Contribution — This article is written in collaboration with Sanketh Kamath — Manager, Transfer Pricing at B S R and Co, Chartered Accountants. Views personal.
The idea behind the Founder Mental Model series of blogs would be to provide current and prospective founders a map to navigate the complex path to starting up.
I saw a question on LinkedIn that asked — “More than 95% of Indian #saas business is registered in North America and every time I talk to founders, the sole reason they set up an Indian subsidiary is to facilitate salary payouts despite having the main business registered in the US. With solutions like Deel, Remote coming into picture, do we need the subsidiary set up?”
That’s a great question and one that needs some amount of delving deeper before we arrive at a “yes” or “no” answer. The short answer is that it depends. I know, you probably hate me for that, but hear me out?
Besides, the US IP laws offer stronger and (perhaps) faster ways to protect the patents/ business IPs. Also, we have seen start-ups citing better valuation prospects (due to higher capital availability) as another key reason.
Off late, there has also been an exodus of Web3 start-ups from India to Dubai due to lack of regulatory certainty on the space. Those start-ups would look at leveraging India for the R&D capabilities.
What are the various considerations for founders who are increasingly setting up their HQ or Holding companies in the USA, Singapore, British Virgin Islands, Cayman Islands etc to name a few.
If this is of interest to you, we can consider doing another deep-dive on the choice of hold-co (Holding company) jurisdiction (“a fancy way to say country, by us finance types”).The short answer there is depth of capital markets and proximity to a large customer base. You’ll need to wait for the longer answer.
Other large organizations like Amazon AWS / Google etc have a way around this problem of customers in India wanting to be billed through an Indian entity. Large companies typically have a vast reseller network through which they invoice to customers in specific locations, the resellers provide customers in their geography favorable credit terms (in some cases more than 45 days), INR denominated billing, free professional services etc. For an early stage start-up, getting to this level may take a few years and few hundred or even few thousand customers.
The employee tax structuring referred to here could include stuff like a car lease plan, driver allowance, broadband allowance, new pension scheme to name a few. As the race for talent intensifies, the benefits that an organization provides will become a crucial part of the evaluation process when talented individuals decide to switch so this is an important consideration.
There is an increased understanding of these structures but this is not a new model. EOR organizations like Velocity Global (2014) have been around for longer than Deel / Remote etc.
While we have covered the reasons to set up an Indian Subsidiary, below are some of the reasons to re-think that approach —
If you have no customers in India and India would not be a significant customer base and the presence is limited to less than 10–25 individuals, it may not be required to set up a full blown private limited company.
For a risk mitigated, captive R&D and such similar service providers, TP requires that the India legal entity perform a cost-plus billing to the US Hold-co(where the Indian subsidiary invoices all the operating cost like salary, consulting cost, rent, utility etc and adds on a mark-up that typically ranges from 12%–20%) on a periodic basis. Aligning with the ‘risk-mitigated’ characterization, the cost-plus billing arrangement typically ensures that the India Subsidiary remains profitable anddue to this cost-plus billing arrangement, the India Subsidiary will almost always be profitable and be subject to tax in India that ranges from 25–33%. All the while, without making any profits at a group (overall)level as the below table illustrates.
Most likely, the tax paid in India would be tax creditable (reduce tax instance in the US as and when the group becomes profitable) but due to the timing mismatch there would be a large outflow for Indian income tax owing to the transfer pricing requirement. Given the abundant availability of capital, entrepreneurs are willing to take bolder and bigger bets which means profitability will remain elusive and the tax above becoming a sunk cost.
India Transfer Pricing Litigation landscape — India has come a long way since the India TP regulations kicked-in. The field officers continue to remain aggressive — and this, frankly, is isn’t a new knowledge for MNCs which have been in India, through Sub-co(s), for generations now — they tend to mitigate/ manage the TP litigation risks through bilateral routes enabled under Tax Treaties. For start-ups, their economies-of-scale simply would not justify opting such bilateral ‘strategies’ — and even going through the actual domestic litigation process, which often is time consuming and expensive, is not be feasible. As a start-up, it is ideal to channel time and efforts in building products/ services, creating market etc. — and not tangle itself in unwarranted TP litigations, which in India could go up to 10–12 years before any reasonable finality is attained.
Disclaimer — This post is for informational purposes only and is not intended to be treated as tax, legal or professional advice. The reader is requested to get the counsel of a qualified professional and the above information is illustrative in nature to provide the reader a high-level introduction to the topic being discussed.
This post was first published on Medium.