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Management Service Fee: Tax Anomalies

Published on Tue, Dec 23,2014 | 22:02, Updated at Tue, Dec 23 at 22:02Source : Moneycontrol.com 

By: Pallavi Singhal, Partner- Tax & Regulatory Services, PwC India

In the era of globalisation and intensifying level of economic activities, it is critical for businesses to rely on strategic inputs from overseas affiliates or skilled third party service providers. In the recent past there has been a surge in Indian business utilising the skill sets available globally. In a typical multinational enterprise (‘MNE’) setup, the services are rendered by a group company to the associated enterprises and the relevant costs are also allocated to such enterprises. The arrangement holds enormous benefit to the businesses worldwide.

However, such arrangements may be considered as a form to erode the tax base through excessive management fee. The allocation of management service costs can be construed in one country as base erosion whereas the other may qualify the same charge as base-protecting.

In order to reduce the scope of erosion of tax base, OECD has issued a discussion draft relating to low value-adding intra-group services on November 03, 2014. According to a related OECD release, the measures proposed in the discussion draft would reduce the scope for erosion of the tax base through excessive management fees and head office expenses by proposing an approach that identifies a broad range of common intra-group services that command a very limited profit mark-up on costs, applies a consistent allocation key for all recipients, and provides greater transparency through specific reporting requirements.

As a result, there is a renewed attention and tremendous focus on the topic, which in turn has led to heightened surveillance by revenue authorities.

Exchange control regulations
The payment of management service fee is considered as a current account transaction and therefore permitted under the regulations without any monetary ceiling.

Direct tax regulations
As per the Indian tax code, in the context of non-residents, the beneficial provisions of the domestic tax laws or tax treaties shall apply.

Management service fee is not defined in the domestic tax laws. Hence, in  common parlance it is taken as “fee relating to the function or responsibility or activity of management”.

Under the domestic tax laws, the management service fee is chargeable to tax as Fees for Technical Services (‘FTS’).

The definition of the FTS under most tax treaties is akin to the definition under the domestic tax laws. The tax rate prescribed under domestic tax law is 25 percent and under most tax treaties is either 10percent or 15 percent.

In the context of treaties with US, UK, Canada etc., the definition does not include the word ‘managerial’. In such instances, if the services do not qualify as a technical or consultancy services, the services may not come under the purview of FTS or Fees for Included Services (‘FIS’).

In certain treaties, the management service fee is taxable in India only if such services ‘make available’ technical knowledge, skill, know-how, process or consists of the development and transfer of technical plan or technical design. In such circumstances, unless the services of the overseas affiliates are actually made available i.e. the Indian business is able to apply such technology sans recourse to the overseas affiliates, such remittance of fee shall not be liable for tax in India. It is pertinent to note that the French treaty among others by virtue of Most Favoured Nation clause in the protocol also gets respite due to ‘make available’ provisions.

Also treaties with Thailand, UAE, Libya etc., do not include the FTS clause. In such cases, the management service fee shall be subject to tax provided such fee qualifies as Business Income and the recipient constitutes a permanent establishment in India by virtue of provision of such services.

It is also pertinent to note that if the services involve travel of overseas-affiliates employees’ to India, there could be a potential service PE risk exposure if certain conditions laid down in the treaties are met. However, if the services qualify as FTS/FIS as per treaty, such risk may be mitigated.

If management service fee is chargeable to tax as FTS, Indian businesses making such remittance to their global-counterparts would be required to withhold tax. The overseas entity, being recipient of such income, has to comply with the requirement of filing a limited India corporate tax return.

Transfer pricing regulations
At the behest of G20, OECD has identified 15 Action Plans on Base Erosion and Profit Shifting (‘BEPS’). Action 10 of the Action Plan on BEPS pertains to low value-adding intra-group services.

The transfer pricing regulations in India encompasses the intra-group services and management services. The regulation prescribes that the transaction in India with a related party has to be at Arm’s Length Price (‘ALP’).  In order to establish the arm’s length nature of payment of management service fee the following pointers are necessary:

-    Necessity of availing such services.
-    Documentation/ Supporting: In order to establish the actual receipt of management services, it is imperative that Indian business maintains robust documentation in support of payment towards management service fee to the overseas affiliates.
-    Benefit Test: It is necessary for Indian Business to establish the benefits received on account of management services.

Based on a survey conducted in 79 countries  the global requirements of adherence are:
-    In almost all countries (94%) legal agreements are highly recommended.
-    While an upfront request to provide a service is not very common but (highly) recommended in about 20% of the countries, mainly located in Asia and mid/south America.
-    As per the survey in several countries specific legislation is in place that determines the application of the benefit test.

The above tests are crucial in order to substantiate such management services.

Service tax regulations
The prevailing service tax regulations seek to tax management service fee based on Place of Provision of Service (‘PoPS’) rules and reverse charge mechanism i.e. the levy would be based on the ‘location of the recipient of service’.
Based on PoPS and reverse charge mechanism, India businesses would be required to discharge service tax at 12.36 percent on management service fee.

Management services enable Indian businesses to improve the business dynamics, thereby ensure enhanced productivity and result in increased profits. However, such services are also construed as base erosion resulting in increased vigilance by the tax authorities and each of the above aspects are being scrutinised. It is vital that contemporaneous documents along with the necessary safeguards are maintained by India businesses to avoid protracted litigations.

 
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