India’s transfer pricing laws are enumerated under Sections 92 to 92F of the IT Act, 1961 and cover intra-group cross-border transactions. Rules and regulations prescribe that income arising from international transactions or specified domestic transactions between Associated Enterprises (AE) should be computed using the arm’s-length price principle, that is, the amount payable if the trading companies were unrelated.
[tips title="Important Tip"]‘International transactions’ refers to transactions between two (or more) AEs involving the sale, purchase, or lease of tangible or intangible property, the provision of services or cost-sharing agreements, the lending/borrowing of money, or any other transaction with a bearing on the profits, income, losses, or assets of such enterprises.[/tips]
Relationships falling under the AE category include direct/indirect participation in the management, control, or capital of an enterprise by another enterprise. They also cover situations in which the same person participates in the management, control, or capital of both the enterprises.
For tax purposes, companies are required to record the exchange of goods using the arm’s-length principal, which states that the prices charged by affiliated companies should be equivalent to the prices that would have been charged by a third-party. The following methods are prescribed under the IT Act for the determination of the arm’s-length price:
- Comparable Uncontrolled Price (CUP) Method;
- Resale Price Method (RPM);
- Cost Plus Method (CPM);
- Profit Split Method (PSM);
- Transactional Net Margin Method (TNMM); and
- Such other methods as may be prescribed.
It has been notified that the ‘other method’ for determination of the arm’s-length price in relation to an international transaction shall be any method that takes into account the price which has been charged for the same or similar transactions, with or between non-associated enterprises, under similar circumstances considering all the relevant facts. No particular method has been accorded priority and the most appropriate method for the transaction would need to be determined with regard to the nature and class of transaction or associated persons and functions performed.
Until the fiscal year 2011-12, transfer pricing regulations were not applicable to domestic transactions. The Finance Act, 2012 extended the application of transfer pricing regulations to domestic transactions, labeled specified domestic transactions (SDT). This amendment has been applicable from the assessment year 2013-14 onwards. Transactions will fall under domestic pricing only if the aggregate value is more than the threshold limit of INR 200 million (US$2.7 million) (from assessment year 2016-17).
Transactions with related domestic parties that qualify as SDT include:
- Expenditures where payment is made or will be made to:
- A director
- A relative of the director
- An entity where a director or the company has a voting interest that exceeds 20%
- Transactions relating to transfer of goods or services provided in Section 80-IA (8) and (10) (that is, profit-linked deductions for enterprises engaged in infrastructure development or industrial undertakings, producers and distributors of power, or telecommunication service providers).
- SDT is also applicable on the transactions between the entity located in a tax holiday area, and the one which is situated in a non-tax holiday area in case both are under same management structure. For example, transactions between undertakings established in special economic zones, free trade zones, or export-oriented units that involve transfer of goods and services to another unit under same management at non-market prices.
Audit under transfer pricing
Under transfer pricing regulations, companies in India are expected to file Form 3CEB if the entity has entered any international transaction with an associated enterprise or some specified domestic transaction (the latter with effect from assessment year 2013-14).
This is filed alongside Form 3CD under Section 92A to 92F of the Income Tax Act, 1961. Form 3CD is a detailed statement of particulars related to various aspects of the business and transactions undertaken.
Though sending company profits from India is much simpler than remitting personal income, the procedures to remit money to the parent company depend upon an entity’s investment model.
Remitting profits from India: Procedures and regulations
Remitting from liaison offices
Typically, foreign companies in India operate through either a liaison office, project office, branch office or wholly owned subsidiary (WOS).
Liaison Offices 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. Expenses must be met entirely through inward remittance of foreign exchange from the head office outside India. Therefore, companies are not permitted to repatriate money from a liaison office.
Remitting from project offices
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 outside India a surplus, only upon completion of the project.
Remitting from branch offices
Branch offices are often used by foreign companies engaged in manufacturing and trading activities in India. They can represent the parent company but have limited operational capacity. Notable operations not allowed by branch offices include retail trading activities and manufacturing or processing activities.
All investments and profits earned by branches of a foreign company are repatriable after taxes are paid. There are, however, two uncommon exceptions to this; first, certain sectors such as defense are subject to special conditions. For these sectors, there is a lock-in period where companies have to wait for permission to be granted by the Indian government. The second exception is only when non-resident Indians (NRIs) specifically choose to invest under non-repatriable schemes.
According to sections 11C.1 and 11C.2 of the Reserve Bank of India’s (RBI) Exchange Control Manual, branch office of foreign companies must file the application for remittance of profits along with the following documents:
- Certified copies of audited balance sheet and profit and loss account statement for the year to which the profit relates;
- Certificate from auditors covering how the remittable amount was calculated;
- Confirmation that the entire income of the branch office was accrued from sources in India;
- Confirmation that the requirements of the Companies Act, 1956, have all been met;
- Certificate from auditors citing RBI’s approval number and date, to the effect that the branch office has carried on business in compliance with approval granted by the RBI;
- Certificate from auditors that shows sufficient funds have been set aside to meet all Indian tax liabilities, or that these liabilities have already been met; and
- Declaration from the applicant that profits sought for remittance are purely earned in the normal course of business and do not include profits from any other source.
Companies must note that authorized dealers scrutinize the documents to make sure that the income is derived from RBI-approved activities and that calculations of the amount sought to be remitted are correct.
An authorized dealer is essentially a bank, specifically authorized by the RBI under Section 10(1) of FEMA to deal in foreign exchange. Most large international banks are authorized dealers.
Besides profits, remittances of winding-up proceeds of a branch office are also permitted under the Indian law. They are subject to prescribed procedures and require submission of the following documents:
- Tax clearance certificate from the Income Tax Department for the remittance;
- An auditor’s certificate confirming that all liabilities in India have been either fully paid or adequately provided for;
- An auditor’s certificate to the effect that the winding up is in accordance with provisions of the Companies Act, 1956; and
- An auditor’s certificate stating that there are no legal proceedings pending against the applicant or the company under liquidation and that there is no legal impediment in permitting the remittance.
Remitting from Wholly Owned Subsidiaries
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 longevity, flexibility, and a stronger legal foundation for doing business in India.
- The two ways of sending profits from a WOS in India are:
- Pay out of profits as dividends; and
- Buyback of shares by the company.
Dividends are freely repatriable without any restrictions if taxes are paid, notably the Dividend Distribution Tax (DDT). Tax credit and/or tax relief is not applicable for the DDT or for repatriation of dividends. Companies do not require permission from the RBI, but the remittance must be made through an authorized dealer.
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Further, there is a limited list of 22 consumer goods industries where repatriation of dividends is subject to certain requirements. The list includes the manufacturing of food products, coffee, and soft drinks among others.
Among specific requirements, the most notable one is that dividends must balance against export earnings for a period of seven years from the commencement of production.
Secondly, profits can be repatriated in the middle of the year with interim dividends after the DDT is paid. However, if using interim dividends, the company must have enough book profits to pay the dividend and enough money to pay taxes in India. If at the end of the year that turns out not to be possible, the directors may be made personally liable and be penalized, as a mistake on their part to declare interim dividends on the wrong judgment.
Profit can also be repatriated along with capital through buyback of shares if a buyback tax of 20 percent is paid on profits distributed by companies to shareholders.
The tax is not applicable if the company concerned is a publicly listed company or a subsidiary of a publicly listed company.
[faq title="FAQ:Repatriating Your Profits from India"]
What are the ways in which profits can be repatriated from India?
Prior to entering any international market, an investor must understand how to repatriate profit from that country. While sending company profits from India is much simpler than remitting personal income, the procedures to remit money to the parent company depend upon the entity’s investment model.
In India, profit can be repatriated using the following methods:
- Buyback of shares
- Reduction of share capital
- Fees for technical services
- Consultancy service/business support services
What are the legal entity types through which a foreign company/investor can repatriate profits out of India?
The procedure to repatriate profit to the foreign investor/parent company depends upon an entity’s 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.
- Liaison offices 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. Expenses must be met entirely through inward remittance of foreign exchange from the head office outside India. 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.
- Branch offices are often used by foreign companies engaged in manufacturing and trading activities in India. They are allowed to represent the parent company but have limited operational capacity. All investments and profits earned by branches of a foreign company are repatriable after the 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 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.
Why is dividend considered the most optimal method to repatriate profits from India?
One of the most used methods of profit repatriation is through dividend payments from a subsidiary to its foreign parent entity. The Indian tax system makes dividend a particularly attractive method of repatriation in many situations.
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.
For a dividend payment to be an optimal solution, there are several factors that need to be considered, including India’s tax treaty status with the foreign country.
Provided that the 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.
Currently, India is a signatory to tax treaties with 96 countries which include a comprehensive agreement with countries such as Australia, Canada, Germany, Mauritius, Singapore, UAE, UK, and USA.
How can a company use fee for technical services (FTS) as a way of repatriating profits out of 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”.
To qualify under the definition of FTS, the consultancy or technical services should be rendered by someone who has special skills and expertise in rendering such services. Thus, both managerial and consultancy services involve expert professionals.
Most foreign companies or non-residents provide technical and consultancy services in the form of management/ business support services that their Indian counterpart uses – to establish best practices or kickstart the growth of the business in India. In turn, the Indian company makes a payment for the services used in the form of a service fee. While making payment to the foreign affiliates, transfer pricing provisions also need to be considered to determine whether the amount or percentage of payment is in line with industry standards.
How can a company use royalty as a way of repatriating profits out of India?
Royalty is generally a consideration received by a person (a creator or an innovator) for allowing their work of art or scientific invention to be used commercially. However, in commercial and industrial terms, the concept of royalty is wider. Royalty is generally a payment received by the owner of an intangible right or know-how under license in any technology transfer.
Such intangible rights are given for making use of intellectual property, such as patents, inventions, models, secret formulae, processes, designs, trademarks, service marks, trade names, brand names, franchises, licenses, commercial or industrial know-how, copyrights, cultural activities, films, or television rights, literary, artistic or scientific works, computer software, exclusivity rights, etc. Royalty essentially signifies payment for ‘user right’.
Such user rights could be an annual payment or a pre-decided periodical payment. Thus, embedded in the concept of royalty is the rentals received as consideration for use of, or the right to use any patent, trademark, design or model, plan, secret formula, or process.
With the increased inflow of foreign direct investment (FDI) to India, it is expected that Indian firms will use more improved technology and frontier research and development (R&D) to expand or advance their industrial production and service capabilities.
It is a common practice for foreign companies to provide their trademark or brand name as well as access to their patented technologies and products to their counterparts in India. The increasing use of technology is linked to the increased royalty and license fee payments by business firms.
While making payment to the foreign affiliates, transfer pricing provisions also need to be considered to determine whether the amount or percentage of payment of royalty is in line with industry standards
Consideration (including lumpsum consideration) in the form of royalty can be for any of the following:
- Transfer of all or any rights (including license) in:
a) invention, patent, model, design, secret formula or process or trademark, etc. (IP)
b) copyright, literary, artistic, or scientific work, including films or video tapes/tapes for use in TV/radio broadcasting
- Imparting of any information concerning:
a) the working of or use of IP
b) technical, industrial, commercial, or scientific knowledge, experience, or skill
- Use of:
a) any IP
b) right to use any industrial, commercial, or scientific equipment
How are royalty & fee for technical services taxed in India for non-residents or foreign companies?
Several foreign companies or non-resident entities run their business in India and their income is directly accrued or received in the country. In some other cases, the income is indirectly accrued or received in India or is deemed to accrue or be received in India.
Whatever the case may be, if the earning of the foreign entity is from royalty or for providing technical services, the payer of such royalty or FTS generally enters into some agreements with the foreign entity. The payer or the user of the royalty or recipient of the technical service may be the government or any other Indian concern. If the agreement is an eligible one, such income is taxed at a lower, preferential tax rate.
Royalty/FTS for non-residents is taxable in India – if sourced in India, such as in cases where a brand name or technical services is given to an Indian entity. Simply understood, FTS or royalty income is liable to tax at a place where the service is consumed or received by any person.
FTS payable by an Indian company, to a non-resident or foreign company, shall be deemed to accrue or arise in India unless it falls under the following two exceptions:
- Where the FTS is payable by a company in respect of technical services utilized in a business or profession carried on by the company outside India.
- Where FTS is payable in respect of technical services utilized for the purpose of earning any income from any source outside India.
As per the Income Tax Act, 1961 – an Indian company, while making the payment to its foreign affiliates/parent towards the royalty, fee for technical services, or consultancy services shall withhold the tax at 10 percent (plus surcharge and applicable cess), subject to the fulfilment of such conditions as may be applicable.
Also, the role of tax treaties comes into play here in taxing the royalty or fee for technical services. The Income Tax Act authorizes the Indian Government to enter into tax agreements with the other countries for avoiding double taxation of the taxable base.
These tax agreements are called Double Taxation Avoidance Agreements (DTAAs). The purpose of such treaties is to set some ground rules to avoid double taxation of the same income. The treaties become even more important as every country likes to tax based on the residence principle (as India has for its residents) or source principle (as India has for non-residents).
The tax liability as determined under India’s income tax law may undergo change by application of the provisions of these tax treaties. In such a scenario, whichever provision (per the Income Tax Act or per the Tax Treaty) is beneficial to the non-resident will prevail.