Expanding a business beyond national borders is a major milestone for any company. It offers access to new markets, customers, talent, and investment opportunities. One of the most effective ways to establish a long-term global presence is by setting up a foreign subsidiary. However, international expansion requires careful planning, legal compliance, and alignment with India's foreign exchange laws especially the Foreign Exchange Management Act, 1999 (FEMA). This article explains when and why to set up a foreign subsidiary, the legal procedures involved, and recent regulatory updates applicable to Indian companies.

In this article, CA Manish Mishra talks about Expanding Globally? When and Why to Set Up a Foreign Subsidiary.

What is a Foreign Subsidiary?

A foreign subsidiary is a company incorporated in a foreign country that is owned and controlled by a parent company based in India. Unlike a branch or liaison office, a subsidiary is a legally independent entity that operates under the laws of the host country while remaining under the ownership and strategic control of the Indian parent company.

Foreign subsidiaries can be wholly owned or joint ventures with local partners. They are ideal for companies looking to establish a permanent base overseas, hire employees, and build a local brand presence.

When to Set Up a Foreign Subsidiary

Setting up a foreign subsidiary should be considered under the following conditions:

• Market Expansion: If your company wants to reach customers in a new geographic region and needs a legal presence to operate, sign contracts, or hire employees.

• Local Hiring: When you need to recruit local talent, especially in markets where regulations prevent foreign employers without a local entity.

• Regulatory Requirements: When local laws require foreign businesses to be incorporated domestically to operate or bid for government contracts.

• Tax and Cost Efficiency: To optimize global taxation or take advantage of incentives in the foreign country.

• Raising Investment: If you are looking to attract local or international investors to fund operations in that region.

• Ease of Banking and Payments: Local incorporation simplifies opening bank accounts, receiving payments, and managing local expenses.

Legal Framework under FEMA for Setting Up a Foreign Subsidiary

The setting up of a foreign subsidiary by an Indian company or resident falls under the purview of FEMA, 1999, especially Section 6, which regulates Capital Account Transactions. These include investments outside India that alter the assets and liabilities of Indian residents in foreign countries.

Applicable Provisions under FEMA

• Section 6(3)(a) of FEMA, 1999: This empowers the Reserve Bank of India (RBI) to regulate investment by persons resident in India in foreign securities.

• Foreign Exchange Management (Overseas Investment) Rules, 2022 & Foreign Exchange Management (Overseas Investment) Regulations, 2022: These two replaced the earlier FEMA 120 and consolidated all provisions relating to Overseas Direct Investment (ODI).

• Automatic vs. Approval Route: Indian entities can make investments under the automatic route, up to a limit of 400% of their net worth, without prior approval. Beyond this limit or in sensitive sectors (like real estate or gambling), prior RBI approval is mandatory.

• Permissible Activities for Foreign Subsidiaries: Investment is allowed only in bona fide business activities. Real estate (excluding construction), banking, or lottery-related activities are not permitted without special permissions.

Compliance & Reporting Requirements

Once a foreign subsidiary is established, the Indian company must comply with various reporting obligations:

• Form ODI – Part I & II: Must be filed at the time of remittance for investment.

• Share Certificate Submission: To be submitted within 6 months from the date of investment.

• Annual Performance Report (APR): Filed every year by December 31, disclosing the financials of the foreign subsidiary.

• Disinvestment Reporting: In case of closure or sale of the subsidiary, it must be reported through the RBI system.

All filings are now done via the RBI FIRMS Portal (Foreign Investment Reporting and Management System).

Taxation Aspects

The income earned by the foreign subsidiary is taxed in the country of incorporation. However, dividends or repatriated profits sent back to India are taxed under Indian income tax laws, subject to Double Taxation Avoidance Agreements (DTAA). The Foreign Tax Credit (FTC) mechanism under the Income Tax Rules, 1962 (Rule 128) allows Indian companies to claim credit for taxes paid abroad.

Additionally, Section 115BBD of the Income Tax Act offers a concessional tax rate of 15% on dividends received from specified foreign subsidiaries, provided certain conditions are met.

Recent Updates and Key Changes (2022-2024)

• Overseas Investment Rules and Regulations 2022: These have replaced older guidelines (FEMA 120) and introduced significant simplification. The key updates include:

  • Clarified definitions of control, subsidiary, and step-down subsidiary.

  • Streamlined reporting through FIRMS Portal.

  • Relaxation in the requirement for valuation certificates for non-cash investments.

  • Easier disinvestment process in case of liquidation.

• Decriminalization of FEMA Non-Compliance: Certain procedural lapses like delayed filings are now treated as compoundable offenses and can be resolved without prosecution.

• Digital Signatures and Online Filings: Most filings with RBI are now digital, promoting faster approvals and tracking.

Risks and Challenges

Despite the benefits, setting up a foreign subsidiary comes with challenges:

• Local laws and regulations

• Maintaining dual compliance (India and foreign jurisdiction)

• Cost of incorporation and ongoing reporting

• Currency fluctuation risks

• Political or tax regime changes

To overcome these, companies should consult with local advisors and ensure robust legal and tax due diligence.

Conclusion

Setting up a foreign subsidiary is a strategic move that can unlock global markets and long-term growth for Indian businesses. However, it demands careful planning, a clear business objective, and strict compliance with FEMA, RBI, and Income Tax regulations. With the new Overseas Investment Rules of 2022, the Indian government has simplified the process to encourage global expansion. Companies should ensure all legal provisions, reporting timelines, and due diligence are followed to avoid penalties and ensure a successful overseas presence.

Frequently Asked Questions (FAQs)

Q1. Who can set up a foreign subsidiary from India?

Ans. Indian companies, LLPs, and resident individuals (subject to eligibility) can set up a foreign subsidiary under the Overseas Investment Rules.

Q2. What is the difference between a foreign branch and a foreign subsidiary?

Ans. A foreign branch is an extension of the Indian company, not a separate legal entity. A foreign subsidiary is incorporated in the host country and has independent legal status.

Q3. What is the limit for investing in a foreign subsidiary under the automatic route?

Ans. Indian entities can invest up to 400% of their net worth (as per last audited balance sheet) in a foreign subsidiary without RBI approval.

Q4. Is RBI approval mandatory to set up a foreign subsidiary?

Ans. Not always. If the investment is within the prescribed limit and not in a restricted sector, it can be made under the automatic route.

Q5. What forms are required to be filed for setting up a foreign subsidiary?

Ans. You must file Form ODI Part I for initial remittance and Part II for financial commitment. Annual Performance Reports (APR) are mandatory every year.

Q6. What are the timelines for FEMA reporting?

Ans. Initial ODI forms must be filed before investment. Share certificates must be submitted within 6 months, and APR by December 31 annually.

Q7. Can an individual set up a foreign subsidiary?

Ans. Yes, a resident individual can invest in a foreign business entity under LRS, subject to limits and RBI conditions.

Q8. Are profits from the foreign subsidiary taxable in India?

Ans. Yes, if profits are repatriated to India. Double Taxation Avoidance Agreements (DTAA) help avoid being taxed twice.

Q9. What if the Indian company fails to report the ODI transaction?

Ans. Non-reporting can lead to penalties under Section 13 of FEMA, including fines and adjudication proceedings.

Q10. Where should ODI filings be made?

Ans. All Overseas Investment filings must be made on the FIRMS Portal using digital signatures by the authorized person.