Friday, July 30, 2010

Law Street - Economic Times (July 2010) -CFC Rules, Keep it simple

Dear Readers,
It appears that India is gearing up to introduce CFC Regime. However, introduction of these without measures such as underlying tax credit, participation exemption or even parent-subsidiary directives will not augur well for Indian companies having overseas subsidiaries. Practical safe harbours must be introduced and an underlying tax credit mechanism assured to Indian companies prior to introduction of the CFC Regime.

You can read this in the online edition of The Economic Times.

This photograph was taken in July 2010 off the Worli Sea Face. If CFC is implemented in a hurry without much thought, the dreams of Indian companies planning overseas expansions will be "ON THE ROCKS"

Alternatively scroll down below.
Best regards,

CFC Rules: Keep it simple!

Alternative measures would do away with the need for CFC rules

If introduced, exemptions must be carved in CFC rules

Underlying tax credit must be introduced

Thick heavy clouds hung over a stormy Arabian Sea. Flashes of lighting streaked across the sky. The scene could be regarded either as spectacular or gloomy, depending on how one chose to see it. Much like the revised discussion paper (RDP) on the proposed direct tax code - one could say that the Central Board of Direct Taxes (CBDT) had ironed out many difficulties or one could say it had only added to the problems of the corporate tax payer.

Zenobia Aunty, down with a few niggling ailments, was not her cheerful self and preferred to see the glass half empty, so to speak. A paragraph tucked away in the RDP proposing the Ministry of Finance intent to introduce Controlled Foreign Corporation (CFC) provisions in India, caught her eye.

This proposal is viewed as an anti-avoidance measure and provides that passive income earned by a foreign company which is directly or indirectly controlled by an Indian resident, shall be subject to CFC provisions. In other words, even where such passive income is not distributed to the Indian shareholders it shall be treated as having been distributed and shall be subject to tax in India in the hands of the Indian shareholders as dividend income.

Mind you, dividend received in India is taxed at the full corporate rate (currently 30%) plus applicable surcharge and cess. It is only dividend that is declared by an Indian company, on which dividend distribution tax has been paid, that is exempt from Indian income tax in the hands of its shareholders be they Indian or foreign shareholders.

“Why introduce something which was not there in the draft direct tax code?” muttered Zenobia Aunty. “Why can’t they go to the root of the problem?” she added and stomped her foot in anger taking a slumbering Spot by surprise.

Dear readers, please bear with her while she repeats herself: If only, India would exempt dividend repatriated from overseas there would be no need for Indian companies making overseas forays to set up intermediary holding companies to park overseas profits and no need for introduction of complicated CFC provisions. True, the Indian corporate tax rate has steadily declined, but if one compares it with the tax rates in some developed regimes, such as neighbouring Singapore which is now 17% we still have a long way to go. Thus bringing back dividends into India and subjecting such income to 30% doesn’t make economical sense, it seems more feasible to keep it overseas and use it for further overseas growth. The best solution, to attract dividend repatriation, is either a full exemption to foreign dividends repatriated to India or if this is not possible, a reduced rate of tax.

“Further, how could the intention of introducing CFC provisions be announced without a parallel intent to introduce underlying tax credit rules? In the absence of underlying tax credit rules, the Indian multinational will be subject to multiple taxation of the same income” exclaims, Zenobia Aunty. An underlying tax credit is a credit for any tax on the underlying profits, out of which the dividend is paid.
Perhaps it was the Vijay Mathur Committee, which in its report in January 2003, first made mention of the need for introduction of CFC provisions. However, the very same report also spoke of the need to introduce underlying tax credit. This report provided illustrations of various exemptions from the CFC regime (in other words instances where the undistributed profits would not be taxed in the hands of the Indian shareholder as dividend income in India). The exemptions covered: a CFC that would distribute a certain percentage of income in a year; was engaged in genuine business activities; was not established for the purpose of avoiding domestic tax; was listed on a stock exchange; or even a de-minimis exemption if the total income of the CFCs did not exceed a particular threshold amount.

In addition, the Vijay Mathur Committee accepted that since CFC regime attributes income to the shareholders before actual distribution of income, relief provisions are ordinarily built in to prevent double taxation of CFCs income which is subsequently distributed. It provided illustrations for inclusion of relief provisions such as: relief on account of foreign taxes paid; relief on account of dividend paid out of the previous attributed income; relief in respect of losses incurred and relief from double taxation on subsequent capital gains arising from disposition of shares arising out of CFC by the shareholder, where the shareholders have been previously taxed on the undistributed income of the CFC.

It would have been simpler to encourage repatriation of foreign dividend into India, but now that the intent to introduce CFC is made clear, care must be taken to ensure it does not sound the death knell for Indian companies. Perhaps, some sensible measures will cheer up Zenobia Aunty.

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