowed as deduction as per section 94B.
Further, where the debt is issued by a lender which is not associated but an associated enterprise
either provides an implicit or explicit guarantee to such lender or deposits a corresponding and
matching amount of funds with the lender, such debt shall be deemed to have been issued by an
associated enterprise and limitation of interest deduction would be applicable.
In the present case, since M/s TD Inc holds 40% of voting power i.e., more than 26% of voting power in
both ND Ltd and M/s TY Inc, ND Ltd. and M/s TY Inc are deemed to be associated enterprises.
Since loan of ` 90 crores taken by ND Ltd., an Indian company from M/s TM Inc, is guaranteed by
M/s TY Inc, an associated enterprise of ND Ltd., such debt shall be deemed to have been issued
by an associated enterprise and interest payable to M/s TM Inc shall be considered for the
purpose of limitation of interest deduction u/s 94B.
Computation of interest to be allowed as per section 94B in the computation of income
under the head profits and gains of business or profession of ND Ltd.
Particulars ` (in crores)
Net profit 11.00
Add: Interest already debited (` 90 crores x 10%) 9.00
Depreciation 5.00
Income-tax 4.00
EBITDA 29.00
Interest paid or payable by ND Ltd. 9.00
Lower of the following would be disallowed
- Total interest paid or payable in excess of 30% of EBITDA 0.30
(` 9,00,00,000 – ` 8,70,00,000) = ` 30 lakhs
- Interest paid or payable to non-resident AE 9.00
Interest to be disallowed as deduction 0.30
Interest allowable as deduction under the head “Profits and gains from 8.70
business or profession (` 9,00,00,000 – ` 30,00,000)
Disallowed interest of ` 30 lakhs can be carried forward to the subsequent assessment year and it
would be allowed as deduction against profits and gains, to the extent of allowable interest
expenditure u/s 94B.

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TEST YOUR KNOWLEDGE

Questions
1. Examine the consequences that would follow if the Assessing Officer makes adjustment to
arm’s length price in international transactions of the assessee resulting in increase in
taxable income. What are the remedies available to the assessee to dispute such
adjustment?
2. Mr. Hari holds 30% of voting power in ABC Inc, a company incorporated under the laws of
Country A. For the purpose of expansion of business, the said company enters into an
agreement with XYZ Ltd., a company incorporated under the Indian laws. As per one of the
clauses of the agreement, ABC Inc has the power to appoint 6 directors of XYZ Ltd., which
has 12 directors on the board. Further, total purchases by XYZ Ltd. for the F.Y. 2025-26 is
estimated to be ` 500 crores, out of which, purchases of ` 48 crores has been sourced
locally and the balance shall be supplied by ABC Inc. The price for entire purchase has
been fixed in the agreement and the conditions for supply are determined by ABC Inc.
Advise Mr. Hari as to whether ABC Inc and XYZ Ltd are Associated Enterprises, on the
basis of the provisions of the Income-tax Act, 1961.
3. I. Limited, an Indian Company supplied billets to its holding company, U. Limited, UK during
the previous year 2025-26. I. Limited also supplied the same product to another UK based
company, V. Limited, an unrelated entity. The transactions with U. Limited are priced at
Euro 500 per MT (FOB), whereas the transactions with V. Limited are priced at Euro 700
per MT (CIF). Insurance and Freight amounts to Euro 200 per MT. Compute the arm's
length price for the transaction with U. Limited.
4. X Ltd., operating in India, is the dealer for the goods manufactured by Yen Ltd. of Japan.
Yen Ltd. owns 55% shares of X Ltd. and out of 7 directors of the company, 4 were
appointed by them. The Assessing Officer, after verification of international transactions of
` 300 lakhs of X Ltd. for the relevant year and by noticing that the company had failed to
maintain the requisite records and had also not obtained the accountants report, adjusted
its income by making an addition of ` 30,00,000 to the declared income and also issued a
show cause notice to levy various penalties. X Ltd seeks your expert opinion.

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5. Anush Motors Ltd., an Indian company declared income of ` 300 crores computed in
accordance with Chapter IV-D but before making any adjustments in respect of the
following transactions for the year ended on 31.3.2026:
(i) 10,000 cars sold to Rida Ltd., US company, which holds 30% shares in Anush
Motors Ltd. at a price which is less by $ 200 for each car than the price charged from
Shingto Ltd.
(ii) Royalty of $ 1,20,00,000 was paid to Kyoto Ltd., a US company, for use of technical
know-how in the manufacturing of car. However, Kyoto Ltd. had provided the same
know-how to another Indian company for $ 90,00,000. Kyoto Ltd. is the sole owner of
technology used by Anush Motors Ltd. in its manufacturing process and the
manufacture of cars by Anush Motors Ltd is wholly dependent on the use of know-
how owned by Kyoto Ltd.
(iii) Loan of Euro 1000 crores carrying interest @10% p.a. advanced by Dorf Ltd., a
German company, was outstanding on 31.3.2026. The total book value of assets of
Anush Motors Ltd. on the date was ` 90,000 crores. The said German company had
also advanced a loan of similar amount to another Indian company @9% p.a. Total
interest paid for the year was EURO 100 crores.
Explain in brief the provisions of the Act affecting all these transactions and compute the
income of the company chargeable to tax for A.Y.2026-27 keeping in mind that the value of
1$ and of 1 EURO was ` 63 and ` 84, respectively, throughout the year.
6. What is the legislative objective of bringing into existence the provisions relating to transfer
pricing in relation to international transactions? Examine.
7. XE Ltd. is an Indian Company in which Zilla Inc., a US company, has 28% shareholding and
voting power. Following transactions were effected between these two companies during
the financial year 2025-26.
(i) XE Ltd. sold 1,00,000 pieces of T-shirts at $ 2 per T-Shirt to Zilla Inc. The identical
T-Shirts were sold to unrelated party namely Kennedy Inc., at $ 3 per T-Shirt.
(ii) XE Ltd. borrowed $ 2,00,000 from a foreign lender based on the guarantee of Zilla
Inc. For this, XE Ltd. paid $ 10,000 as guarantee fee to Zilla Inc. To an unrelated
party for the same amount of loan, Zilla Inc. collected $ 7000 as guarantee fee.

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(iii) XE Ltd. paid $15,000 to Zilla Inc. for getting various potential customers details to
improve its business. Zilla Inc. provided the same service to unrelated parties for
$ 10,000.
Assume the rate of exchange as 1 $ = ` 64
XE Ltd. is located in a Special Economic (SEZ) and its income before transfer pricing
adjustments for the year ended 31st March, 2026 was ` 1,200 lakhs.
Compute the adjustments to be made to the total income of XE Ltd. Assuming that such
adjustments are made by the Assessing Officer, state whether it can claim deduction under
section 10AA for the income enhanced by applying transfer pricing provisions.
8. Examine with reasons whether the two enterprises referred to in the independent situations
given below can be deemed to be associated enterprises under the Indian transfer pricing
regulations:
(i) PQR Inc, a US company having its place of effective management also in the USA,
has advanced a loan equivalent to ` 170 crores to Mahanadi Ltd., an Indian
company on 10-4-2025. The total book value of assets of Mahanadi Ltd. is ` 300
crores. The market value of the assets, however, is ` 320 crores. Mahanadi Ltd.
repaid ` 30 crores before 31-3-2026.
(ii) Queenland plc., a French company having its place of effective management also in
the France, has the power to appoint 3 of the directors of Godavari Ltd, an Indian
company, whose total number of directors in the Board is 8.
(iii) Total value of raw materials and consumables of Saraswati Ltd., an Indian company,
is ` 900 crores. Of this, supplies to the tune of ` 830 crores are by Zoel GmbH, a
German company having its place of effective management in Germany, at prices
and terms decided by the German company.
9. NP Ltd., an Indian Company, has borrowed ` 80 crores on 01-04-2025 from M/s. TL Inc, a
company incorporated in London, at an interest rate of 10% p.a. The said loan is repayable
over a period of 5 years. Further, loan is guaranteed by M/s ST Inc. incorporated in UK.
M/s. Tweed Inc, a non-resident, holds shares carrying 40% of voting power both in M/s NP
Ltd. and M/s ST Inc.
Net profit of M/s. NP Ltd. for P.Y. 2025-26 was ` 7 crores after debiting the above interest,
depreciation of ` 6 crores and income-tax of ` 4 crores. Calculate the amount of interest to

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be disallowed under the head “Profits and gains of business or profession” in the
computation of M/s NP Ltd., giving appropriate reasons.

10. MNO Ltd., having its registered office in Mumbai, is engaged in multiple businesses. It has
borrowed ` 200 crores from State Bank of India (SBI) for which 100% guarantee was given
by the parent company, ABC Inc. of Country A. The total borrowings of MNO Ltd. is ` 1,000
crores.
MNO Ltd. buys mobile phones from ABC Inc. The mobile phones are branded for which
royalty at ` 100 per mobile phone sold is paid to ABC Inc. Similar mobile phones are also
sold to other customers in India by ABC Inc. but no royalty is charged from them. The credit
period offered to MNO Ltd. is 2 months, whereas for other customers, the credit period is 1
month. During the year, 10 lakh mobile phones were bought for an aggregate sum of
` 2,600 crores from ABC Inc. The purchase could be assumed as uniform throughout the
financial year 2025-26. The cost of capital may be adopted as 10% per annum. ABC Inc.
would have billed ` 2,400 crores (excluding interest component for the delay beyond 1
month) for supply of identical quantity of similar mobile phones to other customers. It may
be assumed that the entire purchase has been sold out by 31st March, 2026.
Determine the arm’s length price (ALP) of the transaction of purchase of mobile phones by
MNO Ltd. from ABC Inc., Country A and its impact on the assessable income, if any, for the
assessment year 2026-27.
11. Beta Ltd., an Indian company, has two units in India, a manufacturing unit in Hyderabad
and a trading unit in Surat. Beta Ltd. has entered into various international transactions with
its associate enterprises from both the units. The assessment of Beta Ltd., an Indian
company, for A.Y.2026-27 is pending before the Assessing Officer who referred the matter
to Transfer Pricing Officer (TPO) for determination of arm’s length price (ALP) in respect of
its manufacturing unit at Hyderabad. The TPO, however, expanded the scope of his work by
calling for details in respect of the trading unit of Beta Ltd. located at Surat.

Examine the procedure to be followed by the Assessing Officer before making reference to
TPO. Can the TPO enlarge his scope of work by calling for details of trading activity at
Surat, when the Assessing Officer has made reference only in respect of the manufacturing
unit at Hyderabad? Examine.

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Answers
1. In case the Assessing Officer makes adjustment to arm’s length price in an international
transaction which results in increase in taxable income of the assessee, the following
consequences shall follow:-
(1) No deduction under section 10AA or Chapter VI-A shall be allowed from the income
so increased.
(2) No corresponding adjustment would be made to the total income of the other
associated enterprise (in respect of payment made by the assessee from which tax
has been deducted or is deductible at source) on account of increase in the total
income of the assessee on the basis of the arm’s length price so recomputed.
The remedies available to the assessee to dispute such an adjustment are:-
(1) In case the assessee is an eligible assessee under section 144C, he can file his
objections to the variation made in the income within 30 days of the receipt of draft
order by him to the Dispute Resolution Panel and Assessing Officer. Appeal against
the order of the Assessing Officer in pursuance of the directions of the Dispute
Resolution Panel can be made to the Income-tax Appellate Tribunal.
(2) In any other case, he can file an appeal under section 246 to the Joint Commissioner
(Appeals)/ under section 246A to the Commissioner (Appeals) against the order of
the Assessing Officer within 30 days of the date of service of notice of demand.

(3) The assessee can opt to file an application for revision of order of the Assessing
Officer under section 264 within one year from the date on which the order sought to
be revised is communicated, provided the time limit for appeal to the Commissioner
(Appeals) or the Income-tax Appellate Tribunal has expired or the assessee has
waived the right of such an appeal. The eligibility conditions stipulated in section 264
should be fulfilled.

2. Two enterprises shall be deemed to be associated enterprises if, at any time during the
previous year, more than half of the board of directors or members of the governing board,
or one or more of the executive directors or executive members of the governing board of
one enterprise, are appointed by the other enterprise.
In the present case, the power to appoint is only for half the number and not more than half.
Hence, ABC Inc. and XYZ Ltd. are not associated enterprises under this criteria.

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Two enterprises shall be deemed to be associated enterprises, if 90% or more of the raw
materials and consumables required for the manufacture or processing of goods or article
carried out by one enterprise, are supplied by the other enterprise, or by persons specified
by the other enterprise, and the prices and other conditions relating to the supply are
influenced by such other enterprise.
In this case, ABC Inc. supplies more than 90% of the requirements of purchases of XYZ Ltd.
Further, the price is controlled by the former by way of written agreement. Also, the
conditions for supply are determined by ABC Inc. Hence, the two entities would be deemed
to be associated enterprises under this criterion.
3. In this case, I. Limited, the Indian company, supplied billets to its foreign holding company,
U. Limited. Since the foreign company, U. Limited, is the holding company of I. Limited, I.
Limited and U. Limited are the associated enterprises within the meaning of section 92A.
As I. Limited supplies similar product to an unrelated entity, V. Limited, UK, the transactions
between I. Limited and V. Limited can be considered as comparable uncontrolled
transactions for the purpose of determining the arm’s length price of the transactions
between I. Limited and U. Limited Comparable Uncontrolled Price (CUP) method of
determination of arm’s length price (ALP) would be applicable in this case.
Transactions with U. Limited are on FOB basis, whereas transactions with V. Limited are on
CIF basis. This difference has to be adjusted before comparing the prices.
Amount (in Euro)
Price per MT of billets to V. Limited 700
Less: Cost of insurance and freight per M.T. 200
Adjusted Price per M.T. 500

Since the adjusted price for V. Limited, UK and the price fixed for U. Limited are the same,
the arm’s length price is Euro 500 per MT. Since the sale price to related party (i.e., U.
Limited) and unrelated party (i.e., V. Limited) is the same, the transaction with related party
U. Limited has also been carried out at arm’s length price.
4. The facts of the case indicate that X Ltd. and Yen Ltd. of Japan are associated enterprises
since Yen Ltd. holds 55% shares of X Ltd. and has appointed more than half of the board of
directors of X Ltd. Since Yen Ltd. is a non-resident, any transaction between X Ltd. and Yen
Ltd. would fall within the meaning of “international transaction” under section 92B.
Therefore, the income arising from such transactions have to be computed having regard to
the arm’s length price.

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The action of the Assessing Officer in making addition to the declared income and issuing
show cause notice for levy of various penalties is correct since X Ltd. had committed
defaults, as listed hereunder, in respect of which penalty, as briefed hereunder, is
imposable -
(i) Failure to report any international transaction or any transaction, deemed to be an
international transaction or any specified domestic transaction, to which the
provisions of Chapter X applies, would attract penalty @ 200% of the amount of tax
payable since it is a case of misreporting of income referred under section 270A(9)
read with section 270A(8).
(ii) Failure to maintain the requisite records as required under section 92D in relation to
international transaction makes it liable for penalty under section 271AA which will
be 2% of the value of each international transaction.
(iii) Failure to furnish report from an accountant as required under section 92E makes it
liable for penalty under section 271BA i.e., a fixed penalty of ` 1 lakh.

The Assessing Officer shall give an opportunity of hearing to the assessee with a notice as
to why the arm’s length price should not be determined on the basis of material or
information or document in the possession of the Assessing Officer.
Note: It is assumed that X Ltd. has not entered into an APA and has also not opted to be
subject to Safe Harbour Rules.
5. Any income arising from an international transaction, where two or more “associated
enterprises” enter into a mutual agreement or arrangement, shall be computed having
regard to arm’s length price as per the provisions of Chapter X of the Act.
Section 92A defines an “associated enterprise” and sub-section (2) of this section speaks of
the situations when the two enterprises shall be deemed to associated enterprises.
Applying the provisions of section 92A(2)(a) to (m) to the given facts, it is clear that “Anush
Motors Ltd.” is associated with :-
(i) Rida Ltd. as per section 92A(2)(a), because this company holds shares carrying
more than 26% of the voting power in Anush Motors Ltd.;
(ii) Kyoto Ltd. as per section 92A(2)(g), since this company is the sole owner of the
technology used by Anush Motors Ltd. in its manufacturing process;
(iii) Dorf Ltd. as per section 92A(2)(c), since this company has financed an amount which
is more than 51% of the book value of total assets of Anush Motors Ltd.

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The transactions entered into by Anush Motors Ltd. with different companies are, therefore,
to be adjusted accordingly to work out the income chargeable to tax for the A.Y. 2026-27.
Particulars ` (in crores)
Income of Anush Motors Ltd. as computed under Chapter IV-D, prior to 300.00
adjustments as per Chapter X
Add: Difference on account of adjustment in the value of international
transactions:
(i) Difference in price of car @ $ 200 each for 10,000 cars 12.60
($ 200 x 10,000 x ` 63)
(ii) Difference for excess payment of royalty of $ 30,00,000 18.90
($ 30,00,000 x ` 63) [See Note below]
(iii) Difference for excess interest paid on loan of EURO 1000 crores
(` 84*1000*1/100) 840.00
Total Income 1,171.50
Note: It is presumed that Anush Motors Ltd. has not entered into an Advance Pricing
Agreement or opted to be subject to Safe Harbour Rules.
6. The presence of multinational enterprises in India and their ability to allocate profits in
different jurisdictions by controlling prices in intra-group transactions prompted the
Government to set up an Expert Group to examine the issues relating to transfer pricing.
There is a possibility that two or more entities belonging to the same multinational group
can fix up their prices for goods and services and allocate profits among the enterprises
within the group in such a way that there may be either no profit or negligible profit in the
jurisdiction which taxes such profits and substantial profit in the jurisdiction which is tax
haven or where the tax liability is minimum. This may adversely affect a country's share of
due revenue. The increasing participation of multinational groups in economic activities in
India has given rise to new and complex issues emerging from transactions entered into
between two or more enterprises belonging to the same multinational group. The profits
derived by such enterprises carrying on business in India can be controlled by the
multinational group, by manipulating the prices charged and paid in such intra-group
transactions, which may lead to erosion of tax revenue. Therefore, transfer pricing
provisions have been brought in by the Finance Act, 2001 with a view to provide a statutory
framework which can lead to computation of reasonable, fair and equitable profits and tax in
India, in the case of such multinational enterprises.
7. XE Ltd, the Indian company and Zilla Inc., the US company are deemed to be associated
enterprises as per section 92A(2)(a), since Zilla Inc. holds shares carrying not less than
26% of the voting power in XE Ltd.

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As per Explanation to section 92B, the transactions entered into between these two
companies for sale of product, lending or guarantee and provision of services relating to
market research are included within the meaning of “international transaction”.
Accordingly, transfer pricing provisions would be attracted and the income arising from such
international transactions have to be computed having regard to the arm’s length price. In
this case, from the information given, the arm’s length price has to be determined taking the
comparable uncontrolled price method to be the most appropriate method.
Particulars ` in lakhs
Amount by which total income of XE Ltd. is enhanced on account of
adjustment in the value of international transactions:
(i) Difference in price of T-Shirt @ $ 1 each for 1,00,000 pieces sold to 64.00
Zilla Inc. ($ 1 x 1,00,000 x ` 64)
(ii) Difference for excess payment of guarantee fee to Zilla Inc. for loan 1.92
borrowed from foreign lender ($ 3,000 x ` 64)
(iii) Difference for excess payment for services to Zilla Inc. ($ 5,000 x 3.20
` 64)
69.12
XE Ltd. cannot claim deduction under section 10AA in respect of ` 69.12 lakhs, being
the amount of income by which the total income is enhanced by virtue of the first proviso
to section 92C(4)

8. (i) PQR Inc, a foreign company, has advanced loan of ` 170 crores to Mahanadi Ltd.,
an Indian company, which amounts to 56.67% of book value of assets of Mahanadi
Ltd. Since the loan advanced by PQR Inc. is 51% or more of the book value of
assets of Mahanadi Ltd., PQR Inc. and Mahanadi Ltd. are deemed to be associated
enterprises under the Indian transfer pricing regulations.
The deeming provisions would be attracted even if there is a repayment of loan
during the same previous year which brings down the said percentage below 51%.
(ii) Queenland plc, a foreign company has the power to appoint 37.50% (3 out of 8) of
the directors of an Indian company, Godavari Ltd.
Two enterprises would be deemed to be associated enterprises if more than half of
the board of directors of one enterprise are appointed by the other enterprise.

In this case, since Queenland plc has the power to appoint only 37.50% (which is
less than half) of the directors of an Indian company, Godavari Ltd., Queenland plc
and Godavari Ltd. are not deemed to be associated enterprises.

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(iii) Since Zoel GmbH, a German company, supplies 92.22% of the raw materials and
consumables required by Saraswati Ltd., an Indian company, which is more than the
specified threshold of 90%; and the prices and terms of supply are decided by the
German company, the two companies are deemed to be associated enterprises.

9. If an Indian company, being the borrower, incurs any expenditure by way of interest in
respect of any debt issued by its non-resident associated enterprise (AE) and such interest
exceeds ` 1 crore, then, the interest paid or payable by such Indian company in excess of
30% of its earnings before interest, taxes, depreciation and amortization (EBITDA) or
interest paid or payable to associated enterprise, whichever is lower, shall not be allowed
as deduction as per section 94B.

Further, where the debt is issued by a lender which is not associated but an associated
enterprise either provides an implicit or explicit guarantee to such lender or deposits a
corresponding and matching amount of funds with the lender, such debt shall be deemed to
have been issued by an associated enterprise and limitation of interest deduction would be
applicable.

In the present case, since M/s Tweed Inc holds 40% of voting power i.e., more than 26% of
voting power in both NP Ltd and M/s ST Inc, NP Ltd. and M/s ST Inc are deemed to be
associated enterprises.

Since loan of ` 80 crores taken by NP Ltd., an Indian company from M/s TL Inc, is
guaranteed by M/s ST Inc, an associated enterprise of NP Ltd., such debt shall be deemed
to have been issued by an associated enterprise and interest payable to M/s TL Inc shall be
considered for the purpose of limitation of interest deduction under section 94B.
Computation of interest to be disallowed as per section 94B in the computation of
income under the head profits and gains of business or profession of NP Ltd.

Particulars `
Net profit 7,00,00,000
Add: Interest already debited (` 80 crores x 10%) 8,00,00,000
Depreciation 6,00,00,000
Income tax 4,00,00,000
EBITDA 25,00,00,000
Interest paid or payable by NP Ltd. 8,00,00,000

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Lower of the following would be disallowed

- Total interest paid or payable in excess of 30% of ` 50,00,000
EBITDA (` 8,00,00,000 – ` 7,50,00,000)
- Interest paid or payable to non-resident AE ` 8,00,00,000
Interest to be disallowed as deduction 50,00,000

10. MNO Ltd., an Indian company, and ABC Inc., a Country A based company, are associated
enterprises as per section 92A, since ABC Inc. is a parent company of MNO Ltd. Thus, the
transaction of purchase of mobile handsets by MNO Ltd. from ABC Inc. would be an
international transaction. The value of international transaction is to be worked out on the
basis of Arm’s Length Price (ALP).
ABC Inc. is selling mobile phones to unrelated customers, which would be the comparable
uncontrolled transaction in this case. The purchase price for unrelated customers has to be
adjusted by taking into consideration the functional differences existing between the
transactions of ABC Inc. with associated enterprise (MNO Ltd.) and other unrelated parties.

Accordingly, the arm’s length price for purchase of mobile phones has to be computed for
working out the impact on assessable value as per CUP method.
Computation of Arm’s Length Price

Particulars ` in crores
Purchase price of mobile phones by unrelated parties from ABC Inc. 2,400
Adjustments for functional differences
Add: Royalty payable by MNO Ltd. [` 100 per mobile phone x 10,00,000] 10
Cost of capital for 1 month credit which is not given to unrelated 20
party [10% x ` 2,400 crore x 1/12]
Arm’s Length Price of 10,00,000 mobile phones (A) 2430
Purchase price of mobile phone by MNO Ltd. from ABC Inc., its 2600
parent company (associated enterprise) (B)
Amount to be added to its total income (B) – (A) 170

Note – In case it is assumed that ` 10 crores is not included in the price of ` 2600 crores,
the adjustment of royalty of ` 10 crores paid/payable is not required. The ALP in such a
case would be ` 2,420 crores. The amount to be added to the total income would be
` 180 crores.

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 24.139
TRANSFER PRICING

11. As per section 92CA(1), where the Assessing Officer considers it necessary or expedient so
to do, he may refer the computation of the arm's length price in relation to the international
transaction or specified domestic transaction entered by any person, being an assessee, to
the Transfer Pricing Officer (TPO).
However, the Assessing Officer has to take the prior approval of the Principal
Commissioner of Income-tax (PCIT)/Commissioner of Income-tax (CIT) before making such
a reference.
As per section 92CA(2A), the Transfer Pricing Officer (TPO) can also determine the ALP of
other international transactions or specified domestic transaction which have not been
referred to him, but which have come to his notice subsequently in the course of
proceedings before him.
The Assessing Officer has made reference for determination of ALP in respect of the
manufacturing unit at Hyderabad which shall be taken as the proceedings before him
(TPO).
The TPO can enlarge his scope of work during the course of proceedings before him of
Hyderabad unit by calling for details of trading activity at Surat, and the same is within the
powers conferred by section 92CA(2A).

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India
CHAPTER a
25

FUNDAMENTALS OF BEPS

LEARNING OUTCOMES

After studying this chapter, you would be able to -

❑ gain a broad understanding of the concept of Base Erosion and Profit
Shifting (BEPS);
❑ appreciate the significance of action plans of BEPS;
❑ comprehend and appreciate the provisions incorporated in the Indian
tax laws in line with the different Action Plans of BEPS.

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 25.2 INTERNATIONAL TAXATION

25.1 BACKGROUND
Impact of Globalisation
Globalisation has benefited our domestic economies, boosted trade and increased foreign direct
investments in many countries. The unrestricted movement of capital and labour, the shift of
manufacturing bases from high-cost to low-cost locations, the gradual removal of trade barriers,
technological and telecommunication developments, and the ever-increasing importance of
managing risks and of developing, protecting and exploiting intellectual property, have had an
important impact on the way cross-border activities take place. In this way, it accelerated growth,
created jobs and fostered innovation. Globalisation is not new, but the pace of integration of national
economies and markets has increased substantially in recent years. It has a significant impact on a
country’s corporate income tax regimes.

Growth of Multi-national Enterprises and consequent tax abuse

Way back in 1920s, pursuant to the first world war, the League of Nations recognised that the
interaction of domestic tax systems can lead to double taxation with adverse effects on growth and
global prosperity. Globally, countries concur on the need to eliminate double taxation and the need to
achieve this on the basis of accepted international laws that are clear and predictable, giving certainty
to both governments and businesses. International tax law is, therefore, a pillar in facilitating the
development of the global economy. With the economy, the enterprises also became more globally
integrated. Multi-national enterprises (MNE) now represent a significant proportion of global GDP.
Also, the increasing significance of the service component of the economy, an d of digital products
which are deliverable over the Internet, has made it much easier for businesses to locate many
productive activities in geographic locations that are distant from the physical location of their
customers. These developments have been accompanied by the increasing sophistication of tax
planners in identifying and exploiting the legal arbitrage opportunities and the boundaries of
acceptable tax planning, thus, encouraging MNEs to minimise their tax burden by resorting to
aggressive tax planning.

Adverse Effects of BEPS

Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit gaps and
mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations
where there is little or no real activity but the taxes are low, resulting in little or no overall corporate
tax being paid. This has become a critical issue since governments have to cope with less revenue
and a higher cost to ensure compliance. Moreover, BEPS undermines the integrity of the tax system,
as reporting of low corporate taxes is considered to be unfair. In developing countries, the lack of

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 FUNDAMENTALS OF BEPS 25.3
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tax revenue leads to significant under-funding of public investment that could help foster economic
growth. Further, when tax laws permit businesses to reduce their tax burden by shifting their income
away from jurisdictions where income producing activities are conducted, other taxpayers, especially
individual taxpayers in that jurisdiction bear a greater share of the burden. This gives rise to tax
fairness issues on account of individuals having to bear a higher tax burden. Also, enterprises that
operate only in domestic markets, including family-owned businesses or new innovative businesses,
may have difficulty competing with MNEs that have the ability to shift their profits across borders to
avoid or reduce tax. Fair competition is harmed by the distortions induced by BEPS.

Need for international collaboration to protect tax sovereignty of its

countries
Taxation is at the core of countries’ sovereignty, but the interaction of domestic tax laws with the tax
laws of other countries in certain cases leads to gaps and frictions. While developing their domestic
tax laws, sovereign states may not adequately take into consideration the effect of other countries’
laws. The interaction of separate sets of domestic laws enforced by sovereign countries causes
frictions, including potential double taxation for corporations operating in many countries. It also
causes gaps, in cases where corporate income is untaxed, both in the country of source and in the
country of residence, or is taxed only at nominal rates. In the domestic context, coherence is
generally achieved through a principle of matching – a payment that is deductible by the payer is
usually taxable in the hands of the recipient, unless explicitly exempted. There is no similar principle
of coherence at the international level, which leaves considerable scope for arbitrage by taxpayers,
though sovereign states have united to ensure coherence in a narrow field, namely, to prevent
double taxation. BEPS relates primarily to instances where the interaction of different tax rules &
tax systems leads to double non-taxation. It also relates to arrangements that achieve no or low
taxation by shifting profits away from the jurisdictions where the activities creating those profits take
place. International standards have tried to reduce these frictions in a manner that respects tax
sovereignty; however, gaps still remain. Therefore, there is a need for countries to collaborate on
tax matters so that they are able to get their due share of taxes.

25.2 OVERVIEW OF BEPS

In the background of the above repercussions and the global financial crisis in 2009, the G-20
countries shifted their focus to strengthen the international financial system. The G-20 mandated the
OECD to address the issue of tax avoidance, in light of which during February 2013, the OECD
published a report on “Addressing Base Erosion and Profit Shifting” iterating the need for analyzing
the issue of tax base erosion and profit shifting by global corporations. The OECD followed it up with
publishing draft Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in July 2013

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 25.4 INTERNATIONAL TAXATION

which came to final fruition in October 2015. The BEPS action plan identifies fifteen actions to
address BEPS in a comprehensive manner and sets a deadline to implement those actions.
The Action Plans were structured around three fundamental pillars viz.:
(i) Introducing coherence in the domestic rules that affect cross-border activities.
(ii) Reinforcing of ‘substance’ requirements in existing international standards; Alignment of
taxation with location of value creation and economic activity; and
(iii) Improving transparency and tax certainty.
A brief classification of the various action plans based on the fundamental pillars is as under:

BEPS Actions as per Objectives

Coherence Substance Transparency Horizontal

Action 2 Action 5 - 1st Action 5 - 2nd Action 1

Neutralise the component component Digital
effects of Preferential Exchange of economy
hybrid tax regimes information on
mismatch tax rulings
arrangements Action 6 Action 15
Prevent treaty Multilateral
abuse Action 11 instrument
Action 3 Data analysis
Strengthen CFC
rules Action 7
Prevent the Action 12
artificial Mandatory
avoidance of PE disclosure rules
Action 4
Limit interest status
Action 13
deductibility Re-examine
Action 8-10 transfer pricing
Aligning transfer documentation
pricing
outcomes with Action 14
value creation: Dispute
Intangibles; Risk resolution
and capital; and
Other high-risk
transactions

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 FUNDAMENTALS OF BEPS 25.5
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Coherence Substance Transparency

Present tax laws must be
modified: To align tax with
Greater transparency
Domestic tax substance. and improved data: Pre-
systems are coherent requisites to evaluate the
– tax deductible Domestic and international impact and magnitude of
payments by one tax laws should ideally relate BEPS.
person results in to both income and the
income inclusions by economic activity that
the recipient. generates it. - since at Taxpayers to report their
times,tax treaty and transfer aggressive tax planning
pricing facilitate the separation arrangements and rules
International of taxable profits from value- about transfer pricing
coherence in creating activities, such as documentation, breaking
corporate income through shell companies that down the information on a
have little or no economic
taxation - A pre- substance.
country-by-country basis:
requisite to Assist governments
complement the Concerns in the area of identify risk areas and
standards that prevent transfer pricing should be focus their audit strategies.
double taxation with a addressed within the
new set of standards prevalent system : These
designed to avoid areas include returns related to Making dispute
double non-taxation over-capital-isation, risk and resolution mechanisms
intangible assets. Specific more effective: To
rules, either within or beyond provide businesses with
the arm’s length principle, may greater certainty and
be required for this purpose. predictability

The BEPS measures range from new minimum standards to a revision of pre-existing international
standards, and to common approaches which will facilitate the convergence of national rules and
guidance drawing on best practices.
An unprecedented amount of interest and participation has been witnessed by OECD with more than
sixty countries, both OECD members and G-20 countries, being directly involved as a part of
technical groups in the development of congruent international tax s tandards. The Inclusive
Framework on BEPS works to ensure that the international tax framework for MNEs remains relevant
for today and the future, thereby promoting economic efficiency and global welfare. It will also ensure
that governments continue to efficiently raise revenues not only from traditional but also from digital
businesses, both for direct tax and indirect tax purposes.

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 25.6 INTERNATIONAL TAXATION

The summary explanatory statement indicates the level of political commitment by OECD, G20 and
other States involved in the 2015 work to the various reports. The OECD has iterated the following
terms to indicate the commitment by various participant countries:
New minimum standard - New minimum standard implies application of a new rule to be
implemented by all states, since non-implementation may result in negative spill overs (including
adverse impact of competitiveness) on other countries. Each of the four BEPS minimum standards
[namely, Actions 5, 6, 13 and 14] is subject to peer review in order to ensure timely and accurate
implementation and thus safeguard the level playing field. All members of the Inclusive Framework
on BEPS commit to implementing the minimum standards and commit to participating in the peer
review.
Revision of a standard which already exists – Existing standards have been updated and will be
implemented but with the caveat that all BEPS participants have not endorsed the underlying
standards on tax treaties or transfer pricing; and
Best practice – A best practice is not a standard but optional recommendation for states to follow.
Guidance based on best practices will support those countries proposing to act in the areas of
mandatory disclosure initiatives or controlled foreign company (CFC) legislation.
(1) ACTION PLAN 1 – ADDRESSING THE CHALLENGES OF THE
DIGITAL ECONOMY

Digital economy: Dissolving link between income-producing activity and

physical location
At present, in the digital domain, business may be conducted without regard to national boundaries
and may dissolve the link between an income-producing activity and a specific location. Hence,
business in digital domain doesn’t actually occur in any physical location but instead takes place in
"cyberspace." Persons carrying business in digital domain could be located anywhere in the world.
Entrepreneurs across the world have been quick to evolve their business to take advantage of these
changes. It has also made it possible for the businesses to conduct themselves in ways that did not
exist earlier, and given rise to new business models that rely more on digital and telecommunication
network, do not require physical presence, and derives substantial value from data collected and
transmitted from such networks.
Given the rise of e-commerce, an entire digital economy has emerged in the last decade. Since
there is a concept of ‘intangibility’ attached to the digital model of business, tax authorities often
faced challenges rightly bringing to tax the profits earned from a digital business. To address the

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 FUNDAMENTALS OF BEPS 25.7
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same, the first action plan of the BEPS project was developed by the OECD which outlines the
methods and principles based on which physical and digital economies can be taxed at par. Before
the same, physical locations of the servers of such digital businesses were considered to establish
the tax jurisdiction in which the profits of digital businesses could be taxed. It was observed that
servers were, therefore, placed in tax efficient jurisdictions, even though the main income generation
and customers were from other jurisdictions.

Taxation issues in E-Commerce

These new business models under the industrial revolution 4.0 have created new tax challenges.
Since the existing international tax system was designed during early 20th century, they remain
archaic and are incompatible with the modern day business dynamics:
The typical taxation issues relating to digitalisation are:
(i) the difficulty in characterizing the nature of payment and establishing a nexus or link between
a taxable transaction, activity and a taxing jurisdiction,
(ii) the difficulty of locating the transaction, activity and identifying the taxpayer for income tax
purposes.
The digital business, thus, challenges physical presence-based permanent establishment rules. If
permanent establishment (PE) principles are to remain effective in the new economy, the
fundamental PE components developed for the old economy i.e., place of business, location, and
permanency must be reconciled with the new digital reality.

OECD Recommendations under Action Plan 1 of the BEPS project

The OECD has recommended several options to tackle the direct tax challenges which include :

Modifying the existing Permanent Establishment (PE) rule to provide

whether an enterprise engaged in fully de-materialized digital activities would
constitute a PE, if it maintained a significant digital presence in another
country's economy.

A virtual fixed place of business PE in the concept of PE i.e., creation of a

PE when the enterprise maintains a website on a server of another enterprise
located in a jurisdiction and carries on business through that website

Imposition of a final withholding tax on certain payments for digital goods or

services provided by a foreign e-commerce provider or imposition of a equalisation
levy on consideration for certain digital transactions received by a non-resident from
a resident or from a non-resident having PE in other contracting state.

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 25.8 INTERNATIONAL TAXATION

Taking into consideration the potential of new digital economy and the rapidly evolving nature of
business operations, it becomes necessary to address the challenges in terms of taxation of such
digital transactions.

OECD - BEPS 2.0 – Consensus based solution for tax challenges arising out of
digitalisation
The 2015 Action 1 report provided for options to safeguard against BEPS on account of digitalisation,
however it did not provide for any recommendations and left it to the discretion of the countries to
resort to these measures as part of their domestic law. The report also indicated that it was agreed
between the members to continue to monitor developments in respect of the digital economy, with
a further report to be delivered by October, 2021

After the delivery of the Interim Report in March 2018, the Inclusive Framework has released details
of an agreement on 8th October 2021, titled “Statement on a Two-Pillar Solution to Address the Tax
Challenges Arising from the Digitalisation of the Economy”.

Pillar 1 - Re-allocation of profit and revised nexus rules: This pillar explores potential solutions for
determining where tax should be paid for new business models and on what basis ("nexus"), as well
as what portion of profits could or should be taxed in the jurisdictions where clients or users are
located ("profit allocation").

Pillar 2 - Global anti-base erosion mechanism (Minimum Tax): This pillar explores the design of a
system to ensure that multinational enterprises pay a minimum level of tax. This pillar is intended to
address remaining issues identified by the OECD/G20 BEPS initiative by providing countries with
new tools to protect their tax base from profit shifting to jurisdictions which tax these profits at below
the minimum rate.

The Pillar Two Model Rules have been designed to make sure they accommodate a diverse range
of tax systems, including different tax consolidation rules, income allocation, entity classification
rules etc., as well rules for specific business structures such as joint ventures and minority interests.
As such, many of the specific provisions of the Pillar Two Model Rules will not apply to all
jurisdictions or each individual inscope MNE. Taxpayers that either have no foreign presence or that
have less than EUR 750 million in consolidated revenues are not in scope of the Model Rules. In
addition, the Pillar Two Model Rules do not apply to government entities, international organisations
and non-profit organisations (preserving domestic tax exemptions for sovereign, non-profit and
charitable entities), nor do they apply to entities that meet the definition of a pension, investment or

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real estate fund (preserving the widely shared tax policy of not wishing to add an additional layer of
taxation between the investment and the investor). These entities are excluded even if the MNE
group they control remains subject to the rules. Taxpayers in scope of the rules calculate their
effective tax rate for each jurisdiction where they operate, and pay top -up tax for the difference
between their effective tax rate per jurisdiction and the 15% minimum rate. Any resulting top-up tax
is generally charged in the jurisdiction of the ultimate parent of the MNE. A de minimis exclusion
applies where there is a relatively small amount of revenue and income in a jurisdiction. The Pillar
Two Model Rules also contemplate the possibility that jurisdictions introduce their own domestic
minimum top-up tax based on the GloBE mechanics, which eliminates (or is at least fully creditable
against) any liability under GloBE, thereby preserving a jurisdiction’s primary right of taxation over
its own income.
Indian Taxation Regime

The concept of ‘Significant Economic Presence’ (SEP) which is similar to the virtual fixed place PE as
recommended in the 2015 BEPS Action Plan 1 report has been introduced in the Income-tax Act, 1961
vide Explanation 2A to section 9(1)(i).

Significant economic presence of a non-resident in India shall also constitute business connection in
India. Significant economic presence means-
Nature of transaction Condition
(a) in respect of any goods, services or property Aggregate of payments arising from such
carried out by a non-resident with any person transaction or transactions during the
in India including provision of download of data previous year should exceed ` 2 crores.
or software in India
(b) systematic and continuous soliciting of The number of users should be atleast
business activities or engaging in interaction 3 lakhs.
with users in India

Further, the above transactions or activities shall constitute significant economic presence in India,
whether or not,—
(i) the agreement for such transactions or activities is entered in India;
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
However, where a business connection is established by reason of significant economic presence
in India, only so much of income as is attributable to the transactions or activities referred to in (a)
or (b) above shall be deemed to accrue or arise in India.

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 25.10 INTERNATIONAL TAXATION

Chapter VIII in the Finance Act, 2016 on Equalisation Levy

In order to address the challenges of the digital economy, Chapter VIII of the Finance Act, 2016,
titled "Equalisation Levy", provided for an equalisation levy of 6% of the amount of consideration for
specified services received or receivable by a non-resident not having permanent establishment in
India, from a resident in India who carries out business or profession, or from a non-resident having
permanent establishment in India. This was provided for in section 165 of the Finance Act, 2016.

Meaning of “Specified Service”

(1) Online advertisement;

(2) Any provision for digital advertising space or any other facility or service for the purpose of
online advertisement.

Specified Service also includes any other service as may be notified by the Central Government.

Further, in order to reduce burden of small players in the digital domain, it is also provided that no
such levy shall be made if the aggregate amount of consideration for specified services received or
receivable by a non-resident from a person resident in India or from a non-resident having a
permanent establishment in India does not exceed ` 1 lakh in any previous year.

However, the consideration received or receivable for specified services would not include the
consideration, which are taxable as royalty or fees for technical services in India under the
Income-tax Act, 1961 read with the DTAA notified by the Central Government under section 90 or
section 90A.

Chapter VIII of the Finance Act, 2016 related to equalisation levy was amended by Finance Act,
2020 to provide for imposition of equalization levy (EL) of 2% on the amount of consideration
received/ receivable by an e-commerce operator from e-commerce supply or services.

To reduce the compliance burden, equalisation levy @2% has been withdrawn by the
Finance (No. 2) Act, 2024 on consideration received or receivable for e-commerce supply or
services, on or after the 1 st August, 2024.

Further, equalisation levy @ 6% on specified services has also been withdrawn by the Finance
Act, 2025 with effect from 1st April 2025.

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(2) ACTION PLAN 2 - NEUTRALISE THE EFFECTS OF HYBRID

MISMATCH ARRANGEMENTS
Before understanding what Action Plan 2 recommends, we must understand what a hybrid mismatch is.

Hybrid Mismatch Arrangement: Meaning

A hybrid mismatch is an arrangement that:

Exploits a Under the

Of an entity To achieve
difference in laws of two
or an double non-
the tax or more tax
instrument taxation
treatment jurisdictions

Hybrid mismatch arrangements are sometimes used to achieve unintended double non -taxation or
long-term tax deferral in one or more of the following ways -

Creation of two
deductions for
a single
borrowal

Generation of
Hybrid deductions
Participation mismatch without
exemption arrange- corresponding
regmies ments income
inclusions

Misuse of
foreign tax
credit

Specific country laws that allow taxpayers to opt for the tax treatment of certain domestic and foreign
entities may aid hybrid mismatches. It may not be easy to find out which country has in fact lost tax
revenue, since the laws of each country involved have been complied with; however, there is a
reduction of the overall tax paid by all parties involved as a whole, which ultimately has an adverse
effect on competition, economic efficiency, transparency and fairness.

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Recommended general amendments are as follows:

• A rule denying transparency to entities where the non-resident investors’ resident
country treats the entity as opaque;
Example
Let us say, X Co., a parent company in country X indirectly holds Y Co., an operating
company in country Y. Between X Co. and Y Co. is a hybrid entity that is treated as
transparent or disregarded for country X tax purposes and as non-transparent for country
Y tax purposes. X Co. holds all or almost all equity interest in the hybrid entity which in turn
holds all or almost all equity interests in Y Co. The hybrid entity borrows money from a third
party and the loan is used to invest equity into Y Co (or to buy the shares in Y Co from
either another company of the same group or from an unrelated third party). The hybrid
entity pays interest on the loan. Except for the interest, the hybrid entity does not claim any
other significant deduction and does not have any significant income.

With respect to Country Y, for tax purposes, Hybrid Entity is subject to corporate income
tax. Its interest expenses can be used to offset other country Y group companies’ income
under the country Y group tax relief regime. On the other hand, country X tre ats the hybrid
entity as transparent or disregarded, with the result that its interest expenses are allocated
to X Co, which deducts the interest expense to offset unrelated income. The net effect is
that there are two deductions for the same contractual obligation in two different countries.

Therefore, by virtue of rule denying transparency to an entity which is treated as opaque in

the subsidiary company’s country, the double deduction can be avoided .
• A rule denying an exemption or credit for foreign underlying tax for dividends that are
deductible by the payer;
Example
N Co, a company resident in country N is funded by M Co., a company resident in country
M with an instrument that qualifies as equity in country M but as debt in country N. A
payment made under the instrument would be deductible as interest expense for N Co under
country N tax law. The corresponding receipts are treated as exempt dividends under the
tax laws of country M. Consequently, deduction is available under the tax laws of country N
without a corresponding income inclusion in country M.
Therefore, by virtue of rule denying an exemption or credit for foreign underlying tax for
dividends that are deductible by the payer, exemption of such income in country M would
not be possible.

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• A rule denying a foreign tax credit for withholding tax where that tax is also credited
to some other entity; and
• Amendments to CFC and similar regimes attributing local shareholders the income of
foreign entities that are treated as transparent under their local law.
Treaty changes - Action Plan 2 recommends a new provision in the case of income earned by a
transparent entity. As per the new provision, treaty benefits will only be afforded to so much of the
income of the entity as the income of a resident of that State. A specific o r general saving rule is
proposed so that a State can tax a resident entity generally unrestricted by treaty.
Anti-hybrid rules - The report further issued a series of dedicated domestic anti-hybrid rules which
would work in two stages. The primary rules would deny deductions to payers in situations where either

(i) Those payments will not be included in the recipient’s ordinary income, or
(ii) The same amount is being simultaneously deducted by another entity .
Treatment of Branch mismatches: 2017 Report

Branch mismatches arise where the ordinary rules for allocating income and expenditure between
the branch and head office result in a portion of the net income of the taxpayer escaping the
charge to taxation in both the branch and residence jurisdiction. U nlike hybrid mismatches, which
result from conflicts in the legal treatment of entities or instruments, branch mismatches are the
result of differences in the way the branch and head office account for a payment made by or to
the branch. The 2017 report identifies five basic types of branch mismatch arrangements that give
rise to one of three types of mismatches:

deduction/no
inclusion outcomes

Three types of
mismatches

indirect deduction/ double

no inclusion deduction
outcomes outcomes

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The 2017 report includes specific recommendations for improvements to domestic law intended to
reduce the frequency of branch mismatches as well as targeted branch mismatch rules which adjust
the tax consequences in either the residence or branch jurisdiction in order to neutralise the hybrid
mismatch without disturbing any of the other tax, commercial or regulatory outcomes .

(3) ACTION PLAN 3 - STRENGTHEN CONTROLLED FOREIGN

COMPANY (CFC) RULES
Shifting investment income and passive income to subsidiaries in low tax
or no tax jurisdictions: Deferral of home country taxation
Under the tax laws of several countries, a shareholder of a corporation is not taxed on the
corporation's income until the income is distributed as a dividend. Therefore, it was common for
publicly traded companies to form foreign subsidiaries in tax havens and shift "portable" income to
those subsidiaries. Generally, income shifted were mainly investment income (interest and
dividends) and passive income (rents and royalties), as well as sales and services income involving
related parties. Tax in parent country on this income was avoided until the tax haven country paid a
dividend to the shareholding company. This dividend could be avoided indefinitely by loaning the
earnings to the shareholder without actually declaring a dividend.

Many countries (where global multi-nationals are based) have high tax rates as compared to certain
other countries, which used their low tax rates as a means of attracting inward investment. As a
result, when dividends were repatriated from these lower tax countries, the recipient generally
suffered additional tax on those profits. Therefore, many companies have a tendency to leave the
profits from these low-taxed subsidiaries offshore, with the objective of deferring home country
taxation.

Obviously, Governments were disturbed that multinationals based in their countries kept large
amounts of profits offshore. In order to address this issue, governments in various countries have
introduced legislation aimed at eliminating the benefits of deferral, by currently taxing income in the
parent country even when the income has not been repatriated or remitted to that country. These
rules are generally referred to as Controlled Foreign Corporation (CFC) rules .
CFC Rules: Addressing BEPS
Controlled foreign company (CFC) rules respond to the risk that taxpayers with a controlling interest
in a foreign subsidiary can strip the base of their country of residence and, in some cases, other

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countries by shifting income into a CFC. Without such rules, CFCs provide opportunities for profit
shifting and long-term deferral of taxation.

The OECD Final Report does not propose a minimum standard for controlled foreign company (CFC)
regimes. However, OECD regards CFC rules as being important in tackling BEPS and has made a
series of best practice recommendations in relation to the ‘building blocks’ of an effective CFC
regime. The major reason why the OECD was unable to provide more than best practice was
fundamental disagreement over the policy of CFC regimes, in particular whether states should use
the regime to protect other states’ tax bases from earnings stripping .
(4) ACTION PLAN 4 – INTEREST DEDUCTIONS AND OTHER FINANCIAL
PAYMENTS
The OECD is concerned that multinational groups are able to erode their tax base (i.e., reduce their
taxable profits) with interest expense, for example by:

• Locating third party debt in high tax countries;

• Using intra-group loans to achieve interest deductions in excess of the group’s actual third
party interest expense;

• Using related party or third party debt to finance the production of exempt or deferred income.

The use of third party and related party interest is perhaps one of the most simple of the profit -
shifting techniques available in international tax planning. The fluidity and fungibility of money makes
it a relatively simple exercise to adjust the mix of debt and equity in a controlled entity.

In particular, the deductibility of interest expense can give rise to double non-taxation in both inbound
and outbound investment scenarios. The interest payments are deducted against the taxable profits
of the operating companies while the interest income is taxed at comparatively low tax rates or not
at all at the level of the recipient.

BEPS Action Plan 4 calls for the development of recommendations for the design of domestic rules
to prevent tax base erosion through the use of interest expense and other financial payments that
are economically equivalent to interest.

Common Approach: Linking an entity’s net interest deduction to its level of economic activity

The mobility and fungibility of money enables multinational groups to achieve favourable tax results
by adjusting the amount of debt in a group entity. The 2015 Report established a common approach

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which directly links an entity’s net interest deductions to its level of economic activity, based on
taxable earnings before interest income and expense, depreciation and amortisation (EBITDA). This
approach includes three elements:

A Fixed Ratio Rule

A Group Ratio Rule
Based on a benchmark net
interest/ EBITDA ratio Targeted Rules
This rule allows an entitiy to
deduct more interest
expense based on the These Rules address
position of its worldwide specific risks
group.

Indian Taxation Regime

Section 94B of the Income-tax Act, 1961: Addressing Thin Capitalization

Debt financing of cross-border transactions is often favorable than equity financing for taxpayer. In
view of the above, in line with the recommendations of OECD BEPS Action Plan 4, section 94B of
the Income-tax Act, 1961 provides a cap on the interest expense that can be claimed by an entity to
its associated enterprise. The total interest paid in excess of 30% of its earnings before interest,
taxes, depreciation and amortization (EBITDA) or interest paid or payable to associated enterprise
for that previous year, whichever is less, shall not be deductible.

Applicability
The provision is applicable to an Indian company, or a permanent establishment of a foreign
company, being the borrower, who pays interest in respect of any form of debt issued by a non -
resident who is an 'associated enterprise' of the borrower. Further, the debt is deemed to be treated
as issued by an associated enterprise where it provides an implicit or explicit guarantee to the lender,
being a non-associated enterprise, or deposits a corresponding and matching amount of funds with
such lender.

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Carry forward of disallowed interest expenditure

The provision allows for carry forward of disallowed interest expense for 8 assessment years
immediately succeeding the assessment year for which the disallowance is first made and deduction
against the income computed under the head "Profits and gains of business or profession” to the
extent of maximum allowable interest expenditure.

Threshold limit
In order to target only large interest payments, it provides for a threshold of interest expenditure of
` 1 crore in respect of any debt issued by a non-resident associated enterprise exceeding which the
provision would be applicable. Banks, Insurance business and such class of NBFCs notified by the
Central Government are excluded from the ambit of the said provisions keeping in view of special
nature of these businesses. A finance company, located in any IFSC, has also been excluded from
the ambit of said provisions. Also, section 94B would not be attracted on interest paid in respect of
debt issued by a lender which is a permanent establishment in India of a non-resident, being a
person engaged in the business of banking.
(5) ACTION PLAN 5 – COUNTER HARMFUL TAX PRACTICES
The Action 5 Report is one of the four BEPS minimum standards. The minimum standard of the
Action 5 Report consists of two parts. One part relates to preferential tax regimes, where a peer
review is undertaken to identify features of such regimes that can facilitate base erosion and profit
shifting, and therefore have the potential to unfairly impact the tax base of other jurisdictions. The
second part includes a commitment to transparency through the compulsory spontaneous exchange
of relevant information on taxpayer-specific rulings which, in the absence of such information
exchange, could give rise to BEPS concerns. Thirdly, the review of substantial activities
requirements in no or only nominal tax jurisdictions to ensure a level playing field.

Indian Taxation Regime

In India, the Finance Act, 2016 has introduced vide Section 115BBF of the Income -tax Act, a
concessional taxation regime for royalty income from patents for the purpose of promoting
indigenous research and development and making India a global hub for research and development.
The purpose of the concessional taxation regime is to encourage entities to retain and commercialise
existing patents and for developing new innovative patented products. Further, this beneficial
taxation regime will incentivise entities to locate the high-value jobs associated with the
development, manufacture and exploitation of patents in India.

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Section 115BBF of the Income-tax Act, 1961: In line with nexus approach of
BEPS Action 5
The nexus approach has been recommended by the OECD under BEPS Action Plan 5. This
approach requires attribution and taxation of income arising from exploitation of Intellectual property
(IP) in the jurisdiction where substantial research and development (R & D) activities are undertaken
instead of the jurisdiction of legal ownership. Accordingly, section 115BBF of the Income-tax Act,
1961 provides that where the total income of the eligible assessee includes any income by way of
royalty in respect of a patent developed and registered in India, then such royalty shall be taxable
at the rate of 10% (plus applicable surcharge and cess). For this purpose, “developed” means atleast
75% of the expenditure should be incurred in India by the eligible assessee for any invention in
respect of which patent is granted under the Patents Act, 1970.
(6) ACTION PLAN 6 – PREVENTING TREATY ABUSE

Protection against treaty shopping: Minimum Standard

Bilateral tax treaties concluded by jurisdictions in the world have served to prevent harmful double
taxation and remove obstacles to cross-border trade in goods and services, and movements of
capital, technology and persons. This extensive network of tax treaties has, however, also given rise
to treaty abuse and "treaty-shopping" arrangements.
Treaty shopping typically involves the attempt by a person to indirectly access the benefits of a tax
treaty between two jurisdictions without being a resident of one of those jurisdictions. There are a
wide number of arrangements through which a person who is not a resident of a jurisdiction that is
a party to a tax agreement may attempt to obtain benefits that a tax agreement grants to a resident
of that jurisdiction.
Taxpayers engaged in treaty shopping and other treaty abuse strategies undermine tax sovereignty
by claiming treaty benefits in situations where these benefits were not intended to be granted,
thereby depriving jurisdictions of tax revenues.
Treaty abuse is one of the most important sources of BEPS concerns. It is undesirable for several
reasons, including:
- Treaty benefits negotiated between the parties to a treaty are economically extended to
residents of a third jurisdiction in a way the parties did not intend. The principle of reciprocity
is therefore breached and the balance of concessions that the partie s make is altered;

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- Income may escape taxation altogether or be subject to inadequate taxation in a way the parties
did not intend; and
- The jurisdiction of residence of the ultimate income beneficiary has less incentive to enter into
a tax treaty with the jurisdiction of source, because residents of the jurisdiction of residence
can indirectly receive treaty benefits from the jurisdiction of source without the need for the
jurisdiction of residence to provide reciprocal benefits.
Given the risk to revenues posed by treaty shopping, countries have committed to ensure a minimum
level of protection against treaty shopping (the minimum standard). That commitment will require
countries to include in their tax treaties an express statement that their common intention is to
eliminate double taxation without creating opportunities for non-taxation or reduced taxation through
tax evasion or avoidance, including through treaty shopping arrangements.

Countries will implement this common intention by including in their treaties:

(i) the combined approach of Limitation of Benefits (LOB) and Principal Purpose Test (PPT) rule,
(ii) the PPT rule alone, or

(iii) the LOB rule supplemented by a mechanism that would deal with conduit financing
arrangements not already dealt with in tax treaties.
Implementation of Action 6 Minimum Standard
The latest peer review on the implementation of the Action 6 minimum standard reveals that a large
majority of Inclusive Framework members have modified, or are in the process of modifying, their
treaty network to implement the minimum standard and other BEPS treaty -related measures.
As in previous editions, the latest peer review report continues to demonstrate the efficiency of the
BEPS Multilateral Instrument (BEPS MLI) in implementing the minimum standard. It is by far the
main tool of Inclusive Framework members for implementing the minimum standard. The majority of
the jurisdictions that have signed the MLI have listed almost all their treaties under the MLI.
The provisions of the BEPS MLI have started to take effect with respect to treaties concluded by
pairs of jurisdictions that have signed and ratified the BEPS MLI. For the treaties for which the MLI
is effective, tax administrations can now use effective treaty provisions to put an end to treaty
shopping.
Indian Tax Regime

LoB clause introduced in India-Mauritius Tax Treaty - On 10th May, 2016, India and Mauritius
has signed a protocol amending the India-Mauritius tax treaty at Mauritius. In the said treaty, for the

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first time, it has been provided that gains from the alienation of shares acquired on or after 1.4.2017
in a company which is a resident of India may be taxed in India. The tax rate on such capital gains
arising during the period from 1.4.2017-31.3.2019 should, however, not exceed 50% of the tax rate
applicable on such capital gains in India. A Limitation of Benefit (LOB) Clause has been introduced
which provides that a resident of a Contracting State shall not be entitled to the benefits of 50% of
the tax rate applicable in transition period if its affairs are arranged with the primary purpose of taking
advantage of concessional rate of tax. Further, a shell or a conduit company claiming to be a resident
of a Contracting State shall not be entitled to this benefit. A shell or conduit company has been
defined as any legal entity falling within the meaning of resident with negligible or nil business
operations or with no real and continuous business activities carried out in that Contracting State. A
resident of a Contracting State is deemed to be a shell/conduit company if its expenditure on
operations in that Contracting State is less than Mauritian rupee 15,00,000 or Indian ` 7,00,000 in
the respective Contracting State as the case may be, in the immediately preceding period of 12
months from the date the gains arise.

LoB clause in India-Singapore Tax Treaty - On similar lines, India and Singapore has signed a
protocol amending the India-Singapore tax treaty. Capital gains on sale of shares of an Indian
company by a resident of Singapore was taxable only in Singapore, if such shares were acquired
before 1.4.2017. After amendment of the treaty, capital gains on alienation of shares would be
taxable in a similar manner as laid out in India-Mauritius tax treaty, subject to LoB clause. The
transition period benefit is also similar to that contained in India-Mauritius Tax Treaty. In respect of
shares acquired after 1.4.2017 and sold before 1.4.2019, the expenditure test needs to be met for
the 12 month period immediately preceding the date of transfer.
(7) ACTION PLAN 7 – PREVENT THE ARTIFICIAL AVOIDANCE OF
PERMANENT ESTABLISHMENT (PE) STATUS
Tax treaties generally provide that the business profits of a foreign enterprise are taxable in a
jurisdiction only to the extent that the enterprise has in that jurisdiction a permanent establishment
to which the profits are attributable. The definition of permanent establishment included in tax
treaties is therefore crucial in determining whether a non-resident enterprise must pay income tax in
another jurisdiction.

Strategies used to avoid having a taxable presence in a jurisdiction under tax treaties may cause
cross-border income to go untaxed or be taxed at low rates. The BEPS Action Plan called for a
review of that definition to prevent the use of certain common tax avoidance strategies used to
circumvent the former Model permanent establishment definition, such as arrangements through
which taxpayers replace subsidiaries that traditionally acted as distributors by commissionnaire

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arrangements, with a resulting shift of profits out of the jurisdiction where the sales took place without
a substantive change in the functions performed in that jurisdiction.
These changes will ensure that where the activities that an intermediary exercises in a country are
intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, that
enterprise will be considered to have a taxable presence in that country unless the intermediary is
performing these activities in the course of an independent business. The changes will also restrict
the application of a number of exceptions to the definition of permanent establishment to activities
that are preparatory or auxiliary nature and will ensure that it is not possible to take advantage of
these exceptions by the fragmentation of a cohesive operating business into several small
operations; they will also address situations where the exception appl icable to construction sites is
circumvented through the splitting-up contracts between closely related enterprises.

Thus, the following steps have been advocated:

• Reworking exceptions to PE definition – An anti-fragmentation rule to be adopted to

aggregate all activities carried by an enterprise in a state, along with activities undertaken by
its closely related entities undertaking business operation that create tax mismatch and are
cohesive in nature. The above test can also be applied to understand whether the activities
undertaken by an enterprise in a state are ‘preparatory or auxiliary’.

• Analyzing arrangements entered through contractual agreements –A Commissionnaire

arrangement may be broadly defined as an arrangement through which a person sells
products in a State in its own name but on behalf of a foreign enterprise that is the owner of
these products. Through such an arrangement, a foreign enterprise is able to sell its products
in a State without technically having a permanent establishment to which such sales may be
attributed for tax purposes and without, therefore, being taxable in that State on the profits
derived from such sales. Since the person that concludes the sales does not own the products
that it sells, that person cannot be taxed on the profits derived from such sales and may only
be taxed on the remuneration that it receives for its services (usually a commission).
Commissionnaire arrangements have been a major cause of concern for tax administrations
in many countries.

Progress in implementation of BEPS Action Plan 7

The changes to the PE definitions were integrated in the 2017 OECD Model Tax Convention and in
Part IV of the MLI (Articles 12 to 15). The Multilateral Instrument (MLI) is a flexible instrument that
allows jurisdictions to adopt BEPS treaty-related measures to counter BEPS and strengthen their

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treaty network. The MLI was signed by nearly 90 jurisdictions and about half of the MLI Signatories
have so far adopted the MLI articles that implement the permanent establishment changes [For
detailed understanding of MLI, refer to discussion under Action 15].
(8) ACTION PLAN 8-10 - TRANSFER PRICING OUTCOMES IN LINE WITH
VALUE CREATION/INTANGIBLES/RISK AND CAPITAL AND OTHER
HIGH-RISK TRANSACTIONS
Over the last decades and in step with the globalisation of the economy, worldwide intra-group trade
has grown exponentially. Transfer pricing rules, which are used for tax purposes, are concerned with
determining the conditions, including the price, for transactions within an MNE group resulting in the
allocation of profits to companies within the group in different countries. In this regard, based on the
arm’s length principle, transactions between associated enterprises have to be priced as if the
enterprises were independent, operating at arm’s length and engaging in comparable transactions
under similar conditions and economic circumstances.

The arm’s length principle has proven useful as a practical and balanced standard for tax
administrations and taxpayers to evaluate transfer prices between associated enterprises, and to
prevent double taxation. However, with its perceived emphasis on contractual allocations of
functions, assets and risks, the existing guidance on the application of the principle has also proven
vulnerable to manipulation. This manipulation can lead to outcomes which do not correspond to the
value created through the underlying economic activity carried out by the members of an MNE group.
The aforesaid Action plans represent the OECD’s work on transfer pricing which has been a core
focus of the BEPS Action Plans. The specific Actions focus on Intangibles, Risks and capital and
other high-risk transactions. These are the hard areas of transfer pricing and are summarized
together in the Final Report ‘Aligning Transfer Pricing Outcomes with Value Creation’.

Clarification and Strengthening of existing standards on transfer pricing

Transfer pricing rules, which are set out in Article 9 of tax treaties based on the OECD and UN Model
Tax Conventions and the Transfer Pricing Guidelines, are used to determine on the basis of the ALP
the conditions, including the price, for transactions within an MNE group. The existing standards in
this area have been clarified and strengthened, including the guidance on the arm’s length principle
and an approach to ensure the appropriate pricing of hard-to-value-intangibles has been agreed
upon within the arm’s length principle. The work has focused on three key areas.

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Action Details
Plan

8 Addresses transfer pricing issues relating to controlled transactions involving

intangibles, since intangibles are by definition mobile and they are generally difficult -
to-value. Misallocation of the profits generated by valuable intangibles is a significa nt
cause of BEPS.

9 Contractual allocations of risk are respected only when they are supported by actual
decision-making and thus exercising control over these risks. Moreover, Action 9
addresses the level of returns to funding provided by a capital-rich MNE group member,
where those returns do not correspond to the level of activity undertaken by the funding
company.

10 This action focuses on other high-risk areas, which include:

- the scope for addressing profit allocations resulting from controlled transactions
which are not commercially rational,
- the scope for targeting the use of transfer pricing methods in a way which results
in diverting profits from the most economically important activities of the MNE
group, and
- the use of certain type of payments between members of the MNE group (such as
management fees and head office expenses) to erode the tax base in the absence
of alignment with the value-creation.

Progress in Implementation
- Additional guidance on the attribution of profits to permanent establishments resulting from
the changes in the Action 7 Final Report to Article 5 of the OECD Model Tax Convention was
published in March 2018.
- Revised guidance on transactional profit split method (Action 10) was published in June 2018
and has been incorporated into the next edition of the OECD Transfer Pricing Guidelines.
- Additional guidance addressed to tax administrations on the application of the hard -to-value
intangibles (HTVI) approach (Action 8) was finalised in June 2018 and has been incorporated
in the next edition of the OECD Transfer Pricing Guidelines.
- New transfer pricing guidance on financial transactions (Actions 4 and 8 -10) was published
in February 2020 and has been incorporated in the next edition of the OECD Transfer Pricing
Guidelines.

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(9) ACTION PLAN 11 – MEASURING AND MONITORING BEPS

The adverse fiscal and economic impacts of BEPS have been the focus of the OECD/G20 BEPS
Project since its inception. While anecdotal evidence has shown that tax planning activities of some
multinational enterprises (MNEs) take advantage of the mismatches and gaps in the international
tax rules, separating taxable profits from the underlying value-creating activity, The Addressing Base
Erosion and Profit Shifting report (OECD, 2013) recognised that the scale of the negative global
impacts on economic activity and government revenues have been uncertain.
Although measuring the scale of BEPS proves challenging given the complexity of BEPS and the
serious data limitations, the fiscal effects of BEPS are significant. BEPS causes other adverse
economic effects, including tilting the playing field in favour of tax-aggressive MNEs, exacerbating
the corporate debt bias, misdirecting foreign direct investment, and reducing the financing of needed
public infrastructure.
Measuring the impact and scale of BEPS activities and the effect of the implementation of the BEPS
measures are important components of the ongoing work of the OECD/G20 Inclusive Framework on
BEPS. Such measurement and monitoring is necessary to inform both policymakers and taxpayers
of the effectiveness of the BEPS measures and the extent to which BEPS issues continue to exist.
Indicators of BEPS activity
Six indicators of BEPS activity highlight BEPS behaviour using different sources of data, employing
different metrics, and examining different BEPS channels. When combined and presented as a
dashboard of indicators, they confirm the existence of BEPS, and its continued increase in scale in
recent years.
(i) The profit rates of MNE affiliates located in lower-tax countries are higher than their
group’s average worldwide profit rate. For example, the profit rates reported by MNE
affiliates located in lower-tax countries are twice as high as their group’s worldwide profit rate
on average.
(ii) The effective tax rates paid by large MNE entities are estimated to be lower than similar
enterprises with only domestic operations - This tilts the playing-field against local
businesses and non-tax aggressive MNEs, although some of this may be due to MNEs’
greater utilisation of available country tax preferences.
(iii) Foreign direct investment (FDI) is increasingly concentrated - FDI in countries with net
FDI to GDP ratios of more than 200% increased from 38 times higher than all other countries
in 2005 to 99 times higher in 2012.

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(iv) The separation of taxable profits from the location of the value creating activity is
particularly clear with respect to intangible assets, and the phenomenon has grown
rapidly - For example, the ratio of the value of royalties received to spending on research
and development in a group of low-tax countries was six times higher than the average ratio
for all other countries, and has increased three-fold between 2009 and 2012.
(v) Royalties received by entities located in these low-tax countries accounted for 3% of
total royalties - This provides evidence of the existence of BEPS, though not a direct
measurement of the scale of BEPS.
(vi) Debt from both related and third-parties is more concentrated in MNE affiliates in
higher statutory tax-rate countries. The interest-to-income ratio for affiliates of the largest
global MNEs in higher-tax rate countries is almost three times higher than their MNE’s
worldwide third-party interest-to-income ratio.
(10) ACTION PLAN 12 – DISCLOSURE OF AGGRESSIVE TAX PLANNING
ARRANGEMENTS
A significant challenge faced by tax authorities worldwide is the lack of timely, comprehensive and
relevant information on aggressive tax planning strategies. Timely access to such information would
facilitate quick response to tax risks through informed risk assessment, audits, or changes to
legislation or regulations. Action 12 contains recommendations regarding the design of mandatory
disclosure rules for aggressive tax planning schemes, taking into consideration the administrative
and compliance costs for tax administrations and business and drawing on experiences of countries
that have implemented such rules. It recognises the advantages of tools designed to facilitate the
information flow on tax risks to tax administrations and tax policy makers. The Report provides a
modular framework for guidance drawn from best practices for use by countries without mandatory
disclosure rules to design a regime that suits their requirement to get early information on potentially
aggressive or abusive tax planning schemes and their users. The Action 12 report also sets out
specific recommendations for rules targeting international tax schemes, as well as for the
development and implementation of more effective information exchange and co -operation between
tax administrations. The recommendations in this Report do not represent a minimum standard and
countries can decide whether or not to introduce mandatory disclosure regimes. Where a country
opts for mandatory disclosure rules, the recommendations provide the necessary flexibility to
balance a country’s need for better and more timely information with the compliance burdens for
taxpayers. It also sets out specific best practice recommendations for rules targeting international
tax schemes, as well as for the development and implementation of more effective information
exchange and co-operation between tax administrations.

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(11) ACTION PLAN 13 – RE-EXAMINE TRANSFER PRICING

DOCUMENTATION
The lack of quality data on corporate taxation has been a major limitation to measuring the fiscal
and economic effects of tax avoidance, making it difficult for authorities to carry out transfer pricing
assessments on transactions between linked companies and even more difficult to carry out audits.

Under BEPS Action 13, all large multinational enterprises (MNEs) are required to prepare a country -
by-country (CbC) report with aggregate data on the global allocation of income, profit, taxes paid
and economic activity among tax jurisdictions in which it operates. This CbC report is shared with
tax administrations in these jurisdictions, for use in high level transfer pricing and BEPS risk
assessments. This report contains revised standards for transfer pricing documentation
incorporating a master file, local file, and a template for country-by-country reporting of revenues,
profits, taxes paid and certain measures of economic activity. The revised standardised approach
requires taxpayers to articulate consistent transfer pricing positions and will provide tax
administrations with useful information to assess transfer pricing and other BEPS risks, make
determinations about where audit resources can most effectively be deployed, and, in the event
audits are called for, provide information to commence and target audit enquiries. Country-by-
country reports will be disseminated through an automatic government-to-government exchange
mechanism. The implementation package included in this report sets out guidance to ensure that
the reports are provided in a timely manner, that confidentiality is preserved and that the information
is used appropriately, by incorporating model legislation and model Competent Authority
Agreements forming the basis for government-to-government exchanges of the reports.

Requirements as per OECD report on Action 13 of BEPS Action Plan

The OECD report provides for:

(a) revised standards for transfer pricing documentation; and

(b) a template for country-by-country reporting of income, earnings, taxes paid and certain
measure of economic activity.

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Three-tier structure mandated by BEPS

The BEPS report recommends that countries adopt a standardised approach to transfer pricing
documentation; it mandates the following three-tier structure:-

Document Information
(1) Master File Standardised information relevant for all multinational enterprises (MNE)
group members.
Master file requires MNEs to provide tax administrations with high-level
information regarding their global business operations and transfer pricing
policies. The master file is to be delivered by MNEs directly to local tax
administrations.
(2) Local file Local file requires maintaining of transactional information specific to each
country in detail covering related-party transactions and the amounts
involved in those transactions. In addition, relevant financial information
regarding specific transactions, a comparability analysis and analysis of
the selection and application of the most appropriate transfer pricing
method should also be captured. The local file is to be delivered by MNEs
directly to local tax administrations.
(3) Country-by- The BEPS Action 13 report provides a template for multinational
country enterprises (MNEs) to report annually and for each tax jurisdiction in which
report they do business the information set out therein. This report is called the
Country-by-Country (CbC) Report.
To facilitate the implementation of the CbC Reporting standard, the BEPS
Action 13 report includes a CbC Reporting Implementation Package which
consists of
(i) model legislation which could be used by countries to require the
ultimate parent entity of an MNE group to file the CbC Report in its
jurisdiction of residence including backup filing requirements and
(ii) three model Competent Authority Agreements that could be used to
facilitate implementation of the exchange of CbC Reports,
respectively based on the:
a) Multilateral Convention on Administrative Assistance in Tax
Matters;
b) Bilateral tax conventions; and
c) Tax Information Exchange Agreements (TIEAs).
Following information are required in the CbC report:
Information relating to the global allocation of the MNE's income and taxes
paid; and
Indicators of the location of economic activity within the MNE group.

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CBC report requires MNEs to provide an annual report of economic

indicators viz. the amount of revenue, profit before income tax, income tax
paid and accrued in relation to the tax jurisdiction in which they do
business. CBC reports are required to be filed in the jurisdiction of tax
residence of the ultimate parent entity, being subsequently shared
between other jurisdictions through automatic exchange of information
mechanism.

Advantages of the three-tier structure [As per BEPS Report]:

(a) Taxpayers will be required to articulate consistent transfer pricing positions;
(b) Tax administrations would get useful information to assess transfer pricing risks;
(c) Tax administrations would be able to make determinations about where their resources can
most effectively be deployed, and, in the event audits are called for, provide information to
commence and target audit enquiries.

Indian Taxation Regime

Transfer Pricing provisions under the Income-tax Act, 1961

Chapter X of the Income-tax Act, 1961 comprising sections 92 to 92F contain provisions relating to
transfer pricing regime.
Section 92D requires maintenance of prescribed information and document relating to the
international transaction and specified domestic transaction by every person who has entered into
an international transaction. Also, a constituent entity of an international group is required to keep
and maintain the prescribed information and document in respect of the international group.
Implementation of international consensus in India
India is one of the active members of BEPS initiative and part of international consensus. For the
purpose of implementing the international consensus, a specific reporting regime in respect of CbC
reporting and also the master file has been incorporated in the Income-tax Act, 1961. The essential
elements have been incorporated in the Income-tax Act, 1961 while the remaining aspects would be
dealt with in detail in the Income-tax Rules, 1962.
Note – Refer to Chapter 24 Transfer Pricing, wherein the following have been discussed at length -
(i) Elements relating to CbC reporting requirement and related matters which have been
incorporated in section 286 of the Income-tax Act, 1961
(ii) Maintenance and furnishing of Master file: Consequent provisions incorporated in section
92D of the Income-tax Act, 1961.

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Threshold limit of consolidated group revenue for applicability of CbC

reporting requirement
The CbC reporting requirement for a reporting year does not apply unless the consolidated revenues
of the preceding accounting year of the group, based on consolidated financial statement, exceeds
a threshold to be prescribed. This threshold for total consolidated group revenue of the international
group prescribed under section 286 of the Income-tax Act, 1961 read with Rule 10DB of the Income-
tax Rules, 1962 is ` 6,400 crores.
(12) ACTION PLAN 14 – MAKING DISPUTE RESOLUTION MORE
EFFECTIVE
As novel challenges relating to international taxation surface, the necessity of having robust dispute
resolution processes in place becomes increasingly apparent.
Recent statistics show that tax administrations are closing more cases than ever before. However,
new MAP cases as from 2016 are increasing significantly, thus putting upward pressure on countries'
MAP inventories. Therefore, the total inventory of MAP cases keeps increasing every year since the
number of cases closed has not been able to keep up with the number of new cases.
The BEPS Action 14 Minimum Standard seeks to improve the resolution of tax -related disputes
between jurisdictions. Inclusive Framework jurisdictions have committed to have their compliance
with the minimum standard reviewed and monitored by its peers through a robust peer review
process that seeks to increase efficiencies and improve the timeliness of the resolution of double
taxation disputes.

Objective of measures developed under Action 14 of BEPS

Project

Minimize unintended double

Minimize the risks of uncertainty taxation

through

Consistent and proper

implementation of tax treaties Effective and timely resolution of
disputes regarding their interpretation
or application through MAP

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Eliminating opportunities for cross-border tax avoidance and evasion and the effective and efficient
prevention of double taxation are significant to developing an international tax system that facilitates
economic growth and a buoyant global economy. Countries concur that the measures introduced to
address BEPS pursuant to the BEPS Action Plans should not result in unnecessary uncertainty for
compliant taxpayers and in unintended double taxation. Improving dispute resolution mechanisms
is, therefore, a critical component of the work on BEPS issues.
The Action 14 Minimum Standard consists of elements and best practices, which assess a
jurisdiction’s legal and administrative framework in the following four key areas:
- preventing disputes;
- availability and access to MAP;
- resolution of MAP cases;

- implementation of MAP agreements.

Peer review implications for India
 The BEPS Action Plan 14 had suggested a peer review mechanism to ensure adequate
implementation of the suggested minimum standard. As a result, the peer review undertaken
for India in 2019 highlighted India's progress on MAP Programme and suggested
recommendations for more effective functioning of the MAP. According to the peer review
and BEPS Action Plan 14, the Indian tax authorities have taken significant steps to reform
the MAP framework and make it effective.
 The significant reforms include:
o The CBDT substituted Rule 44G and omitted Rule 44H of the Income-tax Rules, 1962
vide CBDT Notification No. 23/2020 dated 6th May, 2020. The new rule 44G
extensively deals with the implementation and the procedural framework for the MAP
process.
o In line with the BEPS Action Plan 14 recommendation, India had released a detailed
guidance note on MAP dated 7th August, 2020, available at
[Link] The MAP
guidance addresses many of the open issues on procedural aspects of MAP and, more
importantly, clarifies key practical nuances absent in the pre-BEPS era regime for the
taxpayers to resort.

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(13) ACTION PLAN 15 – DEVELOPING A MULTILATERAL INSTRUMENT

MLI’s role in tackling BEPS

Abuse of tax treaties is an important source of BEPS. The MLI helps the fight against BEPS by
implementing the tax treaty-related measures developed through the BEPS project in existing
bilateral tax treaties in a synchronized and efficient manner. These measures will prevent treaty
abuse, improve dispute resolution, prevent the artificial avoidance of permanent establishment
status and neutralize the effects of hybrid mismatch arrangements.
Action 15 of the BEPS Action Plan provides for an analysis of the tax and public international law
issues related to the development of a multilateral instrument to enable countries that wish to do so
to implement measures developed in the course of the work on BEPS and amend bilateral tax
treaties.

Formation of ad hoc Group to develop MLI

Based on this analysis, a mandate for the formation of an ad hoc Group to develop a multilateral
instrument on tax treaty measures to tackle BEPS, was approved by the OECD Committee on Fiscal
Affairs and endorsed by the G20 Finance Ministers and Central Bank Governors in February 2015.
In line with Action 15 report, an ad-hoc group was formed with a pre-defined purpose of development
of such Multilateral Instrument (MLI) and that adopted the text of the Convention and accompanying
Explanatory Statement in November 2016. India was part of the Ad Hoc Group of more than 100
countries and jurisdictions from G20, OECD, BEPS associates and other interested countries, which
worked on an equal footing on the finalization of the text of the Multilateral Convention, starting May
2015. The text of the Convention and the accompanying Explanatory Statement was adopted by the
Ad hoc Group on 24th November 2016.
Features of MLI

The Multilateral Convention is, thus, an outcome of the OECD/ G20 Project to tackle Base Erosion
and Profit Shifting (the "BEPS Project") i.e., tax planning strategies that exploit gaps and mismatches
in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic
activity, resulting in little or no overall corporate tax being paid.

The MLI modifies tax treaties that are “Covered Tax Agreements”. A Covered Tax Agreement is an
agreement for the avoidance of double taxation that is in force between Parties to the MLI and for
which both Parties have made a notification that they wish to modify the agreement using the MLI.

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The MLI is a flexible instrument which will modify tax treaties according to a jurisdiction’s policy
preferences with respect to the implementation of the tax treaty-related BEPS measures. The MLI
provides for different types of flexibility:
(i) jurisdictions can choose amongst alternative provisions in certain MLI articles;
(ii) jurisdictions can choose to apply optional provisions (for instance, the provisions on
mandatory binding arbitration);
(iii) jurisdictions may also choose to reserve the right not to apply MLI provisions (to opt out
through a “reservation”) with respect to all of their Covered Tax Agreements or with respect
to a subset of their Covered Tax Agreements. Jurisdictions only have the possibility to opt
out of provisions that do not reflect a BEPS minimum standard, with the possibility to withdraw
their reservation (and opt in) later.

Coverage of the MLI

In the first signing ceremony of the MLI on 7th June, 2017, more than 65 countries have signed the
MLI making it a historic moment in the international tax framework. India is an active participant in
the BEPS programme and was one of the jurisdictions during the signing event . USA and Brazil
have not signed the MLI and thereby not a party to this convention. The current status of signatories
and parties to MLI is available at [Link]
[Link].
The MLI entered into for the avoidance of taxes is a new concept in International Taxation. The
fundamentals of MLI can be decoded using the rhetoric 3W1H principles (Why, What, When and
How).

Why the need for MLI under the BEPS? – The evolution from Bilateral to Multilateral

Before we embark into what is MLI, we must understand the need for an MLI under the international
tax laws. The existing framework of international tax law is through tax treaties entered bilaterally
between countries.

The MLI convention is synonymous to a treaty. Treaties are instruments which create international
law, it is one of the most common and important sources of international law. They are agreements
between sovereign states and are binding on every sovereign state signatory to such agreement. A
treaty is defined by the Vienna Convention on the Law of Treaties (commonly referred to as ‘VCLT’)
as ‘an international agreement concluded between States in written form and governed by
international law, whether embodied in a single instrument or in two or more related instruments and

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whatever its particular designation’. As much as treaties are instruments under international law,
conventions, agreements, charters are all synonymously used along with treaty.
The tax treaty framework is through Countries which have entered into Double Tax Avoidance
Agreements (generally referred to as ‘DTAA’) with several other countries on a bilateral basis i.e.
agreement between two countries (e.g. Country A with Country B) to prevent double taxation of
income. India has entered bilateral tax treaties with more than 90 countries. The bilateral tax treaties
are, inter alia, entered with a view, majorly to prevent double taxation of income and give relief in
respect of doubly taxed incomes.
The rapid growth of globalization led to the creation of Multinational Enterprises (MNEs) wherein the
entities within a group were present all over the world and in many cases at jurisdictions which were
set up with the main objective to obtain tax arbitrage using treaty shopping mechanism. Consequent
to the 2008 global economic crisis, the international organizations and the fellow nations came up
with the BEPS action plan to recognise and counter unfair tax planning strategies adopted by certain
MNEs which had exploited the gaps in the global taxation system by artificially shifting profits to low
or no-tax locations (where there is little or no economic activity which leads to little or no tax being
paid). These tax planning strategies violated the ‘Economic Allegiance’ principle which means to
compensate to a nation or a kingdom for the benefits that one derived from exploiting that nation or
kingdom’s resources. This resulted in the source taxation principle under the international tax
principles.

As a result of the BEPS agenda, 15 Action Plans were brought out by the OECD under G20’s
mandate to tackle the unfair tax planning mechanisms adopted by MNEs. The action plan 15 can be
considered as the machinery action, which is intended to put into play the anti-avoidance tax
solutions proposed in the other BEPS action items. The need for such a machinery action item is
because currently there are more than 3000 bilateral tax treaties that are active and to invoke the
solutions proposed under the BEPS action plans, these bilateral tax treaties have to be amended.
Amending the bilateral treaties and involves cumbersome legal process as each country have their
own constitutional or other legal mechanisms to invoke international treaties into their domestic l aws.
Further, mere incorporation of these solutions in domestic law will not achieve the desired objective
as the tax treaties will remain a tool for tax evaders. Therefore, to ensure the BEPS solutions are
transposed into the tax treaty, action plan 15 objective was to bring all these amendments under
one single umbrella and hence, the work on developing a multilateral agreement was undertaken.

Multilateral agreements are entered by three or more nations, thus, bringing many countries under
one roof. Such agreements are considered effective and less time-consuming. The World Trade

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 25.34 INTERNATIONAL TAXATION

Organization (WTO) agreement, in which India is a party, is a classic example of multilateralism.

Multilateral agreements, in the context of international taxation, is not new as there have been
precedents from Scandinavian, Caribbean countries entering into such an agreement to avoid
double taxation. India also has its experience through the SAARC Limited Multilateral Agreement
for the avoidance of double taxation. But what distinguishes those agreements from the BEPS MLI
is that the MLI is exclusively entered to ensure there are no double nontaxation and reduction of
taxes, unlike the former whose objective was inter alia to avoid double taxation and to promote
economic relations.

Therefore, the MLI modifies tax treaties not by directly amending the text of the tax treaty, but by
being applied together with the relevant tax treaty. They do not make the existing DTAA otiose, they
operate along with the existing DTAA and will modify the application of some clauses in the existing
DTAA using the lex posterior (later in time) principle. Therefore, the BEPS MLI is an effective tool
to implement the anti-avoidance measures in a synchronised manner without the need to bilaterally
renegotiate each and every agreement. The BEPS MLI can act as a retaliatory tool for tax enforcers
to use against the tax evaders, as it can disentitle a taxpayer from undertaking treaty shopping or
availing unfair treaty benefits based on the anti-avoidance measures initiated under the BEPS action
items. Having seen the need for an MLI on tax treaties, we will dwell further on the operational
aspects of the same.

What is MLI? – Structure and key organs

The MLI under the BEPS action plan 15 is to implement the BEPS work into the existing treaty
network. The MLI will enable to provide a standard language for modification of all the existing
DTAAs. This enables elimination of disputes arising on account of different terms being used
differently or distinctively in each of the DTAA between contracting states thereby acting as
deterrence for tax abuse. It is reiterated that the BEPS MLI is an enabler to the existing tax treaties
and does not replace the existing tax treaties. It operates along with the existing DTAA by modifying
the application of a provision under the DTAA.

Structure of the MLI

Just as bilateral tax treaties are agreements, the MLI is also a similar instrument and its interpretation
will be governed by the principles laid down by VCLT. There are 7 parts and 39 articles in the MLI.
The coverage of MLI through its articles in light of the BEPS action plans is structured in the manner
provided below. Articles 3 to 17 are recognised as substantive provisions under the MLI convention.

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Part Particulars Article

Part I Scope and Interpretation of terms Article 1-Article 2
Part II Hybrid Mismatches Article 3-Article 5
Part III Treaty Abuse Article 6-Article 11
Part IV Avoidance of PE Status Article 12-Article 15
Part V Improving Dispute Resolution Article 16-Article 17
Part VI Arbitration Article 18-Article 26
Part VII Final Provisions Article 27- Article 39

Key Organs of the MLI

Each country before becoming a signatory is required to adopt certain ‘mandatory minimum
standards’, make ‘notification’ of MLI provisions, ‘make a reservation’ to certain provisions of MLI
and also provides for ‘compatibility clauses’ to ‘opt-in and opt-out’ of MLI provisions. Here, we will
discuss the key organs of the MLI which acts as a fulcrum for the operation of the instrument .

Key organs
Covered Tax Agreement
Compatibility Clause

Reservation Clauses
Minimum Standard

Covered Tax Agreements (CTA)

The entire scope and starting point of the MLI revolve around CTA. Article 2 of MLI defines a CTA
as: ‘an agreement for avoidance of double taxation with respect to taxes on income that is in force
between two or more parties and/or jurisdictions with respect to which each party has notified to the
Depository as a listed agreement under the MLI’.
It is, therefore, extremely relevant that to make the MLI operational between two parties (or)
jurisdictions/ states, each country must notify each other's bilateral tax treaty while becoming a
signatory to the MLI. Each country has to notify the DTAA with other jurisdiction under the MLI, upon
which the said DTAA will be the CTA for the purposes of MLI operation.
India has notified 93 jurisdictions under the MLI at the time of ratifying the MLI convention . Similarly,
it is also important that the countries which have signed a bilateral treaty with India must also notify

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DTAA with India while depositing their instrument with OECD. Therefore, ‘the matching principle’ is
a key attribute and only when the other country also notifies the DTAA with India, the DTAA between
India and that country will be considered as a CTA.
Examples
Exhibit 1: Whether the India & Australia DTAA is a CTA under the MLI?

Steps Considerations Comments

Step 1 Whether India and Australia already have a DTAA Yes, move to step 2
in existence?
Step 2 Whether India and Australia are signatories to Yes, both the parties are
MLI? signatories to the MLI.
Step 3 Whether India has notified DTAA with Australia as Yes, India has notified DTAA
a CTA in its MLI deposit note to the OECD? with Australia as a CTA.
Step 4 Whether Australia has notified DTAA with India as Yes, Australia has notified
a CTA in its MLI deposit note to the OECD? DTAA with India as a CTA.
Step 5 - Article 2 – Scope provisions matched and hence MLI provisions will apply.
Conclusion India -Australia DTAA is a CTA.

Exhibit 2: Whether the India & Mauritius DTAA is a CTA under the MLI?
Steps Considerations Comments
Step 1 Whether India and Mauritius already have a Yes, move to step 2
DTAA in existence?
Step 2 Whether India and Mauritius are signatories to Yes, both the parties are
MLI? signatories to the MLI.
Step 3 Whether India has notified DTAA with Mauritius Yes, India has notified DTAA
as a CTA in its MLI deposit note to the OECD? with Mauritius as a CTA.
Step 4 Whether Mauritius has notified DTAA with India No, Mauritius has not notified
as a CTA in its MLI deposit note to the OECD? DTAA with India as a CTA.
Step 5 India – Mauritius DTAA matching provisions not MLI provisions will NOT apply.
Conclusion satisfied. Therefore, the said DTAA is not a CTA. Will be governed only by
existing DTAA provisions
Note: India-Mauritius DTAA was amended in the year 2016, inter alia, to incorporate certain
BEPS provisions. This may be the possible reason for Mauritius not notifying DTAA with India as
a CTA. This shows the flexibility that is available under the MLI for countries to choose.

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Further, there are some countries like the USA and Brazil amongst others which have not signed
the MLI Convention. Hence, in such a scenario, the India-USA DTAA or the India-Brazil DTAA will
have no consideration towards the MLI and the existing DTAA provisions will only govern the tax
treaty framework.
Therefore, once an existing tax treaty is recognised as a CTA in the MLI context, the tax treaty will
have to take cognizance of the operational aspects of the MLI.
Compatibility Clauses – Bridge between the DTAA and the MLI
Once the existing DTAA becomes a CTA, we move to the next main organ of the MLI i.e. the
compatibility clauses. One of the core objectives of the MLI is to ensure consistency amongst the
nations to incorporate the BEPS solutions in their treaty network. Further, the objective of MLI is to
only modify the application of certain provisions in the existing DTAA. Therefore, parties to the MLI
are given the flexibility to choose the relevant provisions of the MLI that needs to be transposed to
their existing DTAA. In a bilateral DTAA, two countries negotiate and have the flexibility to decide
which provisions to be incorporated. Since tax policy of countries vary, flexibility is important to
attract countries to sign the MLI. Therefore, the flexibility is provided in the form of compatibility
clause and the reservation clause.
The compatibility clause is to ensure that there is no conflict between the two treaties i.e. the DTAA
and the MLI. This is because of the uniqueness of the MLI, which is not a standalone treaty as it
operates alongside the bilateral tax treaties. If there is a possible conflict that may arise between
the two treaties i.e., the DTAA and the MLI, the compatibility clause would resolve this conflict.
Further, the compatibility clause also gives options to parties to leave an existing provision of the
DTAA undisturbed, if the existing provision serves the desired objective with which a particular
provision of the MLI was placed to.
There are 4 different categories of compatibility clause(s) which are found under the MLI convention.
They are depicted in the following table
Compatibility Meaning Effect Notification Criteria
Clause
“in place of” Purpose of this clause is The concerned Only when both the
to replace an existing provision of MLI shall parties to the CTA
provision of the CTA, replace the existing notify, the CTA
with that of mutually CTA provision. provision be replaced
notified provisions of by the MLI provision.
MLI between two
countries.

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 25.38 INTERNATIONAL TAXATION

“in the absence Purpose of this clause is The concerned MLI Only when both the
of” to enforce a new provision is added to parties to the CTA
provision into the CTA, the existing CTA notify, the MLI
where such provision is which does not provision gets added in
absent in the CTA. contain such a the CTA.
provision.
“applies to” or Purpose of this clause is This existence of this Only when both the
“modifies” that the relevant CTA compatibility clause is parties to the CTA
provision will be that there should be a notify, the MLI
modified by MLI mutually notified CTA provision would be
provision without provision on which made applicable to the
replacing the CTA this condition is made existing CTA provision.
provision. effective. Thereafter,
the relevant MLI
provision shall be
made applicable to an
existing CTA
provision without
replacing the
provisions of CTA.
“in place of or in Purpose of this clause is Use of “in place of”: With regard to the
the absence of” to replace an existing Where existing notification, this is
provision in CTA with provisions of CTA are different from the
the MLI provision. notified by two earlier clauses,
Further, where there is countries, then, the wherein even if both
no such provision in the MLI provisions are the parties to the CTA
CTA, the MLI provision replaced with CTA does not notify this
will be added to the provisions. clause, the MLI
existing CTA. Use of “in the provision shall apply
absence of”: and supersede the
This is the most provisions of the CTA
Where no such
commonly used clause to the extent of
provisions exist in a
in many of the incompatibility. The
CTA, then the MLI
substantive provisions same holds good even
provisions includes
of the MLI. if only one party
them and gets added
notifies this clause.
into the CTA.

Reservation Clauses – ‘Opt-Out’ Mechanism

The reserved provisions of MLI shall not apply to a CTA if either of the parties makes a reservation.
A reservation is defined in the VCLT as a “unilateral statement made by a State, when signing,
ratifying, accepting, approving or acceding to a multilateral instrument, whereby it purports to
exclude or to modify the legal effect of certain provisions of the Convention”

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Hence, reservations under treaties, introduce flexibility in treaty negotiations, so that States come
forward to be a signatory to such multilateral conventions. The general rule of multilateral instrument
is that its parties are bound by the entire instrument unless the parties make a reservation. The MLI
enables states to opt-out of the provisions, either entirely or partially, by introducing a mechanism
of reservations.
However, reservations concerning minimum standard provisions (discussed later) under the MLI can
be made only on limited situations and subject to satisfying certain conditions.
Examples:
1) India has reserved its position on Article 3 of the MLI on transparent entities (BEPS Action
2), therefore Article 3 will not be added or modified in any of India’s existing DTAA as India
has opted-out.
2) France has reserved its position on Article 4 of the MLI on dual resident entities (BEPS Action
2), therefore when we apply India-France DTAA, Article 4 of the MLI will not affect the DTAA
since France has opted-out/reserved its position on the said Article 4 of the MLI.
A party to the MLI may reserve the right for provisions of the MLI to not apply:
 to its covered tax treaties in their entirety; or
 a subset of its covered tax treaties
Further, the reservations made under the MLI by a party will apply symmetrically wherein it applies
to the reserving party and other parties to the convention. In certain exceptional situation, the
reservation provision also works asymmetrically, which is a unique feature of the MLI, unlike other
multilateral agreements.
Mandatory Minimum Standards
The mandatory minimum standards form the genesis of MLI and without which the object of MLI may
not be fulfilled. One of the core objectives of developing the MLI is to ensure consistency amongst
the 3000 odd tax treaties that are currently in existence. As we have seen earlier, the MLI also gives
flexibility to the parties through compatibility and reservation clause, however, to ensure there is
some consistency, the parties have to adhere to incorporating mandatory minimum standard
provisions in the MLI.
The objective of the minimum standard provisions is to ensure that these anti -abuse provisions will
help eliminating the treaty shopping mechanism and consequentially the elimination of double non -
taxation scenarios by tax-evaders. The minimum standards under the MLI, therefore, achieve certain
consistency amongst the existing tax treaties. These minimum standard provisions, which have to
be incorporated in the tax treaties, help in combating tax avoidance.

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Out of the four minimum standards prescribed under the BEPS action plan i.e.
Action 5 - Countering Harmful Tax Practices
Action 6 - Treaty abuse prevention mechanism
Action 13 - Country by Country Reporting
Action 14 - Effective Dispute Resolution Mechanism
Action 6 and Action 14 solutions are specifically provided as a minimum standard provision under
the BEPS MLI. With regards to Action 5 and Action 13, the solutions are to be incorporated under
domestic laws.
However, in a case where the Contracting States together agree to reflect the minimum standard
provisions specified under the MLI into their existing DTAA, then, such treaty partner may opt-out of
the minimum standards under the MLI.

When – Entry into Force and Effective Date

The historic MLI was signed on 07 June 2017 by more than 65 countries at Paris, France during the
initial signing ceremony. The Entry into Force and the Effective Date is specified under Articles 34 -
36 of the MLI. Since the MLI is a new instrument for the signatory countries, many countries which
were not part of the initial signing ceremony have been signing the MLI on an ongoing basis. It is,
therefore, important to understand when the MLI enters into force and the effective date.
The MLI will apply only to those countries which have:
- Signed the MLI;
- Ratified, accepted or approved the MLI under the domestic law and deposited such
instrument of ratification with the OECD depositary.
Upon deposit of the instrument of ratification, the MLI enters into force on the first day of the month
following the expiry of 3 calendar months beginning on the date of such subsequent deposit.
Effective date
Once the MLI is entered into force by both the Contracting States, the effective date of the MLI shall be:
For withholding taxes – 1st day of next calendar year that begins on or after the latest of the dates
on which this Convention enters into force for each of the Contracting Jurisdictions to the CTA.
For other taxes – Taxable period that begins on or after the expiration of a period of 6 calendar
months from the latest of the dates on which this Convention enters into force for each of the
Contracting Jurisdictions to the CTA.
India’s journey and effective date on the applicability of the MLI

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 FUNDAMENTALS OF BEPS 25.41
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Date Event
7th June, 2017 The signing of the MLI
25th June 2019 Deposit of ratification instrument with the OECD depository.
1st October 2019 Entry into Force of India’s MLI
The provisions of the said Convention would have effect in India with respect to a Covered Tax
Agreement in accordance with the provisions of Article 35 of the said Convention. Accordingly, in
exercise of the powers conferred by section 90(1) of the Income-tax Act, 1961, the Central
Government has, vide Notification No.57/2019 dated 9.8.2019 (available at
[Link] ), notified
that the provisions of the said Convention shall be given effect to in the Union of India, in accordance
with India’s Position under the said Convention, as set out in the Annexure thereto.
If a country has signed and notified DTAA with India, however, the MLI has not entered into force,
then in such a case, the MLI provisions will not be applicable. For e.g., Italy has notified DTAA with
India as a CTA; however, Italy has not ratified its MLI under its domestic laws and hence the
provisions of MLI cannot be applied until Italy’s MLI is entered into force. Therefore, the MLI does
not apply in respect for India-Italy DTAA.
ILLUSTRATION 1
An Indian company intends to withhold taxes on a payment to be made to an Italian Company on
10th April 2025. In this regard, the Indian company wants to understand whether the provisions of
MLI are applicable to read it along with the India-Italy DTAA.
SOLUTION
With effect from 1 st April 2020, India’s MLI has entered into effect. However, Italy has not yet ratified
the MLI as on 10 th April 2025, therefore, the MLI provisions of Italy has not entered into force yet
and therefore, the MLI provisions are not applicable. The Indian company will rely only on the existing
India-Italy DTAA.

How does the MLI Operates - Mechanics

The MLI is only an addition to the existing DTAA and does not replace the DTAA. It only intends to
modify/amend the existing DTAA subject to the discretion of the parties and hence has to be read
along with the DTAA between the parties. Due to the unique feature of MLI not being a standalone
agreement, the operation of the MLI is critical and needs proper application.
The mechanics for applying the MLI is on the satisfaction of the conditions as follows :

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 25.42 INTERNATIONAL TAXATION

Both the Contracting States to the DTAA should be signatories to the MLI.

Both the Contracting States should have duly notified their DTAA as a Covered
Tax Agreement (CTA) and the MLI should have entered into force.

The substantive provisions and choices of the Contracting States to be analysed

through the compatibility clause and notification clause, regarding the provisions
of the CTA that is to be modifed by the MLI.

To identify, whether any reservation is made on the application of a provision of

the MLI by either of the contracting parties.

ILLUSTRATION 2
Whether MLI provisions will apply in the following scenarios?
(a) Country A and Country B are signatories to the MLI. Both countries have ratified the MLI
agreement as per their domestic legislative process. Country A has notified DTAA with
Country B as a CTA, however, Country B has not notified DTAA with Country A.
(b) Country A - Country B DTAA is a CTA under Article 2 of the MLI as both the countries have
notified the concerned DTAA. Country A has ratified the MLI under their domestic laws and
has deposited the ratification instrument. Country B has not ratified the ML I owing to political
instability in their country. In this regard, Country A wishes to invoke the MLI provisions while
accessing the Country A – Country B DTAA. Is the action of Country A valid?
SOLUTION
(a) Since Country B has not notified DTAA with Country A as CTA, the MLI provisions will not
apply with regard to the Country A - Country B DTAA, as per Article 2 of the MLI.
(b) Under Article 34 - Entry into Force of the MLI, only when a Country deposits its instrument of
ratification, the MLI will enter into force according to the timelines stipulated in the mentioned
Article. In the given scenario, since Country B has not ratified the MLI, consequently, the MLI
with regards to Country B has not entered into force yet. Hence, Country A - Country B CTA
under MLI is not in force yet and, therefore, provisions of the MLI are not applicable. The
action of Country A is, therefore, invalid.

Resources: The discussion on BEPS Action Plans contained in this chapter is essentially based on the Action
Plans developed in the context of the OECD/G20 BEPS Project and available at the website
[Link]

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 SUMMARY
BEPS Action Plan 1 : Addressing the challenges of the digital economy
OECD Provision incorporated in Indian Tax Laws
Recommendation
i Modifying existing Significant economic presence
Permanent
Establishment (PE) Significant economic presence of a non-resident in India shall also constitute business
rule to provide connection in India. Significant economic presence means-
whether an
enterprise engaged Nature of transaction Condition

© The Institute of Chartered Accountants of India

in fully de-
materialized digital (a) in respect of any goods, services or property Aggregate of payments arising from
activities would carried out by a non-resident with any such transaction or transactions
constitute a PE if it person in India including provision of during the previous year should
maintained download of data or software in India exceed ` 2 crores.
significant digital
presence in another (b) systematic and continuous soliciting of The number of users should be
business activities or engaging in interaction atleast 3 lakhs.
FUNDAMENTALS OF BEPS

country's economy
with users in India
ii A virtual fixed place
of business PE
when the enterprise
maintains a website
on a server of
another enterprise
25.43

located in a
a

jurisdiction & carries

on business through
that website.
 iii Imposition of a final Section 194-O provides that where sale of goods or provision of services of an e -commerce
withholding tax on certain participant is facilitated by an e-commerce operator through its digital or electronic facility or
25.44

payments for digital platform, such e-commerce operator is liable to deduct tax at source @0.1% of the gross
goods or services amount of such sales or services or both.
provided by a foreign e-
commerce provider.

iv Imposition of an
Equalisation Levy on Equalisation Levy @6% on specified services has been withdrawn by the Finance Act,
consideration for certain 2025 with effect from 1st April 2025.

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digital transactions
received by a Non-
resident from a resident
or Non-resident having
PE in the other
contracting state.
INTERNATIONAL TAXATION
 BEPS Action Plan 6: Preventing treaty abuse
OECD Minimum Standard LoB clause incorporated in Indian Tax Treaties
Given the risk to revenues LoB clause in India-Mauritius Tax Treaty
posed by treaty shopping, • On 10.5.2016, the India-Mauritius tax treaty was amended and for the first time, it has been
countries have committed to provided that gains from the alienation of shares acquired on or after 1.4.2017 in a company
ensure a minimum level of which is a resident of India may be taxed in India.
protection against treaty • The tax rate on such capital gains arising from 1.4.2017-31.3.2019 should, however, not
shopping by including in their
exceed 50% of the applicable tax rate on capital gains in India.
treaties:
• LOB Clause provides that a resident of a Contracting State shall not be entitled to the

© The Institute of Chartered Accountants of India

(i) the combined approach of
benefits of 50% of the tax rate applicable in transition period if its affairs are arranged with
Limitation of Benefits
the primary purpose of taking advantage of concessional rate of tax.
(LOB) and Principal
Purpose Test (PPT) rule, • A shell or a conduit Co. claiming to be a resident of a Contracting State shall not be entitled
(ii) the PPT rule alone, or to this benefit.
(iii) the LOB rule • A shell or conduit Co. is any legal entity falling within the meaning of resident with negligible
supplemented by a or nil business operations or with no real and continuous business activities carried out in
that Contracting State.
FUNDAMENTALS OF BEPS

mechanism that would deal

with conduit financing LoB clause in India-Singapore Tax Treaty
arrangements not already • Capital gains on sale of shares of an Indian company by a resident of Singapore was
dealt with in tax treaties. taxable only in Singapore, if such shares were acquired before 1.4.2017.
• The India-Singapore tax treaty has been amended to provide that capital gains on
alienation of shares acquired on or after 1.4.2017 would be taxable in a similar manner as
laid out in India-Mauritius tax treaty, subject to LoB clause.
25.45

• The transition period benefit is also similar to that contained in India-Mauritius Tax Treaty.
a
 BEPS Action Plan 7: Prevent the Artificial Avoidance of PE Status
OECD Recommendation Provision incorporated in the Income-tax Act, 1961
25.46

Business Connection includes any business activity

Review of definition of PE carried through a person who, acting on behalf of the
NR, habitually concludes contracts or habitually plays
the principal role leading to conclusion of contracts
To prevent tax avoidance by the NR. Such contracts should be-
(i) in the name of the NR; or
(ii) for transfer of ownership of, or for the granting of

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right to use, property owned by that NR or that the
By way of Commissionaire By way of Fragmentation of NR has the right to use; or
Arrangements business activities (iii) for provision of services by that NR

Modification of Article Introduction of anti-

5(5) to include a person fragmentation Rule to
INTERNATIONAL TAXATION

who habitually plays a prevent fragmentation

principal role leading of functions which are
to conclusion of otherwise a whole activity
contracts in the to avail benefit of
definition of agent exemption
 BEPS Action Plan 13 Re-examine transfer pricing (TP) documentation
OECD Minimum Standard Provisions incorporated in the Income-tax Act, 1961

Standardised approach to TP documentation Provisions in the IT, Act, 1961

Master File Local File CBC Report Section 92D Section 286

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Standardised Transactional Information relating Maintenance & CBC Reporting
information info specific to global allocation Furnishing of requirement and
relevant for to each of MNE’s income & Master File related matters
all MNE country in taxes paid; &
group detail indicators of the
members covering location of the eco. Maintenance of Requires aggregate
regarding related party activity within the prescribed information w.r.t. amount of
FUNDAMENTALS OF BEPS

global transactions MNE group information and revenue, P&L before

business documents income-tax, amount of
operations income-tax paid and
& TP accrued, stated capital, no.
policies of employees, nature and
details of main business
activity of each constituent
25.47

To be delivered by MNEs To be filed in the tax entity etc.

directly to local tax residence jurisdiction
a

administrations of ultimate parent

entity
 BEPS Action Plan 15 Developing a Multilateral Instrument (MLI)
25.48

BEPS Report Entry into Force of MLI

The MLI helps fight against BEPS by implementing tax treaty- ➢ The Multilateral Convention to implement tax treaty related
related measures developed through the BEPS Project in existing measures to prevent Base Erosion and Profit Shifting
bilateral treaties in a synchronized and efficient manner to – (BEPS) was signed by India at Paris, France on 7 th June,
• prevent treaty abuse, 2017.
➢ India had ratified the said Convention and had deposited
• improve dispute resolution
the instrument of ratification along-with the list of Covered

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• prevent the artificial avoidance of PE status Tax Agreements, reservations and notifications (India’s
• neutralize the effects of hybrid mismatch arrangements. Position under the said Convention) to the Depositary on
25th June, 2019.
The MLI is flexible instrument which modifies tax treaties that are
“Covered Tax Agreements”. A Covered Tax Agreement is an ➢ The date of entry into force of the said Convention for India
agreement for the avoidance of double taxation that is in force is 1st October, 2019, being the first day of the month
between Parties to the MLI and for which both Parties have made following the expiry of a period of three calendar months
INTERNATIONAL TAXATION

a notification that they wish to modify the agreement using the beginning on 25 th June, 2019, being the date of deposit by
MLI. India of the instrument of ratification.
➢ The earliest date when the provisions of this Convention
can take effect in India is 1 st April, 2020 (six months from
1st October, 2019, the date of entry into force for India)
 FUNDAMENTALS OF BEPS 25.49
a

TEST YOUR KNOWLEDGE

Questions
1. What do you understand by base erosion and profit shifting? Describe briefly its adverse
effects.

2. What are the significant OECD Recommendations under Action Plan 1 of BEPS? Which
recommendation has been adopted in Indian tax laws?
3. Discuss the provision incorporated in the Income-tax Act, 1961 in line with the OECD
recommendations under Action Plan 4 of BEPS.
4. Describe the three tier structure for transfer pricing documentation mandated by BEPS Action
Plan 13.

5. Explain the nexus approach recommended by OECD in BEPS Action Plan 5 which has been
adopted in the Income-tax Act, 1961.
6. What are the ways in which hybrid mismatch arrangements are used to achieve unintended
double non-taxation or long-term tax deferral?

Answers
1. Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies that exploit gaps
and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to
locations where there is little or no real activity but the taxes are low, resulting in little or no
overall corporate tax being paid.
Adverse Effects of BEPS:
(1) Governments have to cope with less revenue and a higher cost to ensure compliance.
(2) In developing countries, the lack of tax revenue leads to significant under-funding of
public investment that could help foster economic growth.
(3) BEPS undermines the integrity of the tax system, as reporting of low corporate taxes
is considered to be unfair. When tax laws permit businesses to reduce their tax burden
by shifting their income away from jurisdictions where income producing activities are
conducted, other taxpayers, especially individual taxpayers in that jurisdiction bear a
greater share of the burden. This gives rise to tax fairness issues on account of
individuals having to bear a higher tax burden.

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 25.50 INTERNATIONAL TAXATION

(4) Enterprises that operate only in domestic markets, including family-owned businesses
or new innovative businesses, may have difficulty competing with MNEs that have the
ability to shift their profits across borders to avoid or reduce tax. Fair competition i s
harmed by the distortions induced by BEPS.
2. The OECD has recommended several options to tackle the direct tax challenges which include:
(1) Modifying the existing Permanent Establishment (PE) rule to provide that whether an
enterprise engaged in fully de-materialized digital activities would constitute a PE, if it
maintained a significant digital presence in another country's economy.

(2) A virtual fixed place of business PE in the concept of PE i.e., creation of a PE when
the enterprise maintains a website on a server of another enterprise located in a
jurisdiction and carries on business through that website.

(3) Imposition of a final withholding tax on certain payments for digital goods or services
provided by a foreign e-commerce provider or imposition of a equalisation levy on
consideration for certain digital transactions received by a non-resident from a resident
or from a non-resident having permanent establishment in other contracting state.
Taking into consideration the potential of new digital economy and the rapidly evolving nature
of business operations, it becomes necessary to address the challenges in terms of taxation
of such digital transactions.
The concept of ‘Significant Economic Presence’ (SEP) which is similar to the virtual fixed
place PE as recommended in the 2015 BEPS Action Plan 1 report has been introduced in the
Income-tax Act, 1961 vide Explanation 2A to section 9(1)(i).
Significant economic presence of a non-resident in India shall also constitute business
connection in India. Significant economic presence means-
Nature of transaction Condition
(a) in respect of any goods, services Aggregate of payments arising from such
or property carried out by a non- transaction or transactions during the previous
resident with any person in India year should exceed ` 2 crores.
including provision of download of
data or software in India
(b) systematic and continuous The number of users should be atleast 3 lakhs.
soliciting of business activities or
engaging in interaction with users
in India

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 FUNDAMENTALS OF BEPS 25.51
a

Further, the above transactions or activities shall constitute significant economic presence in
India, whether or not,—
(i) the agreement for such transactions or activities is entered in India;
(ii) the non-resident has a residence or place of business in India; or
(iii) the non-resident renders services in India:
However, where a business connection is established by reason of significant economic
presence in India, only so much of income as is attributable to the transactions or activities
referred to in (a) or (b) above shall be deemed to accrue or arise in India.

In order to address the challenges of the digital economy, Chapter VIII of the Finance Act,
2016, titled "Equalisation Levy", provided for an equalisation levy of 6% of the amount of
consideration for specified services received or receivable by a non -resident not having
permanent establishment in India, from a resident in India who carries out business or
profession, or from a non-resident having permanent establishment in India. This was
provided for in section 165 of the Finance Act, 2016.

However, the equalisation levy @ 6% on specified services has been withdrawn by the
Finance Act, 2025 with effect from 1st April 2025.
3. In line with the recommendations of OECD BEPS Action Plan 4, section 94B has been
inserted in the Income-tax Act, 1961 by the Finance Act, 2017 to provide a cap on the interest
expense that can be claimed by an entity to its associated enterprise. The total interest paid
in excess of 30% of its earnings before interest, taxes, depreciation and amortization
(EBITDA) or interest paid or payable to associated enterprise for that previous year,
whichever is less, shall not be deductible.
The provision is applicable to an Indian company, or a permanent establishment of a foreign
company, being the borrower, who pays interest in respect of any form of debt issued by a
non-resident who is an 'associated enterprise' of the borrower. Further, t he debt is deemed
to be treated as issued by an associated enterprise where it provides an implicit or explicit
guarantee to the lender, being a non-associated enterprise, or deposits a corresponding and
matching amount of funds with such lender.
The provision allows for carry forward of disallowed interest expense for 8 assessment years
immediately succeeding the assessment year for which the disallowance is first made and
deduction against the income computed under the head "Profits and gains of business or
profession” to the extent of maximum allowable interest expenditure.

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 25.52 INTERNATIONAL TAXATION

In order to target only large interest payments, it provides for a threshold of interest
expenditure of ` 1 crore in respect of any debt issued by a non-resident associated enterprise
exceeding which the provision would be applicable. Banks, Insurance business and class of
NBFCs notified by the Government are excluded from the ambit of the said provisions keeping
in view of special nature of these businesses. A finance company, located in any IFSC, has
also been excluded from the ambit of said provisions w.e.f. A.Y. 2025-26. Also, section 94B
would not be attracted on interest paid in respect of debt issued by a lender which is a
permanent establishment in India of a non-resident, being a person engaged in the business
of banking.
4. Action 13 contains a three-tiered standardized approach to transfer pricing documentation
which consists of:

(a) Master file: Master file requires MNEs to provide tax administrations with high-level
information regarding their global business operations and transfer pricing policies.
The master file is to be delivered by MNEs directly to local tax administrations.

(b) Local file: Local file requires maintaining of transactional information specific to each
country in detail covering related-party transactions and the amounts involved in those
transactions. In addition, relevant financial information regarding specific transactions,
a comparability analysis and analysis of the selection and application of the most
appropriate transfer pricing method should also be captured. The local file is to be
delivered by MNEs directly to local tax administrations.
(c) Country-by-country (CBC) report: CBC report requires MNEs to provide an annual
report of economic indicators viz. the amount of revenue, profit before income tax,
income tax paid and accrued in relation to the tax jurisdiction in which they do
business. CBC reports are required to be filed in the jurisdiction of tax residence of
the ultimate parent entity, being subsequently shared between other jurisdictions
through automatic exchange of information mechanism.
5. In India, the Finance Act, 2016 has introduced a concessional taxation regime for royalty
income from patents for the purpose of promoting indigenous research and development and
making India a global hub for research and development. The purpose of the concessional
taxation regime is to encourage entities to retain and commercialise existing patents and for
developing new innovative patented products. Further, this beneficial taxation regime will
incentivise entities to locate the high-value jobs associated with the development,
manufacture and exploitation of patents in India.

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 FUNDAMENTALS OF BEPS 25.53
a

The nexus approach has been recommended by the OECD under BEPS Action Plan 5. This
approach requires attribution and taxation of income arising from exploitation of Intellectual
property (IP) in the jurisdiction where substantial research and development (R & D) activities
are undertaken instead of the jurisdiction of legal ownership. Accordingly, section 115BBF
has been inserted in the Income-tax Act, 1961 to provide that where the total income of the
eligible assessee (being a person resident in India who is the true and first inventor of the
invention and whose name is entered in the patent register as the patentee in accordance
with the Patents Act, 1970 and includes every such person, being the true and the first
inventor of the invention, where more than one person is registered as patentee under
Patents Act, 1970 in respect of that patent.) includes any income by way of royalty in respect
of a patent developed and registered in India, then such royalty shall be taxable at the rate
of 10% (plus applicable surcharge and cess). For this purpose, developed means atleast 75%
of the expenditure should be incurred in India by the eligible assessee for any invention in
respect of which patent is granted under the Patents Act, 1970.

6. Hybrid mismatch arrangements are sometimes used to achieve unintended double non -
taxation or long-term tax deferral in one or more of the following ways -
(1) Creation of two deductions for a single borrowal;

(2) Generation of deductions without corresponding income inclusions;

(3) Misuse of foreign tax credit; and
(4) Participation exemption regimes.

© The Institute of Chartered Accountants of India

© The Institute of Chartered Accountants of India
CHAPTER a 26

APPLICATION AND
INTERPRETATION OF TAX
TREATIES

LEARNING OUTCOMES
After studying this chapter, you would be able to
❑ identify the connecting factors of double taxation;
❑ appreciate the meaning of, and need for, tax treaties;
❑ appreciate the basic principles of interpretation of tax treaties;
❑ identify the extrinsic aids to interpretation of a tax treaty;
❑ appreciate the importance of commentaries in interpretation of tax
treaties;
❑ appreciate the role of Vienna Convention in application and interpretation
of tax treaties.

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 26.2 INTERNATIONAL TAXATION

26.1 INTRODUCTION
Article 38(1) of the International Court of Justice (ICJ)1 provides that the court shall apply the
following in deciding on a particular matter –

International Convention(s) [general or particular]

• establishing rules expressly recognised by the contesting states

International Customs
• serving as evidence of general practice accepted as law

General principles
• recognised by civilised nations

Judicial decisions and teachings of highly qualified publicists of

various nations
• serving as subsidiary means for determination of rules of law

Success of any law depends upon the manner in which it is interpreted and administered. In order
to interpret any law or agreement, one needs to understand the philosophy of law which has been
kept in mind at the time of passing such law in a country or at the time of forming an agreement
between the two countries on a particular aspect. This gives rise to the principles of public
international law (example – U.N principles on business and human rights).
The interpretation of DTAAs require a different approach than the interpretation of domestic tax laws
as the latter is based on interpretative principles set out by the national courts, whereas, the DTAAs
are an international agreement between the government of two countries. The treaties are interpreted
in light of the customary principles set out under the Vienna Convention of the Law of treaties.
Source(s) of International Tax Law
S. No. Source Particulars relating to the source/origin
(i) Double Taxation Avoidance DTAAs may be comprehensive or limited. It is to be
Agreement (DTAA) noted that along with the DTAA, it is the protocols,
memorandum of understanding, and exchange of
1[Link] The International Court of Justice acts as a world court. The
Court’s jurisdiction is twofold: it decides, in accordance with international law, disputes of a legal nature that
are submitted to it by States (jurisdiction in contentious cases); and it gives advisory opinions on legal
questions at the request of the organs of the United Nations or specialized agencies.

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.3 a

information, etc. forming part of the DTAA which

enables interpretation of a DTAA.
(ii) Customary international law Customary international law is the aspect of
and general principles of law international law that derives from customs and
conventions. Along with general principles of law and
treaties, custom is also considered by the International
Court of Justice, jurists, the United Nations, and its
member states to be among the primary sources of
international law. The vast majority of the world's
governments accept, in principle, the existence of
customary international law, although there are many
differing opinions as to what rules are contained
therein.
(iii) Vienna Convention on Law VCLT is a multilateral treaty signed and ratified by
of Treaties (VCLT) several countries, which codifies the customary
international law for interpretation of tax treaties.

26.2 DOUBLE TAXATION AND CONNECTING FACTORS

The taxability of a foreign entity in any country depends upon two distinct factors, namely, whether
it is doing business with that country or in that country. Internationally, the term used to determine
the jurisdiction for taxation is “connecting factors”. There are two types of connecting factors,
namely, “Residence” and “Source”. It means a company can be subject to tax either on its residence
link or its source link with a country.
If a company is doing business in a host/source country, then, besides being taxed in the home
country on the basis of its residence link, it will also be taxed in the host country on the basis of its
source link as the company would be heavily engaged in doing business in the territory of other
country, for example, through its branch in that country.
However, if a company is doing business with another country (i.e., host/source country), then, it
would generally be subject to tax in its home country alone, based on its residence link, since the
company is not engaged in carrying on the business in the territory of source country (for example,
export of goods to another country). In this regard, it may, however, be noted that significant
economic presence in another country may result in tax liability in the other country. For example,
as per the Income-tax Act, 1961, transaction in respect of any goods, services or property carried
out by a non-resident with any person in India including provision of download of data or software in
India if aggregate of payments arising from such transaction or transactions during the previous year
exceeds ` 2 crores, would be deemed as significant economic presence of such non-resident in

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 26.4 INTERNATIONAL TAXATION

India. Significant economic presence of a non-resident in India would constitute business connection
in India and consequently, income would be deemed to accrue or arise in India and hence, be taxable
in India (the Source country).

Residence
Source

• Juridical double taxation

When source rules overlap, double taxation may arise i.e. tax is imposed by two or more
countries as per their domestic laws in respect of the same transaction, income arises or is
deemed to arise in their respective jurisdictions. This is known as “juridical double taxation”.
In order to avoid such double taxation, a company can invoke provisions of Double Taxation
Avoidance Agreements (DTAAs) (also known as Tax Treaty or Double Taxation Convention–
DTC) with the host/source country, or in the absence of such an agreement, an Indian
company can invoke provisions of section 91, providing unilateral relief in the event of double
taxation.
Example 1
Company ICO is a resident of India. It has set up a branch in UK. Here, India would be the
country of residence for ICO, whereas UK would be the country of source. UK would tax the
profits earned by the branch of ICO located in UK, whereas ICO would be taxed on worldwide
basis in India, including profits of its UK branch. However, ICO can claim relief in respect of
taxes paid in UK while filing its tax return in India under the Indo-UK Double Taxation Avoidance
Agreement.
If, instead of UK, ICO has a branch in a state with which India does not have tax treaty, then it
can claim unilateral relief under section 91 of the Income-tax Act, 1961 in respect of taxes paid
by its branch in that state.
• Economic double taxation
‘Economic double taxation’ happens when the same transaction, item of income or capital is
taxed in two or more states but in hands of different persons (because of lack of subject
identity)

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.5 a

Example 2
When one State attributes an income/capital to its legal owner whereas the tax law of other
State attributes it in the hands of the person in possession or having economic control over the
income, it leads to economic double taxation. For example, if one State (say, Country X) levies
dividend distribution tax on the company resident in that State (say, ABC Ltd.) and the other
State (say, Country Y) levies tax on dividend received by the shareholder who is resident of
Country Y, receiving dividend income from shares held in ABC Ltd., the company resident in
Country X, then, economic double taxation arises.

26.3 TAX TREATIES: AN OVERVIEW

(1) Definition of “Treaty”
Treaty is a generic term embracing all instruments binding under international law, regardless
of their formal designation, concluded between two or more international juridical persons.
The application of the term treaty signifies that the parties intend to create rights and
obligations enforceable under international law.
Article 2 of Vienna Convention on Law of Treaties, 1969 defines a “treaty” as an international
agreement concluded between States in written form and governed by international law,
whether embodied in a single instrument or in two or more related instruments and
whatever its particular designation.
(2) Role of Tax Treaties
“Treaty” represents various compromises agreed upon by the respective Contracting States
depending upon the economic expediency of a particular country.
Tax, in the country of source is considered as a cost, whereas the same is an obligation in
the country of residence. Therefore, there is need to achieve tax efficiency. Double Tax
Avoidance Agreements come into play to mitigate hardship caused by subjecting the same
income to double taxation.
Tax Treaties attempt to eliminate double taxation and try to achieve balance and equity. They
aim at sharing of tax revenues by the concerned States on a rational basis. Tax treaties do
not always succeed in eliminating Double Taxation, but contain the incidence to a tolerable
level.

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 26.6 INTERNATIONAL TAXATION

(3) Types of DTAAs

Types of DTAAs

Comprehensive
Limited DTAAs
DTAAs
Limited DTAAs are those which are limited to certain types of incomes only. e.g. , DTAA
between India and Pakistan is limited to income from international air transport only.

Comprehensive DTAAs are those which cover almost all types of incomes covered by any
model convention. Many a time, a treaty also covers wealth tax, gift tax, surtax, etc.
(4) Directive Principles set out in the Indian Constitution

In the Indian context, Article 51 of the Indian Constitution has, inter alia, set out some directive
principles which must be followed by the State in the context of International agreements and
relationships. It has been provided that-

"The State shall endeavor to -

(a) Promote international peace and security;
(b) Maintain just and honourable relations amongst nations;
(c) Foster respect for international law and treaty obligations in the dealings of organised
people with one another; and
(d) Encourage settlement of international disputes by arbitration.
Article 253 of the Indian Constitution provides that Parliament has power to make any law for
the whole or any part of the territory of India for implementing any treaty, agreement or
convention with any other country or countries or any decision made at any international
conference, association or other body.
It is pertinent to note that entries 10 and 14 of List I of the Seventh Schedule to the
Constitution of India confer the power on Parliament to legislate treaties with foreign
countries. Further, this power of Parliament has been delegated to the Central Government
vide sections 90 and 90A of the Income-tax Act, 1961.

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.7 a

(5) Need for tax treaties

The concept of source and residence prevailing in a majority of the countries is the root cause
of double taxation. Hence, there is a need to have tax treaties in force. Generally, the residence
state has the primary right to tax the global income of its residents unless it exempts that income
under its domestic tax law. The right of the source state gets curtailed under the DTAA as it is
always a secondary state and has limited connection with the taxpayer. The rights of the source
state are sometimes limited (e.g. in case of royalties, interest) or are unconditional or are
conditional (e.g. business profits only taxable if PE exists). Even in some cases, no rights are
granted to the source state and the entire income is taxable in the residence state. The allocation
or distribution of the taxing rights depends upon the negotiation or bargaining power between the
two countries and flow of investment and trade between them.

Tax treaties only distribute or assign taxing jurisdiction. It does not impose tax. Having
assigned the jurisdiction of tax between the State of Residence and State of Source, the
domestic tax laws of the respective State determine taxing rules. Taxing experts in early 1920
appointed by the League of Nations describe the method of classification as Contracting
States dividing tax sources and tax objects amongst themselves by mutually binding
themselves not to levy taxes or to tax only to a limited extent.

English lawyers called it “Classification and Assignment Rule”, whereas German jurists called
it the “Distributive Rule”. According to this principle, “to the extent that an exemption is
agreed to, its effect is, in principle, independent of whether the Contracting States imposes a
tax, in the situation to which the exemption applies, and irrespective of whether the State
actually levies the tax”. The point here is that having agreed to give the right of tax to the
other state, that state may or may not levy tax and if the state in whose favour right to tax is
devolved, chooses not to tax such income, then, it may result in double non-taxation. The
argument in favour of double non-taxation is that income would be subject to tax in the exempt
state as and when the exemption is withdrawn or tax is levied. Thus, this rule ensures that
double taxation does not arise in future also, if the source state decides to levy tax.
In addition to allocating the taxing rights and eliminating double taxation, there are various
other important considerations as mentioned below:
• Ensuring non-discrimination between residents and non-residents
• Resolution of disputes arising on account of different interpretation of tax treaty by the
treaty partner.
• Providing assistance in the collection of the fair and legitimate share of tax.

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 26.8 INTERNATIONAL TAXATION

Allocating
taxing rights

Assisting in
collection of fair
and legitimate Elimination of
share of tax double taxation
Need for
Tax Treaties

Resolution of disputes
on account of different Ensuring non-
treaty interpretation discrimination between
residents and non-
residents

Section 90 also provides that the Central Government may enter into an agreement with the
Government of any country outside India for

(a) granting of relief in respect of Income-tax; or

(b) avoidance of double taxation without creating any opportunities for double non -
taxation or reduced taxation through tax evasion or avoidance (including treaty
shopping arrangements); or
(c) exchange of information for the prevention of evasion or avoidance of income -tax or
for investigation of cases of such evasion or avoidance; or
(d) recovery of income-tax.
Further, in addition to above, there are some other principles which must be considered by
countries in tax treaties –

(i) Equity and fairness: Same income earned by different taxpayers must be taxed at
the same rate regardless of the source of income.
(ii) Neutrality and efficiency: Neutrality factor provides that economic processes should
not be affected by external factors such as taxation. Neutrality is two-fold.
(a) Capital export neutrality and

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.9 a

(b) Capital import neutrality (CIN).

Capital export neutrality (CEN) provides that business decision must not be affected
by tax factors between the country of residence and the target country; whereas CIN
provides that the level of tax imposed on non-residents as well as the residents must
be similar.
(iii) Promotion of mutual economic relation, trade and investment: In some cases, it
is observed that avoidance of double taxation is not the only objective. The other
objective may be to give impetus to a country’s overall economic growth and
development.’

26.4 INTERPRETATION OF TAX TREATIES

(1) Introduction
Tax treaties are signed between two sovereign nations by competent authorities under delegated
powers from the respective Governments. Thus, an international agreement has to be respected
and interpreted in accordance with the rules of international law as laid down in the Vienna
Convention on Law of Treaties (VCLT). These rules of interpretation are not restricted to tax treaties
but also apply to any treaty between two countries. Therefore, any dispute between two nations in
respect of Article 25 relating to Mutual Agreement Procedure of the OECD/UN Model Conventions
has to be solved in the light of the VCLT.
However, when it comes to application of a tax treaty in the domestic forum, the appellate authorities
and the courts are primarily governed by the laws of the respective countries for interpretation.
In India, even before insertion of Section 90(2) by the Finance (No.2) Act, 1991, with retrospective
effect from 1-4-1972, CBDT had clarified vide Circular No. 333 dated 2-4-1982 that where a specific
provision is made in the DTAA, the provisions of the DTAA will prevail over the general provisions
contained in the Act and where there is no specific provision in the DTAA, it is the basic law i.e. the
provisions of the Act, that will govern the taxation of such income.
Section 90(2) of the Income-tax Act, 1961 provides that where the Indian Government has entered
into DTAAs which are applicable to the taxpayers, then, the provisions of the Act shall apply to the
extent they are more beneficial to the taxpayer.
Interpretation of any statute, more so international tax treaties, requires that we follow some rules
of interpretation. In subsequent paragraphs, we shall deal with rules of interpretation of tax treaties.

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 26.10 INTERNATIONAL TAXATION

(2) Role of Vienna Convention in Application and Interpretation of Tax Treaties

The International Law Commission initiated the work on the Vienna Convention on Law of Treaties
in the year 1949 which was completed in the year 1969. It came into force in the year 1980. As of
2.8.2023, it was ratified by 116 Countries. It is an open treaty whereby any country can become
signatory of the Convention at any time.
Since tax treaty is a part of international law, its interpretation should be based on certain set of
principles and rules of interpretation. The Vienna Convention on Law of Treaties provides the basic
rules of interpretation of any international agreement (including a tax treaty). It represents the
customary international law. The VCLT codifies the principles of interpretation laid down by usage,
custom and courts over centuries.
The principles engraved in Vienna Convention on Law of Treaties have been acknowledged and
embraced by the Indian courts of law while pronouncing their ruling. Para 60 of the Supreme Court
ruling in Ram Jethmalani & Ors. v. Union of India & Ors Writ Petition (Civil) No. 176/2009 reads as
follows –

“Article 31, “General Rule of Interpretation”, of the Vienna Convention of the Law of Treaties, 1969
provides that a “treaty shall be interpreted in good faith in accordance with the ordinary meaning to
be given to the terms of the treaty in their context and in the light of its object and purpose.” While
India is not a party to the Vienna Convention, it contains many principles of customary international
law, and the principle of interpretation, of Article 31 of the Vienna Convention, provides a broad
guideline as to what could be an appropriate manner of interpreting a treaty in the Indian context
also”.
The Delhi High Court ruling in AWAS Ireland v. Directorate General of Civil Aviation (W.P.(C)
671/2005 delivered on 19th March 2015, applied the principles enshrined in the Vienna Convention
of Law of Treaties, 1969. The said ruling invited reference to Article 51(c) of the Constitution of India
which enjoins that the State shall endeavour to “foster respect for international law”. T he Court
observed that the provisions of Article 51(c) of the Constitution of India when read with Articles 26,
27 and 31 of the Vienna Convention of Law of Treaties clearly cast an obligation on the Contracting
States to not only remain bound by the terms of a treaty entered into by it but also obliges the State
not to cite internal law as a justification for failure to perform its obligations under a treaty. An
international convention, i.e., a treaty, is required to be interpreted in good faith, in accordance with
the ordinary meaning given to the terms of the treaty, in their context and in light of its stated object
and purpose.

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.11 a

Therefore, it would be worthy to understand some of the Articles of the Vienna Convention of Law
of Treaties which would help appreciate the manner of application and interpretation of tax treaties.
Principles enunciated in the Vienna Convention on Law of Treaties 2
Article No. Article Heading Principle enunciated
26 Pacta Sunt Servanda Every treaty in force is binding upon the parties and
(in good faith) must be followed by them in good faith.
27 Internal law and A party may not invoke the provisions of its internal law
observance of as justification for its failure to perform a treaty.
treaties For instance, the parties to the treaty should not
dishonour their international commitments with each
other by retrospectively amending their domestic tax
laws or by not abiding by the treaty terms.
28 Non-retroactivity of Unless a different intention appears from the treaty or is
treaties otherwise established, treaty provisions do not bind a
party in relation to any act or fact which took place or
any situation which ceased to exist before the date of
the entry into force of the treaty with respect to that
party.
In other words, unless otherwise provided, treaties
cannot have retrospective application
29 Territorial Scope of Unless a different intention appears from the treaty or is
Treaties otherwise established, a treaty is binding upon each
party in respect of its entire territory.
31 General Rule of • A treaty shall be interpreted in good faith in
Interpretation accordance with the ordinary meaning to be given
to the terms thereof in the context and in the light of
its object and purpose. This is a basic principle. It
states that treaties should be interpreted by first
giving the ordinary meaning to the language. It is
only if the ordinary meaning is ambiguous, or leads
to illogical results, that the purpose may be
considered.
• The context for the purpose of interpretation of a
treaty shall comprise, in addition to the text,
including its preamble and annexure
(a) Any agreement relating to the treaty which
was made between all the parties in
connection with the conclusion of the treaty;

2 [Link]

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 26.12 INTERNATIONAL TAXATION

(b) Any instrument which was made by one or

more parties in connection with the
conclusion of the treaty and accepted by the
other parties as an instrument related thereto.
• The following shall be taken into account, together
with the context in that:
(a) Any subsequent agreement between the
parties regarding the interpretation of the
treaty or the application of its provisions;
(b) Any subsequent practice in the application of
the treaty which establishes the agreement of
the parties regarding its interpretation;
(c) Any relevant rules of international law
applicable to relation between the parties.
• A special meaning shall be given to a term if it is
established that the parties so intended.
32 Supplementary Recourse may be had to supplementary means of
means of interpretation, including the preparatory work of the
interpretation treaty and the circumstances of its conclusion, in order
to confirm the meaning resulting from the application of
Article 31, or to determine the meaning when the
interpretation according to Article 31:
(a) leaves the meaning ambiguous or obscure; or
(b) leads to a result which is manifestly absurd or
unreasonable.
33 Interpretation of • When a treaty has been authenticated in two or
Treaties more languages, the text is equally authoritative in
Authenticated in two each language, unless the treaty provides or the
or more languages parties agree that, in case of divergence, a
particular text shall prevail.
• A version of the treaty in a language other than the one
of those in which the text was authenticated shall be
considered an authentic text only if the treaty so
provides or the parties so agree.
• The terms of the treaty are presumed to have the
same meaning in each authentic text.
• Except where a particular text prevails in
accordance with paragraph 1, when a comparison
of the authentic texts discloses a difference in
meaning which the application of Articles 31 and 32
does not remove, the meaning which best

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reconciles the texts, having regard to the object and

purpose of the treaty, shall be adopted.
34 General Rule regarding A treaty does not create either obligations or rights for a
third states third State without its consent.
42 Validity and • The validity of a treaty or of the consent of a State
Continuance in force to be bound by a treaty may be impeached only
of treaties through the application of the Convention .
• The termination of a treaty, its denunciation or the
withdrawal of a party, may take place only as a result
of the application of the provisions of the treaty or of
the Convention. The same rule applies to suspension
of the operation of a treaty
60 Termination or • A material breach of a bilateral treaty by one of the
Suspension of the parties entitles the other to invoke the breach as a
operation of a treaty ground for terminating the treaty or suspending its
as a consequence of operation in whole or in part.
its breach • A material breach of a multilateral treaty by one of
the parties entitles:
(a) the other parties by unanimous agreement to
suspend the operation of the treaty in whole
or in part or to terminate it either:
(i) in the relations amongst themselves and
the defaulting State, or
(ii) as between all the parties;
(b) a party specially affected by the breach to
invoke it as a ground for suspending the
operation of the treaty in whole or in part in
the relations between itself and the defaulting
State;
(c) any party other than the defaulting State to
invoke the breach as a ground for suspending
the operation of the treaty in whole or in part with
respect to itself if the treaty is of such a
character that a material breach of its provisions
by one party radically changes the position of
every other party with respect to further
performance of its obligations under the treaty.
• A material breach of a treaty, for the purposes of
this Article, consists in:
(a) a repudiation of the treaty not sanctioned by
the Convention; or

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 26.14 INTERNATIONAL TAXATION

(b) the violation of a provision essential to the

accomplishment of the object or purpose of the
treaty.
• The foregoing paragraphs are without prejudice to
any provision in the treaty applicable in the event of
a breach.
61 Supervening • A party may invoke the impossibility of performing
impossibility of provision of a treaty as a ground for terminating or
performance withdrawing from it, if the impossibility results from the
permanent disappearance or destruction of an object
indispensable for the execution of the treaty. If the
impossibility is temporary, it may be invoked only as a
ground for suspending its operation.
• Impossibility of performance may not be invoked by
a party as a ground for terminating, withdrawing
from or suspending the operation of a treaty if the
impossibility is the result of a breach by that party
either of an obligation under the treaty or of any
other international obligation owed to any other
party thereto.
62 Fundamental change • A fundamental change of circumstances which has
of circumstances occurred with regard to those existing at the time of
the conclusion of a treaty, and which was not
foreseen by the parties, may not be invoked as a
ground for terminating or withdrawing from the treaty
unless –
(a) the existence of those circumstances
constituted an essential basis of the consent
of the parties to be bound by the treaty; and
(b) the effect of the change is radically to
transform the extent of obligations still to be
performed under the treaty.
• A fundamental change of circumstances may not
be invoked as a ground for terminating or
withdrawing from a treaty –
(a) if the treaty establishes a boundary; or
(b) if the fundamental change is the result of a
breach by the party invoking it either of an
obligation under the treaty or of any other
international obligation owed to any other
party to the treaty.

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.15 a

• If, under the foregoing paragraphs, a party may

invoke a fundamental change of circumstances as
a ground for terminating or withdrawing from a
treaty it may also invoke the change as a ground
for suspending its operation.
64 Emergence of new If a new peremptory norm of general international law
peremptory norm of emerges, any existing treaty which is in conflict with that
general international norm becomes void and stands terminated.
law

(3) Basic Principles of Interpretation of law for interpreting a Treaty

Principles or rules of interpretation of a tax treaty would be relevant only where terms or words used
in treaties are ambiguous, vague or are such that different meanings are possible. If words are clear
or unambiguous, then there is no need to resort to different rules for interpretation.

Prior to the Vienna Convention, treaties were interpreted according to the customary international
law. Just as each country’s legal system has its own canons of statutory construction and
interpretation, likewise, several principles exist for the interpretation of treaties in customary
international law.

Some of the important principles of Customary International law in interpretation of tax treaties are
as follows:

(i) Golden Rule – Objective Interpretation: Ideally, any term or word should be interpreted
keeping its objective or ordinary or literal meaning in mind. The term has to be interpreted
contextually.

Words and phrases are in the first instance to be construed according to their plain and
natural meaning. However, if the grammatical interpretation would result in an absurdity, or
in marked inconsistency with other portions of the treaty, or would clearly go beyond the
intention of the parties, it should not be adopted 3.

(ii) Subjective Interpretation: Under this approach, the terms of a treaty are to be interpreted
according to the common intention of the contracting parties at the time the treaty was
concluded. The intention must be ascertained from the words used in the treaty and the
context thereof.

3 Prof. J. G. Starke in Introduction to International Law 10 th Edition

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 26.16 INTERNATIONAL TAXATION

In Abdul Razak A. Meman’s case [2005] 276 ITR 306, the Authority for Advance Rulings [the
AAR] relied on the speeches delivered by the Finance Ministers of India as well as UAE to
arrive at the intention of parties in signing the India-UAE Tax Treaty.

(iii) Purposive Interpretation: In this approach the treaty is to be interpreted so as to facilitate

the attainment of the aims and objectives of the treaty. This approach is also known as the
‘objects and purpose’ method. For identifying the intention of the parties entering into treaty,
reference can be made to the preamble of the treaty, its protocol and the technical
memorandum.

In case of Union of India v. Azadi Bachao Andolan 263 ITR 706, the Supreme Court of India
observed that “the principles adopted for interpretation of treaties are not the same as those
in interpretation of statutory legislation. The interpretation of provisions of an international
treaty, including one for double taxation relief, is that the treaties are entered into at a political
level and have several considerations as their bases.”

The Supreme Court also made the reference to the preamble of the treaty to ascertain the
purpose of India-Mauritius Treaty. The Apex Court agreed with the contention of the Appellant
that “the preamble to the Indo-Mauritius DTAA recites that it is for ‘encouragement of mutual
trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting
the treaty”.

(iv) The Principle of Effectiveness: According to this principle, a treaty should be interpreted
in a manner as to have effect rather than make it void.

This principle, particularly stressed by the Permanent Court of International Justice, requires
that the treaty should be given an interpretation which ‘on the whole’ will render the treaty
‘most effective and useful’, in other words, which will enable the provisions of the treaty to
work and to have their appropriate effects 4.

(v) Principle of Contemporanea Expositio: A treaty’s terms are normally to be interpreted on the
basis of their meaning at the time the treaty was concluded. However, this is not a universal
principle.

In Abdul Razak A. Meman’s case [2005] 276 ITR 306, the AAR observed that “there can be
little doubt that while interpreting treaties, regard should be had to material contemporanea
expositio, which means that a statute is best explained by following the construction put upon
4 Prof. J. G. Starke in Introduction to International Law 10 th Edition

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.17 a

it by judges at the time it was made, or soon after. This proposition is embodied in Article 32
of the Vienna Convention, and is also referred to in the decision of the Hon’ble Supreme
Court in K. P. Varghese v. ITO [1981] 131 ITR 597.”
(vi) Liberal Construction: It is a general principle of construction with respect to treaties that
they shall be liberally construed so as to carry out the apparent intention of the parties .
In John N. Gladden v. Her Majesty the Queen 5, the principle of liberal interpretation of tax
treaties was reiterated by the Federal Court, which observed that “contrary to an ordinary
taxing statute a tax treaty or convention must be given a liberal interpretation with a view to
implementing the true intentions of the parties. A literal or legalistic interpretation must be
avoided when the basic object of the treaty might be defeated or frustrated in so far as the
particular item under consideration is concerned.”
The Court further recognised that “we cannot expect to find the same nicety or strict definition
as in modern documents, such as deeds, or Acts of Parliament, it has never been the habit
of those engaged in diplomacy to use legal accuracy but rather to adopt more liberal terms.”
(vii) Treaty as a Whole – Integrated Approach: A treaty should be construed as a whole and
effect should be given to each word which would be construed in the same manner wherever
it occurs. Any provision should not be interpreted in isolation; rather the entire treaty should
be read as a whole to arrive at its object and purpose.
(viii) Reasonableness and consistency 6 : Treaties should be given an interpretation in which the
reasonable meaning of words and phrases is preferred, and in which a consistent meaning
is given to different portions of the instrument. In accordance with the principles of
consistency, treaties should be interpreted in the light of existing international law.
An important aspect to be noted regarding the rules of interpretation is that they are not rules of law
and are not to be applied like the rules enacted by the legislature in an Interpretation Act .
(4) Extrinsic Aids to Interpretation of a Tax Treaty
A wide range of extrinsic material is permitted to be used in interpretation of tax treaties. According
to Article 32 of the Vienna Convention, the supplementary means of interpretation include the
preparatory work of the treaty and the circumstances of its conclusion.
According to Prof. Starke, one may resort to following extrinsic aids to interpret a tax treaty provided
that clear words are not thereby contradicted:

5 85 D.T.C. 5188 at 5190, Source: UOI v. Azadi Bachao Andolan 263 ITR 706 (SC)
6 Prof. J. G. Starke in Introduction to International Law 10 th Edition

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 26.18 INTERNATIONAL TAXATION

(i) Interpretative Protocols, Resolutions and Committee Reports, setting out agreed
interpretations;
(ii) A subsequent agreement between the parties regarding the interpretation of the treaty or the
application of its provisions [Art. 31(3) of the VCLT];
(iii) Subsequent conduct of the state parties, as evidence of the intention of the parties and their
conception of the treaty;
(iv) Other treaties, in pari materia (i.e., relating to the same subject matter), in case of doubt.
Provisions in Parallel Tax Treaties
If the language used in two tax treaties (say treaties: X and Y) are same and one treaty is more
elaborative or clear in its meaning (say treaty X) can one rely on the interpretation/explanations
provided in a treaty X while applying provisions of a treaty Y? Though the interpretation or
explanations in treaty X would not be binding while interpreting the treaty Y, however, if the language
is similar between the two treaties, one can make a reference to treaty X for understanding the
intention of the Contracting parties.
The views of the Indian Judiciary are, however, not consistent in this respect. There are contradictory
judgments by Indian courts/Tribunal in this regard.
International Articles/Essays/Reports
Like in the direct tax cases, Courts many a times refer to the Commentaries of Kanga Palkhiwala
and Sampath Iyengar for interpretation as they are considered authoritative source. Also under the
International taxation, various authors like Phillip Baker and Klaus Vogel’s commentary are
considered as classic sources of interpretation for understanding the tax treaties. International
Article/Essays/Reports are referred as extrinsic aid for interpretation of tax treaties. Like, in case of
CIT v. Vishakhapatnam Port Trust (1983) 144 ITR 146 (AP), the High Court obtained “useful
material” through international articles.
Protocol
Protocol is like a supplement to the treaty. In many treaties, in order to put certain matters beyond
doubt, there is a protocol annexed at the end of the treaty, which clarifies borderline issues.
A protocol is an integral part of a tax treaty and has the same binding force as the main clauses therein.
Protocol to India France treaty contains the Most Favoured Nation (MFN) Clause. Thus, one must
refer to protocol before arriving at any final conclusion in respect of any tax treaty provision .

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.19 a

MFN clause is usually found in Protocols and Exchange of Notes to DTCs. Under this clause a
country agrees to extend the benefits to the residents of the other country, which it had (first country)
promised to the residents of third country. It tries to avoid discrimination between residents of
different countries.
Normally, the benefit under this clause is restricted to a specific group like OECD countries or
developing countries. The nature of benefits under MFN clause could either be application of lower
rate of tax or narrowing the scope of the income liable to tax or allowing higher deduction in respect
of executive and general administrative expenses of head office.

CLARIFICATION REGARDING THE MOST-FAVOURED-NATION (MFN) CLAUSE IN THE

PROTOCOL TO INDIA'S DTAAS WITH CERTAIN COUNTRIES [CIRCULAR NO.3/2022 DATED
3.2.2022]
The Protocol to India's DTAAs with some of the countries, especially European States and OECD
members (The Netherlands, France, the Swiss Confederation, Sweden, Spain and Hungary)
contains a provision, referred to as the Most-Favoured-Nation (MFN) clause. Though each MFN
clause in these DTAAs has a different formulation, the general underlying prov ision is that if after
the signature/ entry into force (depending upon the language of the MFN clause) of the DTAA with
the first State, India enters into a DTAA with another OECD Member State, wherein India limits
its source taxation rights in relation to certain items of income (such as dividends, interest income,
royalties, Fees for Technical Services, etc.) to a rate lower or a scope more restricted than the
scope provided for those items of income in the DTAA with the first State, such beneficial treat ment
should also be extended to the first State.
Through this circular, the CBDT clarifies that the applicability of the MFN clause and benefit of the
lower rate or restricted scope of source taxation rights in relation to certain items of income (such
as dividends, interest income, royalties, Fees for Technical Services, etc.) provided in India's
DTAAs with the third States will be available to the first (OECD) State only when all the following
conditions are met:
(i) The second treaty (with the third State) is entered into after the signature/ Entry into Force
(depending upon the language of the MFN clause) of the treaty between India and the first
State;
(ii) The second treaty is entered into between India and a State which is a member of the
OECD at the time of signing the treaty with it;

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 26.20 INTERNATIONAL TAXATION

(iii) India limits its taxing rights in the second treaty in relation to rate or scope of taxation in
respect of the relevant items of income; and
(iv) A separate notification has been issued by India, importing the benefits of the second treaty
into the treaty with the first State, as required by the provisions of section 90(1) of the
Income-tax Act, 1961.
If all the conditions enumerated in (i) to (iv) are satisfied, then, the lower rate or restricted scope
in the treaty with the third State is imported into the treaty with an OECD State having MFN clause
from the date as per the provisions of the MFN clause in the DTAA, after following the due
procedure under the Indian tax law.

The Apex Court, in the case of AO v Nestle SA [2023] 458 ITR 756, held that the above (iv)
condition of issuance of notification under section 90 of the Income -tax Act, 1961 is necessary
and a mandatory condition to give effect to a tax treaty or any protocol which has the effect of
altering the existing provisions of the law.

Preamble

Preamble to a tax treaty could guide in interpretation of a tax treaty. As mentioned above, in case of
Azadi Bachao Andolan, the Apex Court observed that ‘the preamble to the Indo-Mauritius Double
Tax Avoidance Treaty recites that it is for the ‘encouragement of mutual trade and investment’ and
this aspect of the matter cannot be lost sight of while interpreting the treaty’. These observations are
very significant whereby the Apex Court has upheld ‘economic considerations’ as one of the
objectives of a Tax Treaty. Further, now after the BEPS Action Plan 6 recommendation and Multi -
lateral Instrument (MLI), the new text has been added to the Preamble to reflect that the treaties are
not intended for creating opportunities for double-non taxation and treaty shopping arrangements.
This will play a key-role in interpreting the treaties post MLI.

Mutual Agreement Procedure [MAP]

MAP helps to interpret any ambiguous term/provision through bilateral negotiations. MAP is more
authentic than other aids as officials of both countries are in possession of materials/documents
exchanged at the time of signing the tax treaty which would clearly indicate the object or purpose of
a particular provision. Successful MAPs also serve as precedence in case of subsequent
applications.

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 Basic Principles of Interpretation of a Treaty

Golden Rule - Subjective Teleological or The Principle Principle of Liberal Integrated Reasonable
Objective Interpretation Purposive of Contemporane Construction Approach ness and
Interpretation Interpretation Effectiveness a Exposition consistency

Any term or word Treaty is to be interpreted A treaty’s terms are Any provision should
should be so as to facilitate the normally to be interpreted not be interpreted in
interpreted keeping attainment of the aims and on the basis of their isolation; rather the
its objective or objectives of the treaty. meaning at the time the entire treaty should be
ordinary or literal This approach is also treaty was concluded. read as a whole to
meaning in mind. known as ‘objects and However, this is not a arrive at its object and
purpose’ method. universal principle. purpose.

© The Institute of Chartered Accountants of India

Terms of a treaty are to be interpreted A treaty should be It is a general principle Treaties should be given an
according to the common intention of interpreted in a of construction with interpretation in which the
the contracting parties at the time the manner to have respect to treaties that reasonable meaning of words
treaty was concluded. The intention effect rather than they shall be liberally and phrases is preferred, and
must be ascertained from the words make it void. construed so as to in which a consistent meaning
used in the treaty and the context carry out the apparent is given to different portions of
APPLICATION AND INTERPRETATION OF TAX TREATIES

thereof. intention of the parties. the instrument.

Extrinsic Aids to Interpretation of a Tax Treaty

Provisions in International Protocol Preamble Mutual

Parallel Tax Treaties Articles/Essays/Reports Agreement
26.21

Procedure [MAP]
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 26.22 INTERNATIONAL TAXATION

(5) Commentaries on OECD/UN Models and their importance

There are two model conventions – OECD Model Convention and the UN Model Convention. The
OECD Model was framed by the members from the developed countries. It gives importance to
residence based taxation. UN Model Convention represents a compromise between the developing
and developed countries. UN Model focusses on source based taxation. The OECD or UN Model
Convention provides template to the tax administrations for negotiating the tax treaties. There are
commentaries annexed to the Model Convention which helps in interpreting the model conventions.
The OECD Model Commentaries represent the views of the Members of OECD from different
countries. The UN Model Commentaries represent the views of the Group of Experts from different
countries who represent in their individual capacity. Therefore, commentaries are one of the
important rules of interpretation of tax treaties.

Views expressed in the commentaries carry great authority. However, the same are not binding on
the countries even where the countries are signatories to the Model Convention. This is due to the
fact that the actual treaties may be different from the model convention. Where Contracting States
adopt the text of the Article as per OECD Model convention or UN Model Convention without any
change, reliance can be placed on the Model Commentaries for interpreting the tax treaties. In the
Azadi Bachao Andolan case, the Supreme Court has made reference to the OECD convention while
interpreting terms used in DTAA.
(6) Foreign Courts’ Decisions
Tax treaties may be interpreted differently by the different countries. A treaty signed between country
A and B, may be interpreted by courts of Country A and B differently. Therefore, there may be no
harmonization in the interpretation of tax treaties. A same income may be classified as royalty by
one country and business income by another country. Therefore, reliance on foreign court rulings
may result in harmonious interpretation.
In many of the rulings Indian courts have referred to the foreign court cases for interpretation of
treaty provisions. In CIT v. Vishakhapatnam Port Trust’s case [1983] 144 ITR 146, the Andhra
Pradesh High Court observed that, “in view of the standard OECD Models which are being used in
various countries, a new area of genuine ‘international tax law’ is now in the process of developing.
Any person interpreting a tax treaty must now consider decisions and rulings worldwide relating to
similar treaties. The maintenance of uniformity in the interpretation of a rule after its international
adoption is just as important as the initial removal of divergences. Therefore, the judgments rendered
by courts in other countries or rulings given by other tax authorities would be relevant.”

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.23 a

In the under-noted cases, foreign court cases have extensively been quoted for interpretation of
treaty provisions:
Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC)
CIT v. Vishakhapatnam Port Trust [1983] 144 ITR 146
Abdul Razak A. Meman’s case [2005] 276 ITR 306(AAR)
(7) Ambulatory v. Static Approach
International tax law gets updated from time to time to keep up with the developments in the society
and the technology. Over the years, the OECD and UN have come up with different version of
commentaries. Similarly, even the domestic tax laws also amended from time to time. The tax
treaties make a reference to the domestic tax laws for the terms not defined under the treaty.
Therefore, whenever a reference is made in a treaty to the provisions of domestic tax laws or to the
Model Commentary for assigning meaning to a particular term, a question often arises what meaning
to be assigned to the said term – the one which prevailed on the date of signing a tax treaty or the
one prevailing on the date of application of a tax treaty. There are two views on the subject, namely,
Static and Ambulatory.

Meaning at the
Static approach time the treaty was
Meaning of a term signed
(not defined in the
treaty) as per the
domestic law Meaning at the
Ambulatory time of application
approach of treaty provisions

All Model Commentaries including the Technical Explanation on US Model Tax Convention favors
ambulatory approach, however with one caution and that is ambulatory approach cannot be applied
when there is a radical amendment in the domestic law thereby changing the sum and substance of
the term. Therefore, the current position under the domestic law or the latest version of the
commentary should be resorted to if that interpretation provides a suitable meaning of the term and
clarifies the term in a better way. This is due to the fact that such an interpretation has been
introduced under the Model Commentary because of lack of clarity at the earlier point in time.
Therefore, even if the treaty would be based on OECD Model 1977, still the meaning under the 2017
can be resorted to if that meaning provides a better clarity and the amendment is of clarificatory
nature. However, if the meaning of the term changes altogether, then the meaning at the time when
the treaty was signed should be resorted to.

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 26.24 INTERNATIONAL TAXATION

TEST YOUR KNOWLEDGE

Questions
1. What do you mean by double taxation? Discuss the connecting factors which lead to double
taxation.

2. “In addition to allocating the taxing rights and elimination of double taxation, there are various
other important considerations while entering into tax treaty”. Elucidate.
3. What is the General Rule of Interpretation under Vienna Convention of Law of Treaties?

4. What are the Extrinsic Aids to interpretation of a tax treaty?

5. Matrix Inc. incorporated in Country X, holds 26% controlling interest in Pilu Ltd., an Indian
Company. Pilu Ltd. declared dividend of ` 50,00,000 during the P.Y. 2025-26. The DTAA
between India and Country X, which came into force on 1.1.2018, provides for taxation of
dividend @15%. Thereafter, India entered into a DTAA with Country Y, which came into force
from 15.5.2018. The India-Country Y DTAA, inter alia, provides for concessional tax rate of
10% in respect of dividend. Country X is an OECD member since 2015 and Country Y is also
an OECD member since 2017.
Mr. Jack, CFO of Matrix Inc. seeks your opinion on whether the concessional tax rate provided
in the DTAA between India and Country Y can be availed by a resident of Country X and if
so, are there any further conditions to be satisfied in this regard. You may assume that the
protocol annexed to India’s DTAAs with all OECD member countries contain the relevant tax
parity clause.
Would your answer change, if Country Y had become an OECD member only in the year
2020?

Answers
1. The taxability of a foreign entity in any country depends upon two distinct factors, namely,
whether it is doing business with that country or in that country. Internationally, the term
used to determine the jurisdiction for taxation is “connecting factors”. There are two types of
connecting factors, namely, “Residence” and “Source”. It means a company can be subject
to tax either on its residence link or its source link with a country. If a company is doing
business in a host/source country, then, besides being taxed in the home country on the basis
of its residence link, it will also be taxed in the host country on the basis of its source link as

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.25 a

the company would be heavily engaged in doing business in the territory of other country, for
example, through its branch in that country.
However, if a company is doing business with another country (i.e., host/source country),
then, it would generally be subject to tax in its home country alone, based on its residence
link, since the company is not engaged in carrying on the business in the territory of source
country (for example, export of goods to another country). In this regard, it may, however, be
noted that significant economic presence in another country may result in tax liability in the
other country. For example, as per the Income-tax Act, 1961, transaction in respect of any
goods, services or property carried out by a non-resident with any person in India including
provision of download of data or software in India if aggregate of payments arising from such
transaction or transactions during the previous year exceeds ` 2 crores, would be deemed
as significant economic presence of such non-resident in India. Significant economic
presence of a non-resident in India would constitute business connection in India and
consequently, income would be deemed to accrue or arise in India and hence, be taxable in
India (the Source country).
• Juridical double taxation: When source rules overlap, double taxation may arise i.e.
tax is imposed by two or more countries as per their domestic laws in respect of the
same transaction, income arises or is deemed to arise in their respective jurisdictions.
This is known as “juridical double taxation”.
In order to avoid such double taxation, a company can invoke provisions of Double
Taxation Avoidance Agreements (DTAAs) (also known as Tax Treaty or Double
Taxation Convention–DTC) with the host/source country, or in the absence of such an
agreement, an Indian company can invoke provisions of section 91, providing unilateral
relief in the event of double taxation.
• Economic double taxation: ‘Economic double taxation’ happens when the same
transaction, item of income or capital is taxed in two or more states but in hands of
different persons (because of lack of subject identity)
2. In addition to allocating the taxing rights and elimination of double taxation, there are various
other important considerations while entering into a tax treaty, as mentioned below:
• Ensuring non-discrimination between residents and non-residents
• Resolution of disputes arising on account of different interpretation of tax treaty by the
treaty partner.

• Providing assistance in the collection of the fair and legitimate share of tax .

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Further, in addition to above, there are some other principles which must be considered by
countries in their tax system –
(i) Equity and fairness: Same income earned by different taxpayers must be taxed at
the same rate regardless of the source of income.
(ii) Neutrality and efficiency: Neutrality factor provides that economic processes should
not be affected by external factors such as taxation. Neutrality is two-fold.
(a) Capital export neutrality and
(b) Capital import neutrality (CIN).

Capital export neutrality (CEN) provides that business decision must not be affected
by tax factors between the country of residence and the target country; whereas CIN
provides that the level of tax imposed on non-residents as well as the residents must
be similar.
(iii) Promotion of mutual economic relation, trade and investment: In some cases, it
is observed that avoidance of double taxation is not the only objective. The other
objective may be to give impetus to a country’s overall economic growth and
development.
3. Article 31 of Vienna Convention of Law of Treaties contains the General Rule of Interpretation.
It lays down that following general rule of interpretation:
• A treaty shall be interpreted in good faith in accordance with the ordinary meaning to
be given to the terms thereof in the context and in the light of its object and purpose.
• The context for the purpose of interpretation of a treaty shall comprise, in addition to
the text, including its preamble and annexure
(a) Any agreement relating to the treaty which was made between all the parties in
connection with the conclusion of the treaty;
(b) Any instrument which was made by one or more parties in connection with the
conclusion of the treaty and accepted by the other parties as an instrument
related thereto.
• The following shall be taken into account, together with the context in that:
(a) Any subsequent agreement between the parties regarding the interpretation of
the treaty or the application of its provisions;

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 APPLICATION AND INTERPRETATION OF TAX TREATIES 26.27 a

(b) Any subsequent practice in the application of the treaty which establishes the
agreement of the parties regarding its interpretation;
(c) Any relevant rules of international law applicable to relation between the
parties.
• A special meaning shall be given to a term if it is established that the parties so
intended.
4. A wide range of extrinsic material is permitted to be used in interpretation of tax treaties.
According to Article 32 of the Vienna Convention, the supplementary means of interpretation
include the preparatory work of the treaty and the circumstances of its conclusion.
According to Prof. Starke, one may resort to following extrinsic aids to interpret a tax treaty
provided that clear words are not thereby contradicted:

(i) Interpretative Protocols, Resolutions and Committee Reports, setting out agreed
interpretations;
(ii) A subsequent agreement between the parties regarding the interpretation of the treaty
or the application of its provisions [Art. 31(3) of the VCLT];
(iii) Subsequent conduct of the state parties, as evidence of the intention of the parties
and their conception of the treaty;

(iv) Other treaties, in pari materia (i.e., relating to the same subject matter), in case of
doubt.
Provisions in Parallel Tax Treaties
If the language used in two tax treaties (say treaties: X and Y) are same and one treaty is
more elaborative or clear in its meaning (say treaty X) can one rely on the
interpretation/explanations provided in a treaty X while applying provisions of a treaty Y?
Though the interpretation or explanations in treaty X would not be binding while interpreting
the treaty Y, however, if the language is similar between the two treaties, one can make a
reference to treaty X for understanding the intention of the Contracting parties.

The views of the Indian Judiciary are, however, not consistent in this respect. There are
contradictory judgments by Indian courts/Tribunal in this regard.
International Articles/Essays/Reports
Like in the direct tax cases, Courts many a times refer to the Commentaries of Kanga
Palkhiwala and Sampath Iyengar for interpretation as they are considered authoritative

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source. Also under the International taxation, various authors like Phillip Baker and Klaus
Vogel’s commentary are considered as classic sources of interpretation for understanding
the tax treaties. International Article/Essays/Reports are referred as extrinsic aid for
interpretation of tax treaties. Like, in case of CIT v. Vishakhapatnam Port Trust (1983) 144
ITR 146 (AP), the High Court obtained “useful material” through international articles. .
Protocol
Protocol is like a supplement to the treaty. In many treaties, in order to put certain matters
beyond doubt, there is a protocol annexed at the end of the treaty, which clarifies borderline
issues.
A protocol is an integral part of a tax treaty and has the same binding force as the main
clauses therein.

Protocol to India France treaty contains the Most Favoured Nation (MFN) Clause. Thus, one
must refer to protocol before arriving at any final conclusion in respect of any tax treaty
provision.

Preamble
Preamble to a tax treaty could guide in interpretation of a tax treaty. As mentioned above, in
case of Azadi Bachao Andolan, the Apex Court observed that ‘the preamble to the Indo-
Mauritius Double Tax Avoidance Treaty recites that it is for the ‘encouragement of mutual
trade and investment’ and this aspect of the matter cannot be lost sight of while interpreting
the treaty’. These observations are very significant whereby the Apex Court has upheld
‘economic considerations’ as one of the objectives of a Tax Treaty. Further, now after the
BEPS Action Plan 6 recommendation and Multi-lateral Instrument (MLI), the new text has
been added to the Preamble to reflect that the treaties are not intended for creating
opportunities for double-non taxation and treaty shopping arrangements. This will play a key-
role in interpreting the treaties post MLI.
Mutual Agreement Procedure [MAP]
MAP helps to interpret any ambiguous term/provision through bilateral negotiations. MAP is
more authentic than other aids as officials of both countries are in possession of
materials/documents exchanged at the time of signing the tax treaty which would cl early
indicate the object or purpose of a particular provision. Successful MAPs also serve as
precedence in case of subsequent applications.

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5. The CBDT has, vide Circular No. 3/2022 dated 3.2.2022, clarified that the applicability of the
Most Favoured Nation (MFN) clause and benefit of the lower rate or restricted scope of source
taxation rights in relation to certain items of income including dividends provided in India's
DTAAs with the third State (Country Y, in this case) will be available to the first (OECD) State
(Country X, in this case) only when all the following conditions are met:
Condition Satisfaction of condition in the case on hand
(i) The second treaty (with the This condition is satisfied as India has entered
third State) is entered into after into a DTAA with Country Y on 15.5.2018, after it
the signature/ Entry into Force has entered into a DTAA with Country X on
of the treaty between India and 1.1.2018.
the first state
(ii) The second treaty is entered This condition is satisfied as India has entered
into between India and a State into a DTAA on 15.5.2018 with Country Y, which
which is a member of the is a member of OECD since 2017. Hence, on
OECD at the time of signing the 15.5.2018, Country Y was an OECD member.
treaty with it;
(iii) India limits its taxing rights in This condition is satisfied since in DTAA between
the second treaty in relation to India and Country Y, dividend is taxable@10%.
rate or scope of taxation in
respect of relevant items of
income
(iv) A separate notification has In this case, conditions (i), (ii) and (iii) mentioned
been issued by India, importing above have been satisfied. The concessional rate
the benefits of the second of 10% can be applied for taxing the dividend
treaty into the treaty with the received by Matrix Inc. from Pilu Ltd., an Indian
first State as required by the company, only if India has issued a separate
provisions of section 90(1) of notification importing the benefits of India-
the Income-tax Act, 1961. Country Y tax treaty into India-Country X tax
treaty, as required by the provisions of sections
90(1). If such notification has been issued, then,
the concessional rate of 10% can be applied for
taxing the dividend received by Matrix Inc. from
Pilu Ltd., an Indian company; otherwise it cannot
be applied, even if other conditions are satisfied.

In case if Country Y became an OECD member only in the year 2020, then, the concessional
rate of 10% cannot be applied for taxing dividend received by Matrix Inc. from Pilu Ltd., since
Country Y was not an OECD member on 15.5.2018, at the time when India signed the DTAA
with it. Consequently, condition (ii) mentioned above would not be satisfied in such a case.
Hence, dividend received by Matrix Inc. from Pilu Ltd. would be subject to tax@15%.

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© The Institute of Chartered Accountants of India
CHAPTER a
27

OVERVIEW OF MODEL TAX

CONVENTIONS

LEARNING OUTCOMES
After studying this chapter, you would be able to:
❑ appreciate the need for Model Tax Convention;
❑ appreciate the key features of the OECD and UN Model Tax
Conventions;
❑ identify the subject of the various articles of the OECD and UN Model
Tax Conventions;
❑ appreciate the broad similarities and differences between the principles
enshrined in certain articles of the OECD Model Tax Convention vis-à-
vis the corresponding articles of the UN Model Tax Convention.

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 27.2 INTERNATIONAL TAXATION

27.1 INTRODUCTION
In order to enable various countries to enter into treaties, which are standardized to some extent,
Organization for Economic Cooperation and Development (OECD) and the United Nations (UN)
have developed certain Model Tax Treaties. These treaties can be used by various countries as a
starting point in their negotiations with other countries. While these Models are not legally binding,
they have been extensively used by various countries as a reference point while entering into Tax
Treaties. In some cases, they have been incorporated verbatim or with minor changes. However,
in other cases, countries have made suitable changes in the draft model according to their
economic environment and commercial and tax considerations.

The significant model conventions have been briefly discussed hereunder:

OECD Model - The emergence of present form of OECD Model Convention can be traced back to
1927, when the Fiscal Committee of the League of Nations prepared the first draft of Model Form
applicable to all countries. In 1946 the model convention was published in Geneva by the Fiscal
Committee of U.N. Social & Economic Council and later by the Organisation for European
Economic Co-operation (OEEC) in 1963. However, in 1961, the Organisation for Economic Co -
operation and Development (OECD) was established, with developed countries as its members, to
succeed the OEEC, and OECD approved the draft presented to the OEEC. In 1977, the final draft
was prepared in the present form which has been revised several times; the latest being in the
year 2017.
OECD Model Convention (OECD MC) is essentially a model treaty between two developed
nations. This model advocates residence based taxation, i.e., it lays emphasis on the right of state
of residence to tax the income.
UN Model – In 1968, the United Nations set up an Adhoc Group of Experts from various
developed and developing countries to prepare a draft model convention between developed
and developing countries. In 1980, this Group finalised the UN Model Convention (UN MC) in its
present form. Since its first publication in 1980, the Model has been updated previously in 2001,
2011 and 2017. The latest updation was in the year 2021.

The UN MC is a compromise between the source principle and the residence principle. However, it
gives more weight to the source principle as against the residence principle of the OECD M C. UN
MC is designed to encourage flow of investments from the developed countries to developing
countries. It takes into account sharing of tax-revenue with the country providing capital.

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The United Nations MC seeks to be balanced in its approach. As a corollary to the principle of
taxation at source, the Articles of the Convention are based on a recognition by the source country
that
(a) taxation of income from foreign capital should take into account expenses allocable to the
earnings of the income so that such income is taxed on a net basis,
(b) taxation should not be so high as to discourage investment and
(c) it should take into account the appropriateness of the sharing of revenue with the country
providing the capital.

In addition, the United Nations MC embodies the idea that it would be appropriate for the
residence country to extend a measure of relief from double taxation through either a foreign tax
credit or an exemption, as is also the case with the OECD Model Convention.

US Model – This Model Convention is used by the United States while entering into tax treaties
with various countries. The US Model Convention was last revised in 2016.
These Models have a significant influence on international treaty practice, and have important
common provisions. The similarities between these Models highlight the areas of consistency. The
areas of divergence indicate some critical differences in approach or emphasis which need special
focus. These differences are mainly in relation to the taxing rights which would be available to a
country under domestic law and the extent to which any country should forego, under a bilateral
tax treaty, in order to avoid double taxation and encourage investment.
The above model conventions have been illustrated in the following diagram:

Model Conventions

OECD Model UN Model US Model

Model Convention Model Convention

between developed between developed and
Applied by the United
countries – Advocates developing country –
States
Residence Principle More emphasis on
Source Principle

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 27.4 INTERNATIONAL TAXATION

OECD Model contains VII chapters comprising of 32 articles and UN Model also contains VII
chapters but comprising of 31 articles. List of articles of OECD MC and UN MC is given below:
Article OECD Model, 2017 UN Model, 2021
Chapter I : Scope of the Convention
1 Persons covered Persons covered
2 Taxes covered Taxes covered
Chapter II : Definitions
3 General definitions General definitions
4 Resident Resident
5 Permanent establishment Permanent establishment
Chapter III : Taxation of Income
6 Income from immovable property Income from immovable property
7 Business profits Business profits
8 International shipping and air International shipping and air transport
transport (Alternatives A & B)
9 Associated enterprises Associated enterprises
10 Dividends Dividends
11 Interest Interest
12 Royalties Royalties
12A Fees for technical services
12B Income from automated digital services
13 Capital gains Capital gains
14 Independent personal services
15 Income from employment Dependent personal services
16 Directors’ fees Directors’ fees and remuneration of top-level
managerial officials
17 Entertainers and sportspersons Artistes and sportspersons
18 Pensions Pensions and social security payments
(Alternatives A & B)
19 Government service Government service
20 Students Students
21 Other income Other income
Chapter IV : Taxation of Capital
22 Capital Capital

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Chapter V : Methods for the Elimination of Double Taxation

23A Exemption method Exemption method
23B Credit method Credit method
Chapter VI : Special Provisions
24 Non-discrimination Non-discrimination
25 Mutual agreement procedure Mutual agreement procedure (Alternatives A & B)
26 Exchange of information Exchange of information
27 Assistance in the collection of Assistance in the collection of taxes
taxes
28 Members of diplomatic missions Members of diplomatic missions and consular
and consular posts posts
29 Entitlement to benefits Entitlement to benefits
30 Territorial extension
Chapter VII : Final Provisions
31/30 Entry into force Entry into force
32/31 Termination Termination

Now, let us discuss the comparative analysis of some of the significant Articles in the Model Tax
conventions.

27.2 COMPARATIVE ANALYSIS OF SOME OF THE

SIGNIFICANT ARTICLES OF OECD AND UN MODEL
CONVENTIONS
Title and Preamble to the Model Conventions

The title of the UN Model Convention reads as follows:

“Convention between (State A) and (State B) for the elimination of double taxation with
respect to taxes on income and capital and the prevention of tax avoidance and evasion ”
There is a specific reference to “the prevention of tax avoidance and evasion” in the title to
emphasize its significance in the Model Convention.
The Preamble to the UN Model Convention reads as follows:
“(State A) and (State B),

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 27.6 INTERNATIONAL TAXATION

Desiring to further develop their economic relationship and to enhance their cooperation in tax
matters,
Intending to conclude a Convention for the elimination of double taxation with respect to taxes on
income and on capital without creating opportunities for non-taxation or reduced taxation through
tax avoidance or evasion (including through treaty-shopping arrangements aimed at obtaining
reliefs provided in this Convention for the indirect benefit of residents of third States) ”
The Title and Preamble to the OECD Model Convention is almost identical to that of the UN Model
Convention. The only minor difference is the reference to “tax evasion and avoidance” in the place
of “tax avoidance and evasion” in the Title and Preamble.
The Preamble clearly indicates that the UN and OECD Model Conventions do not intend to create
opportunities for non-taxation or reduced taxation through tax avoidance or evasion including
through treaty shopping arrangements.
This language of the Preamble would help ensuring that the provisions of the Conventions are
interpreted and applied to prevent abusive treaty shopping arrangements.
Significant Articles in the Model Conventions

Over the years, both Model Conventions have seen a lot of convergence and the language is
identical in quite a few Articles. However, there are key differences in approach and language in
some Articles which will be the focus of our discussion, in the section below.
The jurisdiction or country of residence of the taxpayer is referred to as the Residence State and
the jurisdiction or country where the source of income is located is referred to as the Source State.
Article 1: Persons Covered

The OECD and UN Model Convention would apply to persons who are residents of one or both of
the Contracting States.
For the purposes of these Conventions, income derived by or through an entity or arrangement
that is treated as wholly or partly fiscally transparent under the tax law of either Contracting State
shall be considered to be income of a resident of a Contracting State. However, the same would
be treated as income only to the extent that the income is treated, for purposes of taxation by that
State, as the income of a resident of that State.
Example
State A and State B have concluded a treaty identical to the Model Tax Convention. State A
considers that an entity established in State B is a company, and taxes that entity on interest that it

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receives from a debtor resident in State A. Under the domestic law of State B, however, the entity
is treated as a partnership, and the two members in that entity, who share equally all its income,
are each taxed on half of the interest. One of the members is a resident of State B and the other
one is a resident of a country with which States A and B do not have a treaty. The paragraph
provides that in such case, half of the interest shall be considered, for the purposes of Article 11,
to be income of a resident of State B.
Note – The above example forms part of the Commentary to the UN Model Tax Convention.

With the exception of benefits granted under certain Articles of these conventions, these
Conventions would not affect the taxation, by a Contracting State, of its resident.

Article 1 of UN Model Convention covers provision dealing with the application of the Convention
to “Collective investment vehicles”. Funds that are widely-held, hold a diversified portfolio of
securities and are subject to investor-protection regulation in the country in which they are
established are referred to as “collective investment vehicles” (CIVs) like REITs.
These funds adopt different legal structures and may be set up, for instance, as companies,
partnerships, trusts or contractual arrangements that create a joint ownership. It is to ensure that
investing through a domestic CIV should result in a tax burden that is equal to the one that applies
in the case of a direct investment, i.e. an investment where the CIV would not exist and where the
investor in the CIV would have acquired directly its share of the assets held by the CIV.
Article 2: Taxes Covered

The OECD and UN Conventions would apply to taxes on income and on capital imposed on behalf
of a Contracting State or of its political subdivisions or local authorities, irrespective of the manner
in which they are levied.
Taxes on income and on capital cover all taxes imposed on total income, on total capital, or on
elements of income or of capital, including taxes on gains from the alienation of movable or
immovable property, taxes on the total amounts of wages or salaries paid by enterprises, as well
as taxes on capital appreciation.
The existing taxes to which the Conventions would apply in case of each Contracting State are
specifically to be mentioned.
The Convention shall apply also to any identical or substantially similar taxes which are imposed
after the date of signature of the Convention in addition to, or in place of, the existing taxes. The
competent authorities of the Contracting States shall notify each other of significant changes made
to their tax law.

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Article 4: Residence

A taxpayer has to demonstrate that he is a resident of one or both Contracting States to be able to
gain access to a tax treaty and avail the benefits thereunder.
The concept of ‘resident of a Contracting State’ has various functions and assumes significance in
the following three scenarios:
• In determining a convention’s scope of application;
• In solving cases where double taxation arises as a consequence of double residence;
• In solving cases where double taxation arises as a consequence of taxation in the state of
residence and also in the state of source of income.
As per paragraph 1 of the UN Model Convention, the term “resident of a Contracting State” means
any person who, under the laws of that State, is liable to tax therein by reason of that person’s
domicile, residence, place of incorporation, place of management or any other criterion of a similar
nature, and also includes that State and any political subdivision or local authority thereof as well
as a recognized pension fund of that State. This term, however, does not include any person
who is liable to tax in that State in respect only of income from sources in that State or capital
situated therein.

Paragraph 1 of the OECD Model Convention is worded on similar lines. However, it does not
contain reference to place of incorporation and does not include recognized pension fund.
Where by reason of the provisions of paragraph 1, an individual is a resident of both Contracting
States, then, his status shall be determined as follows:
(a) he shall be deemed to be a resident only of the State in which he has a permanent home
available to him; if he has a permanent home available to him in both States, he shall be
deemed to be a resident only of the State with which his personal and economic relations
are closer (centre of vital interests);
(b) if the State in which he has his centre of vital interests cannot be determined, or if he has
not a permanent home available to him in either State, he shall be deemed to be a resident
only of the State in which he has an habitual abode;
(c) if he has an habitual abode in both States or in neither of them, he shall be deemed to be a
resident only of the State of which he is a national;
(d) if he is a national of both States or of neither of them, the competent authorities of the
Contracting States shall settle the question by mutual agreement.

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As per paragraph 3 of this Article, where by reason of the provisions of paragraph 1, a person
other than an individual is a resident of both Contracting States, the competent authorities of the
Contracting States shall endeavour to determine by mutual agreement, the Contracting State of
which such person shall be deemed to be a resident for the purposes of the Convention. They
shall do so having regard to its place of effective management, the place where it is incorporated
or otherwise constituted and any other relevant factors. In the absence of such mutual agreement,
such person shall not be entitled to any relief or exemption from tax provided by this Convention
except to the extent and in such manner as may be agreed upon by the competent authorities of
the Contracting States.
The situation of dual residence may arise in case of companies in case where one Contracting
State attaches importance to the place of incorporation and the other State to the place of effective
management. The tie-breaker rule traditionally has been ‘place of effective management’. Even
India has used place of effective management in some of its treaties. In the latest update by OECD
and UN, this has changed to a case by case approach considering the number of tax avoidance
cases involving dual resident companies. Determination under the case by case approach will be
requested by the concerned taxpayer through Article 25 (Mutual Agreement Procedure).
Competent authorities will then rely on a range of factors to resolve the question of dual residency.

The last sentence of paragraph 3 of this Article provides that in the absence of determination by
the competent authorities, the dual resident person would not be entitled to any relief or exemption
from tax provided by this Convention except to the extent and in such manner as may be agreed
upon by the competent authorities of the Contracting States. This will not, however, prevent the
taxpayer from being considered a resident of each Contracting State for purposes other than
granting treaty reliefs or exemptions to that person.
Article 5: Permanent Establishment

The concept of “Permanent Establishment” (PE), defined in Article 5, has considerable importance
as business profits (Article 7) of an enterprise cannot be taxed by a Source State unless it proves
the existence of a PE.
The comparable term to PE under the Indian tax law is “business connection” [Section 9(1)(i)].
Generally speaking, the concept of “business connection” is wider than PE and hence, a business
connection may exist even without a PE, but the absence of a “business connection” may indicate
absence of a PE.

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As the PE concept gives the Source State the right to tax, it is an important Article for developing
countries. Hence, the UN Model Convention varies from the OECD Model Convention in the
following respects:

• As per Article 5(3)(a) of the OECD Model Convention, a building site or construction or
installation project constitutes a PE if it lasts more than twelve months. The UN Model
Convention is wider as it covers “assembly or installation project” or “supervisory” activities
in connection thereto and requires the activity in question to continue only for six months for
constituting a PE.

• Article 5(3)(b) of the UN Model makes a specific reference to Service PE which is absent in
the OECD Model. Article 5(3)(b) of the UN Model reads as follows –

“The furnishing of services, including consultancy services, by an enterprise through

employees or other personnel engaged by the enterprise for such purpose, but only if
activities of that nature continue within a Contracting State for a period or periods
aggregating more than 183 days in any 12 month period commencing or ending in the fiscal
year concerned”.

In the absence of a Service PE reference in OECD Model, the presence has to be

ascertained through general principles under Article 5(1).

• Article 5(1) states the "basic rule" for a PE and expresses the primary meaning of PE. The
definition of PE in Article 5 does not use the qualifying words "unless the context otherwise
requires". As such, the definition needs to be followed in all cases unless specifically
excluded.

Paraphrasing Article 5(1), a PE exists if the following conditions are satisfied cumulatively:

➢ There is an “enterprise”.

➢ Such enterprise is carrying on a "business";

➢ There is a "place of business";

➢ Such place of business is at the disposal of the enterprise (may be owned/rented but
must be one which the enterprise has the effective power to use);

➢ The place of business is "fixed", that is, it must be established at a distinct place with
a certain degree of permanence

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The business of the enterprise is carried on wholly or partially through this fixed place of
business.

A PE does not exist unless all the aforesaid conditions are satisfied.

• As per Article 5(2), the term "permanent establishment" includes especially:

a) a place of management;

b) a branch;

c) an office;

d) a factory;

e) a workshop, and

f) a mine, an oil or gas well, a quarry or any other place of extraction of natural
resources.

• Agency PE under OECD and UN Models targets activities done by a dependent agent of
the enterprise in the Source State. The definition of dependent agent PE include s instances
when an agent habitually concludes contracts, or habitually plays the principal role leading
to the conclusion of contracts routinely concluded without material modification by the
enterprise.

In UN Model Convention, PE is constituted even if the person does not habitually conclude
contracts nor plays the principal role leading to the conclusion of such contracts, but
habitually maintains in that State, a stock of goods or merchandise from which that person
regularly deliver goods or merchandise on behalf of that enterprise.

• The UN Model Convention has an additional Article 5(6) relating to insurance which is
absent in OECD Model.

As per this Article, an insurance enterprise of a Contracting State shall, except in regard to
re-insurance, be deemed to have a permanent establishment in the other Contracting State
if it collects premiums in the territory of that other State or insures risks situated therein
through a person.

In the absence of similar Article in the OECD Model, a PE of an insurance enterprise has to
be determined in accordance with provisions of Article 5(1) or 5(2) of the OECD model.

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Article 7: Business Profits

Business profits of an enterprise can only be taxed by the Residence State. Right of Source State
to tax business profits of an enterprise only exists if a PE exists in its jurisdiction.
As per the approach under the OECD Model Convention, once a PE is proven, the Source State
can tax only such profits as are attributable to the PE. The UN Model Convention amplifies this
attribution principle by a limited Force of Attraction rule (FOA).
The FOA rule implies that when a foreign enterprise sets up a PE in State of Source, it brings itself
within the fiscal jurisdiction of that State (State of Source) to such a degree that profits that the
enterprise derives from State of Source, whether through the PE or not, can be taxed by it (State
of Source).

As per Article 7 of the UN Model Convention, if the enterprise carries on business in the other
Contracting State through a PE, the profits of the enterprise may be taxed in the other State but
only so much of them as is attributable to:

(a) that PE;

(b) sales in that other State of goods or merchandise of the same or similar kind as those sold
through that PE; or

(c) other business activities carried on in that other State of the same or similar kind as those
effected through that PE.
Article 11: Interest

Paragraph 1 of this Article provides the right to Residence State to tax interest. Paragraph 2,
however, also confers right to the Source State to tax interest. Generally, the interest is taxed in
the Source State at a given rate on gross basis. However, if the beneficial owner of the interest is
a resident of the other Contracting State, the tax so charged cannot exceed a specified percentage
of the gross amount of the interest. The OECD Model specifies the percentage as 10%, but the UN
Model leaves this percentage to be established through bilateral negotiations.
It may be noted that the definition of interest in both the models viz. OECD and UN Model is
similar in that it essentially means income from debt claims of every kind , whether or not secured
by mortgage and whether or not carrying a right to participate in the debtor’s profits, and in
particular, income from government securities and income from bonds or debentures, including
premiums and prizes attaching to such securities, bonds or debentures. Penalty charges for late
payment are not regarded as interest for the purpose of this Article.

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Article 12: Royalties

This Article provides the right of Contracting States to tax income from royalty.
Key differences between the two Models are as follows:
• As per the OECD Model, royalties arising in the Source State and beneficially owned by a
resident of the Residence State are taxable only in the Residence State. However, the UN
Model provides that royalties may be taxed in the Residence State. Hence, the UN Model
departs from the principle of exclusive right to tax provided to Residence State in the OECD
Model. Thus, under the UN Model, the Source State may also tax royalties. However, if the
beneficial owner is a resident of the Residence State, the tax charged by the Source State
cannot exceed the specified percentage of the gross amount of royalties. This specified
percentage is to be established through bilateral negotiations.
• The term “royalties” as per UN Model Convention means payments of any kind received as
a consideration for the use of, or the right to use, any copyright of literary, artistic or
scientific work including cinematograph films, or films or tapes used for radio or television
broadcasting, any patent, trademark, design or model, plan, secret formula or process, or
for the use of, or the right to use, industrial, commercial or scientific equipment or for
information concerning industrial, commercial or scientific experience.
• The definition of ‘royalties’ under the OECD Model does not include the following: (a)
rentals for films or tapes used for radio or television broadcasting and (b) equipment rentals
like rentals for industrial, commercial or scientific equipment.
Article 12A: Fees for Technical Services

India is the pioneer of the FTS concept which was added to the Income-tax Act, 1961 since 1976.
Some of our tax treaties do contain a specific provision for FTS.
The UN Model has a specific article pertaining to Fees for Technical Services (FTS). There is no
specific reference to FTS in the OECD Model.
Paragraph 1 of Article 12A provides that the FTS may be taxed in the Residence State but does
not provide that the FTS is exclusively taxable in the Residence State.
Paragraph 2 establishes the right of the country in which FTS arises to tax in accordance with its
domestic law, subject to the limitation on the maximum rate of tax on gross amount of the fees, if
the beneficial owner is a resident of the other Contracting State. The maximum rate of tax is to be
established through bilateral negotiations.

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FTS is defined as payments for managerial, technical or consultancy services but excludes
payment to an employee, payment for teaching in an educational institution or for teaching by an
educational institution, payments by an individual for services for personal use. Management
involves application of knowledge, skill or expertise in the control or administration of the conduct
of a commercial enterprise or organization. Payments made to a consultant for advice related to
the management of an enterprise (or of the business of an enterprise) would be FTS. Technical
involves the application of specialized knowledge, skill or expertise with respect to a particular art,
science, profession or occupation. Fees received for services provided by regulated professions
such as law, accounting, architecture, medicine, engineering would constitute FTS. Services
performed by other professionals, such as pharmacists, and scientists, etc. may constitute
technical services if those services involve provision of specialized knowledge, skill and expertise.
The ordinary meaning of “consultancy” involves the provision of advice or services of a specialized
nature.

An example of FTS can be seen from the following facts: R Company is a financial institution
resident in State R. R Company provides a wide variety of financial services to its customers,
including acceptance of deposits, extension of credit, guarantees, foreign exchange, negotiable
instruments. R Company’s business is conducted primarily in State R, but it also has clients in
other countries, including State S. State R and State S have a tax treaty which contains an article
akin to Article 12A. Payments received for services provided by a financial institution would
constitute FTS if the services involve use of knowledge, skill and expertise to provide research,
analysis or advice to a specific client related to particular circumstances. This has to be
distinguished from provision of non-specialized services such as payment and transmission
services, debit and credit card services, etc., which do not involve the application of any
specialized knowledge, skill and expertise on behalf of a particular client.
Article 12B: Income from Automated Digital Services

With the advent of modern means of telecommunications and the spread of digitalization,
enterprises have the ability to effectively engage in substantial business activities in the market
country (source jurisdiction) without a fixed place of business there, or to conclude contracts
remotely through technological means with no involvement of individual employees or dependent
agents.
Article 12B was added to the United Nations Model Tax Convention in its 2021 update to preserve
the domestic law taxing rights for States from which payments for automated digital services are
made. There is no article in the OECD Model corresponding to Article 12B.

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Paragraph 1 of Article 12B provides that the income from automated digital services arising in a
Contracting State, underlying payments for which made to a resident of other Contracting State,
may be taxed in the Residence State. It does not, however, provide that the income from
automated digital services is exclusively taxable in the Residence State.
Paragraph 2 establishes the right of the country in which income from automated digital services
arises to tax in accordance with its domestic law. However, if the beneficial owner of the income is
a resident of the Residence State, the tax charged by the Source State cannot exceed the
specified percentage of the gross amount of payments underlying the income from automated
digital services. This specified percentage is to be established through bilateral negotiations.
“Automated digital services” is defined in paragraph 5 to mean any service provided on the Internet
or another electronic network, in either case requiring minimal human involvement from the service
provider.
An important indicator of the concept of automated services is whether there is ability to scale up
and provide the same type of services to new users with minimal human involvement. Once the
service offering an automated digital service business is developed (such as a music catalogue or
a social media platform), then, the business can provide that service to one user, or many more,
on an automated basis with the same basic business processes. On the other hand, a non-
automated digital service business would see a proportionate increase in the costs per unit in
connection with providing the services to new customers.
Paragraph 6 lists examples of services that may constitute automated digital services. However,
the provision is not self-standing; the requirements of paragraph 5 must also be met. Paragraph 6
simply provides an indication that an activity may constitute an automated digital service; it does
not provide that an activity listed therein necessarily is an automated digital service. The following
services are expressly mentioned in paragraph 6:
(a) online advertising services;
(b) supply of user data;
(c) online search engines;
(d) online intermediation platform services;
(e) social media platforms;

(f) digital content services;

(g) online gaming;

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(h) cloud computing services; and

(i) standardized online teaching services.
The categories are not mutually exclusive; for example, a digital content service could be funded in
whole or in part by online advertising.
Paragraph 7 provides that the provisions of Article 12B shall not apply if the payments underlying
the income from automated digital services qualify as “royalty” or “fees for technical services”
under Article 12 or Article 12A.
Article 13: Capital Gains

This is the most commonly used Article and it provides for the taxation of income arising from
transfer of a capital asset, including transfer of shares. The right to tax income from capital gains
may be exclusively with the Residence State, or shared between the Residence and Source
States.
The Article does not specify what is a capital gain and how is to be computed, this being left to the
applicable domestic law. The Article contains rules for taxation of gains made from alienation of
different assets such as immovable property, immovable property forming part of a PE, ships and
aircrafts, etc.

In respect of shares, both Models are identical. Rights are conferred to the Source State if more
than 50 percent of the value of shares during the preceding 365 days is derived directly or
indirectly from immovable property in such Source State. Otherwise, the Residence State would
have the exclusive right to tax.
UN Model Convention allows a State to tax gains from the alienation of rights granted under the
law of that State as long as these rights allow the use of resources that are naturally present in
that State and that are under the jurisdiction of that State. This would cover, for example, the
alienation of rights such as fishing quotas granted by the State; the right to fell timber in a forest;
the right to extract water; the right to explore part of a territory of the State for oil, gas or minerals;
the right to install wind or tidal stream turbines in part of the territory of the State as well as the
right to use all or part of the radiofrequency spectrum in the State, including for cell phone
purposes.
This provision does not cover rights granted contractually between private parties even if these
rights are protected under the law of the State. Thus, the alienation of exclusive right to use know
how in a given State would not be covered by the provision as that right granted by the owner of
the know-how is not granted under the law of the State.

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Both UN and OECD Model convention gives exclusive right to Residence State in case of g ains
from the alienation of any property other than covered in the other paragraphs of this Article .
Article 14: Independent Personal Services

Article 14 is only present in the UN Model. It was deleted from the OECD Model on 29-4-2000 on
the basis of OECD Report (2000) on “Issues Related to Article 14 of the OECD Model Tax
Convention”. The Effect of deletion of Article 14 is that income derived from Professional Services
etc., is now dealt with as ‘Business Profits’ (Article 7) under the OECD MC.
This Article deals with the taxation of income derived by a person for professional or specified
services which are offered in the Source State through some presence. This article on
Independent personal services in the UN Model reads as under:

(1) Income derived by a resident of a Contracting State in respect of professional services or

other activities of an independent character shall be taxable only in that State except in the
following circumstances, when such income may also be taxed in the other Contracting
State:
(a) If he has a fixed base regularly available to him in the other Contracting State for the
purpose of performing his activities; in that case, only so much of the income as is
attributable to that fixed base may be taxed in that other Contracting State; or
(b) If his stay in the other Contracting State is for a period or periods amounting to or
exceeding in the aggregate 183 days in any twelve-month period commencing or
ending in the fiscal year concerned; in that case, only so much of the income as is
derived from his activities performed in that other State may be taxed in that other
State.
(2) The term "professional services" includes especially independent scientific, literary, artistic,
educational or teaching activities as well as the independent activities of physicians,
lawyers, engineers, architects, dentists and accountants.
Thus, the Article covers independent activities involving professional skills rendered by individuals
on a principal to principal basis. The meaning of the term “professional services” is illustrated by
some examples of typical liberal professions. The enumeration has an explanatory character only
and is not exhaustive. It excludes industrial and commercial activities that are covered under the
Article on Business Profits. Likewise, it also excludes professional services while in employment
which are covered under the Article on Dependent Personal Services, e.g. a physician serving as
a medical officer in a factory. Income of Artists, Athletes and Sportsmen, etc. is not covered by this
Article. Also, income from Fees from Technical Services is also not covered.

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Article 21: Other Income

This Article deals with taxation of items of income which are not specifically taxable under any
other specific Article. Key differences are as under:
• OECD approach envisages that the exclusive right to tax is with the Residence State. UN
Model contains an additional paragraph, Article 21(3), which provides that Source State
may also tax other income.
• Article 21(2) of both OECD and UN Model provides that for income effectively connected
with a PE maintained in a Contracting State by a resident of the other Contracting State ,
taxation is governed by the provisions of Article 7 (Business Profits). Additionally, UN Model
provides that if the aforesaid income is effectively connected with a fixed base situated in a
Contracting State by a resident of the other Contracting State, taxation would be governed
by the provisions of Article 14 (Independent personal services).
Articles 23A & 23B : Elimination of Double Taxation

In many cases, the application of tax treaty may result into double taxation for tax payers. In such
a case, in order to provide relief to such tax payers, Articles 23A and 23B which contains
provisions relating to elimination of double taxation have to be applied. Articles 23A and 23B
provide for the mechanism through which tax credit/exemption may be available in the Residence
State for taxes deducted in the Source State.

The OECD and UN Model Conventions specify two approaches - Exemption method (Article 23A)
and Credit method (Article 23B). Under the exemption method, tax exemption may be available in
the Residence State. Under the credit method, tax credit may be available in the Residence State
for taxes deducted in the Source State. These methods are not mutually exclusive and there may
be cases where a treaty may adopt exemption method for certain types of income and credit
method for other incomes.
The double taxation referred to here, is juridical double taxation, meaning the same income or
capital is taxable in the hands of the same person by more than one State. It does not thus,
encompass situations of economic double taxation, i.e. where two different persons are taxable in
respect of the same income or capital. If two States wish to solve problems of economic double
taxation, they must do so in bilateral negotiations.
Article 25: Mutual Agreement Procedure

There may be a situation wherein a tax payer may believe that the treatment accorded by either or
both Contracting States is not in accordance with the provisions of the tax treaty. In such a case,
there is a need for dispute resolution which is addressed by this Article. This Article requires

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competent authorities of both countries to endeavor to resolve the conflict by engaging in bilateral
negotiations.
The UN Model Convention provides two alternatives - Alternative A and Alternative B, for the
article on Mutual Agreement Procedure which were introduced in 2011. Under OECD Model the
taxpayer may make a request to either Contracting State while UN Model (Alternative A)
contemplates taxpayer going to Residence State or the country of his nationality. Alternative B of
UN Model Article 25 contemplates reference to an arbitration process as part of the Mutual
Agreement Procedure. The decision arrived at, through the process is binding unless a person
directly affected does not accept it.
Key differences between the OECD Model Convention (Article 25) and UN Model Convention
(Article 25B - Alternative B) are as follows:

• Article 25B(5) of the UN Model provides that an arbitration may be initiated if the competent
authorities are unable to reach an agreement on a case within three years from the
presentation of that case. However, Article 25(5) of the OECD Model provides a time limit of
two years from the date when all the information required by the competent authorities in
order to address the case need to be provided to both competent authorities.
• Article 25B(5) of the UN Model provides that arbitration must be requested by the
competent authority of one of the Contracting States. Once such a request is made, the
taxpayer will be notified. However, as per Article 25(5) of the OECD Model, arbitration must
be requested in writing by the person who initiated the case.
• Article 25B(5) of the UN Model allows the competent authorities to depart from the
arbitration decision if they agree to do so within six months after the decision has been
communicated to them.
Article 26: Exchange of Information

In order to complete tax cases, a country may require certain information which may be available
with the treaty partner. Article 26 provides for the information which may be exchanged and the
manner in which such a request has to be made. The purpose of Article 26 is to facilitate effective
exchange of information between Contracting States. From the perspective of many developing
countries, Article 26 is particularly important not only for curtailing cross -border tax evasion and
avoidance, but also to curtail the capital flight that is often accomplished through such evasion and
avoidance.
The OECD and UN Model Conventions are similar with respect to this Article. A Contracting State
cannot be expected to provide confidential financial information to another Contracting State

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unless it has confidence that the information will not be disclosed to unauthorized persons. A
Contracting State can avoid the exchange of information obligations by showing that the
information pertains to communication between an attorney and his client which is protected from
disclosure under domestic law. However, lack of interest or use in such information cannot form
the basis for a Contracting State to not co-operate with the exchange of information obligations.

Resources: The discussion on Model Tax Conventions in the above chapter is essentially based on
the text and commentaries of the OECD Model Tax Convention, 2017 and UN Model Tax Convention,
2021 available at the websites [Link] and [Link] respectively.

SUMMARY
Article OECD MC vis-à-vis UN MC
Common paras & Significant differences

Chapter I : Scope of the Convention

1 Persons Resident of CS - For application of treaty, a person has to be a

covered resident of one or both of the Contracting States (CSs).
Fiscally transparent entity - Income derived by or through a
fiscally transparent entity under the tax law of either CS to be
considered to be income of a resident of a CS, to the extent such
income is treated, for purposes of taxation by that State, as the
income of a resident of that State.
Collective investment vehicles - Provision dealing with the
application of the UN Model Convention to “Collective investment
vehicles.
2 Taxes covered Taxes on income and capital - The MCs apply to taxes on
income and on capital imposed on behalf of a CS or of its political
subdivisions or local authorities, irrespective of the manner in
which they are levied.

Coverage of taxes - Taxes on income and on capital covers:

Taxes imposed Taxes included
• On total income • taxes on gains from alienation of
• on total capital movable or immovable property
• on elements of • taxes on total amounts of wages or
income or of salaries paid by enterprises
capital • taxes on capital appreciation

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Chapter II : Definitions

4 Resident Resident of either CS - A taxpayer has to demonstrate that he is a

resident of one or both CSs to be able to gain access to a tax treaty
and avail benefits thereunder.
Meaning of “Resident of a Contracting State” - Any person who,
under the laws of that State, is liable to tax therein by reason of that
person’s:

Domicile

Place of incorporation
Residence
(POI)

Any other
Place of
Management similar
criterion

This term, however, does not include any person who is liable to tax
in that State in respect only of income from sources in that State or
capital situated therein.
Note - OECD MC does not contain reference to place of
incorporation.
Tie-breaker Rule
In case of individuals
Where an individual is a resident of both CSs as per domestic tax laws
of that CS, then, his residential status shall be determined by applying
the tie-breaker rule in the following sequence:

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Permanent Home

Centre of vital interests

Habitual abode

Nationality

Mutual agreement between Competent Authorities of the CSs

In case of companies
• Dual residence arises where one CS attaches importance to POI
and the other CS to the POEM.
• The tie-breaker test involves a case by case approach considering
the no. of tax avoidance cases involving dual resident Cos.
• Request has to be made by the tax payer through Article 25
(MAP).
• Competent Authorities will rely on range of factors to resolve the
question of dual residency.

5 Permanent Meaning of PE [Article 5(1)]

establishment
• There should be an “enterprise” (Entr).
(PE)
• Such Entr should be carrying on a "business";
• There should be a "place of business (POB)";
• Such place of business (POB) should be at the disposal of the
Entr (may be owned / rented but must be one which the Entr has
the effective power to use);
• The POB should be "fixed", i.e., it must be established at a distinct
place with a certain degree of permanence
• The business of the enterprise is carried on wholly or partially
through this fixed POB.
A PE does not exist unless all the aforesaid conditions are satisfied.

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Specific inclusions in the meaning of PE [Article 5(2)]

a branch

a mine, oil/gas A place of

well, quarry etc. management

PE
a workshop an office

a factory

Expansion of scope of Agency PE

• Agency PE targets activities done by a dependent agent (DA) of the
Entr in the Source State (SS).
• DAPE now includes instances when an agent habitually concludes
contracts, or habitually plays the principal role leading to the
conclusion of contracts routinely concluded without material
modification by the enterprise.
• In UN Model Convention, PE is constituted even if the person does
not habitually conclude contracts nor plays the principal role leading
to the conclusion of such contracts, but habitually maintains in that
State, a stock of goods or merchandise from which that person
regularly deliver goods or merchandise on behalf of that enterprise.
PE of an Insurance Enterprise

UN MC OECD MC

UN MC has an additional Article In the absence of similar Article

5(6) relating to insurance. An in the OECD MC, a PE of an
insurance Entr of a CS is insurance Entr is to be
deemed to have a PE in the other determined in accord with Article
CS if it collects premiums in the 5(1) or 5(2).
territory of that other CS or
insures risks situated therein
through a person.

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Chapter III : Taxation of Income

7 Business Right of CS to tax business profits (BPs)

profits
OECD MC UN MC

BPs of an Entr can only be taxed by the Residence State (RS). Right
of Source State (SS) to tax BPs of an enterprise only exists if a PE
exists in its jurisdiction.

Once a PE The attribution principle is amplified by a limited

is proven, Force of Attraction rule (FOA).
the SS can The FOA rule implies that when a foreign
tax only enterprise sets up a PE in SS, it brings itself within
such profits the fiscal jurisdiction of that State to such a degree
as are that profits that the Entr derives therefrom,
attributable whether through the PE or not, can be taxed by it
to the PE (i.e., the SS).

Accordingly, if the Entr carries on business in the

other CS through a PE, the profits of the Entr may
be taxed in the other CS but only so much of them
as is attributable to:
(a) that PE;
(b) sales in that other CS of goods or
merchandise of the same or similar kind as
those sold through that PE; or
(c) other business activities carried on in that
other State of the same or similar kind as
those effected through that PE.

11 Interest Right of CSs to tax interest

Para of Right of CS to tax interest
Article
1 Confers the right to RS to tax interest
2 Confers right to the SS to tax interest.
Generally, interest is taxed in the SS at a given rate
on gross basis.
However, if the beneficial owner of the interest is a
resident of the other CS, the tax so charged ≤
specified % of the gross interest.

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The specified % as per OECD MC is 10%, but the UN

MC leaves this % to be established through bilateral
negotiations.
Definition of interest in OECD & UN MCs - Interest means income
from debt claims of every kind,
• whether or not secured by mortgage and
• whether or not carrying a right to participate in the debtor’s
profits.
Specific inclusions in the definition of interest as per OECD &
UN MCs
• income from govt securities
• income from bonds or debentures
• premiums and prizes attaching to such securities, bonds or
debentures.
Note - Interest does not include penalty charges for late payment.

12 Royalties (Roy) OECD MC UN MC

Right of Roy. arising in SS and Roy may also be taxed in

CS to tax beneficially owned by the SS. However, if the
Roy. resident of the RS is beneficial owner is a resident
income taxable only in RS. of the RS, the tax charged
Thus, RS has exclusive by SS ≤ the specified %, (to
right to tax royalty be established through
income. bilateral negotiations) of
gross royalty.

Definition Definition of Royalty Royalty includes:

of Roy does not include: (a) rentals for films or tapes
(a) rentals for used for radio or TV
films/tapes used broadcasting and
for radio/ TV (b) equipment rentals like
broadcasting; and rentals for industrial,
(b) rentals for commercial or scientific
industrial, equipment.
commercial or
scientific
equipment.

12A FTS The UN MC has a specific article pertaining to Fees for Technical
Services (FTS). There is no specific reference to FTS in OECD MC.

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Right of CS to tax FTS [UN Model]

Para of Right of CS to tax FTS

Article

1 Confers right to the RS to tax FTS. However, does

not state that FTS is exclusively taxable in the RS.

2 Establishes the right of the SS to tax FTS in

accordance with its domestic law, subject to
limitation on the max. rate of tax on gross amount of
fees, to be established through bilateral negotiations,
if the beneficial owner is a resident of the other CS.

Meaning of FTS [UN Model]

FTS means payments for managerial, technical or consultancy

services

Exclusions from the meaning of FTS:

i payment to an employee

ii payment for teaching in an or by an educational institution

iii payment by an individual for services for personal use

12B Income from Article 12B was added to the United Nations Model Tax Convention in
Automated its 2021 update to preserve the domestic law taxing rights for States
Digital from which payments for automated digital services are made. There is
Services no article in the OECD MC corresponding to Article 12B.
Right of CS to tax income from automated digital [UN Model]

Para of Right of CS to tax income from automated digital

Article services
1 Confers right to the RS to tax income from automated
digital services arising in a CS. However, does not state
that FTS is exclusively taxable in the RS.

2 Establishes the right of the SS to tax income from

automated digital services in accordance with its domestic
law, subject to the specified percentage of the gross
amount of payments underlying the income from automated
digital services, to be established through bilateral
negotiations, if the beneficial owner is a resident of the
other CS.

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Meaning of Automated digital services [UN Model]

Automated digital services any service provided on the Internet

or another electronic network, in either case requiring minimal
human involvement from the service provider.

Specific inclusions:

i online advertising services

ii supply of user data

iii online search engines

iv online intermediation platform services

v social media platforms

vi digital content services

vii online gaming

vii cloud computing services

i

ix standardized online teaching services

13 Capital gains This Article provides for the taxation of income arising from transfer of a
capital asset, including transfer of shares.
Right of CS to tax income from Capital Gains
• The right to tax capital gains may be exclusively with the RS, or
shared between the RS and SS.
• The Article does not specify what is a capital gain and how is to be
computed, this being left to the applicable domestic law.
• The Article contains rules for taxation of gains from alienation of
different assets such as immovable property, immovable property
forming part of a PE, ships & aircrafts, etc.
• In respect of shares, OECD and UN MCs are identical. Rights are
conferred to the SS if more than 50% of the value of shares during
the preceding 365 days is derived directly or indirectly from
immovable property in such SS. Otherwise, the Residence State
would have the exclusive right to tax.
• UN MC allows a State to tax gains from the alienation of rights
granted under the law of that State as long as these rights allow the

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use of resources that are naturally present in that State and that are
under the jurisdiction of that State.
• Both UN and OECD Model convention gives exclusive right to
Residence State in case of gains from the alienation of any property
other than covered in the other paragraphs of this Article.

14 Indepen-dent This Article present only in the UN MC deals with the taxation of income
personal derived by a person for professional or specified services which are
services offered in the SS through some presence.
Right of CS to tax income from professional services (IPS) [UN
MC]

Right of RS Income derived by a resident of a CS in respect

of professional services or other activities of an
independent character is taxable only in the RS.

Right of SS In the following circumstances, however, IPS may

also be taxed in the other CS (i.e., the SS):

Circumstance Extent of income taxable

in SS

If he has a fixed Only so much of the

base regularly income as is attributable
available to him in to that fixed base may be
the SS for the taxed in the SS.
purpose of
performing his
activities

If his stay in the SS Only so much of the

is for a period > 183 income as is derived from
days in any 12 his activities performed in
month period the SS may be taxed in
commencing or that State
ending in the fiscal
year concerned

Definition of “Professional Services” [UN MC]

The term "professional services" includes especially independent
scientific, literary, artistic, educational or teaching activities as well as
the independent activities of physicians, lawyers, engineers, architects,
dentists and accountants.

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Note – OECD MC does not contain a separate article on IPS. The same
is dealt with as “Business Profits (Article 7)” under the OECD MC.

21 Other income This Article deals with taxation of items of income which are not
(OI) specifically taxable under any other specific Article [i.e., upto Article 20].

OECD MC UN MC

Right to Exclusive Contains an additional para, Article

tax OI right to tax is 21(3), which provides that SS may
with the RS. also tax other income.

Right to Article 21(2) of both OECD and UN MC provides that

tax income for income effectively connected with a PE maintained
[other than in a CS by a resident of the other CS, taxation is
income governed by the provisions of Article 7 (Business
from Profits).
immovable
property] Additionally, UN Model provides that if
effectively the aforesaid income is effectively
connected connected with a fixed base situated
with PE in a CS by a resident of the other CS,
taxation would be governed by the
provisions of Article 14 (IPS).

Chapter V : Methods for the Elimination of Double Taxation

23A/ Exemption In many cases, the application of tax treaty may result into double
23B method/ Credit taxation (DT) for tax payers. In such a case, Articles 23A and 23B
Method provide for the mechanism through which tax credit/exemption may
be available in the RS for taxes deducted in the SS.
Two approaches for elimination of DT under MCs:

Exemption method (Article Credit method (Article 23B)

23A)

Tax exemption may be available Tax credit may be available in

in the RS for taxes deducted in the RS for taxes deducted in the
the SS. SS.

These methods are not mutually exclusive and there may be cases
where a treaty may adopt exemption method for certain types of
income and credit method for other incomes.

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Juridical DT and Economic DT:

Juridical DT Economic DT
Meaning The same income Two different persons are
or capital is taxable taxable in respect of the same
in the hands of the income or capital
same person by
more than one
State
Example FTS may be In respect of dividend distributed
taxable in the by a Co., DDT may be payable
hands of the by the Co. in SS, whereas the
recipient both in the dividend may be taxable in the
RS as well as in hands of the shareholder of the
SS, based on the other CS, on the basis of his
domestic laws of residence.
the CSs.
Type of DT Articles 23A & 23B The Articles do not address
addressed address Juridical Economic DT. If two States wish
by Article DT. to solve problems of economic
23A & 23B DT, they must do so in bilateral
negotiations.

Chapter VI : Special Provisions

25 Mutual Where a tax payer believes that the treatment accorded by either or
agreement both CSs is not in accordance with the provisions of the tax treaty, this
procedure Article provides for dispute resolution through bilateral negotiations
(MAP) between competent authorities (CAS) of both CSs.
OECD MC UN MC
Request The taxpayer may Alternative A - Taxpayer has
for MAP make a request to to approach RS or the country
either CS of his nationality.
Alternative B - Reference to
an arbitration process as part
of MAP. The decision arrived at
through the process is binding
unless a person directly
affected does not accept it.
Time limit Stipulates a time An arbitration may be initiated
limit of 2 years from if the competent authorities
the date when all the (CAS) are unable to reach an
information required agreement on a case within 3

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by the CAS in order years from presentation of that

to address the case case [Alternative B]
need to be provided
to both CAS.
Who can Arbitration must be Arbitration must be requested
request for requested in writing by the CAS of one of the CS.
Arbitration? by the person who Once such a request is made,
initiated the case the taxpayer will be notified
[Alternative B]
Departure No specific provision The CAS may depart from the
from for departure from arbitration decision if they
arbitration arbitration. agree to do so within 6 months
by CAS after the decision has been
communicated to them
[Alternative B]
26 Exchange of Purpose of Article 26
information In order to complete tax cases, a country may require certain info which
(EOI) may be available with the treaty partner.
Article 26 provides for:
• the info which may be exchanged
• the manner in which such a request has to be made.
Importance of Article 26:
• facilitates effective exchange of information between CSs.
• curtails cross-border tax evasion and avoidance,
• curtails the capital flight that is often accomplished through tax evasion
& avoidance. This is particularly relevant in the perspective of
developing countries.
Similar provisions contained in OECD and UN MCs
• A CS cannot be expected to provide confidential financial info to
another CS unless it has confidence that the info will not be
disclosed to unauthorized persons.
• A CS can avoid the EOI obligations by showing that the info
pertains to communication between an attorney and his client which
is protected from disclosure under domestic law.
• Lack of interest or use in such info cannot, however, form the basis
for a CS to not co-operate with the EOI obligations.

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TEST YOUR KNOWLEDGE

Questions
1. Explain briefly the significant difference between the UN and OECD Model Tax Convention.
2. When does it become necessary to apply the tie-breaker rule? Discuss the manner of
application of the tie-breaker rule.
3. Explain the meaning of “interest” and “fees for technical services” under the UN Model
Convention.

4. What is the meaning of Automated Digital Services? Elucidate.

5. What are the payments covered within the scope of “Royalties” under the UN Model
Convention and OECD Model Convention. Elucidate.
Answers
1. OECD Model is essentially a model treaty between two developed nations whereas UN
Model is a model convention between a developed country and a developing country.
Further, OECD Model advocates the residence principle, i.e., it lays emphasis on the right
of state of residence to tax the income, whereas the UN Model is a compromise between
the source principle and residence principle, giving more weight to the source principle as
against the residence principle.
2. Every jurisdiction, in its domestic tax law, prescribes the mechanism to determine
residential status of a person. If a person is considered to be resident of both the
Contracting States, relief should be sought from Article 4 of the Tax Treaty. A series of tie -
breaker rules are provided in Paragraph 2 Article 4 of Model Convention to determine single
state of residence for an individual.
The tie-breaker rule would be applied in the following manner:
(i) The first test is based on where the individual has a permanent home. Permanent
home would mean a dwelling place available to him at all times continuously and not
occasionally and includes place taken on rent for a prolonged period of time.
(ii) If that test is inconclusive for the reason that the individual has permanent home
available to him in both Contracting States, he will be considered a resident of the
Contracting State where his personal and economic relations are closer, in other

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words, the place where lies his centre of vital interests. Thus, preference is given
to family and social relations, occupation, place of business, place of administration
of his properties, political, cultural and other activities of the individual.
(iii) Paragraph (ii) establishes a secondary criterion for two quite distinct and different
situations:
• The case where the individual has a permanent home available to him in both
Contracting States and it is not possible to determine in which one he has his
centre of vital interests;

• The case where the individual has a permanent home available to him in
neither Contracting State.
In the aforesaid scenarios, preference is given to the Contracting State where the
individual has an habitual abode.
(iv) If the individual has habitual abode in both Contracting States or in neither of them,
he shall be treated as a resident of the Contracting State of which he is a national.

(v) If the individual is a national of both or neither of the Contracting States, the matter is
left to be considered by the competent authorities of the respective Contracting
States.

3. As per Article 11 of the UN Model Convention, “Interest” essentially means income from
debt claims of every kind, whether or not secured by mortgage and whether or not carrying
a right to participate in the debtor’s profits, and in particular, income from government
securities and income from bonds or debentures, including premiums and prizes attaching
to such securities, bonds or debentures. Penalty charges for late payment are not regarded
as interest for the purpose of this Article.
As per Article 12A of the UN Model Convention, “Fees for technical services” is defined as
payments for managerial, technical or consultancy services but excludes payment to an
employee, payment for teaching in an educational institution or for teaching by an
educational institution, payments by an individual for services for personal use.
4. As per Article 12B of UN Model Convention, “Automated digital services” means any service
provided on the Internet or another electronic network, in either case requiring minimal
human involvement from the service provider.

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 27.34 INTERNATIONAL TAXATION

The term “Automated digital services” includes specially:

(a) online advertising services;
(b) supply of user data;
(c) online search engines;
(d) online intermediation platform services;
(e) social media platforms;
(f) digital content services;
(g) online gaming;

(h) cloud computing services; and

(i) standardized online teaching services.
5. The term “royalties” as per UN Model Convention means payments of any kind received as
a consideration for the use of, or the right to use, any copyright of literary, artistic or
scientific work including cinematograph films, or films or tapes used for radio or television
broadcasting, any patent, trademark, design or model, plan, secret formula or process, or
for the use of, or the right to use, industrial, commercial or scientific equipment or for
information concerning industrial, commercial or scientific experience.
The definition of ‘royalties’ under the OECD Model Convention does not include the
following: (a) rentals for films or tapes used for radio or television broadcasting and (b)
equipment rentals like rentals for industrial, commercial or scientific equipment.

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CHAPTER a 28
7
LATEST DEVELOPMENTS IN
INTERNATIONAL TAXATION

LEARNING OUTCOMES

After studying this chapter, you would be aware of the -

❑ latest developments in OECD/G20 BEPS Project

❑ two Pillar approach to address tax challenges out of digitalization

❑ key highlights of Pillar One and Pillar Two of BEPS 2.0

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 28.2 INTERNATIONAL TAXATION

28.1 BRIEF BACKGROUND OF BEPS

What is BEPS?
Base erosion and profit shifting (BEPS) refers to tax planning strategies used by multinational
enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. Developing countries’
higher reliance on corporate income tax means they suffer from BEPS disproportionately.
The report Addressing Base Erosion and Profit Shifting (OECD 1, 2013) concluded that no single tax
rule on its own enables BEPS, it is rather the interplay among different issues that makes it possible.
Domestic laws and rules that are not coordinated across borders, international tax standards that
have not always kept pace with the changing global business environment and a pervasive lack of
relevant information at the level of tax administrations and policymakers combine to provide
opportunities for taxpayers to undertake BEPS strategies. The availability of harmfu l tax practices
was also identified as a key pressure area.
Out of a shared desire to address BEPS concerns, there is agreement on a comprehensive package
of measures which are designed to be implemented domestically and through treaty provisions in a
coordinated manner, supported by targeted monitoring and strengthened transparency. The goal is
to tackle BEPS structures by comprehensively addressing their root causes rather than merely the
symptoms.
Thus, in 2015, under the OECD/G20 BEPS Project, 15 Actions Plans were delivered to tackle tax
avoidance, improve the coherence of international tax rules, and ensure a more transparent tax
environment (BEPS package).
ACTION-1 ACTION-2 ACTION-3 ACTION-4 ACTION-5
Addressing the tax Neutralise the effects Strengthen CFC Interest deductions Counter harmful tax
challenges of the of hybrid mismatch Rules and other financial practices
digital economy arrangements payments

ACTION-6 ACTION-7 ACTION-8 ACTION-9 ACTION-10

Preventing treaty Prevent the artificial Transfer pricing Transfer pricing Transfer pricing
abuse avoidance of PE
status
ACTION-11 ACTION-12 ACTION-13 ACTION-14 ACTION-15
Measuring and Disclosure of Re-examine Making dispute Developing a
monitoring BEPS aggressive tax transfer pricing resolution more multilateral
planning documentation effective instrument
arrangements

1 Organisation for Economic Co-operation and Development (OECD)

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Recognising all the progress made, including establishing a new OECD-G20 framework for more
inclusive deliberations, it appears necessary to further deepen cooperation and focus on monitoring
the implementation and effectiveness of the measures adopted in the context of the BEPS Project
as well as the impact on both compliance by taxpayers and proper implementation by tax
administrations.
OECD and G20 countries agree to keep working on an equal footing to monitor the implementation
of the BEPS measures. The monitoring will consist of an assessment of compliance in particular
with the minimum standards in the form of reports on what countries have done to implement the
BEPS recommendations.

28.2 ESTABLISHMENT OF INCLUSIVE FRAMEWORK (IF)

Globalisation requires that global solutions and a global dialogue be established which go beyond
OECD and G20 countries. The strong interest expressed by developing countries through their
participation in the BEPS Project should be sustained by the establishment of an even more inclusive
framework, which will continue to include other international organisations and regional tax
organisations.

Drawing on the successful experience of the Global Forum on Transparency and Exchange of
Information for Tax Purposes, in early 2016 OECD and G20 countries decided to work together to
design and propose a more inclusive framework to support and monitor the implementation of the
BEPS package, with countries and jurisdictions participating on an equal footing.

The idea was to include consideration of the manner in which non-OECD non-G20 countries and
jurisdictions can commit to the agreed standards and their implementation. Thus, it was proposed
to call on the OECD to prepare a framework by early 2016 with the involvement of interested non-
G20 countries and jurisdictions, particularly developing economies, on an equal footing.

Resultantly, in June 2016, at the request of the G20, the OECD/G20 Inclusive Framework on
BEPS (Inclusive Framework) was established in Kyoto, Japan with an initial membership of 89
countries and jurisdictions.

As of 28th May 2024, the Inclusive Framework includes 147 members, who, on an equal footing,
monitor the implementation and contribute to the development of measures to combat BEPS , while
reviewing and monitoring the implementation of the OECD/G20 BEPS Project.

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28.3 INTRODUCTION OF TWO-PILLAR SOLUTION

(BEPS 2.0)
In July 2021, 134 members of the Inclusive Framework, representing more than 90% of worldwide
GDP, reached a historic agreement on a two-pillar solution to address the tax challenges of
digitalisation and introduce a global minimum tax on the profits of large multinational enterprises
(MNEs).

The agreement provides for fundamental tax reforms updating key elements of the century -old
international tax system and will help countries protect their tax bases.

139 countries and jurisdictions 2 have joined the landmark agreement reached on the 8th of October
2021 Statement on a Two-Pillar Solution to Address the Tax Challenges Arising from the
Digitalisation of the Economy (Two-Pillar Solution or 2021 October Statement).

It represented a major step forward in the reform of the international tax system and the outcome of
intensive work carried out under BEPS Action 1 “Addressing the tax challenges arising from the
digital economy,” which has been the top priority of the OECD/G20 Inclusive Framework.

Since the agreement on the 2021 October Statement, the OECD/G20 Inclusive Framework has
moved to its implementation, with significant progress achieved.

2 as of 9 June 2023

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There are two parts to Pillar One: Amount A, the international framework for reallocation of taxing
rights over profits of large and highly profitable MNEs; and Amount B, the simplified transfer pricing
approach for baseline distribution activity.

Pillar Two is similarly structured around two complementary components: the Global Anti -Base
Erosion (GloBE) Rules, which establish a minimum tax framework in each jurisdiction where large
MNEs operate, and Subject-To-Tax-Rule (STTR), which allows a source jurisdiction to “tax back”
where taxing rights have been ceded under a tax treaty and a payment is subject to a low nominal
rate in the residence jurisdiction.

The following discussions provide an overview of Pillar One and Pillar Two.

28.3.1 Overview
Digital transformation spurs innovation, generates efficiencies, and improves services while boosting
more inclusive and sustainable growth and enhancing well-being. At the same time, the breadth and
speed of this change introduce challenges in many policy areas, including taxation.

Reforming the international tax system to address the tax challenges arising from the digitalisation
of the economy, restore stability to the international tax framework and prevent further uncoordinated
unilateral tax measures has therefore been a priority of the international community for several
years, with commitments to deliver a consensus-based solution.

These tax challenges were first identified as one of the main areas of focus of the OECD/G20 BEPS
Project, leading to the 2015 BEPS Action 1 Report (the Action 1 Report) (OECD, 2015). The
Action 1 Report found that the whole economy was digitalising and, as a result, it would be difficult,
if not impossible, to ring-fence the digital economy.

The 2015 Action 1 report provided the options to safeguard against BEPS on account of
digitalisation, however, it did not provide any recommendations and left it to the discretion of the
countries to resort to these measures as part of their domestic law. The report also indicated that it
was agreed between the members to continue to monitor developments in respect of the digital
economy.

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 28.6 INTERNATIONAL TAXATION

Pursuant to this, the OECD Inclusive Framework on BEPS came up with a consensus-based solution
for tax challenges arising out of digitalisation (commonly known as BEPS 2.0), framed within two
complementary pillars, namely, Pillar One and Pillar Two.

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As already discussed above, 2021 October Statement has been agreed upon and joined by 139
countries and jurisdictions3. The agreement demonstrates that developing countries can indeed play
an active and influential role in international standard setting through their participation in the
Inclusive Framework. This is not to say that the agreement reflects developing countr y preferences
in all respects since all participants have recognised the need for compromise.

28.3.2 Pillar One

(1) Introduction
Pillar One is designed to deliver a sustainable taxation framework reflective of today’s digitalising
economy, with the potential to achieve a fairer and more efficient allocation of taxing rights.
It aims to ensure a fairer distribution of taxing rights among countries with respect to the largest and
most profitable MNEs. It will reallocate taxing rights over a portion of the residual profits of MNEs to
the market countries and jurisdictions where they have business activities, regardless of whether
they have a physical presence there.
Under Pillar 1, an MNE is treated as a consolidated entity, and taxing rights are allocated on some
predetermined formulas and assumptions which are briefly discussed in this chapter. These are
primarily classified into two parts, Amount A and Amount B.

(2) Amount ‘A’ and Amount ‘B’

Overview
Pillar 1 modifies nexus and profit allocation rules, redistributing super -profits to market jurisdictions
of the MNE Groups. This allocated profit is termed as ‘Amount A’. Market jurisdictions must fulfil the
nexus test to be eligible for ‘Amount A’ allocation.

3 as of 9 June 2023

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 28.8 INTERNATIONAL TAXATION

Amount B is a critical component of Pillar One. While the work on Amount A updates the international
taxation framework with respect to large and very profitable multinational enterprises (MNE), Amount
B simplifies the existing transfer pricing rules for all taxpayers. It is focused on the application of
transfer pricing rules to so called baseline marketing and distribution activities, likely the most
frequent fact pattern that MNEs encounter in the jurisdictions where they operate. Amount B is
intended to increase tax certainty, reduce compliance and administrative costs and in particular
assist low-capacity jurisdictions that often suffer from the absence of local market comparables.
The Inclusive Framework on BEPS is nearing completion of negotiations on a final package on Pillar
One. This includes the text of Multilateral Convention (MLC) for Amount A and a framework for
Amount B.
Broadly, the material released by OECD till date, explain Amount A and Amount B as under:
Amount ‘A’
In-scope companies are the MNEs with global turnover above 20 billion euros and profitability above
10% (i.e., profit before tax/revenue). Extractives and regulated financial services are out of the
scope.
Amount A is 25% of the residual profit defined as profit in excess of 10% of revenue that will be
allocated to market jurisdictions with nexus using revenue-based allocation keys.

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Allocation of Amount A is majorly based on the following two factors:

(i) Nexus Test

(ii) Revenue Sourcing Rules

Nexus test
The new special-purpose nexus rule applies solely to determine whether a jurisdiction qualifies for
profit reallocation under Amount A. These rules will not alter the nexus for any other tax or non-tax
purpose. Amount A is allocated to the market jurisdiction only if the nexus exists. To determine
whether an MNE in-scope of Amount A satisfies the nexus test for Amount A in a jurisdiction, it will
have to apply the revenue sourcing rules to identify the jurisdiction in which revenue arises for
purposes of Amount A.

To establish nexus, the market revenue thresholds is:

- Greater than or equal to €1 million for jurisdiction with annual GDP ≥ €40 billion

- Greater than or equal to €250,000 for jurisdiction with annual GDP < €40 billion

It transfers taxing rights over residual profits to jurisdictions with business activities regardless of
the physical presence.
Revenue sourcing rules
Revenue will be sourced to the end market jurisdictions where goods or services are used or
consumed. To facilitate the application of this principle, detailed source rules for specific categories
of transactions will be developed. In applying the sourcing rules, an MNE must use a reliable method
based on the MNE’s specific facts and circumstances.

Revenues must be sourced according to the category of Revenues earned. Revenues that fall under
more than one category are sourced according to their predominant character. Revenues derived
from Supplementary Transactions may be sourced in accordance with the revenue sourcing rule that
applies to the Revenues that they supplement.

Specific revenue sourcing rules provide a common basis for identifying an MNE’s market countries
that will benefit from Amount A, categorised per type of revenue. For revenues from online
advertising, for example, the sourcing principle is based on the “eyeballs” of the viewer, and not on
the location of the advertiser. To identify the viewer, the MNE should use data points that reliably

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 28.10 INTERNATIONAL TAXATION

indicate the location of the viewer, such as IP address or geolocation, or other reliable commercial
information.

In some cases, it will be very challenging for an MNE to locate the end-user. This may be the case,
for example, for revenues from cloud computing services, where the MNE may not have information
available on where its customer’s employees use the service. In order to provide certainty in these
more challenging cases, the MNE is allowed to use targeted proxies or allocation keys, which
approximate the market country (such as allocation keys based on statistical information on
aggregated headcount data or macroeconomic proxies). This is a way to balance the compliance
burden while ensuring that Amount A profits are reliably reallocated in all cases.

Once an MNE has determined how much revenue it generates in each of its market countries,
Amount A profit will be reallocated only to the market countries where the MNE meets a new
quantitative special purpose nexus test.

Process to be followed while applying the nexus test and the revenue sourcing rules is summarized
as under:

Amount ‘B’
The Inclusive Framework on BEPS released a report on Amount B of Pillar One on 19 February
2024, aimed at simplifying and streamlining the application of the arm’s length principle to in-country
baseline marketing and distribution activities, with a particular focus on the needs of low-capacity
jurisdictions. On 17 June 2024, the Inclusive Framework published the pending design aspects of
Amount B.

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 LATEST DEVELOPMENTS IN INTERNATIONAL TAXATION 28.11
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In summary, the framework for Amount B, as outlined in the report, is as follows:

Broadly, the steps involved in applying Amount B are as under:

• STEP 1: SCOPING CONDITIONS

The purpose of Step 1 is to determine whether

baseline marketing and distribution activities
carried out by a tested party are in-scope of
Amount B.

When a tested party is involved in a qualifying

transaction (Step 1-1) that meets the scoping
criteria (Step 1-2), then the transaction is in-
scope of Amount B.

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 28.12 INTERNATIONAL TAXATION

• STEP 2: PRICING OF IN-SCOPE TRANSACTIONS

If a qualifying transaction is determined to be within the scope of Amount B, it is priced using
the Amount B pricing framework, unless a reliable internal Comparable Uncontrolled Price
(CUP) is available. The pricing framework comprises the following three sub-steps:

Step 2-1: Application of the Pricing Matrix

The purpose of step 2-1 is to determine the return on
sales percent in the pricing matrix of Amount B:

Factor Intensity Industry Industry Industry

Grouping 1 Grouping 2 Grouping 3
(A) OAS 45% or more, 3.50% 5.00% 5.50%
any level of OES
(B) OAS 30% to 44.99%, 3.00% 3.75% 4.50%
any level of OES
(C) OAS 15% to 29.99%, 2.50% 3.00% 4.50%
any level of OES
(D) OAS less than 15%, 1.75% 2.00% 3.00%
OES 10% or more
(E) OAS less than 15%, 1.50% 1.75% 2.25%
OES less than 10%
*OAS – Operating Assets Intensity
OES – Operating Expenses Intensity

The pricing matrix is derived from a global dataset of comparable companies engaged in
baseline marketing and distribution activities. Their financial information, filtered using
benchmarking criteria and scoping conditions, has been used to approximate ar m’s length
returns, expressed as return on sales.
Note:
Industry grouping refers to the categorisation of specific industries and industry sectors in which
in-scope distributors operate into three pre-defined groupings based on the observed relationships
between specific industries / products and the profitability attributed to baseline distribution of those
products. The categories of goods falling into each of the three industry groups are:
Group 1 perishable foods, grocery, household consumables, construction materials and
supplies, plumbing supplies and metal.
Group 2 IT hardware and components, electrical components and consumables, animal feeds,
agricultural supplies, alcohol and tobacco, pet foods, clothing footwear and other
apparel, plastics and chemicals, lubricants, dyes, pharmaceuticals, cosmetics, health
and wellbeing products, home appliances, consumer electronics, furniture, home and
office supplies, printed matter, paper and packaging, jewellery, textiles hides and furs,
new and used domestic vehicles, vehicle parts and supplies, mixed products and
products and components not listed in group 1 or 3.
Group 3 medical machinery, industrial machinery including industrial and agricultural vehicles,
industrial tools, industrial components miscellaneous supplies.

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Step 2-2: Application of the operating expense cross-check (OECC)

The purpose of Step 2-2 is to apply the operating

expense cross check (OECC) which works as a
corroborative check by assessing the return
derived from the matrix by reference to the
operating expense level of the tested party.

Where the application of the return on sales net

profit indicator produces a result outside of the
pre-defined operating expense cap-and-collar
range, the profitability of the tested party will be
adjusted.

Step 2-3: Application of the data availability mechanism (DAM)

Step 2-3 applies the data availability

mechanism (DAM) which provides for upward
adjustments to the return derived from the
pricing matrix in certain cases. The mechanism
is intended to account for cases where there is
no or insufficient data in the global dataset for
a particular tested party jurisdiction upon
which to validate the appropriateness of the
Amount B pricing matrix coupled with evidence
that that jurisdiction could be reasonably
considered a ‘higher risk’ jurisdiction.

In order to simplify compliance burdens associated with administering the simplified and
streamlined approach, the analysis supporting the determination of the pricing matrix and
operating expense cap-and-collar rates will be updated every five years unless there is a
significant change in market conditions that warrants an interim update. The financial data
and other datapoints will be reviewed annually and updated where necessary.
The Inclusive Framework continues working on an Amount B framework that goes beyond
the elective approach and is linked with Amount A.

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28.3.3 Pillar Two

(1) Introduction

This pillar explores the design of a system to ensure that MNEs pay a minimum level of tax. This
pillar is intended to address the remaining issues identified by the OECD/G20 BEPS initiative by
providing countries with new tools to protect their tax base from profit shifting to jurisdictions that tax
these profits at below the minimum rate.

Pillar Two consists of the Global Anti-Base Erosion (GloBE) Rules and a treaty-based Subject to
Tax Rule (STTR).

The GloBE Model Rules for the minimum tax were released in December 2021, followed by the
related Commentary and Administrative Guidance. The GloBE Model Rules consist of an interlocking
and coordinated system of rules which are designed to be implemented into the domestic law of
each jurisdiction. The GloBE Rules introduced a 15% global minimum tax that applies to MNE groups
with consolidated revenues of at least EUR 750 million. They consist of a coordinated system of
rules, under a common framework, which ensures in-scope MNE groups pay at least the agreed
minimum level of tax on the income arising in each of the jurisdictions in which they operate. The
minimum level of tax may also be imposed locally under a qualified domestic minimum top -up tax.
The implementation of the GloBE Rules has begun globally.

The STTR takes priority over the GloBE Rules. STTR is a treaty-based rule that allows jurisdictions
to impose limited additional taxation on certain cross-border payments between connected
companies where the recipient is subject to a nominal corporate income tax rate below 9%. The rule
has been developed to cater for the priorities of developing countries and is an important part of
achieving consensus on Pillar Two for developing countries. Inclusive Framework members can
elect to implement the STTR by signing the MLI, or bilaterally amending their treaties to include the
STTR when requested by developing Inclusive Framework members.

Common Approach: The jurisdictions are not required to adopt the GloBE rules, but if they choose
to do so, they agree to implement them in a way that is consistent with the agreed outcomes.

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(2) Key highlights of Pillar 2

• Tax liability to be determined on a jurisdictional basis
and will arise when the effective tax rate (ETR) of a
Jurisdictional Blending
jurisdiction in which the MNE Group operates is
below the agreed minimum rate

• Pillar 2 prescribes minimum rate of tax liability to be

Minimum Tax Rate applied on MNEs, i.e., 15% under GloBE rules and
9% under STTR

• Under the model rules, a priority order is prescribed

Rule Order
to be followed while applying the Pillar 2 rules

• A simplification measure to exclude jurisdictions from

Deminimus Exclusion the GloBE rules that have less than a certain
percentage of the MNE Group’s profit

• Provided to exclude a fixed return for substantive

Substance based Income
activities within a jurisdiction from the application of
Exclusion
the GloBE Rules

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(3) STTR and Globe Rules

As already mentioned, Pillar Two consists of the Global Anti-Base Erosion (GloBE) Rules and a
treaty-based Subject to Tax Rule (STTR). However, STTR rules works in prior to GloBE Rules. The
model rules stipulate an order for applicability of the same, as provided under:

Subject to Tax Rules (STTR)

Overview
Works in priority to GloBE rules, STTR is a treaty-based rule that enables developing countries
(source jurisdictions) to tax certain inter-company payments at source which are subject to nominal
corporate income tax (at rates below the STTR minimum rate, i.e., 9%). The STTR is based on an
understanding that where, under a tax treaty, a source state has ceded taxing rights on certain
outbound intragroup payments, it should be able to recover some of those rights where the income
in question is taxed (if at all) in the state of the payee (i.e., the residence state) at a rate below 9%.

The objective is to prevent base erosion in ‘developing countries’ which are defined to have a gross
national income per capita, calculated using the World Bank Atlas method, of USD 12,535 or less in
2019 (to be regularly updated).
Applicability
− Applicable only to covered payments, by an entity in a developing country, made to a group
entity in another country, i.e., connected persons.

− Applies only if the total sum of covered income arising in the source country exceeds
threshold of €250,000 or €1 mn per year (depending on the GDP of source country is above
or below €40 bn).

Covered payments constitute Interest; Royalties; Payments for distribution rights for a product or
service; Insurance or reinsurance premiums; Payments of guarantee or financing fees; Rental
payments for industrial, commercial, or scientific equipment; Payments for service s, etc.

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Connected persons are defined to have legal (direct or indirect ownership of more than 50% of the
interests) or de facto control relationship.
Specified rate
The STTR specified rate is equal to the difference between 9% and the nominal rate applied in the
resident State, further reduced by any source taxation already allocated to the source jurisdiction in
accordance with other articles of the treaty.

Facts
− Company A is a company resident in Country A (a developing country) and has entered into
a royalty agreement (payable in respect of the grant of license to use trademark owned by
Company B) with Company B (resident of Country B). Accordingly, Country A sha ll be the
‘source jurisdiction’ and Country B shall be the ‘resident jurisdiction.’
− In consideration, royalty is payable by Company A to Company B.

− Country A and B has entered into a DTAA, i.e., Double Tax Avoidance Agreement or Tax
Treaty, wherein the source jurisdiction retains withholding taxing rights @5% on royalty
payments.
− Royalty payments are taxable @ 1% in Country B.

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Observations
In the above example, if a payor jurisdiction can impose a 5% withholding tax on a payment of
Covered Income and the recipient is subject to a 1% nominal tax rate, the payor jurisdiction retains
the 5% withholding tax right. However, as per the STTR, the payor jurisdiction can impose an
additional tax equal to 3% of the Covered Income amount (9% - 5% - 1% = 3%).

GloBE Rules
Scope
The GloBE Rules apply to Constituent Entities that are members of an MNE Group that has annual
revenue of EUR 750 million or more in the Consolidated Financial Statements of the Ultimate Parent
Entity (UPE) in at least two of the four Fiscal Years immediately preceding the tested Fiscal Year.
MNE Group means any Group that includes at least one Entity or Permanent Establishment not
located in the jurisdiction of the Ultimate Parent Entity whereas a Group means a collection of
Entities that are related through ownership or control such that the assets, liabilities, income,
expenses, and cash flows of those Entities are included in the Consolidated Financial Statements
of the Ultimate Parent Entity.
Entities that are ‘Excluded Entities’ are not subject to the GloBE Rules. However, their revenue is
still taken into account for the purposes of the consolidated revenue test. The Excluded Entities are
Government entities, international organizations, non-profit organizations, pension funds or
investment funds that are Ultimate Parent Entities (UPE) of an MNE Group or any holding vehicles
used by such entities, organizations or funds. However, this exclusion does not affect the MNE
Group owned by such entities, which will remain in scope of the GloBE rules if the group as a whole
otherwise meets the consolidated revenue threshold.
Overall design
Pillar Two consists of the following rules (together the GloBE rules):
(i) Qualified Domestic Minimum Top-up Tax (QDMTT): QDMTT imposes a jurisdictional top-
up tax on the constituent entity located in a low-taxed jurisdiction (LTJ). It allows the LTJ to
collect the top-up tax computed in accordance with the GloBE rules.
QDMTT provides the right to the LTJ to collect the jurisdictional top-up tax by way of the
introduction of QDMTT in its domestic tax laws. This would preserve a jurisdiction’s primary
right of taxation over its own income.

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(ii) Income Inclusion Rule (IIR): IIR imposes a top-up tax on a parent entity in respect of the
constituent entity located in low-taxed jurisdiction.
A Constituent Entity, that is the UPE of an MNE Group, located in a GloBE implementing
jurisdiction that owns (directly or indirectly) an Ownership Interest in a Low-Taxed Constituent
Entity at any time during the Fiscal Year shall pay a tax in an amount equal to its Allocable
Share of the Top-Up Tax of that Low-Taxed Constituent Entity for the Fiscal Year.
(iii) Undertaxed Payment Rule (UTPR): UTPR imposes deductions or requires an equivalent
adjustment to the extent the low tax income of a constituent entity is not subject to tax under
an IIR.
UTPR is triggered where the UPE jurisdiction does not implement IIR or does not adopt GloBE
rules. Thus, UTPR serves as a backstop to IIR. UTPR transfers the levy of top-up tax to other
constituent entities of the MNE group located in the jurisdiction where the GloBE rules are
implemented.
Let us understand the mechanism of these three rules from the example below:

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Observations
The UPE of an MNE group located in Country X has three wholly owned subsidiaries (“WOS”) in
Country A, B, and C. Let’s say, Country C is a low-taxed jurisdiction (“LTJ”). The priority ranking as
per the model GloBE rules prescribes that:

Priority 1 – Where Country C imposes QDMTT in its jurisdiction, the jurisdictional top-up tax shall
be imposed on WOS 3 (refer to the diagram above).

Priority 2 – Where Country C does not impose QDMTT in its jurisdiction, the UPE of an MNE Group
located in Country X which has implemented IIR under GloBE rules shall be liable to pay a tax in an
amount equal to its Allocable Share of the Top-Up Tax of WOS 3 in Country C

Priority 3 – At last where neither Country C nor Country X implements QDMTT or IIR respectively,
and Country A and Country B has implemented UTPR under GloBE rules, WOS 1 and WOS 2 shall
be liable to pay jurisdictional top-up (pertaining to WOS 3) tax under UTPR in their jurisdictions, i.e.,
Country A and B respectively.

Other Important Topics under GloBE Rules

(i) Effective Tax Rate (ETR): The GloBE rules will operate to impose a top-up tax using an
effective tax rate test that is calculated on a jurisdictional basis. If the jurisdictional ETR
is below the 15% minimum rate, the jurisdiction is treated as a low-tax jurisdiction and the
constituent entities are treated as low-taxed constituent entities (LTCE). The Effective Tax
Rate of the MNE Group for a jurisdiction shall be calculated for each Fiscal Year.

Effective Tax Rate = Total of Adjusted Covered Taxes of each Constituent Entity
located in the jurisdiction / Net GloBE Income of the jurisdiction

Where,

− Adjusted Covered Taxes are the taxes attributable to the income of a Constituent
Entity.

The amount of a Constituent Entity’s Covered Taxes is determined by taking the

Constituent Entity’s current taxes for the Fiscal Year, adjusted to reflect certain timing
differences. Covered Taxes are allocated from one Constituent Entity to another in
certain cases. To the extent there are changes in tax liability after filing, additions or
reductions to taxes are identified and allocated to a particular jurisdiction and time
period.

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− the Net GloBE Income of a jurisdiction for a Fiscal Year is the positive amount, if any,
computed in accordance with the following formula:

Net GloBE Income = GloBE Income of all Constituent Entities – GloBE Losses of all
Constituent Entities

Under the OECD Model Rules, the jurisdictional net GloBE income is the total GloBE income
of all constituent entities in the jurisdiction, less any GloBE losses of constituent entities in
the jurisdiction.

If there is a net GloBE loss, this means the ETR need not be calculated. In most cases this
would mean no top-up tax would be due.

(ii) Jurisdictional Blending: The ETR computation is determined on a jurisdictional blending

basis. Jurisdictional blending allows all the profits, losses, and taxes of the Constituent
Entities of the MNE Group located in the same jurisdiction to be blended for purposes of the
effective tax rate calculation.

Note - For the purpose of determining the applicability of the GloBE Rules, global revenue is
considered. However, for determining ETR, the calculation is done on jurisdictional basis.

Let us understand the above concepts with the help of following example:

UPE Co. (Country A) has wholly owned subsidiaries B Co. and C Co. in Country B.

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Details related to both the subsidiaries are as follows:

Particulars Company B Company C

GloBE income 5,000,000 euros 10,000,000 euros
Adjusted covered taxes 1,000,000 euros 1,000,000 euros
Investments in qualifying local tangible assets 10,000,000 euros 20,000,000 euros
and payroll costs

The calculation of ETR:

Adjusted Covered Taxes of Country B (i) 2,000,000 euros

Net GloBE Income in Country B (ii) 15,000,000 euros
ETR (i)/(ii) 13.3333%

Thus, the ETR of the above MNE group for Country B is 13.3333%.

Further, if Company B had incurred losses of 5,000,000 euros, the net GloBE income for
Country B would have been 5,000,000 euros instead of 15,000,000 euros. This is because of
the concept of jurisdictional blending.

(iii) Substance-based Income exclusion (SBIE) or Substance-based carve-outs: The Net

GloBE Income for the jurisdiction shall be reduced by the Substance-based Income Exclusion
for the jurisdiction to determine the Excess Profit for purposes of computing the Top -up Tax.

The GloBE rules provides the SBIE amount for a jurisdiction which is the sum of the payroll
carve-out and the tangible asset carve-out for each Constituent Entity in that jurisdiction. The
amount of this substance-based income exclusion is equal to the sum of (i) 5% of the carrying
value of tangible assets located in the jurisdiction and (ii) 5% of the payroll costs for
employees who perform activities in the jurisdiction. The GloBE rules also provide for a 10 -
year transition period in recognition of the potential impact of the GloBE rules on existing
incentives and existing investment. It shall be 8% of carrying value of eligible tangible assets
and 10% of eligible payroll costs, both will phase down to 5% over 10 years.

A substance carve-out based on assets and payroll costs allows a jurisdiction to continue to
offer tax incentives that reduce taxes on routine returns from investment in substantive
activities, without triggering additional GloBE top-up tax.

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(iv) Top-up Tax: The Jurisdictional Top-up Tax for a jurisdiction for a Fiscal Year is equal to the
positive amount, if any, computed in accordance with the following formula:

Jurisdictional Top-up Tax = (Top-up Tax Percentage X Excess Profit) + Additional

Current Top-up Tax – Domestic Top-up Tax

Where,

− the Top-up Tax Percentage for a jurisdiction shall be the positive percentage point
difference, if any, computed in accordance with the following formula:

Top up Tax Percentage = Minimum Rate – Effective Tax Rate [ETR]

− the Excess Profit for the jurisdiction is the positive amount, if any, computed in
accordance with the following formula:

Excess Profit = Net GloBE Income – Substance Based Income Exclusion

Note: The Top-up tax percentage is calculated based on the aggregate profits, i.e., Net GloBE
income. However, it is applied to the excess income, i.e., Net GloBE income – substance-
based income inclusion in order to provide the benefits of incentives to M NEs.
Continuing our example, we refer to the information collated below:

Minimum tax rate (i) 15%

ETR (ii) 13.333%
Net GloBE Income in Country B (iii) 15,000,000 euros
Substance-based income exclusion (iv) 4
1,500,000 euros
Top up Tax Percentage (i) - (ii) 1.6667%
Excess Profit (iii) - (iv) 13,500,000 euros
Top-up tax for Country B* 225,004 euros
*Assuming there is no additional top-up tax or any tax payable under a qualifying domestic
top-up tax.

4 calculated@5%of eligible tangible assets and eligible payroll costs

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The concepts explained in the earlier points are summarized as under:

(v) De-minimis Exclusion: The GloBE rules, at the election of the Filing Constituent Entity,
provides a jurisdictional exclusion for LTCEs of an MNE Group on meeting the following
criterion:
− the Average GloBE Revenue of such jurisdiction is less than EUR 10 million; and
− the Average GloBE Income or Loss of such jurisdiction is a loss or is less than EUR 1
million
The policy intent underlying the above exclusion is to avoid the complexities of a full ETR
computation in cases where the amount of any Top Up Tax would not seem to justify the
associated compliance and administrative costs.

Resources: The discussion on Pillar One and Pillar Two contained in this chapter is primarily
based on the content available at the website [Link]

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