Increase in the income-tax rate on royalty and fees for technical services – plugging the rat hole with a big rock

Anjana Singh, Ashish Gogri

Royalty and fees for technical services have always been surrounded with lot of controversies for some or other reasons. Though most of the controversies revolve around the taxability, the finance minister felt the need to correct the anomaly in the tax rate.

The Finance Act, 1976 inserted a provision in the Indian tax law for concessional tax rate for non-residents earning income in the nature of royalty and fees for technical services. The tax rate for royalty and fees for technical services have been changed several times since then, depending upon the date on which the agreement is entered.

 Thus, the current tax rate is @ 10% for agreements made on or after 1 June 2005, subject to fulfillment of certain conditions. The Indian tax law provides an option to the assessee to apply the tax treaties ordomestic tax law provisions, whichever is more beneficial. The tax rates provided under the various Indian tax treaties for royalties and fees for technical services ranges from 10% to 25%.

The finance minister in his budget speech stated that the rate of tax on royalty in the Indian tax law is lower than therates provided in a number of tax treaties and therefore, to correct this anomaly, it is proposed to increase the rate of tax on income of non-residents from royalty andfees for technical services from 10% to 25% for agreements made after 31 March 1976. The revised rates will be effective from assessment year 2014-15. This means that the effective tax rate after adding surcharge and cess would be 26.265% in case total income exceeds INR 10 million and 27.038% where total income exceeds INR 100 million.

The increase in tax rate would definitely add to the tax kitty of the Indian tax authorities, but it will have some far reaching implications for the tax payer.

• The non-resident taxpayers from the countries with whom India does not have a tax treaty or from the tax treaty countries which provide for taxability as per the domestic law (Greece, Libya, Egypt, etc.) will now have to shell out more tax on any payment from India for royalty or fees for technical services. This would lead to substantially higher tax burden for the tax payer.

• Furnishing of a tax residency certificate [TRC] having prescribed particulars was made mandatory for claiming treaty benefit by the Finance Act, 2012. Finance Bill, 2013 proposed to provide that TRC will be necessary but not a sufficient condition for claiming benefits under tax treaties. Concern have been expressed that the proposed amendment may lead to controversies where tax authorities may challenge TRCs for some reasons such as not in the prescribed format, beneficial ownership, fiscally transparent entities, etc. This could have again led to higher tax burden for the tax payer, even in those cases where India has tax treaty but the benefit has been denied.

The finance ministryhas issued a clarification on 1 March 2013 stating that the TRC produced by a resident of a contracting state will be accepted as evidence that he is a resident of that contracting state and the Income-tax authorities in India will not go behind the TRC and question his residential status. He also clarified that this concern will be addressed suitably when the Finance Bill is taken up for consideration. Hopefully, this concern will be taken care to avoid any hardship to the taxpayer. One would have to wait and watch the provisions when the law is finally enacted.

• Assessees from some countries like United States of America, United Kingdom, Italy, Denmark, etc. which have been enjoying the lower tax rate of 10% under the Indian tax law will also feel the pinch as they will now have to pay tax at the higher rate provided in the tax treaties.

• Generally, the foreign parties negotiate the contract with the Indian parties in such a manner that tax liability in India is mostly on Indian parties. The proposed increase in tax rate will eventually increase the costsof the Indian parties.

• It is also pertinent to note that the Indian tax law provides for a higher withholding tax rate of 20% in case the payee does not have a Permanent Account Number (PAN). However, such increase in the tax rate may further discourage the assessees in whose case the income is taxed, under the Indian tax law,  at the increased rate of 25% to obtain PAN. The increase in tax rate to 25% may also render the provisions of higher withholding tax rate in the absence of PAN redundant in some cases.

Though the tax rates provided in Indian tax treaties for royalties and fees for technical services ranges from 10% to 25%, majority of the tax treaties provide for tax rate of 10% / 15% and there are only three tax treaties (Poland, Romania and Brazil) which tax income from royalty and fees for technical services at a rate higher than 20%. Therefore, there is no real justification of such huge hike in the tax rate. Probably, keeping these facts in mind, the tax rate proposed under the Direct Taxes Code, 2010 was only 20%. The only silver line would be the hope that with the proposed hike in the tax rate, more and more countries may try to enter into a tax treaty with India. 

Authors

Anjana Singh is a Senior Manager in Deloitte Haskins & Sells.

Ashish Gogri is a Manager in Deloitte Haskins & Sells.