Prior to the amendments introduced by way of the Finance Act, 2023, a non-resident, who was in receipt of income in the nature of ‘royalty’ or ‘fees for technical services’ (‘FTS’) from India was liable to pay income-tax at the rate of 10% (plus applicable surcharge and cess) in terms of Section 115A of the Income-tax Act, 1961 (‘IT Act’). This rate is further restricted to a flat 10% rate (inclusive of surcharge and cess) under most of the Double Taxation Avoidance Agreements (‘DTAAs’) that India has entered into with other countries, subject to the recipient satisfying the ‘beneficial ownership’ requirement contained there under.

However, under a few DTAAs such as between India and the United States, given that the tax rate on ‘royalty’ and FTS was more than 10%,^[1] the choice of applying the provisions of the IT Act over the applicable DTAA was obvious.^[2] This was also because of the operation of Section 115A(5) of the IT Act, which provides exemption from filing tax return in India to a non-resident if:

i.     The total income of the non-resident consisted only of inter alia, “royalty” or FTS; and

ii.    Income-tax was withheld by the payer at a rate equal to or higher than the rate provided for in Section 115A of the IT Act.

Now, by way of the Finance Act, 2023, the tax rate on ‘royalty’ / FTS as provided for in Section 115A of the IT Act has been doubled to 20% (plus applicable surcharge and cess). This means that for every non-resident, who wishes to opt for the beneficial tax rate on ‘royalty’/ FTS, as provided for in the applicable DTAA,^[3] would necessarily have to obtain tax registration in India, file tax returns in India and undertake all requisite compliances^[4] to claim such benefits. In addition, such non-resident would need to maintain sufficient documentation to satisfy all anti-avoidance rules as prescribed under the applicable DTAA such as ‘beneficial ownership’ test, principal purpose test, limitation on benefits clauses etc. as well as general anti-avoidance Rule contained in Chapter X-A of the IT Act.

That apart, in cases where a non-resident is a fiscally transparent entity (i.e., an entity, whose profits are not taxed in its hands but in the hands of its members/partners), the choice of availing the benefits under an applicable DTAA would come with the risk of litigation qua the eligibility for such entities to claim benefits under such DTAA in the first place. Furthermore, in cases where the non-resident is from a country with which India does not have a DTAA or chooses not to apply the beneficial rate under the applicable DTAA, this increase in domestic tax rate, would significantly impact its claim of foreign tax credit in its home jurisdiction.

[1] Except for where the payment is made in consideration of inter alia, use of an industrial, scientific, or commercial equipment.

[2] In certain DTAAs such as India – Italy, the tax rate of ’royalty’/ FTS is 20%.

[3] Post this amendment, there is no DTAA that India has entered into, which prescribes a higher tax rate on ’royalty’/ FTS as compared to the rate provided for in Section 115A of the ITA except for India – Brazil DTAA and India – Libya DTAA.

[4] To claim the benefits under an applicable DTAA, a non-resident must have a valid Tax Residency Certificate issued by the competent authority in its home jurisdiction. This certificate should be provided to a payer prior to receiving remittances in the nature of ‘royalty’ / FTS. That apart, such non-resident is also required to file a declaration under Form 10F in accordance with Rule 21AB of the Income-tax Rules, 1962.