Residency Reclassification and Tax Implications for Foreign Companies : Clause 220 of the Income Tax Bill, 2025 Vs. Section 115JH of the Income Tax Act, 1961

Clause 220 Foreign company said to be resident in India.

Income Tax Bill, 2025

Introduction

Clause 220 of the Income Tax Bill, 2025 introduces a specialized regime for the taxation of foreign companies that are deemed residents in India. This provision is a continuation of the legislative intent first articulated in Section 115JH of the Income Tax Act, 1961, which was introduced in the Finance Act, 2016, and operationalized through Notification No. 29/2018 dated 22-06-2018. The underlying context for these provisions is the shift to the Place of Effective Management (PoEM) test for determining residency of companies, a move designed to counteract tax avoidance by multinational enterprises that manipulate their place of management to escape domestic taxation. This commentary provides a detailed analysis of Clause 220, its objectives, operative mechanisms, and practical implications, followed by a comparative analysis with Section 115JH and Notification No. 29/2018. The discussion aims to elucidate the continuity and evolution of the law, the interplay between statutory provisions and delegated legislation, and the impact on foreign companies, tax authorities, and the broader regulatory landscape.

Objective and Purpose

The principal objective behind Clause 220 and its predecessor, Section 115JH, is to ensure a fair, orderly, and administratively feasible transition for foreign companies that become Indian residents due to the application of the PoEM test.

The legislative intent is twofold:

1. To prevent hardship: The abrupt application of the entire Indian income tax regime to foreign companies that become residents due to PoEM could result in significant practical difficulties, such as recalculating depreciation, losses, and compliance obligations retroactively. The law seeks to provide a framework for exceptions, modifications, and adaptations to mitigate these hardships.

2. To prevent tax avoidance: The PoEM test was introduced to curb the practice of foreign companies artificially shifting their place of management to low-tax jurisdictions.

By treating such companies as Indian residents, the law brings their global income within the Indian tax net, but with due regard to their prior status as non-residents. The policy considerations are thus rooted in both administrative pragmatism and anti-avoidance objectives, balancing the need for tax compliance with the realities of cross-border business operations.

Detailed Analysis of Clause 220 of the Income Tax Bill, 2025

Clause 220 can be broken down into several operative components, each addressing a specific aspect of the transition from non-resident to resident status for foreign companies:

1. Sub-clause (1): Application of the Act with Exceptions, Modifications, and Adaptations

This sub-clause is the cornerstone of the provision. It states that where a foreign company becomes a resident in India in a tax year, having not been a resident in prior years, the provisions of the Act relating to:

- Computation of total income,

- Treatment of unabsorbed depreciation,

- Set off or carry forward and set off of losses,

- Collection and recovery, and

- Special provisions relating to avoidance of tax shall apply with such exceptions, modifications, and adaptations as may be specified by the Central Government via notification.

Key Points:

- The application of the law is "notwithstanding anything in this Act," indicating an overriding effect over conflicting provisions elsewhere in the Act.

- The scope for exceptions and modifications is broad, allowing the government to tailor the application of the Act to address practical issues arising from the change in residency status.

- The provision is subject to conditions notified by the Central Government, highlighting the role of delegated legislation.

2. Sub-clause (2): Extension to Succeeding Tax Years

If the determination of residency is made during assessment proceedings for a particular year, the exceptions and modifications will also apply to any succeeding tax years that end before the completion of such proceedings.

Key Points:

- This ensures that the benefit of exceptions/modifications is not lost due to the timing of the assessment process.

- It addresses the practical situation where the residency determination may be made retrospectively or after the close of the relevant previous year.

3. Sub-clause (3): Consequences of Non-Compliance with Notification Conditions

If a foreign company, after claiming and being granted benefits/exemptions under sub-clause (1), fails to comply with any of the conditions specified in the notification:

- The benefit/exemption/relief is deemed to have been wrongly allowed.

- The Assessing Officer may recompute the total income as if the exceptions/modifications did not apply.

- The provisions of section 287 (presumably the rectification/amendment section in the new Bill) shall apply, with the limitation period of four years reckoned from the end of the tax year in which the failure occurred.

Key Points: - There is a clear mechanism for withdrawal of benefits and recomputation in case of non-compliance. - The limitation period is aligned with the date of failure, ensuring administrative efficiency.

4. Sub-clause (4): Parliamentary Oversight

Every notification issued under this section must be laid before each House of Parliament.

Key Points: - This ensures legislative oversight over the exercise of delegated powers. - It provides a check against arbitrary or excessive use of executive discretion.

Practical Implications

The practical implications of Clause 220 are significant for various stakeholders:

For Foreign Companies

- Transitional Relief: Companies are protected from the harsh consequences of sudden residency by having their past losses, depreciation, and accounting periods recognized with appropriate modifications.

- Compliance Requirements: Companies must adhere to the conditions specified in the notification to retain the benefits. Non-compliance can lead to retrospective withdrawal of benefits and additional tax liability.

- Certainty and Predictability: The provision, along with the notification mechanism, provides a degree of certainty regarding tax treatment during the transition.

For Tax Authorities

- Administrative Flexibility: The ability to specify exceptions and modifications allows tax authorities to address complex cross-border scenarios.

- Enforcement Powers: The mechanism for withdrawal of benefits in case of non-compliance strengthens the enforcement framework.

For the Legislative and Regulatory Framework

- Delegated Legislation: The provision underscores the increasing reliance on notifications to operationalize complex tax provisions, with parliamentary oversight as a safeguard.

- Alignment with International Standards: The approach is consistent with global efforts to counter base erosion and profit shifting (BEPS) and ensure tax compliance by multinational enterprises.

Comparative Analysis: Clause 220 vs. Section 115JH and Notification No. 29/2018

A detailed comparison reveals both continuity and evolution in the legislative approach.

1. Structural Parity and Legislative Continuity

Both Clause 220 and Section 115JH are structurally similar:

- They apply to foreign companies becoming Indian residents for the first time.

- Both provide for exceptions, modifications, and adaptations via notification.

- Both include mechanisms for withdrawal of benefits in case of non-compliance.

- Both require notifications to be laid before Parliament.

This continuity reflects a settled legislative intent to address the complexities of cross-border taxation in a consistent manner.

2. Substantive Provisions: Key Parallels and Differences

Aspect	Clause 220 of the Income Tax Bill, 2025	Section 115JH of the Income Tax Act, 1961
Triggering Event	Foreign company becomes resident in India in a tax year, having not been resident in earlier tax years	Foreign company becomes resident in a previous year, not resident in any preceding previous years
Scope of Exceptions/Modifications	To be notified by Central Government	To be notified by Central Government
Extension to Succeeding Years	Applies to tax years ending before assessment completion	Similar, applies to previous years ending before assessment completion
Non-Compliance Consequences	Benefit deemed wrongly allowed, AO may recompute, reference to sec. 287 (presumably rectification section)	Benefit deemed wrongly allowed, AO may recompute, reference to sec. 154 (rectification)
Parliamentary Oversight	Notification to be laid before Parliament	Same

Key Observations:

- The core structure and intent remain unchanged.

- The references to specific sections for rectification (Section 287 in the Bill vs. Section 154 in the Act) reflect the reorganization of the new Bill.

- The language has been modernized, but the substance is retained.

3. Notification No. 29/2018: Operationalizing the Exception Regime

Notification No. 29/2018 is the practical instrument through which the exceptions, modifications, and adaptations contemplated in Section 115JH (and now Clause 220) are specified.

Its key features include:

- Depreciation and WDV: Recognizes written down value (WDV) of assets as per foreign tax records or books of account, depending on whether the company was assessed to tax in the foreign jurisdiction.

- Brought Forward Losses and Unabsorbed Depreciation: Allows recognition and carry forward of losses/depreciation as per foreign tax records or books, subject to being set off only against income that becomes chargeable to tax in India due to residency.

- Accounting Year Alignment: Provides rules for aligning foreign company accounting periods with Indian tax years, including special rules for short periods.

- TDS Compliance: Clarifies compliance requirements under Chapter XVII-B.

- Foreign Tax Credit: Allows credit for taxes paid in foreign jurisdictions in accordance with sections 90/91 and Rule 128.

- Continuity and Conflict: The company continues to be treated as a foreign company for certain purposes; in case of conflict, provisions applicable to foreign companies prevail, including the tax rate.

- No Adverse Effect Clause: The notification is deemed to have retrospective effect from April 1, 2017, with a certification that no person is adversely affected.

Notable Points:

- The notification provides detailed, pragmatic solutions to practical issues arising from the transition to resident status.

- It ensures that the tax base is protected while avoiding double taxation or loss of legitimate deductions.

- The notification's approach is likely to be replicated or adapted under the new Bill, unless superseded by a new notification.

4. Unique Features and Potential Issues

- Delegation of Legislative Power: Both the Act and the Bill delegate significant power to the Central Government to specify exceptions/modifications. While necessary for flexibility, this raises questions about the scope and limits of executive discretion.

- Retrospective Application: The notification's retrospective effect is justified by the absence of adverse consequences, but in principle, retrospective tax law can be contentious.

- Ambiguity in Definitions: Terms such as "assessment proceedings," "conditions specified in the notification," and the scope of "exceptions, modifications, and adaptations" could be open to interpretation and potential litigation.

- Interaction with DTAAs: The provisions must be read in conjunction with DTAAs, especially regarding foreign tax credits and reliefs.

Practical Implications: Stakeholder Analysis

Foreign Companies

- Transition Management: Companies must maintain detailed records of depreciation, losses, and accounting periods in both home and host jurisdictions to comply with Indian requirements.

- Risk of Benefit Withdrawal: Any lapse in compliance with notification conditions can result in significant tax liabilities, including interest and penalties.

- Strategic Planning: The potential for PoEM-based residency requires careful planning of board meetings, management decisions, and documentation.

Tax Authorities

- Increased Oversight: The provisions require tax authorities to scrutinize the factual matrix of PoEM, accounting periods, and compliance with notification conditions.

- Capacity Building: Assessing officers must be equipped to handle complex cross-border accounting and tax issues.

Regulatory and Policy Implications

- Policy Evolution: The move from Section 115JH to Clause 220 reflects the evolution of Indian tax policy toward greater sophistication in dealing with international businesses.

- International Alignment: The regime aligns with OECD/G20 BEPS recommendations and global trends in anti-avoidance measures.

Comparative Perspective: International Practices

Many jurisdictions have adopted similar approaches to address the challenges of multinational tax avoidance. The use of PoEM as a residency test, coupled with transitional provisions for companies changing tax status, is found in countries like the UK, Australia, and South Africa. The Indian approach, with its reliance on delegated legislation for operational details, is consistent with international best practices, though the degree of specificity and legal certainty varies.

Conclusion

Clause 220 of the Income Tax Bill, 2025, represents a logical continuation and refinement of the special regime for foreign companies that become Indian residents under the PoEM test. Its structure, objectives, and operational mechanisms closely mirror those of Section 115JH of the Income Tax Act, 1961, with Notification No. 29/2018 providing the practical framework for implementation. The regime seeks to balance the need for tax compliance and anti-avoidance with the practical realities of international business, offering transitional reliefs and clear compliance obligations. The continued reliance on notifications for specifying exceptions and modifications underscores the dynamic nature of international tax law and the necessity for administrative flexibility. However, this also places a premium on clarity, transparency, and robust oversight to prevent arbitrariness and ensure taxpayer confidence. As cross-border business structures become increasingly complex, the law in this area will likely continue to evolve, with further refinements in both substantive provisions and administrative guidance. Judicial clarification may be required on issues such as the interpretation of PoEM, the scope of delegated powers, and the interaction with DTAAs. Stakeholders must remain vigilant and proactive in understanding and complying with these evolving requirements.

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Full Text:

Clause 220 Foreign company said to be resident in India.

 

Dated: 6-5-2025