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India, Japan to benefit from tax pact

Changes in treaty provisions will boost two-way investments

INDIA AND Japan have recently signed a protocol to amend certain provisions of the existing tax treaty between the two countries. The protocol when notified will reduce the withholding tax rate on dividends, interest, royalties and fee for technical services (FTS) to 10 per cent. The current rate on these streams of income ranges from 15 per cent (for dividends and interest, other than interest paid to banks) to 20 per cent (for royalties and FTS).

Japan has been an attractive destination for many Indian players. However, a relatively high corporate income tax and branch tax rate of 30 per cent coupled with a stringent withholding regime, which seeks to tax income from offshore services (not prevalent even in countries like the U.S.) have meant lower repatriation of profits to India.

Many players of the Indian market, especially in the technology industry, have been insisting on a reduced withholding tax rate in the source state, considering the quantum and value of cross border technology transfers between companies in the two countries. Further, the taxes withheld in Japan effectively represent a sunk cost for Indian technology companies, given their tax exempt status in India. Also, the reduction of tax rates on royalties and FTS under Indian tax laws last year has spurred the current reduction in withholding tax rates under the treaty.

India's changed face

A major reason, however, for the reduced rates may be the transformed `purchasing power' of India in the world economy. From a `net importer' prior to the beginning of the 21st century, India is fast becoming a `net exporter,' especially in the Information Technology sector. Experts believe that this changed face of India will be the most significant factor in future treaty negotiations. The recent tax treaties India had with countries such as Hungary and Slovenia and re-negotiations with Singapore and Italy are examples of its willingness to agree for a lower rate of tax withholding in the source state.

Levying lower rates of tax withholding on passive streams of income in the source state is an accepted tax philosophy, specifically in countries (most European countries) following the OECD model. The paradigm shift of India towards this trend augurs well for its future both from the perspective of higher foreign direct investment inflows and increased Indian investments overseas.

PRADEEP NARAYANAN

He can be contacted at Pradeep.Narayanan@in.ey.com

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