With increasing globalization, international geographical boundaries appear to be fading out. Several international companies are set to take advantage of this to cut down on the total taxes by incorporating the low tax regimes in their tax planning.
One of the strategies employed by these international groups includes putting profits in no or low tax countries without having to actually bring the profits to a higher tax jurisdiction country where the parent company is domiciled. This practice could lead to a long term or indefinite deferral of tax payments on the profits made.
Controlled Foreign Corporation CFC Rules seeks to tax such profits that are parked by foreign companies in low or no tax jurisdiction on behalf of the parent company.
While the CFC Rules may not be so helpful in taxing profits in the country where the parent company is domiciled where the profits should really belong, these rules have positive implications in the source country because the taxpayers have little or no incentive to transfer profits to third low tax jurisdiction. Thinking of starting a business in India as a foreign company? Get acquainted with CFC!
CFC Rules Globally
CFC rules have come to be accepted as a very vital tool in OECD’S Action Plan on Base Erosion and Profit Shifting (BEPS). BEPS, simply put, refers to the strategies that these multinational firms employ in avoiding tax. They do this by exploiting the gaps, mismatches and weakness of the tax laws to shift profits to no or low tax jurisdictions.
Over a hundred countries and jurisdictions are collaborating for the implementation of BEPS rules aimed at tackling BEPS, under an all inclusive framework. Several developed countries have set the parameters for the implementation and invocation of the CFC Rules.
CFC Rules in India
CFC was first introduced to the Indian tax regime in 2010 as part of a Direct Tax Code. This code was retained in a revised draft of Direct Tax Code, 2013. Regarding the CFC Rules in the Direct Tax Code, the profits earned by a CF company based in a country with lower tax jurisdiction would be added to the taxable profits of its Indian based parent company.
For this reason, a Controlled Financial Company shall be one that:
– A resident of a location with lower taxation.
– Its shares are not traded in any known stock exchange in such location.
– Is controlled by Indian residents –m whether individually or collectively.
– Is not involved in any business or active trade. One with more than 25% of its income is sourced from passive income like interest, dividend, royalty, annuity, capital gains, etc.
There are provisions in place in the Direct Tax Code that ensures that the profits of CFC which have been taxed in the parent company are not taxed a second time when such profits returned in the form of dividends by CFC to the parent company.
Direct Tax Code is not yet a law in India at the moment, and there are no legal provisions in the present Income Tax Act for the enforcement of CFC Rules.
CFC Rules Vs POEM Under Indian Tax Law
The government has recently introduced a concept known as Place of Effective Management, under the existing Income Tax Act. Regarding POEM, even foreign based companies can be said to be resident in India and its income earned globally would be subjected to taxation in India. As a foreign company thinking of starting a business in India, POEM is worth taking note of.
POEM gives far reaching powers to Indian tax authorities to allege that foreign companies with Indian based parent company are an Indian company and that its key business decisions are taken by directors or promoters that are based in India. As such these should be treated as an Indian resident; their global earning would be taxed regardless of:
– Whether or not the foreign company is based in a tax haven.
– Whether or not the foreign company was set up for genuinely global business expansion of Indian multinationals or just for treaty abuse and parking global profits in tax havens outside of India.
Some of the drawbacks of the POEM concepts include the possibility of it being abused and used as a tool in the hands of tax authorities to harass foreign companies from setting up and operating genuine businesses in India. Also, it does not distinguish between low tax jurisdictions and other jurisdictions which promote genuine businesses without offering such tax haven benefits.
POEM is also perceived as a threat by the foreign companies that are carrying out huge projects in India especially in the oil and gas and infrastructure sectors as the tax authorities may allege that these foreign companies are resident in India and would go out to tax their global profits in India.
In conclusion, the introduction of CFC Rules to the existing Income Tax Act could be a better option to prevent Indian multinational companies to avoid or defer their tax on foreign income by parking such earnings in low tax jurisdiction. This is also in sync with OECD’s Action Plan against BEPS, to which India is an active participant.