Over the last few years, there is a significant spurt in cross-border transactions involving software licensing, use of copyright, patent, trademark and know-how, use of equipment, rendering of services, management cross-charges, etc.
By Himanshu Parekh
The obligation on foreign companies to file tax returns in India has been a fractious issue for a long time now. In the case of foreign companies, India follows a source-based taxation. Accordingly, the income of a foreign company that is received or is deemed to be received in India or that accrues/arises or is deemed to accrue/arise in India is subject to tax in India. This is subject to the beneficial provisions of a tax treaty that may be applicable to the foreign company.
Over the last few years, there is a significant spurt in cross-border transactions involving software licensing, use of copyright, patent, trademark and know-how, use of equipment, rendering of services, management cross-charges, etc. There may be taxes being withheld by Indian entities while making payments to such foreign companies. In a majority of the cases, the taxes withheld by Indian entities would be the final tax liability of such foreign companies in India. Further, there may also be certain cases whereby foreign companies may not be subject to tax in India either on account of exemption under Indian tax laws or beneficial provisions of the respective tax treaties. In such cases, a question arises as to whether foreign companies who have suffered comprehensive withholding in India or who have no taxable income in India are required to file tax returns in India, merely on account of them earning income from India?
As per Section 139 of the Income-tax Act, every company (including a foreign company) and firm is required to file its tax returns in India. Any person other than a company and a firm shall be required to file a tax return only if its total income exceeds the maximum amount not chargeable to tax. These provisions pertaining to obligation of filing tax return in India were amended and substituted by the Finance Act 2001. Prior to the amendment, the erstwhile provisions required every person (including company and firm) to furnish a tax return in India only if their income exceeded the maximum amount not chargeable to tax. The amendment has brought a distinction between the tax return filing obligation in the case of companies and firms on the one hand and other taxpayers on the other hand. Post the amendment, companies and firms are required to file tax returns in India, if they earn any income from India (based on the ‘nexus’ principle), irrespective of whether they have taxable income or not or whether taxes have been withheld from their income.
In case of failure to furnish tax returns on or before the due date, the company (including foreign company) will be subject to late filing fees ranging from Rs 5,000 to Rs 10,000. Along with late filing fees, a penalty of 50% of tax payable on income could be levied for non-reporting of income. Further, when non-reporting of income is in consequence of any misreporting, a penalty of 200% of the under-reported amount could be levied. Apart from that, if tax authorities hold that there is a wilful failure by the company to file its tax returns in India, it may be liable for prosecution as well. Recently, the Delhi High Court in one of the cases upheld the action of the tax office to initiate prosecution proceedings for failure to furnish tax returns and for non-compliance with the notices issued by tax authorities.
Tax authorities are enforcing tax compliances by foreign companies by issuing notices seeking justification for non-filing of tax returns. Tax authorities generally trace India-sourced income of such foreign companies through Indian entities withholding tax returns or filings with bankers at the time of remittances made by Indian entities.
On the part of foreign companies, they feel that such compliances lead to a lot of administrative burden in cases where their income is not liable to tax (either under the provisions of the Act or the tax treaty) or where they have already suffered full tax withholding on their income. Amongst several other countries, India seems to stand out by insisting that foreign companies file tax returns in such cases. This goes against the avowed objective of the government to ease doing business in India.
On the part of the government, there could be two reasons for insisting upon foreign companies to file tax returns in India. One may be to examine the veracity of the claim of the foreign company that their income is not liable to tax in India. The other could be to examine that appropriate taxes have been withheld from their income.
The need of the hour is to strike a fine balance between reducing the administrative burden being faced by foreign companies and the intention of the government to ensure that appropriate taxes have been paid by foreign companies earning income from India. Until that happens, foreign companies are well advised to ensure the necessary tax compliance in India to avoid the grave consequences of failure to do so.
(The author is partner & head, Corporate & International Tax, KPMG in India. Views are personal.
Ravish Kotadia, a chartered accountant, contributed to this article)