Published Wed, 22 Feb 2023
Managing profits and repatriating funds is a key aspect for foreign companies operating in India as it involves various inter-connected local and international laws and regulations – such as The Companies Act, The Foreign Exchange Management Act, relevant income tax regulations, Double Tax Avoidance Agreements, as well as transfer pricing rules.
The procedure to repatriate profit to the foreign investor/parent company depends upon an entity’s legal structure and investment model. Typically, foreign companies in India operate through either a liaison office, project office, branch office, or wholly owned subsidiary (WOS) – depending upon the nature of their activities.
Modes of Operation by Foreign Companies in India:-
Liaison offices means a place of business to act as a channel of communication between the principal place of business or Head Office in foreign country and entities in India. They are only meant to promote the parent company’s business interests, spread awareness of the company’s products, and/or explore further opportunities for business. They are not allowed to undertake any business activities and thus cannot earn any income in India. It is prohibited to undertake any commercial /trading/ industrial activity, directly or indirectly in India and maintains itself out of inward remittances received from abroad through normal banking channel. Therefore, companies are not permitted to repatriate money from a liaison office.
Project offices are set up to execute specific projects in India. They can only undertake activities related to the execution of the specified project. These offices can remit a surplus outside India – only upon completion of the project after ensuring all legal compliances in India.
Branch offices are often used by foreign companies which are engaged in manufacturing and trading activities in India. Branch Offices are only allowed to represent the parent company and have limited operational capacity. All investments and profits earned by branches of a foreign company are repatriable after appropriate taxes are paid and compliance ensured with such rules and regulations as may be applicable.
Wholly owned subsidiaries in India have independent legal status distinct from the parent foreign company. Foreign entities with long-term business objectives often choose to establish their presence with a WOS because it provides control, longevity, flexibility, and a stronger legal foundation for doing business in India. Profits can be repatriated from a WOS via dividend, buyback of shares, reduction of share capital, fees for technical services, consultancy service/business support services and royalty etc.
Before Investing in India, foreign companies should be well aware of how to repatriate their profits from the country. Profit repatriation is generally defined as the ability to return foreign earned profits or financial assets back to the company's home country.
Funds can be repatriated from one country to another in various ways. Investors and companies should, therefore, note that choosing the right strategy to repatriate funds can reduce their tax burden and increase revenue. In turn, such cost savings make it possible for reinvesting in innovation and improving the productivity of the business. Given below are some of the methods of Profit repatriation:-
A foreign company that makes an equity contribution to its Indian subsidiary often demands dividend payouts or whenever company makes huge profits, it may declare dividend in favor of its shareholders, either annually or at a predetermined time interval which is usually a share of the profits earned by Indian subsidiary of Foreign Company.
In India, the Finance Act, 2020 changed the method of dividend taxation. Henceforth, all dividend received on or after April 1, 2020 is taxable in the hands of the investor/shareholder. In a case where the dividends are paid to non-resident shareholders, tax is required to be deducted at 20 percent (plus applicable surcharge and cess) subject to tax treaty benefits where a lower rate, if applicable, can be availed.
In other words, the dividend pay-out forms part of the taxable income of the shareholder and shall be taxed only in the hands of the recipient and the same shall be taxable @ 20% plus surcharge & cess (without allowing any deduction under any other section under Income Tax Act) under section 115A and the Indian entity that is distributing profits through dividends is required to deduct TDS as per income tax provisions. These rate are subject to tax rate provided under treaty if any.
It may also be noted that if foreign affiliate is situated in a country with which India has a tax treaty, dividends from the Indian subsidiary can be remitted to the foreign country simply by deducting withholding tax (WHT), which ranges from five percent to 15 percent, depending on the nature of income and activities carried out in India. For application of lower DTAA rate, the non-resident shareholder has to furnish tax residency certificate of the other country to establish entitlement to claim DTAA benefit.
When the company holds excessive cash with no attractive investments in sight, share buyback is an appropriate mean to repatriate funds and utilizing such excess funds properly.
A foreign company could return the shares that it owns and the Indian company would have to pay the consideration for the shares. Generally the number of shares and the price is pre-determined by both the companies based on internationally accepted valuation methods which are in compliance with Indian foreign exchange regulations.
Once the shares are bought back, they are subsequently cancelled. Most companies having surplus cash with no attractive investment options use this method as a means to return the cash to their shareholders. However, company shall be liable to pay Income-tax at the rate of twenty per cent on the distributed income at the time of buy-back of shares from a shareholder (Section 115QA of Income Tax Act, 1961).
Distributed income is the difference between the consideration paid by the company at the time of buyback and amount received by the company at the time of issue of shares.
It is also clarified that the consideration paid will not be taxable in the hands of Non-resident shareholder.
One of the other means of repatriating profits is capital reduction. The method is generally used when company wishes to repatriate cash through buyback of shares but exceeds permissible buy-back limits. It usually takes place at a pre-determined price. This leads to reduction of holding from the foreign company from the perspective of Indian Company and the return of capital from the Indian company from the perspective of foreign company.
When any company reduces the share capital as per the provisions of the Companies Act, 2013 by way of reducing the face value of shares or by way of paying off part of the share capital, it amounts to extinguishment of the rights of the shareholder to the extent of reduction of share capital. Therefore it is regarded as transfer under section 2(47) of the Income Tax Act, 1961 and would be chargeable to tax.
If the Indian company uses any technology or process that is patented by the parent foreign company, then the Indian company is liable to pay royalties to the foreign company for using the foreign company’s intellectual property.
Companies pay consideration in form of royalty to either the holding company or the foreign owner company for such technological alliance. The payment is made for the right to use technical expertise, design, Trademarks, patents, copyrights and Brand name.
Under the Indian Income Tax Act, Royalty shall be taxable @ 10% plus surcharge & cess (without allowing any deduction under any other section under Income Tax Act) under section 115A. and the Indian company would need to withhold taxes at prescribed rate plus any applicable surcharge and education cess on payment made to Non-resident.
The Royalty payment is subject to the application of DTAA between India and the Recipient country, Indian company has to consider the provision of DTAA and Income Tax Act before making the Royalty Payments.
However, the payee should have a valid Personal Account Number (PAN) allocated by the Income Tax department in India.
As per the Income Tax Act, 1961 “fee for technical services” means any consideration (including any lump sum consideration) for the rendering of any managerial, technical, or consultancy services (including the provision of services of technical or other personnel) but does not include consideration for any construction, assembly, mining, or similar project undertaken by the recipient or consideration that would be the income of the recipient chargeable under the head “Salaries”
A foreign Company can provide services to its Indian subsidiary in the form of Technical Know-how, IT support, Expansion support, Management consultancy etc. In consideration, the Indian company is required to make a payment for the services used in India. This payment could be made in several forms, including service fees etc.
As per the Income Tax Act, 1961 – an Indian company, while making the payment to its foreign affiliates/parent towards the fee for technical services, or consultancy services shall withhold the tax at 10 percent plus surcharge and applicable cess (without allowing any deduction under any other section under Income Tax Act) under section 115A, subject to the fulfilment of such conditions as may be applicable.
The Service payment is subject to the application of DTAA between India and the Recipient country, Indian company has to consider the provision of DTAA and Income Tax Act before making the Service Payments. In such a scenario, whichever provision (per the Income Tax Act or per the Tax Treaty) is beneficial to the non-resident will prevail.