The foreign subsidiary is a non resident company and and hence the income will not be taxable in India. But the dividend received from subsidiary will be added in profit of the holding company and hence taxable.

I think what I came across as reading material may be helpful in understanding the intricacies of the issue involved.Which I quote:"Modified tests to be applied for determining ‘residence' of a company and application of Controlled Foreign Company Rules (CFC Rules), being introduced for the first time in the country on the lines of such rules prevalent in the developed economies, in the revised Direct Taxes Code Bill, 2010 (the Code) will have far reaching implications on the tax liability of Indian companies having presence in multiple nations (Indian MNCs).

Variety of structures used by Indian MNCs to hold investments abroad or to retain profits abroad for reinvestment or for carrying on operations in multiple jurisdictions may satisfy the test of “residence” contained in S4 of the Code or be covered by the CFC Rules and income accruing, arising or received in foreign jurisdictions may attract tax liability in India.

Besides an Indian company (essentially, a body corporate, formed or established under an Indian law and having a registered or principal office in India), any company which has its place of effective management in India, at any time during the year, will satisfy the test of residence for taxation purposes.

At present, besides Indian company, a company, control and management of whose affairs is situated wholly in India during that year, satisfied the test of residence in India.

Effective management

The expression, “place of effective management” is explained in S 314(192) as:

“(i) the place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or

(ii) in a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.”

Take an example of a subsidiary of an Indian company located, say, in Germany. The German subsidiary has its own board of directors; holds board meetings in Germany and the board performs its normal functions in Germany.

Two officers of the Indian holding company, located in India, are directors of the German subsidiary. The board of directors of the German subsidiary generally endorses commercial decisions of the head quarters/officers located in India.

Such a case could satisfy both the tests set out in (i) and (ii) above. First condition refers, inter alia, to the place where its executive directors make their decisions. The term “executive director” is not defined in the Code and in common parlance, it would mean an executive who is serving on the board of directors.

The second condition could also be satisfied as the boards of directors of the German subsidiary routinely approve the decisions of the Indian directors who are located in India and who perform their functions in India.

Operating decisions

This could apply with greater force where the Indian directors participate in the board of directors meeting through video or audio calls from India since, in that case, it could be said that the board decisions are also taken in India.

This, of course, would be a debatable issue as to whether participation of directors in the meeting of board of directors through video or audio calls where such directors do not constitute majority of the board but, who, in reality, take such decisions would satisfy the second or, for that matter, even the first condition.

A distinction is, however, required to be made between operating decisions and commercial and strategic decisions. In common parlance, operating decisions relate to day to day operations, processes and procedures relating to business functions and like whereas, commercial and strategic decisions would refer to decisions relating to business at policy level.

So, what are the consequences? If the effective management is held to be in India, entire income of the foreign subsidiary would become liable to tax in India as it would be regarded as resident in India."

Thank you both of you for the valuable replies. Chinmoy but Direct tax code will not be applicable for current AY never the less thank you for your advanced view and foresight on the tax liability.

Thanks chinmoy for highlighting the new Tax Code provisions regarding foreign subsidiaries of Indian companies. If the income of the foreign company is treated as Indian, tax is payable in India. But as the subsidiary is actually situated abroad and registered in foreign country, law of that country will apply. So will there not be a double taxation? In that case what will be the remedy to avoid double taxation.

And it will be subject of huge debate for authorities and the concerned assessees. Hope the board comes out with the explanation through notification in that case soon.

Hats off to both Gulshan and Chinmoy for sharing your valuable knowledge.Thank you Jayen for your interesting question. :) :)

Thanks,Nagalakshmi!

@Jayen

The existing provisions in respect of degree of control and management answer your question.

@Gulshan
DTAA regime is in place to take care of incidence of double taxation.I also add the following to illustrate and expand the subject further.

To avoid rigours of this provision, Indian companies will have to appoint only independent directors on the board of directors of their foreign subsidiaries and their executives, who are decision makers, should be located in that country/outside India only ?

Besides examining the residence test, one would also have to examine the CFC Rules to determine taxability of income of the foreign company in cases where an Indian resident has interest.

CFC Rules seek to bring income of SPVs located outside India which are not engaged in active trade or business in the foreign jurisdiction where they are established especially, in cases, where such SPVs are located in lower tax jurisdictions to tax in India as the income of the resident (having interest in the SPV) from residuary sources.

Examples of the entities which are likely to be covered under these Rules are Cypriot or Mauritian companies which primarily hold investments and are not engaged in any active trade or business activities in Cyprus or Mauritius, as the case may be.

Income calculation

The income of such CFCs attributable to the Indian resident is to be calculated on the basis of the control exercised by the resident Indian shareholder (value of capital or voting share or interest, whichever is higher) and number of days for which such control existed during the accounting period.

If the specified income of the foreign company does not exceed Rs 25 lakh in an accounting period, it would not constitute a CFC even if all other conditions to determine whether a foreign company is a CFC are satisfied.




The conditions, besides specified income in excess of Rs 25 lakh in an accounting period are:

It is resident of low tax jurisdiction i.e. where the tax payable on the profits of a company in an accounting year is less than half of the tax payable under the Code by a domestic company; and

The company is not engaged in any active trade or business - to be determined on the basis of its active participation in industrial, commercial or financial undertakings through employees or other personnel in the economic life of the territory of which it is tax resident. For this condition to be satisfied, it is also necessary that 50 per cent or more of the income of the SPV for the accounting period is not from business (sale of goods or supply of services to non controlled and non associated enterprises); and

One or more Indian residents exercise control over it; and

The shares of the SPV are not traded on a recognised (under laws of that country) stock exchange of the jurisdiction of which it is a tax resident. Thus, if shares of a Mauritian tax resident company are listed on say, Luxembourg Stock Exchange, it would not constitute CFC if Luxembourg Stock Exchange is recognised by Mauritian authorities. It is pertinent to note that the term used is "shares" and, therefore, if any other financial instruments like Bonds alone are listed on a recognised stock exchange, this condition would not be satisfied.

To illustrate, if, in the above example, shares of the German operating subsidiary are held through a holding company in Mauritius, dividends declared by the German subsidiary to the Mauritian holding company would, by application of the CFC Rules, be taxable in India as the income from residual source of the Indian parent.

The provisions of Double Tax Avoidance Agreement between India and Mauritius will not apply to such income which is includible in the income of the Indian parent although, when Mauritian company, itself, declares dividend, that would not be taxable to the extent that the income of the Mauritian company is already taxed in India in the hands of the Indian parent. CFC Rules have overriding effect over beneficial tax treatment under DTAA .

India is one of the fastest-growing economies and Indian companies have started expanding globally with the liberalisation and globalisation policies of Government adopted over past two decades. Whether at such a point of time, such provisions are needed or not are a matter of debate. The least that an Indian company which has to apply these provisions will expect is a regime similar to that available to its foreign counterparts situated in developed economies, in particular, the provision for underlying tax credit and group taxation regime.