US sets out stringent residency proof norms

Companies asking for withholding tax benefits under the Indo-USA Double Taxation Avoidance Treaty from India, will now have to submit to a stiffer and formal requirement for proving residency proof in the USA from next month.

This follows a notice issued by the US tax department to eliminate the present ad hoc system for obtaining such certificates to avail of such tax benefits.

The formalisation of procedure is significant, as most of the misuse under a similar India-Mauritius DTAA revolves on the question of residency.

A large number of foreign companies investing in the domestic stock markets, claim that they have a residence in Mauritius to avail of the tax benefit.

In 2002, the Central Board of Direct Taxes had to rescind an order tightening the norms for claiming residency status, after the markets went into a tailspin.

The notice issued by the Internal Revenue Service says there will be a set of new procedures for companies to obtain residency certification, with effect from 5 July.

It says they will have to fill in a new form 8802, which "replaces the letter request system previously used by the Service".

Under the India-Mauritius DTAA at present, foreign companies need

to produce only a letter from the latter government stating that the companies are residents of the island nation.

Indian and international tax law requires a foreign national to provide proof of being a resident of a country before reducing withholding tax to the treaty rates.

For instance in India, while the applicable tax rate on income from royalties is 20 per cent, the DTAA reduces the rate to 15 per cent. move replaces the earlier informal system of a letter based residency proof .

Explaining the rationale of the notice, Amitabh Singh, Practice Leader - Global Mobility & Employment Taxes in Ernst & Young said the letter system was proving cumbersome as the number of American companies investing abroad including in India has increased very sharply.

He said it was a welcome move to ensure uniformity and eliminate discretion in issuance of residency certificates.

The notice says under many foreign Income-Tax treaties, US individuals and businesses investing or operating are entitled to a reduced statutory income tax rate.

It adds that this certificate of US residency should be included with the application materials the tax payer sends to the country where it is seeking a treaty reduced rate.