Finance Bill 2015 proposal- Residential Status of Companies- Repercussions

Finance Bill 2015 proposal- Residential Status of Companies- Repercussions

Present government, which is offering red carpet welcome for foreign investors and also liberalising the tax regime for funds raising activities in India, is at the same time making terrain tough for domestic companies having foreign subsidiaries or foreign companies having operations in India through PE.

One amendment which is expected to encounter lot many challenges is change in the way Residential Status of companies in India is to be tested.

Finance Bill 2015 propose that Company will be resident in India (i.e its global income will be taxable in India) if:-

a)      It is an Indian Company

b)      Its place of effective management , at any time in that year, is in India

For the purposes of this clause “place of effective management” means a place here key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.

The million dollar question is whether propose amendment to tax global income of foreign company in India is in consonance with Power vested in Indian Constitution to tax income having territorial nexus with India i.e whether place of effective management of foreign company, at any in India, established sufficient territorial nexus with India to justify the taxation of global income of foreign company in India.

The expected hiccups upon operation of above-said propose amendments are as under:-

1.       Sharing Business secrets with Income tax department.

Since the concept of Place of effective management (POEM) is quite subjective, foreign company may be required to share with Indian Income tax Authority all key management and commercial decisions to substantiate that nothing of such sort has taken place in India.

2.       Referring to Mutual Agreement Procedure

a)      In case there is DTAA between foreign Country, where foreign company is incorporated, and India, there needs to attribute  the residential status of said company under DTAA to any one of the Country, which can claim to have right to tax its global business income.

b)      Under DTAA, following steps are required for arriving at the Residential status of Company:-

i)                    Determine Place of Incorporation or place of management of company.

ii)                   If place of Incorporation is in one country and place of management is in other country or place of management is in both the countries, determine the place of effective management

iii)                 Company will be the resident of Country where the place of effective management is located

iv)                 DTAA has provided any criterion to evaluate Residential Status criterion, where place of effective management is located in the both the countries.

v)                  If that be the case, company has to invoke the Mutual Agreement Procedure under DTAA  for arriving at its residential status under DTAA.

c)       Thus for any decision of foreign company taken  in India, which is claimed by IT Authorities to be key management decision, said company has to go Competent Authorities of both the countries under Mutual agreement procedure to conclude on its residential status.

d)      This aspect will further deteriorate the ranking of Indian under World Bank’s ease of doing business Index.

3.       Impediment in International taxation

a)      Considered a Case where foreign Company is located in Country X and it has cross border transaction (Say FTS) with country Y.

b)      At the time of transaction between X and Y, the foreign company was resident of country X.

c)       Under DTAA between X and Y, Y (Source country) does not have right of taxation and as such, country Y does not withhold the tax on FTS payment made to foreign Company in country X

d)      Later on due to some business exigency, certain Key management decision of foreign company is taken in India and it becomes resident of Indian under Proposed amendment and also under DTAA between Country X and India.

e)      Suppose India has DTAA with country Y and under said DTAA, Country Y has right of taxation on FTS payment.

f)       Now Foreign Company is Resident of India under DTAA between India and country X. In this case, Foreign Company claim to be resident of Country X under DTAA between X and Y seems doubtful.

g)      In this scenario, Country Y may claim that foreign company, which has now become resident of India, is also liable to pay tax in Country Y on FTS payment and will further lead to the complexities relating Triangular Treaties issues.

h)      Thus proposed amendment is likely to create obstacles in the smooth functioning of International Taxation

4.       Other Procedural Issues

Certain payments to foreign company from India (when foreign company was resident of foreign company), which is not taxable under DTAA but taxable under Income Tax Act, , may cast liability on payer for non-deduction of TDS, if foreign company becomes resident of India later on due to operation of  proposed amendment.

I think that ease and certainty in the operation of taxing statute is pressing need in current scenario, merely favourable tax frame work for fund raising activities unaccompanied by analogous treatment in corporate taxation will not serve the desire purpose.