The Finance Minister’s proposal to increase the rate of tax on payments by way of royalty and fees for technical services to non-residents from 10 per cent to 25 per cent has not gone down well with the multinationals operating in India as they will now have to pay more tax while receiving royalties from their Indian subsidiaries.
Tax advisors say the increase in the domestic tax rate on royalties and fees for technical services from 10 to 25% is unnecessary and goes beyond the rates proposed in the direct tax code. Whilst this will not have a very significant impact on investors from most OECD countries where treaty rates have already been reduced to 10%, service providers from major technology and investment partners like the US and the UK will face a hit as their tax bill will go up 15 per cent from the present rate of 10 per cent.
The domestic withholding tax rate in case of payment of royalty would have significant impact in relation to payments made for acquisition of content, transponder hire charges, etc. especially where the tax treaty benefit is not available.
“Though the Finance Minister has outlined the need to provide a stable regime for foreign investors, the clarity that was sought on many aspects on the law relating to indirect transfers is missing. This would impact M&A as this is a big roadblock for global restructuring involving Indian assets,” says N C Hegde, Partner, Deloitte Haskins & Sells.
Payment of royalty and technical fees has been a bone of contention between minority shareholders and MNCs in the recent past. Shares of many multinationals witnessed sharp fall after the board decided to increase royalties and technical fees from India. The independent directors of ACC and Ambuja Cements owned by Holcim, in fact, asked both companies to reduce technical fees by half to Holcim and seek minority shareholders consent.
Analysts say the amendments to Section 115A of the income tax act may also increase the costs for the Indian companies. Very often the foreign companies may pass the tax cost to the Indian Companies. Though the increased tax rate has been prescribed under the provisions of section 115A the Indian companies while making remittances are required to withhold tax at the rate of 25% consequent to this amendment.
“However, if the foreign companies are able to obtain treaty benefits then the lower rate prescribed under the treaty law which is generally 15% will be applicable. In the event foreign companies are not able to obtain TRCs or in the event of making payments to the foreign companies who are not residents of treaty based countries, the enhanced rate of 25% will apply,” says K R Sekar, leader of international tax practice of Deloitte.
Multinationals operating in India said the increased tax on royalty will be paid by parent and not impact the local company. “The tax will be paid by Suzuki as it has to be paid by receiver,” Maruti Chairman R.C. Bhargava said. Maruti is owned by Suzuki of Japan and pays a significant amount of its net sales as royalty to Suzuki.
But investor associations are cheering the increased tax in the hands of MNC parent but wanted more clarity on what basis the multinationals are taking out money from their Indian subsidiaries. “We wanted more clarity on what is the basis for charging royalty from the Indian company. Take for example, many Indian companies have developed a brand in India, for India but it’s their foreign parent which is charging a hefty royalty from their Indian subsidiary. The government should make it mandatory that the majority of all minority shareholders should clear the proposal to pay any royalty to foreign companies,” says Shriram S, founder and MD of InGovern Research Services.