For a nation otherwise given to waffling and quibbling, India’s income tax law has been ruthlessly no-nonsensical, often getting under foreign companies’ skins. All Indian companies are residents, period. And all non-residents are non-residents, also period except if they choose to commit hara-kiri by having their entire control and management in India during the relevant financial year. Predictably, no foreign company has ever walked into the trap so much so that all foreign companies are practically non-residents. A resident of India has to pay tax on his global income whereas a non-resident has to pay tax to the Indian government only on his Indian income. But lest foreign companies and other non-residents thumb their noses at the Indian taxman, the income tax law for good measure has business connection and other rules that obliges them to pay India income tax to the extent an income has its source or moorings in India. Did Vodafone tax imbroglio spring into your mind? Yes, it is the source rule that is at the heart of the bitter struggle between the Indian tax authorities and the UK Company Vodafone.
The US law however is namby-pamby. To be sure, it also taxes US domiciled companies on their global income at a stiff rate of 35 percent but unlike India it gives wiggle-room to US based companies by setting store by the key personnel’s residential status which can be evanescent rather than by setting store by registration which is durable and immutable. Small wonder, Ireland beckons profitable US companies with its soft 12.5 percent corporate tax as opposed to the US’ forbidding rate of 35 percent. It is the done thing among US tax planners to arrange for merger with an obscure company in a tax-friendly country like Ireland or Panama and pretend that with the change in management, the residential status has also shifted to where the obscure company is located. This is only a façade with business as usual -- control continued to be exercised from the USA.
Apple computers attracted the ire of Inland Revenue authorities a few years ago. Now it is Pfizer even though it swears that it is synergy and not tax avoidance that is at the core of its merger with Allergan. Be that as it may.
India can easily empathise with the US Inland Revenue because our source rule of taxation has been designed precisely to enable India to collect tax when a non-resident has earned income thanks to a substantial and real connection with India. Indeed L’affaire Vodafone is all about such connection -- controlling interest in Hutch’s telecom operations in India was passed onto Vodafone in Camay Island. Similarly, if a US Company cocks a snook at its tax authorities despite doing substantial business in the USA, its tax authorities are bound to be peeved.
The US Congress is aghast at the Pfizer temerity, and is planning wholesome changes in its domicile or residential status rule. It would do well to take a leaf out of the Indian tax law -- if a company is incorporated in the USA, it is a resident of the US and hence obliged to pay tax in the USA.
The country where business is done is justified in expecting to earn tax on such transaction. This is however not to say that a US company exporting to India should pay tax to the Indian government. Indeed our income tax law doesn’t seek to tax a US company exporting from the USA except when it has business connection in India like a selling agent in India who procures orders from Indian businesses on its behalf. It however invited opprobrium when it resorted to tax overreach like seeking to tax royalty earned by a foreign company merely on the ground that the technology was going to be used in India. Likewise a foreign bank is required to pay tax in India on the interest earned if the loan amount is going to be used for setting up a business in India or for other income earning activity.