A foreign company can commence operations in India by incorporating the subsidiary company most preferably as a Private limited company under the Companies Act, 2013. It is treated as a domestic company under Indian taxation laws and is eligible for all exemptions, deduction benefits as applicable to any other Indian Company. A subsidiary company is formed when the parent/foreign company owns at least 50% of the shares of the subsidiary subject to Consolidated FDI Policy Circular of 2017. It is quicker to form due to simplified procedure as only prior permission from ROC (Register of Companies) is required for incorporation of business. The automatic route under FDI policy does not mandate any prior regulatory approval for investment in equity shares of a subsidiary and only post incorporation intimation with Reserve Bank of India (RBI) within 30 days of receipt of investment money in India and filling of prescribed documents and particulars of allotment of shares within 30 days of allotment of shares to foreign investors.
However, in case of a Branch office, the procedure is quite cumbersome as compared to a Subsidiary company. The incorporation of a branch office in India by a foreign company is regulated as per Section 6(6) of FEMA, 1999. Prior permission is required from ROC (Registrar of Companies) and Reserve Bank of India (RBI). All documents which are required to be filed with FNC Form like the certificate of incorporation, board resolutions and documents of the authorized signatory of the foreign company need to be legalized either through Indian Embassy or to be apostilled as per Hague Convention. The application for registration of a branch office is filled in FNC Form to the RBI through an AD Category-I bank identified by the applicant. After the approval of RBI for the establishment of branch office in India, an application for registration of Branch Office of the foreign company is filled in form FC-1 within 30 days of such approval and if there are Indian Directors, then DIN number of such director and the digital signature of the Indian Director is needed to e-file statutory forms with the ROC for approval. Lastly, the Branch office needs to register it with the State police under whose jurisdiction it is established.
CRITERIA FOR SET-UP AND TIME LIMIT FOR APPROVAL
In order to be set-up a branch office in India, the Parent/foreign company should have a profit-making track record immediately preceding five financial years in the home county and the net worth of the parent company i.e. total paid up capital and free reserves excluding intangible assets should not be less than USD 100,000 or its equivalent. The time limit for continuance of branch office is three years from the date of approval i.e. registration is allowed for a period of three years. Therefore, the branch office has to apply for an extension after every three years.
The subsidiary company incorporated as a private limited company requires minimum two shareholders and paid up capital of ₹1,00,000 There is no requirement of previous profit-making track record of parent/foreign company as is required for set-up of a Branch office. Therefore, the compliance requirement is more in case of branch office as compared to subsidiary company. In a subsidiary company, there is no limitation on time limit for approval and the company can continue with their business operations until they decide to close down. Hence, once registration is granted it can do business until the company decides to close down its operations.
A subsidiary of a foreign company can undertake any activity mentioned in the ‘Object Clause’ of the Memorandum of Association of the Indian Company subject to FDI regulations on different sectors. In almost all sectors, FDI is 100% through automatic route except some sectors where government approval is required.
Unlike a subsidiary company which may engage in manufacturing activities, a branch office of a foreign company operating in India is not allowed to carry out manufacturing activities on its own but is permitted to subcontract these to an Indian manufacturer. Another limitation is that a foreign company has to be engaged in manufacturing and trading activities abroad in order to set up a branch office in India for the purpose of export or import of goods, rendering professional or consultancy services, research work, representing and acting as buying/selling agent for parent company.
Foreign Company can start their operations in India by opening up a Branch office which is incorporated as a foreign company since it is an extension of the business of foreign/parent company and not a separate Indian company. On the other hand, foreign company can also commence their business operations in India by setting up a subsidiary company and incorporating it as a domestic private limited company under the Companies Act, 2013. Since, a subsidiary company is a separate legal entity distinct from its parent/foreign company hence, a branch office (regarded as foreign company) is subject to a higher Corporate Income Tax (CIT) rate than a subsidiary company.
The tax slabs of a branch office (foreign company) are divided into three categories. Income below 1 crore is taxed at 41.60%, income below 10 crores is taxed at 42.43% and when the income of branch office is above 10 crores then the tax rate applicable is 43.68%.
With respect to a subsidiary company, when annual turnover is less than 250 crores and income is below 1 crore then they are taxed at 26%, income below 10 crores is taxed at 27.82% and income above 10 crores is taxed at 29.12%. When annual turnover of the subsidiary company exceeds 250 crores then income below 1 crore is taxed at 31.20%, income below 10 crores is taxed at 33.38% and income above 10 crores is taxed at 34.94%. On comparing both the branch office as well as subsidiary company, it is amply clear that a branch office of a foreign company incurs higher rate of tax (CIT) as compared to a subsidiary company.
As per DTAA (Double Tax Avoidance Agreement), the subsidiary company should have a permanent establishment (PE) in India, then only income generated in India by the subsidiary company can be taxed by Indian government. Where there is no DTAA treaty signed between India and another foreign country, the subsidiary company would be taxed both from the source country (India) as well as the residence (foreign) country. Article 5(1) of most of the DTAA signed between India and other countries defines “Permanent Establishment” as a fixed place of business through which the business of the enterprise is wholly or partly carried on.
In DDIT v. Daimler Chrysler AG, it was held merely because a foreign company has a subsidiary in India, it is not a satisfactory proof to form a permanent establishment of the foreign parent company in India under the provisions of DTAA. The Finance Act, 2016 amended Section 6 of the Income Tax Act, 1961, to decide the residential status of a company. Section 6(3) states that a company shall be said to be resident in India in a previous year if it is an Indian company or if place of effective management (hereinafter referred to as ‘POEM’) in that year is in India. Ministry of Finance has emphasized that these guidelines were not intended to cover foreign companies or to tax their global income merely on the ground of presence of Permanent Establishment or business connection in India.
In Adobe Systems Incorporated v. Assistant Director of Income Tax and Anr, the Delhi High Court held that where the subsidiary is performing support services which is consequently enabling the foreign parent company to render services to its client services abroad, it is not a sufficient proof that a PE of the foreign company exists in India. The Hon’ble Supreme Court opined that if a foreign company has a subsidiary company in India, however that does not have any right to use the premises registered in the name of the subsidiary company and the income of the subsidiary company is also determined on its income calculated at arm’s length price (transfer pricing policy), then subsidiary company cannot be said to have formed a permanent establishment of the foreign company in India. Therefore, incorporation of the subsidiary company as permanent establishment (PE) would depend on key management and commercial decisions that are necessary for the conduct of business of an entity as a whole. Furthermore, it needs to be seen whether a subsidiary company is carrying on activities which constitute core activities of the foreign parent company or is carrying on activities for its own business.
Since, the Branch office is an extension of the parent/foreign company, therefore any liabilities incurred by branch office are to be paid after liquidation of assets of the foreign/parent company. The assets of the parent company are at risk of attachment in case the liabilities of the branch office exceed its assets.
Whereas, the liability of the parent company is limited to the extent of its shareholding in the subsidiary company as the subsidiary is a distinct legal entity apart from its shareholders. The assets of the parent/foreign company are not subject to any attachments against the debts incurred by the subsidiary. Hence, the parent/foreign company would not prefer to take a risk and instead set-up subsidiary in India instead of branch office.
A Subsidiary company is an Indian Company in every practical sense and therefore would be subject to Companies Act, 2013. After the Companies (Amendment) Act, 2017, Section 185 of Companies Act states that a parent holding company has now been permitted to advance loans or give guarantees or provide security in connection with the loan taken by any ‘person’ which includes subsidiary company in whom the director is interested subject to the prior approval of shareholders by way of a special resolution is obtained and further, loans extended to persons including subsidiary falling within the restrictive purview of Section 185 should be utilised for the principal business activities of the borrowing/subsidiary company.
Foreign/parent company can finance their subsidiary company’s operations through investment in shares and convertible instruments. FEMA Act, 1999 allows capital investment through equity shares, compulsory convertible preference shares, compulsory convertible debentures and warrants. However, capital investment is subject to certain conditions:
1. Restrictions on the level of capital investment in specified sectors depending upon the FDI sectoral caps. Example: permissible capital investment in multi-brand retail is up to 50%.
2. The need to specify the manner of pricing the instrument to ensure that the instrument is not issued/transferred at a lower price than its fair market value (pricing compliance).
A foreign holding company can also advance loans through debt financing the Indian subsidiary in the form of External Commercial Borrowings (ECB). It is because ECB are cheaper than loans from domestic financial institutions because of lower interest rates. After RBI’s notification on Foreign Exchange Management (Borrowing and Lending) Regulations, 2018, rules had been revised and pro-business policies were made in favour of Indian companies for the purposes of availing ECB. Hence, a subsidiary can now borrow loans from its holding parent company with less amount of restrictions.
A Branch office has to open an account in any AD Category-I Bank in India for the purpose of borrowing money from the parent/foreign company. The operational money received from parent office and credited to the account through banking channels should be used for meeting the expenses of the office and any legitimate receivables arising in the process of its business operations.
A branch office operating in India is permitted to repatriate profits to parent/foreign company subject to payment of Indian taxes, on the production of a copy of audited Balance Sheet and Profit and Loss account for the relevant year. Since, branch office is an extension of a foreign company, they are subject to a tax rate of around 40% (applicable for any foreign company).
On the other hand, a subsidiary company can repatriate funds to the parent/foreign company by way of dividend on payment of Dividend Distribution Tax (DDT) of around 16.995% or by payment of royalty/fees for technical services or by way of management fees. However, the subsidiary company should have a Permanent Establishment (PE) in India under the DTAA treaty so that the subsidiary is considered as an Indian company and the taxation rate applicable for repatriation of profits to foreign/parent company is less than the rate applicable for a foreign company (branch office).
CLOSURE OF BUSINESS
A Branch Office needs to file Closure Application with the RBI for closing of business. A Branch Office does not need to go through winding-up process for closure. They have to liquidate the assets which includes immovable properties in India before applying for closure of business. On the other hand, a subsidiary company has a lengthy winding up process which takes around 6-8 months or more depending upon the complexity and the type of assets it owns.
A foreign company should generally prefer opening up a subsidiary company in India over a Branch office. With respect to a subsidiary company, the compliance requirement for incorporation is simplified and easy to fulfil while a branch office cannot carry out manufacturing or processing activities in India which a subsidiary company can do. Furthermore, the Corporate Income Tax (CIT) applicable to a subsidiary company is comparatively less than a Branch office and the assets of the parent company can be attached in case the liabilities of the branch office in India exceeds the value of assets of the parent/foreign company. Moreover, a branch office has limited options to avail for loans/ borrowings while a subsidiary company can avail borrowings from its parent company or External Commercial Borrowings (ECB). It is only for Closure of business operations in India where setting up a branch office is beneficial for foreign company.
1. https://www.indiafilings.com/learn/starting-a-foreign-companys-subsidiary-in-india/ (accessed on 28/03/2019)
2. https://www.setindiabiz.com/branch-office-registration-india.html (accessed on 28/03/2019)
3. DDIT v. Daimler Chrysler AG, 2010-TII-99-ITAT-Mum-INTL
4. Section 6 of Income Tax Act, 1961
5. http://pib.nic.in/newsite/PrintRelease.aspx?relid=157616 (accessed on 10/04/2019)
6. W.P.(C) 2384/2013 & CM 4515/2013, http://lobis.nic.in/ddir/dhc/VIB/judgement/16-05-016/VIB16052016CW23842013.pdf (accessed on 10/04/2019)
7. Assistant Director of Income Tax-I, New Delhi v. M/s E-Funds IT Solution Inc., https://www.sci.gov.in/supremecourt/2014/31382/31382_2014_Judgement_24-Oct-2017.pdf (accessed on 11/04/2019)
*(Author Soumyajit Saha is currently in 2nd year (IV Semester) pursuing B.A. LL.B (Hons.) at National University of Study and Research in Law, Ranchi (NUSRL))