Return filing obligation for non-residents
There are two concepts which a country follows for taxing income. These are residence based taxation and source based taxation. Though Indian residents are subject to tax on their global income, non-residents, earning income from India can only be taxed in India by applying the source rule.
Non-residents earning income and not having any presence in India are subject to tax on a gross basis. The types of income earned by non-residents typically include interest, dividends, royalties and Fee for technical services ('FTS'). For income from India, non-residents are also liable to file a return disclosing the income earned. If the income so earned is subject to withholding tax, such tax can be claimed as credit in the return. If these payments are from a related party, transfer pricing compliances would also need to be undertaken. It can be burdensome for foreign companies and other non-resident taxpayers to file returns in India for just a solitary source of income be it interest, dividends, royalty or FTS.
The Income-tax Act, 1961 ('the Act') states that non-resident taxpayers would not be required to file their income tax returns in India if interest or dividend is the only source of income and on which tax has been withheld. This exemption was not available to non-resident taxpayers who were earning royalty or FTS from India.
While providing some relief to such non-residents, the Hon'ble Finance Minister has proposed in the Finance Bill, 2020 that it would not be necessary to file an income tax return in India for a non-resident taxpayers where royalty/FTS is the only source of income and tax thereon has been withheld at a rate not lower than the rate prescribed under section 115A of the Act
i.e. 10% (plus surcharge and health and education cess).
It is however worth mentioning here that where the beneficial provisions of a Double Taxation Avoidance Agreement ('DTAA') are availed and the royalty/FTS is not subject to withholding tax (because of the restrictive scope) or tax is withheld at a lower rate (flat rate of 10%) than the rate under section 115A, the proposed exemption from filing of the return would not be available.
Generally, the rate of royalty/FTS under DTAAs entered by India is 15%, however, there are a few DTAAs which have a rate of 10%. A few examples of these being the ones entered with France, Germany and South Africa Japan etc. Unless it is contended that the payments are not taxable, taxpayers could choose withholding under the Act and not file a return of income since the tax rate for royalty/FTS is almost same (the difference being only surcharge and health and education cess) under the DTAAs and the Act.
Another amendment proposed in the Finance Bill, 2020 which impacts the return filing obligations for non-residents earning dividend income from India is the abolition of the Dividend Distribution Tax ('DDT'). After this amendment, the tax burden has shifted to the recipient from the Company declaring dividend. Although non-residents for whom dividends is the only source of income from India are not required to file their income tax returns here, the condition of withholding tax on these akin to what has been inserted for royalty/FTS needs to be fulfilled as these are now taxable in the hands of the recipients. In other words, non-residents earning only dividend income from India would not be required to file their income tax returns provided these have been subject to withholding tax at a rate not lower than the rate prescribed under section 115A of the Act. The rate so prescribed is 20% (plus surcharge and health and education cess).
A point to ponder here is that most of the DTAAs which India has entered have got a rate ranging from 5% to 15% which unlike the rates for Royalty/FTS. are much lower than the rate under section 115A. Thus, having regard to the monetary benefit, non-residents would prefer to avail the lower tax rates in the respective DTAA and file their returns in India.
The Government has not provided exemptions to non-residents availing the provisions of the DTAAs as it would want to examine their eligibility for availing these provisions and verify and scrutinize their claims in the return of income filed.
Having said that, though the Government is providing relief to non-residents from return filing in India on fulfilment of conditions of withholding under the Act, there is no exemption for complying with Indian transfer pricing regulations for transactions with related parties. Thus, even if the return is not being filed by virtue of Section 115A, non-residents would need to furnish Form 3CEB through its e-filing account. Further, the exemption is only for prescribed nature of income. A non-resident earning different types income would not be entitled to the exemption for filing its return of income.
The income tax law in India with reference to non-residents has evolved over the past many years. There was a time when non-residents were subject to tax on royalty/FTS at the rate of more than 25% and made to suffer higher withholding for not having a PAN. The rates later were brought down and the requirement of PAN was also relaxed. Now the Government has provided further relief in respect of the requirement for filing tax returns. It will have to be seen that what all is further done by India in order to jump up in the ease of doing business rankings.
The author is a Chartered Accountant. Views expressed are personal.