Tax rates on foreign firms may not be changed

The finance ministry is unlikely to lower the rates of corporate tax imposed on branches of foreign companies to put them on par with domestic firms.

The ministry holds the view that the difference in taxation is also accepted in the US, where the Internal Revenue Service imposes a branch profit tax to equalise the differences with local companies.

The issue pertains to a recent order by the Income-Tax Appellate Tribunal, stating that the Income-Tax department should not charge higher corporate tax from a foreign company.

Under the Income-Tax Act, 1961, branches of foreign companies are taxed at the rate of 42.5 per cent, inclusive of surcharge, while domestic companies pay 36.75 per cent.

The Income-Tax department justifies the different tax rates saying domestic companies also pay a tax on dividends, which does not apply to branches of foreign companies.

The Kelkar panel report on direct taxes had also acknowledged that the differentiation was based on dividend taxation norms, and had therefore recommended continuing with it.

Official sources said the ITAT order is based on the absence of clearly defined rules on the treatment of foreign entities. They said this had risen because of the ambiguity in the definitions under sections 90 to 92 of the Income Tax Act, which deal with taxation of foreign firms. They added that there was a need to tighten up these sections to remove the ambiguities.

However as this would involve an amendment of the Act, it would be possible only during the passage of the Finance Bill by Parliament.

They also said since most foreign companies operating in India set up subsidiaries, they were treated as domestic companies by the Income-Tax department.

The branch route is opted for by very few companies as it restricts their ability to scale up their operations. Hence, the difference is not a major issue for foreign companies.

Some of the Double Taxation Avoidance Agreements like those between India and the US, have provided for specific sections to remove the anomaly.

The sources also said it was a normal practice for the department to appeal against any order, which went against it. Since the present order of the ITAT had wider ramifications, official sources said an appeal was a certainty.