Why US Tax Compliance Matters When You Expand to India
You've decided to expand operations to India. You've researched Indian corporate tax rates (25-30%), labor costs, and market opportunity. But here's what many US companies miss: expanding to India doesn't suspend your US tax obligations.
As a US company (whether C-Corp, LLC, or Partnership), you remain subject to US federal tax law on your worldwide income—including profits generated by your Indian subsidiary or branch.
At Finova Consulting, we guide mid-market US companies (₹50 Cr - ₹500 Cr revenue) through the exact tax compliance framework required for India expansion. This guide covers the specific rules, timelines, and compliance checklist.
Section 1: Entity Structure — Branch vs. Subsidiary Decision
Your first major decision impacts your entire tax profile. There are two ways to structure operations in India:
Option A: Branch Operation
- You operate directly in India under your US parent (no separate Indian entity)
- India office is an extension of your US company
- Indian profits are immediately taxable to US parent
- Simpler compliance initially; higher tax burden
- You file US tax returns only (no Indian separate entity returns)
- Best for: Short-term pilot, limited operations, low profits
Option B: Subsidiary (Indian Private Limited Company)
- You incorporate a separate Indian entity (100% owned by US parent)
- Indian subsidiary operates independently but controlled by US parent
- Indian profits taxed in India first (25-30%), then US parent taxed on dividends
- More complex compliance; potential tax deferral and planning opportunities
- You file both Indian and US corporate returns
- Best for: Long-term operations, significant profits, value-add activity
Section 2: Foreign Earned Income Exclusion (FEIE) vs. Foreign Tax Credit (FTC)
If you're a US citizen working in India, you have two tax strategies. If you're a US company (not individual), you face different rules entirely.
For US Individuals Working in India (Executive/Employee)
If your US executives are physically present in India:
Foreign Earned Income Exclusion (FEIE) — IRC Section 911
- Exclusion Amount (2024): $120,000 per individual (indexed annually)
- What Qualifies: Wages, salary, bonuses earned while in India
- Requirement: Physical presence test (330+ days outside US in 12-month period) OR bona fide residence in India
- Tax Benefit: First $120K of income is excluded from US federal taxation (though still subject to self-employment tax)
- India Tax: Your income is still taxable in India; file Form 8833 to claim exemption under US-India tax treaty (if applicable)
Example: Your VP of Sales relocates to India. Her salary is $180,000. Under FEIE:
- $120,000 excluded (US tax-free)
- $60,000 subject to US federal tax
- All $180,000 taxed in India (plus applicable relief under treaty)
For US Companies (Corporate Level)
FEIE does not apply to corporations. Your US company pays full US federal tax (21% effective rate) on worldwide income, including India profits.
However: You can claim a Foreign Tax Credit (FTC) for Indian taxes paid. Here's the mechanic:
You pay Indian corporate income tax (say, ₹30L on ₹100L profit). You then file Form 1118 with your US return and claim a credit for taxes paid to India, reducing your US tax liability.
- Limitation: FTC is capped at your US tax rate (21%) applied to foreign income. You can't use excess credits, but can carry back 1 year and forward 10 years.
- Timing: File Form 1118 with Form 1120 (US corporate return) by October 15 (plus extensions).
Section 3: Subpart F Income & Current Year Inclusion (CYI)
This is where many US companies get surprised. Even if your Indian subsidiary is a separate legal entity and you don't receive dividends, the IRS may require you to include certain income on your US return immediately.
What is Subpart F Income?
Subpart F (IRC Sections 951-964) requires US shareholders to include certain "foreign personal holding company income" (FPHCI) in their current-year US taxable income, regardless of whether it's distributed.
In plain English: If your Indian subsidiary earns passive income (interest, dividends, rents, royalties), you may owe US tax on that income in the year earned, even if you leave it in India and don't bring it back to the US.
| Type of Income | Subpart F Treatment? | Taxed When Earned? | Example |
|---|---|---|---|
| Passive Income (Interest, Dividends, Rents) | YES — Included as FPHCI | Current year (even if not distributed) | Your India subsidiary earns interest on bank deposits; US tax immediately due |
| Active Business Income | NO — Deferred | Only when distributed as dividend or deemed distributed | Your India subsidiary earns revenue from operations; no current-year US tax until dividend |
| Royalties/IP License Payments | YES — Included as FPHCI | Current year | Your US parent licenses software to India subsidiary; royalty income is Subpart F |
| Sales of Inventory (Foreign Base Company Sales Income) | YES — Included as FBCSI | Current year | Your India subsidiary buys inventory from third parties and sells it; subject to FBCSI rules |
The GILTI Tax (Global Intangible Low-Taxed Income)
IRC Section 250 introduced GILTI in 2018. This is a separate (and sometimes overlapping) rule that can tax your India subsidiary's income even if it's not Subpart F income.
GILTI Rule — The Backstop Tax
Objective: Tax intangible income (intellectual property, brand value, high-margin services) earned in low-tax countries.
- Calculation: GILTI = (Foreign subsidiary's net taxable income) − (Deemed return on tangible assets @ 10% rate)
- US Tax Rate: GILTI is taxed to US parent at 21% effective rate (after foreign tax credit) if conditions met
- Example: Your India subsidiary earns $5M profit. Tangible assets = $20M. GILTI = $5M − ($20M × 10%) = $3M. This $3M is subject to US tax.
- Interaction with FTC: You can credit foreign taxes paid against GILTI; GILTI tax is generally avoidable if your India subsidiary's effective tax rate ≥ 10-13.125%
Transfer Pricing & Subpart F Avoidance
Many US companies use transfer pricing to reduce India subsidiary profits and therefore Subpart F/GILTI exposure. Example:
Scenario: Your India subsidiary is an outsourcing center providing services to your US parent. You charge your US parent a "management fee" from the India subsidiary for services rendered. This fee is deductible by the US parent, and the India subsidiary's income is reduced accordingly.
Risk: The IRS challenges the transfer price as "arm's length" if it's too low. We cover transfer pricing in detail in Section 5.
Section 4: Transfer Pricing & Arm's Length Standard
Transfer pricing is the price you charge for intercompany transactions (services, IP, goods). The IRS requires these to be at "arm's length"—the price unrelated parties would charge.
Why Transfer Pricing Matters for India Operations
If your US parent charges the India subsidiary high fees for management services, IT support, or IP licensing, you reduce India subsidiary profits (and India tax) but don't necessarily reduce US parent's taxable income (since you already have US revenue). This creates tax arbitrage.
The IRS scrutinizes this heavily. Transfer pricing audits are among the most common and expensive IRS enforcement actions for multinational companies.
Transfer Pricing Methods
Transfer Pricing Documentation Requirements
US Rule: If your India operations generate >$100M in gross revenue, you must prepare contemporaneous transfer pricing documentation supporting the "arm's length" nature of your intercompany pricing.
- Economic analysis showing comparable companies/benchmarks
- Description of functions performed, assets used, risks assumed by each party
- Selection and application of transfer pricing method
- Reconciliation of intercompany pricing to support the method chosen
Transfer Pricing Example: US SaaS Company with India Dev Center
Case Study: TechCorp Inc.
Setup: US software company establishes India subsidiary (TechCorp India) to develop software. US parent charges India subsidiary monthly fees for "R&D management, QA oversight, and IP licensing."
The Challenge: What is the "arm's length" management fee?
Finova's Approach:
- Benchmark Analysis: We identify comparable outsourcing relationships (e.g., Accenture, TCS) and determine the typical markup on developer costs (20-35% over developer salaries).
- IP Licensing Component: We value the software IP being licensed using a "profit-split" method; allocate a portion of overall profit to the IP contribution by US parent.
- Fee Structure: We establish a monthly management fee of $X + IP royalty of Y% of subsidiary revenue. This is now defensible.
- Documentation: We prepare 50+ page transfer pricing study supporting the chosen pricing method, ready for IRS examination.
Section 5: Foreign Currency & FBAR/FATCA Reporting
Operating in India means bank accounts, payroll, and intercompany transactions in Indian Rupees. The IRS requires detailed currency reporting.
FBAR Filing (Form 114 — FinCEN Report of Foreign Bank and Financial Accounts)
- Your company has foreign bank accounts (checking, savings, money market) in India
- Aggregate balance of all foreign accounts exceeds $10,000 at any time during the calendar year
- Filing Deadline: April 15 (no extension); penalties for late filing are substantial ($100-$10,000 per account per year)
Form 8938 (Statement of Specified Foreign Financial Assets)
If your company's aggregate foreign financial assets exceed $100,000 (or higher thresholds if you're a foreign corporation), you file Form 8938 with your tax return.
- What to Report: Foreign bank accounts, foreign corporation stock/ownership, foreign investment accounts, foreign loans, foreign contracts
- Filing: With Form 1120 (corporate return) on October 15
- Penalty: Failure to file can result in penalties of up to $10,000 + 40% of underpayment
FATCA (Foreign Account Tax Compliance Act) — Form 5471 / 5472
| Form/Schedule | When Filed | What You Report | Deadline |
|---|---|---|---|
| Form 5471 | You own ≥50% of India subsidiary | Subsidiary's income, stock basis, earnings & profits, foreign taxes paid | October 15 (with Form 1120) |
| Form 5472 | You have significant foreign-related transactions (intercompany sales, services, loans) | Type, amount, and nature of transactions with India subsidiary | October 15 (with Form 1120) |
| Form 8858 | You own ≥10% of India subsidiary | GILTI, Subpart F, foreign tax credit calculations | October 15 (with Form 1120) |
| Schedule G (to Form 1120) | You have foreign-related transactions | Summary of foreign income, foreign taxes paid, transfer pricing statement | October 15 |
Currency Conversion & Functional Currency Elections
Your India subsidiary operates in Rupees (INR). For US tax purposes, you must convert INR to USD. The IRS requires:
- Functional Currency: Your India subsidiary's functional currency is INR (the currency where it operates)
- Exchange Rate Selection: Use the IRS-published yearly average exchange rate or spot rate at transaction date (consistent application required)
- Currency Gain/Loss: When you repatriate profits (INR → USD), any exchange rate fluctuation creates a currency gain/loss on your US return (Section 988 gain/loss)
- Documentation: Keep records of all exchange rates used; file Form 6765 (Foreign Earned Income Exclusion) or Form 8949 (if applicable)
Example: Currency Impact on US Tax
Scenario: Your India subsidiary earns ₹10 Cr profit (Year 1, rate = $1 = ₹83).
Year 1: ₹10 Cr ÷ 83 = $1.20M taxable income (Subpart F inclusion). US tax @ 21% = $252K.
Year 2: Rupee weakens (rate = $1 = ₹88). You repatriate dividend of ₹10 Cr ÷ 88 = $1.14M. But you already paid US tax on $1.20M in Year 1.
Result: You have a $60K foreign currency loss (Section 988) that offsets other income on your US return.
Section 6: Compliance Timeline & Checklist
Here is the exact calendar and compliance checklist for US companies with India operations:
Annual Compliance Calendar
Pre-Expansion Compliance Checklist
Section 7: Common Challenges & Where Finova Consulting Supports You
Challenge 1: Transfer Pricing Documentation Gaps
The Problem: You establish an India development center and charge the US parent a monthly "management fee" without formal documentation. If audited, the IRS disallows the fee and adds income to your US return.
Finova's Solution:
- Conduct benchmarking analysis using software (Bloomberg, RoyaltyRange, Zagat) to identify comparable outsourcing fees in your industry
- Prepare formal transfer pricing study supporting the "arm's length" nature of your fee structure
- Establish contemporaneous documentation meeting IRS standards (IRC Section 6662(e))
- Defend against IRS transfer pricing challenges in examination
Challenge 2: FBAR/Form 5471 Filing Non-Compliance
The Problem: You forgot to file FBAR or Form 5471 in Years 1-2. The IRS discovers this in an unrelated audit. Penalties are $10,000+ per form per year.
Finova's Solution:
- Prepare amended returns (Form 1120-X) for prior years
- File delinquent FBAR/Form 5471 filings with penalty abatement request (Reasonable Cause)
- Implement compliance system to prevent future failures
- Negotiate penalty relief with IRS Criminal Investigation (if applicable)
Challenge 3: Subpart F / GILTI Inclusion Misestimation
The Problem: Your India subsidiary earns $2M in royalty income from IP licensing. You didn't anticipate Subpart F inclusion and underestimated your US tax liability. You owe IRS $400K+ in additional tax + interest + penalties.
Finova's Solution:
- Analyze income character (active vs. passive) to determine Subpart F / GILTI exposure
- Model restructuring options (e.g., check-the-box election, change of accounting method) to defer or minimize inclusion
- File amended return with proper Subpart F/GILTI calculation and penalty abatement request
Challenge 4: Foreign Currency Volatility & Section 988 Loss Tracking
The Problem: The Indian Rupee weakens from ₹83/$1 to ₹92/$1. Your India subsidiary's repatriated dividends create a $150K Section 988 loss. You failed to track this; IRS discovers the loss on audit and disallows it (no documentation).
Finova's Solution:
- Implement quarterly currency monitoring and Section 988 gain/loss tracking
- Maintain documentation of all INR-USD conversions and IRS-published exchange rates
- File Form 8949 (Sale of Capital Assets) or Schedule D to report Section 988 losses properly
- Use currency hedging strategies (forward contracts, options) to mitigate exposure
Challenge 5: India GST / TDS Compliance Impact on US Returns
The Problem: Your India subsidiary failed to file GST returns or remit TDS (Tax Deducted at Source). India Tax Authorities issue demand notice. This creates cascading impact: reduced foreign tax credits on US return, Subpart F adjustments.
Finova's Solution:
- Coordinate with India compliance advisors to resolve GST/TDS issues with Indian tax authorities
- Quantify tax credit impact on US return; file amended Form 1120 if necessary
- Document settlement/payment for foreign tax credit purposes
Section 8: US Federal Tax Compliance Summary Table
| Compliance Area | Key Requirement | Deadline | Penalty for Non-Compliance |
|---|---|---|---|
| Foreign Earned Income Exclusion (FEIE) | US individuals in India can exclude up to $120K of earned income (2024) | Form 2555 filed with 1040 (April 15) | Loss of exclusion; full income taxed |
| Form 1118 (FTC) | Claim foreign tax credit for Indian taxes paid | October 15 (with Form 1120) | Loss of FTC; IRS disallows credit |
| Subpart F / GILTI | Include passive/intangible income of India subsidiary in current-year US income | Form 5471 / Form 8858 due October 15 | Accuracy-related penalty 20%; fraud penalty 75% |
| Transfer Pricing Documentation | Contemporaneous documentation for intercompany transactions | With Form 1120 or within 30 days of IRS request | 40% accuracy-related penalty if position lacks substantial authority |
| FBAR (Form 114) | Report foreign bank accounts if aggregate > $10K | April 15 (no extension) | $100-$10K per account per violation; criminal penalties up to $250K |
| Form 8938 | Report specified foreign financial assets if > $100K | October 15 (with Form 1120) | $10K per violation; 40% accuracy-related penalty |
| Form 5471 | Report India subsidiary ownership, income, basis, E&P if ≥50% ownership | October 15 (with Form 1120) | $10K per year; criminal penalties for willful failure |
| Form 5472 | Report intercompany transactions with India subsidiary | October 15 (with Form 1120) | $10K per year if omitted; penalties increase for willful violations |
| Section 988 Currency Gain/Loss | Report currency gains/losses on repatriated dividends / intercompany payments | Form 8949 / Schedule D with Form 1120 | Disallowance of loss; accuracy-related penalty |
Section 9: How Finova Consulting Supports Your India Expansion
Phase 1: Pre-Expansion Planning (Months 1-2)
We assess your expansion plans and determine the optimal tax structure (Branch vs. Subsidiary; C-Corp vs. Disregarded Entity). We model financial projections under different structures to show tax impact.
Deliverable: Entity Structure & Tax Roadmap (20-page report)
Phase 2: Transfer Pricing Documentation (Months 3-4)
We conduct benchmarking analysis, identify comparable companies/transactions, and draft contemporaneous transfer pricing documentation supporting your intercompany pricing. This document is IRS-audit-ready.
Deliverable: Transfer Pricing Study (50+ pages; benchmarking analysis included)
Phase 3: Annual Compliance Support
Each year, we coordinate with your India CAs and US tax advisors to ensure:
- India subsidiary files compliant ARI (Annual Return of Income)
- US parent files Form 1120 with Form 5471, Form 5472, Form 8858, Schedule G
- Transfer pricing documentation is updated with current-year benchmarking
- FBAR, Form 8938, and currency reporting is completed accurately
Phase 4: IRS Audit Support
If audited, Finova represents your company before the IRS:
- Defend transfer pricing positions with benchmarking data and comparable company analysis
- Respond to Document Requests (DRs) for foreign subsidiary records
- Negotiate transfer pricing adjustments (Mutual Agreement Procedure if applicable)
- File Appeals if IRS proposes adjustments
Ready to Expand to India With Confidence?
US federal tax compliance for India operations is complex. Non-compliance carries severe penalties and IRS scrutiny. Finova Consulting's integrated approach ensures your India expansion is tax-efficient AND fully compliant.
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