Unlock insights into the increased tax rate on royalties and technical service fees in India post the Union Budget 2023-24. Understand the implications for non-residents and Indian companies, the role of Double Tax Avoidance Agreements, and the importance of filing Income Tax Returns. Get expert guidance on mitigating the impact and navigating the changing tax landscape.
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.
Here is what it says:
- Non-residents paid a tax rate of 20% on dividend income received in an IFSC (International Financial Services Centre). However, the amendment proposes a concessional tax rate of 10% on dividend income received in an IFSC.
- The second amendment proposes an increase in the tax rate on income by way of royalties and fees for technical services earned by non-residents or foreign companies from 10% to 20%, with the applicable surcharge and cess.
Please note that the tax rate is dependent on the availability of a Tax Residency Certificate (TRC) and Permanent Account Number (PAN). The following are some points to consider:
A tax rate of 20.8% will be imposed along with a surcharge if:
- Non-residents have neither TRC nor
- Non-residents have only
The Double Taxation Avoidance Agreement (DTAA) can be utilized as long as the foreign company is filing an income tax return (ITR) in India if:
- Non-residents have both TRC and
- Non-residents have only
Most importantly, from April 1, 2023, it is now mandatory for non-residents to file their Income Tax Returns (ITRs) in India.
Financial information? Let us start brush up on the basics.
What is 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. Here is how:
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 favorable tax rates for their residents with India.
Implications for Indian Companies:
- The increase in the tax rate on royalties and fees for technical services will affect Indian companies that make payments to non-residents for the use of intellectual property rights or technical services.
- This increase may result in Indian companies having to pay more tax on their payments to non-residents, which could lead to increased costs and reduced profits.
- To reduce the impact of this change, Indian companies can comply with the provisions of the Income Tax Act and the DTAAs.
- Indian companies can also negotiate with their non-resident counterparts to share the additional tax burden or renegotiate the terms of their agreements to reduce the payments made to non-residents.
- This change may also lead to a decrease in the attractiveness of India as an investment destination for non-residents looking to provide services or invest in the country.
Role of ITR after an increase in Tax Rate:
- The increase in the tax rate for non-residents receiving payments from India will now make it mandatory for them to file their Income Tax Returns (ITRs) in India from April 1, 2023.
- Non-residents should ensure that they comply with the provisions of the Income Tax Act to avoid any legal issues or penalties.
- Indian companies that make payments to non-residents for technical services or royalties should also ensure that they deduct and deposit the increased tax amount in a timely and accurate
- Non-compliance by non-residents or Indian companies may result in penalties and legal consequences. Therefore, it is important for both parties to follow the regulations and file their ITRs on time.
- The increase in tax rate and compliance requirements may create additional administrative burdens for non-residents and Indian companies.
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:
- 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
To conclude, the First Amendment is expected to be advantageous for businesses that receive dividend income from an International Financial Services Center (IFSC). On the other hand, the Second Amendment is likely to have a negative impact on businesses that generate income through royalties and fees for technical services. However, in the end, it may turn out to be advantageous for India as the increased revenue can be invested in the country’s innovation and growth.
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.
Need assistance with filing your Income Tax Returns? Neeraj Bhagat and Co. is here to assist you! Drop us an email or call our professional financial advisors and us would be happy to guide you.
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