Taxation in the Asia-Pacific Region/ndia

INDIA

Introduction

Investment Considerations

Taxation of Resident Entities

Taxation of Nonresident Entities

Taxation of Groups of Companies

Branches and Subsidiaries

Corporate Assessments and Payments

Taxation of Individuals

Personal Assessments and Payments

Withholding Taxes

Other Taxes

Introduction

The Republic of India has an area of about 3.29 million square kilometers (1.27 million square miles), and in 1991 its population was estimated by the government to be about 844 million. Its unit of currency is the rupee (Rs).

Income tax and the other taxes not within the exclusive jurisdiction of individual states are prerogatives of the Union Parliament, consisting of the president, the republic, and the two chambers of the legislature. Tax changes are generally introduced through the annual finance act; however, they may be made through other laws. The Income Tax Act of 1961 is the basic statutory authority on income tax laws. Separate laws have been enacted for taxes on sales, commodities, wealth, and gifts.

The Ministry of Finance is the supreme authority for all financial matters under the jurisdiction of the Union Parliament. The Department of Revenue administers central government taxes. Questions of law may be brought before the High Court if permission of the Appellate Tribunal is obtained. As a final resort, either party may appeal the High Court's decision to the Supreme Court. A national court of direct taxes may soon be established.

Tax and international services: N. V. Iyer, C. C. Chokshi & Co., Bombay
Telephone: +91 (22) 285-4330
Telecopier: +91 (22) 202-4499

International services: S. Ghosh, Gupta Chowdhury & Ghosh, Calcutta
Telephone: +91 (33) 242-5620
Telecopier: +91 (33) 94-3333

International services: N. Srinivasan, Fraser & Ross, Madras
Telephone: +91 (44) 825-1152
Telecopier: +91 (44) 825-2273

International services: S. D. Davar, P. C. Hansotia & Co, Bombay
Telephone: +91 (22) 204-3526
Telecopier: +91 (22) 204-9173

Investment Considerations

Forms of Business Organization. The most common form of business entity-and the most suitable form for direct foreign investment-is the limited liability company, which may be either public or private. A private limited liability company is one whose bylaws restrict the transferability of the company's shares, limit the number of shareholders to fifty, and prohibit a public offering of its shares or debentures. A public limited liability company is one that is not a private limited liability company. Other types of business entities include the partnership, the association of persons, the Hindu undivided family, and the sole proprietorship. Branches of foreign companies can also be formed.

In general, only the limited liability company possesses a separate legal personality distinct from that of its proprietors. For income tax purposes, however, the partnership and the association of persons are also recognized as separate entities.

Exchange Controls. Inbound and outbound investments, imports and exports, foreign remittances, and the like are all subject to exchange control regulations. Violation of these regulations may result in prosecution.

Local Participation Requirements. Under the government's industrial policy of 1991, majority foreign equity, even up to 100%, is encouraged. In many industries, foreign investment up to 51% is eligible for automatic approval.

Investment Incentives. A complete tax holiday is provided to companies that are set up in free trade zones for five consecutive years during the company's first eight years. The free trade zones are Kandla Free Trade Zone (KAFTZ), Kandla (Gujrat); Santa Cruz Electronics Export Processing Zone (SEEPZ), Santa Cruz (Bombay); Madras Export Processing Zone (MEPZ), Madras (Tamil Nadu); Cochin Export Processing Zone (CEPZ), Cochin (Kerala); Noida Export Processing Zone (NEPZ), Noida (Uttar Pradesh); Visakhapatnam Export Processing Zone, Visakhapatnam (Andhra Pradesh); and Falta Export Processing Zone (FEPZ), Falta (West Bengal). Export-oriented undertakings are entitled to a similar tax holiday.

An industrial undertaking set up in a specified underdeveloped state or union territory and beginning production before 31 March 1998, set up in any part of India for power generation and commencing operations before 31 March 1998, or set up in specified industrially underdeveloped districts and commencing manufacturing or production before 31 March 1999 is eligible for a 100% tax exemption on its profits for five years beginning with the year in which it starts generation of power, manufacturing, or production. The exemption is 30% for the next five years.

A domestic company or resident noncorporate assessee engaged in the hotel or travel agency business can enjoy an exemption of 50% of the profits derived from services provided to foreign tourists plus any portion of the remaining profits that is transferred to a reserve account from the profit and loss account. Profits must be received in convertible foreign exchange.

Taxation of Resident Entities

Resident companies are subject to tax on their worldwide income. A company is resident in India if it is either incorporated in India or controlled or managed there.

Corporate Income Tax Rates. Companies must be identified as either domestic or foreign before the proper tax rates can be applied. A company may be treated as a domestic company, regardless of whether it is incorporated in India, if it has made the prescribed arrangements for the declaration and payment of dividends in India out of the income subject to tax in India.

Domestic companies are generally taxable at a rate of 40%, but those with taxable income exceeding Rs 75,000 will also be liable for a surcharge of 15% on their income tax liabilities. Furthermore, a rate of 30% applies to long-term capital gains. A partnership pays tax at 40% on its taxable income; the partners' shares are not taxed in their hands. Click for tax rates for foreign companies.

Taxable Income. Taxable income is divided into five categories. The first of these, employment income, is not relevant for corporate income tax purposes. The remaining categories are income from real estate, business or professional income, capital gains, and income from sources other than the above. Different income computation rules apply to each category. In principle, a company's taxable income is determined by aggregating the income from all of these categories.

Inventory valuation. Inventories are normally valued at cost or the lower of cost or market value. The Department of Revenue provides no guidelines for the method of valuation of inventories, but any method adopted by a taxpayer must be followed consistently.

Dividend income. Dividends received from an Indian company are taxable even if they are paid outside India. Dividends received in India from a foreign company are taxable without any deduction from gross receipts. Dividends received by one domestic company from another qualify for a deduction equal to the amount of dividend received or the amount of dividend distributed, whichever is less. However, an Indian scheduled bank or Indian public financial institution is eligible for a deduction of 60% of its dividend income without any obligation for dividend distribution.

Foreign-source income. India has an extensive network of double tax treaties, which provide relief for income derived from many foreign countries. In the absence of a treaty, the law provides for unilateral relief in the form of credits, limited to the lesser of the foreign taxes paid or the Indian tax on foreign income.

Exchange differences. Profits or losses arising from exchange fluctuations are treated for tax purposes in the same manner as the underlying profit and loss or balance sheet items to which they relate. When foreign exchange fluctuations affect an outstanding foreign currency loan obtained for-or an outstanding liability incurred in-the purchase of fixed assets, the written-down value of the assets is adjusted accordingly for depreciation purposes.

Capital gains. Long-term capital gains from assets held for three or more years (one year for shares) are taxed at a concessional rate of 30%. In the computation of long-term capital gain, the cost of the asset is linked to a cost inflation index fixed by the government.

No capital gain results from the transfer of capital assets between a parent company and a 100% subsidiary or from the transfer of capital assets between two companies in a merger or reorganization if the transferee is an Indian company. In an amalgamation (merger) scheme, no capital gain results from the transfer of shares in any Indian company held by an amalgamating foreign company to the amalgamated company if at least 25% of the shareholders of the amalgamating company continue to be shareholders of the amalgamated company and the transfer is not subject to any capital gain tax in the country in which the amalgamating company is incorporated.

Deductions. Most normal business expenses may be deducted in the computation of taxable income.

Depreciation. The declining-balance method is the only permissible method of depreciation; the sole exception is for oceangoing ships, for which the straight-line method of depreciation is allowed. The Central Board of Direct Taxes prescribes the depreciation rates for four different blocks of assets: buildings, plant and machinery, furniture, and ships. Depreciation and written-down value are computed for each block. There is no additional allowance if extra shifts of workers use the assets. If any asset acquired by the assessee has been used for fewer than 180 days in the year of acquisition , the allowance for depreciation will be restricted to 50% of the normal allowance.

Interest. Interest paid on income tax is not deductible. Interest paid on funds borrowed for business purposes is usually deductible, but no deduction is allowed for interest payable to nonresidents unless income tax has been withheld from the payments or unless the interest is exempt from tax. India does not have any thin capitalization rules (that is, rules restricting the amount of interest that may be deducted when a company's ratio of loan to share capital exceeds prescribed limits).

Directors' remuneration. In principle, remuneration payable to directors is deductible, but the taxpayer must show that the payment is reasonable in relation to the work performed.

Taxes. Deductible taxes include interest tax, sales tax, excise duty, customs duty, service tax, and local real estate taxes. Indian income tax and wealth tax are not deductible. It is uncertain whether foreign income tax is deductible.

Provisions and reserves. Provisions against doubtful debts are not generally deductible, except in the case of some financial institutions. Instead, bad debts can be deducted in the year in which they are written off if conditions are met. In general, transfers to reserves are not a permitted deduction, except in the case of certain finance companies.

Special adjustments. One-half of royalties, commissions, fees, or other payments received by a taxpayer from any foreign state or enterprise and brought to India in convertible foreign exchange are exempt, provided that such income is repatriated to India within six months of the end of the financial year.

Scientific research expenditures and contributions for research projects are fully deductible, subject to certain conditions. Capital assets acquired for scientific research may be written off in full in the year of acquisition.

Expenditures on eligible projects or schemes for promoting socioeconomic advancement are fully deductible, subject to specified conditions. Amounts paid to approved national laboratories, universities, or the Indian Institute of Technology are deductible at 125% of the amount paid. Contributions to approved associations and institutions for carrying out rural development programs and natural resource conservation programs are fully deductible, subject to specified conditions.

Tax Treatment of Losses. Any losses (except speculation losses and capital losses) may be set off against all other taxable income. An unabsorbed business loss not applied against the current year's income may be carried forward against business income for eight succeeding years, provided that the business in which the loss was incurred still exists. Net business income during the eight-year period must first be adjusted for the business loss carryover and then for deferred depreciation. Losses may not be carried back.

Taxation of Nonresident Entities

Nonresident companies-companies that are neither incorporated nor managed and controlled from India-are subject to tax on income received, derived, or deemed to be received or derived in India. Royalties and technical service fees received by a nonresident company are deemed to be derived from Indian sources when the payer uses the know-how or technical services for business carried on in India.

Corporate Income Tax Rates. For the purpose of applying tax rates, Indian tax law distinguishes between foreign companies and domestic companies. Most nonresident companies are also considered "foreign companies", but exceptions do exist Business and most other income of foreign companies is taxable at a rate of 55%; however, long-term capital gains are taxable at a rate of 20%. Income in the form of fees for technical services arising out of any approved project connected with the security of India is exempt. Withholding taxes apply to many payments to foreign companies.

Taxable Income. The categories of taxable income are the same as for residents. Business expenses are generally deductible to the same extent as for residents; however, the deduction for head office expenditure is limited to the lower of 5% of Indian gross income or head office expenditure attributable to business in India.

In the case of a nonresident, the capital gain on a transfer of shares or debentures of an Indian company is computed after converting the cost of the asset, transfer expenses, and the consideration for the transfer of the asset into the foreign currency in which the shares or debentures were purchased. The capital gain computed in the foreign currency is then converted back into Indian rupees. In this case, the benefit of indexation for cost is not available.

Advance Rulings. An advance ruling scheme for nonresidents has been introduced. The scheme is intended to prevent unnecessary litigation. Any interested nonresident may apply for an advance ruling with the payment of a fee of Rs 2,500. An advance ruling binds only the applicant and the tax authorities with respect to the specific transaction for which the ruling was sought. The ruling remains enforceable unless there is a change in law or fact that forms the basis of the pronouncement.

Taxation of Groups of Companies

Consolidated tax returns may not be filed. Indian law does not allow for the losses of one company to be transferred to profitable group companies.

Any amount paid to a related person that the tax authorities consider excessive or unreasonable may not be deducted. In the case of a transaction between a resident and nonresident, if it appears to the tax authorities that, owing to a close connection between the parties to the transaction, no profit or a lower-than-normal profit was produced, the tax authorities may include a reasonable profit in the income of the resident.

Branches and Subsidiaries

A resident Indian subsidiary of a foreign parent is treated as a domestic company and is taxed at domestic company rates. A branch of a foreign company would bear tax on Indian income at specified rates. In the case of subsidiaries, withholding tax is levied on dividends paid to their foreign parents. There is no withholding tax on branch remittances to a foreign head office.

Corporate Assessments and Payments

The assessment year starts on 1 April and ends on 31 March. The tax is based on the income of the previous year (that is, the twelve-month period ending on 31 March preceding the assessment year). A company must file its tax return, reporting its income of the previous year, together with a copy of its final accounts and supporting schedules by 30 November of each assessment year.

Every company is required to pay advance income tax on its estimated income if the amount of advance tax payable is Rs 1,500 or more. The advance tax is payable in installments on specified dates. Self-assessment tax, calculated on the basis of the tax return, after deducting advance tax paid and tax withheld, must be paid before the return is filed.

Taxation of Individuals

Individuals who are resident and ordinarily resident in India are subject to tax on their worldwide income. Individuals who are nonresident are subject to tax only on income arising or received in India or deemed to arise or to be received in India. Individuals who are resident but not ordinarily resident are subject to tax in much the same way as nonresidents, except that they are also subject to tax on income arising outside India from a business controlled or profession set up in India.

Individuals are resident in India if they are physically present in India for at least 182 days in the tax year or if they are physically present in India for at least 365 days in the four preceding years, with at least 60 days' physical presence in India in the previous year. Individuals are resident and ordinarily resident if they have been resident in India in nine out of ten preceding years or were physically present in India for at least 730 days during the seven preceding years. If one or both of these conditions remain unsatisfied, the individual will be regarded as not ordinarily resident.

Treatment of Families. In general, a husband and wife are taxed as separate individuals on their respective incomes. Some exceptions exist. Income of a minor child is aggregated with that of the parent having the higher income.

Personal Income Tax Rates. Click to see personal income tax rate schedule.

Taxable Income. An individual's taxable income is divided into the same categories as those applying to companies.

Employment income. Employment income includes all payments made by an employer to an employee, such as salaries, wages, bonuses, perquisites, allowances, and so forth.

Business income. Business income is taxed in accordance with the rules applying to companies.

Capital gains. Long-term capital gains arising to individuals from assets held for three or more years (one year for shares) are taxed at a concessional rate of 20%. Individuals who derive a long-term capital gain on the sale of a house enjoy a 100% tax exemption if the capital gain is reinvested in a new house.

Deductions and Reliefs. Salaried taxpayers are allowed a statutory deduction as follows: for men, 33.33% of their salary or Rs 15,000, whichever is lower; for women having income of up to Rs 75,000, 33.33% of their salary or Rs 18,000, whichever is lower. A rebate of 20% of the amount deposited in specified tax saving schemes is allowed as a deduction from the income tax payable by an individual, subject to a maximum rebate of Rs 12,000.

Personal Assessments and Payments

The assessment year for individuals, as for companies, is the period of twelve months beginning on 1 April each year. Income tax is levied for each assessment year, at the rates prescribed for the year, on the previous year's income. The provisions regarding returns, assessments, and payments are similar to the rules applying to companies. Employers withhold the tax of salaried individuals at source. If withholding is insufficient, advance tax is payable in installments. The due dates for filing returns are 31 October if the individual is obliged by law to prepare audited accounts, 31 August if the individual is not so obliged but has income from a business or profession, and 30 June in any other case.

Withholding Taxes

Basic Rates. Income tax must be withheld from a variety of payments. Rates vary depending on the type of payment and the status of the recipient. Click to see Basic Withholding Tax Rates

Rates Under Double Tax Treaties. India has concluded double withholding tax rates for treaty countries which often reduce the basic rates of withholding payable on various types of income.

Other Taxes

Excise and Customs Duties. Excise and customs duties are the principal central indirect taxes, forming a major part of the revenues of the central government. Excise duty is imposed on the production or manufacture of movable goods in India. The liability for the duty is on the manufacturer or producer. Rates are based on quantity or are ad valorem. Some goods are exempt.

A modified value added tax (MODVAT) scheme, which prevents cascading of excise duty and double taxation, is in effect. Under this scheme, a manufacturer of excisable goods receives a credit from the duty paid on certain inputs used in the manufacture of the final product, which can be used toward the duty payable on removal of the final product.

Customs duty is payable on goods imported into India, as well as on specified goods exported out of India. Rates are quantity based or ad valorem, and various goods are exempt.

Social Security Contributions. Employers in manufacturing and certain other establishments are required to make contributions at specified rates to the Employees' State Insurance Fund. The fund provides benefits in cases of sickness, disability, and death.

In some industries, employers must contribute to the Provident Fund at the rate of 8.33% or 10% of employee wages.

Employees make equal contributions. The accumulated balance in an employee's account is paid over to him or her at the time of retirement or, in some cases, earlier.

Wealth Tax. Individuals and companies are liable for wealth tax at 1% on specified assets. The first Rs 1.5 million of net wealth is exempt. Also, urban land held as stock-in-trade is exempt from tax for three years from the date of its acquisition, and one house belonging to an individual is exempt.

Gift Tax. Gift tax is levied on the donor. Gifts valued up to Rs 30,000 are not subject to gift tax. Tax is levied at 30% on the excess of value over Rs 30,000. This limit will be increased to Rs 100,000 from accounting year 1995/96. Gifts received in foreign currency are exempt.

Sales, Purchase, and Use Taxes. Each state has its own laws imposing sales or purchase tax and other local taxes. The interstate sale of goods attracts a central sales tax. Export sales are not subject to sales tax. Some municipalities charge a use tax on goods sent into their jurisdictions.

Additional Taxes. Other taxes include an interest tax levied on certain financial institutions; a service tax levied on services of stockbrokers, telephone authorities, and general insurance companies; a research and development levy on the import of technology; local real estate and other taxes; and stamp duty.