Don’t skip ITR: Taxman to foreign companies

For years, the market practice among foreign companies – often endorsed by their tax advisors – has been to file tax returns only if there were some earnings, or sale of shares or properties to make money. Few, if any, filed the 49-page form that seeks a whole lot of information if there were only purchases of stocks or other assets (but no sale or capital gains).

However, foreign investors have sensed this won’t work anymore. In a flurry of notices sent over the last few weeks, the Income Tax Department has specifically pointed out the details of stocks, mutual fund units or properties purchased by non-residents. It’s a stark reminder that irrespective of whether you make money or post a capital gain, you must file tax returns if you have a permanent account number (PAN).

December 31, 2022 was the last date for filing income tax returns (ITR) for 2021-22.

But why did several foreign companies not file ITR despite being familiar with the law? It’s not just because of the paperwork and cost. The real reason is their reluctance to give details of the “immediate parent” and the “ultimate parent,” as the return form requires them to do.

The fear is that once the tax office gets hold of this information, it could probe who is controlling the foreign investment vehicle and also question whether capital gains from sale of assets can escape tax.

Tax Residency Certificates

If there is a change of parent between the purchase and sale of an asset, a tax officer may conclude that this was done to avoid tax. Also, if a new parent steps in, it could trigger a demand for tax on indirect transfer (where underlying assets are stocks in India).
“As a result of the robust information collection mechanisms in place, as well as data analytics at the tax department’s end, a snap-shot summary of underlying transactions that trigger these notifications is shared with the recipients,” said Ashish Mehta, partner at law firm Khaitan & Co. “This is also in line with the tax administration’s motto of fairness and keeping taxpayers informed in terms of advance intimation of the information in their possession. On receipt of such notifications, it may be prudent to consider the reason for notification and, if required, revisit positions/strategies on tax filings.”

The strong hint from the taxman for filing returns assumes importance as some tax officials are questioning the adequacy of tax residency certificates produced by foreign investors on the grounds that investing entities were mere fronts formed for treaty shopping, while actual control lay with holding companies incorporated in countries that do not qualify for tax exemption. The unwillingness to disclose details on the parent entity and ‘beneficial owners’ post purchase of assets stems from such concerns.

“Failure to file ITR may lead to prosecution under section 276CC of the Act,” said Ved Jain, former president of The Institute of Chartered Accountants of India (ICAI). “With the complete digitisation of all the data of every entity, it has become very easy for the tax department to identify non-filers of tax returns and to initiate proceedings against them.”

“It is also important to point out that the I-T Act mandates all partnership firms, LLPs and companies to file ITR, irrespective of whether… (it) is dormant with no activity or no transaction during the year. So, even if there is no income or no transaction during the year, one should file a return to avoid any penal consequences,” said Jain.

While filing returns, a company must also disclose whether it is a resident of a country or specified territory with which India has tax avoidance agreement; particulars of managing director, directors, secretary and principal officer(s) who have held office during the previous year; details of the eligible person who is verifying the return; and particulars of the persons who were ‘beneficial owners’ of shares holding not less than 10% of voting power at any time in the previous year.

According to some tax practitioners, such details should be shared in the ITR by domestic as well as overseas companies.