Possible impact of an amendment in Section 9 of the Income Tax Act on film distributors
The beauty of the Income Tax Act of 1961 is the way in which the sections are linked with each other. A small amendment in one of them may have swingeing consequences in another provision. Such a case is this one. The Finance Bill 2020 of the Union Budget Proposal 2020 brought about 104 amendments in the Income Tax Act. This article is concerned with one small amendment in Section 9 of the said Act though there are several other amendments in the same section.
Section 9 of the Income Tax Act 1961 deals with Income deemed to accrue or arise in India. Clause (vi) of sub-section (1) of Section 9 encompasses income by way of royalty payable by the Government or any person, be it resident or non-resident. Earlier clause (v) of Explanation 2 to clause (vi) of sub-section (1) of Section 9 specifically excluded consideration for the sale, distribution or exhibition of cinematographic films from the definition of royalty. But now that exclusion has been removed which implies that it automatically falls within the ambit of royalty.
This omission has a radical effect on Section 194J of the same Act. Section 194J enumerates the provisions relating to deduction of tax at source on fees for professional or technical services. Clause (c) of sub-section (1) of Section 194J talks about payment to a resident any sum by way of royalty by any person, not being an individual or a Hindu Undivided Family.
A logical connect can now be established between the two sections, Section 9 and 194J. The consideration for the sale, distribution and exhibition of cinematographic films now falls within the purview of royalty and hence TDS at the rate of 10% shall be levied on the payment by theatres to the distributors.
The reason stated in the Finance Bill 2020 is as follows,
"Due to exclusion of consideration for the sale, distribution or exhibition of cinematographic films from the definition of royalty, such royalty is not taxable in India even if the DTAA gives India the right to tax such royalty. Such a situation is discriminatory against Indian residents, since India is foregoing its right to tax royalty in case of a non-resident from another country without that other country offering similar concession to Indian resident. Hence, it is proposed to amend the definitionof royalty so as not to exclude consideration for the sale, distribution or exhibition of cinematographic films from its meaning.
These amendments will take effect from 1st April, 2021 and will, accordingly, apply in relation to the assessment year2021-22 and subsequent assessment years."
In simple terms, the theatre has to pay an agreed percent of the theatre's net collections (ticket price deducted by state taxes) reduced by GST to the film distributor. That payment is subject to deduction of tax at source at the rate of 10%. This reduces the distributor margin to such an extent that it is impossible for him to break even.
For example, say a distributor has bought a film's distribution rights for a particular region from the producer for ₹ 10 crore. Let us assume the film did not run well and the distributor managed to collect only ₹ 8 crore. His loss comes to ₹ 2 crore. When this provision kicks in, the theatres deduct tax at 10% from ₹ 8 crore and pay effectively only ₹ 7.2 crores to the distributors. Thus the distributor’s revenue is further reduced by ₹ 80 lakhs thereby increasing his loss to ₹ 2.8 crores.
Consider another example where the distributor’s share from the theatres is ₹ 11 crore. ₹ 1.1 crore would be deducted by the theatre as TDS and the effective earnings of the distributor would be ₹ 9.9 crore. This shows that even when the distributor stands a chance to make a profit margin of 10% on his cost of distribution rights, the TDS provision makes him worse off to incur a loss of ₹ 10 lakhs thus wiping of any chance of making a profit in an industry where margins are already low.
It is an extremely tedious process to claim the refund of TDS amount from the Government and its not economically feasible to wait for the TDS refund for a long period of time. This leads to a serious cash flow strain on distribution business. As stated in the Finance Bill 2020, this would take effect from the assessment year beginning on 1st April 2021. This would make distribution business very cash intensive without adequate returns and de-incentivise this line of business. Consequently this has the potential to impair the cycle of film trade.
Cover image designed by Sudarshan Sreeram.