Controlled foreign firms: Is this last resort?

The Union Budget 2012 is expected to introduce Controlled Foreign Companies (CFC) provisions. The intent is to tax passive income earned by a foreign company even if it is not repatriated or distributed to the controlling shareholders.

Historically, countries such as the US, the UK, South Africa, Canada, Germany, etc, have introduced CFC legislation to tax passive income such as dividend, interest, royalty earned by foreign companies owned and controlled by residents. On the other hand, there are several countries such as Russia, Singapore, the Netherlands, etc, which do not have CFC legislation and also do not tax overseas dividend income. Clearly, the intent of such a tax regime is to promote local companies going global and making investments abroad. The Indian government realised the harm caused by taxing offshore dividend and reduced the tax rate on such income to 15 per cent for 2011-12.

In this context, it is important to relook at the importance of CFC provisions, particularly when on one hand a country like the UK is already looking to reform its CFC provisions and on the other the US, (the first country to have CFC provisions) is battling with failure in achieving the intended results. The introduction of CFC will lead to double or triple taxation of the same income — first, in the country where the operational income is earned; second, by way of withholding tax; and third, in the hands of the Indian shareholders. However, countries with CFC provisions have addressed this anomaly by providing credit for the tax paid in the first or second instance mentioned above. Therefore, the introduction of CFC legislation without providing for the credit of corporate tax paid by the foreign company in overseas jurisdictions is a non-starter and is going to harm the Indian economy more than giving any perceived gain.

Not only should CFC not be introduced but the provision for taxing dividends of foreign corporations should also be completely done away with to avoid double taxation and make Indian companies competitive in the global world.

Ashutosh Chaturvedi & Dheeraj Chaurasia
Executive Director and Associate Director (International Tax), PwC India