For foreign businesses operating in India, managing profits and repatriating funds can be difficult because of the many interconnected local and international laws and regulations that must be followed. These laws and regulations include the Companies Act, the Foreign Exchange Management Act, applicable income tax laws, Double Tax Avoidance Agreements, and transfer pricing guidelines.
There are various regulations that limit how much money can be remitted from India and for what purpose. Prior to investing in India, companies must know how to repatriate their profits from the country.
Methods to repatriate funds
While sending company funds 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.
Funds can be repatriated using the following methods:
- Payment of dividend;
- Upon closure or winding up of the entity;
- Remittance upon buyback of shares;
- Upon reduction of share capital;
- Fees for technical services;
- Consultancy service/business support services; and
- Royalty.
Procedures and Regulations for Remitting Profits
The procedure to repatriate profit to the foreign investor/parent company depends upon an entity’s investment model. Foreign companies operate through either a liaison office, project office, branch office, or wholly owned subsidiary (WOS) – depending upon the nature of their activities.
Remitting from liaison offices
Liaison offices are not permitted to repatriate money from a liaison office.
Los is only meant to spread awareness of the company’s products and/or carry out market research. They are not allowed to undertake any business activities and thus cannot earn any income in India.
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 surplus only upon completion of the project.
Remitting from branch offices
All investments and profits earned by branches of a foreign company are repatriable after taxes are paid.
There are two notable exceptions to this rule:
- 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; and
- The second exception only applies when non-resident Indians (NRIs) choose to invest under non-repatriable schemes.
Branch offices 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 ensure that the income is derived from RBI-approved activities and that the amount sought to be remitted calculations are correct.
An authorized dealer is essentially a bank specifically authorized by the RBI to deal in foreign exchange. Most large international banks are authorized dealers.
In addition to profits, Indian law also permits the remittance of branch office wind-up funds. 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 states that no legal proceedings are 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.
Funds can be repatriated from a WOS via a dividend, buyback of shares, reduction of share capital, surplus funds on closure or winding up of the WOS, fees for technical services, consultancy service/business support services, and royalty.
Dividends
Dividends are freely repatriable without any restrictions if taxes are deducted at source from the dividend and the net amount remitted. Companies do not require permission from the RBI, but the remittance must be made through an authorized dealer.
Profits can be repatriated in the middle of the year with interim dividends. However, if using interim dividends, the company must have enough book profits to cover depreciation for the full year 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 personally liable and be penalized as a mistake to declare interim dividends on the wrong judgment.
Technical consultancy fees, management fees, & royalty
The WOS may remit these to the parent company if tax is deducted at source on such remittances at the prevailing rates and deposited with the Government. Such remittances with the recipient country will be covered under the DTAA to avoid double taxation.
Buyback of shares
Funds can also be repatriated along with capital through the buyback of shares if a buyback tax of 20 percent is paid on profits distributed by companies to shareholders.
Surplus funds on closure or winding up of the WOS
Capital gains tax will be payable on the gains arising out of the share valuation at the time of on winding up/closure of the WoS.
Tax is not applicable if the company concerned is a publicly listed company or a subsidiary of a publicly listed company.
FAQ: Repatriating Your Profits from India
Why is a 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 dividends 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, including 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) to repatriate 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 payments to 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 royalties to repatriate 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 are the rentals received as consideration for the 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 payments to 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); and
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; and
b) Technical, industrial, commercial, or scientific knowledge, experience, or skill. - Use of:
a) Any IP; and
b) Right to use any industrial, commercial, or scientific equipment.
How are royalties & fees 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 20 percent (plus surcharge and applicable cess), subject to the fulfillment 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 other countries to avoid 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.
The changes introduced by the Finance Act 2023 to the taxation of income from royalties and FTS in the hands of non-residents are as follows:
- Increase in tax rate from 10 percent to 20 percent for royalty and FTS income earned by non-residents.
- Non-residents can choose to be taxed as per the provisions of a tax treaty entered into between India and the country of residence of the taxpayer or the Income-tax Act, whichever is more beneficial.
- A non-resident is required to furnish a valid tax residency certificate (TRC) issued by the government of its country of residence to claim benefits under a tax treaty.
- Tax treaties provide for lower tax rates for royalty and FTS, provided that the recipient is the beneficial owner of such income.
- Circular 789, issued by the CBDT, clarifies that a TRC will constitute sufficient evidence for accepting the status of residence as well as beneficial ownership for applying the provisions of a tax treaty.
- In the case of non-residents, where the tax treaty provides for a rate higher than 10 percent, or in case India does not have a tax treaty with the jurisdiction of the non-resident, the change may result in an additional tax burden.
- Withholding on royalty and FTS payments to non-residents may be made at a lower rate as per the applicable tax treaty, therefore, non-residents may no longer be exempt from filing an income tax return.
- Non-residents may have to obtain a PAN in India to comply with the increased compliance burden.
