The Finance Act, 2023 has increased the withholding tax payable on income by way of royalty and fees for technical services earned by non-residents and foreign entities under the Income Tax Act, 1961 ("the Act") from 10% (ten percent) to 20% (twenty percent), with effect from April 1, 2023. The sudden increase in the tax rates will impact several Indian companies in the technology, manufacturing, and entertainment industries as they often remit substantial payments as royalties or fees for technical services to non-resident entities for usage of brand and other intellectual property rights, technical know-how/services or licensing rights.
Section 90(2) of the Act allows a non-resident entity to choose and apply the provisions of the applicable double taxation avoidance agreement ("DTAA"), which India has entered with the country of residence of the said non-resident entity, if that is more beneficial than the provisions of the Act, subject to certain conditions.1 Therefore, foreign entities receiving royalty or fees for technical services have an option to opt for the lower tax rate as prescribed in the DTAA applicable to such country, subject to the compliance of certain obligations under the Act. For instance, many of the DTAAs with India, including those with Singapore, Switzerland, France, Germany, Japan, Bhutan, China, Indonesia, Korea, Malaysia, Luxembourg etc., prescribe withholding tax deduction on royalties and fees on technical services at 10% (ten per cent).2
In case of those countries with whom DTAAs with India provide for a 15% (fifteen per cent) withholding tax rate for payments of royalty and technical services fees, such as the U.S., U.K., Philippines, and Mauritius, the impact would be two-fold, firstly the residents of such countries will have to bear an additional 5% (five per cent) withholding tax levy under the DTAA (as opposed to the earlier benefit of lower tax rate of 10% (ten percent) levy under the Act) and secondly, there would be increased compliance obligations (as explained below) in order to avail the lower tax benefit under the DTAA. The countries that do not have any DTAAs with India will have to bear the full brunt of the increased withholding tax as prescribed by the aforesaid amendment.
In terms of section 90(4) of the Act, a non-resident is entitled to claim treaty benefits, if it obtains a tax residency certificate ("TRC") of being a resident of its home country from the Government of that country or specified territory outside India.3 Further, Section 90(5) of the Act requires the non-resident assessee to furnish certain additional information and documents in Form 10F4, as prescribed under Rule 21AB(1) of the Income Tax Rules, 1962 ("the Rules") along with documents supporting the same. The information inter alia includes:
a. Status of the assessee;
b. Permanent Account Number or Aadhaar Number of the assessee if allotted;
c. Nationality (in the case of an individual) or country or specified territory of incorporation or registration (in the case of others);
d. Assessee's tax identification number in the country or specified territory of residence and if there is no such number, then, a unique number on the basis of which the person is identified by the Government of the country or the specified territory of which the assessee claims to be a resident;
e. Period for which the residential status as mentioned in the TRC is applicable; and
f. Address of the assessee in the country or territory outside India during the period for which the TRC is applicable.
It may be noted that vide the Central Board of Direct Taxes' ("CBDT") notification dated March 28, 20235, partial relaxation in respect of the electronic filing of Form 10F has been provided till September 30, 2023, to those non-resident taxpayers who do not have permanent account number (PAN) and are not required to have PAN as per the relevant provisions of the Act read with the Rules. Such category of taxpayers may make statutory compliance of filing Form 10F till September 30, 2023 in manual form.
Deduction of taxes by Indian recipient of services from payments due to non-residents is always a touchy subject during commercial negotiations and many a times the liability is shifted to Indian companies to bear the tax and gross up the payments to ensure that the non-residents receive payments as if no deductions have been made. Alternatively, beneficial tax deduction rates available under the Act and/or the DTAAs are agreed. With the increase in withholding tax under the Act and in the absence of beneficial tax rates available under the DTAAs, many foreign companies may want to pass the impact of tax deduction on the Indian companies or look at other countries to outsource their technical services. Needless to say, in case the Indian companies are required to bear the withholding taxes on technical services and royalty, it would invariably impact the competitiveness of Indian businesses in the Indian and global market.
Foonotes
1. Section 90 (2) - Where the Central Government has entered into an agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.
2. Tax Rates - DTAA v. Income-tax Act (incometaxindia.gov.in)
3. Section 90 (4) - An assessee, not being a resident, to whom an agreement referred to in sub-section (1) applies, shall not be entitled to claim any relief under such agreement unless a certificate76 of his being a resident in any country outside India or specified territory outside India, as the case may be, is obtained by him from the Government of that country or specified territory.
4. https://incometaxindia.gov.in/forms/income-tax%20rules/103120000000007197.pdf
5 https://www.incometax.gov.in/iec/foportal/sites/default/files/2023-03/Refer%20Notification.pdf
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