ROYALTY AND FEES FOR TECHNICAL SERVICES
World is viewed as a global village thanks to technological advancement and connectivity through fast internet. Technology developed and mastered in one part of the world is shared across the globe and commercially exploited for the good of mankind and eventually resulting in eliminating regional disparity.
Technology and knowledge share are generally compensated in the form of Royalty and fees for technical service (FTS) across the globe. When two entities belonging to countries are involved in the form provider and receiver of service, naturally tax litigation with respect to jurisdiction of each country to tax the resulting income from such transaction also have increased.
Many tax provisions and treaty/DTAA are put in place to avoid or minimise litigation. Applying the right provision and interpreting the intent of law is very important to avoid any disputes. We will try to look at various provision of the law that can help in identifying the responsibility of deductor as well as deductee with respect to payment of applicable tax.
Definition of term Royalty and FTS are provided in Income tax act:
Section 9(1) of the income tax act defines Royalty and Fees for technical Service (FTS) as follows
Royalty - Any payment in respect of right, property or information used or services utilised
Fees for technical services (FTS) - Any consideration (including any lump sum consideration) for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining or like project undertaken by the recipient or consideration which would be income of the recipient chargeable under the head "Salaries".
When is the income taxable in India ?
As per Section 9 of the Income tax Act, Income from Royalty and FTS is deemed to have accrued or arisen in India only if the rights with respect to Royalty and FTS are used in business or profession carried on within the country. In other words, if any royalty or FTS is paid towards using the rights outside the country it is not taxable. For example, if the royalty is paid for using the brand name in any other country, any payments towards this will not be classified as income accrued in India.
Foreign entity having a permanent establishment (PE) in India:
Rate of tax on income from Royalty and fees for technical services (FTS) received in India depend on whether the foreign entity has a Permanent establishment (PE) in India or not.
If any non-resident with a fixed place of business in India received income by way of royalty and fees for technical service (FTS), income so derived will be taxed as per provisions of Section 44DA.
Computation of profit under section 44DA:
Profit and gain from operation will be computed after considering deduction allowed under Income tax Act.
However, while computing the profit, no deduction will be allowed with respect to following.
1. Expenditure or allowance which is not wholly and exclusively incurred for the business of such PE.
2. Any amount paid to head office by the PE
Rate of taxation:
Nature of Income |
Tax Rate |
Royalty received or fees for technical services (FTS) from government or any Indian concern under an agreement made before April 1, 1976 and approved by central government |
50% |
Any other income |
40% |
Taxation of income in the hands of foreign entity without PE:
Provisions of IT Act:
Section 115A of Income Tax Act provides for determination of taxation on Royalty and fees for technical services (FTS) by a non-resident.
Rate of taxation:
Nature of Income |
Tax Rate |
If such royalty or fees for Technical service (FTS) is received in pursuance of an agreement made on or before the 31st day of May, 1997 |
30% |
Any other income |
20% |
Tax treaty/DTAA and its implication on withholding tax:
Government of India has signed more than 160 agreement with various countries to avoid double taxation of same income in both the countries. These agreement work with a fundamental principle that between provisions in the Income tax act and DTAA, most beneficial provisions shall prevail.
It will be interesting to note that, while all the agreement are to avoid taxation of same income by both the countries, each agreement can be different and may provide for different tax treatment in each country for the same income.
For example, DTAA Netherland, USA and UK defines fees for technical service as payments of any kind to any person in consideration for the rendering of any technical or consultancy services if such service
a. are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment of royalty is made or
b. make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.
Whereas DTAA between India and Japan, India and Taipe defines fees for technical service as payment of any amount
a. in consideration for the services of a managerial, technical or consultancy nature, including the provisions of services of technical or other personnel.
Since payment is not related to royalty and there is no use of word make available in the agreement with Japan and Taipe, all kind of service will be taxed in India which is not the case with DTAA with Nehterlands, USA and UK. We will see the reason for the same in following paragraphs.
Tax Withholding:
When any resident entity make a payment to an non-resident person towards Royalty and FTS it is incumbent upon the resident entity to ensure that the provisions of section 195 of Income tax Act is complied with.
As per section 195 of Income tax act, any person responsible to make paying to a non-resident, not being a company, or to a foreign company shall, at the time of credit of such income to the account of the payee deduct income-tax thereon at the rates in force.
With respect to application of withholding tax, firstly determine whether the service is covered under DTAA or not, if the service is covered under DTAA, check for most beneficial tax provision between DTAA and IT Act and apply the most favourable to the tax payer. In case the service is not covered under DTAA, apply provision of IT Act on such service.
As mentioned earlier, each word in DTAA needs to be read and interpreted very carefully as even a single word can make a lot of difference in applying provision of withholding tax.
One such example is provided below.
While the DTAA with Netherland, USA, UK use the word ‘make available’ of FTS, it is not used in the DTAA with Japan, Taipe. Which means that in case of DTAA with Netherland, USD and UK, FTS is not taxable in India unless it fulfils the meaning of word Make available of technology. Whereas DTAA with Japan and Taipe same service is taxable in India as the agreement did not use the word Make available.
It is worthwhile to mention CIT vs. De Beers India Minerals Pvt Ltd (Karnataka High Court) where in clarity to term ‘make available’ was provided.
Background: Foreign service provider was contracted by an Indian entity to do a survey and ascertain availability diamond in a particular area. As part of this service, service provider would use his own equipment’s to do necessary study and generate report. The study report provided goes as input in planning, feasibility analysis and other decision making of the service recipient.
Department was of the view that the service be classified under FTS and claimed that the service provider had made available technical knowhow to the service recipient due to which withholding tax is applicable on the said payment .
Clarification of term “make available”: the service should be aimed at and result in transmitting technical knowledge etc. so that the payer of the service could derive an enduring benefit and utilize the knowledge or know-how on his own in future without the aid of the service provider. In other words, to fit into terminology “making available”, the technical knowledge, skills” etc. must remain with the person receiving the service even after the particular contract comes to an end.
Whether PAN required for withholding tax ?
As per provision of Section 206AA of the Income-tax, any person entitled to receive any sum or income or amount, on which tax is deductible under Chapter XVIIB shall furnish his Permanent Account Number to the person responsible for deducting such tax, failing which tax shall be deducted at the higher of the following rates, namely:—
(i ) at the rate specified in the relevant provision of this Act; or
(ii ) at the rate or rates in force; or
(iii ) at the rate of twenty per cent.
However, Section 37BC of IT act provides for exception to provision of section 206AA if the income of the non-resident is in the nature of interest, royalty, fees for technical services and payments on transfer of any capital asset provided the deductee furnishes the details and the documents specified in Section 37BC (2) to the deductor
List of documents to be provided specified in subsection 2 is as follows
(i) name, e-mail id, contact number;
(ii) address in the country or specified territory outside India of which the
deductee is a resident;
(iii) a certificate of his being resident in any country or specified territory
outside India from the Government of that country or specified territory if the
law of that country or specified territory provides for issuance of such
certificate;
(iv) Tax Identification Number of the deductee in the country or specified
territory of his residence and in case no such number is available, then a
unique number on the basis of which the deductee is identified by the
Government of that country or the specified territory of which he claims to be
a resident.
Conclusion: Taxation of income from royalty and Fees for technical service varies from country to country. Extra precaution is needed while advising the client to ensure that tax withholding is done at appropriate rate and client is not exposed to liability arising out of non-compliance and at the same time foreign service provider is also not burdened with higher tax.
No comments:
Post a Comment