RPT, Transfer Pricing & Permanent Establishment — The Silent Legal Risk for Indian Subsidiaries

Why This Risk Hides in Plain Sight

Every Indian subsidiary of a foreign company runs on related party transactions. Management fees flow up to the parent. Software licences and IP royalties flow down. Group employees are seconded across borders. Raw materials, components and finished goods move between group entities. None of this is unusual — it is how multinational groups operate. And that is exactly why the risk is so easy to miss: these transactions feel routine, even administrative, right up until a tax officer or a regulator asks the one question that matters — was this transaction priced, approved and documented the way the law requires?

For most Indian subsidiaries, the honest answer is "not fully." The finance team raises the intercompany invoice because the global ERP system generates it automatically. The board resolution, if it exists, is templated and undated. The transfer pricing study, if commissioned at all, is prepared months after the transactions have already occurred, purely to support the annual Form 3CEB filing. Nobody has asked whether the seconded employees or the frequent visits by the parent company's regional manager have quietly created a taxable presence for the foreign parent in India.

Three separate legal frameworks converge on this single set of facts — related party transactions (RPT) under company law, transfer pricing (TP) under income tax law, and permanent establishment (PE) exposure under India's tax treaties. Each is administered by a different authority, uses different tests, and carries different consequences. Very few Indian subsidiaries treat them as one connected risk. That gap — not any single non-compliance — is where the real exposure sits.

Related Party Transactions — The Companies Act Layer

The first layer of risk sits in company law. Under Section 188 of the Companies Act 2013, any contract or arrangement between an Indian company and a "related party" — which explicitly includes a holding company, subsidiary, or associate company, and by extension the foreign parent of an Indian subsidiary — requires specific board approval, and in certain cases shareholder approval, before the company can enter into it. Related party transactions include sale or purchase of goods, sale or disposal of property, availing or rendering of services, appointment of agents, and — critically for most subsidiaries — payment of royalties, management fees, and secondment-related reimbursements.

The compliance obligation is not satisfied by simply disclosing the transaction in the annual financial statements after the fact. The Act requires prior approval by the board (via a resolution passed at a meeting, not by circulation, for most categories), disclosure of the transaction in the board's report with justification, and — where the transaction exceeds prescribed thresholds relative to turnover or net worth — approval by shareholders through an ordinary resolution, with related shareholders barred from voting. For subsidiaries where the foreign parent is effectively the only shareholder, this creates a structural tension that is frequently handled incorrectly: the parent, as a related party, cannot vote on the resolution approving its own transaction with the subsidiary, and companies that simply pass a shareholders' resolution with the parent voting risk having that approval treated as invalid.

The Audit Committee Layer

Where the Indian subsidiary is required to constitute an Audit Committee — a requirement that applies more broadly than many founders and country managers assume, including to certain classes of unlisted public companies and companies meeting specified financial thresholds — all related party transactions, including those that would otherwise fall within ordinary course of business at arm's length, require prior approval of the Audit Committee before they reach the board. Omnibus approval is permitted subject to specified criteria (transaction value ceilings, periodicity, and the nature of the transaction being clearly defined in advance), but an omnibus approval that is too vague to actually constrain the transaction is vulnerable to being treated as no approval at all.

Transfer Pricing — The Income Tax Act Layer

The second layer sits entirely within tax law and operates independently of whether the Companies Act approval was correctly obtained. Sections 92 to 92F of the Income Tax Act 1961 require that every "international transaction" between associated enterprises — which includes an Indian subsidiary and its foreign parent, and extends to transactions between the subsidiary and any other group entity anywhere in the world — be priced at "arm's length," meaning the price that would have been agreed between unrelated parties in comparable circumstances.

This obligation attaches to every category of intercompany dealing: sale and purchase of goods, provision of intra-group services, licensing of intellectual property and payment of royalties, cost allocation and cost-sharing arrangements, intercompany loans and guarantees, and secondment of personnel. The arm's length principle must be demonstrated, not merely asserted, using one of the prescribed methods (Comparable Uncontrolled Price, Resale Price, Cost Plus, Transactional Net Margin Method, Profit Split Method, or any other method notified by the CBDT) supported by a benchmarking analysis against comparable independent transactions.

Documentation Is the Defence

Every taxpayer engaging in international transactions above the prescribed threshold must maintain contemporaneous transfer pricing documentation under Rule 10D, and obtain and file an accountant's report in Form 3CEB certifying the arm's length nature of the transactions. "Contemporaneous" is the operative word — documentation prepared at the time of the transaction carries far greater evidentiary weight than a study commissioned retrospectively to justify a number that was already decided for commercial reasons elsewhere in the group.

Where a subsidiary is part of a group meeting the consolidated revenue threshold, additional Master File and Country-by-Country Reporting obligations apply under Sections 92D and 286, requiring disclosure of the group's global value chain, intangible ownership, and financial position — information that Indian tax authorities increasingly cross-reference against the subsidiary's own transfer pricing positions.

A transfer pricing adjustment is not merely an accounting correction. Where the assessing officer determines that a transaction was not conducted at arm's length, the subsidiary's taxable income is increased by the shortfall, tax is levied on the enhanced income, and penalties apply on top — ranging from 50% of the tax on the adjustment where documentation exists but is deemed inadequate, up to 200% where the authorities conclude that income was under-reported through misreporting. Interest accrues on the tax shortfall from the original due date, often across several years of retrospective assessment before a dispute is resolved.

Permanent Establishment — The Layer That Taxes the Parent

The third layer is the one most subsidiaries do not see coming, because it does not primarily create a liability for the Indian subsidiary — it creates a liability for the foreign parent. Under India's tax treaties (Double Taxation Avoidance Agreements) and Section 9 of the Income Tax Act, a foreign company's business profits are taxable in India if the foreign company has a "permanent establishment" here. The Indian subsidiary itself is not automatically a PE of its parent merely by virtue of being a subsidiary — but the day-to-day conduct of the relationship very often creates one anyway.

The Three Routes to PE

PE exposure typically arises through one of three routes, each triggered by facts that look entirely ordinary from an operational standpoint:

The subsidiary structure itself does not prevent any of these. A liaison role that drifts into deal negotiation, a regional director who visits India frequently enough and takes on enough operational involvement, a seconded employee whose reporting line and instructions continue to run to the foreign parent rather than the Indian entity — each of these can shift the facts from "we have a compliant Indian subsidiary" to "the foreign parent has a taxable presence in India," entirely independent of anything the subsidiary itself has done wrong.

How the Three Risks Interlock

The reason this is presented as a single article rather than three is that, in practice, these risks are rarely independent of one another. A single fact pattern usually implicates all three frameworks simultaneously, and a response designed to fix one in isolation can worsen exposure under another.

Consider a common scenario: an Indian subsidiary pays its US parent an annual management fee for "global support services," backed by a transfer pricing study using the Transactional Net Margin Method. The Companies Act question is whether this payment was properly approved as a related party transaction. The transfer pricing question is whether the fee reflects genuine services actually received, priced at arm's length — tax authorities in India have become notably aggressive in disallowing management fee deductions where the "benefit test" is not clearly evidenced. And the PE question is whether the individuals who actually deliver those "global support services" — frequently traveling parent-company employees — have, through the frequency and nature of their presence, created a service PE for the parent that now owes Indian tax on a portion of its own global profits attributable to that presence.

A structure built to survive scrutiny under only one of these three frameworks is not actually a defensible structure. It is a partial answer waiting to be tested by whichever authority looks at it next.

The Fourth Layer Most People Forget — FEMA and RBI Reporting

Related party payments crossing the border do not stop at company law, transfer pricing and PE. Every outward remittance to the foreign parent — royalty, management fee, dividend, or loan repayment — is also a foreign exchange transaction regulated under FEMA, routed through an authorized dealer bank that will itself demand supporting documentation before releasing funds. Royalty and technical know-how payments beyond certain structures may require specific classification under the current automatic route framework, and the authorized dealer bank routinely asks for the same board approvals and agreements that Section 188 requires — so a gap in RPT documentation does not just create a Companies Act problem, it can stall or block the remittance itself.

Separately, an Indian subsidiary with any foreign shareholding must file an annual Foreign Liabilities and Assets (FLA) return with the Reserve Bank of India, and any fresh foreign investment must be reported through the appropriate FC-GPR or FC-TRS filing within the prescribed timelines. These are not optional administrative footnotes — a missed or inaccurate FEMA filing can itself trigger a compounding proceeding, adding a fourth regulator to a picture that most subsidiaries are already struggling to manage across three.

Compliant Structure vs. Informal Arrangement — A Direct Comparison

The practical difference between a properly structured intercompany relationship and an informal one is not cosmetic. It determines whether a routine tax assessment becomes a multi-year dispute.

What It Costs When This Goes Wrong

The financial consequences compound across the three layers rather than being capped at any single figure. A transfer pricing adjustment brings tax on the enhanced income plus penalty of 50% to 200% of that tax, plus interest accruing from the original due date — often across several assessment years reopened together. A PE determination against the foreign parent brings Indian corporate tax on profits attributed to the Indian operations, calculated on a basis the parent rarely controls or agrees with, plus the practical burden of defending a position in a jurisdiction where the parent has no local presence to manage the dispute. An unauthorized related party transaction under the Companies Act exposes the company to a penalty and exposes every director who was party to the arrangement to potential personal liability, independent of the tax consequences running in parallel.

Beyond the direct financial cost, these disputes are slow. A transfer pricing dispute that begins with a scrutiny assessment can run through the Dispute Resolution Panel, the Income Tax Appellate Tribunal, and potentially the High Court, consuming years of management time and creating an unresolved contingent liability that shows up in every subsequent audit, funding round, and group restructuring discussion until it is closed.

How LexWin Structures RPT, TP & PE Risk

We work with Indian subsidiaries of foreign companies — from newly incorporated entities to groups that have operated in India for years without ever having their intercompany structure reviewed as a single connected risk — to build and maintain a framework that holds up under scrutiny from all three directions at once.

Who Needs This — and When

This is not a risk unique to large multinational groups. It attaches the moment an Indian entity has a foreign parent or affiliate and transacts with it — which describes essentially every Indian subsidiary, regardless of size.

Subsidiary Risk Health Check — 10 Questions to Ask

Run this quick diagnostic against your Indian subsidiary's current intercompany arrangements. If you answer "no" or "unsure" to more than three, the underlying structure carries meaningful legal and tax risk.

• Is every payment to or from the foreign parent backed by a dated, India-specific intercompany agreement signed before the transactions began?
• Has each related party transaction been approved by the board (and shareholders, where thresholds apply) with the parent's votes correctly excluded?
• Is your transfer pricing documentation prepared contemporaneously, rather than assembled retrospectively to support the Form 3CEB filing?
• Can you evidence the actual benefit received for every management or support service fee paid to the parent?
• Do you track the cumulative days parent company personnel spend in India against the applicable treaty's service PE threshold?
• For any seconded employee, is it documented — in substance, not just on paper — that the Indian entity exercises day-to-day control and supervision?
• Does anyone in India have, or appear to have, authority to conclude contracts on behalf of the foreign parent?
• If you operate a liaison or representative office, have its activities been reviewed against the RBI's permitted scope and the treaty's PE definition in the last 24 months?
• Were your intercompany agreements drafted for India specifically, or are they the group's global template with the entity name changed?
• Has your RPT, TP and PE position been reviewed as one connected structure — not as three separate compliance exercises handled by different advisors who do not talk to each other?