1 TAX IMPLICATIONS OF DOING BUSINESS IN INDIA NOVEMBER 6, 2006 22nd ANNUAL SJSU/TEI HIGH TECHNOLOGY...
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Transcript of 1 TAX IMPLICATIONS OF DOING BUSINESS IN INDIA NOVEMBER 6, 2006 22nd ANNUAL SJSU/TEI HIGH TECHNOLOGY...
1
TAX IMPLICATIONS
OF
DOING BUSINESS IN INDIANOVEMBER 6, 2006
22nd ANNUAL SJSU/TEI HIGH TECHNOLOGY INSTITUTE
Nishith DesaiNISHITH DESAI ASSOCIATES
David GillGagan MalikERNST & YOUNG LLP
Barton BassettFENWICK & WEST LLP
2
Overview of Economy and Key Regulations
Legal Entity Comparison
Indian Tax Regime
Refreshment Break
Structuring Issues and Opportunities
Agenda
3
Overview of Economy and Key Regulations
4
INDIA ADVANTAGE
GDP growth rate for 2005-06: 8.1%
Inflation rate for 2005-06: 4.1%
Rising young population
Parliamentary form of Government
Worlds largest democracy
Worlds 4th largest economy
World-class recognition in IT and bio- technology
Services sector contributing 54% to GDP
Largest English speaking nation in the world
India-China, rising powers in Asia
India could emerge as the world's fastest growing economy by 2020
Bold and independent judiciary
5
KEY CONSIDERATIONS
Tax Corporate
Exchange Control
6
Companies
ActS
EB
I ES
OP
G
uid
elin
es
ADR / GDR
Scheme Exchange
Controllaws
Takeover
Code
SE
BI D
IP
Gu
idelin
es
Stamp
duty
Income tax Act
Investments
KEY REGULATIONS
7
FOREIGN INVESTMENT REGULATIONS
Foreign Institutional Investment(FII)
Foreign Venture Capital Investment (FVCI)
Foreign Direct Investment (FDI)
Non-Resident Indian Investment (NRI)
8
100% foreign investment permitted in most sectors on automatic basis except:
Banking (74%) Telecom services (74%) Civil Aviation (49%) Insurance (49%), etc. Retail trading – Single Brand up to 51% with prior approval
Certain sectors where FDI is prohibited: Atomic Energy Lottery business Gambling and Betting
Certain sectors where there are minimum capitalisation requirements:
Non-banking financial services activity (certain activities – fee based and fund based)
Real estate construction and development projects
FDI REGIME
9
Entry Pricing: Price at which a non-resident can subscribe into or purchase shares of an Indian company
Exit Pricing: Price at which a non-resident can sell shares of an Indian company to an Indian resident
Pricing Restrictions
Exchange Control Laws
RBI Pricing guidelines applicable for transfer of shares by a non-resident to an Indian resident and transfer of shares by an Indian resident to a non-resident
In case of unlisted companies, valuation shall be done in accordance with the guidelines issued by the erstwhile Controller of Capital Issues and based on CA certificate or certificate issued by a merchant banker
External Commercial Borrowings: end use restrictions, terms, approvals, etc.
Corporate Laws
Allotment of shares on preferential basis shall be as per the requirements of the Companies Act, 1956, which will require special resolution in case of a public limited company
Securities Laws
In case of listed companies, valuation of shares issued on a preferential basis shall be as per the SEBI guidelines
Tax Laws
Pricing of international transactions pertaining to transfer of shares to be at an arm’s length price
ENTRY AND EXIT PRICING
10
FLOW OF INVESTMENT INTO INDIA
11
Legal Entity Considerations
12
ENTITY OPTIONS
Foreign Investor
Investment
Unincorporated entity Incorporated entity
Company
India
PO BO
Offshore Jurisdictions
TrustUJV P’shipLO
13
ENTITY OPTIONS
Taxation of Entities
Liaison Office: Taxed at 41.82% only if the foreign company has a BC/ PE in India
Project Office: Taxed at 41.82% only if the foreign company has a BC/ PE in India
Branch Office: Taxed at 41.82% since BO would result in BC/ PE in India
Unincorporated Joint Venture: May be taxed as “Association of Persons” at 33.66%
Trust: May be taxed at 33.66% or may get a pass-through status
Partnership: Partnership is usually taxed at the rate of 33.66%
Company: Company is taxed at the rate of 33.66%. DDT at 14.025%
14
PARTNERSHIPS
Only General Partnerships allowed and structures such as LLPs or LPs not currently allowed in India
Partnerships are taxed at the rate of 33.66% and are not pass-through entities under the Indian tax laws if certain conditions are satisfied
Once the Partnership is taxed, the share of profit derived by the partners is exempt from tax and hence only one level of taxation
If certain conditions are not satisfied, the partnership is considered as an “Association of
Persons” and the partners will be taxed at the rate of 33.66% Partnerships are not subject to Minimum Alternate Tax applicable to companies
15
TRUSTS
Typically used for making Venture Capital / Private Equity investments
Trusts may be taxed at the rate of 33.66% or could be pass-through entities under the Indian tax laws if certain conditions are satisfied
Registered trusts (i.e. Venture Capital Funds registered with SEBI) are accorded pass-through status for tax purposes and the investors are taxed when the income is distributed by the registered trusts
Unregistered trusts are usually taxed at the rate of 33.66% if the share of the
beneficiaries are indeterminate or if the trust is irrevocable Unregistered trusts may also be accorded pass-through status if the share of the
beneficiaries are determinate or if the trust is revocable Trusts are not subject to Minimum Alternate Tax applicable to companies
16
Deemed Public Company: Check-the-Box Issue
Under prior law, section 43A treated a private limited company as a deemed public company under certain circumstances (U.S. check-the-box regulations treated as non-per se)
Current law treats an Indian private limited company that is a subsidiary of an Indian public company as a deemed public company (> 50% ownership by Indian public shareholder)
Lack of certainty as to whether per se or non-per se for U.S. tax purposes (since section 43A withdrawn, U.S. regulation no longer directly relevant)
Informal discussions with IRS
17
Indian Tax Regime
18
INDIAN TAX REGIME DIRECT TAXES: OVERVIEW
Domestic company : 33.66%; Foreign company : 41.82%
Dividend distribution tax : 14.025%
Capital gains tax : on exit or restructuring
Withholding taxes: nagging problems
The above taxes could increase on account of: Minimum Alternate Tax : 10.46% on book profits
Fringe Benefits Tax : 33.66% on specified value of certain fringe benefits provided to employees, payable by the employer
Transfer pricing : New regulations, strict penalties (up to 300% of the tax sought to be evaded by way of concealment of income or furnishing of inaccurate particulars), transfer pricing adjustments not covered by the tax holiday
Business Connection : Tricky issues
The above taxes could decrease on account of: Use of tax incentives available under the local tax laws
Use of tax treaties entered into by India with foreign countries
* These rates are inclusive of the applicable surcharge of 2.5% /10% on tax and education cess of 2%
19
INDIAN TAX REGIME…
Particulars Amt (US$)
Taxable income 100
Less: Corporate Tax on the same (33.66%)
33.66
= Profits After Tax 66.34
Less: Transfer to reserve (10% of PAT)[1] 6.63
= Profits available for distribution 59.71
Less: Dividend Distribution Tax (14.025%) 8.37
= Dividends distributed to Shareholder 51.34
[1] As per the Indian Companies Act, up to 10% of Profits After Tax need to be transferred to reserves before an Indian company can declare dividends
FLOW OF DIVIDEND INCOME FROM INDIA
20
Indirect taxes• Payment of services tax at 12.24 % on certain services availed
• Service Tax paid on input service is available as credit to discharge either service tax or excise duty liability of output service and finished product respectively.
• VAT introduced in most Indian states from April 1, 2005
• VAT implementation expected to streamline multi point levies
• Tax credit mechanism for VAT paid on inputs against tax due on outputs
• Octroi / entry tax also levied in certain states on purchases from other states
• Customs duty leviable on goods imported into India
• R&D cess imposed on payment made for import of technology
• Certain tariff concessions on imports from Singapore, Sri-Lanka, etc as a result of free trade agreements
EXCISE DUTY SERVICE TAX• Excise duty levied on manufacture
• Packing/re-packing, labeling / re- labeling of certain products amount to manufacture
• Excise duty is payable on transaction value i.e. usually sale price.
LEVIES ON IMPORTS / EXPORTS VALUE ADDED TAX
INDIAN TAX REGIME INDIRECT TAXES: OVERVIEW
21
INDIAN TAX REGIME…
Type of gains Tax^
Long term capital gains*: listed shares on the stock exchange# 0%
Long term capital gains: listed shares off the stock exchange 10%
Long term capital gains: unlisted shares 20%
Short term capital gains**: listed shares on the stock exchange# 10%
Short term capital gains: listed shares off the stock exchange 30/40%
Short term capital gains: unlisted shares 30/40%
TAXATION OF CAPITAL GAINS
* Long term capital gains means gains on sale of shares held for a period of more than 12 months
** Short term capital gains means gains on sale of shares held for a period of 12 months or less
^These rates are exclusive of the currently applicable surcharge on tax and education cess
# Sale on the stock exchange shall attract Security Transaction Tax at applicable rates
22
INDIAN TAX REGIME…
TAXATION OF CAPITAL GAINS: Treaty Considerations
USA (taxable in India as per domestic laws and tricky issues)
Cyprus (tax-exempt in India)
Singapore (tax-exempt in India subject to LOB conditions)
Netherlands (tax-exempt in India subject to certain conditions)
Mauritius (tax-exempt in India)
UAE (tax-exempt in India but tricky issues)
23
Royalty income• Payable by Government• Payable by resident• Payable by non-resident• If PE in India
Royalty income• Payable by Government• Payable by resident• Payable by non-resident• If PE in India
• for the purposes of business carried on outside India
• for making or earning any income from any source outside India
• for the purposes of business carried on outside India
• for making or earning any income from any source outside India
10/20%(gross)
40%(net)
10/20%(gross)
40%(net)
10/20% (gross)
40%(net)
10/20% (gross)
40%(net)
ParticularsParticulars ExceptionsExceptions Rate of Tax
Rate of Tax
Interest income• Payable by government• Payable by resident• Payable by non-resident• If PE in India / loan in INR
Interest income• Payable by government• Payable by resident• Payable by non-resident• If PE in India / loan in INR
• debt incurred / monies borrowed and used for purposes of business or profession carried on outside India
• for making or earning any income from any source outside India
• debt incurred / monies borrowed and used for purposes of business or profession carried on outside India
• for making or earning any income from any source outside India
Fees for technical Services• Payable by Government• Payable by resident• Payable by non-resident• If PE in India
Fees for technical Services• Payable by Government• Payable by resident• Payable by non-resident• If PE in India
• for the purposes of business carried on outside India
• for making or earning any income from any source outside India
• for the purposes of business carried on outside India
• for making or earning any income from any source outside India
10/20%(gross)
40%(net)
10/20%(gross)
40%(net)
INDIAN TAX REGIME… WITHHOLDING TAXES
24
INDIAN TAX REGIME…
WITHHOLDING TAXES: Treaty Considerations
USA, UK and Singapore (narrow definition of “fees for technical services”)
Mauritius (no Article on “fees for technical services” and hence exempt from tax in India in absence of a PE in India)
Tax Havens (certain problems on payment made by a non-resident to another non-resident)
Sweden and Israel (the Article pertaining to Royalty excludes royalty paid for use of equipment from the definition of Royalty)
25
INDIAN TAX REGIME…
Separate Chapter introduced to tax employee benefits where attribution to employees is difficult
Tax payable by employer at 30% (plus surcharge and education cess) on value (as prescribed) of such benefits
Tax not allowable as deduction to employer
Separate provisions for advance tax, filing of return and assessment
ISSUES
Position for foreign companies
Availability of tax credit in home country for foreign companies
Position of business expenses with no element of ‘personal benefit’
FRINGE BENEFITS TAX
26
INDIAN TAX REGIME…
TRANSFER PRICING REGULATIONS Introduced in 2001 for regulating prices at which the international transactions
between two related enterprises are undertaken Applicable only to international transactions wherein at least one party is a non-
resident of India unlike UK and US where transfer pricing is applicable even to domestic transactions
Onerous documentation requirements prescribed under Rule 10D of the Transfer Pricing Rules
All entities having an aggregate value of international transactions in a financial year exceeding INR 15 crs (i.e. approx. US$ 3.3 mn) subject to compulsory transfer pricing scrutiny by the Indian tax authorities
The following methods prescribed for benchmarking the international transactions Comparable Uncontrolled Price Method (“CUP”) Cost Plus Method (“CPM”) Resale Price Method (“RPM”) Profit Split Method (“PSM”) Transactional Net Margin Method (“TNMM”)
27
INDIAN TAX REGIME… TRANSFER PRICING AUDITS
Revenue’s reactions Preference to CUP method
Comparison with external data regarding charge-out rates
Wide spread choice of TNMM questioned
Basis of rejection of CPM / RPM questioned Cost sharing arrangements challenged Information asked for by the TPOs beyond Rule 10D documentation
requirements Review of the assumptions made and benchmarks used for determination of
transaction prices (for e.g., in royalty transactions, benefits derived from the technology questioned)
Global arrangements challenged if proper documentation not submitted
28
INDIAN TAX REGIME…
Issues
Aggregation of transactions in applying TNMM
Contract manufacturers
Use of Foreign Comparables
Use of secret comparables not available in public domain
Use of loss-makers as comparables Cost allocations / reimbursements
TRANSFER PRICING AUDITS
29
For Software Technology Park (“STP”) / Electronic Hardware Technology Park (“EHTP”) – section 10A of Income-tax Act (“ITA”)
For Units set up in Special Economic Zones (“SEZ”) – section 10AA of ITA
For Export Oriented Units (“EOU”) – section 10B of ITA
For companies undertaking exclusive R&D – section 80-IB(8A) of ITA
INDIAN TAX REGIME…
TAX INCENTIVES RELEVANT FOR IT/ITES COMPANIES
30
INDIAN TAX REGIME… Software Technology Park Special Economic Zone (SEZ)
Direct tax holiday
Eligibility conditions
100% of export profits exempt from tax
Sunset clause: March 31, 2009
Indirect tax benefits
Customs duty
Sales tax
Stamp duty
Other local taxes
Direct tax holiday
Eligibility conditions
Phased Income-tax Holiday for 15 years [100% for first 5 years and 50% for next 5 years and another 50% for next 5 years subject to certain conditions]
Indirect tax benefits
Customs duty
Sales tax
Stamp duty
Other local taxes
Special Tax Holiday for 10 years for R&D Companies
31
Host of incentives proposed for SEZ developers and units under the SEZ Act and SEZ Rules
Frantic rush for setting-up SEZs and obtaining approvals – Cheap land, minimal taxes and high anticipated returns on investment
150 formal approvals (18 notified) and 117 in-principle approvals given till date
More than 200 applications pending with Central Government
26 formal approvals and 19 in-principle approvals in Maharashtra
*Press release dated September 1, 2006
Commerce ministry expects significant gains to the Government on account of the additional economic activity generated in the SEZs - SEZ scheme expected to create 500,000 jobs and
attract FDI of USD 5-6 bn by December 2007*
Finance ministry expects revenue losses of more than U.S. $20 billion. Suggestion to cap number of SEZs at 150 and introduce stringent norms for developers and units
Cap of 150 SEZs removed--Government to review the matter once 75 SEZs are operational
INDIAN TAX REGIME…
SEZ - RECENT DEVELOPMENTS
32
Andhra Pradesh: Total – 27: IT SEZ -17
Maharashtra: Total – 26: IT SEZ -11
Tamil Nadu: Total – 20: IT SEZ -17
Karnataka: Total – 19: IT SEZ -16
Gujarat: Total – 13: IT SEZ - NIL
Haryana: Total – 8: IT SEZ - 5
West Bengal: Total –7: IT SEZ -6
Uttar Pradesh: Total – 6: IT SEZ -5Punjab: Total – 5: IT SEZ - 2
Rajasthan: Total – 3: IT SEZ - 1
Kerala: Total – 8: IT SEZ -5
Others: Total – 8 (Madhya Pradesh, Delhi, Goa, Jharkhand, Pondicherry, Uttaranchal)
INDIAN TAX REGIME…
SEZ approvals - formal
33
HOT ISSUES
Characterization of income
Royalties and fees for technical services
Capital gains
Permanent Establishment / Business Connection
34
LEGAL REMEDIESLitigation process
under ITAAuthority for
Advance RulingAdvance Pricing
Agreements
Not yet available in India
Income Tax Officer
Commissioner of Income Tax (Appeals)
Income Tax Appellate Tribunal
Time: 5-6 years
• Special mechanism under ITA
• Chairman – retired judge of Supreme Court
• Ruling is binding on applicant and tax authorities
• To be effective until change in law / facts
• No appeal against ruling
Time: 3-6 months
High Court
Supreme Court
35
CASE LAW UPDATE
TAXATION OF SOFTWARE TRANSACTIONS
Position gradually evolving in light of favorable rulings
Lucent Technologies - Software bundled with H/W not royalty
Samsung Electronics - Shrink-wrapped software imported by end-user held as “sale” - relied on Supreme Court decision on Tata Consultancy Services under Sales Tax law
Sonata/ PSI Data Systems (2005) - Shrink-wrapped software imported for re-sale by distributor held as “sale” and not royalty
Motorola, Ericsson, Nokia (2005) - Recognized the concept of “copyright article” and copyright right” for distinguishing between “sale” and “royalty” classification
36
CASE LAW UPDATE…
ATTRIBUTION OF INCOME TO PE
Summary of facts
Finnish company held as having a “fixed place” PE under India/ Finland treaty on account of activities carried on by its subsidiary
Activities included network planning & installation, negotiation & signing of contracts
Issue before Tribunal was extent of income attribution to PE
Ruling
Worldwide net profit margin of foreign company applied to revenues earned from India
20% of net profit attributed to PE for functions performed by PE
37
CASE LAW UPDATE…
AZADI BACHAO ANDOLAN & OTHERSSummary of facts
1994 – Central Board of Direct Taxes (“CBDT”) Circular , clarification on Treaty provision – surge in FII investment
2000 – Circular No. 789 (on April 13, 2000) (“Circular”), clarifying that capital gains derived by a Mauritius resident from the sale of shares of an Indian company, shall in view of the Treaty be taxable only in Mauritius and not in India
Circular challenged in the High Court in a Public Interest Litigation 2002 – Special Leave Petition in the Supreme Court filed by the Government of India
and CBDT
Ruling Supreme Court upheld the India-Mauritius treaty (“Treaty”) for avoidance of double
taxation by upholding that the benefits of treaty should be available to third country residents investing in India via Mauritius.
Judgment discusses important international tax issues of ‘double non-taxation’, ‘treaty shopping’, ‘tax avoidance v. tax planning’, ‘form and substance in tax law’
38
RECENT ADVANCE TAX RULINGS
MORGAN STANLEY & CO INTERNATIONAL LTD
Summary of facts
USCo had outsourced certain services to an affiliate “captive” BPO Co in India USCo was to send personnel to provide “stewardship” services to BPO Co as
well as to work under direction of BPO Co Question before Authority for Advance Ruling (AAR) on whether USCo had a
PE in India
Ruling
USCo does not have a “fixed place of business” PE as business of USCo is not carried out through premises of BPO Co
USCo would have a PE under “Service PE” rule on account of deputation arrangement
39
RECENT ADVANCE TAX RULINGS…
DUN & BRADSTREET ESPANA S.A.Summary of facts
Dun & Bradstreet (“DB”)- a business information database which provides products including Business Information Reports (“BIR”s) to businesses worldwide
DB India, a subsidiary of DB SAME which is a tax resident of Spain, electronically purchased BIRs from DB SAME for sale in the Indian market
Questions raised as to the characterization of income of DB SAME from India
Ruling
BIRs were copyright protected Transaction involved sale of copyrighted good and not transfer of copyright Therefore, income of DB SAME from electronic sale of BIRs to be treated as the
business profits of DB SAME in India, and not taxable in the absence of a PE Separately, it was held that DB India could not be said to be a PE of DB SAME
in India.
40
RECENT ADVANCE TAX RULINGS…AGENCY PE
Summary of facts
USCo engaged in business of international transportation services Transportation agreement between USCo and JVCo (India) for movement of
packages within and outside India JVCo to provide services to USCo for delivery of packages within India (inbound
consignment) and USCo to provide services to JVCo for delivery of packages outside India (outbound consignment)
Question before AAR was if USCo would have a PE in India under the agency rule
Ruling
JVCo would be regarded as an agent of USCo as it is acting for and on behalf of USCo
Description of the relationship as independent contractors in agreement not conclusive
JVCo “secures orders” for USCo both with regard to outbound consignments and inbound consignments
USCo would therefore have an agency PE on account of its relationship with JVCo
41
RECENT ADVANCE TAX RULINGS… Fidelity Advisors Series VIII
General Electric Pension Trust
Key Outcomes of the Rulings
Gains from trading in shares by FIIs may be regarded as business income which is not taxable in India in the absence of a PE in India
Determinative tests: If seller holds security as stock-in-trade & not as capital investment Substantial nature of transactions, manner of maintaining books of accounts, magnitude of
purchases & sales, purchases & sales ratio motive of earning a profit versus objective to derive income by way of dividend, etc
Treaty benefits not available to a tax exempt US pension trust since it is not subject to tax in US
42
RefreshmentBreak
43
Structuring Issues and Opportunities
44
STRUCTURING OF INVESTMENTS
General Structuring Considerations Deferral vs. U.S. tax deductions?
Is U.S. investor interested in maximizing deferral planning?
Is U.S. investor more interested in obtaining U.S. tax deductions – are losses expected?
Management of contributions to IndCo What assets/cash? Consider § 367 issues.
Which entities in the group will make contributions?
Management of IP Will IndCo own any IP?
License/royalty issues with respect IndCo
45
STRUCTURING OF INVESTMENTS
General Structuring Considerations What are the U.S. investor’s cash needs?
Is there a need to maximize flexibility in terms of the movement of funds?
Can the U.S. investor tolerate a cash build-up in India from a business standpoint?
Influences type of investment
Debt/ Equity/Hybrids
What functions will IndCo perform with respect to the U.S. investor’s business operations?
R&D
Services – direct/outsourced/combination
Sales
Manufacturing/production
46
STRUCTURING OF INVESTMENTSSTRUCTURING – U.S. Perspective
General U.S. Out-bound considerations
Full Indian tax vs. tax holiday.
Utilization of deferral vs. flow-through of income/losses.
DCL issues with loss flow-through.
Management of Subpart F provisions
Cash management constraints if first-tier sub has tax holiday.
Holiday benefits eliminated when dividends paid – loss of deferral.
Consider other mechanisms for extracting profits from IndCo
Transfer pricing – competing issues.
Consider length of holiday.
Advantage vs. disadvantages of maximizing IndCo’s profits
FTC issues
Exit concerns – no treaty protection on capital gains
US Co
IndCo
47
STRUCTURING OF INVESTMENTSSTRUCTURING – U.S. Perspective
General U.S. Out-bound considerations
Provides blocker for distributions out of IndCo.
Full Indian tax vs. tax holiday
Cash management and base erosion
Greater flexibility as of May 2006 with respect to check-the-box decision for IndCo
Check-the-box election for IndCo can give rise to §954(e) issues with respect to related party services
Check-the-box election with respect to IndCo can be made at later date if §954(c)(6) is not extended
Check-and-sell exit structure available if IndCo is later sold. See Dover v. Commissioner
SPV considerations
Local tax considerations in SPV’s country
Ease of cash movement/cash build-up considerations
US Co
IndCo
ForeignSPV
48
STRUCTURING OF INVESTMENTS…
COMMONLY CONSIDERED JURISDICTIONS FOR SPVS Singapore
No tax on incoming or outgoing dividends. CECA with India
Netherlands
Participation exemption - no tax on incoming dividends and on sale of shares of the subsidiary
Cyprus
International Business Company regime. No tax on dividends and capital gains received and no withholding tax on dividends and interest distributed
UK
Substantial shareholding (based on % of holding and length of ownership) – underlying tax credit is available
Mauritius
GBC 1 regime, effective 3% tax. Tax credit available in India for underlying taxes in respect of dividends. Credit in India for taxes “payable”
49
STRUCTURING OF INVESTMENTS…
COMPARISON OF COMMONLY USED TREATIES Singapore
LOB issuesBuy-Back could raise §301(c) type concerns in Singapore
Netherlands
Can provide repatriation benefitsComplexity on capital gainsRemoval of capital duty makes more attractive
Cyprus
Benefits for debt push-down in India Access to EU directivesU.S. business concerns can arise
Mauritius
Continues to be preferred from a U.S. perspectiveChina-Mauritius developmentsIndian Supreme Court validated use of MauritiusAmendment/withdrawal of India-Mauritius Treaty?
50
STRUCTURING OF INVESTMENTS…USE OF MAURITIUS AS A SPV
Offshore Offshore CompanyCompany
No dividend WHT at Mauritius level
Corporate tax @ 33.66%; 0% if enjoys tax holiday
Dividend distribution tax @ 14.025%
3% tax on income, effective rate 0%
Indian Indian SubsidiarySubsidiary
No CGT
No CGT
Offshore Jurisdictions
Mauritius
India
Mauritius Mauritius HoldCoHoldCo
51
STRUCTURING OF INVESTMENTS…PROFIT REPATRIATION STRATEGIES
Dividends Only out of profits Up to 10% transfer to reserves Dividend distribution tax Creditability
Royalty/Fees for technical (included) services Withholding tax of 10% on gross amount Remittance subject to exchange control
Interest
Buy-back of equity shares 25% of paid-up capital in one financial year No fresh issue of same kind of shares for 6 months Shares to be cancelled within 7 days of buy-back
Redemption of preference shares
Deferral of income recognition in the home country and maximum benefit in home country for foreign tax credits, tax sparing and foreign losses
52
Group Company
Mauritius Group entity
Share buy- back
Equity
Equity Dividends
Mechanics
Group Company holds Indian operations through a Mauritius entity
Dividend payment by the Indian Company to the Mauritius entity would attract Dividend Distribution Tax (“DDT”) at 14.025% in India
Indian Company uses its profits to buy-back part of the equity held by the Mauritius entity (instead of distributing dividends)
Applicable Regulations
To be made out of free reserves, securities premium account or proceeds of any shares/ other specified security, subject to certain limits
Consideration received on buy-back of shares ordinarily taxed as capital gains
Indian Company
PROFIT REPATRIATION – BUY BACK OF SHARES
STRUCTURING OF INVESTMENTS…
53
Mechanics
Investment structured using two holding companies
HoldCo1 invests <10% of the total capital by way of equity
HoldCo2 invests balance 90% by way of preference shares
HoldCo1 located in Netherlands
(Other possible jurisdictions – Belgium, Denmark, Spain, France)
Profit repatriation structured as follows:
Preference share redemption at cost basis
Buy-back of equity shares at fair value
IndCoIndCo
HoldCo2HoldCo2 HoldCo1(Netherlands)
HoldCo1(Netherlands)
EquityPreferenceRedemption
at par
Buy-back
at fair value
STRUCTURING OF INVESTMENTS…PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
54
Benefits
Share buy-back classified as capital gains in India
Capital gains from alienation of 10% or less participation in capital not taxable in India under the treaty
No taxable gains on redemption of preference shares at cost basis
Implementation Issues Structuring of preference
shares terms
Company law provisions relating to share buy-back
Buy-back and redemption to be carried out in a manner to ensure that HoldCo1’s participation remains less than 10%
Section 902 must be managed
STRUCTURING OF INVESTMENTS…PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
55
FINANCING – HYBRID INSTRUMENT
IndCo (India)
IndCo (India)
Dutch Finance
Co
Dutch Finance
Co
US Co/ Holding
Co
US Co/ Holding
Co
Hybrid Debt
Interest
Equity
STRUCTURING OF INVESTMENTS…
Mechanics
US/ Hold. Co sets up/ has an existing company in India i.e. IndCo
IndCo is “thinly capitalized”
IndCo issues “convertible debentures” to Dutch Finance Co
IndCo pays arm’s length interest to Dutch Finance Co
IndCo uses debt for funding requirements
56
Implementation Issues
Structuring of Hybrid Debt from an Indian corporate law & exchange control perspective
Cost - 10% withholding tax on interest under Dutch treaty
Possible solution in Netherlands post January 1, 2007
“Term sheet” of the hybrid note would be vital for effective implementation
U.S. tax classification
Benefits
Convertible Debentures not subject to External Commercial Borrowing guidelines
End-use restrictions and other limitations not applicable
IndCo eligible for interest deduction
Participation exemption on interest earned in Netherlands may also be possible
STRUCTURING OF INVESTMENTS…FINANCING – HYBRID INSTRUMENT
57
US STRUCTURING CONSIDERATIONS
Direct from US Defer from US tax (likely not check-
the-box (CTB)) Impact of DDT Transfer pricing structure
From US through Intermediary Jurisdiction Repatriation generally negates benefit
of deferral, but consider CFC to CFC look-through
CTB Profit repatriation disregarded FBC services income and impact
thereof
Direct from US CTB may be beneficial but confirm
ability to utilize foreign tax credits Losses can offset US taxable income
subject to DCL and branch loss recapture
Sourcing issues on intercompany transactions
From US through Intermediary Jurisdiction Base erosion opportunities (whether
part of CTB deferral structure or using CFC to CFC look-through
Check the box FBC services income Facilitates elimination of related party
transactions
India Tax Holiday
India Full Taxation
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STRUCTURING OF INVESTMENTS
Managing U.S. Deferral A popular planning option for managing Subpart F has been to make
a disregarded entity election for IndCo in SPV structure
Enables taxpayer to maintain deferral with respect to dividend distributions from IndCo to SPV
This planning technique can give rise to issues with respect to the application and management of §954(e) with respect to related party service activities
Potentially problematic with respect to the application of the Branch rule of §954(d)(2)
Also applicable to “Super Holdco” structures
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STRUCTURING OF INVESTMENTS
Managing U.S. Deferral Significantly greater flexibility following the introduction of
§954(c)(6) in May of 2006
Exception to FPHCI provisions – provides look-through treatment with respect to dividends, interest, rents, and royalties received from related party CFCs
Impacts check-the-box decisions with respect to SPV structures
Now consider delay of check-the-box elections until §954(c)(6) sunsets.
Consider restructuring out of prior check-the-box elections to the extent there is an exposure to §954(e)
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STRUCTURING OF INVESTMENTS
U.S. Issues with Respect to Managing IP Ownership IP ownership with respect to R&D functions performed by IndCo can
present issues from both a business and U.S. tax standpoint
Will IndCo own any IP rights?
What entities within the corporate group will contract with IndCo for the performance of contract R&D functions
Issues can arise under proposed §482 service/intellectual property regulations
Services can be transmuted into deemed IP transfers
Consider the use of cost-sharing structures
Proposed cost-sharing regulations are problematic, even with respect to foreign-to-foreign cost-sharing structures
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STRUCTURING OF INVESTMENTSTAX EFFICIENT EXIT
Sale of shares of the Indian entity
Consider “check-and-sell” option in SPV structure if IndCo not characterized as a disregarded entity for U.S. purposes
Sale of assets of the Indian entity
Sale of shares of the immediate Parent company in case of global restructuring
Buy-back of equity shares by the Indian entity
Redemption of preference shares
Liquidation of the Indian entity
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Acquisition PlanningUS CONSIDERATIONS
Consideration and Financing US or offshore cash Debt and at what level Stock – likely at US parent level
Section 338
Ownership of IP and integration
Legal integration into global structure Sale of assets followed by liquidation Merger / amalgamation
Change in related and unrelated party transaction flows?
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Acquisition Planning…INDIAN CONSIDERATIONS
Regulatory Issues
Carryover of incentives/holidays and other tax attributes
Special rules Mergers Demergers Slump sales
Legal integration into global structure Sale of assets followed by liquidation Merger / amalgamation
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Acquisition Planning…Growing Interest in Inversion Transactions
Recent trend of private U.S. companies seeking access to Indian capital market, which applies lower-thresholds for public offerings
U.S. tax issues under §§ 367 and 7874 need to be managed
US PrivateCo
IndCo
Shareholders
Restructuring
US PrivateCo
IndCo
Shareholders
New IndCo
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THANK YOU
Nishith DesaiNishith Desai & AssociatesMumbai, [email protected]
Barton BassettFenwick & West LLPMountain [email protected]
David GillErnst & Young LLPSan [email protected]
Gagan MalikErnst & Young LLPSan [email protected]