An entity incorporation in India depends on the long-term objective of the business founders, viz. to earn profits or secure gains from selling the business. A repatriation of dividend does not require permission from the federal bank, i.e. Reserve Bank of India (RBI) subject to compliance with certain other conditions like payment of dividend distribution tax (DDT), discussed below.
A foreign entity may set up either a branch office (BO), liaison office (LO), wholly owned subsidiary corporation (WOSC) or a limited liability partnership (LLP) depending on the activities to be carried out in India. These entities are taxable in India for their operations in India.
In setting up a LO or BO, the foreign entity should obtain a permission from the RBI. Further, a LO or BO can be set up only to carry out certain permissible activities. A LO cannot remit any income to its parent from Indian operations. A BO is allowed to remitits income to foreign parent entity after paying taxes in India. It is to be noted that RBI regulates the term of an entity to function as an LO or BO in India.
Where foreign parent sets up either a WOSC in India, dividends received by the shareholders from Indian resident corporations are not taxable. There is no withholding tax on dividends but WOSC must pay dividend distribution tax (DDT) at the rate of 20.36%. In essence, the Indian corporation pays around 45% tax on its profits before distributing to its shareholders (i.e. considering lowest base tax rate of 25% and additional 20.36%). It is for this reason most foreign investors consider to set up an LLP in India as there is no DDT.
In case of a deemed dividend (i.e. amount given to the shareholders in the form of loan or any other payment that may be deemed to be a dividend), the base rate is 30%. There is an additional tax to DDT at the base rate of 10%that the Indian company is required to if dividend is received by another Indian company, individual, or firm. Effectively, if a foreign individual owner is paid dividend by an Indian company, the base tax rate may be 25%. However, in case of buy-back of shares, the corporation pays an additional income tax at the rate of 10%, of such amount is more than INR 1million (approx. USD 15,000). Additionally, the owner should pay capital gains on surrender of shares. Thus, buy-back of shares may seem a more tax effective system than paying out dividends but if yearly return is expected and complying with Indian corporate law conditions to buy-back shares may seem a burden than dividend.
In the U.S., the latest tax reforms have substantially reduced base corporate tax rate to 21% and exempted U.S. corporations to be taxed for dividend received from foreign subsidiaries.
Our whitepaper titled Interaction of Indian and U.S. Tax Laws captures the interaction of Indian and the U.S. tax laws. The dividend repatriation from an Indian subsidiary corporation to a corporation in the U.S. implies higher tax in India compared to having an LLP in India. The effective tax liability is further increased if the owner of the Indian entity is an individual as the dividend deduction is only available for corporate entities in the U.S. Therefore, the effective base tax rate increases to 65.71% (45.36% in India and 20.35%, assuming taxed in the U.S. in the highest tax slab). More importantly, the latest tax reforms taxes profits of foreign subsidiaries classified as controlled foreign corporations in the U.S. even if there no actual distribution of profits. This additional tax cost if ignored may result in huge costs to the parent entity.