By Rahul Krishna Mitra - Executive Director, PricewaterhouseCoopers
Ever since the Indian economy treaded on the path of globalisation, the maximum focus of the Government has been towards giving fiscal reliefs for inbound investments. However, after more than a decade of globalisation and with the Indian economy doing exceedingly well in the recent years, several Indian companies or multinationals are going global, or in other words, venturing for outbound investments through acquisition of foreign companies or setting up green-field projects abroad. Increase in the number and volume of outbound investments is a correct indicator of the maturity or development of the economy of a country. While the Indian multinationals are making all efforts to keep the tricolour flying in foreign or alien land, it is the responsibility of the Indian Government to prove the necessary fiscal incentives for promoting outbound investments.
The Challenge:
One of the banes of outbound investments is the country’s derogatory policy of taxing foreign dividends, i.e. dividends received by an Indian company from a foreign subsidiary. Taking a small example, say, an Indian multinational has a subsidiary in UK, which makes a profit of Rs.100 in UK. The subsidiary would pay corporate income-tax in UK @ 30%, which works out to Rs.30, and thereafter it remits the balance profits of Rs.70 to its Indian parent. The entire dividends of Rs.70 are taxed in India in the hands of the Indian multinational at the full corporate tax rate of 33.66%, thus resulting in a tax outgo of Rs.23.56 in India. The total tax cost in UK and India therefore works out to Rs.53.56, which is approximately 54% of the total earnings from the outbound investment. No doubt, the effective tax cost is too high to encourage the Indian multinationals to venture into outbound investments and bring in foreign dividends to service its Indian shareholders.
Solution:
There is an easy solution to this problem. Generally, countries provide fiscal incentives for outbound investments, vis-à-vis taxing of foreign dividends, through either of the two methods, i.e. exemption method, where the foreign dividends are fully exempt from tax in the country of the parent company, or the method of providing underlying tax credit. Under the first method, the total tax cost on the foreign dividends is capped at the level of the foreign country corporate tax rate, whereas in the second method, the total tax cost on the foreign dividends is capped at the level of the home country corporate tax rate.
In other words, if the Indian Government adopts the exemption method to provide fiscal incentives for foreign dividends, then the entire Rs.70 would be exempt from tax in India in the hands of the Indian multinational, with the result that the total tax cost for the group would be Rs.30, i.e. 30%, being the corporate tax rate of the country (UK), where the subsidiary company is situated. On the other hand, if the Indian Government prefers to adopt the method of providing underlying tax credit as a measure to provide fiscal incentives for foreign dividends, then the entire profits of the UK subsidiary, i.e. after grossing up of the corporate tax paid in UK, which, in the present case, works out to Rs.100, becomes the taxable dividends in the hands of the Indian parent, on which it is liable to pay tax in India @ 33.66%, which works out to Rs.33.66, however, it receives credit for the corporate taxes paid by the UK subsidiary on its profits out of which the dividends are distributed, i.e. Rs.30. Thus, the Indian parent pays the balance amount of Rs.3.66 as corporate tax in India, with the result that the total corporate tax liability for the group gets pegged at Rs.33.66, i.e. 33.66%, which is the tax rate of the country of residence.
Next Generation Tax Reforms:
Provision of such fiscal incentives for foreign dividends is the only remedy to remove the impediment for outbound investments, vis-à-vis the hesitancy in bringing back the profits of the foreign subsidiary in order to service the Indian shareholders. It is high time that the Indian Government seriously considers introducing such fiscal measures. It would not be out of place to mention that only a few tax treaties entered into by India provide for relief on account of underlying taxes, e.g. Mauritius, Singapore, etc. However, the large majority of the tax treaties do not provide for such relief for the Indian multinationals. Instead of amending each and every treaty for introducing such fiscal measures, the Indian Government would be better off in introducing such benefits in the domestic tax laws of India, so as to provide the incentive to Indian multinationals to invest in any and every jurisdiction without having to cherry pick for availing treaty protection for foreign dividends. Further, introduction of benefits of underlying tax credit in tax treaties would only enable the Indian multinational to pick up the underlying taxes upto one tier of investment, i.e. the immediate subsidiary company located in the treaty jurisdiction, while ideally the Indian Government should introduce underlying tax credit mechanism for multiple tiers to cater to even step down subsidiaries located around the world, which are set up for operational purposes. These measures are in the nature of next generation tax reforms, which would go a long way in catapulting the Indian economy to the next level.
