Franchise Business & Indian Taxation Regime: Best Corporate Lawyer Advice
Direct taxes and indirect taxation are the two divisions of tax laws in India. In India, a direct tax is imposed on the taxpayer’s earnings. Indirect taxes are assessed on the delivery of goods and services and are controlled by legislation governing the goods and services tax. The principal legislation controlling all income taxes is the IT Act (“GST Laws”).
A. Taxation of Franchised Businesses in India
In India, the IT Act requires master franchisees and sub-franchisees to pay direct taxes, while the GST Laws require them to pay indirect taxes. Depending on a taxpayer’s residency status during a given fiscal year, they may have to pay direct taxes. The IT Act establishes criteria for determining the residency status of various kinds of Indian taxpayers and classifies them into seven distinct categories. Even if they are owned or managed by foreign firms or foreign persons, all businesses that are formed in India are regarded as resident entities. Every financial year, the Government of India may revise the income tax rate. In addition to paying income tax, Indian franchisees may also be obliged to pay other direct taxes, such as capital gains taxes or dividend distribution taxes, at the relevant rates. With effect from “July 1, 2017”, the Indian government overhauled the existing indirect tax system by eliminating a significant portion of the indirect taxes imposed by the state and federal governments and replacing them with the GST Laws. In principle, all providers of goods and services with annual sales of more than two million (INR) are obliged to register under the GST Laws and pay the appropriate rates of goods and services taxes (GST) on the items and services they provide to their clients. Being an indirect tax, GST is often collected from customers by the provider.
B. Taxation of Foreign Franchisor
1. Withholding Taxes on Franchisee Payments to the Franchisor
Indian franchisees are required by the IT Act to deduct the appropriate amount of tax from payments made to a foreign franchisor in accordance with the terms of the franchise agreement. Withholding tax must be withheld and filed with the government at the time the sum owing to the franchisor is due, or at the time of the actual payment, whichever comes first. The IT Act also states that, depending on which option is more advantageous to the franchisor, withholding tax shall be withheld at the rate specified in the IT Act or at the rate specified in the double taxation avoidance agreement (DTAA) between India and the franchisor’s place of residence. Different withholding tax rates are established for various service categories under the IT Act and DTAA. A wide range of mandated payments, including “royalties, fees for technical services, advertising costs, business support fees, and administrative fees”, are frequently imposed on franchisees under franchise agreements. As a result, to ascertain the precise rate of withholding tax applicable to each sort of payment, franchisors must examine both the DTAA and the IT Act. We’ll talk about the actions an Indian franchisee must take to deduct withholding taxes before sending money to the franchisor.
2. Payments Made by the Franchisee to the Franchisor Subject to Goods and Services Tax
Due to the foreign franchisor’s location outside of India under an international franchise agreement, it is the responsibility of the Indian franchisee to pay GST on the services rendered by the foreign franchisor. In a worldwide franchise agreement, the local franchisee will thus be obligated to pay GST on the payments to be made to the foreign franchisor.
Authored By: Adv. Anant Sharma & Lehar Saini
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