The taxing poem
Rakesh Nangia

Tax incidence on a taxpayer in India is determined on the basis of its residential status. Global income of the taxpayer is taxed in India if its status is ascertained as resident as per the Indian Income Tax Act. Prior to the 2015 amendment, a foreign company was said to be resident in India, if the control and management of its affairs is situated wholly in India, which resulted in shift of profits by incorporating shell companies outside India that were largely controlled from India. To combat this, concept of place of effective management (POEM) was introduced, where under a foreign company could be treated as an Indian resident if its POEM in a given year is in India.

To facilitate ease in implementation of the new provisions, special provisions were introduced in the Act which provided guiding principles for computation of total income of the foreign company considered resident for the first time in India. These special provisions gave power to the Central Government to issue notification subject to which these provisions shall apply. The Apex Tax Administrator in India i.e. Central Board of Direct Taxes (CBDT) has now issued final notification on 22 June 2018 dealing with different aspects of the computation of income of such foreign companies constituting Indian resident owing to its POEM, such as depreciation, carry forward and setoff of losses, foreign tax credit, difference in the tax year than that adopted by the foreign company. Interestingly, the notification shall be deemed to come into force retrospectively, effective from the April 1, 2017.

What is the allowance for depreciation, losses, etc.? The notification provides that the written down value (WDV), unabsorbed losses and depreciation shall be adopted as per the tax records of the jurisdiction where the foreign company is assessed to tax and comparable parameters as per the books of account where the foreign company is not assessed to tax.

What if the foreign company’s tax year doesn’t end on March 31? The manner of determining the tax year aligned to the Indian tax year has been laid if the foreign company follows a different accounting year etc. Requirement to prepare the balance sheet and profit and loss account creeps in for the financial year preceding the period in which it becomes resident in India till the financial years it remains resident. Adjustments for the time period shall be made while preparing such balance sheet and profit and loss account to compensate any difference in the tax years adopted in India and foreign jurisdiction. 

What about the TDS compliance? A foreign company need not worry about the TDS compliances applicable to a resident company before it attains the status as a resident, if it has already complied with the TDS provisions applicable to the foreign company. Even after becoming the resident, it shall adhere to the provisions applicable to a foreign company in case of any contradiction.

Whether the beneficial provisions applicable to a resident company apply to such foreign company? A much needed clarity has been provided to the foreign companies considered as a resident owing to its POEM being in India. It provides guidance in case any conflict arises in the application of provisions of the Act to such foreign company qualifying as a resident company vis-à-vis a domestic resident company. The Act do not intend to grant any benefit of the favourable provisions provided to the domestic companies. The foreign company qualifying as a resident owing to its POEM being in India, shall be taxable @ 40 per cent on its total income and not the rate applicable to a resident company. Thus, the intention of the law is clear that the provisions which are more beneficial to the resident companies shall not apply to foreign companies becoming a resident owing to its POEM. However, it shall be entitled to claim the credit of foreign taxes as per the Act.

Moreover, there is no incentive available to such foreign company which may be available to an Indian-resident company such as exemption for corporate reorganisation, concessional rate of corporate tax, concessional rate for dividend received from foreign subsidiary etc.

What if the foreign company is already liable to tax in India, irrespective of its POEM? Income which is otherwise taxable in India irrespective of its residency on account of POEM shall not be governed by the provisions of this notifications. Meaning thereby, that the foreign company shall continue to be taxed for such income as if it is a foreign company.

Much done, still some more left! Though the guidelines provide clarity on treatment of the items which are not year specific and relate to previous years such as depreciation, set off losses. This will ease the understanding and lead to smooth implementation of the provisions in the cases where the foreign company is considered as resident for the first time in India.

However, various aspects remain unaddressed, viz. the Notification does not provide any specific relief from obligation of complying with provisions of advance tax, various procedural requirements such as tax audit, transfer pricing reports, filing return of income, etc. Defaults on these can trigger mandatory interest and stiff penalty. Further, applicability of all the provisions of the Act also means that Income Computation and Disclosure Standards (ICDS), being unique to Indian taxation system which is based on the accounting system adopted by the taxpayers, becomes applicable for the computation of income of such foreign company in addition to the various provisions of the Act such as disallowance for default of withholding or disallowance for payment other than by account payee cheque.

(With Neha Malhotra, executive director, Nangia Advisors )

(The writer is Managing Partner of Nangia Advisors)