US President Donald Trump. The differential in corporate tax rates will prevent US parents from fully adjusting the tax credits earned in India to meet their tax liability on worldwide income in the US. Photo: AP
New Delhi: President Donald Trump’s US tax bill, signed into law on Friday, is set to hit the competitiveness of US firms’ Indian subsidiaries and encourage flow of capital from these units to their parents.
The Tax Cuts and Jobs Act is set to make some taxes that Indian units of US multinational firms pay in India a cost to their parents. The differential in tax rates—30% in India, exclusive of surcharge, versus the proposed 21% in US— will prevent US parents from fully adjusting the tax credits earned in India to meet their tax liability on worldwide income in the US. The unused tax credit becomes a cost.
Also, the US tax overhaul is expected to encourage Indian units to repatriate their ‘passive income’ back to their parents as repatriated dividends will be taxed at a nominal rate. Many Indian arms of US firms have so far been deferring repatriation owing to the high tax rate on such receipts.
All these changes put together could see a major change in the way US corporations invest and structure their businesses in India.
The steep decline in tax rates and the elimination of certain deductions will sharply increase the tax cost for Indian subsidiaries of US corporations, said Sudhir Kapadia, national tax leader, EY India.
“The current effective Indian corporate tax rate of 35% and the dividend distribution tax of 20% on top will result in a significant increase in the after-tax cost of doing business for Indian subsidiaries of US corporations. This is because US corporations will end up with much larger Indian tax costs which will not be possible to set off against the proposed lower tax rate of 21%,” he said.
“Further, US is moving towards a territorial system of dividend taxation, which means that dividends paid by an Indian subsidiary to its US parent will be exempt in US and the 20% DDT (dividend distribution tax) paid in India will be an unclaimed tax cost,” he said, adding that the problem will get compounded by proposed provisions for disallowing of expenses made to related US affiliates outside the US.
“This will impact payments made by US corporations to their captive technology centres in India. Similarly for Indian multinationals with subsidiaries in the US, any payments made to the Indian head-quartered company, let’s say for offshoring work, will be impacted by these proposed changes in the US tax laws,” he added.
The high corporate tax rate in the US, among other things, has over the years encouraged many US firms to use overseas tax planning structures. That has led to regulatory agencies questioning how non-US subsidiaries of such groups, accounting for a smaller share in a group’s global revenue, account for a disproportionately higher share of profits.
Experts said the US tax reform could impact capital flows between India and the US and would encourage New Delhi to quicken its promised corporate tax rate cut to 25% to a larger section of the industry, but admitted that cross-border investments are not solely dependent on tax policy. India had reduced the tax rate for companies with annual revenue of less than Rs50 crore a year to 25% from 30% in the Union budget for 2017-18.
According to Amit Maheshwari, partner, Ashok Maheshwary and Associates LLP, the impact of US tax reform in India may be on the information technology (IT) and IT-enabled services and contract research and development industry, which had a cost advantage over the US. The tax rate cut could slightly narrow the advantage India had on account of the wage differential, he said.
The income tax department cautions against knee-jerk reactions to the sharp corporate tax cut by the US.
“Taxation alone does not determine the competitiveness and growth potential of an economy. Singapore, for example, always had a lower corporate tax rate of close to 20% but that never prevented foreign direct investments coming to India from that country. Besides, we already have stated our policy of reducing corporate tax rate to 25%,” said a tax department official, who asked not to be named.
The official also said subsidiaries of US firms in India repatriating profits home will not affect the revenue receipts in India as these are already taxed in the country.
“The US tax overhaul is meant to encourage investments and job creation in the US. Many European nations have announced tax rate cuts or plans to cut rates. If large economies take this approach, it will prompt us also to have a competitive corporate tax rate, although taxation alone does not determine investments,” said Neeru Ahuja, partner Deloitte India.