Budget 2013: Taxation as a Solution to a Governance Problem

A couple of months ago, we had discussed
the corporate governance issues that emerge when Indian subsidiaries of
multinational companies pay substantial amounts to their parents in royalty.
While we will have a chance to discuss
the taxation issues in the Budget in greater detail, the proposal to increase
taxation on such royalty payments stands out. The Finance Minister’s speech
notes:
147. Another
case is the distribution of profits by a subsidiary to a foreign parent company
in the form of royalty. Besides, the rate of tax on royalty in the Income-tax
Act is lower than the rates provided in a number of Double Tax Avoidance
Agreements. This is an anomaly that must be corrected. Hence, I propose to
increase the rate of tax on payments by way of royalty and fees for technical
services to non-residents from 10 percent to 25 percent. However, the
applicable rate will be the rate of tax stipulated in the DTAA.

While the precise impact of
this proposal would depend on the use of appropriate double taxation avoidance
treaties, the higher taxation is likely to have a negative effect on the payment
of royalty at least in some cases. In those, the unintended consequences of
taxation may turn out to be a creative solution to address the corporate
governance problem (whereby minority shareholders are unable to share in the
returns of the company to the same extent as the controlling shareholder due to
excessive payments of royalty).

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

3 comments

  • This measure seems to have no value in terms of actual revenue collection apart from cases in which there is no DTAA. Considering that such cases are highly irrelevant with respect to the amount of tax collectible, this measure can only be seen as a possible deterrent. However the value and need of the measure as a deterrent is also questionable seeing that transfer pricing regulations more or less take care of this scenario

  • Peremptory Reaction :

    On the points of doubt /reservation raised, in several quarters, on many of the Budget proposals, one wonders whether even the FM and / or his coterie would have any satisfactory answer or honest solution to offer !.
    Be that as it should, In the current Budget, as noted herein above, wrt the changes proposed with the stated aim of rationalising the applicable ROT, it reads:
    “147. Another case is the DISTRIBUTION OF PROFITS by a subsidiary to a foreign parent company in the form of royalty…..”
    No one concerned, whatever be the individual’s level of ingenuity or faculty to understand, would not have failed to abruptly realise the wisdom, or lack of it, of the draftsman’, if not of the FM, in construing the very concept of ‘royalty’. The point is, it has come to be given such a violent twist as to offend the thus far obtaining common understanding thereof; even assuming that were dictated by the often claimed human faculty of ‘common sense’.
    To dilate: One would have thought that ‘royalty’, basically an item of ‘expenditure’, – in accounting or legal or any other known parlance, or sense of the concept,, – could be, howsoever remotely, or with any of the ‘imaginary initiatives’- so generously attributed to the chief architect (FM) in certain quarters , read BSR’s article in Business Line, Budget steers clear of populism – be so contemptuously dubbed or sinfully decried as a ‘DISTRIBUTION OF PROFITS’.

    The projected view in the subject write-up is seen to bear out a different stroke , perhaps rooted in self-same ‘imaginary initiative’ or individual perspective, whatever one wishes to call it.

    (Left open to the enlightened Readers, to reflect and edit – add / modify)

  • Sorry!
    Intended reference was to BSR’s article titled – "Booster shot for economy", wherein the FM has been copiously commended for his exemplary ingenuity in “a judicious blend of well-conceived incentives and imaginative initiatives.”

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