In part IV of our series on key legal consideration for establishing global capability centres (“GCCs”) in India,[1] we discuss the key taxation issues that foreign companies must be aware of ahead of setting up its operations in India.
Introduction
Understanding the intricacies and implications of taxation has been one of the key considerations of foreign companies seeking to establish their presence in India. [CAM1] Foreign entities and multi-national corporations (“Foreign Entity”) have started setting up Global Capability Centres in India (“GCCs”) to help cut costs and provide operational support to/for their service offerings. Before setting up such a GCC and employing individuals for the same, a Foreign Entity first has to establish a “place of business” in India in the form of a legal entity recognised under Indian laws.[2] When structuring its GCC in India, the Foreign Entity can choose from various options – a wholly owned subsidiary (“WOS”), a joint venture company (“JV”), a branch office (“BO”), or a limited liability partnership (“LLP”). As these entities also attract taxation under Indian tax laws, it becomes a cost for the Foreign Entity.
It is essential that the Foreign Entity evaluates different corporate proposals and decisions from a taxation perspective to understand how best to structure its taxes and resultantly its costs. Given that the GCC will primarily serve the Foreign Entity or the group, i.e., non-resident entity(ies), some additional considerations – “permanent establishment” risks, transfer pricing, secondment arrangements, indirect tax benefits, etc. – require a deeper dive.
Permanent establishment (“PE”) taxation risks
A Foreign Entity could end up establishing in India[3] any of the various forms of Permanent Establishments (“PE”), but the possibility of constituting a fixed-place PE or a service PE is significantly higher in case of a GCC. It is important to understand if the GCC is constituting a PE because of the tax outgo of 40 per cent of the taxable profits of such PEs, along with an increased compliance burden in the form of filing of tax returns, maintaining the books of account (audited and reported), withholding taxes, undertaking the resultant obligations, etc. Following are some of the considerations when evaluating PE risks:
- Fixed-Place PE – The key consideration for evaluating “Fixed Place PE” includes assessing the nature of activities being outsourced to the GCC and the extent of the Foreign Entity’s involvement in this process. It is pertinent to ensure that the nature of activities outsourced and actually carried out by the Foreign Entity and the GCC are duly reported in the transfer pricing analysis being conducted in India. It is also pertinent to offer appropriate profits to tax in India. [CAM2] Where the activities undertaken by the Foreign Entity are adequately compensated, this would ensure that no additional income is attributed in India even if it is alleged that the Foreign Entity has constituted the “Fixed-Place PE” in India through its GCC.
- Service PE –A “Service PE” is constituted primarily due to the continuous movement of people (employees) from one jurisdiction to another and their continuous professional engagements. To determine the formation of a Service PE, it is important to evaluate the nature of activities/services the Foreign Entity’s employees render to the GCC (e.g., the duration, the manner of providing such activities/services, etc.) If the Foreign Entity’s employees visit India to undertake stewardship activities,[4] it may not lead to the constitution of a “Service PE”. Accordingly, when the employees of the Foreign Entity visit India, it is important to ensure a clear bifurcation based on the type of activities they would be expected to undertake during their presence in India.
In this regard, it is imperative to establish the standard operating procedures within which the GCC employees should work and interact with the employees of the Foreign Entity or other group entities. There is a possibility of establishing a dotted-line reporting to the Foreign Entity, while maintaining and strictly respecting the straight-line reporting to the relevant GCC-level department heads.
Strategising secondment arrangements
As accessibility of diversified “human capital” is a strong decisive factor for setting up GCCs in India – evidenced by the fact that as of FY 2022–23, India’s approximately 1,580 GCCs have 1.66 million employees[5] – it becomes crucial to also evaluate the tax considerations vis-à-vis employees working with the GCC. This would include both Indian resident employees as well as the Foreign Entity’s employees working with the GCC in India for short stints. These short stints could be different in form and purpose (e.g., ranging from supervising or training), but if such stints include a visit to India, it is best to evaluate the employment structures from a taxation perspective. Depending on the length of these stints, the engagement of any of the Foreign Entity’s employees in India (with the GCC) could expose the Foreign Entity to PE risks.
To this end, it may be beneficial for the Foreign Entity to relocate its own/group entity’s employees to India through a secondment arrangement with the GCC. As secondees, these employees would work under the directions, control, and supervision of the GCC and report to the GCC management for the duration of their secondment. This will make the GCC their de facto as well as de jure employer for the course of their secondment and stay in India. As discussed earlier, it is important to follow the reporting lines strictly to avoid any PE risks, especially given the numerous litigations that disregarded the secondment arrangements, leading to the constitution of a PE for the Foreign Entity.
Further, it is required to draft the documentation of the secondment arrangement carefully and meticulously so that it is properly recorded in line with the actual arrangement agreed with the Foreign Entity and the secondees.
GST on secondment arrangement
The extant GST legislations do not treat the services that employees render to their employers during the course of their employment either as supply of goods or as supply of services. However, the services provided by a Foreign Entity in a secondment arrangement could be construed as service and accordingly, the reimbursement of salaries of the secondees’ (employees of the Foreign Entity) may be taxed as an import of manpower supply services under the reverse-charge mechanism.
Key transfer pricing considerations from a tax perspective
In most of the structuring models, the GCC forms part of the same group as the Foreign Entity, even though it could be set up in different ways. If the GCC and the Foreign Entity form part of the same group, all transactions, including provision of services, would have to be undertaken at a price determined on an arm’s-length basis. The GCC may be remunerated as per the cost-plus method, wherein the margin shall be dependent on the functions, assets, and risks analysis (“FAR Analysis”). FAR Analysis is a transfer-pricing study based on the functions undertaken, assets employed, and risks assumed by the GCC and the related party (which would include the Foreign Entity). The transfer-pricing study maintained by the GCC and the Foreign Entity should be detailed and comprehensive enough so that, if required, the arm’s-length price for the various transactions may be substantiated before the Indian tax authorities.
Further, where the GCC ends up using the global relationship that the group may command, the procurement agreements entered with third parties may also come under the purview of deemed international transactions. Hence, it would be prudent to evaluate if such transactions should be undertaken at an arm’s-length price.
Assessing indirect tax benefits
The Foreign Entity could also explore either setting up its GCC in a Special Economic Zone (“SEZ”) in India or register its GCC as a Software Technology Park (“STP”) unit, as both cases enable claim of certain indirect tax benefits. In a SEZ, the GCC would likely be given certain concessions on taxes and levies ordinarily levied on their operations; however, if it registers as an STP, it would be able to avail indirect tax benefits at the time of imports. The latter could prove to be particularly beneficial for GCCs that require intensive use of hi-tech equipment, enabling duty free import and procurement of goods. While an SEZ has to necessarily operate in a demarcated geographical area, no such geographical restriction is imposed for operating an STP unit.
India has been increasingly offering exemptions and relaxations to Foreign Entities setting up GCCs in the country as these are transforming into centres of excellence and potential technological and development headquarters. It is pertinent that Foreign Entities carefully manage the tax compliances to realise the benefits of the SEZ or STP status and undertake a proper analysis before committing to avail any such beneficial regimes.
Conclusion
It is evident that tax considerations will surely influence the macroeconomics of doing business in India. Hence, it is crucial that a Foreign Entity desirous of setting up its GCC in India undertakes a comprehensive analysis from a tax perspective up front to understand and carefully evaluate the costs involved in operating in India. With GCCs likely to play a significant role in the growth of the economy by providing employment opportunities, the expectation is that Indian policy makers would consider providing more benefits.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
sr.patnaik@cyrilshroff.com
[1] You can read part I here – Global Capacity Centres (GCCs) take centre stage in fuelling global growth | India Corporate Law (cyrilamarchandblogs.com), part II here Strategic structuring and modelling Global Capability Centres (GCCs) in India: How to set up | India Corporate Law (cyrilamarchandblogs.com), and part III here 3. Strategically building a workforce for Global Capability Centres (GCCs) in India | India Corporate Law (cyrilamarchandblogs.com)
[2] Regulation 3 of the Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016 stipulates that “no person resident outside India shall without prior approval of the Reserve Bank open in India a branch office or a liaison office or a project office or any other place of business by whatever name called except as laid down in these Regulations”.
[3] India’s DTAAs contain the various ways in which a foreign enterprise can end up having a taxable presence in the form of a PE in India like fixed place PE, installation PE, supervisory PE, service PE, etc.
[4] As described in the Supreme Court judgment in the case of Director of Income-tax (International Taxation) vs. Morgan Stanley & Co. [2007] 162 Taxman 165 (SC), stewardship activities involve monitoring of the operations of Indian entity so as to ensure an agreed quality of output, wherein the ultimate objective is to protect the interests of the group as a whole.
[5] ‘GCC 4.0 | India Redefining the Globalization Blueprint’, NASSCOM-Zinnov, (June, 2023) Accessible here – GCC 4.0 | INDIA REDEFINING THE GLOBALIZATION BLUEPRINT | nasscom
