India's New Rule 37BC: Can You Forget About Applying for a PAN?

India is well known as a difficult place to do business, currently ranking 130 out of 189 countries by the World Bank for ease of doing business. There are some signs, however, that Indian authorities are concerned about this state of affairs and trying to reduce bureaucracy and simplify regulatory obligations for non-resident businesses.

On June 24, the Indian Tax Authority issued a new rule that relieves non-residents of the requirement to obtain an Indian tax registration known as a Permanent Account Number, or PAN, when claiming reduced tax-treaty withholding rates on certain types of payments.

Background

Prior to the introduction of the new rule, non-residents with income subject to Indian withholding tax were required to obtain a PAN in order to claim reduced treaty withholding tax rates under applicable tax treaties. In the absence of a PAN, withholding tax rates as high as 20% could be imposed under domestic tax law, compared with approximately 10% under most treaties.

It should be noted that India is unusual in requiring non-residents to obtain a local registration number before they can claim treaty benefits. Most countries only require the non-resident to present a Tax Residency Certificate (TRC) certified by the tax authority of its home country as evidence that it’s entitled to the DTA benefits. Moreover, non-residents in India are required to present not only a PAN and a certified TRC, but also a declaration of “No PE in India” in order to qualify for the reduced rates.

The Indian Tax Authority had always argued that these requirements superseded any double tax agreement (DTA) provisions. As a result, Indian payers would often withhold tax according to domestic law in the absence of complete documentation. This practice was understandable, since payers that withheld taxes at a reduced treaty rate without supporting PAN and other documentation risked bearing the withholding tax themselves if later challenged by the Indian Tax Authority. Needless to say, non-residents had no realistic choice but to go through the administrative process of obtaining a PAN to avoid excessive withholding taxes on their India-sourced income.

Summary of the new rule 37BC

India’s new legislation in this area is called rule 37BC and took effect June 24, 2016. Under the new rule, non-residents can choose to furnish the documentation listed below instead of a PAN on certain payment types and still be entitled to claim treaty benefits. (A declaration of “No PE in India” is still required in any case.)

• Name, email address and phone number;
• Address in the country where the non-resident is resident;
• TRC, if the law of the relevant country provides for issuance of such certificate;
• Tax Identification Number or equivalent unique identifier of home country.

The new rule applies only to the four following payment types:

• Interest
• Royalties
• Fees for technical services
• Payments on the transfer of any capital asset

For payments not falling within the scope of the new rule (for example, most trading income, dividends, etc.) or for taxpayers who fail to provide the above information, the higher rate of withholding tax will continue to apply.

What India’s new rule means for you

Non-residents who already have a PAN can continue to provide it to claim treaty benefits. Moreover, the Indian Tax Authority will continue to accept PAN applications and issue PANs as before, and Indian payers must continue to accept this documentation when making payments to non-residents.

Non-residents without a PAN who receive (or expect to receive) any of the four specified payments from India will not have to go through the time-consuming process of obtaining a PAN. The process typically takes two to three months and requires certain prescribed documents to be authenticated and apostilled at the Indian embassy in the non-resident’s home country.

Obviously, the lifting of this requirement will come as a welcome relief to many non-resident businesses and prospective non-resident businesses in India. In addition to reducing administrative burdens, the simplified requirements should reduce the likelihood of a higher withholding tax rate being wrongly applied and subsequent tax-refund requests to the Indian Tax Authority.

While this is good news, a word of caution should be given. Until the new rule becomes commonly applied, Indian payers may decide to continue taking a conservative approach and demanding a PAN before releasing any payment with reduced rates of withholding tax applied. Some non-residents may therefore decide to obtain a PAN even under the new law to avoid having to explain the rule to their Indian payers.

Similarly, there may be ambiguity around whether certain payments fall within one of the four prescribed types under the new rule. For example, the characterization of computer software payments is a highly contentious issue in India, with some arguing they should be treated as royalties (no PAN needed to obtain the lower rates of withholding tax) and others as business income (PAN needed). Non-residents may find it more efficient to obtain a PAN if they foresee this kind of situation so they can claim reduced withholding tax rates in any case.