Indian information technology players doing business in Japan can look forward to lower taxes there from the next financial year. A dispute over a 20 % withholding tax levied by Japan seems to have been resolved, with Japan agreeing to reduce the tax to 10 %.

The Double Taxation Avoidance Agreement (DTAA) is likely to become operational from the next fiscal. The move will benefit Indian IT industry as the national tax authority of Japan has been treating off-shore work by the Indian companies as “fees for technical services”, and taxing such work at 20 % on gross basis.

The move will benefit Indian companies which are tapping the Japanese market. India's IT and IT-enabled services exports to Japan are estimated to exceed $450 mn in the financial year 2004-05. In 2003-04 the exports had grown by 43.2 % to $385.4 mn.

The issue assumes importance as the off-shore services are being taxed at 20 % on gross billing, whereas for on-site services the tax is on profits (gross billing less costs), which works out lower.

India has lowered the rate for “fees for technical services” in the recent budget to 10 %. This has benefited the Japanese companies as industry experts indicate there is a substantial import of technical know-how from Japan.

According to tax experts, the Japanese interpretation of the tax treaty is not in line with international norms, as software and IT-enabled services are generally not taxed as “fees for technical service”.

Further, DTAA, which is a tax avoidance agreement, cannot be used to levy a tax, the experts say. All these factors have led to an agreement on reducing the tax rates.

The Indian authorities had taken the position that off-shore services should not be taxed, while part of them relating to management and co-ordination services could be included as part of on-site work and taxed accordingly.

The issue relating to interpretation of DTAA came up about three years ago when the Indian industry raised concerns that the Japanese were interpreting the agreement in their favour. This was because the DTAA overrode the Japanese domestic law which did not tax off-shore services.