India: Income Tax Issues and Basic Procedures

Last Updated: 6 September 2002
Article by Keshav Jetsey

India today is a vibrant, information technology savvy financially strong country. It is one of the largest industrialized countries, as also has one of the largest skilled manpower in the world.

It has a free economy with liberalized, market driven policies that strengthens the base at macro and micro levels.

The country’s focus is on fast track development of infrastructure like power, communications, roadways and highways, airports etc.

Capital goods, consumer goods, service industry all have a huge market potential in India.

The controlled low inflation rate, a stable Indian rupee, repatriation of earnings, free convertibility on trade account, comfortable forex reserves and improved balance of payments position are a further reflection of the strong economy.

With a commitment to continuous reforms, the Indian economy after its turnaround from 1991 has truly and firmly set its path on globalisation.

And the firm establishment of multinational giants in India sees the success of its policies. Establishment of activities in India by foreign companies can be made through various routes.

a) Liaison office:

Before opening a full-scale branch, a liaison office could be set up. Reserve Bank of India covers its incorporation in India. This office, being a purely correspondence office, cannot conduct business activities and earn profits. Consequently there is no income tax liability. However, the liaison office has to meet its expenses through remittances from its principals abroad.

b) Branch Office:

Foreign companies can open branch offices in India for

  • Acting as buying and selling agents in India.
  • Conducting banking activities.
  • Undertaking business activities.

The Reserve Bank of India again governs operating of branch offices. A branch has also to be registered under the Indian Companies Act, 1956 and has to file its (branch’s) accounts every year with the Registrar of Companies.

The branch, on its net income earned, has to pay tax under the Indian Income Tax Act, 1961.

c) Joint Venture (JV) / wholly owned subsidiaries (WOS):

A corporate entity can be floated in India. The permission of Foreign Investment Promotion Board is necessary in certain categories for setting up JV/WOS IN India. The foreign group can invest upto 51%/74%/100% in a corporate body in India.

Repatriation of both – the principal and the income are allowed, subject to Income tax, without any other restrictions.

d) Project Offices:

Foreign entities executing contracts in India can set up a project office in India for site supervision. RBI gives permission for such offices. Project offices cannot conduct business in India.

e) Direct Sale:

Even without an office in India, the foreign entity from its foreign office can sell goods to India. This being a direct sale, the foreign entity is not liable to pay any income tax in India as no income has arisen or accrued in India.

The foreign entity could also transfer know how through technology transfer/ technical collaboration. Any fees or royalty received by the foreign entity is subject to tax in India.

All businesses set up in India and generating revenue and income are liable to pay income tax and file their returns of income in India.

A broad picture of the system, persons liable, taxation and related issues is stated herein.

INDIAN INCOME TAX ACT:

The liability to tax is dependent upon the residential status of the person receiving the income. Income accrued or arisen in India is subject to tax in India. An income received in India is taxable in India. The residential status is either residential or non-residential.

A foreign entity is resident if:

  • It is an Indian company

Or

  • During the relevant year, the control and management of its affairs is situated WHOLLY in India.

Control and Management refers to the head and the brain of the company, which directs the affairs of policy, finance, utilization of profits and other vital matters.

A resident company is liable to Income Tax in India on its WORLD income i.e. Income received, accrued or arisen in India and that which accrues or arises outside India.

A non-resident company is liable to income tax in respect of income received or deemed to be received in India or which accrues or arises or is deemed to accrue or arise in India. Non-residents are not liable to Indian Income Tax in respect of income accruing or arising outside India.

Status

Indian Income

Foreign Income

Income arising outside India

Resident

Taxable

Taxable

Taxable

Non-Resident

Taxable

Not Taxable

Not Taxable.

INCOME ACCRUING OR ARISING IN INDIA:

Income Taxable will include:

  1. All incomes accruing or arising whether directly or indirectly through or from any business connection in India or through or from any property in India or through or from any asset or source of income in India or through the transfer of a capital asset situated in India.
  2. Salary income if it is earned in India or income payable for services rendered in India.
  3. Income by way of interest payable by a person for debt incurred or moneys borrowed and used for the purpose of a business or profession carried on by such person in India.
  4. Income by way of royalty payable by a person in respect of any right, property, information or services utilized for the purpose of business or profession carried on in India by such person.
  5. Income by way of fees for technical services payable by a person in respect of services utilized in a business or profession carried on in India.

TO SUMMARISE

Indian Companies are liable to pay tax in India on their worldwide income, irrespective of its source and origin.

Foreign companies are liable to pay tax only on income, which arises or accrues or is deemed to arise or accrue in India.

A domestic (Indian) Company means an Indian company or any other company, which has made prescribed arrangement for declaration and payment, within India, of dividends payable out of Income liable to tax.

A Foreign company is one, which is not incorporated in India, and which has not made prescribed arrangement for declaration and payment of dividends within India.

A company is a resident of India, if:

  • It is a domestic company or
  • In case of a foreign company, if its control and management is wholly in India.

TAX RATES FOR COMPANIES

SR.NO

Nature of income

Rate

I)

A Domestic Company.

On income other than long term capital gains

35%

B)

Foreign Companies:

i)

Interest received on foreign currency debts

20%

ii)

Royalty or fees for Technical services

20%

iii)

Income from units, bonds or shares

(Other than dividend u/s. 115-o)

10%

iv)

Income from listed securities:

a) Short term capital gains

30%

b) Long Term Capital gains

10%

c) Other Income

20%

v)

Other Long Term capital gains

20%

vi)

Other Income

40%

II) i) All revenues accruing to foreign companies (excluding royalties and fees for technical services from business connected with exploration or production of petroleum or natural gas,) are subject to tax on a deemed profit of 10% of gross revenues.

ii) Foreign companies engaged in civil construction, erection, testing or commissioning of plant and machinery for turn key power projects are subject to tax on deemed profits of 10% of gross revenues.

iii) Foreign companies carrying on shipping operations in India are liable to pay tax on deemed income computed @ 7.5% of freight revenues earned in India.

iv) Non-residents engaged in the business of operation of Aircraft shall be liable to tax on profits computed @ 5% of the amount received by the non-resident.

COMPUTATION OF INCOME FOR TAX:

Non-deduction of expenses on income and rebates will be allowed with respect to income specified in (I) (B) (i) to (v) above.

Moreover benefits of exchange rate fluctuations and cost inflation index shall not be allowed for computing long-term capital gains.

The foreign company should compute its income for the year and tax shall be the aggregate tax calculated at the rates given above on all the sources of income.

PAYMENT OF TAX:

The tax liability for the year running from April to March has to be paid by companies in four instalments before 15th of June, September, December and March. From the aggregate tax payable, any tax deducted at source should be reduced and the balance tax paid in instalments as stated above.

FILING OF RETURN:

Companies have to file their returns of income relevant for the period April to March by 31st October of each year.

In case of non-residents earning income in category I) B) (i) to (v) above, return of income need not be filed if tax has been deducted at source in full.

RESPONSIBILITY OF FILING THE RETURN:

Every person earning income in India has to file their return of income. If the person is out of India, his representative can file the return.

For a foreign collaborator, the Indian company with whom they are doing business can be the representative assessee.

ISSUES TO BE NOTED:

  1. The residential status in India for the purposes of Income Tax Act is the most crucial factor determining the taxability of income of a foreign company. It should be ensured that control and management of the foreign company is situated wholly outside India.
  2. The foreign collaborator while billing can bifurcate his fees and expenses so that the Indian company can pay him both separately. This will ensure that the foreign collaborator pays tax on his fees only and not on the aggregate receipts.
  3. A non-corporate foreign party can deduct expenses from certain categories of income whereas companies cannot.
  4. India has Double Taxation Avoidance Agreements with many countries and provisions of the DTAA should be kept in mind while drafting agreements.

Every foreign collaborator should ensure that every issue of the Indian Income Tax law is considered and complied with.

The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.

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