The Hindu Business Line : More pain than gain for non-residents

The existing tax law, which has been around for more than 47 years, may have the dubious distinction of being one of the most amended laws. Repeated amendments, whether for providing benefits or for plugging loopholes, made it very complex, beyond the comprehension of an ordinary taxpayer.

The Direct Taxes Code Bill, 2009 seeks to simplify the language to enable better comprehension. While releasing the Code for public comments the Finance Minister underlined that “the thrust of the Code is to improve the efficiency and equity of our tax system by eliminating distortions in the tax structure, introducing moderate levels of taxation and expanding the tax base”. The Code introduces several provisions causing paradigm shifts in taxation of foreign companies.

Residency rule

In the area of international taxation, there are several provisions in the Code which provide tremendous powers in the hands of tax authorities. Possibly intended for combating tax evasion/avoidance, these may cause unintended hardships for genuine taxpayers. The first one concerns definition of “residence” of a company.

It is provided that foreign companies and persons other than individuals would be treated as resident in India if the place of control and management of its affairs is situated wholly or partly in India at any time in the financial year.

Generally speaking, the place of control and management is considered the place where the board meetings are held or where the directors of the company take decisions. Thus, even if one of the board meetings is held in India, the foreign company may be held as resident in India, liable to taxation on global income.

Apart from becoming a source of litigation this may have undesired negative impact on genuine companies. Another possible absurd inference is that in accordance with Section 99 of the Code such a foreign company may be possibly subject to the dividend distribution tax at 15 per cent.

Tax treaties

The second paradigm shift concerns the position of a tax treaty vis-À-vis domestic law. As it stands, a taxpayer can follow either of the two, whichever is beneficial to it. The Code prescribes that neither the treaty nor the Code shall have a preferential status, but the one which is later in time would supersede the earlier one.

(The authors are with Deloitte Haskins & Sells, New Delhi.)

No doubt, similar provisions exist in several countries but the constitutional requirements for introducing tax treaties in those countries are different from those in India.

The most important consequence of the provision is that the Code would supersede all existing treaties. Though in practise it may affect only a few treaties significantly, conceptually this would send an undesirable message to prospective investors that the treaties may not provide a stable tax regime.

Deemed accrual of income

The third significant provision concerns definition of ‘deemed income’. It is proposed that assets situated in India if transferred directly or indirectly would amount to deemed accrual of income in India. This may be to cover under the tax net the arrangements where a chain of holding companies in various countries are used to transfer shares of Indian companies.

General Anti-avoidance Rules

The fourth significant suggestion is introduction of General Anti-avoidance Rules which incorporate provisions concerning thin-capitalisation. These enable the tax authorities disregard or re-characterise any transaction or modify the same. Similar provisions exist in several countries.

However, as these powers are quite extensive, the success of the Code would depend on the judicious actions by the tax authorities and more on active, sincere, and intellectually honest monitoring by the senior officers.

Technical services

Apart from the above, there are several provisions which are important for foreign companies. The Code tries to reiterate the source rule regarding royalty and fees for technical services (FTS).

A significant benefit to foreign companies is exemption from taxation granted to payment of lump-sum royalty by a resident to a non-resident for the transfer of any rights in respect of computer software along with a computer or computer-based equipment, under any scheme approved under the Policy on Computer Software Export, Software Development and Training, 1986 of the Government of India.

Tax rates

The Code tries to implement a long-standing suggestion that the tax rate on foreign companies should be competitive. The tax rate is sought to be reduced to 25 per cent. However, a foreign company would be required to additionally pay branch profits tax of 15 per cent (in effect, this would be 11.55 per cent).

As this tax is leviable on every foreign company, it would be also applicable even when the foreign company earns only special incomes in India — interest, royalty, FTS, etc. — and do not have business income in the country.

Such a provision will be harsh on foreign companies which do not enjoy treaty benefit, as the tax rate for royalty and FTS is sought to be increased to 20 per cent against the earlier 10 per cent; incidence of branch profits tax will further enhance tax payout.

Foreign companies are also liable for Minimum Alternate Tax (MAT) which is 0.25 per cent of the value of gross assets in the case of banking companies and 2 per cent for other companies. Methodology has been prescribed in the Code for computation of gross assets. Further, MAT credit will not be available.

It cannot be denied that the Code has used simple language. It is also a good move by the Government to put the Code for public debate. It will be still better if the Government adopts reasonable suggestions. However, as the taste of pudding is in eating, the success would depend on the way it is implemented.