Mumbai: Indian companies with US subsidiaries are gearing up to meet challenges that have arisen owing to US tax reforms.
Typically, overseas subsidiaries of an Indian parent company pay their share of head office administrative expenses, or pay royalty for use of trademark or brand name.If the overseas arm is based in the US, such payments now come with an additional tax cost. Or, if the US subsidiary was financed through debt, the US tax reforms may result in the entire quantum of interest not being allowed as a deduction for tax purposes in the hands of the US arm.
The common perception in the industry was that the US tax changes would result in a higher flow of dividend from an MNC in India to its American parent. However, the ramifications for Indian companies with US subsidiaries or branches are equally significant.
Introduction of the Base Erosion Anti Abuse Tax (BEAT), which imposes a 10% minimum tax on 'adjusted taxable profits' for payments made by US entities to all foreign related parties, is considered the most draconian. Adjusted taxable profit is the profit excluding related party payments. Only payments made for purchase of goods by a US entity is out of the BEAT ambit, others like royalty or administrative fees to head office will now attract this tax, which is payable by the US entity.
"The concern is that BEAT is not akin to a withholding tax on payments to the Indian parent or group company, but is an additional tax cost for the US subsidiary. Further, in an endeavour to mitigate BEAT, if the quantum of payment is reduced it may trigger concerns for the Indian parent company from the Indian transfer pricing perspective," said Abhishek Goenka, partner and leader, direct tax practice at PwC India.
According to Punit Shah, partner, Dhruva Advisors, "BEAT applies to US companies with at least $500 million of annual gross receipts over a three-year averaging period and where deductible payments exceed certain thresholds of taxable income. The saving grace is that smaller US companies will not have to bear this additional tax cost." That said, he foresees high value business operations and IPR which was parked in low tax countries moving back to the US.
"In the IT sector, typically an overall contract with the customer is entered into with a US subsidiary, which under a back-to-back contract, offshores work to the Indian parent or group company. With BEAT, there is an incentive to spilt the offshore and onshore contracts between the US subsidiary and Indian company," said Sudhir Kapadia, partner and tax leader at EY India.Normally, payment of interest against loans is allowed as a deduction in the hands of the company making the payment, which reduces its taxable profits. Interest limitation rules now introduced in the US provide that deduction for interest expense in the hands of the US company making such payment, will be limited to 30% of its adjusted taxable income (based on a formula).
Tax and Regulatory Partner, BDO India says, "This will impact debt funding of the US subsidiary by the Indian parent. There seem to be no transitional provisions to offer protection to existing debts, thus even current financing structures of US companies are likely to be hit." According to tax experts, Indian companies will be more inclined towards equity funding for their US subsidiaries.
"However , there is a silver lining. If the Indian parent brings back dividends from its US subsidiary, it will bear a tax cost of 15% in India, which can be offset against the 15% tax that was withheld in the US under the India-US tax treaty," added Kapadia.
Under India's tax laws, a foreign company which has its place of effective management (POEM) in India, is taxed in India at the applicable corporate tax rate (ie 30% if turnover is more than Rs 50 crore). "Earlier there was little incentive for Indian tax authorities to examine POEM of a US subsidiary of an Indian parent company. This was because the US corporate tax rate was higher at 35% and after allowing for a foreign tax credit, little or no revenue would accrue in India. With the US tax rate now 21%, if a POEM of a US subsidiary exists in India, there is a leeway for additional tax revenue. Thus, Indian tax authorities may pay closer attention to this issue. Indian companies with US subsidiaries should undertake a comprehensive review of their governance and management structure as evaluation of POEM is completely dependent on facts and circumstances," says Shah.
"The low corporate tax rate may be an impetus for Indian companies to set up operations in the US. However, owing to introduction of interest limitation rules and BEAT traditional structures may no longer be suitable," added Tax and Regulatory Partner, BDO India.