Income received by a foreign company for distributing films in India is not treated as royaltywhich attracts a higher taxbecause of a specific exemption under the law (Section 9 of the Income Tax Act) that payments towards sale, distribution or exhibition of films is not regarded as royalty. According to analysts, for foreign distributors, relief may also be available under a Double Tax Avoidance Agreement signed between the US and India.
But all this is set to change when the direct tax code comes into force, following which profitability of foreign distributors will be under pressure. As Sandeep Ladda, executive director, E&M sector leader at PwC India, explains: In the direct tax code, this exemption is not there. However, it is unlikely that the tax code will take shape this year. But once the direct tax code is in place, films are likely to have tax liabilities of 10-20%the rate of royaltyassuming the foreign company doesnt have a permanent establishment in India. In fact, the entertainment industry has been urging the government to charge a flat 16% tax under GST and do away with the several local taxes levied now, including entertainment tax, VAT and so forth.
In a recent ruling, the Mumbai bench of the Income tax Appellate Tribunal ruled in favour of Warner Brothers Pictures, saying that income received by a foreign company for granting film distribution rights didnt attribute to royalty under Section 9 (1) (vi) of the Income Tax Act or Article 12 (2) of the India-US Double Taxation Avoidance Agreement. The tribunal further held that in the absence of permanent establishment of Warner Brothers in India, the consideration was not taxable as business income. This particular case dates back to 2005 when Warner Brothers Pictures entered into an agreement with Warner Brothers India, granting it exclusive rights of distribution of films. Accordingly, Warner Brothers India, in that relevant year, deducted an amount of R50.82 crore as tax deducted at source. Warner Brothers Pictures filed a nil tax return of income, claiming the amount of TDS as tax refund, filing detailed submissions why the consideration received from Warner Brothers India was not taxable under the provision of the Act, as well as the treaty. But the assessing officer passed an order, saying it should be taxed 15% for royalty, and thats how the case landed up at the Tribunal, which passed its order in favour of Warner Brothers recently.
An email to Warner Brothers India went unanswered.
But tax experts say we havent heard the last of this and that there is a possibility of the income tax authorities appealing to the high court. According to E&Ys Rakesh Jariwali, partner, filmed entertainment, while the ruling reaffirms that income from sale, distribution or exhibition of films should not be regarded as royalty, the question remains whether this exclusion means income is exempt from tax by virtue of a specific exclusion from the definition or it could still be taxable under source rule of the domestic law on the basis of it being a business income. This has been a matter of immense tax debate and the Mumbai Tribunal seems to have proceeded on the basis that the source rule may still need to be applied to determine the taxability, he says.
But the ruling per se does make Indian markets profitable for foreign film distributors, says Jariwala, adding, it should certainly aid cash flow position of foreign film distributors.
Foreign and domestic entertainment players arent happy with the suggestion that has come from several state governments that even when the direct tax code is in place, local taxes like entertainment tax, etc, should continue. CA Gupta, partner, Deloitte, Haskins and Sells, says with liquidity conditions tight the world over, a harsh tax regime will definitely be protested.
Its a good time for Hollywood studios in India, and there is a great interest in the India market, says Uday Singh, MD, Motion Pictures Association of America-India, but its also a fact that the entertainment industry is a highly taxed industrythere are several issues like service tax, entertainment tax and VAT.
Two of the top Hollywood studios, Warner Bros and Sony Pictures, released at least 30-odd films in 2011
and have announced another 30 films for release in 2012. Though the base is still small, Sonys Adventures of Tintin collected R26 crore in India, the last Harry Potter R32 crore and Mission Impossible 4 about R35 crore. Hollywood studios had been earning an average of R15-20 crore for a big film, but Avatar appears to have changed all that. It released with 700 prints and grossed R100 crore, reaping huge benefits for Fox Star in India. With 3D screens growing and the exhibition space showing huge expansion possibilities, there is a growing Hollywood interest in India, and the foreign studios are clued in.
Over the years, Hollywood studios have nurtured the Indian market, which sells four billion tickets annually, dubbing the films in regional languages for a wider reach, releasing films the same day and date with the US and so forth. In fact, Tom Cruises Mission Impossible 4 was released a week ahead of its US release to get a longer playing time in the Indian market, and perhaps fob off local competition from SRKs Don 2. Leading star Tom Cruise was in India to promote the film, another sign that Hollywood is taking India seriously.