Foreign arms of Indian firms may come under tax net

The revised discussion paper on the Direct Taxes Code (DTC) has proposed to tax the income of foreign subsidiaries of Indian companies. It also suggests that a company incorporated outside India will be taxed only when its management is taking decisions in India.

As an anti-avoidance measure, in line with internationally-accepted practices, the revised draft also proposed to introduce Controlled Foreign Corporation (CFC) provisions to ensure that passive income earned by a foreign company controlled directly or indirectly by a resident in India is taxed by authorities here.

“(In cases) where such income is not distributed to shareholders resulting in deferral of taxes, shall be deemed to have been distributed. Consequently, it would be taxable in India in the hands of resident shareholders as dividend received from the foreign company,” said the discussion paper.

The government’s revenue collections are being affected in the absence of CFC rules as many Indian companies avoid or defer bringing back the profits to the country, and instead, deploy the funds for overseas expansion. This results in delayed or non-payment of taxes on the profits made by the foreign arm.

“The revised discussion paper suggests that the profits of a foreign subsidiary will be taxed in the hands of an Indian company. It is not clear what percentage of these profits will be taxed and how many layers will be taxed. Some of the global companies have explored creation of layers to mitigate tax,” said Pranay Bhatia, associate partner, Economic Laws Practice.

The revised paper also made changes to the concept of residence in the case of a company incorporated outside India. The DTC had proposed that a foreign company will be treated as resident in India if, at any time in the financial year, the control and management of its affairs is situated “wholly or partly” in India (it need not be wholly situated in India, as at present).

“Under the current law, the global income of a company controlled and managed wholly in India is taxed in India. This is the reason many foreign companies do not want the control and management of its affairs in India. DTC changed it further to ‘wholly or partly’ managed in India. This means even if one of board meetings of a company takes place in India, its global income could be taxed here. This has been proposed to be rationalised to tax the companies having ‘place of effective management in India’,” Bhatia said.

The word ‘partly’ used in DTC set a very low threshold for regarding a foreign company as a resident in India. Apprehensions were raised that it could lead to a foreign multinational company being held as resident in India on the ground that some activity like a single meeting of the board of directors is held in India.

Also, a foreign company owned by residents in India could be held to be a resident in India as part of its control may be in the country.

“It has been represented that this will result in uncertainty in taxation and will impact foreign direct investment into India,” said the discussion paper.