Under the existing provisions of Income-tax Act income earned by a non-resident by way of “Royalty” or “Fees for Technical Services” (FTS) shall be charged to income tax at10 per cent. The rate of tax applies on the gross amount of Royalty & FTS. As a matter of fact the rates of tax on Royalty or FTS have been declining since 1997. The rate of tax on the income accruing under the agreement made before 31.05.1997 was 30 per cent, and the same was reduced to 20 per cent for agreements signed between 01.06.1997 and 31.05.2005. The rate of tax was further reduced to 10 per cent on the agreements made after 01.06.2005, which continues to prevail till date.
The rate of tax in most of the Tax-Treaties is also 10 per cent. While some of the earlier Tax-Treaties contain rate of tax on Royalty and FTS ranging from 10 per cent to 20 per cent, but the treaties signed in the recent past invariably prescribe the rate of tax on such income at 10 per cent.
It may be noted that income from Royalty / FTS is charged to tax at10 per cent in most of the developed countries. Even in cases where the domestic tax rates are higher, the Tax Treaties normally provide a lower rate. In such a situation, the rates prescribed in the Tax Treaty will prevail. (See Azadi Bachao Andolan 263 ITR 706 (SC)). Thus the effective rate of tax remains at 10 per cent.
Existing Income-tax Act is proposed to be substituted by Direct Taxes Code. In the revised Direct Taxes Code the income has been broadly classified under the following two heads:
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The income from FTS and Royalty of a non-resident has been considered as income from special sources. So far as the taxability of the income from special source is concerned, the new DTC provides that such income shall be liable to tax at 20 per cent. Further, Schedule 9 of the Code provides that while computing the tax on income from special sources, no deduction or set off shall be allowed. In other words, the income from Royalty or Fees for Technical Services will be taxed at 20 per cent of the gross amount. The rate of TDS is also 20 per cent.
Since the tax @ 20 per cent is applicable on the gross amount of Royalty / FTS, the net profit margin which the new Code deems on Royalty / FTS is very high compared to the margin deemed under the existing IT Act. To take an example: suppose a foreign company receives Rs 100 as royalty. Under the existing law it shall pay Rs 10 as income tax. It impliedly means that the profit which is expected out of Rs 100 is estimated at Rs 25, 40 per cent of which is 10. But, under the new Code, foreign company shall be required to pay Rs 20 as income tax. It implies that the profit which is estimated out of Rs 100 will be Rs 66.67, 30 per cent of which is Rs 20. Therefore, the net profit margin which the new Code expects from Royalty / FTS receipt is 66.67 per cent as compared to 25 per cent expected earlier.
It is thus apparent that the rates of tax on Royalty and FTS payable by the foreign companies in India are abnormally high. Such rates neither compare with the tax rates prevailing in most of the other countries, nor with the various Tax Treaties which India has signed with other countries.
Since the Tax Treaty, under the revised draft of DTC, will supersede the provisions of DTC, there appears to be no justification in prescribing the rate of tax on Royalty and FTS as 20 per cent. It is suggested that the Government should bring down the rate under the DTC from 20 per cent to 10 per cent so as to synchronise the same with not only the existing tax rates under the Income-tax Act but also with the Tax-Treaties signed by India with other countries.
The author is a Sr. Partner in S.S. Kothari Mehta & Co.
E-mail: hp.agrawal@sskmin.com