Taxation of Wholly-Owned Subsidiaries of Foreign Companies in India: Understanding PE and Income

Understanding the tax implications of wholly-owned subsidiaries of foreign companies in India can be complex, as the concept of 'income' under India's Income Tax Act is broadly defined. This article aims to provide clarity on when and how subsidiaries may be subject to taxation in India. Specifically, we explore the criteria for income recognition, the concept of permanent establishment (PE), and the impact of double tax avoidance agreements (DTAA).

Introduction

The term 'income' as defined by the Income Tax Act is very wide, encompassing any receipt that may be considered taxable by the act, regardless of general understanding. Therefore, even if a wholly-owned subsidiary of a foreign company does not generate direct income, certain receipts and transactions may still fall under the scope of taxation. This article delves into the various tax implications and necessary considerations for such subsidiaries.

Legislative Framework

Under Section 4 of the Income Tax Act, the charge to tax is applicable to the total income of every person, including a company. This means that all income received or deemed to be received in India, as well as any income that accrues or arises in India or is deemed to have accrued and arisen in India, is included in the total income. Section 902 provides that where a double tax avoidance agreement (DTAA) exists with any country outside India, the provisions of the act apply only to the extent they are more beneficial to the assessee.

Revenue Inclusions and Exclusions

Section 5 of the Act defines the scope of total income, while Section 9 outlines scenarios under which income is deemed to have accrued or arisen in India. These provisions are crucial in determining the taxable income of a wholly-owned subsidiary in India.

Permanent Establishment (PE)

The concept of a 'permanent establishment' is pivotal in determining the taxability of activities conducted by a foreign company's subsidiary in India. PE includes a fixed place of business through which the business of the company is wholly or partly carried on, and it arises broadly due to certain types of operations conducted by the company in India. However, just because a subsidiary has no direct income, it doesn’t necessarily mean no tax liability exists.

Double Taxation Avoidance Agreements (DTAA)

Section 90 of the act allows the Central Government to enter into agreements with other countries for the avoidance of double taxation. These agreements, while beneficial for certain taxpayers, can vary widely in their application. Models of DTAA conventions differ, with some allowing tax on profits only if they are attributable to a permanent establishment (No Force of Attraction principle), some allowing tax only on direct transactions similar to those through the PE (Limited Force of Attraction principle), and others including all transactions (Full Force of Attraction principle).

Conclusion

While it is evident that a wholly-owned subsidiary of a foreign company in India may not have taxable income in the conventional sense, the complex interplay of income definitions, PE rules, and DTAA provisions necessitates a thorough examination of each individual case. Businesses and their legal advisors should carefully evaluate these factors to ensure compliance and effective tax planning.