Monday, November 29, 1999

Revised DTC draft to benefit non-resident cos

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The much awaited revised discussion paper of the direct taxes code (DTC) is finally out for second round of public consultations. The paper seeks to address major concerns raised in the first round and promises a consideration of left out issues with the suggestions on the fresh proposals in the Bill to be introduced in Parliament.The revised proposals in relation to non-resident taxation seek to restore confidence that was terribly shaken at the time of first round. The overall approach is accommodating and portrays responsiveness to key concerns.The test of Indian tax residence for a foreign company in the DTC provided that even a part of control and management in India is sufficient to expose the foreign company to a tax residence in India. The implication of such a low threshold for tax residence is liability to pay tax on income attributable to the Indian presence at 36.25% (corporate tax and branch profits tax). In terms of extant tax laws, a foreign company is tax resident in India if the control and management of its affairs is wholly situated in India, a threshold which is much higher. The new draft makes a case for applying the test of 'place of effective management'. Accordingly, a company incorporated outside India will be treated as a tax resident of India and taxed in India if its 'place of effective management' is situated in India. The test is well recognised as a tie-breaker rule for determining tax residence under most of the tax treaties concluded by India with other countries.Major developed countries have a set of rules called controlled foreign corporations rules which deals with tax liability in respect of income from overseas group companies. CFC rules will finally see daylight in India. The paper provides that the passive income earned by a foreign company controlled directly or indirectly by an Indian resident will be deemed to have been distributed to resident shareholders and taxed as dividends. The intention behind the deeming fiction is to strike at deferral of tax payments where the income is not actually distributed.Indian companies have lately started looking out of India for inorganic growth opportunities and needs all regulatory and tax regime support to establish brand INDIA across the globe. The constraints under exchange control regime in relation to overseas direct investments (ODI) will be accentuated by the fresh tax proposals. On balance, it needs to be examined whether our ODI activities have matured enough to sustain the proposed jolt and whether introduction of CFC rules needs to be deferred. Alternatively, introduction of 'participation exemption' should be considered. Participation exemption regime envisages a tax exemption for dividends and capital from an investment in a company say an overseas company based on a prescribed percentage of equity participation in such company.Ordinarily, provisions of the domestic tax laws or the provisions of the applicable tax treaty whichever are more beneficial are applied to an eligible taxpayer. The principle is known as 'treaty overrides'. The original proposals advocated abolition of the said principal in favour of 'later-in-time' principle. In view of the strong reactions, the paper seeks to restore the 'treaty overrides' principle. However, the provisions of applicable tax treaty will not override the domestic tax laws in relation to invocation of CFC rules, general anti-avoidance rules and the levy of branch profits tax at 15% on the income after corporate tax of a foreign company. The exceptions carved out of the general principle may provide a fertile ground for litigation.Hopefully, the DTC will usher in a simplified and futuristic direct taxes regime.Views are personal

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