India: Taxation Of Foreign Companies In Direct Taxes Code Bill, 2010 - A Summation

Last Updated: 26 July 2011

By Gaurav Jain, Principal Associate, Vaish Associates Advocates, New Delhi

The Direct Taxes Code Bill, 2010, ('the Code'), which is proposed to be enacted w.e.f. 1-4-2012 and will replace the Income-tax Act, 1961, ('the Act'), makes a substantial change/shift in the provisions relating to taxation of foreign companies in India from the provisions contained in the Act.

An attempt has been made in this Article to collate and summarize the various provisions relating to taxation of foreign companies scattered in the proposed Code.

As per section 2 of the Code, every person is liable to pay income-tax in respect of total income of the financial year. The word "person" has been defined in section 314(184), and includes, inter alia, "a company". The word "company" has also been defined in section 314(54) as under:

""company" means-

(a) any Indian company,

(b) any body corporate incorporated by or under the laws of a country outside India, or

(c) any person who is or was assessable or was assessed as a company under the Indian Income-tax Act, 1922, or the Income-tax Act, 1961;"

In accordance with the provisions of section 2 read with First Schedule to the Code, total income of a company arising from ordinary sources (other than income from special sources, like winning from lotteries, interest, dividend, royalties, fees for technical services, etc. for which special rate of tax has been prescribed in Part III of Schedule I), is subject to tax @ 30%

Section 3 of the Code (which is pari materia to section 5 of the Act) determines the scope of total income of a person, including a company, that would be subject to tax in India, depending upon the residential status of such person/company.

Income earned by a resident of India, whether in India or outside India, is subject to tax entirely in India, whereas in the case of a non-resident, income which – (a) accrues or is deemed to accrue in India, or (b) is received or deemed to be received in India, shall only be subject to tax in India.

Test of Residency

In accordance with the provisions of section 4(3) of the Code, a company is regarded as resident of India, if, interalia , its place of effective management, at any time in the year , is in India.

At this stage, it would be pertinent to understand and examine the meaning of aforesaid expression, viz., "place of effective management".

Place of effective management

The captioned expression has been defined in section 314(192) of the Code as under:

"place of effective management" means-

(i) the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or

(ii) in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions:"

The aforesaid test primarily look at a place, where strategic business decisions of the company are taken or executive functions are performed. The introduction of the concept of "place of effective management" in the Code is an attempt to bring the Indian law in line with the international tax practice. The aforesaid definition read with provisions of section 4(3) of the Code implies that when at any time during the year, a foreign company takes such strategic decision in India, it would be considered as a resident in India.

The aforesaid test of residency of a foreign company in India is much wider in scope as compared to the provisions of section 6(3) of the Act, which provides that a company would be regarded as resident in India only if during the year its control and management of affairs is situated wholly in India.

The primary distinction between the provisions under the Act and Code is that former required the control and management of the affairs to be wholly situated in India during the year, whereas the latter provides for place of effective management at any time in the year to be in India.

Under the provisions of the Act, if even part of control is established to rest outside India at any time during the year, such company cannot be regarded as resident in India. On the other hand, under the Code, on bare reading of the provisions, if even for a single day, it is established that effective control/management was in India, such company would qualify as resident of India and would be subject to tax in India on global income.

It would be pertinent to point out that a company may become resident of two countries, if it has its place of effective management at any time during the year in two countries. In such a situation, there are no effective means to avoid double taxation even under the Double Taxation Avoidance Agreement entered by India with other countries. The provisions of the Treaty do not incorporate provisions like Tie Breaker Rule to deal such a situation of dual residency in case of a company.

In my view, in the above situation there could be potential double taxation, which could be relieved only if there are provisions relating to tax credit prevailing in domestic laws of country.

Rate of Tax

As stated hereinabove, a foreign company is liable to tax, inter alia, in respect of income deemed to accrue in India. The incomes which are deemed to accrue or arise in India are prescribed in section 5 of the Code (pari materia to section 9 of the Act), and include the following:

(a) income arising from a business connection in India, which is reasonably attributable to operations carried out by foreign company in India;

(b) income arising from any property in India;

(c) income arising from any asset or source of income in India; or

(d) income arising from transfer of a capital asset situated in India;

(e) royalty payable from India;

(f) fees for technical services payable from India, etc.

It is pertinent to note that section 5(4)(g) of the Code deems income arising to a non-resident from transfer outside India of any share or interest, in a foreign company to arise in India, if at any time in the 12 month period preceding the transfer, the fair market value of the assets in India, owned directly or indirectly by the company, represent at least 50% of the fair market value of all assets accrued by the company. The aforesaid provision, it appears, has been made to take care of the issue which arose in the case of Vodafone International Holdings B.V: 329 ITR 126, before the Bombay High Court.

The aforesaid incomes of a non-resident foreign company shall be subject to tax at following rates:

Income from special sources

(i) Interest

20%

(ii) Dividend on which DDT has not been paid in India

20%

(iii) Royalty/Fees for technical services

20%

(iv) Income by way of winnings from lottery, races, games, etc.

30%

Balance income – Income from ordinary sources

  30%

Schedule 14 of the Code provides for a presumptive taxation at specified rates on receipts earned from India in case of following businesses:

1.

Business of civil construction in connection with a turnkey power project approved by the Central Government in this behalf

10%

2.

Business of erection of plant or machinery or testing or commissioning thereof, in connection with a turnkey power project approved by the Central Government in this behalf

10%

3.

Business of provided services or facilities in connection with the prospecting for, or extraction or production of, mineral oil or natural gas.

14%

4.

Business of supplying plant and machinery on hire, used or to be used, in the prospecting for, or exctraction or production of, mineral oils or natural gas.

14%

5.

Business of operation of ships (including an arrangement such as slot charter, space charter or joint charter)

10%

6.

Business of operation of aircraft (including an arrangement such as slot charter, space charter or joint charter)

7%

The tax at the specified rates on the aforesaid income shall be payable without any other deductions on the gross receipts collected in relation to business carried out at India.

Branch Profit tax

In addition to income-tax payable on income earned through or from India in the aforesaid manner, the Code proposes to impose additional tax, viz., Branch Profit tax (section 111 of the Code) on income attributable to the permanent establishment or an immovable property situated in India. The aforesaid tax would, however, be levied on net income, post normal tax paid on such income in India by the foreign company. The word "Permanent Establishment" has been defined in section 314(183) of the Code borrowing the parameters usually found in the Double Taxation Avoidance Agreements in relation to similar concept therein. However, the definition of permanent establishment in the code is much wide in scope and not restricted to the definition/parameters in the DTAAs. For instance, furnishing of services through employees in India, without any threshold time limit of stay of employees in India, would result in constitution of PE; a substantial equipment in India which is being used by, for or under any contract, is also deemed as PE.

With the imposition of aforesaid branch profit tax, business income of a foreign company would be effectively subject to tax @40.5% under the Code. It may be relevant to point out that where a foreign company has effective place of management in India, the same would be regarded as resident of India and would not be subject to branch profit tax. However, in such a case global income of the foreign company would be liable to tax in India.

In accordance with the provisions of section 291 of the Code, a foreign company would have the option to pay tax in accordance with the provisions of DTAA entered between India and the country of residence of such foreign company, to the extent the provisions of DTAA are more beneficial than the provisions of the Code. However, by virtue of provisions of sub-section (8) thereof, no exemption shall be available in relation to branch profit tax liability arising under the Code on business profits of PE and income from immovable property in

India. Also, the provision of DTAA will not apply, where a transaction is considered as an impermissible avoidance agreement under General Anti Avoidance Rules (GAAR) or in a situation where the provisions of Controlled Foreign Corporate (CFC) are applicable.

In my view, the Branch Profit Tax, being nothing but an additional income-tax levied under the Code, credit for the same should be available against the tax payable in the home jurisdiction of the foreign company, in accordance with the provisions of domestic law of that company. However, disputes may arise if the credit of such tax would be available in terms of the Treaty provisions, if the term 'tax' as defined in the Treaty does not take into account branch profit tax.

*COPYRIGHT NOTICE: © 2011, India. All rights reserved with Vaish Associates Advocates, Flat No. 5, 10, Hailey Road, New Delhi-110001, India

The content of this article is intended to provide a general guide to the subject matter. Specialist professional advice should be sought about your specific circumstances. The views expressed in this article are solely of the authors of this article.

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