Many corporates in India (MNCs and Indian groups) make huge payments to foreign firms. Before making payments outside India, it is critical to determine the TDS (also known as Withholding Tax or WHT) implications on these payments. Most of these payments are for services or assets/intellectual property rights. These are taxable in India as royalty or fee for technical services (FTS). Tax implications on royalty/FTS payments are relevant as taxes are borne by the Indian payee in many such contracts.
In recent years, the scope of taxation of royalties and FTS under the Indian Income Tax Act has been significantly expanded (eg various amendments to Section 9). There has been considerable Indian jurisprudence on principles of treaty interpretation. An increase in the tax rate on royalty/FTS to 25% (unless treaty relief is available) would create a significant tax impact.
Royalty/FTS Payment to Non-resident
The tax rate on royalty and fees for technical services (‘FTS’) along with the withholding tax rate on such payments under the Income-tax Act (‘Act’) has been increased from 10% to 20% (plus applicable surcharge and cess) with effect from 1 April 2024 (i.e., assessment year 2024-25) vide the Finance Act 2023. This is a substantial shift by India in the taxation landscape concerning Royalty/FTS income of non-resident taxpayers from India. This move of doubling the tax rate from the existing rate could bring a dent in the cashflows in the hands of non-residents.
The Indian Union Budget 2023-24 received the assent of the President of India on 31 March 2023, paving the way for a slew of changes to tax laws, including 64 additional amendments to the initially proposed Finance Bill on 01 February 2023. One of the key amendments impacting non-residents/ foreign companies (not having a permanent establishment in India) is the doubling of the withholding tax rate on royalties and fees for technical services (‘FTS’) from the existing 10% to 20%, plus surcharge and cess.
India has traditionally been a net importer of technology and high-end services from foreign jurisdictions. As a result, Indian multinational companies often pay substantial royalties to related and unrelated foreign entities for the utilization of technologies and fees for technical services (FTS). According to the source rule of taxes, income of this nature is deemed to have originated in India. Therefore, when remitting any amounts that qualify as royalties or FTS, the Indian payer has the responsibility of withholding taxes.
A non-resident or foreign company has the choice to be taxed either under the provisions of the Double Tax Avoidance Treaty (DTAA) between India and the country where the non-resident or foreign company is located, or under the Income-tax Act, depending on which option is more advantageous.
Section 115A of the Income Tax Act, of 1961
Section 115A of the Income Tax Act, 1961 is a provision that deals with the tax rates applicable to non-residents in India for certain types of income. It outlines the tax rates for royalties, fees for technical services, and other similar payments made to non-residents. The section also covers the tax treatment for other types of income, such as dividends, interest, and capital gains, earned by non-residents in India. Section 115A is a crucial provision in the Income Tax Act as it helps determine the tax owed by non-residents in India and provides clarity on how the tax rates are applicable to various types of income.
In March 2023, the Indian Government amended Section 115A with the aim of aligning the tax rate on royalty and FTS (Foreign Technical Service) earnings with international standards. Additionally, this alteration will also contribute to enhancing domestic investment and innovation. It is worth noting that the country’s Double Taxation Avoidance Agreements (DTAAs) with other countries influence the tax rate on royalties and fees for technical services in India as well.
Double Taxation Avoidance Agreements (DTAAs): India has signed DTAAs with various countries to avoid double taxation and to promote economic cooperation. These agreements generally provide for a lower tax rate on royalty and fees for technical services than the domestic tax rate in India. This means that non-residents who are residents of any country with which India has a DTAA may be able to benefit from a lower tax rate.
Most Favored Nation (MFN) clause: Some of India’s DTAAs have an MFN clause. This clause means that if India enters into a DTAA with another country that provides for a lower tax rate on royalty and fees for technical services, the lower rate will automatically apply to the residents of the country with which India has the MFN clause.
Benefits for non-residents: The combination of DTAAs and MFN clauses means that non-residents who are residents of a country with which India has an MFN clause may be able to benefit from a lower tax rate even if their country does not have a DTAA with India. This provides an incentive for countries to negotiate favourable tax rates for their residents with India.
Impacts of the increase in tax rate
The increase in the tax rate on royalties and technical service fees paid to non-residents has received a mixed reaction of appreciation as well as criticism. Rightfully so, considering the several significant impacts that come along with it. The following are some positive impacts:
Improved transparency: The new amendment mandates non-residents who receive payments from India to file income tax returns in the This will enhance transparency in the Indian economy, as the government will be able to better track foreign investments in India.
Increased government revenue: The amendment can the government revenue that can be used to fund critical government programs and services.
In addition, some negative impacts are as follows:
Reduced foreign investment: The increase in tax rate may make India a less attractive destination for foreign investors who will have to pay more taxes on their income from India. Therefore, they may look for other countries to invest in with lower tax This could lead to reduced foreign investment in India and ultimately, may negatively influence economic growth.
Increased costs for Indian companies: Indian companies that make payments to non-residents for technical services may have to pay more tax on these payments, which may hamper their profits over costs. This may also make it more difficult for Indian companies to compete with foreign companies that do not have to pay such high taxes.
Impact on employment: If foreign investors reduce their investment in India, this could lead to a reduction in job opportunities in the country. Similarly, if Indian companies have to pay more taxes on their payments to non-residents, they may have to downsize their workforce to maintain profitability.
Potential for renegotiation of contracts: Indian companies may try to renegotiate the terms of their contracts with non-residents to reduce the payments made to them, which could lead to a renegotiation of existing contracts and agreements. This could influence business relationships between Indian and foreign companies.
Conclusion
The revision in the tax rate for Royalty/FTS income presents profound legal and professional implications for non-resident taxpayers in India. While the revised base tax rate stands at 20%, NR taxpayers can still harness reduced rates or exemptions extended under the purview of DTAA provisions.
Ensuring proactive compliance with the revised tax regulations, meticulous record-keeping, acquisition of a PAN, and prompt filing of India Tax Returns constitute pivotal obligations for NR taxpayers. In navigating the intricate nuances of the Indian tax system and adhering to all tax obligations in a compliant and efficient manner, it is strongly advised to solicit.
It is crucial for Indian companies and non-residents to comply with the provisions of the Income Tax Act and the Double Taxation Avoidance Agreements to reduce the impact of the change. Furthermore, the role of Income Tax Returns (ITR) has become even more important for non-residents receiving payments from India.
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