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Income of India’s non-residents: Taxable on receipt or accrual basis?

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Income of non-residents is taxable on receipt or accrual basis

Puneet Jain and Aanchal Jain of Lakshmikumaran & Sridharan discuss the controversy on taxability of royalty, FTS and interest on receipt basis in India from the perspective of non-residents.

Certain types of income of non-residents may be taxable in India both as per the domestic tax laws of India as well as under the applicable tax treaty. India typically has full taxing rights under treaties on business profits attributable to a permanent establishment in India of the non-resident. As a source country, India may have limited taxing rights with respect to other income of non-residents in the form of royalty, FTS, interest, etc.

A question has arisen as to whether royalty, fees for technical services (FTS) or interest is taxable on receipt basis or accrual basis in the hands of non-resident under the domestic law read with tax treaty. This question is also relevant to determine when the payer of such income, who is an Indian resident, is liable to withhold and deposit taxes. To appreciate this controversy, it may be worthwhile to first understand the general scheme of taxation.

Basis of taxation under Indian tax laws: Mercantile v. cash basis

As per Indian tax law, a non-resident can be taxed in India on income which is either received by him in India or accrues/arises to him in India. Indian tax law also allows a taxpayer to compute income in accordance with the system of accounting regularly followed by the taxpayer. Such a system of accounting can be either cash/receipt basis or mercantile/accrual basis. 

An interesting question which arises is whether, for an Indian non-resident, who maintains its accounts on cash/receipt basis, income is taxable at the time of accrual or at the time of receipt. This issue has been a subject matter of litigation in India for a long time.

One of the Indian High Courts (see CIT v. Standard Triumph Motors (1979) 119 ITR 573 (Madras HC)) has held that the income of a non-resident, who maintains accounts on a cash/receipt basis, will be taxable in the year of accrual and not in the year of actual receipt of income. The court held so because it presumed that an anomalous situation of complete escape from taxation will be created otherwise. 

In the court’s view, the income, which accrued in India in a year, will never be taxed if it is received outside India in a subsequent year, if the non-resident taxpayer is preparing accounts on cash/receipt basis. This conclusion of the court is questionable. 

An alternate view could be that income, which has accrued in India, will be in all cases taxed in India, either in the same year or in another year. If the non-resident taxpayer is preparing accounts on a cash/receipt basis, it will be taxed either in the same year or in a different year, depending upon the year in which it is received. It can never go untaxed just because it is received outside India in a different year. This is because once the charge of tax is created, the method of accounting may only alter the time of taxation. 

This alternate view has also been upheld by another high court (see Pfizer Corp v. CIT (2003) 129 Taxman 459 (Bombay HC)). Therefore, the income of a non-resident, who prepares its accounts on a receipt basis, should normally be taxed in the year of receipt and not in the year of accrual.

What constitutes ‘receipt’ of income?

The next question arises as to what constitutes ‘receipt’ of income. 

The Apex Court of India in Standard Triumph Motor ((1993) 67 Taxman 160 (SC); Raghava Reddi v. CIT (1962) 44 ITR 160 (SC)) held that the credit entry to the account of the non-resident in the books of the payer in India amounts to receipt by the non-resident in India. In this case, the court noted that the payer placed the amount at the disposal of the non-resident.

Can the ratio of the above judgment be that the mere credit entry in the books of the Indian payer constitute ‘receipt’ of income (see CIT v. Toshoku Ltd (1980) 125 ITR 525 (SC)? With due respect, this may not be the case. 

The ratio of the decision of the Apex Court should be applicable only in limited cases wherein the effect of the book-entry is that the funds are effectively at the disposal of the non-resident. Hence, in other cases, it may still be possible to contest that mere credit entries in the books of the payer of income will not constitute receipt of income in the hands of the non-resident.

Position under the tax treaty 

Like many of India’s tax treaties, certain incomes like royalty, FTS, interest, etc. arising in India and ‘paid to’ a non-resident is subject to limited taxation in India, usually in the form of withholding.

In the judgment of Faber Castel (see ITA No. 7619/Del/2017, December 9 2021), the tribunal held that royalty income of an Indian non-resident is taxable in India only on ‘actual receipt’ of income by the non-resident, irrespective of the system of accounting used. 

Several other Indian courts (see CIT v. Siemens Atkiengensellschaft, ITA No. 124 of 2010 (Bombay HC)) and tribunals (see Pizza Hut International v. DCIT, (2012) 22 taxmann.com 111 (ITAT Delhi); CSE Technology Pte Ltd v. ACIT, (2019) 19 taxman.com 123 (ITAT Delhi)) have held along the same lines in the context of royalty/FTS/interest income of an Indian non-resident. This is because the courts/ tribunals have interpreted the word ‘paid’ used in the tax treaty to mean ‘actual payment’ and not ‘payable’. 

However, it should be noted that the courts and tribunals have not analysed the connotations of the word ‘paid’ in light of the Apex Court judgment in Standard Triumph Motors, domestic law meaning and OECD commentary. Hence, the Mumbai Tribunal (see Ampacet Cyprus Ltd v. ACIT, ITA No. 1518/Mum/16, ITAT Mumbai) had earlier referred the matter to a larger bench for reconsideration and their decision is still pending. 

A waiting game

When a tax treaty is applicable, the Indian courts and tribunals have given the benefit of the same to the taxpayer based on the word ‘paid’ used in the treaty. However, one will have to wait for the final decision on this issue, since the same is currently pending before the Apex Court and special bench of tribunal. 

 Puneet JainJoint partner, Lakshmikumaran & SridharanE: puneet.jain@lakshmisri.com  

Aanchal JainAssociate, Lakshmikumaran & SridharanE: aanchal.j@lakshmisri.com  

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