USC doing business via S-Corp after return to India – US-India Tax & related implications

Last Updated – Jan 15, 2025

Many a times a US resident (mostly US Citizen) has an active business in US via a S-Corp entity structure but he/she has to return to India for family or other compelling personal reasons.  The question of such clients is how would the S-Corp entity profits gets taxed in India once they become an Indian resident, will they be taxed even in RNOR status, what other legal requirements are there etc. I am discussing this topic in my today’s post.

S-Corp in USA

S-Corp is a recognised entity election for tax purposes in US in US. The entity is first incorporated under the respective state laws as a Limited Liability Company and later is designed as a S-Corp via an election under the Internal Revenue Code (IRC) in Form 2553. 

The reason the entity is called an S-Corp is that the IRC has a dedicated Subchapter S that deals with the taxation of these entities and of the distribution to the shareholders of S-Corp.

Income of the S-Corp is not taxable in US at an entity level and income passes through to the shareholders. The S-Corp issues a K1 to the shareholder and the shareholder reports the K1 income on his/her Form 1040.

Now, in US, there are FICA taxes which fund the Social Security and Medicare programs in the US. Employees pay 7.65% on salary income, matched by employers for a total of 15.3%, while self-employed individuals pay the full 15.3% on net earnings from self-employment income. This is subject to wage base limits for Medicare and Social Security as per IRC.

The benefit of S-Corp over other entity structures such as a Single Member LLC treated as a disregarded entity is that unlike in case of SMLLC where the entire income is subject to 15.3% self-employment tax, in case of S-Corp there is a flexibility that the shareholder can plan the distribution in such a way that he/she pays out a certain reasonable amount from the salary to himself and the balance payout is characterised as profits and is not considered salary/self-employment income and not subject to FICA taxes. This results in an effective net tax saving of FICA taxes (generally 15.3% otherwise) on the profit payout.

A S-Corp is generally preferred by solo or small businesses over a C-Corp because since the income is passed through to shareholder, there is no double layer of taxation on the profit element like in case of a C-Corp and the ease of compliance. Having said this, S-Corp faces certain restrictions like max. 100 shareholders, no non-resident alien shareholders, only a single class of stock etc. Additionally, there is a requirement to file a S-Corp tax return in Form 1120-S unlike a disregarded entity structure.

S-Corp taxation in India

India does not expressly recognise US tax structures and would most likely on its internal tax provisions to tax the income of a S-Corp in India. I tried to find out any legal precedents for a S-Corp taxation in India at an entity/shareholder level but could not find any.

Now. while the tax outcome in India of such entities is complex and fact-specific, generally speaking, in absence of clear judicial precedents, there is a tax litigation risk involved – in such situations, the right course can be to consider the taxation going by the substance and not the form of the structure.

If the core business activities are carried out from India, Indian tax office will very likely asset a Permanent Establishment (PE) in India and tax the S-Corp’s profits in India under Article 5 of India US DTAA. So, it is very important to first analyse the business activities from India and hence the PE Risk. If it can be established that activities from India are incidental and a PE does not exist, then there is a chance that India tax may be avoided/reduced via attribution rules.

For a single member S-Corp, since all profits are passed through to the owner, in my view the S-Corp may be treated as a sole proprietorship structure in India wherein there is no separate taxation of the S-Corp in India and the taxation will be in the personal assessment of the owner shareholder.

Even then, at the shareholder level, given owners can be returning NRIs from US, the tax incidence should depend on the tax residency status of the shareholder. India can tax the shareholder on S-Corp profits only if shareholder qualifies as an Indian tax resident.

Generally, as long as a person is under RNOR status in India, foreign income is considered exempt from Indian tax purposes. However, a nuance here is that even if the shareholder is in RNOR status, if the business is run from India, the income may be taxable to the shareholder in India even in the RNOR status. This goes even for activities like trading in US securities market from India – see my detailed post on that topic here

An exception to this will be where the S-Corp holds certain assets which generate a passive income in India wherein the Indian resident shareholder can take a view that foreign passive income (without any active effort/involvement) is not taxable in RNOR status. However, once the shareholder enters a ROR status in India, entire income should be taxable.

Now, coming to the issue of multi member S-Corp, can it be taxed as a partnership/LLP in India? In my view, the answer is no because if we see the definition of firm in Section 2(23) of Income Tax Act, 1961, the definition includes partnership/LLP as per Indian laws. An S-Corp is not incorporated as per the Indian laws but is incorporated as per US state law.

So, a natural course of action can be to treat the S-Corp as an Association of Persons (AOP)/ Body of Individuals (BOI) which are defined as “person” in Section 2(31)(v) and the taxation scheme laid out in Sections 67A, 86 and 167B of the Income Tax Act. Since shares of members are determinate (as members have their percentage holdings in S-Corp as shares), the income will not be taxed at the level of AOP (i.e. S-Corp) and hence the relevant proportion of income (basis share in S-Corp) will be taxed in India on a passthrough basis in hands of the member in India.

For a single member S-Corp, considering that the income of shareholder in US in form of salary & profit distribution, in my view the substance of the transaction for India purposes is that it is a profit (India will disregard the salary/profit split for US tax purposes) and hence person should consider disclosing the entire income under the head “Profits and Gains of Business or Profession”.  An aggressive position will be to disclose the salary income from S-Corp as “Income from Salaries” wherein the person claims INR 75,000 as a standard deduction if the new tax regime is chosen. In my view, this is not a correct approach as generally, for an income to be considered salary income in India, a “employer-employee” relationship must exist – one person may not be an employer and an employee at the same time. For a multi-member LLC, salary/profit split approach for India taxation may still hold some ground.

In the recent past, there have been decisions by ITAT like in the Delhi Tribunal in case of General Motors Company (covered by me in this post) which have held in favour of assessee that even though foreign entities which are passthrough in nature are “liable to tax” in their own right under US tax law and hence they qualify as a “resident” for Article 4 of DTAA and can claim benefits under the DTAA. Having said this, the issue of treaty benefits for fiscally transparent entities is a complex topic and needs a separate discussion on its own and hence is not the focus area of this post.

Alternative India structure for USC returning to India

Now let us discuss about a situation where the person is a US Citizen and returns to India but wish to continue his business in US. Now the issue in front of that person is to continue S-Corp in US vis a vis setting up an Indian structure like a One Person Company (OPC)/Private Limited Company (OPC) type structure.

Note here that an OPC structure is not possible for a USC as one of the requirements in Companies Act, 2013 is that the person should be an Indian citizen. OPC structure may be possible for GC however keep in mind that for India tax purposes, OPC will be treated almost similar to a domestic company with a dual layer of taxation.

PLC structure is possible for USC however please note that while there are no restrictions on member’s citizenship, however Indian Companies Act provisions have an express requirement that at least one member need to be a “resident” of India for the financial year. The definition of “resident” in the respective section is stay in India > 182 days in a financial year.  So, especially in case of a USC couple who wish to incorporate an S-Corp in India and have a future plan of returning to US or any other country, PLC may not be the right structure as one member will be bound to live in India for the PLC to continue.

There is also a risk with OPC/PLC type structures in India by US persons that very likely the structure may also qualify as a Controlled Foreign Corporation (CFC) as per US tax rules which has its own set of punitive tax implications.

Also, one disadvantage of PLC structure is the double layer of taxation – the profits are taxed at the PLC level (~ 22%) + again at the level of shareholder post distribution (as dividend taxable at up to 39%) which makes a setup with withdrawal of profits tax efficient. As compared to that, in case of a S-Corp, there is a tax passthrough so there is only one level of taxation in India at up to 39%.

Here, please note that the income of S-Corp will be taxed in US (via Form 1040) and also in India. Given that a DTAA exists between India and US, India should give credit to taxes paid in US subject to Form 67 filing requirements etc. However, it is very likely that for S-Corp having significant income, effective tax rate in India may end up being higher than the effective tax rate on the same income in US.  

So, the question can be would S-Corp still make sense for a USC who has returned to India? – While the outcome here is fact specific, my view is that the FICA tax savings on profits component would still be available to the person for US tax purposes if the S-Corp structure is continued. The reason is that FICA taxes are separate from the income taxes and remain unaffected from the FTC under the DTAA which applies only to income taxes.

Other legal aspects/important points

1. S-Corp election requires all members to be other than Non-Resident Alien as per US tax law. If a member is not a USC/GC & say returns to India and becomes an NRA, this can cause a termination of S-Corp election wherein the S-Corp effectively becomes taxable as a C-Corp with the double layer taxation. There are provisions though under the Regulations to seek a relief for inadvertent terminations here & IRS Revenue Procedure 2013-30
2. IRS requires all members to receive a reasonable compensation for services (which are subject to FICA taxes. IRS and courts scrutinise unreasonably low salaries. Refer this IRS factsheet for on this matter here
3. For a USC owing a S-Corp and entering ROR status, he/she needs to be careful to disclose the interest in S-Corp in Schedule FA in Indian tax return. My detailed post on foreign assets disclosure requirement here.
4. For a USC running business from India, he/she needs to comply with the provisions under Goods and Services Tax Law also especially if the turnover > INR 20 lacs. Again, GST compliance in a situation where a S-Corp is involved is not very clear & requires a separate detailed discussion and hence not the focus of this post. But there are requirements like getting a GST registration, obtaining a LUT, raising a 0% IGST invoice on the S-Corp for GST compliance purposes, getting FIRA etc.
5. FEMA compliance needs to be also taken care of. For a USC who qualifies as a resident of India under FEMA, there is a requirement under Export of Goods and Services Regulations 2025 to bring the export proceeds to India within 15 months and retain necessary documentation for inward remittance etc. All those compliances need to be ensured.
6. S-Corp is a good tax-efficient and low compliance structure for solo entrepreneurs and small businesses but in situations like the US profits need to be ring fenced from Indian tax/FEMA law restrictions on taxability and repatriation, or back end development work to be done by Indian employees, or a fundraising in the US and non-US investors is needed, then a C-Corp structure or a combination of C-Corp in US with a PLC structure in India can be a better alternative from a long term point of view. I’ve done a detailed video on that topic here.
7. If a USC is based in India and planning to incorporate a S-Corp (or any entity in US), a strategy can be to use either the Section 6(4) funds for incorporating the entity which will bypass Indian FEMA OI compliances or if that is not possible, then care should be taken to route the funds via an AD bank in India in compliance with the FEMA OI regulations – detailed post on that topic here.
8. If the USC transfer part of the S-Corp profits to India, he/she need to be careful of the FBAR/Form 8938 thresholds and ensure compliance. Read my detailed post on FBAR/Form 8938 here.

Checklist for returning U.S. citizen with a U.S. S-Corp

1. Evaluate whether the S-Corp’s activities create a PE in India (DTAA Article 5).
2. Confirm U.S. payroll compliance: reasonable compensation to shareholder-employee and associated FICA withholdings; document justification for salary/distribution split.
3. Confirm S-Corp eligibility (no ineligible shareholders) — a change of residence can terminate S-election; evaluate inadvertent termination relief.
4. Assess own residential status in India.
5. File accurate Indian return and complete Schedule FA / Schedule FSI / TR as applicable.
6. Prepare cross-border transfer-pricing and inter-company service agreements if applicable (if Indian staff/contractors perform work).
7. Review FEMA & RBI export realisation rules and GST registration / LUT compliance for export of services.

Hope this post has been useful. Please share any feedback in the comments below.

Copyright © Abhinav Gulechha. This article is my original work. Excerpts may be shared with proper attribution and link to the source. The content is for general informational purposes only and does not constitute legal, tax, or professional advice. Laws and interpretations may change, and outcomes depend on individual facts. Readers should consult their own advisors before acting on any information herein.