Foreign Companies and Income Tax Filing in India

The filing of taxes for foreign companies in India can often be a complex endeavor, filled with confusing rules and regulations.

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 and claim their tax credit, if they are available, at the end of every financial year.
 
There had been a continued debate for many years on whether foreign companies are required to pay taxes in India, with the authorities heavily supporting in favour 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 corporates. Other than the IT Act, India has also entered into double taxation agreements with many countries, and companies may choose to avail the benefits under them.
 
Residence Rule of Income:
 
An individual or 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, foreign companies will be considered a residential company of India if they fulfil 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 30% of corporate tax paid by Indian 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 which 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 agreements entered by India with other countries, and they can choose for the more beneficial rules to apply. As per these sections, only the profits attributable to India for non-resident companies will be taxable in India. Hence, the concept of ‘permanent establishments’ are important.
 
What are Permanent Establishments?
 
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 (‘PE’). 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. India taxes the business income of a non-resident company 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 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, need 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 a 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 doing an analysis of 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, they will be subject to an income tax levied at 40%. Foreign Companies with a PE will have to also pay minimum alternate tax at 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 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 which 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 had mandated the requirement of PAN card for all companies deducting tax at source. If a company did not furnish PAN then the deductor could charge tax at the higher rate. Further, in such cases, foreign companies were also not allowed to avail any beneficial provision under their DTA, if it was applicable.
 
However this rule has received some relaxation, as based on rulings by tribunals in India. The benefits of the DTAs can be availed by foreign companies, even if it is in contravention of the IT Act. To avail the benefits under the DTAs, foreign companies must ensure to file Form 10F 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 and 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.
 
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.