MARCH 12, 2015

By Sameer Gogia, Amit Agarwal & Vibha Bhatija Deloitte Haskins & Sells LLP

THE Finance Minister, Mr. Arun Jaitleyin the Finance Bill for 2015 has reinstated the erstwhile tax rate of 10% from existing rate of 25% on payments made to non-resident tax payers on income in the nature of Royalty & Fees for Technical services (FTS) earned from India.

The trend of the tax rates on royalty and FTS under Section - 115A of the Income Tax Act, 1961 has been as under:

#Plus Surcharge and Education Cess

It is interesting to note the rationale given each time a change happened:

Budget Speech 1997 - reduction from 30% to 20%

"There has also been a demand from the corporate sector that the tax rate of 30 per cent on royalty and technical services fees payable to foreign companies is too high and acts as a hindrance to the transfer of technology. I, therefore, propose to reduce this rate to 20 per cent"

Budget Speech 2005 - reduction from 20% to 10%

"To encourage technological up-gradation, I propose to reduce the withholding tax on technical services from 20 per cent to 10 per cent"

Budget Speech 2013 - increase from 10% to 25%

"The rate of tax on royalty in the Income-tax Act is lower than the rates provided in a number of Double Tax Avoidance Agreements. This is an anomaly that must be corrected. Hence, I propose to increase the rate of tax on payments by way of royalty and fees for technical services to non-residents from 10 percent to 25 percent. However, the applicable rate will be the rate of tax stipulated in the DTAA"

Budget Speech 2015- reduction from 25% to 10%

"Today I see a lot of young entrepreneurs running business ventures or wanting to start new ones.  They need latest technology.  Therefore, to facilitate technology inflow to small businesses at low costs, I propose to reduce the rate of income tax on royalty and fees for technical services from 25% to 10%."-

The Finance Act, 2013 had amended Section-115A to increase the rate of tax from 10% to 25% on payments made to non-residents in respect of the income in the nature of Royalty & FTS on the ground of aligning the same with the rates provided in a number of Double Taxation Avoidance Agreements (DTAAs).

The enhanced withholding tax rate of 25% under the Indian tax law had essentially increased the tax burden on the Indian companies (i.e. the receiver of the royalty or technology) because very often the foreign companies would pass the tax cost to the Indian companies.

Moreover, the requirement of Tax Residency Certificate (TRC)was made mandatory w.e.f 1 st April 2013 for enabling the non-residents to avail tax relief under the relevant DTAA. This also acted as a deterrent to availing the lower rate. In case the foreign companies do not furnish the TRC or in case the payments are being made to the foreign companies from a non-treaty country, the Indian companies become obligated to deduct tax at the enhanced rate of 25%.

With a view to reduce this tax burden and to facilitate the inflow of latest technology needed by the Indian entrepreneurs, the Finance Minister in his Budget 2015 has proposed to reinstate the withholding tax rate applicable for Royalty & FTS from 25% to 10%. The revised rate would be applicable with effect from the Assessment Year commencing from 1 st April, 2016 i.e. Financial Year commencing from 1 st April, 2015

As a consequence of this proposed change, when the non-resident is not able to obtain TRC from his respective home country, the rate as per the Indian Income Tax Act, 1961 (i.e. 10% plus surcharge and education cess instead of previously applicable higher rate of 25%) shall apply.

The lower tax rate of 10% would apply only when the non-resident possesses a Permanent Account Number (PAN) duly allotted by the Indian Tax Authority. In the absence of the Indian Permanent Account number, tax rate of 20% plus surcharge and education cess would apply as per the provisions of Section-206AA of the Income Tax Act, 1961.

It is also worthwhile to note that the rate of 10% is lower than the rates as specified in many of the DTAAs, which India has signed and it would also provide some leverage benefit to Indian companies in case of grossing up i.e. wherein such tax is borne by the Indian resident.