As one of the world’s fastest growing economies, India’s tax policies/reforms play a vital role in attracting foreign investment in various sectors, including infrastructure, manufacturing and financial services. Clear, well-defined and rational tax policies and tax administrative framework, as well as time-bound resolution of tax issues, would provide a further impetus.
The election of a stable government at the Centre seems to have significantly raised expectations of reform and growth. The coming Union budget is awaited keenly as a key document of the new government’s thinking and policy direction.
This article seeks to suggest some measures the government could consider, in terms of cross-border tax issues.
Currently, under the provisions of the Income-tax Act, 1961, for determining the tax withholding rate on payments to non-residents, either the payer (under section 195) or the recipient (under section 197) can make an application to the revenue authorities. In the event the withholding tax rate determined by the revenue authority is not considered appropriate, it could be challenged through an appeal.
However, it would be worthwhile to rationalize the appeals provisions, whereby an appeal against a withholding tax determined on payments to a non-resident could be preferred, regardless of the nature of income and who is to bear the tax. Further, the appeal could be preferred by both the payer and the recipient of the income, as the case may be.
In 2001, the government introduced transfer pricing regulations (TPRs) to ensure international transactions between group companies were undertaken on an arm’s length basis. But, as in the case of any other tax laws, the TPRs have not been free from controversies. High-pitched transfer pricing assessments have culminated in massive tax demands/litigation. This has created uncertainty in the minds of taxpayers.
With the TPRs having been in force for eight years, it is perhaps an opportune time to attempt some certainty around pricing arrangements.
In several countries, up-front clarity is achieved through advance pricing arrangements, or APAs. An APA is an arrangement that determines, in advance, an appropriate set of criteria to determine the arm’s length price for such transactions. This could be done through negotiations and agreement between the associated enterprises and tax administrators.
India already has a body known as the Authority for Advance Rulings (AAR), where either a resident or a non-resident being party to an international transaction can seek a ruling in advance on the Indian tax implications of a proposed transaction. However, AAR’s scope does not extend to transfer pricing matters. Hence, the introduction of APA for determination of arm’s length price in advance would be welcome; they could provide a platform to sort out complex pricing issues and assist in mitigating transfer pricing disputes and help in achieving upfront clarity on pricing arrangements.
Possibly the most vexed issue one encounters today in cross-border transactions is “income characterization”. This is because the characterization of incomes under one head, as opposed to another, can affect taxability in terms of the rate of tax, and indeed, in some cases, whether taxable at all.
There are several instances of such treatment. Here are some:
Software transactions: Taxability of payments made by Indian companies to multinational companies for the purchase of software has been an area of perennial litigation with the authorities.
Usually, if a person acquires a copy of a computer program but not the right to make copies of it for distribution to the public by sale or other transfer of ownership, or the right to prepare derivative computer programs based on the copyrighted program, etc., the payment should normally be classified as being one for transfer of a copyrighted article.
As an example, a typical retail sale of a shrink-wrapped program or book generally will be considered a “copyrighted article”. In the absence of a permanent establishment in India, this would then not be taxable in India. Various judicial decisions in India have held that payments made for copyrighted articles do not qualify as royalties.
However, this controversy continues to thrive, and tax authorities keep on taking very aggressive positions on this. India needs to recognize that such positions can, and will, lead to retaliation by other countries as Indian companies expand their global footprint, and such confrontationist positions do not augur well for the growth of global trade.
Taxability of international bandwidth charges: Another instance is of taxability of the international bandwidth charges paid to international telecom service providers for transmission of data, etc. Such payments are for arranging/facilitating communication links and not for the use of any intellectual property or for imparting any “information concerning industrial, commercial or scientific experience” or for “use of equipment” so as to be characterized as royalty income.
But invariably, such payments are taxed by revenue authorities as royalty/fees for technical services (FTS), despite a number of judicial decisions holding that such income is not subject to tax in India. The contrary position adopted by the tax authorities has resulted in prolonged and repetitive litigation.
The government needs to seriously consider taking proactive steps to avoid this needless litigation; the benefits of attracting international companies would far outweigh a revenue loss which, one would venture to say, was not India’s revenue in the first place.
Section 10(15)(iv) of the Income-tax Act provided that in case the tax on interest on foreign currency loans satisfied certain conditions, the interest income of the overseas lender would not be subject to tax in India. This was a good incentive and effectively reduced the cost of overseas borrowings, especially where the tax cost on the interest was to be borne by the Indian company. However, the Finance Act, 2001, had limited the availability of the exemption for loans agreements entered into on or before June 2001.
Typically, infrastructure/capital intensive projects have huge and ongoing funding needs. Though the liquidity situation presently has eased considerably, companies would prefer to lower the cost of borrowings to make their projects more viable and profitable.
The government should restore the exemption under section 10(15)(iv). This would facilitate increased flow of foreign funds at a comparatively lower cost of borrowing and make the infrastructure projects more viable.
Section 115A of the Income-tax Act provides that royalties/FTS received by non-residents be taxed at a concessional rate of 10%, if the agreement under which these royalties/FTS are received is either approved by the Union government, or relates to a matter that is covered under the industrial policy.
The conditions of government approval or industrial policy were introduced nearly 15 years ago, in 1992. Since then, the exchange control regulations have been substantially liberalized. In fact, the Foreign Exchange Regulations Act, 1973, has been repealed and replaced with the far more liberal Foreign Exchange Management Act (Fema). Under Fema provisions, most payments to non-residents on the current account are permitted on an automatic basis. Hence, in the current situation, the aforesaid conditions are redundant.
However, in practice, in certain cases the concessional tax rate under section 115A is being denied in respect of payments that are permitted under the automatic route under the liberalized exchange control regime, on the ground of non-satisfaction of the government approval/industrial policy condition. It is clearly not the intent of section 115A to burden non-residents with a higher rate of tax.
Given the uncertainty, and to settle the prevailing doubts, the budget should consider deleting some conditions and propose that all FTS/royalty payments be taxed at the concessional rate.
These are some of the international tax measures India should consider in the coming budget, or at least in the new direct tax code, likely later this year. Such an approach would go a long way in instilling confidence among foreign investors in the Indian government and its tax administration.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org