The department is of the view that these payments, however huge they might be, cannot be denied if the relevant tax norms are not violated. At the most, such payments could be said to involve a minority investor protection issue, something that is not in the tax authority's domain, the department is learnt to have conveyed to the commerce ministry.
High royalty outflow from MNC units, recognised as an expenditure while computing their profits, depresses the income available for distribution as dividend and could hit domestic minority shareholders of the company.
It is a minority shareholder protection issue. The capital market regulator could look into it. The rate of tax on royalty and fee for technical services paid to recipients in countries, which do not have a Double Tax Avoidance Agreement (DTAA) with India, has already been raised in the Finance Act 2013-14 to 25% from the earlier 10%, said a person privy to the revenue department's views.
In the case of most of the countries with which India has DTAAs, a 10% tax on royalty is offered, while the rate is 15% in the case of the US and the UK. These rates cannot be altered without renegotiating the treaties.
Sharma had recently requested finance minister P Chidambaram to see if a ceiling could be reintroduced on royalty payments and fee for technical services paid by Indian units of MNCs to their foreign parents or subject them to higher taxes as a measure to curb FDI outflows. Finance ministry's concern at the beginning of the 2013-14 fiscal-- a high current account deficit-- now stands entirely under control as the country is believed to have added to its forex reserves in 2013-14 after financing CAD. There were ad valorem ceilings on royalty payments before 2009.
Tax experts endorse the revenue department's views as these payments are anyway intensely scrutinised under transfer pricing audits to ensure that these are not used as vehicles for shifting profits to another country, eroding India's tax base.
It may not be appropriate to stipulate a ceiling on royalty payments to overseas parents by their Indian group companies. If royalty payments pass the test of arms length principle, there is no reason why there should be a restriction on the quantum of such payments, said Rohan K Phatarphekar, Partner & Head India, Global Transfer Pricing Services at KPMG.
He said no owner of intangibles will give it to a third party without adequate compensation and the same would apply to a related party (the parent company) as well. Arms length principle is enforced by the tax department to ensure that cross-border payments are comparable to what may be paid to an independent third party for the same services so that payments are neither inflated or under-invoiced to manipulate tax liability.