US companies doing business with Indian entities may be subject to withholding taxes at the time the customer makes the payment. Generally, withholding occurs on payments for royalties or services, but can also be on other types of payments.
Withholding taxes can be in excess of 40% of the gross payment, so it is crucial to understand potential withholding liabilities in advance of negotiating contracts. In addition, it is also important to understand the documentation requirements necessary to get paid.
In many cases the US business will be required to get a Permanent Account Number (“PAN”), which is issued by the Indian Income Tax Department. The PAN is then provided to the Indian payee so payment can be made. Understanding these issues in advance will help minimize delays in receiving payments.
Many times reduced withholding rates can be obtained under the US Income Tax Treaty with India. This process generally involves making a treaty based position claim in the format required by the Indian government. This process can take an extended period of time depending on the type of claim being requested. As a result, payments may have to be delayed in order to get the proper documentation necessary for the reduced withholding. Alternatively, taxes that are over-withheld may take several years to recover or never be recovered. While most withholding taxes would qualify as foreign tax credit against US tax liabilities, the formula for taking the credit is limited based on net foreign source income where tax is being withheld on gross income, which can result in an excess credit position.
To best manage this situation, it is recommended that US businesses:
- Communicate with their India-based customers to understand, in advance, what taxes may be withheld from payments.
- Consider whether pricing or contracts need to be adjusted to address withholding.
- Speak with their tax advisors to determine if withholding rates can be reduced and the process for obtaining the reduction.
- Coordinate the timing of payments with the customer so the proper documentation can be obtained before withholding occurs.