Calculating Withholding Taxes in India
Aug. 9 – Withholding taxes are a government’s way of making sure that the proper taxes are paid on an item by way of either withholding or deducting the relevant tax amount from an individual’s or an enterprise’s income. They are of particular note to international companies doing business with India yet without a presence there, as some services provided to Indian customers can be subject to withholding tax. They may also impact on foreign subsidiaries of international companies in inter-company agreements.
Withholding taxes in India
Chapter XVII-B of India’s Income Tax Act provides for the deduction of taxes at the source of any payments made by an assessee. Furthermore, section 195 of the Income Tax Act casts an obligation on the person responsible for the payment to the non-resident to deduct the relevant tax amount at the source at the time of payment or at the time that the sum is credited to the non-resident’s account.
These provisions also apply to payments made to non-residents.
Withholding taxes for NRIs and foreign companies
Withholding tax rates for payments made to non-residents are determined by the Finance Act that Parliament periodically updates. The current rates are:
- Interest on investment income – 20 percent of gross amount;
- Dividends – 10 percent;
- Royalties – 25 percent;
- Technical services – 25 percent;
- Any other services – individuals – 30 percent of net income; and
- Companies/corporations – 40 percent of net income
Note: the above rates are for general reference only, and are only valid for income earned by companies based in countries with which India does not currently have a double taxation avoidance agreement (DTA). Details of the countries India has a DTA with are here:
Director of income tax (international taxation)
Statutory functions in respect of taxation of foreign companies and non-residents and withholding taxes payments on amounts to be remitted abroad are performed by the relevant Director of Income Tax (International Taxation).
There are currently eight DITs located throughout India, namely in Delhi, Mumbai, Kolkata, Chennai, Bangalore, Pune, Ahmedabad and Hyderabad.
Permanent account numbers and filing of returns
In 2010, the Indian government passed various amendments relating to the requirement that a foreign company must obtain a permanent account number (PAN) to register with the Indian Tax authorities. As such, foreign companies are now required to furnish a PAN when selling to an Indian company.
If the recipient fails to provide the buyer with its PAN, then the applicable withholding tax rate would be based on the existing rates listed above, or at 20 percent (whichever is higher). Furthermore, in the absence of a PAN, Indian tax authorities will not allow foreign companies to apply for lower withholding tax rates.
Currently, Indian law requires that all foreign companies file returns on all income earned in India even if the applicable taxes have already been paid in India. It would thus be advisable for foreign companies to initiate the process to obtain a PAN, especially if they expect to receive certain royalties/fees/interest payments from their Indian group companies/collaborators.
Taxability of technical, managerial or consulting services provided by foreign companies to Indian clients performed outside India
Another important amendment relates to the taxability of technical, managerial or consulting services provided by foreign companies to Indian clients when such services are performed outside of India.
However, foreign companies decided to take a stand against the issue, citing that such services should not be taxable in India since they were not actually physically performed in India. This culminated in the Indian Supreme Court case of Ishikawajima Harima Heavy Industries (288 ITR 408), where the apex court held that services that are both rendered and used in India are to be taxed in India. Simply put, the Supreme Court’s opinion was that if both of conditions were not fulfilled, then the fees for such services are not to be charged as a tax in India.
Relevant Case Studies
In the Samsung Case, the Karnataka High Court observed that every overseas payment would be liable to withholding taxes despite the payment ultimately being taxable income in India or not.
Prasad Productions case
A special bench of the Chennai tribunal ruled that tax needs to be withheld only on payments made overseas that are taxable in the hands of the non-resident. However, that ruling is contradictory to the Karnataka High Court decision in the Samsung case, which said that every overseas remittance had to withhold tax unless it had a nil withholding order from the Revenue Department.
The Chennai Tribunal, however, further observed that it is up to the taxpayer to decide whether a transaction is taxable. If not there is no need for a nil withholding order.
Van Oord case
In this case, the Delhi High Court ruled that withholding taxes apply only to payments that are taxable in India.
Retrospective amendments were created to further clarify the legislative intent of the source rule of taxation on non-residents in India, particularly in respect of indirect transfers of underlying assets.
Under the proposed amendment, all persons (whether residents or non-residents) who have business connections in India will be required to deduct taxes at source and pay them to the Indian government even if the transaction is executed on foreign soil. This amendment is crucial because a review petition by the government is currently pending before the Supreme Court, which may now revise the changes in tax laws when it revisits its previous judgments.
India-Singapore tax treaty
The Authority for Advance Ruling (AAR) held that fees paid by Indian companies for technical services provided by a foreign company are not taxable in India under the India-Singapore tax treaty. The rationale given behind this decision is that advisory services do not fall within the purview of the term “Fee for Technical Services” under Article 12 of the said treaty.
This AAR ruling came upon the wake of an application being filed by the Bharati AXA General Insurance Co. Ltd. (BAGICL) to see if a foreign company is liable to pay taxes in India in respect of the fees received from BAGICL.
This ruling has come as a relief to foreign companies that render support services in that it ensures uniformity and flawless quality in future business dealings. Furthermore, this ruling can provide some respite to companies that do not have a permanent establishment (PE) in India as it also states that payments received by companies that do not have a PE in India cannot be taxed as business profits under the treaty.
Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.
You can stay up to date with the latest business and investment trends across India by subscribing to Asia Briefing’s complimentary update service featuring news, commentary, guides, and multimedia resources.
Trading with India
In this issue of India Briefing Magazine, we focus on the dynamics driving India as a global trading hub. Within the magazine, you will find tips for buying and selling in India from overseas, as well as how to set up a trading company in the country. India is poised to become a major global sourcing center, and we hope this issue both educates and informs our readers how best to approach this growing market.
Dalian & India Office
Dezan Shira & Associates' National Tax Partner Sabrina Zhang discusses repatriating profits from mainland China. She also discusses royalties, service fees and payment-on-behalf.
Ronin Lin introduces the China tax system for the Confederation of Indian Industry (CII). He goes over corporate taxes, individual income tax, and VAT reform.
Sarina Zhang, National Tax at Dezan Shira & Associates, discusses permanent establishment’s (PE) importance for companies sending employees to China for short term business trips.