Taxation of a foreign company having POEM in India- Section 115JH
Introduction:
Section 6(3) of the Income Tax Act, 1961 provides the provisions for determination of “Place of Effective Management” (POEM) in case of a foreign company. According to section 6(3) if the POEM of a foreign company is in India, it shall be treated as “Resident” for the purposes of Income Tax in India and the global income of such foreign company shall be taxable in India for that previous year. This might also lead to double taxation as it’s income will be taxed in the country of incorporation as well as in India. Therefore, a section has been inserted in the Income Tax Act to provide special provisions for a foreign company which is having its POEM in India effective from April 1st, 2017. In this article, we shall discuss section 115JH and corresponding circular issued by CBDT to give effect to the provisions of section 115JH.
Section- 115JH:
(1) Where a foreign company is said to be resident in India in any previous year and such foreign company has not been resident in India in any of the previous year preceding the said previous year, then, notwithstanding anything contained in this Act and subject to the conditions as may be notified by the Central Government in this behalf, the provisions of this Act relating to the computation of total income, treatment of unabsorbed depreciation, set off or carry forward and set off of losses, collection and recovery and special provisions relating to avoidance of tax shall apply with such exceptions, modifications and adaptations as may be specified in that notification for the said previous year:
Provided that where the determination regarding foreign company to be resident in India has been made in the assessment proceedings relevant to any previous year, then, the provisions of this sub-section shall also apply in respect of any other previous year, succeeding such previous year, if the foreign company is resident in India in that previous year and the previous year ends on or before the date on which such assessment proceeding is completed.
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Analysis: If a foreign company is said to have POEM in India in any previous year, it will be treated as “Resident” in India in that previous year. Therefore, the global income of the foreign company including income in the country of incorporation shall also be taxable in India in respect of the said previous year. Such foreign company might have to pay tax in India as well as country of incorporation. However, it will be allowed the benefit/ relief of double taxation avoidance provisions of the Income Tax Act. Income of foreign company having POEM in India shall be calculated in accordance with the provisions of section 115JH. As per section 115JH, the provisions of this Act will be applicable to such foreign company and computation of income of the company shall be made as a resident assessee as per the provisions of the Act. Unabsorbed depreciation & carry forward losses of such foreign company in the country of incorporation may also be set off & carried forward in India while computing taxable income as per Income Tax Act, 1961. However, a notification shall be issued to prescribe the modifications, exceptions and adaptations in this regard. |
(2) Where, in a previous year, any benefit, exemption or relief has been claimed and granted to the foreign company in accordance with the provisions of sub-section (1), and, subsequently, there is failure to comply with any of the conditions specified in the notification issued under sub-section (1), then, -
(i) Such benefit, exemption or relief shall be deemed to have been wrongly allowed;
(ii) The Assessing Officer may, notwithstanding anything contained in this Act, re-compute the total income of the assessee for the said previous year and make necessary amendment as if the exceptions, modifications and adaptations referred to in sub-section (1) did not apply; and
(iii) The provisions of section 154 shall, so far as may be, apply thereto and the period of 4 years specified in sub-section (7) of that section being reckoned from the end of the previous year in which the failure to comply with the conditions referred to in sub-section (1) takes place.
To give effect to the provisions of section 115JH, CBDT has issued a detailed Notification No. 29/2018 dated 22-06-2018 which notifies modifications and adaptations in relation to the said section as below:
A. In case where a foreign company is said to be resident in India on account of its POEM being in India under sub-section (3) of the Act in any previous year and such foreign company has not been resident in India in any of the previous years preceding the said previous year, then, notwithstanding anything contained in the Act, the provisions of the Act relating to the computation of total income, treatment of unabsorbed depreciation, set off or carry forward and set off of losses, collection and recovery and special provisions relating to avoidance of tax shall apply to the foreign company for the said previous year with exceptions, modifications and adaptations specified here under:
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If the foreign company is assessed to tax in the foreign jurisdiction |
If the foreign company is not assessed to tax in the foreign jurisdiction |
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WDV of Depreciable Assets (a) Where it is required to take into account depreciation for the purposes of computing taxable income: WDV of the depreciable asset as per the tax record in the foreign country on the 1st day of the previous year shall be adopted as the opening WDV for the said previous year. (b) In cases not covered by (a), WDV shall be calculated in the manner, as though the asset was installed, utilized and the depreciation was actually allowed as per the provisions of the laws of that foreign jurisdiction and the WDV so arrived at as on the 1st day of previous year, shall be adopted to be the opening WDV for the said previous year. |
WDV of Depreciable Assets WDV of the depreciable assets as appearing in the books of accounts as on the 1st day of the previous year maintained in accordance with the laws of that foreign jurisdiction shall be adopted as the opening WDV for the said previous year. |
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Brought Forward Losses & Depreciation
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Brought Forward Losses & Depreciation
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Note:
Provided that the losses and unabsorbed depreciation of the foreign company shall be allowed to be set off only against such income of the foreign company which have become chargeable to tax in India on account of it becoming resident.
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Analysis: There may be two situations in respect of the foreign company which has been treated as resident in the previous year due to POEM established in India: (a) Such foreign company is assessed to tax in that country or It should be noted that on being treated as resident, the income of such foreign company, globally including country of its jurisdiction will be taxable in India. Therefore, we would need to ascertain WDV of its assets as located in foreign jurisdiction as on the 1st day of the relevant previous year for the purpose of computation of its taxable income in India.
For example: the asset (computer) was purchased on 01-05-2017 for Rs. 1 Lakhs in Singapore and was not subjected to depreciation there. Relevant previous year is 2020-21. Now, we will compute WDV as on 01-04-2020 by deducting depreciation at 40%= Rs. 21,600 which will be treated as opening WDV as on 01-04-2020.
The similar issue will also come in respect of unabsorbed losses & depreciation in the country of foreign jurisdiction. If the foreign company is assessed to tax in that country, unabsorbed losses & depreciation as per the tax records shall be considered. But if such company is not assessed to tax in that country, the unabsorbed losses & depreciation as per the books of accounts shall be taken into account. Now a question arises as to the period for which such unabsorbed losses shall be allowed to be set off & carried forward as per Indian laws. In this regard, it has been clarified that set off & carry forward shall be allowed for the remaining period as per Indian tax laws. For example, Alpha Inc. based at Hungary has unabsorbed business losses Rs. 10 Lakhs for Previous year 2016-17 (AY 2017-18) as per tax records of Hungary. It is treated as “resident” in India for previous year 2020-21 (AY 2021-22). So, losses of Rs. 10 Lakhs can be carried forward and set off for remaining period of 5 years (8-3) from AY 2021-22 to AY 2025-26. Further, it has also been provided that set off of such unabsorbed losses or depreciation shall be allowed against only those income of the foreign company (having POEM in India) which becomes chargeable to tax in India due to foreign company becoming resident in India on account of POEM in India. For example: Alpha Inc. (Hungary) was earning royalty income from Beta Limited (India) Rs. 50 Lakhs every year which was otherwise also taxable @ 10% (being income deemed to accrue or arise in India) in the hands of the foreign company even if the POEM had not been established in India. Therefore, set off of unabsorbed losses or depreciation shall not be allowed against the royalty income. |
Adjustments owing to difference in the accounting period:
- In cases where the accounting year does not end on 31st March, the foreign company shall be required to prepare profit and loss account and balance sheet for the period starting from the date on which the accounting year immediately following the said accounting year begins, up to 31st March of the year immediately preceding the period beginning with 1st April and ending on 31st March during which the foreign company has become resident. The foreign company shall also be required to prepare profit and loss account and balance sheet for succeeding periods of 12 months, beginning from 1st April and ending on 31st March, till the year the foreign company remains resident in India on account of its POEM.
Situation-1: If books of accounts of foreign company closes on 31st March: No adjustment will be required in the books of account to fetch WDV or balances of unabsorbed losses or depreciation.
Situation-2: If the foreign company closes books of accounts on 31st December: Suppose Foreign company is found to have POEM in India in PY 2020-21, then foreign company shall prepare its financial statements for:
(a) 01-01-2020 to 31-03-2020
(b) 01-04-2020 to 31-03-2021
(c) For 12 months ending on 31st March in every subsequent year in which it is resident in India on account of POEM
Closing balances as on 31-03-2020 shall help us ascertain opening WDV as on the 1st day of previous year (2020-21) in which the foreign company becomes resident in India on account of POEM.
Situation-3: If the foreign company closed books of accounts on 30th June: Suppose Foreign company is found to have POEM in India in PY 2020-21, then foreign company shall prepare its financial statements for:
(a) 01-07-2019 to 31-03-2020
(b) 01-04-2020 to 31-03-2021
(c) For 12 months ending on 31st March in every subsequent year in which it is resident in India on account of POEM.
- For the purpose of carry forward of loss and unabsorbed depreciation in cases where the accounting year followed by the foreign company does not end on 31st March and the period starting from the date on which immediately following year begins up to 31st March of the year, immediately preceding the period beginning with 1st April and ending on 31st March during which it has become resident, is, -
(a) Less than 6 months, it shall be included in that accounting year;
(b) Equal to or more than 6 months, that period shall be treated as a separate accounting year
Thus, if the accounting year followed by the foreign company is calendar year, the accounting year immediately preceding the accounting year in which the foreign company is held to be resident in India, shall be increased by 3 months i.e. 1st January to 31st March; and if the accounting year followed by the foreign company is from 1st July to 30th June, the accounting year immediately preceding the accounting year in which the foreign company is held to be resident in India, shall be of 9 months from 1st July to 31st March.
- In cases covered under the above para, loss and unabsorbed depreciation as per tax records or books of accounts, as the case may be, of the foreign company shall, be allocated on a proportionate basis.
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Take an example: The accounting year followed by the foreign company is 01-01-2020 to 31-12-2020. The company became resident in India on account of POEM in previous year 2020-21. Solution: In this example, the accounting year of the foreign company 2019 shall be increased by 3 months i.e. 01-01-2019 to 31-03-2020.
Now, for the period of 01-01-2019 to 31-03-2020, the losses shall be taken as: 50 Lakhs + 100*3/12 = Rs. 75 Lakhs In this case, accounting year of the company shall be:
Losses for the period of 01-07-2019 to 31-03-2020 shall be taken on proportionate basis = 100 * 9/12 = Rs. 75 Lakhs |
- Where more than one provision of Chapter XVII-B of the Act applies to the foreign company as resident as well as foreign company, the provision applicable to the foreign company alone shall apply.
- Compliance to those provisions of Chapter XVII-B of the Act as are applicable to the foreign company prior to its becoming Indian resident shall be considered sufficient compliance to the provisions of the said Chapter.
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Analysis: Chapter XVII-B of the Act deals with the TDS provisions under various sections. Whereas section 195 deals with the withholding tax rates in respect of payment made to non-residents and foreign companies. We have seen above that a foreign company becomes resident in India in any previous year due to its POEM being established in India. So, there might be a conflict as to the applicable rates of TDS in respect of any payments made to such foreign company. For example, TDS rates prescribed under section 194C for payments made towards any works contract is 2% whereas under section 195, the rate of withholding tax for similar payments is 40%. The above paragraph makes it clear that the provisions of section 195 are specific to foreign companies as against the general provisions of TDS under Chapter XVII-B. Therefore, section 195 being specific provision shall prevail over section 194C. Hence, the foreign company will be subjected to TDS @ 40% in their status as foreign company even though it has become a resident in India on account of POEM in India. It is to be noted that where there is a conflict between the provisions applicable to resident as well as foreign company, the provisions applicable to the foreign company shall prevail. |
- The provisions contained in sub-section (2) of section 195 of the Act shall apply in such manner so as to include payment to the foreign company
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Analysis: Section 195(2) provides that any person who is responsible for making any payment to non-resident may apply to A.O. for nil or lower deduction of tax. However, the foreign company which was earlier non-resident becomes resident in India on account of POEM in India, thus section 195(2) losses relevance for such company. Therefore, the above paragraph provides that section 195(2) shall continue to apply in respect of such foreign companies which has become resident in India on account of POEM in India. |
- The foreign company shall be entitled to relief or deduction of taxes paid in accordance with the provisions of section 90 or section 91 of the Act.
- In a case where income on which foreign tax has been paid or deducted, is offered to tax in more than one year, credit of foreign tax shall be allowed across those years in the same proportion in which the income is offered to tax or assessed to tax in India in respect of the income to which it relates and shall be in accordance with the provisions of rule 128 of the Income Tax Rules, 1962.
Explanation- For the purposes of this notification, -
(i) The term “Foreign Jurisdiction” would mean the place of incorporation of the foreign company.
(ii) The rate of exchange for conversion into rupees of value expressed in foreign currency, wherever applicable, shall be in accordance with provision of rule 115 of Income Tax Rules, 1962.
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Analysis: Suppose the accounting year of the foreign company based in Singapore is 01-01-2020 to 31-12-2020. In this year, it earned a total income of Rs. 100 Lakhs on which it paid tax @ 10% = Rs. 10 Lakhs in Singapore. The same income is also liable to tax in India owing to POEM in India during the 2 P.Y. 2019-20 (3 months) as well as 2020-21 (9 months). Part of this income taxable in India in PY 2020-21 will be 100 Lakhs * 9/12 = Rs. 75 Lakhs taxable @ 40% i.e. tax payable in India will be Rs. 30 Lakhs Rate of exchange as per Rule 115 means Telegraphic Transfer Buying rate (TTBR) in respect of foreign currency. |
B. The exceptions, modifications and adaptations referred to in para-A shall not apply in respect of such income of the foreign company becoming Indian resident on accounts of POEM being in India which would have been chargeable to tax in India, even if the foreign company had not become Indian resident.
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Analysis: A simple example to understand the above paragraph is interest or royalty income. The foreign company shall always be liable to pay tax on interest income or royalty income in India as such income shall be deemed to accrue or arise in India. Tax will have to be paid @ 20% or 5% or 4% in case of interest income and 10% in case of royalty income by such foreign company. The above paragraph- B therefore provides that the exceptions, modifications and adaptations as given in Para-A shall not apply to such incomes which was also otherwise chargeable to tax in India if the foreign company had not become an Indian resident. So, the interest and royalty income shall continue to be taxable at concessional rates of (4% to 20% as prescribed) and not at 40% rate by virtue of this notification. |
C. In a case where the foreign company is said to be a resident in India during a previous year, immediately succeeding a previous year during which it is said to be resident in India; the exceptions, modifications and adaptations referred to in Para-A shall apply to the said previous year subject to the condition that the WDV, the brought forward loss and the unabsorbed depreciation to be adopted on the 1st day of the previous year shall be those which have been arrived at on the last day of the preceding previous year in accordance with the provisions of this notification.
D. Any transaction of the foreign company with any other person or entity under the Act shall not be altered only on the ground that the foreign company has become Indian resident.
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Suppose, Mr. David (USA) is holding 6% shares of M/s Maxima Inc. Singapore. M/s Maxima Inc. has become resident in India in P.Y. 2020-21 due to its POEM in India. Mr. David sells his stake in Maxima Inc. to Mr. Stacks (USA). Since, the transfer of shares of a foreign company is made by a non-resident to another non-resident outside India, the capital gain shall not be liable to tax in India even though M/s Maxima Inc. has become resident in India. This is the effect of Para-D as above which states that even if the foreign company becomes resident on account of POEM in India, it will not alter the taxability of any transaction of such foreign company with any other person or entity. However, the above example is subject to the provisions of Explanation 5 to section 9(1)(i) of the Act. |
E. Subject to the above, the foreign company shall continue to be treated as a foreign company even if it is said to be resident in India and all the provisions of the Act shall apply accordingly. Consequently, the provisions specifically applicable to, -
(i) A foreign company, shall continue to apply to it;
(ii) Non-resident persons, shall not apply to it; and
(iii) The provisions specifically applicable to resident, shall apply to it
F. In case of conflict between the provision applicable to the foreign company as resident and the provision applicable to it as a foreign company, the later shall generally prevail. Therefore, the rate of tax in case of foreign company shall remain the same, i.e. rate of income-tax applicable to the foreign company even though residency status of the foreign company changes from non-resident to resident on the basis of POEM.
