Export of Services: Condition for Indian Subsidiaries Providing Services to Foreign Parent Companies

Introduction

On September 20, 2021, the Central Board of Indirect Taxes and Customs (CBIC) issued Circular No. 161/17/2021-GST to clarify the interpretation of condition (v) of Section 2(6) of the IGST Act, 2017. This condition determines whether services provided by an Indian subsidiary to its foreign parent company qualify as an export of services or merely a transaction between distinct persons.

Background

Several representations were made regarding ambiguities in Explanation 1 under Section 8 of the IGST Act, 2017, which defines when establishments are treated as distinct persons. Concerns arose about whether services provided by an Indian subsidiary or sister concern to its foreign parent or group company fall within this definition and hence, do not qualify as an export of services.

Key Legal Provisions

1. Definition of Export of Services (Section 2(6) of IGST Act, 2017)

A supply of services qualifies as an export of services when:

  • The supplier is located in India.
  • The recipient is located outside India.
  • The place of supply is outside India.
  • Payment is received in convertible foreign exchange.
  • The supplier and recipient are not merely establishments of a distinct person (as per Explanation 1 of Section 8 of IGST Act).

2. Explanation 1 of Section 8 of IGST Act

This Explanation defines when establishments of the same entity in different locations (India & abroad) are treated as distinct persons:

  • an establishment in India and any other establishment outside India (An Indian establishment and its foreign counterpart are considered distinct persons).
  • an establishment in a State or Union territory and any other establishment outside that State or Union territory; (An establishment in one Indian state/UT and another establishment in a different state/UT are distinct persons.) or
  • an establishment in a State or Union territory and any other establishment being a business vertical registered within that State or Union territory, then such establishments shall be treated as establishments of distinct persons. (A business vertical registered in the same state as another establishment is a distinct person.)

3. Explanation 2 of Section 8 of IGST Act

A person carrying on a business through a branch or an agency or a representational office in any territory shall be treated as having an establishment in that territory, which means If a foreign company operates in India through a branch, agency, or representative office, that Indian branch is treated as the same entity as the foreign company.

4. Definition of a Person (Section 2(84) of CGST Act, 2017)

A person includes:

  • Companies incorporated in India.
  • Foreign companies incorporated under foreign laws.
  • LLPs, partnerships, trusts, individuals, and government bodies.

As per Companies Act, 2013:

  • A company is any entity incorporated under Indian law.
  • A foreign company is any entity incorporated outside India but having business operations in India.

Analysis of the Issue

1. Services Between Distinct Persons Are Not Export

  • If a foreign company operates a branch or representative office in India, then services supplied between them are not considered export as they are deemed distinct persons.
  • Likewise, services provided by an Indian company to its overseas branch are also not an export.

2. Indian Subsidiaries Are Separate Legal Entities

  • An Indian subsidiary incorporated under Indian law is treated as a separate legal entity from its foreign parent.
  • Therefore, services provided by an Indian subsidiary to its foreign parent company do not fall under the distinct person rule and can qualify as export of services.

Clarification by CBIC

The circular provides the following clarification:

  1. A company incorporated in India and a foreign company are separate legal entities.
  2. An Indian subsidiary providing services to its foreign parent or group company qualifies as an export of services, as long as the other conditions of Section 2(6) of the IGST Act are met.
  3. The transaction will not be treated as a supply between distinct persons, as per Explanation 1 of Section 8.

Implications for Businesses

  • IT & Software Companies: Indian subsidiaries of global IT firms can export services to their foreign parent without GST liability.
  • Consulting & BPOs: Indian consulting and outsourcing firms can classify their services as exports, ensuring tax benefits.
  • Manufacturing & R&D Firms: Indian firms engaged in R&D, testing, or back-office operations for foreign counterparts can avail of zero-rated GST benefits but not merely establishments of a distinct person

Key Benefits of the Clarification

The clarification helps businesses in several ways:

  • Avoiding unnecessary tax burdens: Indian subsidiaries providing services to their foreign parent companies will not be charged GST.
  • Boosting the ease of doing business: By treating these transactions as exports, the government promotes business-friendly tax policies.
  • Ensuring global competitiveness: This clarification supports India’s push to be a global outsourcing and IT hub.
  • Encouraging foreign investment: Foreign companies will find it more attractive to set up subsidiaries in India.

Practical Steps for Businesses

1. Review Business Structures

Businesses should ensure their contractual and operational structures align with the clarification. Companies should analyze their service agreements and tax compliance strategies.

2. Proper Documentation for Export Classification

Companies must maintain proper documentation, such as:

  • Agreements between the Indian subsidiary and the foreign parent.
  • Proof of foreign exchange receipts.
  • Invoices clearly mentioning export of services.

3. Avail GST Refund Benefits

Since exports of services are zero-rated under GST, Indian subsidiaries should ensure:

  • Timely filing of GST returns.
  • Claiming Input Tax Credit (ITC) to reduce costs.
  • Applying for refunds under the GST framework.

Challenges and Considerations

While this clarification is beneficial, businesses may still face challenges such as:

  • Compliance with FEMA regulations: Ensuring transactions adhere to the Foreign Exchange Management Act.
  • Transfer pricing scrutiny: The pricing of services between Indian subsidiaries and foreign parent companies must meet transfer pricing norms.
  • GST refund processing delays: Companies should ensure timely submission of refund applications to avoid delays.

Final Words

The CBIC’s clarification removes doubts regarding export classification for Indian subsidiaries providing services to foreign companies. This ensures that genuine exports are not taxed unfairly and aligns with India’s goal of promoting global business operations. Companies should carefully assess their corporate structure and tax compliance to benefit from this ruling.

By ensuring proper compliance and documentation, businesses can fully utilize the export benefits under the GST framework and contribute to India’s growing reputation as a global services hub.

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