Designing a structure to help FX hedging effectiveness, address tax and regulatory issues, and reduce leakage.
Establishing centers of excellence or global capabilities centers is one way a growing number of multinational corporations are transforming themselves into more efficient enterprises that tap skilled talent in overseas markets with lower labor costs to perform value-added services. These corporates must make decisions about where to locate the centers, their functional currencies, how to fund them and how they invoice the parent or subsidiaries.
- Many NeuGroup member companies have set up these centers in India, introducing exposure to the Indian rupee, often requiring the use the non-deliverable forward market to hedge. NDFs are offshore dollar-settled currency derivatives.
Billing in INR or USD? One NeuGroup member company is establishing an innovation hub or global capabilities center in India. A US-based assistant treasurer explained to NeuGroup Insights that “the initial intent is to hire technical talent in order to provide ‘value add’ work; the intent isn’t to move ‘low value’ work to this operation.”
- The AT recently posed a question to peers on NeuGroup’s members-only, online community platform: “For companies that have global capabilities centers in India (or elsewhere) that are providing services to your companies headquartered in the US: In what currency does your global capabilities center bill or invoice (cost-plus) your US operation? INR or USD?”
- In elaborating, the AT told NeuGroup Insights that the question concerns financial reporting and which entity “we want to incur the FX risk.”
- The majority of members responding said their companies’ centers in India bill in USD. And one member advised, “generally, you should bill in functional currency of the beneficiary. I think a good conversation to have with your tax team is about export of services/what the controlled currency is and if there are any risks or benefits in settling in USD and having that conversion onshore.”
Tax enters the picture. No surprise, treasury’s decision on billing and functional currencies for the capabilities center in India has to take tax and accounting considerations into account.
- “It was the desire of our accounting team to have the Indian operation (which is not in a Special Economic Zone) be INR functional and for the billing/invoicing to be in INR,” the AT said. “There is an argument that if the revenue of the Indian entity is USD, the functional currency should be USD as well. Our new operation in India is a branch of an existing Indian subsidiary. We didn’t want to impact the functional currency of the sub.”
- Adding to the complexity, a non-US (and non-Indian) subsidiary has administrative oversight over the Indian operation. So the Indian subsidiary bills that non-US/Indian subsidiary, which in turns bills the company’s US parent. “Ultimately, it is the Indian operation performing services for the US businesses,” the AT explained.
- One reason that matters: “Since this work is being performed in India on behalf of our US operations, it is considered an export, exempt from goods and services taxes,” the member said. “Depending on billing currency, the India government might not consider it an export (which would have an impact on GST).”
A nostro vostro process. The AT’s company consulted its US auditing firm and its banking partner in India to find a way to retain the exemption from GST while billing in INR. “We can do this through the use of the banking nostro/vostro process,” the AT explained. Here’s how that will work:
- “While billed in INR, our non-US/Indian subsidiary will send USD equivalent to the nostro account of their correspondent bank in India. Through the nostro process, USD will be converted to INR and deposited in our Indian subsidiary bank account.
- “We will have the audit trail of USD being sent into the country and then converted to INR, which meets the export regulatory requirements. And we are centralizing the FX exposures at a parent entity which helps simplify future hedging activities.”
- The bank, the member added, will provide the documentation of the conversion (credit advices) to the corporate’s tax team, “which will be the required documents to be filed for our GST refund.” One other achievement: “Regarding leakage, we are able to competitively bid out the FX conversions versus having a single counterparty monopolize the economics.”
- One of the peers responding to the AT’s question noted other benefits of this approach: “If the GCC is INR functional and the billing is in INR (even though settling in USD), then it eliminates P&L volatility for US GAAP in the local entity and centralizes the FX exposures at HQ. Any other option will give rise to volatility that may/may not be hedged out efficiently.”
