India has a complex tax system and a well-developed tax structure. The tax structure is also largely compliance driven. Taxes have to be considered while preparing budgets by companies /individuals. Companies/ individuals planning/proposing to do business in India need to plan every step of their transaction meticulously to avoid any unpleasant surprises, which directly affect their profitability.
India has a three-tier structure, comprising of-
- The Union Government,
- The State Governments and
- The Local Bodies.
The power to impose direct and indirect taxes and collect taxes, duties, cesses etc. is distributed among the Union Government, the State Governments and the Local Bodies, as per the Constitution of India. Since the onset of liberalization in the country, tax structure of the country has been rationalised and is an on going process.
The Finance Minister of India has presented the Annual Budget for the Financial Year
2008-09 on February 29, 2008. “Financial Year” for taxation is the period of 12 months commencing from 1st Aril to March 31st of the next calendar year.Taxes/Duties levied by the Union Government
Corporate and Personal Income Tax (IT)
Tax on income is levied under the Income Tax Act, 1961 (ITA).
Corporate IT Rates
IT rates applicable to entities having taxable income* of more than INR 10 million for the previous year** commencing from April 01, 2008:
- Domestic Companies (Company registered in India) - 33.99% [30% basic tax plus surcharge of 10% on IT and Education Cess (EC) of 3% of the basic tax and surcharge]
- Foreign Companies (including Branch/Project office) - 42.23% [40% basic tax plus surcharge of 2.5% and EC -3% of the basic tax and surcharge]
- Partnership Firms – 33.99% [30% basic tax plus surcharge of 10% and EC -3% of the basic tax and surcharge]
* “Taxable income” is broadly the Gross income less admissible business expenditure and depreciation. For individuals certain additional deductions are permitted towards certain specified expenses such as premium paid on medical insurance and investments etc.
**“Previous year” is the Financial Year prior to the Assessment year. The tax assessment of a previous year is carried out in the assessment year.
Tax rates applicable to entities having taxable income of LESS than INR 10 million for the year commencing from April 01, 2008:
- Domestic Companies - 30.9% [30% basic tax and EC -3% of the basic tax]
- Foreign Companies (including Branch / Project office) - 41.2% [40% basic tax and EC -3% of the basic tax]
- Partnership Firms – 30.9% [30% basic tax and EC -3% of the basic tax]
Personal IT Rates
In case of Individuals, the 1st INR 150,000 is exempt from taxation.
The income beyond INR 150,000 is taxed as follows:
- INR 150,000 to INR 300,000 - 10%.
- INR 300,000 to INR 500,000 - 20%.
- INR 500,000> - 30%.
- Surcharge of 10% on tax is added if the Taxable income exceeds INR 1 million.
- EC @3% on tax (and surcharge, if any).
The residential status of individual/taxable entity is very relevant and has to be checked for each year.
The broad parameters for deciding the residential status are:
Individual- An individual can be a ‘resident and ordinarily resident’ or ‘resident but not ordinarily resident’ or ‘non-resident’.
An Individual is said to be resident in India if either of the following conditions is satisfied:
- he has been in India for a period of 182 days or more during the previous year, or
- he has been in India for a period of 60 days or more during the previous year and 365 days or more during 4 years immediately preceding the previous year.
If he does not satisfy any of the above conditions then he is treated as a non-resident.
Resident and Ordinarily Resident – If an individual has been in India for atleast two years out of ten previous years immediately preceding the relevant previous year; and he has been in India for a period of 730 days or more during the seven years immediately preceding the relevant previous year.
If either of the above conditions for Resident and Ordinarily Resident is not satisfied then the individual is a ‘resident but not ordinarily resident’.
Company- In case of Company:
- An Indian company is always resident in India.
Implication of residential status on IT
Resident and Ordinarily Resident- In case of a person ‘resident in India’ both Indian income and foreign income are taxable.
Resident but not ordinarily resident- In case of a person ‘resident but not ordinarily resident’ income generated in India from business whether partly or fully controlled from India is taxable but income from business set up and controlled wholly outside India is not taxable.
Non-resident- In case of ‘non-resident’ Indian income is taxable but the foreign income is not taxable. Therefore, generally, if the control and management of a foreign company is situated wholly out side India the foreign Income is not taxable. For non-resident, Indian Income would mean income accrued or received in India.
IT on Presumptive Profit Basis [Presumptive Profit is generally understood as notional profit in a business/industry without refering to the books of account.]
Certain identified business activities, listed below, carried on by non- residents in India may be taxed on presumptive basis:
- Activities connected with the Exploration of Mineral Oil -10% of the total turnover will be taken as profit and taxed without deductions and depreciations.
- Shipping profits - 7.5% of the total turnover will be taken as profit and taxed without deductions and depreciations.
- Business of Civil Construction - 10% of the total turnover will be taken as profit and taxed without deductions and depreciations.
- Royalties and Technical Services Fees -10% of the total turnover will be taken as profit and taxed without deductions and depreciations.
Sectoral Tax Holidays & Other Benefits
Considering the importance of various industries for the economy, like mining, E&P of Mineral Oils, Power, Information Technology, infrastructure etc., various special provisions are incorporated in the ITA giving special concessions, benefits and tax holidays. Therefore, any person proposing to do business in India in any sector, should seek competent legal advise to properly structure their strategies.
Fringe Benefit Tax (FBT)
FBT is payable by the companies/firms. It is a tax on certain facilities provided/enjoyed by the employees of the companies/ firms.
The rate of FBT is 30% on the value of fringe benefits and surcharge (10% in case of domestic companies or 2.5% in case of Foreign Companies, as the case may be) and 3% EC on FBT and surcharge thereon.
Minimum Alternative Tax (MAT)
MAT is applicable to companies which are making profits however not liable to pay IT because income computed after adjusting the depreciation/ amortization of expenditure etc. is either nil or negative or insignificant.
The calculation of MAT plus surcharge and EC is given below:
- Domestic company (taxable income more than INR 10 million): 11.33% including Surcharge & EC.
- Domestic company (taxable income less than INR 10 million): 10.30% including EC (Surcharge not applicable)
- Foreign Company (taxable income more than INR 10 million): 10.5575% including Surcharge & EC
- Foreign Company (taxable income less than INR 10 million): 10.30%. including EC (Surcharge not applicable)
Tax on Capital Gains (CGT)
CG is the profit arising out of the disposal of a ‘capital asset’ – the difference between the cost of acquisition and sale consideration.
Long term CGT (transfer beyond 3 years from the date of acquisition/ for shares and securities more than 1 year) is 20% and short term CGT (transfer within 3 years from the date of acquisition/ for shares and securities within 1 year) is 15% subject to certain conditions and the nature of the asset.
Withholding Tax obligation/Tax Deductable at Source (TDS)
When payments are made on account of contracts, salaries, rent, interest, royalty, commission etc., the companies/ Association of Persons/ partnerships certain percentages are to be deducted from the amounts so paid.
The deducted amount has to be deposited with the tax authorities in the manner prescribed. There are other obligations like issue of certificate for TDS and filing of quarterly returns.
Dividend Distribution Tax (DDT)
Dividend declared by an Indian company is taxable in the hands of that company.
Total DDT is 16.995% [including tax @ 15%, surcharge on tax @ 10% and EC @3% (on tax and surcharge)].
Wealth Tax
Net wealth on the valuation date is chargeable to wealth tax and only Individual and company is chargeable to wealth tax.
Net wealth in excess of INR 1.5 million is chargeable to wealth tax @1% and surcharge and EC thereon.
Valuation date is 31st March immediately proceeding the assessment year.
Productive assets like shares, debentures, bank deposits and investments in mutual funds are exempt from wealth tax.
The non-productive assets include jewellery, residential house (in case the person has more than one house) bullion, motor cars, aircraft, urban land, etc. are liable for WT.
Foreign nationals are exempt from wealth tax on non-Indian assets.
Customs Duty & Countervailing Duty
These duties are levied on the import of goods according to the Customs Act, 1962 and the rates prescribed under the Customs Tariff Act, 1975.
The Tariff is aligned with the internationally recognized Harmonized System of Nomenclature. The Central Government has the power to lower the rate of duty prescribed in the Tariff for any item by issuing a notification in the Official Gazette.
The taxable event occurs the moment the goods enter the territorial waters of India.
Project Imports
Certain duty benefits/concessions are available for the import of certain capital goods, spare & consumables, in relation to:
- Industrial Plant;
- Irrigation Project;
- Power Project;
- Mining Project;
- Project for the exploration for oil or other minerals; and
- Such other projects as the Central Government may, notify.
In the recent Budget it is proposed to reduce the customs duty on project imports from 7.5% to 5%.
ED (also, Special Excise Duty and Additional Excise Duty in some cases) is payable on the goods manufactured in India.
The rates depend on the product manufactured or produced. ED on most commodities ranges between 0 to 14% proposed Central Value-added Tax (CENVAT) benefits are also available on the goods manufactured or produced in India. CENVAT is applicable to practically all manufactured goods, so as to avoid cascading effect on duty.
Service Tax (ST)
ST is levied on most of the services availed by a recipient of any service. The lists of assessable services are notified by the GOI from time of time. A service Provider with receipts above INR 1 million is liable to collect and deposit ST. Services received from outside India are also taxable from the recipient of services in India.
The rate applicable is 12% and along with EC the effective rate becomes 12.36%.
Central Sales Tax (CST)
CST is applicable in inter-state sale of goods. The new budget proposed to reduce the CST from 3% to 2%.
There is a proposal to substitute CST with Goods and Services Tax by April 1, 2010.
Research and Development Cess (R&D Cess)
R&D Cess is levied under the Research and Development Cess Act, 1986, at the rate of 5% on the import of technology into India. R&D Cess is payable by the importer on payments made for such imports.
Technology means any special or technical knowledge or any special service required for any purpose by an Industrial concern under any foreign collaboration including designs, drawings, publications and technical personnel.
Education Cess (EC)
EC is levied on all the taxes and duties imposed by the GOI as a surcharge on all taxes and duties @ 3%.
Taxes/Duties levied by the State Governments
Local Sales Tax (LST) / Value Added Tax (VAT)
LST/ VAT is levied by States in which the sale of goods take place, which may vary from 1% to 20%.
Every state has its own LST/ VAT laws, rates and classification of goods. Also the transaction involving application of labour and material to be used is taxed under VAT/LST as ‘works contract’, although the same may be chargeable to Service Tax also.
Stamp Duty
The stamp duty is payable on specified transactions under the Indian Stamp Act, 1899 (ISA) as amended/ modified by the State governments. The stamp duty is payable when a deed/ document/ instrument, like bill of exchange, bill of lading, letter of credit, transfer of shares, mortgage, lease, agreements, conveyance deed and many more, as specified in the ISA, is executed. The amount of duty largely depends on the amount involved in a transaction, the document executed and the State in which it is executed or operated.
Local Area Development Tax / Octroi / Entry Tax
These taxes are levied by certain States for the development of the local areas where the business is taking place or carried on. These taxes are levied and collected on the entry of specified goods, into any local area for consumption, use or sale therein.
Different rates are applicable for different areas, classes of goods and categories of persons.
OTHER State Government TAXES/ Local Bodies Taxes
- IT on agricultural income,
- State Excise (mainly duty on manufacture of alcohol),
- Land Revenue (levy on land used for agricultural/non-agricultural purposes),
- Duty on Entertainment like movies and performances.
- Tax on Professions & Callings.
- Property Tax - levy tax on properties (buildings, etc.),
- User Charges for utilities like water supply, drainage, etc.and
- Tax on local Markets.
Obligations under Various Tax Laws
There are time bound/periodical obligations under various tax laws, which include:
- Obtaining permanent account numbers and similar registrations.
- Deposit of tax in advance.
- Withholding tax, issuing certificate of withholding and deposit obligations.
- Filing of monthly/ quarterly/ annual returns as prescribed by the relevant law.
There are DTAAs between India and many foreign countries, which will have a role to play in the ultimate tax liability.
Foreign income of a person generally becomes liable to tax in two countries – the country in which the income is earned and the country in which the person is resident.
Double taxation of such income is avoided by means of DTAA.
Where the income accrues or arises in a country with which no agreement exists, unilateral tax relief is provided on the doubly taxed income under the provisions of ITA.
Transfer Pricing
Transfer pricing regulations were introduced to battle the tendency of multinationals to park profits in low tax regimes. The regulations allow the IT authorities to determine at arm’s length price in respect of international transactions between related enterprises.
These regulations are the current hot favourite of the tax administration in India and the adjustments made in respect of the value of international transactions have assumed significant importance in tax administration in India.
Transfer Pricing issues are dealt with in cases of Customs Duty and IT under separate rules.
Advance Rulings
For non-residents, there are special provisions under ITA, Central Excise Act and Customs Act, to apply for advance ruling by the ‘Authority for Advance Ruling’.
This will help, in advance, in the determination of certain tax issues, in relation to any transaction which such non-resident has undertaken or proposes to undertake.
EXCHANGE RATES AND CONTROLS
Reserve Bank of India (RBI) is regulator for financial and banking system, formulates monetary policy and prescribes exchange control norms.
RBI regulates foreign exchange under the Foreign Exchange Management Act (FEMA) and the Regulations made there under. Under FEMA nothing is permitted unless specifically permitted. There are various general and special permissions issued by the RBI which are investor friendly and especially facilitate repatriation of business profits, salaries etc.
All the foreign exchange transactions have to be done only through the normal banking channels/authorized dealers (AD).
Except with the general or special permission of the RBI no person can:
- deal in or transfer any foreign exchange or foreign security by any person not being an authorized person;
- make any payment to or for the credit of any person resident outside India in any manner;
- receive otherwise through an authorized person, any payment by order or on behalf of any person resident outside India in any manner;
- reasonable restrictions for current account transactions as may be prescribed.
Repatriation of Investment Capital and Profits Earned in India
All foreign investments made under the permitted FDI routes are freely repatriable except for the cases where Non-resident Indians choose to invest specifically under non-repatriable schemes.
Dividends declared on foreign investments can be remitted freely through an AD.
Non-residents can sell shares on stock exchange without prior approval of RBI and repatriate through an AD if they have necessary NOC/tax clearance certificate issued by IT authorities.
Profits, dividends, etc. (which are remittances classified as current account transactions) can be freely repatriated.
Remittance of the winding-up proceeds of a BO/PO/LO of a Foreign Company is permitted, subject to RBI approval.
Generally Indian companies are allowed to retain and remit payments for the services of foreign nationals/companies.
CONCLUSION
In view of the complex tax and foreign exchange laws, it is always necessary and advisable to ensure that a foreign entrant has the required guidance from competent professionals from the very first stage. Our experience shows that certain companies who did not care to take appropriate guidance on taxation clauses in the agreements, tax planning & compliance have ended up with unfavourable contract conditions, avoidable tax burdens and arbitrations eating up their profit margins.
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