The budget which was recently enacted contains an amendment with regards to the rate of tax of a foreign company. The tax rate has now been reduced to 35% as against the rate of 40% which has existed for more than two decades now.

Over a period of time, the tax rate of foreign company was significantly higher than that of a domestic company as there was no cost of repatriation of profits involved for a foreign company operating under a branch office model in India.  While domestic companies operated under a lower rate of tax, there was additional cost of repatriation of profits by way of dividend which increased the effective rate of tax.  Also, the rate of tax of a foreign company has remained constant at 40% over the years, while the rate of tax for a domestic company has undergone several changes and has moved from the headline rate of 35% (when 40% was introduced for foreign companies) to 22% for companies which do not claim prescribed tax holidays/ deductions.  During certain years, it would have been tax efficient to operate under a branch office model while in the recent years, the balance has shifted towards a private company model.

The current article analyses the recent change of tax rate of foreign companies to 35% vis-à-vis operating under a private company model to determine if the balance has shifted one way or the other.

The below illustration presumes a company from USA setting up a branch office in India as compared with a subsidiary company.  Also, for the purpose of dividend, the rate of tax as prescribed by the India-USA Double Taxation Avoidance Agreement has been considered.

Further, a branch office of a foreign company would be considered as a non-resident in India, unless the Place of Effective Management (“PoEM”) in India.  The illustration accordingly considers the branch office of the foreign company as a non-resident and the tax rate of 35% has been considered.

• As could be seen from the above table, while the tax rate has been reduced for a foreign company, the effective tax rate is still beneficial for a domestic company which does not avail any other tax holiday. The difference in the total taxes is on the lower side when the total income does not exceed Rs 10 crores.  However, once the income exceeds Rs 10 crores, considering a higher rate of surcharge for foreign companies, the tax savings increase significantly under a subsidiary model.
• Also, the above illustration is in the context of a USA subsidiary to which the India-USA DTAA prescribes 15% as the rate of tax for dividends. In the case of certain countries such as Mauritius, Saudi Arabia, Malaysia, the rate of tax prescribed for dividends stands at 5% in which case, the tax outflow is much lesser under a subsidiary model.
• Additionally, while a subsidiary model may be attractive from a tax perspective, the branch office model may still be relevant for companies which intend to explore investments on a short term basis and considering the compliance procedure involved in winding up of a private company which is tedious as compared with that of a branch office. However, the other big talking point in a branch vs subsidiary model would also be that of liability.  Typically, under normal conditions, the liability of a subsidiary is limited to its own capital, however, the branch is only an extension of the foreign company and any Indian liabilities could also be sought to be recovered from the foreign company as well.

With the aforesaid points, one could have a basic entry plan strategy.  It is of course always advisable to consult tax experts prior to implementing any of the above models which could factor facts specific to each case such as group holding structure, existing operations in India, prevalence of intellectual properties and usage of the same in other jurisdictions and compensating mechanism for the same etc.

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