Withholding Tax From Reimbursement Of Expenses Routed Through Group Companies

Most of the companies in India which are subsidiaries of entities operating abroad face this one common problem. The expenses incurred by the Indian entity are paid by the foreign entity directly & then the latter is reimbursed by the Indian entity. When the auditors & accountants arrive, they raise a concern regarding various compliances that were overlooked while executing this rather simple transaction.

This tax alert summarizes a recent ruling of the Mumbai Bench of the Income‐tax Appellate Tribunal (‘ITAT’) in the case of C. U. Inspections India Pvt. Ltd. (‘taxpayer’) on the taxability of payments made to the related company in the nature of reimbursements.
Payment to a third party, directed through a related concern (Foreign company), would not be considered as a reimbursement. Consequently, whether tax is required to be withheld on such payment would depend upon the taxability of the payment in the hands of the third party.

Determination of taxability of the payment made to third party

This transaction shall be seen through as if the Indian company paid directly to the third party as below.

If an Indian subsidiary company incurs any expenses or avails any service from some third party abroad and the payment to such third party is routed through its parent or related company abroad, the withholding tax provisions would apply as if the Indian subsidiary company has made the payment to the independent party ignoring the routing of payment through the parent company.

Detailed facts of the case & common questions faced by the parties involved & the tax department

The taxpayer entered into an agreement with its parent company whereby the parent company agreed to incur various costs for and on behalf of the taxpayer and other group concerns.
Question 1: Whether third party payments made by a parent company and reimbursed by the taxpayer can be allowed under the Act on account of failure to withhold taxes from the same scenario in the books of the tax payer?
ITAT’s Ruling: Disallowance of expenses in the hands of taxpayer can be made only if the amount paid is chargeable to tax in the hands of the recipient. Indian entities effecting remittances to foreign related parties should clearly analyse the nature of remittance in context of the ultimate beneficiaries / service providers before remitting it as a reimbursement.
Question 2: Whether payment to a third party, routed through a related concern, would be considered as a reimbursement?
ITAT’s Ruling: ITAT rejected the plea of treating payment to a third party routed party through group company as reimbursement. It holds that if the contention of the assessee is accepted, then the relevant Provisions the Act can be dodged by simply following the process to make the payment to the third party not directly but through an intermediary and give the shade of reimbursement of the cost to the intermediary.

These rulings pronounced by Mumbai ITAT provide more clarity on reimbursement payments carried on within group companies. Moreover, documentation proofs are inevitable to strengthen the case for non-withholding of taxes on reimbursements.