Tax on royalty, technical services need scaling down
February, 08th 2010
Existing Income-tax Act provides that income earned by a non resident by way of Royalty or Fees for Technical Services (FTS) shall be charged to income tax at 10 per cent. The rates of tax in most of the Tax Treaties are also 10 per cent in respect of income from Royalty or FTS.
Recently, India has signed tax treaties with several countries, eg: Botswana, Iceland, Myanmar etc., Tax rate in these treaties as also in some other treaties like France, Germany, Ireland, Israel, Malaysia etc. is only 10 per cent.
It appears that income from royalty / FTS is charged to tax at 10 per cent in most of the countries. Even in cases where the domestic tax rates are higher, the tax treaties normally provide a lower rate. In such a situation the rates prescribed in the tax treaty will prevail. (See Azadi Bachao Andolan 263 ITR 706).
Existing Income-tax Act is proposed to be substituted by new Direct Taxes Code. Rates for Royalty or FTS have been prescribed at 20 per cent. Thus, the rates proposed in the Code are two times of the existing rates.
The overall tax rate in the case of foreign company under the existing act is 40 per cent, whereas in new Code it is 25 per cent. However, for TDS, the rate prescribed is 35 per cent. The royalty / FTS is taxable at 20 per cent.
Since the tax at 20 per cent is applicable on the gross amount of royalty / FTS, the net profit margin which the new Code deems on royalty / FTS is very high compared to the margin deemed under the existing Act. To take an example: suppose a foreign company receives Rs 100 as royalty. Under the existing law it shall pay Rs 10 as income tax.
It impliedly means that the profit which is expected out of Rs 100 is estimated at Rs 25, 40 per cent of which is 10. But, under the new Code, foreign company shall be required to pay Rs 20 as income tax. It implies that the profit which is estimated out of Rs 100 will be Rs 80, 25 per cent of which is Rs 20.
Therefore, the net profit margin which the new Code expects from royalty / FTS receipt is 80 per cent as compared to 25 per cent expected earlier.
Further, to implement the high rate of tax, Section 258(6) of the new Code provides that The provisions of this Code shall not be regarded as discriminatory against the foreign company merely on the consideration that the liability of the foreign company to pay tax is calculated at a rate higher than the rate at which the liability of domestic company is calculated.
Further, sub-section (8) of section 258 provides that neither the treaty nor the Code shall have a preferential status by reason of its being a treaty or law, and the provision which is later in time shall prevail. The effect of the new Code is that Indias domestic laws will effectively override the tax treaty.
This will be against the principles adopted in international practice. Recently, the Supreme Court has affirmed the internationally accepted view. The Apex Court rejected the SLP filed by the department against the order of the Honble Bombay High Court in the case of CIT v Siemens Aktiongesellschaft, [310 ITR 320].
In the said case, the Honble High Court held that by an unilateral amendment in the domestic law it is not possible for one nation which is a party to the tax treaty to tax income which otherwise was not subject to tax under the tax treaty.
It is therefore, recommended that while some provisions of Direct Taxes Code are being reportedly redrafted, the government should re-consider the provisions in respect of non residents. As discussed earlier, the tax rates on royalty and fees for technical services are not only excessively high but that they are highly discriminatory to foreign enterprises.