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Foreign companies will be taxed for money earned by Indian arms

Questioning has begun. The tax department has already issued notices to subsidiaries of several MNCs.

, ET Bureau|
Last Updated: Jan 17, 2020, 05.19 PM IST
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The tax department has started questioning the local subsidiaries of several multinational companies to ascertain whether they have foreign operations managed from India. In cases where this is established, the department wants them to pay tax here on their income from such operations.

It has already issued notices to the subsidiaries of several MNCs. In the notices, details such as members on the board of directors, minutes of meetings, bank account statements and holding structures of their foreign units have been sought. In some cases, the department has also demanded tax, people with direct knowledge of the matter said.

In one such notice, which ET has seen, the department states that the Indian subsidiary had effective control and management of certain foreign operations, and so revenue allocating to those businesses was taxable in India.

Tax experts said in most cases, the notices did not mention the clause on place of effective management (POEM). Under POEM, overseas subsidiaries could be treated as domestic entities for tax purposes if they are controlled and managed from India.

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The government had introduced the POEM framework in 2018, to tax the income of Indian companies’ foreign subsidiaries. Officials were required to follow a procedure before they could invoke the POEM provision. The notices issued to companies, however, do not refer to any income tax section or provisions related to POEM, but merely seek explanation and in some cases demand a penalty and interest, said the people with direct knowledge of the matter.

In almost all cases, notices have been issued to foreign companies that also have a base in India. Many companies may have to pay about 42% tax on their income generated outside India, said people in the know.

Industry trackers said while the notices had been issued to companies mainly in the services sector, this could be extended to others as well. “After transfer pricing, POEM is set to become a new battleground in international taxation,” said Jeenendra Bhandari, a partner at international tax advisory firm MGB.

In another notice that ET has seen, the department has asked the Indian arm of a software services company to explain the relationship between it and an entity in Nepal. According to the notice, the taxman was of the view that the management of the Indian entity, specifically its chief financial officer, seemed to be controlling the finance functions of the Nepalese subsidiary. It demanded that the company pay 42% tax on the income generated by the unit in Nepal.

“Overall, there is greater rigour in tax proceedings to understand the activities being performed in crossborder situations. One should expect in the context of multinational enterprises to offer explanations regarding visits of overseas employees, nature of services performed, travel details (and) justification for services procured,” EY India tax market leader Sameer Gupta said.

In another instance, an Indian subsidiary that is also into the services sector has been asked to submit a number of details including minutes of meetings, bank transactions and travels of overseas staff to India. Industry trackers said all the notices were in line with the POEM framework, but the taxman had avoided naming the particular sections. There could be a reason for that.

POEM guidelines require the tax officer to seek the approval of the commissioner of income tax before initiating any proceedings, Deloitte India partner Rajesh H Gandhi said. “There is another check, which requires that any decision on whether a foreign company has a POEM in India can be given only after seeking prior approval of a collegium of three members. The collegium will also provide the company with an opportunity to be heard before issuing directions,” he said.

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