July 10, 2018
TaxBuzz - Final Notification under section 115JH of the Act – Clarifications for foreign companies having POEM in India
In exercise of powers conferred under section 115JH, the Central Board of Direct Taxes has issued the Notification No. S.O. 3039 (E) dated 22 June 2018 providing the exceptions/modifications/adaptation relating to mode of computation of total income, unabsorbed depreciation, brought forward loss, collection and recovery of tax in case of a foreign company deemed to be resident in India on account of its ‘place of effective management’.
Background
Section 6(3) of the Income Tax Act, 1961 (‘the Act’) deems a foreign company to be resident in India if its ‘place of effective management’[1] (‘POEM’) during that year is in India.
Where a foreign company as per the aforesaid provisions of section 6(3) is deemed to be ‘resident’ in India in a previous year, the issue arises as to the applicability of certain deductions/exemptions to foreign company while computing business income, such as calculation of unabsorbed depreciation, brought forward losses, opening Written Down Value (‘WDV’) of depreciable assets etc. In order to address the same, section 115JH provides that certain provisions of the Act relating to mode of computation of total income, unabsorbed depreciation, brought forward loss, collection and recovery of tax shall be applicable to such foreign company (deemed to be resident in India) with certain exceptions/ modifications/ adaptations as may be notified by the Central Government.
In exercise of aforesaid powers conferred under section 115JH, a draft notification[2] dated 15 June 2017 was issued by the Central Board of Direct Taxes (‘CBDT’) for public comments. The CBDT has now issued final notification viz. Notification No. S.O. 3039 (E) dated 22 June 2018.
As per the provisions of section 115JH(3) of the Act, the notification is required to be laid before each House of Parliament.
Salient features of the Final Notification
Method for determination of the opening Written Down Value (‘WDV’) of depreciable assets for the purpose of computation of depreciation
Where the foreign company is assessed to tax in a foreign jurisdiction and depreciation is required to be taken into consideration while computing taxable income
The WDV of the depreciable assets as per the taxpayer’s tax record in the foreign jurisdiction as on the 1st day of the previous year shall be deemed to be the opening WDV of the depreciable assets.
Where the foreign company is not assessed to tax in a foreign jurisdiction or where depreciation is not allowed as deduction while computing taxable income
WDV of the depreciable asset as appearing in taxpayer’s books of accounts (maintained in accordance with the laws of the foreign jurisdiction) as on the 1st day of the previous year shall be adopted as opening WDV.
Method of determination of unabsorbed depreciation and brought forward losses
Where the foreign company is assessed to tax in a foreign jurisdiction
To be determined year wise on the basis of the taxpayer’s tax record in foreign jurisdiction on the 1st day of the previous year
Where the foreign company is not assessed to tax in a foreign jurisdiction
To be determined year wise on the basis of the taxpayer’s books of account prepared in accordance with the laws of foreign jurisdiction on the 1st day of the previous year
Other points in relation to method of determination
The brought forward loss/unabsorbed depreciation shall be allowed to be carried forward and set off in accordance with the provisions of the Act for the remaining period calculated from the year in which they first occurred by considering such year as the first year.
VA Comments:
For example: If unabsorbed business loss occurred in the hands of the foreign company in AY 2015-16 whose POEM was found to be in India in assessment year 2018-19, which could not be set-off even in that year, then such business loss shall be available for carry forward only for the remaining period of 5 assessment years out of 8 assessment years commencing from AY 2016-17 in terms of section 72 of the Act.
The brought forward loss/ unabsorbed depreciation would not be allowed to be set off against income of the foreign company which would have been subject to tax in India even in its capacity as a non-resident. Accordingly, the brought forward loss/ unabsorbed depreciation can be set off only against such income of the foreign company which became chargeable to tax in India only by virtue of the foreign company becoming resident in India on account of POEM in India.
VA Comments:
For example: Where ‘royalty’ income earned by a foreign company is subject to tax in India in its capacity as a non-resident and the foreign company is also treated as resident in India on account of its POEM in India, then the brought forward loss/unabsorbed depreciation would not be permitted to be set off against such ‘royalty’ income.
Where the brought forward loss or unabsorbed depreciation is revised in the foreign jurisdiction, the amount of losses or depreciation will stand revised in India as well.
In the event of different ‘previous year’ being followed in the foreign jurisdiction, separate guidelines have been issued, which are discussed infra.
Where a foreign company is deemed to be resident of India on account of POEM in subsequent years, then the modifications prescribed by the notification shall continue to apply in those years as well. In such subsequent year(s), the WDV and brought forward loss/unabsorbed depreciation shall be as per the provisions of this final Notification.
Preparation of profit and loss account and balance sheet
Where the accounting year followed by the foreign company does not end on 31 March (eg. where it ends on 31 Dec), then such foreign company would be required to prepare its profit and loss account and balance sheet for the period starting from the 1st day of the immediately succeeding accounting year followed by the foreign company (ie 1 January) and ending with 31 March of the immediately preceding financial year during which the foreign company became resident in India on account of POEM.
The foreign company shall also be required to prepare the profit and loss account and balance sheet for the succeeding periods of twelve months, beginning from 1 April and ending on 31 March, till the year the foreign company remains resident in India on account of its POEM.
Applicability of other provisions to a ‘foreign company’ resident in India
It is provided that where there is a conflict between the provisions applicable to resident as well as foreign company, the provision applicable to the foreign company alone shall prevail.
VA Comments:
Illustrations
The withholding tax obligation on payment for ‘works contract’ by a resident in India to such foreign company deemed to be resident in India on account of POEM shall be governed by the provisions of section 195 as against section 194C; the former being specific to foreign company shall prevail over the latter.
The rate of income tax as applicable to a foreign company (currently 40%) shall continue to apply, even though the tax status of the foreign company changes from non-resident to resident on account of POEM.
Transaction of a foreign company with any other person or entity under the Act shall not be altered only on the ground that the foreign company is resident in India on account of POEM.
VA Comments:
Illustration
Where the shares of a foreign company deemed to be resident in India on account of POEM held by a non-resident entity are transferred, then such sale will not be taxable in the hands of non-resident seller in India, merely because such company is deemed to be resident in India, unless it meets the test of substantial assets being located in India in terms of Explanation 5 to section 9(1)(i) of the Act.
The exceptions/modifications prescribed in the final Notification shall not apply in respect of such income of the foreign company (becoming tax resident in India on account of POEM) which would have been chargeable to tax even if it was not resident in India.
VA Comments:
Illustration
‘Royalty’ income is earned by the foreign company and such royalty income is chargeable to tax in India under section 115A in its capacity as a non-resident in India. The foreign company is treated as resident on account of it POEM in India. In such a case its global income will be subject to tax in India and normally it should be eligible to claim credit for foreign taxes paid. However, the notification expressly mentions that its provisions will not be applicable to the abovementioned ‘royalty’ income. Consequently, there is a possibility that the relief of foreign tax credit as specifically provided for in the final Notification, may not be available against tax paid in foreign jurisdiction on such ‘royalty’ income.
Relief from double taxation
The foreign company deemed to be resident in India on account of POEM shall be entitled to credit of foreign tax paid outside India in accordance with the provisions of sections 90/91 of the Act. The relief in the form of foreign tax credit shall be provided in the same proportion in which income is offered to tax in India in accordance with the Foreign Tax Credit rules contained under Rule 128 of the Income Tax Rules, 1962.
Other miscellaneous features
The rate of exchange for conversion of a value expressed in foreign currency, shall be in accordance with Rule 115 of the Income Tax Rules, 1962[3].
The final Notification shall be deemed to have come into force from April 1, 2017.
VA Comments:
The Notification seeks to bring clarity on application of various provisions of the Act on such foreign companies more specifically relating to allowance of set-off of brought forward losses, unabsorbed depreciation and credit of foreign taxes paid, which were ambiguous prior to the issuance of the Notification.
However, there are still several additional questions which would need clarity as to taxation of such foreign companies deemed to be resident in India like:
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Applicability of Section 115JB relating to ‘Minimum Alternate tax’ on book profit
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Applicability of advance tax provisions qua such foreign companies
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Requirement to obtain tax audit report under section 44AB of the Act
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The transfer pricing provisions apply in relation to international transaction between a person resident in India and its non-resident associated enterprise. Hence, greater clarity is required on whether the transfer pricing provisions shall apply on transaction between such foreign company, deemed to be resident in India, and another associated/related Indian company resident.
The Act provides certain incentives/deductions to an Indian company (like deduction under section 80IA/80IB, etc.) Pending further clarification, while the foreign company deemed to be resident in India will be subject to tax like an Indian company, however, it shall stand discriminated and not be allowed incentive/deduction available to similarly placed Indian companies. Where non-discrimination provisions exist in the applicable Tax Treaty, it may be possible for the resident foreign company to invoke the said Article and defend against such discrimination.
The Notification, while seeking to clarify and extend benefits to foreign companies deemed to be resident in India simultaneously takes away certain benefits, such as not extending some exemptions/deductions under the notification to that income of the foreign company which would have in any event been taxable in India in its capacity as a non-resident. The issue would arise whether such notification to the extent it goes beyond the scheme of the Act and is not favorable to the taxpayer would be binding on such taxpayers and a view different than the notification could be taken.
For any details and clarifications, please feel free to write to:
[1] Explanation to section 6(3) defines POEM as a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole, are in substance made.
[2] F No 370142/19/2017 - TPL
[3] Rule 115 provides for adoption of telegraphic transfer buying rate of foreign currency as on the specified date i.e. the rate or rates of exchange adopted by the State Bank of India for buying such currency, where such currency is made available to that bank through a telegraphic transfer. (Refer Explanation to Rule 26)
