Background
The receipt of royalty and fees for technical services (‘FTS’) for non-residents is deemed to accrue or arise in India. Therefore, the same is construed as taxable in India. Section 115A of the Income Tax Act, 1961 (‘the Act’) was introduced by the Finance Act 1976 which deals with taxation of specified income streams for non-residents, including royalty and fees for technical services (‘FTS’) whose tax rate has been 10 per cent (plus surcharge and cess). The Finance Act 2013 provided an amendment to increase the said rate of taxation of royalty and FTS from 10 per cent to 25 per cent (plus surcharge and cess tax). However, through the Finance Bill, 2015, the Hon’ble Finance Minister again restored the earlier rate of 10 per cent taxation for royalty and FTS.
Amendments made by Finance Act, 2023
The Finance Act 2023 was recently introduced. One of the amendments is to increase the tax rate on royalty and FTS from 10 per cent to 20 per cent (plus surcharge and cess tax) with effect from 1 April 2023. As per provisions of the Act, a non-resident can opt to be taxed as per the domestic tax provisions or tax treaty entered between India and the country of residence of the taxpayer or the Act, whichever is more beneficial.
Implications of amendments
Considering tax treaties with major countries (e.g. United Kingdom, Canada and the United States of America) provide for a tax rate of 15 per cent, many non-residents receiving royalty and FTS were opting for the tax rate under section 115A of the Act. Furthermore, even in the case of the majority of the tax treaties (e.g. Belgium, Netherlands, Singapore) signed by India which provide for the tax rate of 10 per cent, the recipient non-residents were opting for section 115A due to specific exclusion of filing of tax return which is available to non-resident recipients if (i) such non-resident only had income from royalty/FTS from India and (ii) tax has been withheld from such income at a rate which is not lower than the rate provided under section 115A, which was formerly 10%.
However, pursuant to the amendment, the tax rate for royalty and FTS is doubled, and for the taxpayer a way forward to avoid the increased tax rate is to make use of the treaty benefit which would result in certain compliances which may include obtaining tax registrations, filing return of income in India, providing tax residency certificates, etc. detailed below:
Increased compliances by virtue of amendments
1. Obtaining tax registrations and the filing of a tax return in India:
- As detailed above, the Act exempted a non-resident earning royalty and FTS income from the tax return filing requirement if the taxes were withheld as per the rate provided under Section 115A.
- Pursuant to the amendment, the non-resident who will be claiming the treaty benefit on taxation of royalty and FTS would now be required to file the tax return in India.
- To file a tax return in India, it will be imperative for the non-resident to obtain the tax registrations in India as without the same, one cannot file the tax return.
2. Electronic filing of Form 10F:
- Form 10F is an essential document used by non-resident taxpayers to claim tax benefits under an applicable Tax Treaty with India.
- The Central Board of Direct Tax (‘CBDT’) recently mandated the electronic filing of Form 10F by non-residents.
- However, considering the practical challenges faced by the non-residents in filing Form 10F electronically, the CBDT had provided relief to provide Form 10F manually until 31 March 2023, but now extended this to 30 September 2023 for non-residents who do not have a tax registration number.
- Given the recent amendment in tax rates on royalty and FTS, non-residents making use of treaty benefits would now have to mandatorily obtain a tax registration to file Form 10F electronically for the period post 30 September 2023 (unless there is a further extension).
3. Documentation for claiming treaty benefits to be obtained by Indian payers from non-residents:
- The increased rate on royalty and FTS to 20 per cent under the domestic provisions considering the highest rate as compared to tax treaties would insist that non-residents make use of the treaty rate benefit.
- To claim benefit under the tax treaty, the non-resident needs to maintain specific documents and the resident payers are required to obtain the following documents:
- Tax residency certificate
- No permanent establishment declaration
- Electronically filed Form 10F
- Failure to furnish the above documents by the non-resident to resident payers will result in withholding as per the Act and there will be penal consequences for the resident payers such as interest on short deduction, penalties and prosecution.
Enhanced cash outflow for resident payers in the case of grossed-up payments
Separately, this amendment may adversely impact Indian payers in cases where royalty/FTS payments were being grossed-up for tax. If non-resident recipients are not going to be out of pocket for withholding taxes, obtaining the above documents could be more cumbersome, resulting in additional cash outflow for resident payers.
Conclusion
In conclusion, the decision to increase the tax rates for royalty and FTS will increase the compliance for non-residents. However, whether or not the amendment will result in more revenue for the government is yet to be seen.
