India: Positive Developments for Corporate Withholding Tax
When a non-resident (NR) company provides services to a local company, the invoiced amount will often be subject to a tax withholding applied at the source by the customer. This withholding is then remitted to the local tax authorities. For international businesses withholding taxes on service fees can amount to a sizeable expense. The rate of tax applied is often mitigated by a reduced treaty rate agreed upon between contracting countries.
With regards to the withholding tax regime in India, the position has been made more difficult in recent years due to Indian tax laws that are in direct conflict with treaty provisions.
The Indian tax law states that a rate of 10% should be applied to technical service fees payable to an NR, but only if the NR has an Indian tax ID, also known as a Permanent Account Number (PAN). If the NR does not have a PAN, then the rate is the higher of either the applicable local rate, the treaty rate or 20%. Given that the treaty rate agreed with most countries is between 10-15% the local tax law has had the effect of applying a higher 20% rate to most service fees paid to NRs.
The Indian tax authorities have aggressively applied this rule and have targeted local Indian companies that fail to apply the 20% rate. Needless to say, given the local intensity of the tax authorities, the risk of penalties and the further risk that a failure to withhold can result in a disallowance of the expense on the payer's tax return local companies have been diligently applying the 20% rate in what would appear to be a contravention of treaty rules.
The Indian tax authorities are obviously keen to ensure NRs are visible to them due to the potential revenue that could be gained from successful PE investigations. A PAN is an effective way of doing this and by offering a rate of withholding that is even lower than the rate stated in some treaties NRs have been incentivized to apply for a PAN.
However, given that the statute of limitations for tax returns is 7 years registering for PAN can expose an NR to sizeable amounts of unpaid back taxes should a PE investigation be upheld…..or a lengthy and costly defense in the alternative. As a result, many NRs have continued to swallow the 20% rate on each service fee paid rather than apply for a PAN.
However, following the recent case of Serum Institute of India Limited, it would appear all is about to change.
Serum Institute of India Limited is engaged in the manufacture and sale of vaccines and during the course of its business made several payments to NRs which included royalties, interest and fees for technical services all of which were subject to withholding tax. Despite the fact that the suppliers did not have a PAN the taxpayer applied treaty rates rather than the 20% rate required by Indian tax law. The Indian tax authority initiated proceedings against the company to recover the tax due.
The company appealed and the Pune Income Tax Appellate Tribunal held that whilst a PAN was required by law in its absence the rate of tax to be applied to technical service fees was the rate stipulated in the treaty rather than the higher rate detailed in the Indian tax law.
The decision of the tribunal reaffirms the principle that treaty provisions preside over local tax law and is a welcome reversal of what has been a very contentious area of tax policy.
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