Many foreign companies providing Software as a Service (SaaS) products like Amazon, Microsoft, Google, Oracle, IBM, and Salesforce have received a new notice of tax demand from the Income Tax Department for the financial years 2021-22 and 2022-23. According to sources, the tax department has issued assessment orders to these companies. Under this, the income earned by these companies from Indian customers will be considered as ‘fees for technical services’ (FTS) under Indian tax law. Any payment for technical, managerial, or consulting services is considered FTS, and such income is taxed at 15 per cent under the India-US Double Taxation Avoidance Treaty.
Emails were sent to the concerned companies as well as the Central Board of Direct Taxes (CBDT) for information in this regard, but there was no response at the time of writing the news. Before 2021, such payments were often considered ‘royalties’. However, in a landmark judgment in 2021 in the Engineering Analysis Center of Excellence case, the Supreme Court held that payments for standard, off-the-shelf software are not taxable as royalties under Indian law or tax treaties.
Despite the apex court’s ruling, the tax department has begun examining whether payments made by Indian users to foreign SaaS providers can be taxed as FTS. “The income tax department has now passed assessment orders proposing tax demand for FY22 and FY23, even though many companies have already paid the 2 per cent equalisation fee on these transactions during that period. This could lead to a case of double taxation,” said a person aware of the development.
A tax expert, on condition of anonymity, said that the Finance Ministry argues that such companies have paid the equalization fee voluntarily, while according to the Income Tax Act, they are required to pay tax on FTS. India introduced a 2 per cent equalization fee in 2020 on overseas e-commerce operators who had large users in India but did not have a physical presence. The fee was intended as a backstop tax. It applies in places where income tax provisions and tax treaties could not be implemented. However, the government has agreed to phase out this fee in April 2024.
Experts have cautioned that the new tax demand could lead to double taxation as companies have paid equalisation charges on gross receipts and are now facing income tax demand on the same income. They also do not have any clear mechanism to claim credit. Tax experts argue that SaaS services are automated, standardised, and do not involve human input, and there is no transfer of intellectual property. Hence, it cannot be considered as royalty or FTS under Indian law or the India-US tax treaty.
Himanshu Parekh, partner at KPMG, said, “According to the Supreme Court’s decision in engineering analysis, the income of SaaS companies should not be equal to royalty. Also, SaaS is a standard facility provided to customers, so the income should be considered as FTS. ” Legal experts believe that the affected companies may challenge the assessment order. Another expert, on condition of anonymity, said, “Unless the CBDT issues guidelines to clarify the position of the Income Tax Department, there is a possibility of new litigation in this matter, and uncertainty may increase for foreign digital businesses operating in India. “