The Indian Union Budget 2023-24 received 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 withholding tax rate on royalties and fees for technical services (‘FTS’) from the existing 10% to 20%, plus surcharge and cess.
India has been a net importer of technology and high-end services from foreign jurisdictions. In such cases, Indian multinationals pay significant amount of royalties for the use of technologies and also FTS to its related and non-related foreign parties. Income of this nature is considered to have arisen in India and applying the source rule of taxes, withholding tax obligation is in the hands of the Indian payer while remitting any sums which qualify as royalty or FTS. A non-resident/ foreign company has the option to be taxed as per the provisions of Double Tax Avoidance Treaty (‘DTAA’) entered into between India and the country of residence of the non-resident/ foreign company or the Income-tax Act, whichever is more beneficial.
Till date, the DTAA rate (in most treaties) and the domestic income tax rate were the same @ 10 percent for royalty/ FTS. As a matter of fact, the DTAA rates were more beneficial as the domestic withholding rate of 10% attracts surcharge and cess. Even where the DTAA rates were higher than 10%, beneficial option was always available to adopt the domestic withholding tax rate of 10% (plus surcharge and cess). Now with the increase in domestic withholding tax rate to 20% (plus surcharge and cess), there will be an additional tax burden on non-residents/ foreign companies from countries where the DTAA rate is higher than 10%. Example – If the DTAA rate is 15% for royalty/ FTS, withholding tax rate will increase from 10% (prescribed under the erstwhile domestic withholding tax provisions) to 15% (as per the DTAA), as the new domestic withholding tax rate of 20% is now not beneficial.
In addition to the increase in withholding tax rates, additional compliances are required to be undertaken by non-residents/ foreign companies in order to claim a beneficial tax rate under the respective DTAA. This includes obtaining a Tax Residency Certificate (TRC) from the country of residence and such TRC should contain the requisite information (such as tax identification number, residency period, address, etc.) as prescribed by the India Income Tax Rules. The non-resident/ foreign company is also required to furnish Form 10F to the Indian payer to disclose the aforementioned details; Form 10F is available and is required to be filled electronically on the Indian Income Tax portal. Accordingly, to adopt a lower rate under the DTAA, greater compliance obligations arise for both Indian payers as well as foreign recipients. Illustratively, a non-resident/ foreign company choosing to adopt the DTAA tax rate will be required to undertake the following compliances from an Indian Income tax perspective:
Obtaining a Permanent Account Number (PAN) from Indian tax authorities
Obtaining a TRC from the respective tax authorities in the resident jurisdiction
Filing Form 10F electronically on the India Income Tax Portal
Filing an Income Tax Return in India
Obtaining Digital Signature Certificate (DSC) to file Form 10F online/ file Tax Return in India
Issuing a ‘No Permanent Establishment’ declaration to the Indian paying entity
To summarise, in the case of non-residents/ foreign companies, where the tax treaty provides for a rate higher than 10 percent or in case India does not have a tax treaty with the recipient’s jurisdiction, the change will result in an additional tax burden. The increase in tax rate is likely to impact certain pass through/ tax transparent entities who may not be able to obtain a TRC in their home jurisdiction and hence may not be eligible to claim the lower DTAA rate.
Authors: Deni Shah and Anmolee Deole
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