INDIA (DOMESTIC FIRMS): An Introduction to Tax

Domestic Manufacturing and The International Financial Services Centre 

Foreign companies (having a permanent establishment or Branch/ Project Office), including Foreign Portfolio Investors (FPIs) in India, are taxable at a higher rate of 40%, with applicable surcharge and cess. Special rates apply under the Income Tax Act on capital gains arising to non-residents and Foreign Portfolio Investors (FPIs).

A recent trend in the taxation policy of India has been to incentivise domestic manufacturing of goods. Also, the Indian government has taken initiatives to develop an International Financial Services Centre (IFSC) to cater to overseas financial institutions outside India and undertake transactions relating to the flow of finance, financial products, and services across borders. Such IFSC is set up at the Gujarat International Finance Tec-City (GIFT City).

The tax incentives/concessions for the domestic manufacturing are as follows:

• a concessional rate of 22% applies under Section 115BAA to companies whose total income is calculated without claiming specified deductions, incentives, exemptions, and additional depreciation; and

• a concessional rate of 15% applies under Section 115BAB to companies that are registered on or after 1 October 2019 and commence manufacturing, including generation of electricity, on or before 31 March 2024.

The following tax incentives are available to units established in the IFSC:

• corporate tax exemption under Section 80LA of the Income Tax Act in respect of approved business income derived by the IFSC unit for a block of ten years out of 15 years, subject to certain conditions;

• exemption from GST;

• exemption from customs duties on the import of goods and services from outside India and on the supply of goods and services outside India;

• exemption from securities transaction tax, commodities transaction tax, and stamp duty on transactions carried out in the IFSC, provided such transactions are undertaken in foreign currency;

• exemption from capital gains on transfer of specified securities listed on a recognised stock exchange located in the IFSC, provided such transactions are undertaken in foreign currency;

• exemption from capital gains on the relocation of funds established in a jurisdiction outside India to an IFSC unit, provided the transfer is carried out prior to 31 March 2025;

• a reduced MAT rate of 9%, provided the IFSC unit derives its income solely in convertible foreign exchange. The MAT provisions do not apply if the IFSC unit exercises the option for the reduced corporate tax rates of 22% and 15%;

• exemption on dividends distributed by an IFSC unit, provided the unit derives its income solely in convertible foreign exchange;

• exemption on interest paid to a non-resident by an IFSC unit in respect of monies borrowed by it on or after 1 September 2019;

• exemption of income of a non-resident from offshore derivative instruments, or over-the-counter derivatives issued by an offshore banking unit located in IFSC;

• exemption of royalty or interest income of a non-resident derived from the lease of ships and aircraft to an IFSC unit; and

• exemption of income of a non-resident derived from a portfolio of securities or financial products or funds, managed or administered by any portfolio manager on behalf of such non-resident, in an account maintained with an offshore banking unit in IFSC, to the extent that such income accrues or arises outside India and is not deemed to accrue or arise in India.

Additional options for valuation of shares in investment by non-residents in an Indian unlisted public company  

The Finance Act, 2023, has brought in an amendment to bring the consideration received from non-residents for issue of shares by an unlisted company within the ambit of section 56(2)(viib) of the Income-tax Act, 1961 (the Act), which provides that if such consideration for issue of shares exceeds the Fair Market Value(FMV) of the shares, it shall be chargeable to income tax under the head "Income from other sources".

Consequently, there is an amendment in Rule 11UA of the Income Tax Rules, 1962 providing that in addition to the two methods for valuation of shares, namely the Discounted Cash Flow (DCF) and Net Asset Value (NAV) methods available to residents under Rule 11UA, five more valuation methods have been made available for non-resident investors, namely the Comparable Company Multiple Method, the Probability Weighted Expected Return Method, the Option Pricing Method, the Milestone Analysis Method, and the Replacement Cost Method.

Withholding Tax Rate on Royalties and Fees for Technical Services Paid to Non-Residents  

Effective 1 April 2023, the withholding tax rate on royalties and fees for technical services paid to non-residents is increased from 10% (effectively 10.92% including surcharge and cess) to 20% (effectively 21.84% after surcharge and cess).

Several tax treaties signed by India, including those with Singapore, France, Germany, Japan, Malaysia, Luxembourg, and the UAE, provide for a lower tax rate of 10%. However, this lower tax rate did not provide significant relief compared to the previous domestic tax rate of 10.92%. As a result, non-residents frequently did not opt for tax treaty relief due to onerous documentation requirements and filing income tax returns in India. With the doubling of the withholding tax rate, non-residents are more likely to seek tax treaty relief at the time of withholding. To do so, they will need to fulfil documentation requirements, including obtaining a tax residency certificate (TRC) from their country of residence containing information specified in Rule 21AB of the Income Tax Rules, 1962. If the TRC does not contain all the required information, the non-resident is required to furnish Form 10F online by creating an account on the Income Tax Portal. It is important to note that the income tax department has now enabled a new category while registering on the income tax portal, ie, "non-residents not having a PAN and not required to have a PAN".

Signing of Advance Pricing Agreements  

To provide certainty to the foreign investors, India has a well-developed APA programme in place. In India, APAs are generally granted for a maximum period of five future years but may on election be rolled back to cover the preceding four years.

The Central Board of Direct Taxes (CBDT) reported having signed during FY 2022-23 a record number of Advance Pricing Agreements (APAs). With 21 APAs signed on 24 March 2023 alone, the number of APAs signed during FY 2022-23 reached a total of 95, a record since the inception of the programme. The APAs signed during the FY consisted of 63 unilateral APAs and 32 bilateral APAs (mainly with Denmark, Finland, Japan, Singapore, the United Kingdom and the United States). The total number of APAs signed since the inception of the programme has consequently risen to 516, consisting of 420 unilateral and 96 bilateral APAs.

Judicial Trends in Corporate Taxation  

Benefit of tax treaty not available for reduction of Dividend Distribution Tax which applied before 1 April 2020  

A special bench of the Income Tax Appellate Tribunal (ITAT) of Mumbai has issued a decision finding that the DDT is a domestic tax liability of the domestic company paying the dividend and that this liability will not be affected by a tax treaty. In its decision, the special bench agreed with the earlier decision of the Mumbai bench, holding that tax treaty rates for dividends may not override the DDT rate prescribed under the Income Tax Act.

Note that the DDT no longer applies from 1 April 2020, with dividends paid to non-residents subject to a 20% withholding tax that may clearly be reduced by an applicable tax treaty.

Most Favourable Nation clause in tax treaties  

The Supreme Court has concluded that when the conditions for an MFN clause under an earlier tax treaty are met, this does not automatically lead to the integration of more beneficial treatment under the relevant treaty based on India's subsequent tax treaty with a third state. In such cases, the terms of the earlier tax treaty must be amended through a separate notification under Section 90 of the Income Tax Act 1961. With respect to tax treaties with third states that become OECD members after a treaty with India is signed, the Supreme Court concluded that such treaties do not qualify for triggering an MFN clause that is contingent upon a third state being a member of the OECD. For an MFN clause to be triggered, the third state must be an OECD member at the time the treaty is signed.

The judgment of the Supreme Court is in line with the tax authority's guidance on the matter as explained in Circular No. 3/2022 of 3 February 2022.