The Finance Minister in the Budget Speech emphasized reducing the tax burden in India and making India an attractive destination for foreign investments. For this, several measures are undertaken, such as incentives to startups, lower/incentivized tax rates for domestic companies, single-window clearance, ease of doing business in India, etc.
It is proposed that the foreign companies earning Royalty or Fees for Technical Services (FTS) from the Indian Company are not required to file tax returns in India, if the said income is subject to tax in India, which is not lower than the tax stated in the specified provision, i.e., Section 115A of the Income Tax Act.
There has been a myth related to the foreign filing tax returns in India when appropriate taxes are withheld. Although there was an exemption in the Act for interest and dividend income, a similar exemption was not available for the royalty or FTS income. It is, therefore, a significant step to reduce tax compliances for foreign companies.
However, the exemption will be available only for the Royalty or FTS income taxed under the domestic Act and not under the Double Tax Avoidance Tax Treaty. In the following situations, filing tax returns may not be exempted.
- Where the taxes are not withheld basis relying on the Treaty provisions:
- Under the Domestic Act, an obligation is cast on the payer to withhold tax at source while making payment to a foreign company if the income is taxable in India. A foreign company is eligible to claim the benefit of the beneficial provision of the Act or the relevant double tax avoidance treaty. If the payer has applied the beneficial provision of the tax treaty and has not withheld the tax at source, then as the said income is not taxed in India, there will be no exemption from filing of the tax returns in India.
- For instance, the Indian company is making payment of FTS to a Foreign Company in Singapore. This income is taxable under the domestic tax provision. However, under the Double Tax Treaty between India and Singapore, the said income can be taxable only if it 'makes available' technical knowledge or skill or know-how to the Indian Company. Assuming the available condition is not satisfied, and therefore the Indian payer has not withheld the tax at source.
- Similarly, there could be some Tax Treaties where there is no FTS clause, for instance, the UAE. In such a case, although the income under the domestic Act is taxable as Royalty or FTS, it may qualify as business income under the Tax Treaty in the absence of the FTS clause. It may not be taxable in India unless the foreign company has a permanent establishment in India.
- In the cases since no tax is withheld in India, the exemption from filing the tax return will not be available even if the income is not taxable under the relevant Tax Treaty as FTS.
- Where the foreign companies/payers have obtained a ruling from the Authority for Advance Rulings (AAR), Income is not taxable in India
- The proposed provision exempts the foreign company from filing tax returns in India if the appropriate taxes are withheld. Under the Domestic Act, there are provisions where the foreign company or the Indian payer can approach the AAR and obtain a ruling on the taxability of the proposed transaction in India. If the AAR has ruled that the income of royalty or FTS is taxable under the Act but not under the Treaty, then the said income shall not be subject to tax in India. In such a case, even though the income is not taxable, they may be required to file tax returns in India, as there were no taxes withheld on the said income.
- In addition to the above, there may be certain instances where the foreign company needs to consider filing the tax return in India, even though the taxes are withheld under the Domestic Act.
- Where the Tax withheld is more than the specified Tax Rate (i.e., cases where the foreign company does not have Permanent Account Number (PAN) in India)
- Under the Domestic Act, if the foreign company does not have a PAN in India, it is subject to a higher withholding tax rate of 20% (as compared to the tax rate of 10% applicable on royalty or FTS income). Although the government has liberalized, and the higher tax rate is not applicable to a company not having PAN, provided they furnish the specified documents. If the company has not provided documentation and the income is subject to tax @20%, in such cases, the foreign company may need to analyze the filing of the tax return depending upon the quantum of transactions and claim the refund of additional tax of 10%.
- Where the tax is deducted but the foreign company wants to adopt a position different from the position adopted by the payer while withholding tax at source
- Under the Domestic Act, there are stringent provisions imposed on the payer who has defaulted in deducting tax, such as the denial of corporate tax deduction of the expenses, considered as assessee in default and subject to tax, interest, and penalty. The payer while making payment to the foreign company is required to ascertain if the income is taxable in India and is subject to withholding tax. Also, for various payments like payment for reallocation cost, recharge of salary cost, payment relating to software, reimbursement of expenses, etc., there are mixed judicial rulings and therefore, the payer may have adopted a conservative approach and withheld tax while making payments to the foreign company. However, if the foreign company is of the view that the income is not taxable in India, then they can adopt a different position in the tax return and claim the refund of taxes paid in India. As such, even if the income is subject to tax in India and the exemption is available for not filing the tax return in India, the foreign company may need to consider whether they want to file the tax return and claim the refund of taxes withheld, especially when they may not be able to utilize the credit of taxes withheld in India in their country of residence.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.