India-Singapore DTAA: Double Tax Avoidance Agreement

According to the Singapore-India double tax treaty, the profits of an enterprise are taxable only in the state where its business operations are carried out. If a Singapore-based business has a permanent establishment in India, profits attributable to the permanent establishment are taxed only in India.

If Singapore and India did not have a DTAA in force, business profits could be taxed in both Singapore and India. Profits generated by the permanent establishment would thereby bear the tax burden twice.

The India-Singapore double tax agreement defines applicable tax rates for income derived from interest, royalties, dividends, and more. Generally, DTAA tax rates are lower than prevailing tax rates in the individual countries.

Interest

Without the treaty, the withholding tax rate in Singapore for any interest paid to non-residents is 15%. In India the rate ranges from 5–20% (depending on the type of interest) plus surcharge and cess. Under the India-Singapore DTAA, tax on interest is as follows:

• 10% of the gross amount if interest is paid on the loan, which is granted by a bank or any such financial institution
• 15% of the gross amount in all other cases

Royalties

Without the treaty, the withholding tax rate in Singapore for any royalties paid to non-residents is 10%. In India the withholding tax rate for any royalty paid to non-residents is 10% plus surcharge and cess. Under the DTAA, the tax rate for royalties is 10–15% (depending on the kind of royalty paid to non-residents).

Dividends

Prior to April 1, 2020, India did not levy any withholding tax for dividends. However, the company paying dividends bears a dividend distribution tax (DDT) of 15% (plus surcharge and cess) when paying the dividend to its shareholders. The recipient shareholder is exempt from paying any tax on dividends. Thus, in India shareholders pay no tax on dividends, but the company pays a tax.

As of April 1, 2020, India abolished the DDT. Dividends are now taxed in the recipient's hands. India has since introduced a dividend withholding tax. The rate is 10% for dividends paid to shareholders who reside in India and 20% if paid to foreign investors. The India-Singapore double tax agreement reduces this rate to 10% or 15% as described below.

The India-Singapore double tax agreement states that dividend income is taxed in the recipient’s state of residence as follows:

• 10% if the recipient company holds at least a quarter of the shares of the company paying dividend
• 15% in all other cases

In Singapore, dividend distributions by a company are tax free. Additionally, the recipient shareholder is exempt from taxes on dividend income. Thus, in most situations setting up a company in Singapore is the right strategy since its dividends will not be taxed either at the company level or at the recipient level.

The introduction of the new dividend tax regime by India creates an exciting opportunity for substantial tax savings for both foreign and Indian shareholders if they use the proper corporate structure. To learn more, see our article Singapore Benefits From India's New Dividend Tax Policy.

To compare which one of these two countries is more beneficial for launching a startup, check out our article Launching a Startup in India vs Singapore.

In 2005, the India-Singapore DTAA was amended. The amendment provides that any capital gains from property sales or shares are taxable only in the country where the investor resides. Thus, capital gains on Indian assets realized by a Singapore resident will only be taxed in Singapore. But since Singapore does not levy any tax on capital gains, such a transaction will be tax free.

For example, if a Singapore resident sells shares of an Indian company, it will be exempt from capital gains tax both in India and Singapore. This significant tax benefit is designed to encourage investments in India from Singapore-based companies.

However, to avoid the misuse of this exemption (especially by third-country residents who establish holding companies in Singapore to avail the capital gains exemption) the treaty added a Limitation of Benefits (LOB) clause.

Under this clause, a Singapore-incorporated company is not entitled to the capital gains exemption if the sole purpose of the company’s establishment is to avail of the benefit. Additionally, companies that have negligible business operations in Singapore with no continuity in business activities are not entitled to this benefit. As a result of the LOB clause, the agreement is not applicable to shell companies.

What Is a Shell company?

A shell company is a legal enterprise which is “resident” of either Singapore or India but has negligible business operations in the state or no continuous business activities. A “resident” company of either country is considered a shell company if (in the 24 months before gains accrue to the company) the total annual expenditure of its operation is:

• Less than S$200,000 if it’s a Singapore company
• Less than S$50,00,000 if it’s an Indian company

According to the third protocol DTAA amendment that was signed Dec. 30, 2016:

• Shares acquired before April 1, 2017 must fulfill LOB conditions for each of the 12-month periods in the immediately preceding 24-month period from the date on which the gains arise
• Shares acquired from April 1, 2017 to March 31, 2019 must fulfill the LOB conditions for the immediately preceding 12-month period from the date on which the gains arise
• The protocol does not currently state the LOB conditions that must be fulfilled for shares acquired after March 31, 2019

Capital Gains on Sale of Shares: Third Protocol

Prior to the Dec. 30, 2016 amendment, the India-Singapore DTAA  stated that the capital gains on the sale of shares were to be taxable only in the country where the investor resides. However, the third protocol to the Singapore-India double tax treaty outlines the following changes:

• The existing provisions continue to apply to capital gains from the sale of shares acquired before April 1, 2017. For example, if you reside in Singapore capital gains on the sale of shares acquired in an Indian company before April 1, 2017 are not taxable in India.
• Capital gains from the sale of shares acquired by a company from April 1, 2017 to March 31, 2019 will be taxed in the country where the company is a tax resident at a rate of 50% of the capital gains tax rate applicable in that country. Note that the 50% rate is applicable only on capital gains arising from the sale of shares acquired in a company during the two-year transition period from April 1, 2017 to March 31, 2019.
• Capital gains arising from the sale of shares acquired in a company on or after April 1, 2019 are taxed in the country where the company is a tax resident at the full capital gains tax rate applicable in India at the time of the sale.

This amendment is beneficial to Indian investors or entrepreneurs who wish to invest in Singapore companies or incorporate their businesses in Singapore. Since Singapore does not levy any capital gains tax, the capital gains that arise from the sale of shares of a Singapore company by an Indian resident are not subject to taxation.

It’s also important to note that this treatment of capital gains taxation is limited only to gains arising from the sale of shares. Capital gains on any other type of property are still taxable in the country where the investor resides.

Summary of Amended Capital Gains Tax Treatment

The DTAA also regulates the activities of companies called associated enterprises. Under its provisions, two enterprises are considered to be associated when:

• An enterprise residing in state A participates directly or indirectly in the management, control, or capital of an enterprise residing in State B, or
• The same persons participate directly or indirectly in the management, control, or capital of enterprises in State A and State B, and
• The commercial relations of such enterprises are different from the relations of independent ones

Legislation within India and Singapore requires that transactions between associated enterprises be conducted at arm’s length. That means the prices of goods and services exchanged between companies under common control should be similar to those between independent enterprises.

The treaty also regulates situations where an arm’s length principle is breached. In such a case, any profits that have not accrued to one of the enterprises (by reason of the above conditions) may be included in the profits of that enterprise and taxed accordingly.

Any pricing disputes between the associated enterprises and their countries may be resolved through a mutual agreement procedure (as explained in Article 27 of the treaty). In order to prevent such disputes and ensure transactions between associated enterprises are at arm’s length, companies may seek to conclude an advance pricing arrangement (APA). An APA is an ahead-of-time agreement (between the taxpayer and tax authority) on an appropriate transfer pricing methodology to be used for a set of transactions over a fixed period of time, which are called covered transactions.