Fringe Benefit Tax: Imbroglio for foreign companies

While the extra-territorial limitation of the various provisions of the Income-tax Act, 1961, vis-à-vis foreign companies is still actively debated at the various appellate levels, the introduction of Fringe Benefit Tax (FBT) in the Finance Act, 2005, appears to have amplified this dispute further.

As per the FBT regulations, every employer is required to pay additional income tax (named as fringe benefit tax) at the rate of 30% (plus applicable surcharge and cess) on the value of fringe benefits provided or deemed to have been provided to employees during the relevant financial year. The term "employer" is defined to include a "company" which would cover foreign company as well. But, the charging section fails to provide any clarity on the manner of taxability of foreign companies. That is, when a foreign company will be liable for FBT and how such liability needs to be computed.

CBDT circular

Most of the foreign companies had to anxiously wait for a few months for the explanatory circular to be issued by the Central Board of Direct Taxes (CBDT) to understand their position. The circular was eventually issued on August 29, 2005, and the CBDT has clarified some of the aspects relating to taxability of foreign companies.

The significant points are outlined below "�

• FBT will apply to foreign companies if it has employees based in India.
• If a foreign company has employees based in India and the remuneration received by all its employees is not taxable in terms of the Article relating to dependent personal services in any tax treaty, such foreign companies would not be liable to FBT in India.
• FBT is payable by a foreign entity even if it does not have any taxable income in India.
• If a foreign company has employees based in India, it will be liable to FBT in respect of fringe benefits provided or deemed to have been provided.
• A foreign company not having any permanent establishment (fixed place of business, such as a branch) in India and doing business promotion through an event manager or a liaison office would not be liable to the FBT in India if it does not have any employees based in India.
• FBT will apply to liaison offices of foreign companies in India if the liaison offices have employees based in India.
• In case where a foreign company has a permanent establishment in India, FBT is payable on the expenses attributable to operations of the permanent establish irrespective of the fact whether they are incurred in India or outside India.
• The credit for FBT paid in India may be available in the foreign country of residence on the basis of the tax laws prevailing in the foreign country and in the light of the provisions of the tax treaty entered into between India and that foreign country.

Even after issue of this circular some areas are shrouded in grey. These instances are illustrated below:

Employees based in India

The Circular states that a foreign company will be liable for FBT if it has employees based in India. It is interesting to note that the term "employees based in India" has not been defined or explained either in the provisions or in the circular.

It is a common practice for foreign companies to send employees on deputation to India for a period ranging from one to three years. Generally, these employees report exclusively to the Indian entity and work under the direct supervision and control of the Indian entity. However, for administrative convenience, these employees continue to remain on the payrolls of the foreign entity. Their salary is delivered to a bank account outside India and their retirement and social benefits continue to be maintained with the foreign entity. The employees join the overseas entity again on completion of the deputation period.

Given these facts, the question to be asked would be whether the employees would be treated as employees of the foreign company based in India?

Expenses

Even if a foreign company is assumed to have employees based in India, it is an onerous task to determine what needs to be considered for FBT. Whether the expenses should be restricted to those incurred for the employees who are taxable in India or can it be extended to employees who are otherwise not liable to any tax in India?

While clarifying the method of computing FBT liability for an Indian company having employees based both in and outside India, the Circular states that FBT is payable on the proportion of the total amount of expenses incurred for the purpose covered under the FBT regulations and attributable to the operations in India.

It further states that if the company maintains separate books of accounts for its Indian and foreign operations, FBT would be payable on the amount of expenses reflected in the books of account relating to the Indian operations.

Taking a clue from this clarification, it can be contended that expenses relating to Indian operations should be considered for FBT levy. However, the word "operations in India" has not been defined either under the provision or in the circular. The term "operations" have wider meaning and is likely to create further controversies.

Double tax treaty

It would be interesting to see whether it is possible to put forward an argument that as the FBT is not discussed or covered under any of the tax treaties entered into by India, the Fringe Benefit Tax cannot apply to a foreign entity that does not have any taxable presence in India. Generally, tax treaties would provide for distributive rules relating to allocation of income to the source and resident countries. As FBT is more in the nature of taxation of expenditure, the treaties do not cover this scenario unless specifically stated.

The other aspect is on the availability of tax credit in the resident country of foreign company in relation to FBT paid. Though FBT is stated as additional income tax in the Indian Income-tax Act, in the absence of specific mention in the treaty, the resident countries could deny the tax credit to the foreign entity.

Australia and New Zealand do have an FBT regime and the treaty entered into between them specifically addresses the FBT issues. In case the government continues with the FBT levy, it should try to include the tax credit aspect of FBT while re-negotiating the current tax treaties and signing the new treaties.

Conclusion

As may be discerned, foreign companies are likely to have serious hardship in first determining their FBT liability and also complying with the various procedural requirements. In an era of tax simplification and exchange control liberalisation to promote foreign investment, introduction of FBT levy has already created a blot in the Indian regulatory environment. Continuation of the same is likely to create further uncertainty in the minds of the foreign investors.

(Courtesy: Ernst &Young)