TAXABILITY OF ESTABLISHMENTS OF FOREIGN COMPANIES IN INDIA

TAXABILITY OF ESTABLISHMENTS OF FOREIGN COMPANIES IN INDIA

The charge of tax under the Indian Income Tax Act, 1961 is based on

·         Residential basis (section 6)

·     Source of the income: - (section 5) income received or is deemed to be received in India or accrues or arises or is deemed to accrue or arise India.

·     Business connection:- (section 9) A business connection involves a relation between a business carried out by a non-resident which yields profits and gains and some activity in the taxable territories which contributes directly or indirectly to the earning of those profits or gains. It predicates an element of continuity between the business of a non-resident and the activity in the taxable territories, a stray or isolated transaction is normally not to be regarded as business connection.[1]

Taxablility of Liasion office

A Liaison Office is not permitted to undertake any commercial / trading / industrial activity, directly or indirectly, and cannot, therefore, earn any income in India. It is required to maintain itself out of inward remittances received from abroad through normal banking channels. Hence it does not constitute a taxable entity in India. Also, the liaison office is not subjected to taxation in India as there is no mechanism for the income tax department to examine and ascertain as to whether the activities under taken by it result in any taxable income in India. However, the Liaison Office would be required to withhold tax from certain payments and hence to comply with the requisite tax withholding requirements under the domestic tax law.[2]

Taxability of Branch office

A branch office is considered as an extension of a foreign company in India. Therefore, income earned by the branch office is taxed in India in accordance with the taxation provisions applicable to foreign companies under the Act. In case the provisions of a tax treaty between India and the country of which the foreign company is resident, are more beneficial than the Act, then it is open to the foreign company to elect being taxed under the provisions of the relevant tax treaty.

Permanent Establishment

One important term that occurs in all the Double Taxation Avoidance Agreements is the term 'Permanent Establishment' (PE), which has not been defined in the Income- tax Act.

Article 5 of Convention between the Government of the United States Of America And the Government of the Republic of India for the avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to taxes on income describes the term “permanent establishment” as a fixed place of business through which the business of an enterprise is wholly or partly carried on

There is a consensus that the host country can tax income of foreign companies only if it maintains a PE. Normally, a PE includes the following:

·         a place of management.

·         a branch.

·         an office.

·         a factory.

Thus, a PE takes the form of a facility, a construction site or an agency relationship, all of which require a measure of permanence. An issue which generally arises is the scope of income earned by a PE in a country, i.e., what is the portion of the income of PE earned in India that can be taxed. Under the ‘Attribution Rule’, only those profits are taxable which are attributable to the PE, computed on the basis of a hypothesis that the establishment in a country is completely independent of the head office in another country. The profits, which such an independent enterprise might be expected to derive on the amount so ascertained, are taken into account in the computation of the business income of the PE.[3]

Concept of control and management

The term “control and management “indicates the power to take vital policy decisions as against routine daily operations. Control and management is situated where the head and brain operate. In the case of a firm, the control and management is with the partners. Furthermore it’s not just a theoretical right to control; the persons should actually be controlling operations. Control and management refers to the Central Controlling power and not the day to day affairs of the company. For a company, although the shareholders are the ultimate owners and have the voting rights, the management and control is with the Board of directors. Generally the control and management of the company affairs is said to be situated at a place where the Board of Directors’ meeting are held. Therefore in case of a foreign company, if all meetings of the Board of Directors are generally held in India and crucial decisions regarding the management of the company are taken in India, then the foreign company shall be resident of India. The courts have held that merely because a person has such powers in India, this does not create residency; such power should be actually exercised from India or the entity should be managed or controlled from India.[4]

Section 90-Double Taxation Relief

In case of conflict between Income-tax Act and provisions of DTAA, provisions of DTAA would prevail over provisions of Income-tax Act. Section 90(2) makes it clear that the Act gets modified in regard to the assessee insofar as the agreement is concerned if it falls within the category stated therein[5].The provisions of section 90 prevail over those of sections 4, 5 and 9, and therefore, even where a business connection is established the profits of a company could be free from tax if they are covered by a Double Taxation Agreement.[6]

Morgan Stanley case

Where respondent-non-resident company entered into agreement with a group company MSAS, incorporated in India, for support services by latter, respondent-company could not be said to have a fixed place PE in India under article 5(1) of DTAA as MSAS would be performing only back office operations in India; nor was there an agency PE as MSAS had no authority to enter into or conclude contracts; nor would stewardship activity of respondent-company in India constituted a PE under article 5(2)(1); however deputa­tionists of respondent-company in India would constitute a serv­ice PE.[7]

Income Taxes Rates

If the company is domicile to India, the tax rate is flat at 30%. But for a foreign company, the tax rate depends on a number of factors and considerations. The companies that are domicile to India are taxed on the global income whereas the foreign companies in India are taxed on their income within the Indian territory. The incomes that are taxable in case of foreign companies are interest gained, royalties, income from the capital assets in India, income from sale of equity shares of the company, dividends earned, etc.

Foreign Companies income tax rates

For dividends 20% in case of non-treaty foreign companies and 15% for companies under the treaty based in United States

For interest gains 20% in case of non-treaty foreign companies and 15% for companies under the treaty based in United States

For royalties 30% in case of non-treaty foreign companies and 20% for companies under the treaty based in United States

For technology based services in case of non-treaty foreign companies and 20% for companies under the treaty based in United States

For other kinds of income and gains 55% in case of non-treaty foreign companies and 55% for companies under the treaty based in United States.[8]