Are you aware that multinational corporations are increasingly choosing India as a destination for setting up their Global Capability Centers (GCCs)? The primary reasons behind this interest are the country’s skilled workforce, cost advantages, and robust infrastructure.
However, alongside these advantages comes a crucial consideration for foreign companies: the tax implications and considerations of tax liability at the central and local levels in India. Such considerations are critical in deciding the form of legal entity to establish. This article covers key taxation aspects for businesses to address while setting up a GCC in India.
1. HOW TO DECIDE BUSINESS STRUCTURE AND THE FORM OF ENTITY
Establishing a “place of business” is crucial for a GCC’s tax structuring. A private limited company (PLC) and a limited liability partnership (LLP) are the most prevalent legal forms of GCCs set up in India. The choice of form of legal entity is influenced by various parameters such as flexibility in the form of capitalisation and level of compliance. However, with respect to taxation, a PLC structure has a lower effective tax rate (25.17%) compared to a LLP structure (34.94%). Further, the distribution of profits from the PLC is subject to tax in the hands of the shareholder, depending on the jurisdiction of the holding entity. On the other hand, there is no tax on profits distributed by an LLP.
Further, with respect to jurisdiction in India, setting up a GCC in Special Economic Zones (SEZ), Software Technology Parks (STPI), and International Financial Services Authority (IFSCs) can also lead to regulatory advantages and certain tax concessions, including but not limited to income tax, customs duties, and indirect taxes on goods and services supplied. SEZs, in particular, attract foreign entities with duty-free imports of specific goods and equipment. However, GCCs in SEZs or STPIs must manage restrictions on subcontracting and navigate the regulatory framework to handle tax liabilities effectively.
2. NAVIGATE PERMANENT ESTABLISHMENT RISK
Foreign entities must be cautious about Permanent Establishment (PE) risks when operating GCCs in India. If a foreign entity is deemed to have a PE in India, it could face up to 40% tax on profits and increased compliances like bookkeeping, tax filings and withholding taxes. To avoid such PE risks (largely – Fixed PE or Service PE), it is crucial to establish clear standard operating procedures for GCC employees interacting with foreign entities, including appropriate documentation and clear bifurcation of responsibilities.
2.1 PE risk entailing from secondment arrangements
The establishment of GCCs in India hinges significantly on access to diverse human capital. Evaluating tax implications is pivotal when engaging employees of a foreign entity moving from the home jurisdiction to the host jurisdiction on secondment/short-term assignments within GCC operations in India, largely concerned with a trigger of PE of the foreign entity in India.
Past legal precedents under Indian Income Tax have shown that poorly structured secondment arrangements can lead to the establishment of a permanent establishment (PE) for the foreign entity. Careful drafting of secondment agreements is essential to align documentation with the agreed-upon terms between the foreign entity and the secondees. This ensures clarity and compliance with regulatory frameworks.
Further, the Supreme Court has decided on the issue of levy of Service Tax as ‘Manpower recruitment and supply services’ on cross-charge of salary paid to a foreign group entity by its Indian group company for seconded employees. Therefore, GCC will have to analyse whether the arrangement under which the expat employees are being seconded to India qualifies as a supply of service under the Goods and Service Tax (GST) Act.
3. AVOID TRANSFER PRICING OBLIGATIONS
For smooth inter-company transactions within a GCC, it is crucial to maintain a detailed Inter-Company Agreement which is aligned with the GCC’s functions to avoid transfer pricing obligations. Such agreement should encompass detailed terms and conditions, including pricing mechanisms and clearly defined roles and responsibilities. At the heart of ensuring robust compliance and minimising tax risks lies a meticulous Functions, Assets, and Risks (FAR) analysis.
For the services provided by the GCC to the foreign entity, such GCC can be remunerated on a cost-plus markup basis wherein all the direct/indirect costs, including royalty/fees for technical services incurred by GCC, would form part of the cost-base, and appropriate markup shall be added. However, such inclusions in the cost base need further evaluation. In such cases, the comprehensive transfer pricing documentation maintained by the GCC and the Foreign Entity assumes pivotal importance.
Transfer pricing litigation can also be dealt with cost-effectively by adhering to safe harbour rules and meticulously picking the dispute resolution mechanisms amongst traditional litigation – Advance Pricing Agreements (APA) and Mutual Agreement Procedures (MAP).
4. CRAFTING EMPLOYEE STOCK OPTION PLAN
Often, employees are offered a stock option scheme (ESOP) that entitles the option holder to the right to subscribe to the shares of the foreign parent company at a concessional rate. The GCC should put in place a mechanism for the deduction of applicable withholding taxes from the employees. Further, the discount on which ESOP is issued can be allowed as a business expenditure for the employer company. The applicability of the above in the GCC setup remains litigative.
5. MANAGING ROYALTY, FEES FOR TECHNICAL SERVICES AND LEASE PAYMENTS
GCCs must manage IP created or shared in India, following local and international laws to protect their rights. Proper structuring of technology and IP licensing agreements is crucial for tax efficiency and protecting both the Foreign Entity and the GCC. Non-resident’s income from royalty and technical services is taxable in India. Hence, GCCs must withhold taxes under the Income Tax Act and relevant Double Taxation Avoidance Agreements.
With respect to lease payments to the resident vendor, income shall be subject to taxation in the hands of such vendor. Accordingly, the GCC will be required to withhold taxes on such lease payments.
CONCLUSION
To summarise, setting up of GCCs in India can be riddled with numerous tax challenges, which need to be addressed with meticulous planning and a deep understanding of the country’s tax landscape. When the process of setting up GCC in India is well executed, it will enable MNCs to ensure compliance, minimise liabilities and avoid legal obstacles to fully leverage India’s potential in the domain.
The contents of this microsite/repository are intended for informational purposes only and are not in the nature of a legal opinion. Readers are encouraged to seek legal counsel prior to acting upon any of the information provided herein. For further information, please visit www.trilegal.com
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