Income Tax Regulations books sit in the House Ways and Means Committee before the start of a markup hearing on the Tax Cut And Jobs Act in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

How U.S. Tax Reforms May Impact India Inc. 

The United States Senate and the House of Representatives are in the process of reconciling proposals passed by each house to bring in the first big-ticket tax reform in the country in thirty years.

The Republican party controls both houses of the U.S. Congress, and the presence of a Republican president in the White House makes the passage of these proposals likelier than in the past.

While the two bills currently differ in language on some aspects, they set out a common broad direction in which the Republican party wishes to take tax policy - from the headline-grabbing proposal to cut the corporate tax rate to around 20 percent, to incentives to bring capital back into the U.S., and make it costlier to send it abroad.

So which Indian sectors are likely to get impacted the most? IT-ITES, pharmaceuticals and contract manufacturing are the sectors that would definitely be affected said Maulik Doshi, partner at SKP Business Consulting.

Rupak Saha, tax partner at PWC India was more circumspect about the impact of the U.S. tax reforms.

Watch the full conversation:

Here are the edited excepts from the conversation:

Based on your article, #1 the reduction in the headline tax rates of U.S. corporate tax from 35 percent to 21 percent will make it more attractive for U.S. corporations to make profits in the U.S. and could impact transfer pricing policies or how they remunerate Indian subsidiaries. #2 The move to the territorial system of taxation means that there are no incentives anymore for U.S. corporations in retaining profits overseas because they could bring those back in a tax-free fashion, except for a one-time tax. #3 the 20 percent excise tax, which may apply to payments made by U.S. corporations to their subsidiaries elsewhere in the world could increase the cost of outsourcing in U.S. corporations. Is it your assessment that these will substantially change the way Indian subsidiaries of U.S. MNCs behave financially. the way U.S. investors invest in India?

Maulik Doshi: It will have a substantial impact on the way the Indian subsidiaries behave. U.S. multinationals will try and put more profits and move income back to the U.S. Because of tax litigation in India sometimes companies were conservative. There is no further incentive to do it. In fact, it will be much more beneficial in keeping far more profits in the U.S. rather than keeping it in India.

Outsourcing or contract manufacturing, pharmaceutical research and development activities in India are going to be more costlier with this. The final thing - excise is still not out. The House committee and Senate committee were entirely apart on how overseas payments should be taxed. Once we have a final word on it, then we can see the impact on offshore payments.

The U.S. headline tax rate is expected to come down to 21 percent. In India, the headline tax rate is 35 percent. But the effective tax rate, according to the finance ministry, is roughly around 22 percent. Will countries like India fear losing out investments?

Maulik Doshi: It will make a huge difference. Economies will compete on the headline tax rate, for reducing the tax rate. Our Finance Minister promised four years ago that he is going to bring down the tax rate to 25 percent. Minimal corporate population pays 25 percent tax rate. We [individuals] are at 30-33 percent tax rate. It will prompt all the economies to re-look at their tax policies and tax structures and see if they can bring down tax rates to more competitive rates than the current one.

The fiscal balance should be maintained, so I don’t know how India is going to react. There was news that the Finance Minister has asked for reactions or feedback from industry. It is going to be a race to the bottom.

What did you make of this changes in U.S. tax code and how do you think it will impact how MNCs invest in India and other countries in the world?

Rupak Saha: People need to be more circumspect. I think the tax profession and media is getting ahead of the curve. A lot will depend upon the versions of the bill and how they reconcile with each other. I am not aligned with Maulik on the view that the outsourcing cost will jump up.

Even in the context of the border tax, there is a provision of the deemed foreign tax credit. For example, if any payment made to the Indian related party while that is subject to U.S. tax of 20 percent if the Indian related party opt for effective related income option by which the 20 percent will be on the net income basis.

Again, on the net income basis, you will get deemed foreign credit of 80 percent of foreign tax. So, if the Indian tax is over 25 percent on those payments then there will be no excise tax back in the U.S. As long as India tax rate is more than 25 percent on those payments, under the House version, there should not be any extra tax. I don’t think we should jump to a conclusion immediately. I think we need to see how the whole legislation evolves.

How did you read the broad thrust of the U.S. tax code? And its effort to keep earnings and investments in the U.S.?

Rupak Saha: There is the general feeling that because of protectionist policies in the U.S,. or because of the current economy getting strengthened, because of a Trump administration in U.S. businesses in the U.S. has looked more inwards and see what more they can do in the U.S.

I think that will impact jurisdictions such as Singapore and other low tax jurisdictions which were getting a disproportionate share of U.S. investments compared to the market there. But where there are broad, stable markets in India, I am not sure that it will make a day and night difference to investment into the country. I refuse to buy that.

Maulik, do you see specific structures, industries being impacted more than others - like pharma, big KPOs or BPOs in India that some large U.S. companies have?

Maulik Doshi: Absolutely. If there is an excise tax and if the industry is opting for SEZ unit in India, then they don’t pay any tax in India, apart from minimum alternate tax (MAT). So, the overall tax cost will increase for these companies, be it pharma outsourcing, which is in research and development, or contract manufacturing or the IT, ITES space.

Till now, Indian IT companies having a subsidiary in the U.S. would treat the business as a cost-plus entity, and remunerate with a small mark up. With these dynamics, Indian multinationals will want to park their profits in the U.S. rather than bringing it back to India and tax it in India. So, the transferable mechanics in that model will change. It will impact the India-U.S. trade and the investments.

Rupak Saha: Until now, pushing debt leverage down into U.S. operations and getting the deduction for those has been a significant strategy for investors in the U.S. With the interest limitation rule, it will get impacted. How you deploy capital in the U.S., and whether there is need to restructure needs to be looked at. Some of those restructurings at the U.S. end and by India outbound businesses will come to the fray.