New rules soon to tackle offshore tax deferral

The finance ministry will in the near future add Controlled Foreign Corporation (CFC) rules to the Income Tax Act in order to prevent the tax deferral that many Indian multinational companies resort to by not repatriating the profits of their foreign subsidiaries for long periods.

The proposed rules will come with safeguards to make sure that these are genuinely anti-tax deferral provisions targeting only the profits of unlisted foreign subsidiaries of Indian companies that pay in their country of incorporation less than half of the taxes they would have paid in India. The un-repatriated profits of such entities would be deemed to have been distributed and would be taxed as dividend in the hands of the Indian shareholder.

To encourage repatriation of profits, India already has a concessional tax rate of 15% on the dividend an Indian parent or shareholder would receive from a foreign subsidiary.

CFC framework is one of the last remaining ideas from the Direct Tax Code to be incorporated in the income tax law, which has already adopted most of the concepts proposed in the Code, the latest being the definition of place of effective management, which has been adopted through Finance Act 2015.

Introduction of CFC rules has become imminent with India’s commitment to join a new multilateral agreement to prevent the corporate practice of shifting of profits to low tax countries causing erosion of the tax base of the country where actual economic activity takes place.

“CFC rules are one of the action points of OECD-G20 project on base erosion and profit shifting (BEPS). By September, we will have a fair idea of the finer points of the provisions. As all G-20 nations have committed to the project, we cannot act differently,” said a person privy to the government’s thinking.

The problem businesses would find with the CFC rules is that it would not give credit to the taxes paid in the country of incorporation. The amount of un-repatriated profits which are once taxed under CFC rules would not be targeted for taxation in subsequent years.

Under the current law, profit of a subsidiary is not offered to dividend tax unless it is distributed considering the fact that such profits belong to a different legal entity. CFC rules make the un-distributed dividends of a foreign subsidiary taxable if the parameters are met. Experts said this would have huge implications for many businesses.

“There are many companies that park their profits abroad and are likely to get impacted including many holding and operating companies,”said Amit Maheshwari, partner, Ashok Maheshwary & Associates.

In the case of domestic companies, dividend is taxed at the company level and the received funds are tax exempt in the hands of the shareholders.