Foreign Companies & Income Tax Filing in India

As per Section 139 of the Income Tax Act (IT Act) every company, both domestic and foreign, are mandatorily required to furnish their tax returns for an assessment year. Every company should file their return on income accrued and claim their tax credit, if they are available, at the end of every financial year.

There has been a continued debate for many years on whether foreign companies are required to pay taxes in India, with the authorities heavily supporting in favor of taxing foreign companies in India. After many rulings were made on this point of law, the IT Act has been amended since 2017 to incorporate new and specific rules on the taxing of foreign corporations. Other than the IT Act, India has also entered into Double Taxation Avoidance Agreements with many countries, and companies may choose to avail the benefits under them subject to certain conditions.

Residence Rule of Income:

An individual, firm, or company’s residence is important for taxation in India, as the type of residence determines to what extent their income will be taxed.

In the instance of companies, all Indian (i.e. domestic) companies are considered to be residents and will have both their Indian and global incomes taxed under the IT Act. These are companies that are registered or incorporated in India.

To determine whether a foreign company is considered a resident or not, the place of effective management rules were introduced.

Resident Companies and Place of Effective Management:

In 2017, the ‘Place of Effective Management’ (‘POEM’) Rules were introduced by the central government. Under the POEM rules, a foreign company will be considered a resident company of India if it fulfills the following conditions:

• They are not engaged in active business outside of India.
• And on identifying and ascertaining the persons who make the key managerial decisions for the conduct of the company’s business, and where these decisions are taken, the place of such decision-making is found to be in India.

The POEM rules require a holistic analysis of a company’s decision-making, to determine the actual place of effective decision-making and management of a company. If it is found on reviewing the locations of regular meetings of the board, or the location of the executive committees that make the decisions for the company, etc. that the place of effective management of that company is in India, then the foreign company will be deemed to be a resident company. If it is a resident company, then their entire income (including their global income) is liable to be taxed in India.

Although these foreign companies are deemed to be a ‘resident’ company they will be liable to pay a higher tax rate of 40% as opposed to the rate of 22%/25%/30% of corporate tax paid by Indian domestic companies.

Taxation of Non-Resident Companies:

All foreign companies that do not have POEM in India will be considered a non-resident company. While resident companies (including foreign companies with POEM in India) will be taxed according to the residence rule, non-residence companies will only be taxed on income that arises in India. This is known as the ‘source’ rule of taxation.

According to Section 90 of the IT Act, non-resident companies are provided the benefit of both the IT Act and the double taxation avoidance agreements entered by India with other countries, and they can choose whatever is more beneficial. As per these sections, only the income attributable to India for non-resident companies will be taxable in India. Hence, the concept of ‘permanent establishments’ is important.

What are Permanent Establishments (PE)?

In international taxation, the taxability of the income of a foreign company in a domestic jurisdiction is dependent on whether the activities of the company are conducted through a permanent establishment. A PE is defined in Indian law, as “a fixed place of business through which the business of a foreign enterprise is carried on wholly or in part.”

A PE provides a mechanism to determine the taxation of companies that might be widely established across different countries. In India, the business income of a non-resident company taxes that arises or accrues either directly or indirectly through (or from) its PE in India.

Hence, whether or not PEs have been established in a country, becomes a very important question for companies.

When non-resident companies have PEs in India:

PEs are defined in every tax treaty, and these definitions can contain specific inclusions and exclusions. Non-resident companies can always avail the more beneficial part of a double taxation avoidance agreement, depending on the facts and circumstances. The details for PEs are generally laid down in Article 5 of the Tax Treaties with India.

To determine the existence of a PE in India, the type of PE and the relevant factors therein have to be considered. There are three main kinds of PEs: fixed place PE, agency PE, and service PE.

1. Fixed place PE: For such a PE to exist, the following factors have to be complied with:

• The foreign company has a fixed place of business i.e. a physical place of business in India; and
• Business must be carried on (wholly or partly) from this place with a reasonable degree of continuity and regularity.

Examples of such PEs are branch offices of foreign companies in India, sales outlets, factories, etc.

2. Agency PE: A situation where an Indian resident (agent) is representing or acting on behalf of a foreign company. The following factors should be considered to determine whether such a PE exists:

• If the agent has the authority to enter into contractual agreements on behalf of the foreign company, and
• Agent acts on behalf of the foreign entity, and
• Whether the agent is subject to control and direction from the foreign entity,
• The agent is not an agent of independent status.

3. Service PE: If a PE is engaging the services of the employees of a foreign company in India, for a period of more than 6 months, then that could indicate the establishment of a PE.

Simply having a physical office or subsidiary or outlet, does not mean that a PE has been established in India. Here are some other rules that are relevant to determine the existence of a PE:

• Mere fixed place of business would not indicate a PE. The place has to be actually carrying forward activities in business.
• The business activity should have a connection to the place of business.
• The management and control should be exercised in the PE in India.

Once the PE of a foreign company is determined in India, then the business income (royalty fees, technical service fees, etc.) derived from the PE, which is attributable to India, will be subject to taxation under the IT Act. i.e. the facts and circumstances will have to be considered to determine which of the income can be attributed to the PE operations in India. This is done by analyzing the functions performed, assets utilized, and risks assumed (FAR analysis). Only the income attributed to India will be taxed in India.

As it is a non-resident company, it will be subject to an income tax levied at 40%. Foreign Companies with a PE will have to also pay a minimum alternate tax of 15%, under the IT Act.

While these are the general provisions under the IT Act, if any special provisions are mentioned under the double taxation avoidance agreement, then those will prevail. Similarly, in case there are any conflicts between the provisions of the DTA and the Indian law, the provisions of the DTA will prevail.

If a foreign company does not have a PE:

If a foreign company does not have a PE in India, it does not mean that they are completely excluded from being taxed in India. There are still some activities that will be taxed, and where the company will still have to file their returns.

Even if a foreign company does not have a PE, the income earned by a foreign company from an Indian company by way of fees for royalty or technical services, is considered to be income arising or accruing in India. If the Indian company has deducted and paid withholding tax, then the foreign company need not make the payment but will have to furnish their returns alongside the required timelines.

If the tax is not paid and deducted by the Indian company, then it will be the liability of the foreign company. Similarly, they will have to pay and file for any other sources of income that arise in India.

Foreign companies without a PE in India are exempt from having to pay minimum alternate tax.

Do foreign companies require PAN details for filing of tax?

All companies that are deducting tax at source would have to furnish PAN as part of their income tax filing. Section 206AA of the IT Act mandated the requirement of a PAN card for all companies deducting tax at source. If a company did not furnish PAN then the deductor could charge tax at a higher rate. Further, in such cases, foreign companies were also not allowed to avail of any beneficial provision under their DTAA, if it was applicable.

However, this rule has received some relaxation, based on rulings by tribunals in India. The benefits of the DTAAs can be availed by foreign companies, even if it is in contravention of the IT Act. To avail of the benefits under the DTAAs, foreign companies must ensure to file Form 10F electronically as mentioned in the IT Act. This form requires companies to submit details on the tax residency status, country of origin, etc.

Generally, if a non-resident company has a PE in India, there will be a requirement to deduct tax at source so PAN will be required. For non-resident companies only having income by way of technical fees, or royalty services and no PE, then PAN details will not be necessary.

Documents required to take benefit of DTAA

Any foreign company taxable in India under the Income Tax Act 1961 but not under the DTAA, or taxable at a higher tax rate under the Income Tax Act 1961 but a lower tax rate under the DTAA, can avail of the Double Taxation Avoidance Agreement by providing the following documents:

• Tax Residency Certificate: It is necessary to submit a Tax Residency Certificate while filing Form 10F electronically to the Income Tax Department.
• Form 10F: It is necessary to submit Form 10F electronically to the Income Tax Department after 30/09/2023.
• Declaration of No Permanent Establishment in India: The company must furnish a declaration stating that they do not possess any permanent establishment in India, such as a place of management, a branch, an office, a factory, or a workshop.

RECENT CHANGES TO FORM 10F

Form 10F is a self-declaration tax form used by non-resident (NR) taxpayers to claim benefits under the DTAA (Double Taxation Avoidance Agreement). Recent changes in the Form 10F procedures have implications for foreign companies rendering technical services in India without a permanent establishment. Historically, non-residents were required to submit a Tax Residency Certificate (TRC) and a self-certified Form 10F in written format.

However, in July 2022, the CBDT mandated the electronic filing of Form 10F. This change posed challenges for non-residents, including the necessity for income tax portal registration, a mandatory Permanent Account Number (PAN), and a Digital Signature Certificate (DSC).

Key developments and considerations by CBDT:

• PAN relaxations: To accommodate non-residents without a PAN, the CBDT introduced relaxations in March 2023, allowing manual submission of self-certified Form 10F until September 30, 2023.
• New registration category: Following the relaxation period, a new registration category was introduced for 'non-residents not having a PAN and not required to have a PAN.' This allows non-residents to register without a PAN and file Form 10F electronically.
• Digital Signature Certificate: Non-residents must digitally sign Form 10F using a DSC obtained in India.

Judicial Pronouncements:

There may be a scenario where the income earned by a foreign company in India is liable to tax under the Act but may be exempt from tax in India under the DTAA.

The following paragraphs briefly explain two possible points of view:

The Authority for Advance Rulings (‘AAR’) in Veneburg Group, In re [2007] 289 ITR 464 and others, have held, on the issue of filing of the return by a foreign company whose income is exempt from tax under the DTAA, that Section 139 and other sections are merely machinery sections to determine the amount of tax and that there would be no occasion to call a machinery section in aid where there is no liability at all. And therefore, there is no requirement to file the return of income by such foreign companies. The AAR in holding so relied on Chatturam v. CIT [1947] 15 ITR 302 (FC). In Chatturam (supra), the Federal Court in a different context observed that ‘The liability to pay the tax is founded on Sections 3 and 4 of the Income tax Act, which are the charging sections. Section 22 [casted as section 139 under the 1961 Act] etc are the machinery sections to determine the amount of tax’.

Therefore, in one view, the more favorable provisions of the DTAA for a foreign company replace the provisions of the law, i.e. Section 139(1), which requires the company to file the return of income shall not apply to such a company.

However, subsequently, the AAR in VNU International B.V., In re [2011] 334 ITR 56 (AAR), while ruling on the identical issue, noted that the Legislature in its wisdom has, while casting obligation to file a return of income by a company, omitted to include the expression ‘exceeded the maximum amount which is not chargeable to income-tax’. Further, as per the third proviso, every company is required to file its return of income, whether it has an income or a loss. That a foreign company is covered within the definition of a company under Section 2(17) of the Act. It also took note of the fact that where it is not necessary for a non-resident to furnish a return under Section 139(1) of the Act, the statute has specifically provided. It thus held that there is an obligation to file the return of income by a foreign company on the income earned in India, even though the resulting tax is Nil on account of the applicability of DTAA.

Further, as regards the reliance placed on Chatturam (supra), it may be noted that the observation was that the liability to pay tax can only be as per sections 4 and 5. One may argue that what is contemplated under Section 139(1) is only to furnish a return of income; it does not contemplate the payment of taxes thereof and thus, the payment of taxes is still governed by the charging provisions.

Therefore, another view could be that if the income of a foreign company accrues or arises in India which is taxable under the Act but is exempted from taxation under the DTAA, the foreign company is under an obligation to file a return of its income accrued or arise in India. The same applies if the income of the foreign company consists of dividends, interest, royalties, or technical services, and the said incomes are exempt from taxation under the DTAA or the tax has been deducted as per the rate of tax under the DTAA which is lower than the rate prescribed under section 115A(5) of the Act.

Conclusion:

The rules of taxation for a foreign company may feel very complex, but changes have been slowly introduced to try and make it easier for foreign companies to do business in India.

The main considerations to remember are these:

• Residential companies are taxed on both their Indian and global income. Foreign companies with a POEM in India are also residential companies.
• Non-residential companies are taxed in India if they have a PE in India. However, only the profits attributable to the Indian PE will be taxed.
• Non-residential companies without a PE will be liable to pay for income earned by way of fees and royalty for technical services. Unless this has been paid and deducted by the Indian company.
• Residential companies and non-residential companies with a PE in India will be liable to pay minimum alternate tax.