The Hindu Business Line : Decoding branch profits

Several provisions in the Direct Taxes Code are left without explanation about the origin and purpose for introducing the same. There is a Discussion Paper explaining several provisions, but it remains silent on some important ones.

One such provision is found in Section 100 in Chapter VII relating to branch profits tax. Subject to the provisions of the Code, every foreign company shall be liable to branch profits tax at the rate specified in Paragraph C of the Second Schedule.

The branch profits shall be the total income for the financial year as reduced by the amount of income-tax thereon. The Second Schedule prescribes a rate of 15 per cent on the branch profits.

Computation problems

The tax is supposed to be on the branch profits of the foreign company. A foreign company is also liable under Section 5 of the Code for profits derived from its operations in India. Any income accruing whether directly or indirectly through or from a business connection in India, a property in India, an asset or source of income in India or the transfer of a capital asset situate in India shall be deemed to accrue in India for purpose of taxation.

Section 5(3) declares that when all the operations of the business are not carried out in India, the income of the business deemed to accrue in India shall be only such part of the income as is reasonably attributable to those operations carried out in India.

Unanswered questions

Section 5(4) exempts income of a non-resident accruing from operations confined to purchase of goods in India for export out of India. The question arises: What is the relationship between the branch profits of the foreign company and the normal income from Indian operations of the same foreign company subject to Indian taxation? Will the branch profits be telescoped into the normal income? There is no answer.

Will the branch profits tax be set off against the normal tax paid by the foreign company? No answer.

It can never be the intention that both Sections 5 and 100 will operate independently in separate fields for purposes of taxation. Branch profits can include income from purchase operations of the branch of the foreign company in India. Section 5(4) excludes such income from purchase operations in India. What has Section 100 got to say on this question? Will Section 100, being a special provision, override the general enactment of Section 5? Several foreign banks have branches in India. What is the residential status of such foreign branch which is managed from India? They are at present considered non-residents. The residency test has undergone radical shift under the Code.

Even partial management from India will be sufficient to consider such branches of foreign companies as resident in India. Carrying the logic further, can any income-tax officer (ITO) argue that the parent company will have to suffer tax on worldwide profits in India because it is partially controlled through its branch in India? Certainly this cannot be the intention.

Deduction for head-office expenses attributable to Indian operations is permitted under Section 33(1)(xxxii) of the Code to the extent of an amount equal to 0.5 per cent of the total sales, turnover or gross receipts.

Under the present law, such deduction is allowable as a proportion of the adjusted total income of the Indian branch. The deduction under the Code is based on turnover and not the world income in proportion to the Indian income.

Why did not the authors of the Code think of taxing the Indian branch of the foreign company on the remittances made from India? These Indian branches make remittances of only profits which can be dividends. Domestic companies are taxed at 15 per cent of the dividend they distribute.

Domestic companies

Parity with domestic company taxation will require that only remittance of profits by Indian branches of foreign companies be subjected to the tax at 15 per cent. Such a measure will go to clarify the law on the subject to a great extent. As it is, the branch profits will be subject to 15 per cent tax even if they do not remit such profit abroad.

Tax jurists are of the view that levy of branch profits tax will go against the principles of the Double Tax Avoidance Agreements (DTAAs) which limit liability only to income attributable to Indian operations.

Income by way of interests, royalty and technical fees are charged at 10 per cent and dividend at nil rates. The provision for a separate 15 per cent tax on branch profits tax will add to the tax burden of the foreign companies operating through a branch in India.

It is a pity that the Discussion Paper is silent on the issues raised in connection with the branch profits tax.

(The author is a former Chief Commissioner of Income-Tax.)