As a strong force within future global trade, India is fast becoming a major focal point of interest for companies outside of India who are seeking a place for their future business activities; therefore, many of those businesses find that registering a subsidiary in India provides them with an opportunity to have their own presence in India through the establishment of a wholly-owned Indian subsidiary. For example, if you are considering establishing an Indian subsidiary in the field of Information Technology or manufacturing or consulting or any other type of activity such as back office, sales, or marketing, establishing a wholly-owned Indian subsidiary will give you operational control, a form of recognition under Indian law, and an opportunity to access a very rapidly expanding Indian economy. However, one of the most frequently asked (and misunderstood) questions by foreign investors is: If a foreign parent company transfers funds to its wholly owned subsidiary for the sole purpose of supporting the day-to-day operations, must the Indian subsidiary pay tax on those funds in India? Unfortunately, there is no simple yes or no answer to that question; therefore, we will explain in detail how funds sent to an Indian subsidiary by a foreign parent company could be classified, what their intended purpose is, and how the financial records for the transaction would be prepared and maintained. In addition, this blog will cover the commonly held misconceptions of foreign companies registering a subsidiary in India and provide them with some guidance concerning the tax and compliance issues that they will encounter after registering their Indian subsidiary.
Understanding the Relationship Between a Foreign Parent Company and an Indian Subsidiary
When international businesses officially incorporate in India, they form an entirely separate legal entity under Indian legislation. As such, although the parent company owns 100% of it, for all intents and purposes of India law, the subsidiary operates as a completely independent business entity.
The importance of this legal independence is illustrated in the following ways;
• That the Indian subsidiary will be treated as a resident Indian corporation for purposes of tax.
• The Indian subsidiary will be required to comply with all applicable Indian laws including the Companies Act of 2013, the Income Tax Act of 1961, the Foreign Exchange Management Act and any and all other law which may state otherwise.
• In general, unless exempted, any income derived or received by the Indian subsidiary will be subject to taxes in India unless there is otherwise a specific exemption available. Therefore, all transfers made from the foreign parent corporation to the Indian subsidiary must be documented and classified and supported by documentation detailing their purpose.
Why Do Parent Companies Send Funds to Indian Subsidiaries?
After a foreign company registers an Indian subsidiary in India, it generally sends funds to its Indian subsidiary for the following purposes:
While these types of funds are critical to the operation of the business, their tax treatment will vary depending on whether they qualify as capital or revenue.
Types of Funds Received from a Foreign Parent Company
To correctly calculate tax liability, we need to understand what funds will fall under Indian Law. 1) Capital Contribution as Equity Investment.
When a foreign parent company remits money as share capital or shares premium for registration of its Indian subsidiary this will be treated as a capital receipt by the Indian subsidiary.
Tax Treatment:
• The capital contribution is not going to be treated as taxable income by the Indian subsidiary.
• Just because the Indian subsidiary receives funds does not mean that it will pay tax on those funds.
• The capital contribution will still need to meet the requirements of FEMA (Foreign Exchange Management Act), valuation norms and reporting obligations (e.g. FC-GPR).
This method will give the foreign company a tax-efficient way to fund the Indian subsidiary during the early stages of operation.
2) Loans From the Parent Company.
In some cases, instead of sending funds as equity, the parent company may send money to the Indian subsidiary in the form of a loan.
• The principal amount of the loan is not taxable income for the Indian subsidiary.
• The Indian subsidiary will be liable to pay tax on the interest that it pays on the loan.
• Interest on the loan is subject to withholding tax (TDS) for which the Indian subsidiary will have to deduct TDS, subject to the provisions of any Double Taxation Avoidance Agreement (DTAA).
Loans to Indian Subsidiaries must comply with guidelines for External Commercial Borrowings (ECB) under the FEMA.
3. Reimbursement of Expenses
In some cases, the parent company pays certain expenses on behalf of the Indian subsidiary and later gets reimbursed.
Clear inter-company agreements are essential to avoid disputes.
4. Service Fees or Management Fees
If the parent company provides services such as management support, technical assistance, branding, or administrative services to the Indian subsidiary, the funds received may be classified as service income.
Improper structuring of service arrangements is one of the most common reasons for tax scrutiny after Indian subsidiary registration in India.
Does the Indian Subsidiary Pay Tax on Operational Funding?
The key principle under Indian tax law is:
Only income is taxable, not the mere receipt of funds.
If funds are received purely to run operations and are:
then no income tax is payable simply on receipt of funds.
However, once the Indian subsidiary:
it becomes liable to pay corporate income tax in India.
Tax Residency and Permanent Establishment Considerations
After registering as a Subsidiary in India, the Subsidiary will be deemed to be a Resident Indian Company regardless of where its Parent Company might be located. As such, it must:
Importantly, an Indian Subsidiary provides Foreign Companies with a means of avoiding creating a Permanent Establishment (PE) risk in India because Operations and Activities will be performed using a separate Corporate Entity in India.
Transfer Pricing Compliance: A Critical Aspect
When a foreign company decides to register its Indian subsidiary, compliance with transfer pricing regulations is mandatory. Under these regulations, all transactions between the parent company and the Indian subsidiary must:
Non-compliance can lead to:
Proper structuring at the time of registration of the subsidiary in India can greatly minimize any potential future problems.
FEMA and Regulatory Compliance on Fund Inflows
Besides income tax obligations, funds sent by a foreign parent into India must comply with:
FEMA regulations,
RBI reporting requirements, and,
KYC (Know Your Customer) norms for inward remittances.
Many companies fail to comply with these regulations, however even if there are no taxes due, penalties will still be incurred for non-compliance.
Common Misconceptions About Tax on Parent Funding
Misconception 1: Any and all money received from outside India is taxed.
Reality: Only income is taxed in India, not loans or capital.
Misconception 2: A fully foreign-owned company in India is exempt from paying taxes in India.
Reality: An Indian subsidiary pays taxes just like other Indian companies.
Misconception 3: Any operational support fund will automatically qualify for an exemption from income tax.
Reality: Depending on how the operational support fund has been documented, it may or may not qualify for an exemption from income tax.
Importance of Proper Structuring During Indian Subsidiary Registration
When an international business establishes a presence in India as part of the Indian subsidiary registration process, the way that business structures its relationship with India will have a significant impact on the company's long-term tax and compliance structure.
Important issues to consider include:
• Deciding whether to fund through equity or debt.
• Establishing inter-company agreements.
• Defining service scope clearly.
• Developing Transfer Pricing Policies.
Working with a qualified professional for Indian subsidiary registration services will help ensure that you are in compliance with the regulations and tax requirements from day one.
Impact of Funding Structure on Indian Subsidiary Operations
Funds' receipt methods also play a major role in determining:
• Your overall tax liability.
• Managing cash flow.
• Stay compliant with regulations.
• Audit risk level.
• The method of reporting profitability.
By selecting the incorrect funding structure, it is possible to incur additional tax expense regardless of whether your subsidiary generates any revenue from outside the company.
Tax planning needs to be part of the process of Indian subsidiary registration if you are choosing this option.
Common Mistakes Foreign Companies Make
Even if a foreign corporation has the best of intentions, it still may fall into one of these pitfalls after forming a Indian subsidiary in India:
1. Treating all funding from the parent company as "non-taxable."
2. Failing to comply with transfer pricing requirements.
3. Misclassifying services income as a "reimbursement."
4. Delaying filings with the Reserve Bank of India ("RBI") and Foreign Exchange Management Act ("FEMA").
5. Not having the correct inter-company agreements.
6. Not considering whether GST applies.
Tax audits and assessments will frequently reveal non-compliance with one or several of these areas.
Consequences of Incorrect Tax Treatment
If you misclassify or do not show compliance with/misclassify your Funds, it can be extremely detrimental to you in terms of:
1. Income tax assessments
2. Interest and penalties
3. Adjustments made to transfer pricing
4. Disallowing expenses
5. Litigation against tax authorities
6. Damaging your company's reputation as the parent company
Extensive non-compliance may negatively impact a subsidiary's ability to remit profits or cease business without difficulty.
Regulatory and Compliance Requirements to Watch
An Indian subsidiary receiving foreign funds must comply with:
Professional support during the Indian subsidiary registration process and post-registration phase ensures these obligations are handled correctly.
Strategic Tax Planning for Indian Subsidiaries
Minimization of tax risk requires the following steps:
• A clear definition of the source of funds' purpose.
• The use of equity for funding wherever possible.
• The creation of strong intercompany agreements.
• The maintenance of accurate and complete documentation.
• The annual performance of transfer pricing studies.
• Regular reviews of the applicability of the Goods and Services Tax (GST).
By obtaining expert assistance from a qualified company that provides Indian subsidiary registration services and ongoing compliance support, a company's operational and tax challenges will be significantly reduced.
Conclusion
A foreign company's establishment of an Indian subsidiary through doing business registration within India, it does not mean that the new Indian subsidiary is liable to pay taxes on the amount(s) received from its parent company, as it is based on the type of amount(s) received from the foreign company. In other words, the Indian subsidiary may receive capital contributions from the foreign company as a means of establishing an Indian business entity or providing a loan to the Indian subsidiary. In either case, capital and loan inflows into a business are generally not subject to Indian taxation; however, all income generated by an Indian subsidiary will be subject to Indian taxation laws. Through the use of professional Indian subsidiary registration services, the proper structuring, documentation, and compliance during the Indian subsidiary registration process creates a greater opportunity for tax efficiency, regulatory compliance, and successful long-term operations in India.
FAQs
1. Is money sent by a foreign parent to an Indian subsidiary always taxable?
No. Money sent as share capital, share premium, or loans (principal amount) is not taxable. Tax applies only if the funds are treated as income.
2. Does an Indian subsidiary have to pay tax even if it is not profitable?
No income tax is payable if the subsidiary does not earn taxable income. However, compliance filings are still mandatory.
3. Are operational expenses funded by the parent taxable in India?
If funded through capital or loan, they are not taxable. If charged as service fees, they may be taxable.
4. Is transfer pricing applicable to all parent-subsidiary transactions?
Yes. All international transactions between the parent and Indian subsidiary must follow transfer pricing rules.
5. Can improper fund classification lead to penalties?
Yes. Incorrect classification or documentation can result in tax demands, penalties, and regulatory action.
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