Taxation of investment income of Non-residents

Tax Treatment of Interest

Interest income received by or accruing to a non-resident in India is taxable. Interest wherever received or accruing is considered as accrued in India if the same is payable by the Government or, if payable by any other person, it is in respect of the money used for business or profession in India or for any Source of income in India.

The following interest income is exempted from tax:-

1. Interest on the notified securities and interest as well as premium on redemption on any notified bonds issued by the Central Government is exempt. For this purpose 4%% National Defence Loan,  1968 and 4 3/4% National Defence Loan, 1972 have been notified as exempt [Section 10(4)].
2. Interest on deposits in the Non-Resident (Non repatriable) Rupees Deposits Scheme.
3. Interest on deposits in N.R. (external) Account in any bank in India in accordance with the Foreign Exchange  Regulation  Act,   1973. This  exemption  is available to a person who is a person resident outside India within the meaning of Sec. 2(q) of the Foreign Exchange Regulation Act, 1973. This exemption is also available to one who has been permitted by the Reserve Bank of India to maintain such account [Sec.1094)(ii)]
4. Interest income of a bank incorporated outside India authorised to perform central banking function on any  deposit made by it with any scheduled bank if such deposit is approved by the Reserve Bank of India [Sec. 10(15)(iii)(a).]
5. Interest  income  in  respect of  moneys  borrowed outside India if the interest is payable by-

i.              Government or a local authority [Sec.10(15)(iv)(a)].

ii.             Industrial undertakings in India on moneys bor­rowed by them under a loan agreement entered into with any financial institution in a foreign country which is approved by the Central Government. [Sec. 10(15)(iv)(b)].

iii.           Industrial undertakings in India on any moneys borrowed or debt incurred by them in a foreign country in respect of purchases outside India of raw materials or components or capital plant and machinery to the extent to which the interest is calculated at the rate approved by the Central Government. For this purpose, the purchase of capital plant and machinery would include its purchase under a hire purchase agreement or a lease agreement with an option to purchase such plant and machinery [Sec. 10(1 5)(iv)(c)].

iv.          Industrial undertakings in India on any moneys borrowed in foreign currency under a loan agreement approved by the Central Government to the extent to which the interest does not exceed the amount of interest calculated at the rate approved by the Central Government [Sec.10(15)(iv)(f)

v.            Industrial Finance Corporation of India or the Industrial  Development Bank of India or the Export-Import Bank of India or the National Housing Bank or the Small Industries Develop­ment bank of India or the Industrial Credit and Investment Corporation of India to the extent to which the interest does not exceed the amount of interest calculated at the rate approved by the Central Government [Sec. 10(15)(iv)(d)].

vi.          Any other financial institution established in India or a banking company on any moneys borrowed by them under a loan agreement approved by the Central Government where the moneys are borrowed either for the purpose of advancing loans to industrial undertakings in India for purchase outside India of raw materials or capital plant and machinery or for the purpose of importing any goods which the Central Govern­ment may consider necessary to import in the pubic interest. The exemption is, however, allow­able to the extent to which the interest does not exceed the amount of interest calculated at the rate approved by the Central Government (Sec. 10 (15) (iv) (e)

vii.         Industrial undertaking on money borrowed in foreign currency under a loan agreement approved by Central Government having regard to the need for industrial development in India. The exemption is to the extent of interest calculated at the approved rate [Sec. 10(15)(iv)(f)].

viii.       A Scheduled bank on deposits in foreign cur­rency if such deposits are approved by the Reserve bank [Sec. 10(15)(iv)(fa)].

ix.           An Indian public company carrying on the busi­ness of providing long-term finance for construc­tion or purchase of house in India for residential purposes on any moneys borrowed by it in foreign currency under a loan agreement ap­proved by the Central Government. The exemp­tion is limited to the extent to which the interest does not exceed the amount of the interest calculated at the rate approved by the Central Government. It is necessary that such a com­pany is eligible for deduction under Section 36(1)(viii) of the Act [Sec. 10(15)(iv)(g)].

 

Rates of tax on interest Income

Interest income of certain non-residents is charged to tax at a fixed rate on the gross receipts without deduction of any expenses incidental to earning such income or the deduction referred to in Chapter V. Such non-resident persons and the rate of tax are:-

(i) Foreign companies in respect 20% of  interest received from the Government or Indian concern on borrowing in foreign currency [Sec. 115A].	20%
(ii) Non-corporate  non-residents in 20% respect of interest received from the Government or Indian concern on borrowing in foreign currency [Sec. 115A].	20%
(iii) Non-residents in respect of 10% interest on Bonds of an Indian company if the Bonds are issued in accordance with scheme notified by the Central Government and the same are purchased by them in foreign currency or acquired as a result of demerger or amalgamation. Foreign currency convertible Bonds and ordinary shares (Through Depository Receipt Mechanism) Scheme, 1993 is the one notified for this purpose [Sec. 115AC].	10%
iv) Notified Foreign institutional 20% investors in respect of income from securities listed in a Recognised Stock Exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 [Sec. 115 AD]	20%

 

Income from interest other than those specified above is  charged to tax on net income basis at the normal rate applicable  to the tax payer depending upon whether he is individual, company or any other person.

Rates of tax as per 'Double Tax Avoidance Agreement'

In terms of the double tax avoidance agreements in force with different countries income from interest derived by a person resident of the country with which such agreement exists is chargeable to tax in India at the agreed rates which are generally lower than the rates of tax mentioned in above para. If, however, in any case the rates in the agreement are higher, the tax payer is entitled to be assessed at the rates prescribed in the Income Tax Act. Rate of tax on interest as agreed with different countries are given in the annexure.

Tax Treatment of Dividend/Income from units

Dividend declared, distributed or paid by a domestic company on or after 1.6.1997 is exempt from tax. Similarly income from Units of Unit Trust of India and other mutual funds and from Venture Capital Company/fund is exempt. As for dividend etc. declared, distributed or paid prior to the date from which exemption is effective, the law provides for taxation of such income in case of certain non-residents at a flat rate on gross receipts i.e. without deduction of any expenses incidental to earning such income.

 

i) Foreign companies in respect of dividend or income from units of a notified Mutual Fund or the Unit Trust of India purchased in Foreign currency [Sec. 115A]	25% upto assessment year 1994-95 20% w.e.f. the assessment year 1995-96
ii) Non-Corporate non-residents in respect of dividend or income from Units of a notified mutual fund or the Unit Trust of India purchased in Foreign currency [Sec. 115A]	20% w.e.f. the assessment year 1995-96
iii) Overseas Financial Organisation (known as Off-shore Fund) in respect of units purchased in foreign currency. "Overseas Financial Organisation" means any fund institution, association or body established under the laws of a country outside India which has entered into an arran­gement for investment in India with any public sector bank or public financial institution or a notified mutual fund and such arrangement is approved by the Central government (Sec. 115 AB)	10%
iv) Any non-resident in respect of dividend from shares of an Indian Company which are issued in accordance with a scheme framed and notified by the Central government and which are purchased by him in foreign currency or acquired in an amal­gamated or resulting company as a result of amalgamation or demerger. Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme, 1993 is the one notified for this purpose [Sec. 115 AC]	10%
v) Notified Foreign Institutional 10% investors in respect of income from securities listed in a recognised Stock Exchange in India in accordance with the Securities Contracts (Regulation) Act, 1956 [Sec. 11 SAD]	10%

 

Income from dividend etc. relating to period prior to exemption which is not specified above is taxable on net income basis at the normal rate of tax.

Rate of tax as per 'Double Tax Avoidance Agreements'

The rates of tax applicable to income from dividend etc. as agreed to in the 'Double Tax Avoidance Agreements¹ entered into by India are given in the Annexure I. The Non-resident is entitled to be assessed at the normal rate applicable to him or the rate specified in the agreement with his country whichever is favourable to him.

Tax Treatment of capital gains

A discussion about the tax treatment of Capital Gains in general is made in Paras 4.5 to 4.5.9 of Chapter IV of the income tax Act. There are certain special provisions applicable to non-residents in the matter of computation of such gains as well as rates of taxation which are discussed here.

Special Provisions for computing capital gains from trans­fer of shares/debentures

Capital gains arising to a non-resident from the transfer of shares in or debentures of Indian companies is, at his option, computed by first converting the cost and the transfer considera­tion into the same foreign currency which was initially utilized in the purchase of such shares/debentures and then the difference being the capital gains expressed in that foreign currency is reconverted into Indian currency for the purpose of taxation. This is done to ensure that the amount of capital gain chargeable to tax is not influenced by the exchange rate fluctuation and represents only the accretion in value. The rates of conversion and re-conversion to be applied are as prescribed in rule 115A, which is the average of the telegraphic transfer buying rate for cost of acquisition and telegraphic transfer selling rate for transfer consideration on the respective dates. For conversion of capital gain, the conversion rate will be the telegraphic transfer buying rate as on the date of transfer of the capital asset. The aforesaid manner of computation of capital gains is also applicable in respect of capital gains accruing or arising from every reinvest­ment thereafter in share or debentures of an Indian Company. Where this option is availed of, the non-resident is not entitled to the benefit of indexation adjustment mentioned in para 4.5.4

In order to facilitate the restructuring of business it is provided that  transfer of shares in Indian companies from one foreign company to another, in a scheme of amalgamation or demerger would not be regarded as a transfer provided two conditions are satisfied - firstly, that a specified percentage of the shareholders of the amalgamating company or the demerged company continue to be the shareholders of the amalgamated company or the resulting company and secondly that such transfer is not subject to capital gains tax in the country where the amalgamating company or the demerged company is incorporated.

Capital gains arising from the transfer of short term capital asset are included in the total income and taxed at the normal rate applicable to the income of the person earning it. Capital gains arising out of the transfer of long term capital assets in the hands of non-residents are, however, assessed at the flat rates as follows:-

(i) Foreign Companies		40% upto A.Y. 1994-95 20% w.e.f. A.Y. 1995-96
(ii) Non-Corporate non­residents assessees:	(a) Individual	25% upto A.Y. 1994-95  20% w.e.f. A.Y. 1995-96
	(b) Others e.g. firm etc.	30% upto A.Y. 1994-95  20% w.e.f. A.Y. 1995-96

 

Non-residents of certain categories are, however, assessed at special concessional rates of tax in respect of capital gains arising from the transfer of certain specified assets. In computing the capital gain in such cases special provision applicable in the case of non-residents for avoiding the influence qf exchange rate fluctuation mentioned in para 7.3.1 are not to be applied. Such categories of non-resident earners are:-

Overseas Financial Organisation (known as Off-shore Funds) in respect of long term capital gains arising from the transfer of units purchased in foreign currency. "Overseas Financial Organisation" means any fund institution, association or body established under the laws of a country outside India which has entered into an arrangement for investment in India with any public sector bank or public financial institution or a notified mutual fund and such arrangement is approved by the Central Government (Sec. 11 5AB)	10%
ii) Any non-resident in respect of long 10% term capital gains arising from the transfer of bonds or shares of Indian Companies which are issued in accordance with a notified scheme and purchased by him in foreign currency. Foreign Currency Convertible Bonds and Ordinary shares (through Depository Receipt Mechanism) Scheme 1993 is the one notified for this purpose (Sec. 115AC)	10%
iii) Notified Foreign Institutional investors on capital gains arising is from the transfer of securities listed in a recognised Stock Exchange in India in accordance  with the provisions of Securities Contracts is long (Regulation) Act, 1956.	(a) If the gain  short term-30% b) If the gain  long term-30%

 

Double Tax Avoidance Agreements

The Jurisdiction to tax capital gains between the source country and the country of residence of the person holding the assets is governed by the double tax avoidance agreement, if any, existing with the country to which the non-resident belongs. Such agreements should, therefore, be referred to.

Income from Leasing Activities

Where the government of a foreign State or a foreign enterprise derives income from an Indian company engaged in operation of aircraft by leasing aircraft or aircrafts engine to it  under an agreement entered after 31.3.97 and approved by the Central government and tax on such income is payable by that Indian Company, the tax so paid is not to be considered as Income of the lessor and consequently the payment is not to be grossed up [Sec. 10(6BB)]. Total exemption in respect of such payment was withdrawn in respect of agreements entered after 31.3.1997, but the same has been revived by the Finance Act 1999 and will be available in respect of income earned in pursuance of agreements entered into prior to 1.4.97 or after 31.3.99.

Exemption in respect of any net of tax income

In case the recipient receives net of tax payment from Government or Indian concern under an agreement between Central Government and a Foreign Government or between Central Government and an international organisation, the tax paid by the payer of the income will not be considered as the income of the recipient and the requirement of grossing up will not apply [Sec. 10(6B)].

Exemption from the obligation to file the return of income

If the income of the non-residents governed by Section 115A and 11 SAC consists only of the income from interest, dividend or income from units covered by these sections and tax has been deducted at source, such persons need not file the return of income which he is otherwise required to file.