An important amendment proposed in the Finance Bill, 2013 (Finance Bill) is the increase in tax rate for royalty and Fees for Technical Services (FTS) payable to non-residents to 25% (against the current tax rate of 10%) as one of the measures for additional resource mobilization. As indicated in the Finance Minister’s speech, the purpose of the proposed amendment is to correct the anomaly of tax rates for royalty and FTS being lower under the Income-tax Act, 1961 (the Act) as compared to the rates specified in some of India’s tax treaties.
It is true that in cases of treaties with rates higher than 10%, royalty / FTS income earned by Indian companies may be taxed in the foreign source country at the higher rate (as provided by the treaty), while residents of those nations earning similar income from India could benefit from a lower tax rate under the Act. While the anomaly definitely existed, it does not appear to be the rationale behind the proposed amendment. Moreover most countries do not have a source rule for taxation of royalties and FTS like India and would normally tax services only if rendered physically in that country.
With respect to the proposed rate, it is interesting to note that the tax rates under the Act were originally as high as 30%. These were gradually reduced to 10% taking cognizance of the fact that higher tax rates are a hindrance to the inflow of technology into India. This underlying rationale appears to have been entirely overlooked while proposing the higher tax rate of 25% on the gross amount of royalty / FTS income of a non-resident in cases where such income is not effectively connected to a Permanent Establishment in India.
That apart, the basis of proposing a rate of 25% seems to be misplaced. Taking royalty for instance, majority of India’s tax treaties (including with France, Germany, Japan, Netherlands, Singapore and Switzerland) provide for a tax rate of 10%. Approx. 18 treaties (such as with USA, UK, Australia, Korea, Canada and Indonesia) contain a tax rate of up to 15% and merely 8 (such as with Denmark, Poland and Romania) allow a rate higher than that. A similar trend is observed in the rates for FTS as well. The peak rate of 25% is found only in the treaty with Brazil and that too just in respect of royalty for the use of trademarks. Accordingly, while in the current scenario the Act does specify a rate of 10% for royalty / FTS (consequently, there being no need to apply the tax treaty provisions in many cases), given that a rate of 10% / 15% is applicable in most of India’s tax treaties (either directly or through presence of the ‘Most Favoured Nation’ clause), the proposed rate of 25% seems undoubtedly unreasonable.
The proposed rate is also higher than the rate of 20% contained in the Direct Taxes Code Bill, 2010 and the penal withholding tax rate of 20% applicable for non-furnishing of the payee’s Permanent Account Number (“PAN”).
Further, the 150% increase in the tax rate (from 10% to 25%) may not actually yield the desired overall revenue to the Indian exchequer as majority of royalty / FTS payments are made to countries like USA, UK, Japan, Singapore, Switzerland, Germany, Netherlands, which may not be governed by the rate of 25% owing to a lower rate of 10% / 15% under the respective tax treaties.
However, the non-residents may be faced with some hurdles before they obtain relief under the tax treaties. This is on account of the compliance requirement of furnishing a Tax Residency Certificate (“TRC”) containing prescribed particulars. Additionally, as proposed in the Finance Bill, the said TRC would be a necessary but not sufficient condition for availing such benefits. As a result, the beneficial ownership of the royalty / FTS income (necessary for applying lower rates under the tax treaty) may be prone to greater challenge.
Thus, the increase in tax rate may not only fail to achieve its purpose, it may in fact result in detriment and greater burden on the Indian payer as very often, the commercial arrangements require the Indian companies to bear the related tax cost and pay royalty / FTS ‘net of Indian taxes’. In cases where the 25% rate is applicable, this would result into an effective rate of approx. 33% since the tax would have to be paid by the Indian company on a grossed up amount of royalty / FTS and consequently a substantial increase in the cost of doing business. Even where the lower rate under the tax treaty is applicable, the Indian payer may be impacted to the extent the applicable treaty has a tax rate higher than 10%.
Also, non-residents who may have hitherto been willing to bear the India tax cost may now insist on passing the same to the Indian payers. The chances of convincing them to the contrary would be very slim.
If the proposed hike in tax rate is enacted, in due course Indian companies may find it difficult to implement new technology, avail technical expertise, etc. owing to the associated tax burden (if the tax liability is to be borne by them) or reluctance on the part of multinational companies that are discouraged to deal with a complicated and uncertain tax scenario in India.
While the Finance Minister’s speech did lay emphasis on encouraging investment and industrialization in India, the increase in tax rate on royalty / FTS, if enacted, may prove to be a roadblock to development in the times to come.
N. C. Hegde is ‘Partner’ at Deloitte Haskins & Sells
|Rajiv Bajoria is ‘Director’ at Deloitte Haskins & Sells||Shivali Valecha is ‘Deputy Manager’ at Deloitte Haskins & Sells||
Niki Manek is ‘Assistant Manager’ at Deloitte Haskins & Sells