Forms of Business Entities

In India, modern businesses prefer a corporate structure, given the convenience of setting up, management, expansion and exit. The various types of structures for running a business are as follows.

Company

A company is a separate legal entity, incorporated under the Companies Act, 2013.

Companies can typically be classified into the following types.

• A one-person company – all the shares are owned by one member.
• Private companies – these are closely held companies, requiring a minimum of two members, with an upper limit of 200 members. There is a restriction on the transfer of shares.
• Public companies – these companies require a minimum of seven members, with no maximum cap. The shares of these companies can be traded publicly on a stock exchange. A business set-up or a private company can, after evolving into a reasonable size, transform itself into a public company, if the members so choose.

One-person and private companies can further be divided into three sub-types.

• A company limited by shares – suitable for a new business set-up, a business managed by a foreign holding company, a family, or a business managed by a small group of people. This structure is the widely used form of setting up a presence in India by foreign investors.
• A company limited by guarantee.
• An unlimited company.

A company limited by guarantee and unlimited companies are not practically suitable for business operations, given the unlimited liability of investors/shareholders attached therewith.

Partnership

A partnership is a common name by which two or more persons carry on their business; although, under common law, a partnership is not seen as a person distinct from its partners. However, under the Indian tax laws, a partnership is considered to be a person separate from the partners. Partners can be natural persons or a juridical person (such as a company).

There are, broadly, two types of partnerships:

• a general/unlimited liability partnership – all partners have unlimited liability; and
• a limited-liability partnership (LLP) – all partners have limited liability.

Many traditional businesses and family-managed businesses are carried on as partnerships in India. The unlimited liability attached to the partners has at times discouraged businesses from adopting a partnership as a form of business. Sometimes, partnerships are formed to execute specific projects as a joint venture. However, with the recent legislative introduction of LLPs with limited liability on partners, few small and medium-sized businesses have adopted the LLP set-up for carrying on business.

While foreign direct investment (FDI) in a general partnership firm is allowed only subject to prior approval of the Reserve Bank of India (RBI), FDI in an LLP is allowed freely under an automatic approval route, subject to other conditions.

Sole proprietorship

A sole proprietorship is owned and managed by a single person.

Unincorporated business associations

An association of persons (AOP) or a body of individuals (BOI), whether incorporated or not, is treated as a separate person for taxation in India.

Taxation of Business Entities

A company is taxed separately on its profits, and its shareholders are taxed only on the dividend income received by them from the company.

For tax purposes, partnerships (including LLPs) are each considered as a separate legal entity. Accordingly, a partnership is taxed on its profits. The partners are taxed on their salary and interest income from the partnership; whereas their share in profits is exempt from tax. Thus, partnerships are treated as tax-opaque entities in India. Likewise, an AOP/BOI is considered as a tax-opaque entity and is taxed as a separate legal entity.

Sole proprietorships are taxed as individuals.

India generally does not recognise any business entity as fiscally transparent. However, in recent times, investment vehicles and investment trusts have been permitted to be set up as transparent entities/pass-through entities. Such a set-up helps in removing the cascading tax effect on the return on investment. Final tax is levied on the investor alone and the investment trust is exempt from taxation. Pass-through entities are more common in sectors where collective investments are essential, such as real estate, infrastructure sectors, etc.

In India, the determination of residence is on a year-to-year basis.

Subject to a double-taxation avoidance agreement (a tax treaty), a company is said to be resident in India, if:

• it is an Indian company (incorporated under Indian law); or
• its place of effective management (where key management and commercial decisions are in substance made) is in India.

For a partnership firm/AOP/BOI, unless the control and management of its affairs is located wholly outside India, it would be resident in India.

The basic rule for determination of residential status of an individual is if their physical presence in India is 182 days or more, in a year. A few other rules must also be applied, on a case-by-case basis, for determining the residential status of individuals.

Tax rates applicable to companies vary, according to their residential status.

Domestic Companies

A domestic company whose total turnover or gross receipt during the financial year 2020–21 does not exceed INR4,000 million is taxed at the rate of 25%. For any other domestic company, the rate of tax is 30%.

The amount of tax in both cases is to be increased by a surcharge and cess. The rate of surcharge and cess is notified annually, and ranges between 11.28% to 16.48% of the aforementioned basic tax, depending on the taxable income of the company. 

Minimum alternative tax (MAT) on domestic companies

Where the normal tax liability of a company is less than 15% of its profits shown in the books of accounts (book profits), India levies a MAT at 15% of book profit (plus surcharge and cess, as applicable) instead of normal tax liability. An excess of MAT over normal tax liability so paid is available as credit against normal tax liability in subsequent years, subject to certain restrictions.

Concessional tax regime for domestic companies

In order to stimulate economic activities and investments, the following domestic companies may opt for concessional rates of taxation, subject to the condition that they do not claim certain stipulated deduction or incentives which are usually available to such companies:

• new manufacturing companies (which are set up after 1 October 2019 and which have commenced manufacturing before 31 March 2024) – 15% (plus applicable surcharge and cess); and
• other domestic companies – 22% (plus applicable surcharge and cess).

A domestic company which has opted for a concessional tax regime is exempted from applicability of MAT provisions.

Non-resident Companies (Foreign Companies)

A foreign company is taxed at a flat rate of 40% on the business income received or accruing in India.

However, income in the nature of dividends, interest, royalties and fees for technical services (FTS) (collectively referred to as “special incomes”) are taxed at special rates on a gross basis (without providing for any deduction for expenditure):

• dividend – 20%;
• interest – 5% to 20%, depending on the source of income; and
• royalties and FTS – 20%.

The basic tax rates previously mentioned are subject to surcharge and cess, which ranges between 6.08% to 9.2% of the basic tax, depending on the taxable income of the foreign company.

MAT on foreign companies

MAT is not applicable to foreign companies that do not have a permanent establishment (PE) in India.

Further, capital gains income from the transfer of securities and special income earned by a PE of a foreign company in India will not be chargeable to MAT, if the tax payable on such income is less than 15% (exclusive of surcharge and cess, as applicable).

Partnerships

The business income of a partnership firm (whether resident or non-resident) is taxable at the rate of 30%. The amount of tax will be increased by a surcharge and cess, which ranges between 4% to 12.48% of the basic tax, depending on the taxable income of the partnership.

Alternative minimum tax (AMT) on partnerships

Where the normal tax liability of the partnership is less than 18.5% of the adjusted total income, the partnership shall be liable to pay AMT at 18.5% of the adjusted total income (plus surcharge and cess, as applicable) instead of discharging normal tax liability. An excess of AMT over normal tax liability so paid is available as a credit against normal tax liability in subsequent years, subject to certain restrictions.

Adjusted total income means total income under normal provisions as increased by certain deductions claimed by a taxpayer. Thus, AMT shall apply only if the partnership has claimed certain deductions provided under the domestic income tax law.

Sole Proprietorships

In India, a sole proprietorship business is not taxed as a different legal entity. Rather, the business owner, a resident or a non-resident of India is taxed on their total income, including the income from sole proprietorship business. The tax liability is determined on the basis of the slab rates applicable to their taxable income, which varies from 5% to 30%. The rate of tax would be increased by applicable surcharge and cess, which varies from 10.4% to 38.48% of the basic tax, depending on the taxable income earned by the individual.

AOP/BOI

The taxability of an AOP is usually dependent on factors such as whether its members’ share is determinate or not and the rate at which members’ income is taxed. Accordingly, the rate at which an AOP is taxed varies as per the facts involved in each case, and the effective rate of tax ranges from 5.2% to 42.74%.

Taxable profits are largely calculated based on accounting profits, after making certain adjustments for specific deductions/restrictions provided under the taxation laws. Substantial adjustments to accounting profits include the following.

• Depreciation – the rate at which depreciation is computed for taxation purpose is separately provided.
• Deductions of expenses – for instance, capital expenses may be allowed as a deduction in certain cases when calculating taxable profits. Weighted or accelerated deductions of expenses may also be allowed.
• Denial of certain deductions – for instance, expenses on which withholding tax is not applied, expenses incurred in cash over INR20,000, Corporate Social Responsibility expenses and penal expenses are not allowed as a tax deduction.
• Deferment of expenses – pre-incorporation expenses and expenses for raising capital to expand a business are allowed as a deduction over five years.
• Denial of excessive expenditure to associated enterprises (AEs) – expenditure in excess of an arm’s length price (ALP), where payment is made to an AE, is denied as deduction.
• Notional income – where any income accrues from an AE and is less than an ALP, the difference is deemed as income of the enterprise carrying on business in India.

The profits are taxed on the basis of the method of accounting consistently followed by a company, which could either be on a receipt basis or on an accrual basis.

Indian income tax law provides for a concessional taxation regime for income from patents. Any income by way of royalties in respect of a patent developed and registered in India earned by an eligible taxpayer is subject to tax at the rate of 10% (plus surcharge and cess) on a gross basis, with no allowance of expenditure incurred on royalty income.

Further, Indian tax law provides for special tax deductions, including weighted deductions, on certain other technology investments:

• capital expenditure on scientific research pertaining to the business;
• a contribution made to an approved research association, university, college or other institution, to be used for scientific research;
• a contribution made to an approved company registered in India, to be used for scientific research;
• a payment made to a national laboratory or university, or to an Indian institute of technology or a specified person, for scientific research;
• capital expenditure incurred by a company on scientific research, in approved in-house scientific research and development facilities;
• additional or accelerated depreciation on investments in plant and machinery used in manufacturing or generation/transmission/distribution of power; and
• 100% profit linked deductions for a period of three years for the eligible start-ups engaged in business which involves innovation, development, deployment or commercialisation of new products, processes or services driven by technology or intellectual property (eligible start-ups should be set up between April 2016 and March 2024).

India provides a number of tax incentives to various industries, transactions and businesses, such as the following.

Offshore Banking Units and International Financial Services Centres (IFSCs)

A deduction of 100% of the income is available to an offshore banking unit located in a Special Economic Zone (SEZ) for an initial five consecutive years. Further, for a subsequent five years, the deduction is allowed at the rate of 50% of income for financial year(s) up to 31 March 2022, and at the rate of 100% for the financial year 2022–23 and onwards.

A unit set up in an IFSC is eligible for deduction of 100% of its income for ten consecutive years out of 15 years, among other incentives.

Start-Up Companies

A deduction of 100% of the profits and gains is available for three consecutive years out of ten years, beginning from the year of incorporation, subject to certain conditions. Start-ups are exempt from angel tax provisions in India, which seeks to tax excess of consideration received upon issuance of shares at premium, in excess of the fair market value of those shares, subject to the fulfilment of certain conditions.

Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs)

REITs and InvITs are real estate and infrastructure investment vehicles, respectively, which undertake investments either directly in real estate/ infrastructure projects or through special purpose vehicles (SPVs).

Pass-through benefits have been given to the following incomes received by REITs and InvITs:

• interest received from SPVs;
• dividends received from SPVs; and
• rental income received from assets directly held by REITs.

The aforementioned incomes are directly taxable in the hands of the unit holders/investors upon distribution by REITs and InvITs. However, the dividend income is exempt in the hands of unit holders/investors in certain circumstances.

Weighted Deduction for Employment Generation 

A taxpayer can claim additional deduction of up to 90% of the total employee cost incurred by it on new employees employed by it. The deduction is allowed equally over a period of three consecutive years starting from the year in which employment was provided, subject to fulfilment of certain conditions.

Offset of Losses

Business loss

Loss from business can be offset against any other income, except salary and profits from speculative business. Losses from a speculation business can be offset against the profits of the speculation business only.

Speculation business means involving purchase and sale of any commodity, including stocks and shares which are periodically or ultimately settled without actual delivery of commodities/scrips.

Loss from transfer of capital asset (“Capital Loss”)

Capital Loss can be offset against gains from transfer of other capital assets only. The regulations, however, vary, depending on the period for which the asset is held (short-term or long-term) and the nature of the asset. For instance, set-off rules may vary for listed or unlisted shares and securities of an Indian company, and for units of a mutual fund, in comparison to other assets. 

Carry-Forward of Losses

Business loss

A loss from speculation business can be carried forward for up to the next four assessment years from the assessment year in which the loss was incurred, and can be adjusted against income from speculation business only.

Other business loss can be carried forward for up to the next eight assessment years from the assessment year in which the loss was incurred. The carried-forward loss can be adjusted only against business income. The carry-forward and offset of business loss in a private company is allowed only if the beneficial shareholders holding shares carrying 51% of voting rights remain the same on the dates on which loss was incurred, and on the date on which it is being claimed.

Loss from the transfer of a capital asset

Capital loss can be carried forward for up to the next eight assessment years from the assessment year in which the loss was incurred.

Offset and Carry-Forward of Unabsorbed Depreciation

Any depreciation which cannot be offset against business income during a particular year is allowed to be carried forward indefinitely as unabsorbed depreciation and offset against any income of any future year.

Interest paid on capital borrowed for the purposes of business is a tax-deductible expenditure.

However, if the capital is borrowed for acquiring a capital asset, interest liability pertaining to the period until the time the asset is put to use is added to the cost of that asset and is not allowed as a tax-deductible expense.

Transfer-Pricing Rules

Indian transfer-pricing rules apply to interest that is paid by an Indian corporation to its foreign-related parties, where the interest that is in excess of an arm’s length interest is disallowed.

Thin-Capitalisation Rule

India recently introduced a thin-capitalisation rule as a specific anti-tax avoidance mechanism to cap interest deductions claimed by an Indian company or Indian PE of a foreign company on account of interest paid to non-resident AEs on debts issued by the latter. The restriction would be over and above the ALP rule followed in relation to all expenditure, where payment is to be made to an AE.

The rule seeks to disallow any interest expense which exceeds 30% of earnings before interest, taxes, depreciation and amortisation (EBITDA) of the borrower. The rule applies only to those whose total interest expense exceeds INR10 million in the year.

Further, where the loan is advanced by a non-AE, but an AE provides a guarantee to that lender, the loan is deemed to have been issued by an AE. Accordingly, the thin capitalisation rule becomes applicable in such a case.

Consolidated tax grouping is not permitted under Indian income tax law. Instead, each individual company of a group files and pays corporation tax on a standalone basis.

India distinguishes between business income and capital gains for tax purposes. For companies, capital gains and losses arising from the transfer of capital assets are calculated separately, with net chargeable gains taxed at prescribed rates. The tax rate depends on the nature of the capital asset, the period of holding (long-term/short-term) and the residential status of the transferor.

Generally, an indexation benefit is available on the cost of acquisition and the cost of improvement for assets classified as long-term, while computing capital gains.

Further, certain transactions are not regarded as transfers and are thus exempt from taxation – for example:

• transfer of a capital asset by a demerged company to the resulting Indian company during the course of a demerger;
• transfer of capital assets in a scheme of amalgamation; and
• transfer of capital assets between a holding and a wholly owned subsidiary are not regarded as a transfer for capital gains tax purposes, subject to fulfilment of certain conditions.

An incorporated business may have to pay the following taxes on a transaction:

• goods and services tax (GST), which has subsumed the various indirect taxes that were levied previously (such as excise duty, service tax and value-added tax (VAT)/central sales tax (CST));
• the importation of goods/services will attract integrated GST and may attract customs duty, among others;
• the exportation of goods/services is zero-rated under GST – exporters can claim a refund of input tax credit of inputs/input services used in the exportation of goods/services, subject to the fulfilment of prescribed conditions;
• stamp duty is payable on all legal property transactions;
• property tax; and
• securities’ transaction tax (STT), which is applicable to transactions that involve the purchase/sale of equity shares through a recognised stock exchange.       

Incorporated businesses are generally subject to GST.

Closely held local businesses of a large or medium scale usually operate in corporate form. Partnerships and sole proprietorships are usually preferred for small businesses.

India follows progressive tax rates for individuals. While individuals earning a minimal income experience lower taxes (0%, 5% or 10%, based on the income), individuals earning a substantially higher income are generally liable to tax at rates higher than corporate rates.

Individual professionals are, however, barred from carrying on a profession as a corporate, under the laws by which they are permitted to practise as professionals. For example, the Advocates Act, 1961, the Indian Medical Council Act, 1956, and the Chartered Accountants Act, 1949 prohibit a professional from carrying out their profession in corporate form. Such professionals carry out their practice as sole proprietors, unlimited partnerships or LLPs.

Currently, there are no specific rules preventing closely held corporations from accumulating earnings for investment purposes, although such rules have existed in the past.

Dividend Income

From the financial year 2020–21, an individual shareholder is liable to pay tax on dividend income from shares held in a company. If the shares are held as a trader, the dividend income therefrom is taxable as business income; whereas if shares are held as an investment, income arising in the nature of a dividend shall be taxable as income from other sources. While dividend income of resident individuals is taxed as per applicable slab rates, dividend income of non-resident individuals is taxed at 20% plus surcharge and cess.

Capital Gains

Capital gains arising from the sale of equity shares held by individuals in closely held corporations are taxed as follows:

• long-term capital gain for residents – 20% (plus the applicable surcharge and cess) with the benefit of indexation;
• long-term capital gain for non-residents – 10% (plus the applicable surcharge and cess) without the benefit of indexation; and
• short-term capital gain – as per the slab rates applicable to the individual.

Shares of closely held corporations held for more than two years are considered to be long-term assets.

Dividend Income

From the financial year 2020–21, an individual shareholder is liable to pay tax on dividends from shares in publicly traded corporations – ie, listed on a recognised stock exchange. There is no distinction in the taxation of dividend income from a closely held company and from a publicly traded company.

Capital Gains

Capital gains arising from the sale of equity shares held by individuals in publicly traded corporations are taxed as follows.

• Long-term capital gain (listed if STT is paid) – 10% (plus the applicable surcharge and cess) without benefit of indexation, if that gain exceeds INR100,000 in a year.
• Long-term capital gain (listed, if STT is not paid) – option for residents to be taxed at 20% (with indexation) and 10% (without indexation). However, for non-residents, the gains are taxed at the rate of 10% (without indexation), plus the applicable surcharge and cess.
• Short-term capital gain – 15% (plus the applicable surcharge and cess).

Equity shares of publicly traded corporations held for more than one year are considered long-term assets.

Withholding taxes on interest, dividends and royalties are applied as final tax on the gross income earned by a non-resident. The withholding tax rates would be increased by surcharge and cess, depending on the income earned by the non-resident.

• Interest – usually, a withholding tax rate of 20% is applicable on the interest on a foreign currency loan paid by an Indian resident to a non-resident. A concessional rate of 5% is applicable in certain cases.
• Dividends – a withholding tax rate of 20% is applicable on the payment of dividends to a non-resident.
• Royalties/FTS – a withholding tax rate of 20% is applicable on the payments in the nature of a royalty and FTS made to a non-resident.

India has signed tax treaties with around 100 countries.

Earlier, tax treaties entered into with Mauritius, Singapore and Cyprus were beneficial to the taxpayer, as capital gains on the sale of shares of Indian companies were exempt from taxation in India, and the domestic law of these countries did not tax capital gains. Accordingly, India received a significant quantum of investments from these countries. These treaties have, however, been amended, with effect from the financial year 2017–18, to provide for source-based taxation on gains from the sale of shares.

Some tax treaties, such as those with the Netherlands and Sweden, still provide exemptions for gains derived from the sale of shares of an Indian company in certain situations.

Despite the amendments to the tax treaties, foreign investors continue to invest in India from Mauritius and Singapore.

The Indian tax authorities challenge the use of an entity that is a resident of a tax-treaty country, if that entity is effectively owned or controlled by a person who is a resident of a different country. Legal basis for denial of benefits includes the following:

• the limitation of benefits clause or the “beneficial owner” clause in the applicable treaty;
• the “principal-purpose test” under the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (MLI), as incorporated in the applicable treaty; and
• general anti-avoidance rules, as in domestic tax law.

The main issue in disputes regarding transfer pricing is the adequacy of documents maintained for establishing the nature of the transaction entered into with the AE. Tax authorities have raised many transfer-pricing disputes in the past relating to the following:

• intragroup services;
• cost-contribution arrangements;
• corporate guarantees;
• advertisements;
• marketing and brand promotion (AMP) expenses;
• royalties/fees for technology/know-how; and
• secondary adjustments, etc.

Other transfer pricing issues include the following:

• the examination of the transfer-pricing methodologies chosen;
• the comparable companies adopted; and
• ensuring the fulfilment of various reporting requirements.

The use of a related-party limited risk distribution arrangement is not challenged in principle by the tax authorities. However, based on the nature of functions actually carried out and the risks assumed by the distributor, tax authorities may seek to re-characterise the distributor as bearing medium or full risk, and, accordingly, may enhance the ALP margin of the distributor.

Indian transfer-pricing rules, by and large, follow the OECD Transfer Pricing Guidelines.

Transfer pricing issues have always been susceptible to scrutiny from the tax department. Domestic tax law permits officers to re-open cases from earlier years; however, the limitation to opening such cases is usually three years from the end of the relevant assessment year, which can be extended to ten years in high-income cases. 

The tax treaties entered into by India provide for resolution of any taxation that is not in accordance with the treaty, through the Mutual Agreement Procedure (MAP).

In line with the BEPS final report on “Making Dispute Resolution More Effective”, India substituted the rule which dealt with the same issue of implementation of the MAP. India has also issued MAP guidance for the benefit of the taxpayers, tax practitioners, tax authorities and chartered accountants (CAs) of India and of treaty countries.

While in the past, the MAP has not led to much success, in view of recent changes it is now expected that the taxman would look favourably upon the resolution of disputes via the MAP rather than litigation.

Although compensating adjustments are allowed to settle a transfer-pricing dispute or claim, this is not very popular among taxpayers in India.

Globally, India lags behind in the settlement of disputes when referred under the MAP. Disputes have been pending for a long period of time in certain cases.

An Indian subsidiary of a foreign corporation is liable to the same taxing rules/rates as an Indian corporation. However, an Indian branch of a foreign corporation is liable to the higher rate of tax that is applicable to foreign corporations.

For local branches, the taxable entities remain the foreign corporations only, who will be required to obtain tax registrations in India. For ensuring computation of profits at an ALP, the branch office is hypothetically considered a separate legal entity from the foreign corporation. The deduction allowable to the branch on payments made towards certain head office expenses is restricted to 5% of the income of the branch.

India taxes the capital gains arising for a non-resident on the direct sale of shares of an Indian company.

India also levies tax in the case of indirect transfers – ie, where the gain is on the transfer of shares of a foreign holding company that derives substantial value from Indian assets, including shares of an Indian corporation.

Almost all the tax treaties entered into by India allow India to tax the direct transfer of shares of an Indian company.

Many of these treaties, such as those with Mauritius, Singapore, the Netherlands, Japan and South Korea, eliminate the capital gains tax in India applicable to the indirect transfer of shares of an Indian company.

Some of the treaties, such as those with the USA, UK, Canada, Israel and South Africa, allow India to tax both direct and indirect transfers of shares of an Indian company.

India levies tax on indirect transfers as well, subject to treaty benefits. That is, the gains arising from the transfer of any share or interest in a non-resident company are taxed in India, if that share or interest derives its value substantially from the assets located in India.

Changes in ownership amounting to a change in control can also disentitle an Indian company from carrying forward and offsetting accumulated losses, as stated in 2.4 Basic Rules on Loss Relief.

There are no specific formulas used to determine the income of foreign-owned local affiliates selling goods or providing services. The income would, however, have to comply with the arm’s length principle.

All expenditure allowed for the carrying on of business is allowed as a deduction, irrespective of the nature of the corporation. The expenditure deduction would, however, have to comply with the arm’s length principle.

There are no restrictions in tax laws on the amounts that can be borrowed from a related party. However, the allowability of a deduction on any such borrowings from related parties will be subject to the arm’s length principle in transfer pricing and under the thin capitalisation rule.

Indian companies are tax residents of India; hence, their global income is liable to tax in India. Foreign income of Indian companies is liable to tax on the same basis as profits from activities in India, subject to the benefit of foreign tax credits to avoid double taxation.

Generally, foreign income of an Indian company is also liable to tax in India. However, if some foreign income is tax-exempt in India, any expenses incurred to earn such income will not be tax-deductible in India.

A dividend received from a foreign company is taxed as business income (where shares are held as stock in trade) or as other-sources income (if shares are held as investments). Such dividend income is taxed at applicable corporate tax rates. Any expense incurred to earn dividend income can be claimed as deduction while computing business income, but deduction allowance is restricted to certain expenses while computing dividend income under the head of other sources.

Further, any tax paid outside India by a local corporation can be claimed as credit against tax liability in India. 

Where the intangibles developed and owned by an Indian corporation are used by a non-Indian subsidiary, the Indian corporation is entitled to receive royalties. Such royalties would be subject to the arm’s length principle under transfer-pricing regulations. Even if the non-Indian subsidiary does not pay a royalty, for the purpose of the transfer-pricing rules, the Indian corporation would be deemed to receive an arm’s length royalty from the non-Indian subsidiary and would be taxed accordingly.

If intangibles developed by an Indian corporation are assigned or transferred outright to a non-resident subsidiary, the arm’s length sale consideration for that intangible may be subject to tax as business income or capital gains. 

There are no provisions relating to CFC-type rules in Indian income tax law.

There are no rules relating to the substance of non-local affiliates in Indian income tax law.

Indian companies are tax residents of India; hence, their global income is liable to tax in India. Any gains arising from the sale of shares in a non-Indian affiliate of an Indian company are taxed as capital gains in India, subject to treaty and foreign tax-credit benefits. There are no special rules prescribed for these.

India has enacted the General Anti-Avoidance Rules (GAAR) with effect from 1 April 2016. The provisions are based on the doctrine of “substance over form”, and are applicable to arrangements regarded as “impermissible avoidance agreements” that are primarily structured to achieve tax benefit. The taxman has been empowered to re-characterise any such arrangement and even to deny tax and/or treaty benefits in order to curb the tax avoidance intended through such arrangement. An “impermissible avoidance agreement” is a defined term under the domestic tax law. Presently, the monetary threshold for applicability of the GAAR is INR3 crores.

Apart from the GAAR, specific anti-avoidance regulations also form part of domestic law in specific instances – eg, where certain assets are transferred at a price less than their fair market value, anti-avoidance regulation deems the fair market value as the consideration received on the transfer.

Income tax returns are filed on a self-assessment basis by the taxpayers. India does not have a regular routine audit cycle.

India has moved to a hybrid system for selecting tax returns for audit. A computer-aided scrutiny selection (CASS) system has been designed to identify high-risk tax returns for audit. Tax returns are also picked up for audit based on historic audit findings, the nature of business, etc.

India is an active supporter of the OECD BEPS project and has implemented many of its recommendations/actions, as follows:

• BEPS Action 1 (Equalisation Levy and Significant Economic Presence (SEP));
• BEPS Action 4 (Thin-Capitalisation Rule);
• a patent box regime (BEPS Action 5);
• BEPS Actions 6 and 15 (MLI);
• country-by-country reporting (BEPS Action 13); and
• Guidelines on MAP (Action Plan 14).

Indian law is already in line with Action Plans 8–10 (Intangibles).

India has been actively involved in the implementation of the OECD recommendations in relation to the BEPS.

OECD Pillars One and Two are likely to be revolutionary reforms in the international tax landscape. India is among those countries that have joined the OECD statement. India is likely to introduce necessary changes into domestic tax laws to give effect to Pillar One and Pillar Two.

Furthermore, India has already reached a compromise with the USA in relation to credit of excess amounts paid in the form of the unilaterally levied equalisation levy of 2% during the transition period over the liability, as per Pillar One.

Moreover, India’s taxation regime operates on a source basis. In view of that, Pillar Two’s “Subject to Tax Rule (STTR)” would help India to curb base erosion and profit-shifting. The STTR is based on the rationale that a source jurisdiction that has ceded taxing rights in a tax treaty should be able to apply a top-up tax, where the income is taxed below the minimum rate by the resident country. Accordingly, on implementation, India would be able tax those multinational enterprise (MNE) groups which are otherwise not being taxed by their resident jurisdictions.

International tax is seen as a high-profile portfolio in India. Experienced Revenue Officers are specifically trained for handling cross-border taxation, including transfer pricing. The recent introduction of an equalisation levy and SEP Rules have increased their importance. The presence of a separate team of highly skilled personnel will help India in implementing BEPS recommendations at a faster pace.

Traditionally, India has not pursued a competitive tax policy. In fact, the corporate tax rates in India are already above the global minimum corporate tax rates of 15% prescribed under Pillar Two. India was either already compliant with, or had already implemented, a significant number of BEPS recommendations. As a result, India seeks to achieve international standards for fair and realistic tax competition.

India does not have a competitive tax system that might be particularly affected by anti-BEPS measures.

Indian businesses are looking at hybrid instruments as an alternative mechanism for raising funds at a competitive price. However, the lack of clarity on its taxation has stalled the process of augmenting capital. Recently, representations have been made to frame rules for taxing such instruments, but the diversity of the characters of those instruments is delaying the policy decision.   

India generally taxes the worldwide income of its residents and does not follow a territorial tax regime. Non-residents, including the PE of non-Indian residents, are generally taxed only on the income derived from Indian sources.

The thin capitalisation rule will have a significant impact on investments.

India does not have a territorial tax regime for resident companies.       

The Limitation of Benefit (LoB) Rule and other anti-avoidance rules, such as the Principal Purpose Test (PPT), introduced into tax treaties entered into by India (either directly or through a multilateral instrument (MLI)) are likely to have a significant impact both on inbound and outbound investors.

Even without these provisions, Indian tax authorities have, time and again, challenged benefits claimed under various tax treaties by applying the substance-over-form test and judicially recognised GAAR principles. Express inclusion of such provisions in the tax treaties, as well as legislative GAAR provisions, will further encourage the tax authorities to question and challenge treaty benefits claimed by investors.

The PPT introduced by the MLI is vague and subjective, and will likely expose investors to increased litigation in jurisdictions such as India.

Transfer-pricing matters involving intellectual property are a crucial issue for companies and advisers in India, as the evaluation, benchmarking and documentation of intellectual property are always challenged in Indian tax audits.

In light of the transfer-pricing documentation/reporting requirement covering country-by-country reporting, as well as the master file and the local file, intellectual property must be documented more extensively. Therefore, comments must be made regarding the creation, beneficial ownership, chances and risks, etc, of intellectual property.

This does not radically change things. However, information regarding intellectual property will be available to tax authorities in India and other countries with a greater level of transparency. Consequently, there are concerns that this could lead to more challenging tax-audit procedures.

In response to BEPS Action 13, “Guidance on Transfer Pricing Documentation and Country-by-Country Reporting”, India has already incorporated transfer-pricing provisions to adopt the three-tiered documentation approach consisting of a country-by-country report, a master file and a local file.

Owing to these comprehensive reporting and documentation requirements, there is concern regarding the administrative barriers that companies may have to face.

India has introduced an “Equalisation Levy” and the concept of a “significant economic presence” for the taxation of digital economy businesses.

An Equalisation Levy of 2% is levied on the amount of consideration received or receivable by an e-commerce operator from an e-commerce supply or services made, facilitated or provided by the operator. Exemption from income tax is provided where the Equalisation Levy is chargeable (applicable from 1 April 2021).

Further, a new nexus rule in the form of an SEP has been introduced into Indian tax law. Generally, any income of a non-resident arising from a business connection in India is subject to tax in India. Any such business connection will include an SEP of a non-resident taxpayer in India.

A non-resident is said to have an SEP in India in the following cases:

• for transactions in any goods, services or property carried out by a non-resident in India, whereby aggregate payments exceed INR20 million in a year; and
• where the non-resident systematically and continuously solicits business or interacts with 300,000 or more users in India.

India has been one of the first countries to introduce digital taxation by way of an Equalisation Levy and SEP provisions. However, India is expected to withdraw these unilateral measures, after implementation of Pillar One.

Any income by way of a royalty or FTS received by a non-resident from offshore intellectual property deployed in India is generally taxable in India at the rate of 20% plus the applicable surcharge and cess.

Taxation of such income usually takes the form of a tax-withholding by the payer in India. However, when no tax has been withheld by the payer as applicable, the taxpayer is directly required to discharge tax liability on such royalty/FTS income.

Indian tax law does not distinguish between non-resident owners of intellectual property in tax havens or in other countries. Non-residents located in countries that have favourable tax-treaty provisions with India may be eligible to avail of the applicable benefit under the treaties.