It is an undisputed fact that economic growth and tax legislation are inextricably linked together. This would concurrently boost tax revenues and bring debt ratios under control.
An excessively complex tax legislation has an adverse impact on the investment climate of the country. Laws which are unnecessary, unclear, ineffective and disjointed generate an expendable burden on the economy. Even the Guiding Principles for Regulatory Quality and Performance, endorsed by Organisation for Economic Co-operation and Development (OECD) member countries, advised governments to “minimise the aggregate regulatory burden on those affected as an explicit objective, to lessen administrative costs for citizens and businesses”, and to “measure the aggregate burdens while also taking account of the benefits of regulation”.
In the recent Indian context, ‘Make in India’ which is a major new national programme of the Government of India, designed to facilitate investment and build best in class manufacturing infrastructure among other things in the country. The primary objective of this initiative is to attract investments from across the globe and strengthen India’s economic growth. This programme is also aimed at improving India’s rank on the ‘Ease of Doing Business’ index by eliminating the unnecessary laws and regulations, making bureaucratic processes easier, making the government more transparent, responsive and accountable. Though India has jumped up 30 notches and entered the top 100 rankings on the World Bank’s ‘Ease of Doing Business’ index, thanks to major improvements in indicators such as resolving insolvency, paying taxes, protecting minority investors and getting credit, it still has a long way to go, standing at ranking of 100 out of 190 surveyed countries. A review of the application of tax policies and tax laws in the context of global best practices and implement measures for reforms required in tax administration to enhance its effectiveness and efficiency, is the need of the hour for India. This article discusses the concept of Group Taxation Regime, a suggested effective tax reform, in line with the global best practices which could help India provide some policy support to investors and achieve its political, social and economic objectives.
GROUP TAXATION REGIME
A company diversifies into other fields of business as a part of its strategy. As a part of their strategy, the companies incorporate subsidiary companies with different business objectives due to regulatory requirement, ensure corporate governance or to invite fresh capital from other shareholders. Some businesses have a medium to long gestation period as a company takes time to establish its strategies, markets, financers. The idea of group taxation is to reduce the burden on the holding company as it may be required to inject funds into a loss making company without any reduction in corporate tax. Also, the holding company shall receive a return on its investment only when the subsidiary becomes profitable.
The group taxation regime has been adopted by several countries viz, (a) Australia; (b) Belgium (c) Denmark (d) France (e) Germany (f) Italy (g) New Zealand (h) Spain (i) United Kingdom; and (j) United States of America.
A group taxation regime permits a group of related companies to be treated as a single taxpayer. Group taxation is designed to reduce the effect that the separate existence of related companies has on the aggregate tax liability of the group. The principles under the group taxation regime for income tax purposes are discussed below:
– the assets and liabilities of the subsidiary companies are treated as assets and liabilities of the head company;
– transactions undertaken by the subsidiary companies of the group are treated as transactions of the head company;
– the head company is liable to pay instalments on behalf of the
consolidated group based upon income derived by all members of the consolidated
group;
– intra-group
transactions are ignored (for example, management fees paid between group
members are not deductible nor assessable for income tax purposes);
– the
head company is liable for the income tax-related liabilities of the
consolidated group that relate to the period of consolidation. However, joint
and several liability is imposed on members of the group in the event that the
head entity defaults;
– eliminate
income and loss recognition on intragroup transactions by providing for deferral
until after the group is terminated or the group member involved leaves the
group; and
– permit
the offset of losses of one group member against the profits of a related group
member.
Unlike many countries, India does not have a system to consolidate the tax reporting of a group of companies or to offset the profits and losses of the members of a group of companies. The introduction of a system of group taxation would constitute a fundamental change to the Indian tax system. Such a regime could lead to significant benefits like (a) economic efficiency by better aligning the unit of taxation with integrated companies within a group (b) reduce compliance costs for taxpayers as groups of companies would have to apply a single set of tax rules across and deal with only one tax administration; (c) make certain compliance driven tax provisions like specified domestic transfer pricing redundant; (d) give flexibility to organise business activities and engage in internal restructurings and asset transfers without worrying about triggering a net tax; and (e) reduce the cost the government incurs in administration of the tax system including litigation cost.
The specific provisions of group taxation framework vary from country to country. The significant provisions relating to the regime are highlighted below:
Eligible Head of tax group (parent): The group tax consolidation laws in most countries consider a domestic company or a permanent establishment of a foreign company who is assessed to tax as per the domestic laws as an eligible parent company. Most of the countries restrict the definition of group companies to resident companies only and non-resident companies are excluded from this relief.
Group company eligibility: Group taxation includes all legal entities within a group of taxable entities. The criteria is that a company is deemed to control another company if, on the first day of the tax year for which the consolidated regime applies, it satisfies certain requirements. In Spain, the controlling company must directly or indirectly hold at least 75% of the other company’s share capital. In France, at least 95% of the share capital and voting rights of the company must be held, directly or indirectly, by the French company. In New Zealand, a group of resident companies that have 100% common ownership can be considered for consolidated group regime. The subsidiary company will be deemed to be 100% owned by the parent if the requisite degree of control is met as per the provisions of the group tax regime. The total income/ loss of the subsidiary company will be included in group taxation, even if the parent does not own 100% of a subsidiary. Prima facie, this advantage is given to the holding company of being able to utilise the losses of the subsidiary company although it does not own all the subsidiary’s shares. The minority shareholders will not be able to claim a group relief as they do not meet the requite control requirement. However, if the losses to be set off are restricted to percentage of shareholding, then it would mean that the loss making company in the group will be left with losses that cannot be set off immediately and can only be utilised against the company’s future profits.
Hence, in such scenarios, agreements, if any, made between shareholders may also be important. In several binding international rulings, it has been concluded that even if a company has the majority of the voting rights or the majority of the capital, joint taxation may still be denied due to agreement between shareholders. For instance, a minority shareholder has a veto on important decisions in the company, the majority shareholder cannot be jointly taxed with its subsidiary. For illustration, in Denmark the tax consolidation regime provides for a cross-border tax consolidation option based on an “all-or-none principle”, which means that (i) either all foreign group entities are included in the Danish tax consolidation group or (ii) none of them are. In case of a veto power provided and exercised by the minority shareholder vide an agreement may cause hindrance for applicability of the group taxation regime for the entire group. In India, companies having 100% shareholding must only be covered within the group tax regime to avoid disparity between shareholders.
Minimum Term: The minimum term for opting for group taxation differs country to country. In Denmark, the minimum period is 10 years, in France and Germany, the minimum period is 5 years. In Italy, Spain and USA, there is no requirement to opt for a minimum period. In India, having a minimum term of 5 years – 10 years would provide consistency and stability in the tax approach adopted by the group and as well as to the Revenue authorities from an assessment point of view.
Net operating loss: In all group relief provisions, only the current year losses and tax depreciation of group companies are available for set-off against the profits of the other companies in the group. In case of subsidiaries that are acquired, no consideration needs to be given to whether the items are post or pre-acquisition as only the current year losses and tax depreciation are available for relief.
1.Worldwide Corporate Tax Guide, 2017
2. BDO Joint Taxation in Denmark
3. IBFD Country Tax Laws
Exiting the group: A group member may exit the group at any point of time without terminating the group. A company will automatically exit the group as a result of liquidation or sale or merger or if the ownership requirements are not met. On exit, the adjustments made at the consolidated level maybe reassessed according to the standard rules and may give rise to additional tax liability in the hands of the exiting company. The exiting group member’s net operating loss carry forwards realised during the consolidation period would remain with the group. The losses generated while being a member of the consolidated group are transferred to the group and cannot be carried forward at the level of the exiting company when assessing its future taxable income. In France, the question was raised whether the exiting company should be compensated for the losses surrendered to the group. The Supreme Court of France ruled that the compensation given by a parent company to a loss making company subsidiary that exits a group does not constitute taxable income. Correspondingly, the payment is not a deductible expense of the parent company.
In light of the aforesaid provisions, it can be safely stated with the introduction of group taxation regime, the compliance burden would reduce for companies as intra group taxation would be disregarded and only the ‘real income’ would be taxed. It would also promote stability in corporate structures in India and attract foreign investment in India. The Revenue authorities may be at a disadvantage due to loss of revenue due to setting off of income by way of intra group transactions. However, this is fairly insignificant as compared to the advantages that the introduction of this regime would have to offer. The introduction of a group taxation regime would be a welcome move by the Government and will allow the exchequer to tax the real income which is in line with International tax practices. For illustration, if A Co (holding company) has a profit of Rs. 2 million and A Co’s wholly owned subsidiaries B Co and C Co have a loss of Rs. 0.5 million each. With the introduction of group taxation the real income of A Co i.e Rs. 1 million (2-0.5-0.5) would be liable to tax in India.
Currently, with the Indian Revenue authorities being well integrated with the wave of automation and digitisation lead by the current Government, the Revenue authorities can keep a real time tab on filings being made in different jurisdictions. For illustration, a company having a head office in jurisdiction X and subsidiaries in various jurisdictions like Y and Z would have to file separate return of income in each of the jurisdictions for each entity. The group taxation regime would require only the holding company to file its return of income in the jurisdiction where its head office is situated. This would lead to reduction in compliance burden for the corporates. Also, the Revenue authorities of the concerned jurisdiction i.e. Y and Z could view the filings made in jurisdiction X. With easy accessibility of records and integration of the tax systems, a robust infrastructure system is put in place by the tax administrators which makes it feasible to implement the group taxation regime and provide ‘ache din’ to the corporates.
As aptly quoted by Edward VI, the King of England and Ireland, “I wish that the superfluous and tedious statutes were brought into one sum together, and made more plain and short”. We wait with baited breath for India to bridge the gap between its tax legislation and simplify them to further boost economic growth.
REFERENCES
– BDO, Joint Taxation in Denmark
– Ernst & Young, Implementation of Group Taxation in South Africa
– IBFD, Group taxation laws
– India Brand Equity Foundation
– Length of a tax legislation a measure of complexity – Office of Tax Simplification, UK
– Pre and Post Budget Representations, 2017
– Tax Administration Reform Commission Reports
– When laws become too complex, Review by UK Parliamentary Counsel
– Worldwide Corporate Tax Guide, 2017 _
4. IBFD Group Taxation in France
