In the past few years, several Non Resident Indian (NRI) entrepreneurs have successfully set up companies in India and the trend is only likely to continue.
For a decade now, India has been a growth center and this has attracted companies and individuals alike to set up ventures in India. In the past few years, several Non Resident Indian (NRI) entrepreneurs have successfully set up companies in India and the trend is only likely to continue.
At the same time, here are some important facets of the US tax law that you must not forget.
"Ownership by US citizens, residents or green card holders in a foreign company can attract provisions of subpart F income as well as certain reporting requirements such as Form 5471, FBAR etc. Most entrepreneurs do not plan keeping these in mind and end up facing complications later on," says Vinay Navani, a CPA and director of tax at New Jersey based firm Wilkin & Guttenplan, PC.
So let's look at what you need to know before starting up a company in India.
One: Is your company a Controlled Foreign Corporation (CFC)?
Generally, the earnings of foreign corporations are not taxed in the US until the foreign corporation repatriates its earnings through the distribution of dividends. There is, however, an exception. If the foreign corporation is a Controlled Foreign Corporation (CFC), a different set of rules applies. For starters, the CFC will not automatically get exemption from taxation in the US on income earned in India.
So the first thing you need to check is whether the company you set up in India is a CFC. Broadly put, a foreign corporation is a CFC if on any day during the foreign corporation's taxable year, either more than 50% of the combined voting power of all classes of stock, OR more than 50% of the total value of the foreign corporation is owned by US shareholders.
A US shareholder is defined as a US corporation, partnership, citizen or resident, or US estate or trust, owning at least 10% of the total combined voting power of all classes of voting stock of the foreign corporation. US shareholders don't have to be related to each other.
It is important to understand these definitions clearly so that the shareholding can be planned efficiently. Navani explains, "For instance, an Indian Pvt Ltd owned equally by 11 US people is not a CFC but if it were owned equally by 10 US people it would be a CFC."
"Generally, a CFC by default gets taxed in the US on any net earnings earned in the foreign country even if those earnings are not repatriated. That is, the 'current' earnings are taxed even if there is no dividend declared from the CFC. This is called subpart F income" explains Rahul Ranadive, a Florida based tax attorney.
The good news is that there are exceptions to subpart F income (we will see them in the next point.) But remember, they can be complex. "Before you set up your company, your first attempt should be to see if you can avoid CFC status completely. You can do that with some smart planning and arrange ownership in such a way that it does not attract CFC status. For instance, if you are starting up a company in India, you might consider having one or more relatives or business colleagues from India to hold 51% share holding. That way, you hold 49% and the company does not qualify as a CFC for US tax purposes," Ranadive says.
At the same time, here are some important facets of the US tax law that you must not forget.
"Ownership by US citizens, residents or green card holders in a foreign company can attract provisions of subpart F income as well as certain reporting requirements such as Form 5471, FBAR etc. Most entrepreneurs do not plan keeping these in mind and end up facing complications later on," says Vinay Navani, a CPA and director of tax at New Jersey based firm Wilkin & Guttenplan, PC.
So let's look at what you need to know before starting up a company in India.
One: Is your company a Controlled Foreign Corporation (CFC)?
Generally, the earnings of foreign corporations are not taxed in the US until the foreign corporation repatriates its earnings through the distribution of dividends. There is, however, an exception. If the foreign corporation is a Controlled Foreign Corporation (CFC), a different set of rules applies. For starters, the CFC will not automatically get exemption from taxation in the US on income earned in India.
So the first thing you need to check is whether the company you set up in India is a CFC. Broadly put, a foreign corporation is a CFC if on any day during the foreign corporation's taxable year, either more than 50% of the combined voting power of all classes of stock, OR more than 50% of the total value of the foreign corporation is owned by US shareholders.
A US shareholder is defined as a US corporation, partnership, citizen or resident, or US estate or trust, owning at least 10% of the total combined voting power of all classes of voting stock of the foreign corporation. US shareholders don't have to be related to each other.
It is important to understand these definitions clearly so that the shareholding can be planned efficiently. Navani explains, "For instance, an Indian Pvt Ltd owned equally by 11 US people is not a CFC but if it were owned equally by 10 US people it would be a CFC."
"Generally, a CFC by default gets taxed in the US on any net earnings earned in the foreign country even if those earnings are not repatriated. That is, the 'current' earnings are taxed even if there is no dividend declared from the CFC. This is called subpart F income" explains Rahul Ranadive, a Florida based tax attorney.
The good news is that there are exceptions to subpart F income (we will see them in the next point.) But remember, they can be complex. "Before you set up your company, your first attempt should be to see if you can avoid CFC status completely. You can do that with some smart planning and arrange ownership in such a way that it does not attract CFC status. For instance, if you are starting up a company in India, you might consider having one or more relatives or business colleagues from India to hold 51% share holding. That way, you hold 49% and the company does not qualify as a CFC for US tax purposes," Ranadive says.
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