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By Siri Bulusu
Uncertainty looms in the weeks leading up India’s union budget with no clarity on how the government will tackle offshore tax deferral for outbound investments.
At issue is whether the Indian government will pursue a previously announced “place of effective management” tax or introduce an anti-avoidance controlled foreign corporation provision.
Both provisions are aimed at taxing passive income earned by a foreign company that is controlled either directly or indirectly by an Indian resident, but experts say the government could introduce both provisions or neither in the upcoming union budget.
Outbound investments from India totaled $8.86 billion in 2011-2012, about half of total investments from 2010-2011 which totaled $16.84 billion.
The place of effective management (POEM) provision was introduced in the 2015 budget with the intent to apply it to fiscal year 2015-2016, but the government released draft guidance close to the end of 2015 year and therefore postponed application to fiscal year 2016-2017.
Industries have responded negatively to the draft rules—saying they would discourage outbound investments and lead to an increase in tax litigation, which could sway the government to defer the provision yet again.
The controlled foreign corporation (CFC) provision, however, would ensure that passive income earned by an Indian resident via a foreign company falls under India’s tax jurisdiction, but using a fact-based approach to determining whether the foreign entity may be deemed a controlled foreign company.
“I think POEM will get deferred again because there are no set rules stating how they will execute the law,” Girish Vanvari, tax head and partner at KPMG India, told Bloomberg BNA Jan. 7. “The question is whether place of effective management will be ‘checked and balanced’ by controlled foreign corporation.”
Place of effective management and controlled foreign corporation are very similar in matured economies in that they both tax the global income of Indian-run companies , Vanvari said, but POEM needs to clarify what constitutes running a company in India by segregating stewardship and management.
“Not knowing what will fall under POEM is a big deterrent and complication,” Vanvari said. “If a foreign company holds board meetings in India, will it become taxable? The guidelines need to be specific.”
Vanvari said if the government is keen on implementing place of effective management, then it should introduce controlled foreign corporation simultaneously to ensure tax officers don’t harass companies and discourage India’s steps toward globalization.
“It’s important that Indians are encouraged to do business overseas,” Vanvari said. “This cannot happen if you have POEM without CFC. We must have both or neither.”
Tax professionals agree that the subjectivity associated with place of effective management can be a deterrent for outbound investments, but feel that place of effective management can stand on its own once industry comments are incorporated into the final draft of the law.
“There was uproar among stakeholders because of the subjectivity of the POEM rules,” Arpit Jain, director of Baroda-based accounting firm K.C. Mehta and Co., told Bloomberg BNA Jan 10. “If there is no clear-cut guidance, then it should not be invoked because tax officers would harass companies.”
Jain said a place of effective management tax provision with “tight rules” would sufficiently establish taxing rights on passive income of companies operated in India and that the general anti-avoidance rules coming into affect on April 1, 2016, are enough to rein in the shell companies the controlled foreign corporation provision is targeting.
“CFC is generally perceived as an anti-avoidance mechanism, but what it would do is end up taking the entire income earned abroad.” Jain said. “I don’t see a sudden policy shift that would cause the government to go back on POEM and bring in CFC, especially with GAAR coming into the mix.”
Rajesh Gandhi, tax partner at Deloitte in Mumbai, disagreed with Jain. Gandhi said that while the controlled foreign corporation rules are anti-avoidance, they aren’t redundant to India’s general anti-avoidance rules because the CFC rules are specific to taxation of passive income earned overseas while GAAR has a much wider scope.
Gandhi added that if the Indian government wants to promote offshore investments, then India isn’t ready for either tax provision, but if anything passes it should be CFC.
“It is difficult to say,” Gandhi said, adding that if the government has to do something, “they should only do CFC.”
“The Indian tax system is becoming mature and if you implement CFC in the proper way, there wouldn’t be any negative impacts on outbound investments,” he said.
Gandhi said the controlled foreign corporation provision is more in line with international best practices while the place of effective management provision would discourage Indian companies from doing business abroad and keep international boards from holding meetings in India.
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