Company Taxation

Planning Points for Foreign Investors

According to the Indian exchange control regulations, a foreign business can have a presence in India in the form of a liaison office, branch office, project office, company, and Limited Liability Partnership (LLP).

The factors to be looked at are as follows:

Particulars Liaison office Branch office and Project office Subsidiary company Limited liability partnership (LLP)
Regulatory approval Reserve Bank of India (RBI)5, Registrar of Companies (ROC) and local registrations RBI, ROC and local registrations ROC and local registrations ROC and local registrations
Rate of tax6 Nil (since it is not permitted to carry out any revenue-generating activity) Normal tax rate - 40% of net taxable income. Minimum Alternate Tax (MAT)7 Normal tax rate - 30% of net taxable income.
Companies with total turnover in FY 2017-18 less than INR 4000 million: 25%
Certain manufacturing companies foregoing specific deductions - 25%
MAT - 15% of adjusted book profits.
Consessional Tax Regime8 : New manufacturing company – 15%
Special rate for domestic companies foregoing specific deductions and complying with specific requirements – 22%* (MAT is not applicable under concessional tax regime)
Normal tax rate - 30% of net taxable income. Alternate Minimum Tax (AMT)9 - 18.5% of adjusted book profits.

*It may be noted that conditions provided for availing concessional tax rate is likely to be fulfilled by most Indian companies. Accordingly, the virtually corporate tax rate for an Indian company is reduced to 22%.

Particulars Liaison office Branch office and Project office Subsidiary company Limited liability partnership (LLP)
Long-term capital gain tax rate on exit from business10 Not Applicable Not applicable 10% on the capital gain exceeding INR 100,00011 or 20%12 20%
Advance tax payment Not applicable (since it is not permitted to carry out revenue- generating activity) To be paid in four installments To be paid in four installments To be paid in four installments
Minimum capital norms Not applicable (funded by head office) Not applicable (funded by head office/internal accruals) No minimum capital No minimum capital
Repatriation of profits Not applicable No further tax on repatriation of profits Dividend distributed to the shareholder would be taxable in the hands of shareholders No further tax on repatriation
Permanent Establishment (PE) Generally, do not constitute PE, but litigation exists Constitutes a PE and a taxable presence under a tax treaty or income tax provisions An independent taxable entity and not a PE of a foreign company. However, based on the role and function of the Indian entity, PE risk may be evaluated Should not constitute PE. However, based on the role and function of LLP, PE risk may have to be evaluated
Applicable surcharge and education cess Not liable to tax Surcharge:
Total income of: Up to INR 10 million - Nil
Up to INR 100 million - 2%
Above INR 100 million - 5%
Health and education cess at the rate of 4%
Surcharge: Total income of: Up to INR 10 million - Nil
Up to INR 100 million - 7%
Above INR 100 million - 12%
Education cess at the rate of 4%
Concessional Tax Regime : Surcharge at the rate of 10%
Health and education cess at the rate of 4%
Surcharge: Total income of: Up to INR 10 million - Nil
Above INR 10 million - 12%
Health and education cess at the rate of 4%

Investment via Shares or Loans

A foreign corporation can fund its Indian subsidiary by infusing share capital (FDI) or by extending a loan (External Commercial Borrowing (ECB)). Both FDI and ECBs can be availed by the Indian subsidiary subject to the fulfillment of prescribed exchange control regulations. The critical tax and regulatory implications of FDI/ECBs are:

  • Repatriation of capital : Foreign capital invested in India is generally allowed to be repatriated along with capital appreciation, if any, after payment of taxes due on them, provided the investment was made on a repatriable basis. The repatriation is, however, subject to lock-in conditions in certain sectors.
  • Return of dividend : The dividend income is freely repatriable. The same would be taxable in the hands of the shareholder.
  • Payment of interest on ECBs : Subject to certain conditions, withholding tax on ECBs (wherever allowed) has been reduced from 20% to 5% (with applicable surcharge and cess) for ECBs availed between 1 July 2012 and 1 July 2023. Further, in case of monies borrowed by the issue of long- term bonds or Rupee Denominated Bonds (RDBs), issued on or after 1 April 2020 but before 1 July 2023, and listed in the stock exchange located in International Financial Service Centers (IFSC), the rate would be 4%. The concessional rate of 5% would apply even if the non-resident does not have a PAN in India.

Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)

The Finance Act (No. 2), 2014 introduced a taxation regime for business trusts - REITs and InvITs. These business trusts give small investors access to large-income-producing real estate and infrastructure assets, much like how mutual funds provide access to stocks. The Securities and Exchange Board of India (SEBI) issued guidelines for regulating such business trusts, and an investor can enter the property market with as little as INR 200,000. Both these models have the following distinctive elements:

  • The trust would raise capital by issuing units, which would be listed on recognized stock exchanges in India
  • The trust can raise debt from residents as well as non-residents
  • Income-bearing assets would be held by the trust by acquiring controlling or another specific interest in an Indian company (Special Purpose Vehicle (SPV)) from the sponsor (promoters of the SPV)

Furthermore, the taxation regime of such business trusts would, among other things, include the following:

  • No capital gains tax on the sponsor at the time of exchange of shares of the SPV with the units of the trust.
  • Capital gain on transfer of units shall be taxable at the rate of 10% on an amount exceeding INR 100,000.
  • Capital gains on the disposal of other assets by the trust shall be taxable in the hands of the trust. However, the same would not be taxable in the hands of the unit holders at the time of distribution.
  • Dividend, interest, and rental income received by the trust from the SPV is accorded a pass-through status. Accordingly, this dividend, interest, and rental income would not be chargeable to tax in the hands of the trust. However, at the time of distribution of this income to investors of the business trust, taxes would be required to be withheld as per the ITA.
  • Other income of the trust shall be taxable at the maximum marginal rate (30%).

In addition, certain other reporting compliances like filing of tax returns, etc. would be required to be undertaken by business trusts.

Alternative Investment Funds (AIFs)13

An AIF is any fund established or incorporated in India in the form of a trust, company, LLP, or a body corporate that is a privately-pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.

Category I AIFs are those that invest in start-ups or early-stage ventures, social ventures, Small-and Medium-sized Enterprises (SMEs), infrastructure, other sectors or areas that the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME funds, social venture funds, infrastructure funds and such other AIFs as may be specified. AIFs that are generally perceived to have positive spill-over effects on the economy and for which the Board, or government, or other regulators in India might consider providing incentives or concessions shall be included, and such funds that are formed as trusts or companies shall be construed as ‘venture capital company’ or ‘venture capital fund’ as specified in the ITA.

Category III AIFs are those that employ diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives. AIFs, such as hedge funds or funds which trade with a view to make short-term returns or such other funds which are open-ended and for which no specific incentives or concessions are given by the government or any other regulator shall be included.

Category II AIFs are those that do not fall in Category I and III and do not undertake leverage or borrowing other than to meet day-to-day operational requirements as permitted in the regulations. AIFs, such as private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other regulator, shall be included.

From FY 2019-20 onwards, a special tax regime for Category I and II AIFs have been provided, irrespective of whether they are set up as a trust, company, LLP, or as any other body corporate:

  • Any income (other than income from profits and gains of business) of the investment fund will be taxable in the hands of the unitholders and not the investment fund.
  • Income from profits and gains of business of the investment fund shall be taxable in the hands of the investment fund only.
  • Accumulated losses except business losses as on 31 March 2019 shall be distributed to the unitholders in their investment ratio and shall be allowed to be carried forward in future years. Losses of business shall still be subject to set-off and carried forward to the subsequent years, only at the fund level (i.e. it will not be passed on to the unit holders).
  • Any losses, except business loss, shall be distributed to the unit-holders post 1 April 2019 and shall not be eligible to be set-off/carry forward by the investment fund. The unit holder should have held the units for at least a period of 12 months. The share of losses of the unitholders who have held units for a period less than 12 months shall lapse.
  • Any income that is not taxable at the fund level and paid to unitholders by the investment fund would be subject to withholding tax at the rate of 10%. According to the Finance Act, 2016, when the unit holder is a non-resident, the withholding tax shall be at the rates in force (depending on the source of income taxable in the hands of unitholders or the price provided under the relevant tax treaty, whichever is lower). However, withholding tax would not be applied if the income is not chargeable to tax under the provisions of the ITA itself.
  • Any income of the investment fund would be exempt from TDS requirements. This would be provided by issuing the appropriate notification.
  • It is mandatory for the investment fund to file its Return of Income. The investment fund shall also be required to provide the details of various components of income, etc. for the purpose of the scheme to the prescribed income tax authorities and the investors.

This tax pass-through will enhance the ability of these funds to mobilize higher resources and make higher investments in small and medium enterprises, infrastructure and social projects, and provide the much-required private equity to new ventures and start-ups.

Tax incentives to International Financial Services Centers (IFSCs)

To incentivize the growth of IFSCs into world-class financial services hubs, the following tax benefits are provided to IFSC’s:

  • Long-term capital gains arising from transactions undertaken in a foreign currency on a recognized stock exchange located in an IFSC (even when the STT is not paid with respect to such transactions) will be exempt from tax14
  • Short-term capital gains arising from an operation undertaken in foreign currency on a recognized stock exchange located in an IFSC (even when STT is not paid with respect to such transactions) will be taxable at a concessional rate of 15% (plus the applicable surcharge and cess)
  • In the case of a company, being a unit located in an IFSC and deriving its income solely in convertible foreign exchange, MAT shall be chargeable at the rate of 9%
  • The Finance Act, 2018, exempts the transfer of specified bonds or GDRs, RBDs of an Indian company, or derivatives by a non-resident in foreign currency on a recognized stock exchange located in any IFSC. Furthermore, the Finance Act (No. 2), 2019, has also exempted the transfer of any derivatives or such other securities as notified by the Central Government.
  • STT/Commodities Transaction Tax (CTT) shall not be levied on the taxable securities transactions/commodities transactions entered into by any person on a recognized stock exchange located in an IFSC where the consideration for such a transaction is paid or payable in foreign currency (applicable from 1 June 2016)
  • Any income by way of interest payable by a unit in an IFSC to a non-resident after 1 September 2019 shall be exempt.
  • After 1 September 2019, no additional income tax shall be payable by a specified mutual fund out of its income derived from transactions made in a recognized stock exchange located in an IFSC, and where such consideration is paid in convertible foreign exchange.

Other Tax Incentives

The Indian government offers various types of tax incentives to accelerate economic growth and extend various direct and indirect incentives to the business community. Some incentives available under the ITA are as follows:

  • India has robust tax treaties with many countries. Taxpayers have the option of availing benefits under a tax treaty to the extent it is more beneficial vis-a-vis the provisions of the ITA (subject to documentation requirements).
  • The rate of withholding tax on interest on ECBs has been reduced from 20% to 5% subject to certain conditions.
  • Profit and investment-linked incentives:
    • For units located in Special Economic Zones (SEZs): 100% income tax exemption on export income for the first five years, 50% for the next five years, and 50% on the re-invested export profit for the next five years.
    • For SEZ developers: Income tax exemption on income for a block of 10 years in 15 years.
  • Investment-linked incentives are available for specified activities/sectors, such as :
    • Infrastructure
    • Oil and gas
    • Research and development activities
    • Activities in specified geographical areas
    • Cold storage, warehousing facilities for agriculture produce and sugar
    • Hotels, hospitals, and slum redevelopment or rehabilitation with certain restrictions.

However, the company will be liable to pay tax under the provisions of MAT wherever profit- and investment linked incentives are available.

  • Accelerated depreciation at the rate of 20% is available on new plant or machinery acquired and installed by an undertaking engaged in the manufacture of any article.
  • In addition, an investment allowance of 15% on the cost of machinery is allowed to a manufacturing company that is investing a minimum of INR 250 million within a specified time frame and subject to certain conditions.
  • In the case of additional wages paid to new employees across all sectors, the taxpayer will enjoy an additional tax deduction of 30% of the salary paid for a period of three years, subject to certain conditions.
  • 100% deduction will be allowed for business income earned by an eligible start-up for a period of three consecutive years. The start-up should be engaged in a business that involves innovation, development, deployment or commercialization of new products, processes or services driven by technology or intellectual property and should hold a certificate of eligible business from the Inter-Ministerial Board of Certification notified by the Central Government. The turnover of the business should not exceed INR 250 million in any year from 1 April 2016 to 31 March 2021.
  • The taxpayer will have the option of claiming this deduction for three consecutive years from a period of seven years starting from the year of incorporation of the start-up15. The start-up should not be formed by splitting up or reconstructing a business already in existence. It should also not be formed by using second- hand plant and machinery exceeding 20% of the total value of plant and machinery. From 1 April 2016, an exemption from CGT is also provided in cases where the proceeds from the sale of certain assets are invested in specified funds/shares related to start-ups, subject to conditions.
  • In order to encourage indigenous research and development activities and to make India a global R&D hub, the government has decided to put in place a concessional taxation regime for income from patents. Accordingly, an Indian resident earning royalty from a patent developed and registered in India can, subject to conditions, choose to pay tax at the rate of 10% (plus the applicable surcharge and cess) on the gross amount of the royalty. However, no expenditure or allowance of such royalty income shall be allowed. This income is also exempt from the levy of MAT. However, the concessional tax benefit will be available only if at least 75% of the expenditure for patent development is incurred in India.
  • 5.Could be under the automatic or government approval route involving post-facto intimation or prior approval, respectively.
  • 6.Excluding surcharge and Health and education cess
  • 7.MAT is designed to ensure that no company with substantial accounting income can avoid tax liability by using exclusions, deductions, and incentives available under the Income Tax Act
  • 8.MAT is designed to ensure that no company with substantial accounting income can avoid tax liability by using exclusions, deductions, and incentives available under the Income Tax Act
  • 9.AMT is similar to MAT and applies to non-corporate bodies only if they are claiming incentive-linked or profit-linked deductions.
  • 10.Excluding surcharge and Health and education cess.
  • 11.Transfer of listed equity shares/unit of an equity-oriented fund which attracts STT and transfer of unlisted shares (without benefit of indexation and foreign currency fluctuation)
  • 12.Other cases
  • 13.This income would be taxable in India whether or not the non-resident has a residence or place of business in India or has rendered services in India
  • 14.This amendment has been applicable from 1 April 2016.
  • 15.Section- 80-IAC, Income Tax Act, 1961-2018, https://www.incometaxindia.gov.in/pages/acts/ income-tax-act.aspx, accessed 30 April 2020
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Maulik Doshi
Senior Executive Director
Transfer Pricing and Transaction Advisory Services

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