Taxation of foreign passive income is at the core of CFC regulations. Foreign sourced income is usually taxed after it is accrued or received in the country of residence; this makes avoidance of tax fairly easy. Countries regard this deferral as unjustifiable loss of revenue and it also encourages corporates to invest more outside India and less in home country.
CFC are corporate entities which are established in low or NIL tax jurisdiction and are controlled directly or indirectly by residents of higher tax jurisdiction. Since each entity is treated as a separate person, the profits are not taxed until they are repatriated. CFC’s earn passive income (i.e. Interest, royalty, dividend etc.) and because they don’t repatriate any of its passive income there is no taxation in home country.
Most CFC rules apply to those CFC’s over which the domestic shareholders holds more than 50% of control. CFC rules apply to both direct and indirect control so that misuse of rules does not happen by creating multiple layers of holding companies.
CFC Regulation – Approaches (As Introduced in DTC )
Typically CFC regulation has following approaches.
1. |
Jurisdictional Approach
Under this approach residents of a country creates a subsidiary for earning passive income and have no operations as such in a country having lower taxation rates, such entities are deemed to be CFC for eg. If any resident creates a subsidiary say in Cyprus having more than 50% control, then such company shall be deemed to be CFC. |
2. |
Transactional Approach
Under this approach, the focus is generally restricted to passive income earned by foreign subsidiaries Passive income includes income like royalty, interest, rent, capital gain etc. |
3. |
Typical Approach
It is a mixed approach where CFC regulations are triggered when subsidiary is setup in a low tax area and when the foreign subsidiary has passive income stream.
CFC regulations proposed under DTC followed the hybrid approach only. |
If CFC rules are introduced in India, it will have significant effect on the taxation of multi-national corporations as they will be taxed with a more subjective concept. CFC rules are not yet introduced in India and an honest taxpayer can hope of its introduction in near future.