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:
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:
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:
Most importantly, from April 1, 2023, it is now mandatory for non-residents to file their Income Tax Returns (ITRs) in India.
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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:
Role of ITR after an increase in Tax Rate:
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:
In addition, some negative impacts:
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.