Company Taxation

Foreign Companies

Income Tax

Under the ITA, a foreign company is liable to income tax in India on income received or deemed to be received in India or income accruing or arising in India or deemed to accrue or arise in India.

Income deemed to accrue or arise in India would include:

  • Income arising from a business connection in India or property or asset or source of income in India
  • Capital gains from the transfer of capital assets situated in India
  • Interest, royalties, and fees for technical services paid to a non-resident2

An asset or capital asset being any share or interest in a foreign company is deemed to be situated in India if it derives its value, directly or indirectly, substantially from assets located in India.

Accordingly, any indirect transfer of such shares would also be taxable in India. To provide clarity, the criteria for when such taxation would be triggered has been laid down from FY 2015-16 onwards. The criteria are as follows:

  • Share of a foreign company shall be deemed to derive substantial value from Indian assets if the fair value of the Indian assets:
    • exceeds INR 100 million
    • the said value is equal to or greater than 50% of the value of all assets owned by the foreign company.
  • The fair value of assets (without deduction of liabilities against such assets) is to be decided as per rules laid down in Rule 11UB, 11UC, and 114DB. Furthermore, the requirements under Form 3CT and Form 49D must also be complied with.
  • The amount to be taxed in India should be proportional to the value of Indian assets to the global assets of the foreign company
  • An exemption has been provided from indirect transfers to:
    • Small shareholders, i.e., shareholders who hold less than 5% voting power/share capital and do not have management or control
    • Foreign amalgamations and demergers, subject to certain conditions
    • Category-I* and Category-II* FPIs under the SEBI Act3 :-

      *As mentioned above, there is an exemption from indirect transfer provisions applied to Category-I or Category-II FPIs under the SEBI Act. With SEBI coming up with SEBI (FPI) Regulations, 2019, it has been provided for the current exemption to be grandfathered and protected.

      *Furthermore, a similar exemption is proposed to be extended to investments by only Category-I FPIs under the SEBI (FPI) Regulations, 2019

  • An Indian company whose ownership or control outside India gets transferred directly or indirectly would be required to report such a transaction to the tax authorities and:
    • Failure of reporting will attract a penalty of 2% of the transaction value in case the transfer has the effect of transferring the right of management or control
    • in other cases, the penalty will be INR 5,000.

Exemption to non-residents from the filing of income-tax returns

  • Under the current regime, a non-resident is exempt from filing tax returns if the total income consists only of a certain dividend or interest income, and the due taxes are provisionally withheld;
  • It is now proposed to employ this benefit even in cases where the total income of non-residents consists of Fees for Technical Service/ Royalty and due taxes under the provisions of the Act are withheld.

Taxability of Business Income

In case non-residents have a business connection or PE(Permanent Establishment) in India, income attributable to such business connection or PE would be taxable in India at the rate of 40% (plus applicable surcharge and Health and education cess).

However, while calculating the taxable income, a deduction for expenses incurred for earning such income and some part of general administrative expenses are allowed as an expense.

In line with ongoing international discussions, ‘Income attributable to the operations carried out in India,’ has been defined as:

  • a. Advertising revenues from ads that target Indian customers or customers who access the advertisement through an Indian IP address;
  • b. Income from the sale of data collected from an Indian resident or from anyone through an Indian IP address;
  • c. Income from the sale of goods and services using data collected from an Indian resident or from anyone through an Indian IP address.

The business connection includes any business activity carried out by a non-resident through a person acting mainly or wholly on their behalf. Furthermore, keeping in mind the challenges of taxation in a digital economy, the Finance Act, 2018 has introduced the concept of ‘Significant Economic Presence’ (SEP) for business connections in India. This relates to virtual business connections of non-residents in India without any physical presence. PE means some presence in India in the form of a fixed place, employee presence, and more through which business activities are carried out in India by the non-resident. Where a non-resident constitutes a business connection or PE in India, it is required to carry out compliances as expected of a domestic company (i.e., maintaining books of accounts, getting accounts audited, various regulatory filings, etc.)

Presently, SEP of a non-resident in India constitutes ‘business connection’ in India. The threshold to determine SEP of a non-resident is given below:

  1. Revenue-linked condition: threshold of INR 20 million
  2. User-linked condition: threshold of 300,000 Indian users.

As mentioned earlier, if a foreign company has a PE in India, the tax authorities may try to subject that company to the provisions of MAT– this view of the tax authorities may, however, be subject to litigation.

Goodwill not eligible for depreciation

Finance Act 2021 has stated that the goodwill of a business or a profession is not a depreciable asset and hence the same is not eligible for depreciation. However, it has been stated that the cost of such goodwill will be allowed as a deduction as and when such goodwill is sold/transferred.

Fund Managers in India not to constitute a Business Connection or PE

Before the Finance Act, 2015, the presence of a fund manager in India was deemed to constitute a business connection in India even though the fund manager was an independent person. Thus, when a manager located in India undertook any fund management activity with respect to investments outside India for an offshore fund, the profits earned by the fund from such investments could be liable to tax in India.

In the Finance Act, 2015, it was clarified that the presence of a fund manager in India would not give rise to a business connection/PE in India with respect to offshore funds subject to the fulfillment of specific conditions and compliances by both the offshore fund and the fund managers.

With a view of introducing a relaxation, for calculating the aggregate investment, a provision was made to exclude the contribution of fund managers during the first three years up to INR 250 million.

For funds which are incorporated during any relevant previous year, it is proposed to extend the applicability of the monthly average of the corpus to INR 1,000 million, to be fulfilled within twelve months from the last day of the month of its establishment.

Presumptive Taxation

As stated earlier, the ITA also provides for a mechanism wherein income in the case of specified businesses, such as shipping, aircraft, civil construction, etc. is computed on a presumptive basis, which results in a lower effective tax rate.

  • Royalty/Fees for Technical Services : Income earned by a foreign company in the nature of royalty/fees for technical services is taxable in India on a gross basis at the rate of 10% (plus applicable surcharge and Health and education cess).
    • Presently, the definition of ‘Royalty’ excludes the sale, distribution, or exhibition of cinematographic films. As such, non-residents are not taxed in respect of such income, although a Double Taxation Avoidance Agreement (DTAA) may provide India the right to impose a tax.
    • In order to avoid such discriminatory situations for Indian residents, the Finance Act 2022 amended the definition of 'Royalty' and made the sale, distribution, or exhibition of cinematographic films taxable for non-residents.
  • Interest : Interest income earned by non-residents for loans provided in a foreign currency is taxable in India at the rate of 20% (plus applicable surcharge and Health and education cess).

However, the interest from foreign currency loans and any long-term bonds would be taxable at a concessional rate of 5% (plus applicable surcharge and Health and education cess) provided the loan or bonds are acquired during a specified period and subject to specified conditions. Furthermore, the said concessional rate of 5% (on the interest income of such bonds) would apply even if the non-resident does not have a Permanent Account Number (PAN) in India. The benefit of 5% taxation has also been extended to interest earned from Rupee Denominated Bonds.

  • Transfer of carbon credits : The Transfer of carbon credits is taxable on a gross basis at the rate of 10%.
  • Dividend : Dividend income received from an Indian company on which DDT has not been paid, is taxable in the hands of foreign companies @ 20% as per Section 115A.
  • Other income : Other income earned by foreign companies would be liable to be taxed at the maximum rate (i.e. 40% plus applicable surcharge and Health and education cess).

However, with respect to the above, where a beneficial rate/provision is prescribed under any treaty entered into by India with a foreign country, a non-resident can claim such beneficial rate/provision subject to conditions mentioned under the treaty with the respective country.

Equalization Levy

An equalization levy of 6% shall be charged on the amount of consideration for any ‘specified service’ received/receivable by the non-resident person from a person resident in India and carrying on business or profession; or from a non-resident having a PE in India. The term ‘specified service’ means an online advertisement, any provision for digital advertising space, or any other facility or service for the purpose of online advertisement and includes any other service as may be notified by the Central Government in this regard.

The equalization levy shall not be charged where the non-resident providing the specified service has a PE in India, and the specified service is effectively connected with such PE, or the aggregate amount of consideration does not exceed INR 100,000 in the previous year, or the payment made is not for the purpose of carrying out business or profession of the taxpayer.

Specific exemptions provided under Section 10 (50) of the ITA for income arising from any specified service is prescribed in this ‘Equalization Levy’ chapter. This chapter has become effective from 1 June 2016.

The Finance Act, 2020 has extended the scope of equalization levy, and the new amendments to the same are as follows:-

  • a. Applicability - E-commerce supply of goods or services on or after 1 April 2020
  • b. E-commerce supply or service will include online sale of goods or online provision of services or both facilitated/owned by the e-commerce operator
  • c. E-commerce operator means a non-resident who owns, operates, or manages a digital or e-facility or platform for the online sale of goods or online provision of services or both
  • d. The equalization levy will be applicable at the rate of 2% of the consideration received or receivable on e-commerce supply of goods or services or both by the e-commerce operator
  • e. It will be applicable for the sale or facilities provided to a resident in India or a non-resident in specified circumstances or to a person who buys goods or services or both using the internet protocol address located in India
  • f. Specified circumstances means sales of advertisements which target a customer who is resident in India, or a customer who accesses the advertisement through an internet protocol address located in India, and sale of data collected from a person who is resident in India, or from a person who uses an internet protocol address located in India
  • g. The equalization levy will not be applicable where the e-commerce operator has a PE in India, or it is leviable @ 6% as per the existing provision, or the sales of such goods/services is less than INR 20 million during the previous year
  • h. The equalization levy will be paid by every e-commerce operator by the due date to the Central government as follows
    Quarter Ending Due date for the quarter
    30 June 7 July
    30 September 7 October
    31 December 7 January
    31 March 31 March
  • i. The interest leviable is @1% and a penalty equal to equalization levy will be applicable in case of failure to pay the equalization levy.

It is also provided that income arising from e-commerce supply or services chargeable to the equalization levy (not being income which is already chargeable to tax as royalty/fees for technical services read with the relevant tax treaty) would now be exempt under Section 10(50) of the Income Tax Act, 1961.

  • 2.This income would be taxable in India whether or not the non-resident has a residence or place of business in India or has rendered services in India
  • 3.Security and Exchange Board of India Act, 1992
Get in Touch
Maulik Doshi
Deputy Managing Director
Transfer Pricing and International Tax

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