Taxation of Foreign Companies for Foreign Direct Investments (FDI) in IT and IT Enabled Services: Best FDI Attorney Advice in India
“Tax Planning before FDI in India or understanding the Tax Structure before making Foreign Direct Investment in India is the primary step which every investor should take before even registering their company or corporation in India. The tax structure in India is a bit complex as the same involves central and state taxes and have to be understood in detail. A proper legal consultation should be obtained from FDI attorney in India before making any decision. The tax compliances are statutory in nature and their non-compliance attracts heavy penalties.”
In India, the taxability of the payment to the foreign corporation will be determined by how it is classified. Depending on the nature of the transaction, payments paid by an Indian corporation to a foreign entity might be classified as royalties, fees for technical services, capital gains, or commercial earnings. If the payment is classified as royalty, it is subject to a 20% gross withholding tax (which may be lowered under the conditions of a Double Taxation Avoidance Agreement (“DTAA”) between India and the foreign company’s home country). When making a payment or crediting the amount in its books to the foreign firm, the payer would be obligated to withhold tax at the relevant rate on a gross basis.
A payment that is classified as business income is taxed in India only if the foreign firm has a business relationship (permanent establishment in the event of a DTAA between India and the foreign company’s home country). Only the share of income related to a business association or a permanent establishment (“PE”), as even the case may be, in India will be taxed at a rate of 40% on a net basis in India.
Taxation for services done by Indian Company to Foreign Company
If payments made by an Indian company to a foreign corporation for computer software services are considered “fees for technical or included services,” they may be subject to taxation in India at a rate of 20% on a gross basis (this rate may be lowered by regulations of a DTAA between India and the foreign company’s home country). If the transaction is categorized as capital gains realised by a foreign firm on the sale of a capital asset located in India, it will be taxed in India as long or short term capital gains, based on how long the foreign company owned the asset. Capital gains from a capital asset of this sort held for more than 36 months are classified as long term capital gains and are taxed at a rate of 20%, whereas capital gains from a capital asset kept for less than 36 months are classified as short term capital gain and are taxed at a rate of 40%.
Taxation in case of Mixed Transactions
If the purchaser does not have complete rights to the property, for example, when the property may only be used within India, complications may develop. The commentary on Article 12 of the OECD Model Convention on Royalties, which deals with royalty, admit that complications may develop in such situations. While the specifics of each instance will vary, in generally, such payments are more likely to represent company income or capital gains than royalties.
The tax liabilities on a foreign corporation is more over a domestic Indian company. Thus, registration of company in India and obtaining necessary licenses and permits is a more advisable option.
To summarise, if the consideration provided is for the acquisition of a shrink-wrapped product, i.e. a right other than an intellectual property right, the payment should not be considered as royalties but rather as business revenue. Nevertheless, if the payment is for the right to commercially utilise the software’s intellectual property, it might be considered a royalty. If the foreign company’s services in connection to computer software make accessible technical knowledge, expertise, talent, understand, or processes, or comprises of the formulation and transfer of a technical design or technical layout, the costs for included or tech support would be considered.
Authored By: Adv. Anant Sharma & Afsana Khan