India

Increased withholding tax rate (WHT) for royalty and fee for technical service (FTS) payments made to non-residents

The 10% special tax rate, as provided under the domestic tax laws, on royalty and FTS income earned by a non-resident or a foreign company that does not have permanent establishment (PE) in India has been increased to 20%. Accordingly, royalty/FTS incomes that are chargeable to tax for a non-resident on or after 1 April 2023 will require withholding of taxes at the rate of 20% plus applicable surcharge and cess under the domestic tax laws.

However, non-residents or foreign companies can still avail the benefit of a lower tax rate provided in the tax treaties, subject to compliance with the treaty eligibility conditions.

Share issue consideration received by Indian entity from non-residents taxable to the extent it exceeds fair market value (FMV) of shares

The domestic tax law hitherto provided that if a closely held Indian entity receives any consideration from a resident person for issue of its shares and such consideration exceeds the face value of such shares, then so much of the consideration that exceeds the FMV of the shares shall be taxable in the hands of such Indian company.

An amendment has been brought in to also include the consideration received from non-residents for issuance of shares to such non-residents. Therefore, starting 1 April 2023, if a non-resident subscribes to share capital of a closely held Indian entity that exceeds the face value of shares, then so much of the consideration that exceeds the FMV of the shares shall be taxable in India in the hands of such Indian entity.

Benefits accruing on account of Most Favoured Nation (MFN) clauses cannot be granted unless a notification is specifically issued for the same

A position was/has been taken by a few non-resident companies that they are eligible to claim the benefits of the MFN clause as provided in the tax treaties entered into by India with the respective countries in which they operate as they were of the view that the MFN clause is self-operational and there is no requirement to issue a separate notification for the operation of the MFN clause. The aforesaid position was also upheld by the Delhi High Court in various judgements. However, the Indian tax authorities were not in agreement with the decision of the Delhi High Court and accordingly issued a circular wherein the position of the tax authorities was clearly laid down and it was provided that the MFN clause becomes operational only upon fulfilment of certain conditions as mentioned in the said circular. One such condition was that a separate notification importing such beneficial taxation into the tax treaty with the MFN clause must be issued prior to the benefit being extended with respect to such MFN clause with respect to the jurisdiction in question.

The Supreme Court of India in its judgement dated 19 October 2023 has held the following:

• The MFN clause present in a tax treaty cannot lead to automatic import of favourable tax rate or scope of taxation extended to another country. In other words, India has to, as a matter of domestic legal procedure and past precedents, issue a separate notification so that benefits extended to a third country can be imported and made part of a tax treaty with the country with which it has an MFN clause.
• The Supreme Court has further provided that for the beneficial provisions (agreed in another treaty entered into by India with any other jurisdiction) to be imported in the tax treaty relevant for the non-resident in question, the country with which such beneficial rate was agreed should have been a member of the Organisation for Economic Co-operation and Development (OECD) as on the date when such country had entered into the tax treaty with India. In other words, what is relevant for the application of the beneficial provision of the MFN clause is the date when the tax treaty from which the beneficial provisions are being imported was entered into and whether the country with which such treaty was entered into was a member of the OECD on the date when such country entered into the tax treaty with India and not whether such country was a member of the OECD on the date when the benefit is being claimed by the non-resident in question.
• The Supreme Court also held that the lower tax rate of 5% for dividends in India’s treaties with Slovenia, Lithuania, and Columbia cannot be applied by giving effect to the MFN clause since these countries were not members of the OECD when the aforesaid lower rate of 5% was agreed with them in their respective tax treaties. Even otherwise, the benefit of the lower rate would not have been available in the absence of a specific notification by the Indian government specifically extending the beneficial rate agreed with such country to other countries.

A quick snapshot of the impact of the above judgment on various payments made from India along with the relevant tax treaties is given below.

Dividends

Royalties and fees for technical services (FTS)

A review petition has been filed before the Supreme Court against this judgement, which is currently pending for final disposal.

Indian government notifies lower royalty and FTS tax-rate in India-Spain tax treaty

The Ministry of Finance has issued a notification on 19 March 2024 permitting the benefit of the MFN clause under the India-Spain tax treaty. The Indian government amended the India-Spain tax treaty by importing a lower tax rate of 10% for royalty and FTS from the India-Germany tax treaty. The lower tax rate shall be applicable from financial year 2023/24 corresponding to tax year 2024/25.

Government notifies list of payments to International Financial Services Centre (IFSC) units on which no taxes are required to be withheld

The Indian government has notified the list of payments made by any payer to the IFSC units on which no taxes are required to be withheld by the payer. The list includes 14 different kinds of IFSC units where taxes are not required to be withheld by the payer on various payments, subject to fulfilment of conditions prescribed in the said notification. This notification is effective from 1 April 2024.

E-filing of Form 10F without Permanent Account Number (PAN) enabled

In order to be eligible to claim tax treaty benefits, a non-resident is, inter alia, required to furnish certain details in Form 10F. Said form is required to be filed electronically on the income tax portal. The Central Board of Direct Taxes (CBDT) has enabled non-residents who do not have a PAN (i.e. tax identification number) and are not required to have a PAN to e-file Form 10F on the income-tax portal by creating an account without the requirement of first obtaining a PAN.

Relief to eligible start-ups

The domestic tax laws provide certain tax deductions to eligible start-ups, provided such eligible start-up is incorporated on or before 31 March 2023. The sunset clause of 31 March 2024 has now been extended to 31 March 2025.

Further, eligible start-up can now carry forward and set off the losses for a period of ten years as compared to the earlier limit of seven years.

Income by way of interest from Indian company: Beneficial WHT rate of 5% shall not be available on loan agreements entered into after 30 June 2023

The domestic tax law provides a beneficial WHT rate of 5% on interest income earned by any non-resident, subject to satisfaction of certain conditions. This beneficial rate was applicable for money borrowed by an Indian entity, by way of entering into a loan agreement or issuing bonds, before 1 July 2023. The aforesaid date has not been extended, hence interest income from an Indian company earned consequent to a loan agreement entered into or bond issued on or after 1 July 2023 shall be subject to withholding at the rate of 20% where the money is borrowed in foreign currency.

Other developments

Withholding on winning from online gaming

New tax provisions have been introduced under the domestic tax law to provide for taxation and withholding on winnings from online gaming. The net winning from online games are to be taxed at the rate of 30% (plus surcharge and cess). Further, taxes are required to be withheld at the end of the financial year (FY) or at the time of withdrawal from the user account, whichever is earlier.

Speedy disposal of appeals

To enable the speedy disposal of appeals pending at the first appellate authority, a new appellate authority at the Joint Commissioner/Additional Commissioner level has been created to handle a certain class of cases involving low-value disputed tax demands.