India Taxation for Foreign Companies: PE, Transfer Pricing and Safe Harbour
How India taxes foreign companies in 2026: permanent establishment risk, transfer pricing, the proposed 15.5% IT services safe harbour and repatriation planning.
By Nagavarapu Sudheer, M.Com., F.C.S., L.L.B., Partner, A2 Consultants
Tax is often the deciding factor when a foreign company chooses how to enter India. The wrong structure can create unexpected tax exposure, withholding costs and compliance burdens. This article explains the core rules foreign companies should understand in 2026: the new Income-tax Act, how foreign companies are taxed, permanent establishment (PE) risk, transfer pricing and the proposed IT services safe harbour.
A new Income-tax Act from April 2026
The Income-tax Act, 2025 replaces the 1961 Act for tax years beginning on or after 1 April 2026. The substance of most rules continues, but section numbers, forms and procedures change, so existing templates, contracts that cite old sections and internal checklists need review. Our guide to India's new income tax framework for foreign companies covers the changes in more detail.
How foreign companies are taxed in India
A foreign company is taxed in India on income that accrues or arises in India, or is deemed to do so. If you operate through an Indian subsidiary, the subsidiary is a resident taxpayer on its worldwide income, while the foreign parent is taxed only on the dividends, interest, royalties or fees it receives from India, generally through withholding tax and subject to any applicable tax treaty. If you operate through a branch or project office, the foreign company itself is taxed on the profits attributable to India, usually at a higher rate than a domestic company.
Subsidiary, branch or LLP?
| Structure | Typical advantages | Typical watch-outs |
|---|---|---|
| Private limited subsidiary | Separate legal entity, limited liability, dividends flow to the parent, widely accepted by banks and customers | Annual audit, ROC compliance, dividend withholding, transfer pricing |
| Branch or project office | Quick to set up for a defined activity, no separate incorporation | Restricted permitted activities, profits taxed in the foreign company's hands, higher exposure |
| LLP | Flexible, lighter compliance | FDI allowed only in sectors open to 100% automatic-route FDI without FDI-linked conditions; treaty and financing limits |
Entry structure also affects repatriation. Dividends, royalties, technical service fees and loan interest each face different withholding rates, treaty relief and FEMA conditions, so plan the cash route before signing the shareholders' agreement. See liaison office vs branch office vs subsidiary and how to repatriate profits from India.
Permanent establishment risk
A PE is a fixed place of business, a dependent agent who habitually concludes contracts, or a long-running project through which a foreign company carries on business in India. Once a PE exists, India can tax the profits attributable to it. Common triggers include seconded employees who negotiate deals, sales agents with authority to bind the company, and construction or installation projects that exceed treaty time limits. Review the treaty definitions, document who does what, and keep contract-conclusion authority outside India where appropriate.
Transfer pricing basics
Transactions between an Indian entity and its foreign related parties must be priced at arm's length. That means an intercompany agreement, a benchmarking analysis, annual documentation and an accountant's report filed with the tax authorities. Penalties for non-compliance can be significant, and disputes often arise from services charged without a clear benefit, royalties on intangibles, and cost allocations.
The proposed IT services safe harbour
The Union Budget 2026-27 proposed grouping software development, IT-enabled services, KPO and contract R&D into a single "IT services" category with a common 15.5% cost-plus safe harbour margin, a much higher eligibility threshold of Rs 2,000 crore, a five-year opt-in and faster unilateral APAs for IT services. For captive centres and GCCs, a safe harbour reduces audit risk and effort, but the margin can be higher or lower than an arm's-length benchmark would show, so run both numbers before electing.
Status note: these changes were announced as Budget proposals. Check the notified rules and rates before relying on them. For the full detail, read our guide to the transfer pricing safe harbour for GCCs and IT services.
Other issues to put on your checklist
- GST registration and invoicing for services and goods supplied from or into India.
- Withholding tax on payments to non-residents, and tax residency certificates for treaty relief.
- Buyback proceeds, which the Budget proposed to tax as capital gains rather than as dividends.
- Minimum alternate tax and other provisions that can affect cash tax.
- Thin capitalisation, external commercial borrowing limits and interest deductibility.
- Ongoing FEMA and tax filings: see our FEMA compliance calendar for foreign-owned Indian companies.
A practical sequence
Start with the commercial model, then choose the entity, then map the tax on every cash flow into and out of India, and document intercompany arrangements before the first invoice is raised. Fixing the tax structure after operations begin is far more expensive than getting it right at the start.
Talk to A2 Consultants
A2 Consultants is a Hyderabad-based cross-border advisory firm that helps foreign companies enter and operate in India, across entry structuring, FDI and FEMA compliance, international tax and transfer pricing, PE risk, repatriation planning and GCC setup. The first conversation is free: book a 30-minute call at www.a2consultants.in or write to sudheer@a2consultants.in.