The government plans to provide comfort to Indian companies with foreign subsidiaries that would be covered by the provisions on Controlled Foreign Corporations.
While the finance ministry unveiled the proposal on CFCs in the revised discussion paper on the Direct Taxes Code, released yesterday, officials said they were working on the details of how the mechanism would work.
The rules are proposed to be invoked only when a company breaches the threshold prescribed by the government on ownership, nature of income and location of the company. Besides, officials said, the rules are to apply to any other foreign company set up under an offshore entity for the purpose of avoiding tax.
So, if an Indian company or promoters hold stake below the prescribed threshold, the CFC provisions will not be triggered. Similarly, if a company is set up in a high tax jurisdiction, CFC rules would not be required. But the government can invoke the provisions in case other conditions are met and the entity is based in tax havens such as Mauritius, the Cayman Islands or the Isle of Man.
THE THREE TRIGGERS
- Government may prescribe limits on ownership, nature of income and location of a company.
- These will be invoked if any of these three thresholds is breached.
- The rules will also apply to any other foreign company set up under an offshore entity to avoid tax.
Also, the provisions will come into play based on the nature of income of the holding company, which may include income from dividends, business or royalty. The government is, however, considering a proposal under which even in the absence of dividend distribution by a foreign entity, the income would be deemed to have been distributed under the rules, and the shareholders taxed accordingly. A senior finance ministry official said the triggers in each of the areas will be defined in the legislation and the rules.
In the US, a CFC is a foreign corporation more than 50 per cent owned by US shareholders, who are persons owning 10 per cent or more of a foreign corporation. The shareholders include individuals, corporations, partnerships, trusts, estates, and other juridical persons.
The triggers are akin to those prescribed under the General Anti Avoidance Agreement, which were proposed to be open-ended but are now likely to be triggered only in four situations. Incidentally, the discussion paper on DTC has suggested the domestic tax law will override double tax avoidance agreements in case the CFC provisions came into play.
"CFC is a mechanism to check tax evasion and avoidance by companies. Any company, anywhere in the world, controlled directly or indirectly by an Indian company, will be subject to CFC rules if it breaches any of the three thresholds," said a senior finance ministry official who did not wish to be identified.
Indian companies, which have been spreading their wings overseas through the organic and inorganic route are watching the government's moves carefully. So are tax consultants.
"Normally, CFC rules apply only to multinationals of a particular size with presence in many countries. In India, we have to see how much income of the holding company will be treated as passive income... Many companies will be subjected to scrutiny once these rules are introduced. They may have to reorganise their operations," said Shanto Ghosh, senior director, Deloitte.
The new discussion paper on DTC had proposed to introduce CFC provisions to check tax avoidance. The rules will allow tax authorities to extend domestic laws for taxing profits of Indian subsidiaries aboard. Currently, profits of foreign companies controlled by residents are taxed in the hands of the Indian company only when distributed in the form of dividends to the parent.
CFC rules have been adopted by most developed countries in various forms. The industry has raised concerns that the discussion paper was not clear on how many layers could be taxed under the rules. Globally, there have been many instances where companies have incorporated companies under companies to mitigate tax. Direct or indirect control over the foreign company by the Indian parent would ensure the passive income of all the companies in the chain is taxed.
CFC rules have been adopted by countries like the US, the UK, Japan and Germany, where outbound investments have exceeded inward flows. Some experts have opposed the introduction of CFC rules, arguing India was not prepared for it, as capitals inflows are still higher than outflows. The finance ministry feels markets have matured and the rules would prepare us for the eventuality.
In 2003, a working committee on non-resident taxation, headed by Vijay Kelkar, had also recommended introduction of a CFC regime in India, terming deferral of taxes as an unjustifiable loss of revenue.
