Finance Bill, 2023 was passed by the Lok Sabha with certain amendments[1]. In one of the amendments, the Finance Minister unexpectedly doubled the tax rate on Royalty and Fees for Technical Services (“FTS”) from 10% to 20% in case of non-residents w.e.f. FY 2023-24.
Assuming a surcharge rate of 5%[2], income from Royalty and FTS arising to a non-resident will now be subjected to an effective tax rate of 21.84%, unless the non-resident avails treaty benefit.
A look into the legislative history of S. 115A[3] shows that the tax rates prescribed for Royalty and FTS income have fluctuated overs the years.
In Finance Act 2013 (FA 2013) when the tax rate was increased to 25%, the rationale laid down in the Explanatory Notes indicated that the treaty allows tax at higher rate ranging from 10-25%, whereas S. 115A provides for lower rate of 10%. In order to correct this anamoly, tax rate u/s 115A on royalty and FTS was increased to 25%. Thereafter, when the tax rate was reduced to 10% vide FA 2015, a combined reading of the Budget Speech and Explanatory Notes indicated that the tax rate was reduced in order to facilitate technology inflow to small businesses at low costs and reduce hardship faced by small entities. The Government has been promoting and encouraging digitalization. Also, over the years there is an increase in start-ups in the field of technology. Indeed, the increase in the tax rate to 20% to going to cause hardships to small businesses even today. However, the rationale behind the increase in the tax rate to 20% by FA 2023 is not known yet.
The sudden increase in the tax rate on royalty and FTS is a major setback for the non-residents. In fact, they are not even given a fair chance to make representations on the same considering the time constraints. The increase in rates was proposed on March 23, 2023, and in a weeks’ time it has become effect.
Key impact of the increase in tax rates is discussed hereunder:
With increase in the tax rate to 20%, the significance of tax treaty has increased. The taxpayers will now seek benefit under the treaty, where in most cases the tax rate on Royalty and FTS ranges from 10-15%[4]. In certain cases, the income may not even be chargeable to tax at all in the treaty (for instance, exclusion of equipment royalty under Indo-Netherlands DTAA; benefit of ‘make available clause under Indo-US/UK/Singapore DTAA; absence of FTS clause under IndoUAE/Thailand DTAA, exclusion of Independent Personal Services from the scope of FTS under Indo-US/UK DTAA, etc.)
However, it is noteworthy that entitlement to treaty benefit is subjected to several antiabuse provisions like the Beneficial Owner test, Limitation of Benefit provisions (LOB), Principal Purpose Test (PPT) under Multilateral Instrument (MLI), etc.
Moreover, in order to avail treaty benefit, S. 90(4) and (5) requires furnishing of Tax Residency Certificate and Form 10F.
Thus, in order to claim treaty benefit, the nonresident will have to maintain robust documentation justifying their entitlement.
Vide Notification No. 03/2022, Form 10F is required to be furnished electronically w.e.f. July 16, 2022. Now in order to furnish Form 10F electronically, one requires a PAN which should be registered on the income-tax portal. Due to practical challenges faced by non-residents not having a PAN and not required to have one, such category of non-residents have been allowed by CBDT to furnish manual Form 10F till September 30, 2023. Unless CBDT grants further relaxations, all non-residents claiming treaty benefit would be expected to obtain PAN and register on the Indian income-tax portal to generate electronic Form 10F.
In cases where electronic Form 10F is not generated, one may argue on first principles that the treaty benefit cannot be denied on grounds of procedural lapse and overriding effect of treaty. Also, in cases where the TRC contains all the prescribed information, one may not be required to furnish Form 10F itself. However, these contentions are unsettled and certainly prone to litigation. With the increase in Indian tax rate on royalty and FTS, the risk undertaken by the non-residents as well as the payers also increases significantly.
As per S. 139(1) of the Income-tax Act, a ‘company or a firm’ is required to furnish income-tax return. For other persons, S. 139(1) requires furnishing of return where total income exceeds maximum amount chargeable to tax.
S. 115A(5) of the Income-tax Act provides for relaxation from return filing where the total income of the non-resident consist only of interest, dividend, royalty and/or FTS and tax deducted is not less than that prescribed u/s 115A(1). Due to the increase in tax rate u/s 115A(1), in most cases, the non-resident would seek treaty benefit. As a consequence, the benefit of relaxation from filing of income-tax return would no more be available and the compliance burden on non-residents will increase.
The increase in tax rate will have far reaching and draconian implications on the person responsible for paying the sum to the non-resident. In the event, the tax authorities hold that the non-resident is not entitled to treaty benefit, then the payer/deductor would be at a risk of being treated as an assessee-in-default and consequences like disallowance of expense, penalty and prosecution will follow.
The payer will now have to be more vigilant and might also be expected to conduct a reasonable due diligence before granting benefit of treaty to any non-resident.
Also, in cases where taxes are to be borne by the payer and the non-resident does not furnish the requisite documents to grant treaty benefit, the taxes will have to be grossed-up at the rate of 20%, increasing the cost for the payer significantly.
On a concluding note, the increase in the tax rate on Royalty and FTS is not a welcome amendment for the non-residents as well as the payers/deductors:
The above document is contributed by – Ronak Doshi & Jinal Jain, Partners
[1] The Bill has received the President’s assent and has been enacted as Finance Act, 2023.
[2] Highest surcharge rate applicable to a Foreign Company
[3] S. 115 A provides for special tax rates on inter alia royalty and FTS in the case of non-residents
[4] For instance, refer India’s tax treaties with Australia, Mauritius, Singapore, Switzerland, UK, US
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