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Rashmin Sanghvi & Associates

Chartered Accountants

220, 2nd Floor, Arun Chambers,
Tardeo Road,
Mumbai - 400 034,
Maharashtra, India.

Tel. Nos.: (+91 22) 2351 1878, 2352 5694.

Fax : (+91 22) 2351 5275.

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Home Articles Taxation         Share :

Budget 2016Chapter D

Chapter D. Foreign Companies & Non-Residents:

9. Place of Effective Management: [S. 6(3) and 115JH]

9.1 POEM provisions deferred to 1st April 2016:

Companies are held to be Indian resident if they are incorporated in India or if they are wholly controlled and managed from India.

The Government had amended the rule determining residence of companies last year whereby companies which are effectively managed from India would be held as resident in India.

The Explanatory Memorandum to Budget 2015 provided that the change was brought in mainly to bring in to the tax net shell companies which were incorporated by Indian residents outside India. Such companies were effectively managed from India. However, the earlier provision allowed such companies to remain non-resident by making sure that just a part of its management lies outside India. Our detailed note on the provision form part of our last year’s Budget Notes and is available here - http://rashminsanghvi.com/downloads/taxation/international-taxation/place_of_effective_management(poem).htm.

The Explanatory Memorandum further mentioned that the Income-tax Department will come out with Guidelines on determining where a company’s place of effective management is situated. However, these guidelines have still not been finalised. Draft Guidelines were issued in December 2015. Several representations have been made on the same. However, the final guidelines have still not been issued. Meanwhile, the POEM provision had become effective from 1st April 2015 itself.

As there was general lack of clarity, representation was made for deferring this provision.

The Budget now proposes that the POEM rules will become effective from 1st April 2016 instead of 1st April 2015. However, it must be noted that the final guidelines have still not been issued by the Department. We hope that these guidelines will be finalised by the time the President approves the Finance Bill.

Thus upto FY 2015-16, the residence of a foreign company will considered to be in India, if control and management is “wholly” in India.

9.2 Transition provisions:

There are several implications on a foreign company being held to be an Indian resident due to POEM provisions. If a foreign company is considered tax resident of India, it needs to submit its world-wide income to tax in India; pay advance tax by the prescribed deadlines; and file its tax return in India. Apart from these immediate implications, the company would need to comply with TDS obligations; Transfer Pricing provisions; and have issues under Foreign tax credit. In fact, once a foreign company is held to be tax resident in India; and if it does not pay tax in India; Black Money Act will also be applicable.

Income-tax department of the host country (where the company is incorporated) will also treat the company as resident there. Thus these companies will have the problems of Dual Residence.

As POEM test is a subjective, there can be instances where a foreign company is held to be resident in India only on conclusion of assessment proceedings. If it is so held during assessment proceedings, it would be impossible for the foreign company to comply with any of the Indian tax provisions as the deadlines would have been crossed. Further, in most cases, facts remaining the same, the company can be held to be Indian resident for the following tax years too.

Therefore, the Finance Bill has proposed a new section 115JH to provide for transition mechanism in such cases. It is proposed that the Government would issue a notification providing exemption or modification to such companies with regard to computation of income; treatment of unabsorbed depreciation; set off or carry forward of losses; collection and recovery of taxes and transfer pricing provisions. The notification would also provide certain conditions which need to be fulfilled by such company before it can avail of these relaxations. Further, if such conditions are not met by a company subsequently, the exemptions and modifications would be reversed and the tax officer would have the power to recompute the income chargeable to tax.

These provisions will apply to those foreign companies which become Indian residents for the first time. Thus the provisions will apply to the “first year” in which it becomes an Indian resident. Further if the foreign company is held to be an Indian resident during an assessment, the provisions will also apply to the years subsequent to the “first year” - till the previous year ending before the date of assessment. For example, the foreign company is considered as Indian resident for the first time for FY 2016-17. This happens during an assessment which happens in January 2020. These relief provisions will apply for FY 2016-17 (first year); and subsequent financial years 2017-18 and 2018-19. It would have been better to extend this relief for FY 2019-20 the company would come to know its position in January 2020 only.

In our view, the Government has well considered various representations on this matter and these transition provisions should bring in required flexibility for assessees to whom POEM provisions are applied. However, we need to wait for the proposed notification to check which implications are finally covered; and what conditions are cited by the Government for availing such relaxations.

A safe course of action may be: where the Company considers itself to be Indian Resident under PEOM, it should comply with the law, file Indian tax returns and pay tax. Do not wait until Income-tax officer asks you.

10. MAT on Foreign Companies: [S. 115JB]

In case of companies, there is a minimum alternative tax (MAT). If the normal income tax is less than 18.5% of book profits, then a minimum of 18.5% of book profits has to be paid as MAT.

There has been a controversy on whether these provisions are applicable to a foreign company or not. The issue was revived on account of certain contradictory judgements by the Authority for Advance Rulings (AAR). By way of Finance Act 2015, it was provided that incomes earned by a foreign company in the nature of capital gains, interest, royalty and fees for technical services would be allowed as a deduction from book profits if the tax rate is lower than the rate as per MAT provisions. This brought in relief for Foreign Institutional Investors (FIIs)/Foreign Portfolio Investors (FPIs) from MAT provisions.

However, this amendment was brought in prospectively and hence would be applicable only from 1st April 2015. Taking support of such prospective amendment, tax authorities started issuing notices on FIIs and FPIs for payment under MAT provisions for earlier years.

Therefore the Government set up a committee under the Chairmanship of Justice A P Shah to provide recommendations for FIIs/FPIs. The committee recommended that it should be clarified that these provisions were not applicable to FIIs and FPIs since inception. The Government accepted this recommendation and issued a press release accordingly.

However, the matter was still not resolved for other foreign companies. The Government then issued a further press release on 24th September 2015 stating that section 115JB shall not be applicable to a foreign company if —

- the foreign company is a resident of a country having DTAA with India and such foreign company does not have a permanent establishment in India; or
- the foreign company is a resident of a country which does not have a DTAA with India and such foreign company is not required to seek registration under section 592 of the Companies Act 1956 or section 380 of the Companies Act 2013.

It also clarified that appropriate amendment will be brought in the Income-tax Act. The Finance Bill 2016 hence proposes an Explanation to be added to the MAT provisions to bring the above clarification as part of law with retrospective effect from AY 2001-02.

It is good to note that while the Government has promised not to pass any retrospective taxing provisions it has provided a retrospective relief even though the matter was controversial.

Thus in essence now MAT will apply to foreign companies which have a place of business in India and earn taxable income in India. Due to place of business in India, foreign companies have to register themselves with Registrar of Companies. They have to file annual accounts with ROC. These companies will be liable to maintain accounts from which book profit can be computed. They will be liable to pay MAT.

11. Relaxation on citing PAN for payments to Non-residents: [S. 206AA]

S. 206AA of the Act mandates a person receiving any income to furnish his Permanent Account Number (PAN) to the payer. If PAN is not furnished, the payer needs to deduct tax at source at applicable tax rates or at a rate of 20 per cent, whichever is higher.

While the provision is applicable for all payments on which tax is deductible at source; it became especially cumbersome for payments to non-residents as most non-residents would not possess a PAN. Further even if there is a DTA between the countries of payer and payee, tax rate had to be deducted at a rate higher than the DTA rate. In some cases, the residents had to bear the higher tax if they did not have the bargaining power.

Some payers litigated the matter. They argued that if the tax rate as per DTA is lower than 20%, then whether PAN is available or not, the DTA rate should apply. Some decisions were in favour of the tax payer.

The Finance Bill now proposes that these provisions will not be applicable to a non-resident if specified conditions are met. Thus even if the non-resident does not have a PAN, section 206AA will not apply. Tax will have to be deducted as per the DTA rate. This is a much required relaxation in law and will ease cross-border transactions. However, the conditions are yet to be prescribed by the Government and may form part of amendments in Income-tax Rules.