India’s Finance Act, 2023 has increased the withholding tax rate on royalties and fees for technical services (FTS) paid to nonresidents. The rate has doubled from 10% to 20% (10.92% and 21.84%, respectively, taking into account the 5% surcharge and 4% education cess). The Finance Bill, 2023 was originally introduced when the FY 2023-24 budget was announced on 1 February and underwent over 60 changes by the Parliament. Interestingly, the amendment to the withholding tax rate was not a part of the original bill.
Nonresidents are taxable only on India-source income i.e., income that accrues or arises or is deemed to accrue or arise in India. Income from royalties and FTS is deemed to accrue or arise in India, and thus is taxable for nonresidents. However, based on India’s Income Tax Act (ITA), a nonresident can elect to be taxed either under the ITA or as per the provisions of an applicable DTA, whichever is more beneficial.
The increased tax rate on royalties and FTS under Indian domestic tax law is now higher than the rates prescribed in most of India’s DTAs. As a result, most nonresidents are likely to take the benefits of DTA rates rather than the domestic rate. In addition, the increase in the withholding tax rate may give rise to additional tax in situations where India does not have a DTA with the country where the nonresident is resident or the rate under a DTA is higher than the Indian domestic rate.
To claim benefits under a DTA, a nonresident must furnish a valid TRC issued by their country of residence, as well as Form 10F if certain details are not included in the TRC. These documents must be submitted via the Indian tax portal, which requires Indian tax registration (known as a Permanent Account Number (PAN)) and which not all nonresidents have (currently, there is a temporary relaxation of the PAN requirement through 30 September 2023). Additionally, an Indian tax return must be filed if DTA benefits are claimed.
Impact of the new rules
With the domestic rate on royalties and FTS increased, it is useful to look at the various scenarios that could arise and the tax consequences:
- Situation 1: The nonresident does not claim benefits under a DTA (even though eligible) and instead pays tax at the Indian domestic rate; either the income is not taxable under the DTA or the DTA rate is 10%.
- Situation 2: The nonresident is from a country where the applicable DTA rate is 15% and elects to pay tax at the Indian domestic rate as this is more favourable than the DTA rate.
- Situation 3: The nonresident pays tax at the domestic rate because it is not entitled to benefits under a DTA (e.g., there is no DTA between India and the country where the nonresident is resident, etc.).
The impact of the new rate in the three situations is as follows:
- Situation 1: Nonresident taxpayers that do not claim benefits under a DTA (even if eligible) and instead pay tax at the domestic rate will have to pay a 21.84% tax. However, if they wish to claim DTA benefits, the tax rate will be reduced to 10%. In that case, they will have to furnish a TRC and Form 10F, obtain a PAN and file a tax return in India once they claim DTA benefits.
- Situation 2: Nonresidents from countries where the applicable DTA rate is 15% (e.g., Australia, Belarus, Mauritius, Oman, UK, U.S.), but that elected to pay tax at the Indian domestic rate of 10.92% as it was more favourable than the DTA rate will likely want to use the 15% rate under the DTA, rather than the new higher 21.84% domestic rate. However, this will entail additional compliance obligations in the form of furnishing a TRC and Form 10F, obtaining a PAN and filing a tax return in India.
- Situation 3: Nonresidents that were required to pay tax at a rate of 10.92% will have to pay tax at the higher rate of 21.84% under domestic law. There will be no change in compliance requirements.
In cases where the tax is borne by the payer, and hence the rate is grossed up, the impact on the tax rate will be substantial.
It also should be noted that where the nonresident has a tax withholding certificate that grants a lower rate, that certificate may not be available for future lower tax withholding certificates even though there is no change in the taxpayer’s facts.
The change in the withholding tax rate will result in an additional compliance burden for affected nonresident taxpayers. And with the rate change being effective as from 1 April 2023, many nonresident taxpayers likely may have been caught off guard. Taxpayers that were not claiming DTA benefits but that now wish to claim them will need to obtain a PAN (if they do not have one) as soon as possible, and existing transactions/contracts may also need revisions.
BDO in India