The Hindu Business Line : Major changes for non-residents

Tax incidence is one of the main factors considered in all business decisions. Business strategy involves a thorough study of domestic tax laws and the tax treaties among countries. The flexibility of opting for the provisions under tax treaties is no longer available. The general anti-abuse rule given in the Direct Taxes Code will override the tax treaty provisions.

Deeming provision

A foreign company will be treated as resident in India if, at any time, in the financial year, the control and management of its affairs are wholly or partly situated in India (it need not be wholly situated in India as at present).

Though the DTC has done away with the category of ‘resident but not ordinarily resident’, the tax consequence is kept in tact by a provision in the schedule of exempt income.

Thus, any income of an individual is exempted, if:

a) the income (i) accrues to him outside India; or (ii) is received outside India, in the year, by or on behalf of such individual;

b) the income is not derived from a business controlled in, or a profession set up, in India;

c) the income relates to (i) the financial year in which the individual ceases to be a non-resident; or (ii) the financial year immediately succeeding the financial year in which the individual ceases to be non-resident; and

d) the individual was a non-resident for nine years immediately preceding the financial year in which he has ceased to be a non-resident.

Source-based taxation

Under the Code, residence-based taxation is applied for residents and source-based taxation is applied for non-residents. However, a non-resident in India will be liable to tax in India only in respect of accruals and receipts in India (including deemed accruals and receipts).

The DTC intends not to stay with the pure application of either of them. In case any international agreement/treaty leads to unintended consequences like tax evasion or flow of benefits to unintended person, it is open to the signatory to take corrective steps to prevent abuse of treaty. Already, there is a provision in some of the treaties for limitation of benefits (LOB).

The theory of territorial nexus postulated in the Ishikawajima-Harima Heavy Industries (288 ITR-408 SC 2007) case is likely to be rendered ineffectual because of the wordings in the DTC with respect to deemed income. The provisions in the DTC which deem certain income as accruing in India is made applicable even if the payment is made outside India, the services for which payment is made also rendered outside India or the income has otherwise not accrued in India.

Foreign companies

Tax rate for non-resident companies is brought on a par with domestic companies, that is, 25 per cent. No separate rate is prescribed for non-domestic companies as in the existing rate schedule.

In the case of companies, including foreign companies, gross assets tax (GAT) in the place of Minimum Alternative Tax (MAT) is sought to be levied if the tax liability under the regular provisions of the Code is less than 2 per cent of gross assets of the company (the rate prescribed for MAT). There could be no tax credit to carry over when tax is paid under GAT.

Branch profits tax

The Code introduces a tax on branch profits of foreign companies at the rate 15 per cent. The branch profits in this context means the total income of the branch for the financial year as reduced by the amount of income-tax thereon. This is an irksome provision which amounts to taxing the income twice. In case there is a permanent establishment (PE) which is liable for tax on the profits attributable to the PE, whether it has once again be exposed to branch profits tax is a matter of concern.

The amount of interest on deposits in a Non-resident (External) Account in any bank in India will not be included in the total income, if the assesse is an individual and is resident outside India as per the FERA Act, or has been permitted by the RBI to maintain the aforesaid.

The amount of interest payable by a scheduled bank to a non-resident or to a person who is not ordinarily resident, on deposits in foreign currency where the acceptance of such deposits by the bank is approved by the RBI.

From special sources

The following items of income of non-residents are sought to be taxed as from "special sources" at the flat rates given against each:

(a) on investment income, by way of i) interest and ii) dividend on which dividend distribution tax has not been paid, 20 per cent; ii) capital gains, 30 per cent; iii) any other investment income, 20 per cent; and

b) on income by way of royalty or fees for technical services, 20 per cent.

The rate of tax on income by way of royalty or fee for technical services is at 10 per cent as of now if the agreement for the same is entered into on or after June 1, 2005. The definition of royalty and technical services has been significantly widened.

Under the existing provision, the computation of capital gain on transfer of a capital asset being shares in, or debentures of, an Indian company, is done in the following manner for a non-resident:

The cost of acquisition and the full value of consideration received as a result of the transfer of the capital asset is converted into the same foreign currency as was initially used for the purchase of the shares or debentures;

Capital gain is ascertained (as expressed in foreign currency) by netting against the cost of acquisition of the full value consideration less expenses of transfer, without indexation benefit.

The capital gains so computed shall be converted into Indian currency.

The aforesaid computation method is not retained in the DTC. However, under the DTC, if the transfer of the investment asset takes place after one year from the end of the financial year in which the asset was acquired, indexation benefit is provided for, which is not currently available to a non-resident assessee who transfers shares or debentures of an Indian company.

The ninth schedule specifies the computation of income from any other special source. Accordingly, income from any special source shall be the amount computed in accordance with the provisions of Sections 44 to 53 (relating to capital gains) arising from the transfer of an asset, being equity share in a company or a unit of an equity-oriented fund, and chargeable to securities transaction tax (STT). If the capital gain referred to here accrues to a non-resident, a flat rate of 30 per cent will be applicable.

Any other investment income will be chargeable to tax on the amount of accrual or receipt. It is important to note that the phrase `investment income' is not defined though `investment asset' is defined to mean any capital asset which is not a business capital asset. This proposition of law leads to an inference that the amount of accrual or receipt [that is, consideration] will have to be categorised as investment income chargeable at flat rate of 20 per cent.

The income or gains arising from transfer of all investment assets other than financial assets (shares and securities), and business capital assets would be income from special sources for non-residents taxable as "any other investment income" at the flat rate of 20 per cent.

For example, if the non-resident transfers land or buildings in India, the transaction is not to be covered by the provisions of capital gains, in which case the net receipts on transfer may be in for flat rate taxation as aforesaid. As the transaction does not fall under the head of capital gains, there is no question of deducting the cost from the full value of consideration

Perhaps, the intention of levying tax at the flat rate of 20 per cent of the consideration received on transfer of any investment asset in India, other than financial assets, may be due to the fact that the investments were made out of income which was not charged to tax in India.

However, from the present wordings of the provisions, it appears that the flat rate of 20 per cent is applicable even if the non-resident had made the investment out of income which had suffered tax in India. This apparently may not be the intention of the legislature, which is against equity and natural justice.

It is suggested that a pragmatic and rationale approach may be adopted to remove the complexities in interpreting the provisions contained in different parts of the DTC.

Deduction for tax incentives

It may noted that a person shall be allowed deductions, such as for savings, children's education, interest on loan taken for higher education, health insurance premium, medical treatment and maintenance of disabled dependent, only out of his "gross total income from ordinary sources," for the financial year. Income from special source is not available for such deductions.

Wealth tax impact

Person of Indian origin or a citizen of India who was ordinarily residing in a foreign country and returns to India with the intention of residing permanently therein, is exempted from wealth tax for a period of seven successive assessment years beginning from the year of return to India, in respect of assets brought into India within one year prior to the date of his return to India or at the time of return or at any time thereafter.

The omission of this exemption in the DTC will have an impact on the wealth tax liability of NRIs returning to India for permanent settlement. However the scheme of wealth tax leaves some breather in the form of phenomenally increasing the threshold limit to Rs 50 crore.

The DTC makes a radical departure in notifying what assets shall not be included for wealth tax purposes. But for those assets, all assets wherever located on the valuation date are considered in the computation of net wealth.

The value of all debts which have been incurred in relation to such assets falling under the purview of assets have to be deducted for arriving at net wealth. If the net wealth exceeds Rs 50 crore, the excess would be chargeable at 0.25 per cent.

(The authors are Chennai-based chartered accountants.)