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Tax shadow on foreign arms' dividend
July, 31st 2009

Undistributed dividends of foreign corporations controlled or owned by Indian companies will be taxed in the near future, said income tax (I-T) department sources.

Most countries have Controlled Foreign Corporation (CFC) laws that enable authorities to levy such taxes. These laws effectively check the governments revenue loss due to the transfer of undistributed dividends to offshore tax havens like Isle of Man, Cayman Islands and Mauritius.

Indian tax authorities, for long, have maintained that there is a need to have a similar law here. Tax experts say it will be difficult for the government to refrain from introducing such a legislation as there is a substantial flow of outbound investments from India.

We should tax the undistributed dividend of the foreign corporations owned by Indian companies. It does not matter if the dividends are brought to India or not. Tax for this has to be paid here since the resources for making these cross-border acquisitions are mobilised from India, said a senior I-T department official, who asked not to be named.

PwC taxation leader Dinesh Kanabar said it was important that the introduction of CFC be preceded by a major change in the I-T Act that would allow consolidation of separate legal entities. A company that exists in a foreign country could be controlled by an Indian company. It still, however, remains a separate legal entity. To treat both of them as a single legal entity requires a major change in the Income-tax Act.

Today, besides the UK and US, CFC laws are present in 25 countries. Most have guidelines for defining CFCs. In the US, 50% of the voting rights or 50% of the value of shares is an indication of CFC. In some countries, CFC laws cover even the Permanent Establishments (PEs) of resident companies.

Cross-border taxation specialist TP Ostwal said it is still too early for India to introduce CFC laws. CFC laws are introduced by developed countries whose outbound investments have substantially exceeded inward flow of funds for long. India has not got to that point, he added.

Incidentally, the major reason for the rising pressure on the government for CFC rules is the change in the investment pattern that shows outbound investments increasing at a steady pace in recent years. Across the world, the objective of introducing CFC laws is to curtail the loss of revenue. In line with that, tax is levied on the resident company irrespective of whether the dividend of its overseas company is distributed or not.

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