Sudhir Rao, an Indian businessman with substantial interest in the winemaking and brewery sector, recognised the growing opportunity in Australia for investment in the vinification business. As this would be a perfect compliment to the vintner's Indian business, he contemplated investing a couple of million dollars in this business in Australia. The benefits of bilateral trade agreements between India and Australia are being explored by many business houses, especially in view of the fact that India has emerged as the 21st largest outward investor globally.
Sudhir completed a due diligence study, and was satisfied with the report on the probability of establishing a successful business model in Australia. The next logical step, of course, was to study the statutory compliances and related aspects of making a foreign investment. The essential first step was to decide on the type of entity to be set up in Australia, in consonance with various laws such as Securities and Exchange Board of India guidelines, Companies Act, Income Tax Act, RBI and FEMA guidelines etc.
The common practice is to set up a subsidiary company in Australia, carry on operations, pay taxes and have the dividends repatriated to the parent company in India. However, the choice of entity could vary, if one examines the benefit of taxation on the subsidiary company versus a branch office at Australia. Purely from a taxation point of view, the following facts deserve consideration. Let us say, the profit of the Australian entity is Rs 100, and assuming that the tax rate is 35 per cent, the profit after tax is Rs 65 in both situations (the subsidiary model and branch model in Australia).
If the subsidiary company declares this profit of Rs 65 as dividend, the Indian parent company needs to pay a tax of Rs 20 (at 30 per cent tax rate in India), and thus the outflow of tax in total would be Rs 55. Whereas, if it is a branch model, the Indian company will have to include the profit of the Australia branch viz. Rs 100, and pay a tax of Rs 30 (at 30 per cent). Since India and Australia have signed a Double Taxation Avoidance Agreement, the Indian Head Office can take credit of the extent of taxes already paid in Australia by the branch office.
Thus, the Indian Head office takes credit to the extent of taxes payable in India i.e. Rs 30, and the effective outflow of tax in total is limited to Rs 35. It must be remembered that though the Australian branch has paid Rs 35, the credit cannot result in refund in India. Thus, the effective tax rate for the branch model is 35 per cent, as against the subsidiary model, at a formidable 55 per cent. It will be very relevant to consider the taxation aspects, in addition to the some other factors for the entity selection.
Having decided the entity, Sudhir needs to plan for compliances with RBI/FEMA regulations. The Reserve Bank of India has simplified the foreign investment procedure to the extent that its designated authorised dealers (specific branches of commercial banks) may allow customers remittances abroad without prior permission upto US$ 200,000 per fiscal year, per person, including a minor. The provisions of FEMA do require that the applicant should have maintained the bank account with the bank for a minimum period of one year, but the said branch, at its discretion, based on the declaration, proof of funds and Income Tax returns of the applicant, can affect outward remittance.
Sudhir's initial requirement of investment is one million dollars. The plan is to carry this out with the help of his family members, with each of them investing $200,000, without seeking specific permission of the RBI. The second phase of investment would be done via the five persons in the next financial year, viz after the month of April. Sudhir's company also has the choice of investing abroad from the balance lying in its EEFC account (Exporter Earner's Foreign Currency Account). The company can invest up to 400 per cent of its net worth abroad without prior RBI approval. The ceiling doesn't apply if the investment is made out of balances held in EEFC account.
Sudhir will have certain reporting duties as well. Sudhir would need to receive a share certificate as evidence of investment, repatriate dues receivable to India and submit an Annual Performance Report for the subsidiary to RBI, through the authorised dealer. In cross-border transactions, it is equally important to comply with various regulations, to be within the framework of the law.
(The author is a Coimbatore-based chartered accountant.)