Rollback in Income Tax Rate on Royalty and fees for Technical Services

‘Make in India’ is an initiative of the Government of India to encourage companies to manufacture in India. The program includes major new initiatives designed to facilitate investment, foster innovation, protect intellectual property, and build best-in-class manufacturing infrastructure. It represents an attitudinal shift in how India relates to investors as a true business partner.

The major objective behind the initiative is to focus on certain sectors of the economy like automobiles, pharmaceuticals, textiles, ports, railways, defense manufacturing, etc. for job creation and skill enhancement. The initiative hopes to attract the much required capital and technological investment in India in these sectors.

In order to attract foreign capital investments the Government of India has relaxed the sectoral caps in sectors like defense, railways, pharmaceuticals, etc.

For developing the manufacturing and infrastructure sectors it is important that India has access to high-end technology, know-how, processes, software, etc. To improvise the sharing of technology, the Government of India has increased the validity of licenses and has introduced simplified process for obtaining new licences.

One of the major area concerning import of technologies is the taxation of royalty and fees for technical services (FTS) fees received by the non-resident from Indian entities for sharing of know-how, processes, software, etc.

By the Finance Act, 2013, the rate of Income Tax in India on royalty and FTS which are not effectively connected to a permanent establishment in India was increased from 10% to 25% (plus applicable surcharge and cess) on gross amount of royalty and FTS. As explained in the memorandum to the Finance Bill, 2013 the reason for increase in tax rate for royalty and FTS from 10% to 25% was to reduce the disparity of tax rate as per the Indian tax law and Double Tax Avoidance Agreements (DTAA).

This majorly hampered the growth of small entities as in practice majority of the technology and licensing agreements provide for payment of royalty and FTS net of taxes to the non-residents. In other words, the Indian entities were the ones who bore the burden of taxes while making payment to non-residents. This caused lot of hardships to the Indian entities as it increased their cost of importing the technology. On a related note it is important to mention that majority of the DTAA entered by India provide for a tax rate of 10% or 15% on royalty and FTS. Non-residents from countries with whom India does not have DTAA or countries with which India has entered into DTAA but which provide for taxability as per the domestic law were discouraged for sharing technology and know-how with the Indian entities due to the increase in tax rate.

The new Government, as stated above, is working on a path for providing a tax regime which encourages more foreign investment and import of technologies to promote the ‘Make in India’ initiative. Accordingly, the Budget 2015 proposes to rollback or reduce the rate of income-tax on royalty and FTS from 25% to 10% (plus applicable surcharge and education cess). The reduced Income Tax rate of 10% will be applicable prospectively from assessment year 2016-17 on wards.

Reduced rate will definitely help in encouraging technology upgradation which in turn will boost domestic production. This will also reduce the additional burden on the Indian entities which enter into contracts for payment of royalty and FTS on net basis as they will have to bear less income-tax on such payments.

The proposed rate of 10% will be marginally increased due to surcharge and education cess compared to the lowest rate of 10% in DTAA. This will also reduce the burden of compliances like obtaining tax residency certificate and Form 10F required to claim benefits of the DTAA.

The DTAA with countries like United States of America, United Kingdom, Canada, Australia, etc. provide for a tax rate of 15% on royalty and FTS. The proposed amendment will help them enjoy lower tax rate of 10% under the Indian tax law and encourage more technical collaborations from such developed economies. Further, it will also reduce the tax outflow for non-resident tax payers in countries with which India has not entered into DTAA.

The lower tax rate of 10% can be applied only if the non-resident has a permanent account number (tax registration number) allotted by the Indian authorities. In the absence of permanent account number the tax rate under the Indian tax law will be 20%.

The proposed reduction in the tax rate on royalty and FTS is a welcome move and will encourage the Indian entities to import technology, know-how, software, etc. and also help the Government in achieving the objective of its ‘Make in India’ program leading to a win-win situation. It is a significant amendment to win more investor confidence and send a positive message to overseas investors that India is an investor friendly country. This will encourage the non-residents to enter into more and more technological collaborations with Indian entities which in turn will help the Indian entities to use better technology, grow and boost the Indian economy.

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