Royalty and permanent establishment

The Indian government has over the years tightened its grip on royalties earned by foreign companies from India.

No matter where such royalty is paid or where the requisite technology is imparted, it is deemed to accrue in India so long as it is for the purpose of earning income from any source in India by a resident of India.

And to seal the issue beyond any doubt and to prevent tax evasion, the Indian resident is called upon to deduct tax at source at the rate prescribed which corresponds to the one given in Section 115A which, in addition, says while computing such royalty income, no expense or loss would be countenanced, period. In other words, royalty to foreign companies is taxable at its gross amount sans deductions.

Thus, if a foreign company is payable $20,000 and the tax rate prescribed in section 115A is 10 per cent, the Indian company has to pay only $18,000 to the foreign company and deposit $2,000 to the government as tax on behalf of the foreign company. This makes for certainty and simplicity of tax computations and makes life simpler for the Indian resident dealing with a foreign company.

DTC BILL

The Direct Taxes Code Bill, 2010 (the DTC), however, threatens to rock the boat by introducing certain wishy-washy elements into the computation.

While royalty earned from an Indian resident would continue to be deemed as Indian income as hitherto, Section 15 of the DTC queers the pitch for the Indian government as well as the Indian resident dealing with the non-resident foreign company by bailing out royalty, among other things, from the clutches of special sources of income if the income is attributable to any permanent establishment maintained in India by the non-resident. The Authority for Advance Ruling has in fact been at its wits' end trying to ward off challenge to the simple regime of taxation mounted by wily foreign companies through the ingenious plea of presence of permanent establishment so that royalty, instead of being sequestered and taxed at a flat rate, is allowed to mix freely with the foreign company's business income in computation of which there is no bar on deduction of expenses, thus opening up the prospect of paying much lesser tax or none at all vis-à-vis the one mandated by Section 115A.

Unfortunately, the DTC falls into this trap and machinations of foreign companies by allowing them to raise the bogey of permanent establishment in India and thus breaking free of the 20 per cent tax mandated to be deducted at source by the third Schedule at source on the gross amount of royalty.

The Indian company would be at a loss to know whether it has to deduct tax at source or not. To be sure, Schedule 4 mandates it to deduct tax at the rate of 20 per cent but then this schedule as indeed any schedule at all for that matter must be read along with and in the context of substantive provisions of the DTC.

Special source

Section 15, as said earlier, bails royalties emanating out of permanent establishment in India maintained by a foreign company from the clutches of special source, warranting a flat rate of taxation sans deduction of expenses.

And if a foreign company claims that the royalty earned by it belongs to this genre, it might put pressure on the Indian resident not to deduct tax at source though it would be perfectly justified in going ahead and deducting tax at the rate of 20 per cent of the gross amount, obeying the mandate of Schedule 4. The foreign company is likely to contend that a 20 per cent tax is not warranted as its average rate of tax on its business receipts is lower than 20 per cent.

(The author is a Delhi-based chartered accountant.)

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