On February 1, 2020, the Hon'ble Finance Minister presented her second Union Budget with the longest budget speech, wherein she rightly attempted to address various pressing issues faced by the foreign investors/non-residents. The Budget 2020 proposes slew of measures which may act as a catalyst to attract and retain foreign investment in India. One such measure was an attempt to provide relief to non-residents (including foreign companies) from tax return filing compliances upon fulfilling specified conditions. In the ensuing paragraphs, we elucidate and discuss the key aspects of such proposal.
2. Existing provisions of section 115A of the of the Income-tax Act, 1961 ('IT Act')
The provisions of section 115A of the IT Act, provide rates for taxation of income by way of dividend; specified interest; royalties; or Fees for Technical Services ('FTS') in the hands of non-resident taxpayers. Further, as per the existing provision of section 115A(5) of the IT Act read with Chapter XVII-B of the IT Act, non-resident taxpayers are not required to furnish tax return in cases where their total income consists only of dividend and/or specified interest income and taxes thereon have been withheld as per rate prescribed under the IT Act or the applicable Double Taxation Avoidance Agreement ('DTAA'), whichever is more beneficial. It seems that the rational for providing such an exemption was to provide relief to non-resident taxpayers from undertaking cumbersome compliances in India where the income has already suffered withholding on a gross basis at the applicable rates.
3. Proposed amendment in section 115A of the Act
With an intent to extend similar relief to income streams comprising of royalties and/or FTS, the Finance Bill, 2020 ('Finance Bill') proposes to substitute the existing sub-section (5) of section 115A of the IT Act and provides as under:
A non-resident taxpayer would not be required to furnish their tax return where:
a. Such non-resident taxpayer derives income by way of dividend, specified interest, royalties or FTS; and
b. Taxes thereon have been withheld at rates not less than those specified under section 115A(1) of the IT Act.
The memorandum to the Finance Bill states that the above relief is proposed in light of various representations received by the Government. While the intent of the Government is laudable, the same may have felt marginally short to deliver the necessary relief to the non-resident taxpayers. On closer examination of the aforesaid proposal, the finer aspects that requires consideration are as under:
4.1 Interest income derived by non-resident taxpayer
As per the existing provisions of section 115A(5) of the IT Act, a non-resident deriving income only from specified interest and where taxes have been withheld (under the IT Act or DTAA, whichever is more beneficial) are not liable to furnish their tax return in India. However, as per the proposed amendment, where such withholding of taxes takes place at the rates lower than those specified under section 115A(1) of the IT Act (i.e. where the non-resident taxpayer may wish to avail beneficial withholding tax rate under the applicable DTAA) or where such interest income is not taxable in the under the DTAA, in such cases, the non-resident taxpayer would now be required to furnish its tax return in India. Thus, the proposed amendment has effectively withdrawn the earlier relief which was available to such non-resident taxpayers and therefore on a going forward basis taxpayers opting to be governed by the beneficial provisions of the applicable DTAA would now be required to undertake tax return compliances in India.
Certain DTAAs like Mauritius and Germany, exempt interest income in the hands of taxpayers engaged in specified business (e.g. banks, specified financial institution, etc.) or on fulfilment of specified conditions (e.g. loans guaranteed by local government, sovereign bodies, etc.) or both. In such a scenario, under the existing provisions, such interest income would be exempt under the DTAA and such non-resident taxpayers are not liable to furnish tax return in India. However, going forward under the proposed amendment such relief would not be available to the non-resident taxpayers.
Also, consider a scenario where Co. A and Co. B, (both tax resident of USA) derive interest income from loans provided to an Indian company in Indian rupees (not covered under 115A of the IT Act) and foreign currency (covered under 115A of the IT Act) respectively. The income of Co. A would be liable for withholding @ 15% (under India-USA DTAA) and income of Co. B would be liable for withholding @ 5.46% (under 115A of IT Act). However, as per the proposed amendment, while Co. B would not be required to furnish its tax return in India, Co. A (despite the fact that withholding has undertaken at a rate higher than that applied in Co. B) would be required to furnish its tax return in India.
4.2 Dividend income derived by non-resident taxpayer
Under the existing law, dividend is subject to dividend distribution tax @ 20.56% in the hands of the Indian company issuing such dividend whereas such dividend income is exempt in the hands of the shareholders. Thus, there was no question of furnishing tax return if the income of non-resident shareholders/taxpayers comprised only of such dividend income.
The Finance Bill proposes to abolish dividend distribution tax and tax such dividend in the hands of the shareholders. Thus, in case of non-resident shareholders such dividend would be liable for withholding @ 21.84% under section 115A(1) of the IT Act. From the perspective of DTAA, except for a few DTAAs entered by India which tax dividend @ 25% (like Canada, USA, etc.), most of the other DTAAs tax dividend income in the range of 5% to 15%. It is a well settled principle that a taxpayer can adopt tax rates under the IT Act or DTAA, whichever is more beneficial to them. Thus, most of the non-resident taxpayers would like to avail such lower rate of tax withholding as per the applicable DTAA. In such a scenario, under the proposed provisions, a non-resident taxpayer would be required to obtain PAN and also carry out tax compliances in India including furnishing of tax return. The proposed amendments would impact MNC group or non-residents merely earning dividend income from a subsidiary in India with a cumbersome compliance requirement.
4.3 Royalty & FTS
As mentioned above, the proposed amendment provides for relief from furnishing tax return to non-resident taxpayers only when withholding has been undertaken at the rates specified under the IT Act. However, an unintended consequence of the proposed amendment is that the tax rate in respect of royalties or FTS in most DTAAs entered by India is 10%, while the rate under section 115A(1) of the IT Act is also 10%, such rate would need to be increased by applicable rate of surcharge and cess. Thus, in case taxes have been withheld at 10% as against 10.92% (after considering surcharge and cess), there is a high probability that the tax authorities may hold that the non-resident would still be required to furnish its tax return in India.
Separately, there are various scenarios wherein the relief from not filing tax return may not be available to non-resident taxpayers. Some of these scenarios are as under:
a. Invocation of make available clause in various DTAAs entered into by India
Various DTAAs entered into by India (e.g. USA, UK, Singapore, etc.) provide that for a service to qualify as FTS, the non-resident taxpayer should also make available technical knowledge experience, skill, know-how, or processes to the resident service recipient. In view of the above condition prevalent in various DTAAs certain services like feasibility and project report, information technology help desk and user administration services, etc. would not tantamount to FTS under the DTAAs as the make available test is not met even though the same are taxable as per the provisions of the IT Act.
b. Invocation of performance source rule in DTAA entered into by India with Finland
As per article 12(5) of the India-Finland DTAA, royalties/FTS is deemed to arise in the State where the services are actually performed, regardless of residence of the taxpayer. Hence, where service fees are paid by an Indian resident service recipient to a Finland based service provider and the services (being in the nature of training) are being performed in Finland, only Finland would have the right to tax such service fees and India would have no taxation rights on the same even when the payment is made by an Indian resident service recipient.
c. Invocation of the most favoured nation clause to take benefit of the above
In addition to the above, the protocol of certain DTAAs entered into by India also contain a clause which is commonly referred as the 'Most Favoured Nation' clause. As per this clause one state pre-emptively agrees with another state in respect of any future favourable tax treatment afforded by it to a third state. In view of the above Most Favoured Nation clause, the benefit of make available clause or performance source rule can be taken by residents of countries like Belgium, France, etc.
Separately, it seems that the above amendment proposes to overrule various judicial precedents1 which have held that in case any income is not liable to tax in India as per the provisions of the DTAA, then there would not be any requirement on the part of the non-resident taxpayer to furnish tax return in India. Additionally, as a fallout of the proposed amendment, the non-resident may also be required to undertake transfer pricing compliances in India if it receives royalty/FTS income from an associated enterprise in India.
5. Concluding Thoughts
It is undeniable that the Government has undertaken various effective measures to make India an attractive destination for investment and doing business. This is also reflected in the proposal of the Government to enshrine a 'taxpayers charter' under the IT Act in order achieve the purpose of bringing fairness and efficiency in tax administration. Taking this forward, it would be certainly helpful if Government comes up with an appropriate clarification in relation to the issues discussed above. Additionally, the Government could also consider specifying a particular threshold below which a non-resident taxpayer can avail immunity from furnishing tax return even where benefit has been claimed under the DTAA.
(This article has been co-authored by Bhavin Shah, Chartered Accountant; Arpit Jain, Chartered Accountant and Devdutt Thakkar, Chartered Accountant. The view expressed in this article are personal views of authors and under no circumstances shall constitute professional advice)
1. Venenburg Group BV (2007) 289 ITR 464 (AAR), Factset Research Systems Inc (2009) 317 ITR 169 (AAR) and Dow Agro Sciences Agricultural Products Ltd (2016) 380 ITR 668 (AAR).