TAX NEWS - June 2010

Avoiding taxes

Avoiding taxes would no more be easy for multinationals that deliberately structure their companies in a way to escape tax liabilities in India.The government has introduced the Controlled Foreign Corporation (CFC) rules in its second draft of the Direct Taxes Code (DTC) that will enable the taxman to seek information regarding these companies from other countries

The proposal is to empower the tax department to investigate foreign firms that are held by Indian companies but routed through other countries through a complex structure. Controlled Foreign Corporation (CFC) rules would help them ascertain their place of residence. The second draft of DTC has also introduced the General Anti-Avoidance Rule (GAAR) provisions that would also help combat tax avoidance.

" The CFC rules are only for lifting the corporate veil of those firms that avoid tax payment. After bringing in these rules, we can ask the other country for information about these companies," a finance ministry official told FE.

Under the Controlled Foreign Corporation (CFC) rules, passive income earned by a foreign company — which is controlled directly or indirectly by Indian resident where such income is not distributed to defer tax payments — will be deemed to be distributed and taxed in India in the hands of resident shareholders.

The discussion paper clearly said that the tax treaty would have a preference over the tax code. It, however, pointed out said that the Double Taxation Avoidance Agreement (DTAA) will not have preferential status over the domestic law in case the GAAR provisions are invoked or when Controlled Foreign Corporation provisions are invoked.

Finance ministry officials point out that this is to solve the problem of round tripping and treaty shopping that we have been facing. " Earlier we had no authority to seek information from the non-resident companies that were avoiding legitimate tax liabilities in India. After these rules come into being."

Experts say this is a significant change but it is essential that domestic tax law should have detailed guidelines on Foreign Tax Credit (FTC) rules as at present the FTC is governed by DTA and not by the Domestic Tax Law.