Introduction
Section 115JH of the Income Tax Act of 1961 (“ITA”) pertains to residential status of foreign companies in India. It stands for ‘special provisions relating to foreign companies said to be resident in India’. This section is an important part of the taxation laws of India as foreign companies are subjected to different taxation treatments on the basis of their residential status, i.e., whether the company is a resident or non-resident in India. Thus, this section is the key determinant of how the foreign companies should be taxed and managed in the Indian legal framework.
By examining the intricacies of Section 115JH and its impact on the residential status of foreign companies in India, this article aims to provide valuable insights for companies navigating the complexities of the Indian taxation system.
Objective
The objective of this article is to conduct a deep analysis of section 115JH of the Income Tax Act of 1961 and to understand its implications and effects on foreign companies operating in India. This article further aims to discuss the different considerations that have to be made when determining the residential status of a foreign company in India. Further, this article will analyze the legal framework of taxation imposed on foreign companies in India and how it affects their operations.
ANALYSIS OF SECTION
I. Taxation of Foreign Companies in India
Under Indian law, the taxation of foreign companies operating in India is determined by their residential status as specified in section 115JH of the Income Tax Act, 1961. According to the provisions of this section, a foreign company can be classified as either ‘resident in India’ or ‘non-resident in India’.
A. Determining the Residential Status of a Foreign Company
With effect from Assessment Year 2017-18, a company is said to be resident in India in any previous year, if:
(i) it is an Indian company; or
(ii) its place of effective management, at any time during that year, is in India.
For this purpose, the “place of effective management” means a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.
The concept of POEM is effective from Assessment Year 2017-18. The CBDT has issued the final guidelines for determination of POEM of a foreign company.
The guidelines issued by the Central Board of Direct Taxes (CBDT) for determining POEM introduce some unique features, such as the Active Business Outside India (ABOI) test. Under these guidelines, a company is regarded as engaged in “active business outside India” if passive income does not exceed 50% of its total income. Additional conditions related to the location of assets, employees, and payroll expenses must also be satisfied.
For companies engaged in active business outside India, the place of effective management is presumed to be outside India if a majority of the board of directors’ meetings are held there.
In cases of companies not engaged in active business outside India, determining the POEM involves a two-stage process-
- The first stage involves identifying the individuals responsible for making key management and commercial decisions for the company as a whole.
- The second stage entails determining the actual location where these decisions are made.
However, it is important to note that the POEM guidelines do not apply to companies with a turnover or gross receipts of INR 50 crores or less in a financial year, as specified in Circular No. 8, dated 23-2-2017.
The residential status of a foreign company in India is decided by the application of the ‘residence in India’ test. This test is based on the ‘place of effective management’ criterion. Under the residence in India test, if the place of effective management of a foreign company is situated within the territories of India then it shall be considered as resident in India. The concept of ‘place of effective management’ is not defined in the ITA. However, it is explained as the direction and management of the operations and affairs of the foreign company’s business. Further, under section 115JH of the ITA, the provisions of the applicable tax treaty signed between India and the foreign country shall have the overriding effect if there is any conflict between the provisions of the ITA and the tax treaty.
B. Taxation of Foreign Companies in India
The taxation of foreign companies resident in India is governed by the provisions of the ITA. The taxation framework is mainly divided into three categories, namely, domestic taxation, global taxation, and taxation on international transactions of foreign companies.
1. Domestic Taxation
In regards to domestic taxation, the provisions of the ITA that apply to domestic taxation are the same as those applicable to Indian companies. The applicability of tax laws in the case of foreign companies depends on the fact whether they have a ‘permanent establishment’ in India or not. In case of foreign companies having a permanent establishment in India, they will be taxed just like Indian companies on their Indian operations. The rates of income tax as imposed by the ITA are Zero in case a foreign company has profits in its income of up to 2 million rupees. For incomes more than 2 million rupees the rate of income tax ranges from10% to 30%. Further, profits earned by the foreign company on its operations outside India shall not be liable for taxation in India.
2. Global Taxation
The global taxation framework applies both to the income of a foreign company earned within India and outside India. Under this framework, foreign companies will be liable to pay taxes on their worldwide income. The tax rate imposed on the global income of the company will be the higher of the rate applicable in India on its domestic operations or the rate of tax applicable in the foreign country in which the foreign company is located.
3. International Transactions
International transactions involving transfer of funds such as payments of royalty, technical fees, or interest shall be subject to the provisions of the ‘Transfer Pricing Rules’ and the ‘Advance Pricing Agreement Rules’ as specified in section 92 of the ITA. Further, these transactions will be subject to the ‘arm’s length’ principle that intends to provide a ‘fair’ pricing mechanism for all such transactions.
C. Tax Treaties
India has entered into ‘double taxation avoidance agreements’ with several countries across the globe. These agreements provide relief from double taxation arising out of international transactions. According to these agreements, if any income or profits earned by a foreign company located in India is being taxed in the foreign country then the same shall not be subject to taxation under the ITA.
II. Analysis of Implication of Section 115JH on Foreign Companies
From an analysis of section 115JH, it can be observed that the taxation of foreign companies in India is regulated by their residential status, i.e., whether it is considered as resident or non-resident in India. Further, the taxation regime applicable to foreign companies varies depending upon the place of effective management of the company and the tax treaty, if any, between the two countries. The taxation framework applicable to foreign companies is mainly divided into domestic taxation, global taxation, and taxation on international transactions.
Conclusion
In conclusion, it can be observed that section 115JH of the Income Tax Act, 1961, is an important section that determines the residential status of foreign companies in India. The residential status of a foreign company in India determines the taxation to which it is subjected and affects its business operations. Under the provisions of this section, foreign companies can be classified as either ‘resident in India’ or ‘non-resident in India’ based on the application of the ‘residence in India’ test. Further, the taxation framework applicable to foreign companies is divided mainly into domestic taxation, global taxation, and taxation on international transactions. Thus, to conclude, it can be said that section 115JH of the ITA is an important consideration for determining the tax obligations of foreign companies in India.
(Author can be reached at email address casharma.sharad2000@gmail.com or on Mobile No. 9990365673)
Disclaimer: “Neither this article nor the information contained herein shall in any way be construed as forming a contract or shall constitute professional advice required before acting upon any matter. CA Sharad Kumar Sharma has taken all due care in the preparation of this article for accuracy in its contents at the time of publication. However, no liability shall be accepted by him in the event of any direct, indirect or consequential damages arising out of or in any way connected with the use of this article or its contents. “
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