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M&A and RestructuringsMLI – inbound and outboundChanging landscape
November 10, 2019
Ifs and buts of the Indian Economy…….
Mood in the market……..
Governments’ denial and acceptance – From ‘all is well’ to weekly stimulus
Tackling the new normal – Millennials; new age disruptive business models; paradigm shift in priorities and habits (traditional facing turbulence but Amazon/Flipkart sales are a success)
Coping up with fast changing regulations in a changing business environment – IBC/ stressed assets; Budget/amendment/ordinance; Regulators view (Jet Airways, Bank lending etc)
Geopolitical (e.g., US-China; Brexit; Huawei’s fiasco; thrust on substantive presence, Digital economy etc.) leading to change in the way business is done – e.g., Apple de-risking from China and opening up a facility in India
Uncertainty creates threats and opportunities which requires businesses to structure/restructure, divest/acquire and diversify……….. 2
Deal Trends
A mixed Bag Asset light- Asset heavy, OYO externalisation, shift of residencies, overseas listings
M&As – GSK- HUL, Vodafone Idea- PSU bank mergers, Bharat financial –IndusInd Bank
ESSEL Propack, NIIT
Deleveraging – Café Coffee day, Indiabulls, Deewan Housing, Yes Bank, IBC cases- Ruchi Soya, Jet, Essar, Bhushan
Family splits, internal reorganisation
3
Reduction in tax rate – Impact assessment beyond timing to opt for the new rate
Reversal of MAT Credit/ Deferred Tax reversal – Order of adjustment of losses for determining remainder losses? Impact on Earnings?
Interplay with GAAR if expansion undertaken through WOS?
Splitting-up/ Reconstruction
(Land already acquired, Environmental Clearance obtained, Board announcement to SEs)
4
Tax Arbitrage – LTCG/ STCG
Particulars Direct LLP CompanyCompany
(if under MAT)
Short Term –Listed (111A) 17.94% 17.47% 41.08% 41.30%
Short Term -Other than listed 42.74% 34.94% 46.77% 53.73%
Long Term –Listed (112A) 11.96% 11.65% 37.01% 37.15%
Long Term -Other than listed 28.50% 23.30% 45.14% 45.44%
Bonus stripping. Dividend stripping – fizzle out
Company v/s LLP- What to do?
5
Transition and GAAR
Chaos on Demerger cost splits, sale of shares by promoters in IPO
• Timing
• Tax Rate
• Tax withholding
• Limitations under FDI
Earnouts / Deferred
Consideration
• Period
• Taxability – Business Income vs Capital Gains vs Other Income
• Withholding obligation
• GST implications
Non-Compete• Typical tax indemnities
under Section 281, 170 of the IT Act
• Quantification, capping and period of coverage of Tax liabilities
Indemnities
Deal Dossier….. key matters
Withholding Tax on Sale consideration payable to non-resident – Section 195 Vs 197 Vs Indemnities 6
Amendments impacting IBC process
Opting for Non applicability of
MAT Relief on reversal/ write-back of liability;
Normal provisions –
M&M?
CIRP to be completed
within 330 days including
extended legal proceedings
providing certainty
Comprehensive corporate
restructuring allowed through
merger, amalgamation and demerger
under a resolution plan
Clarification that resolution plan is binding on all
Govt. authorities
7
COC empowered to determine the manner of distribution as per the liquidation waterfall in Section 53 of the Code
Internal reorganization and GAAR on the ground...
Transfer of business – BV
Vs Tax Net worth Vs FV?
Do Gifts work anymore?
Holding Subsidiary
mergers – Has Ajanta Pharma settled down?
8
Contd…..Internal reorganization and GAAR on the ground...
Accelerating utilization of carry
forward losses through
Merger/Demerger?
Non-classical Demerger –
OCRPS/RPS etc
GAAR in Family Settlement?
9
Navigating through a web in transfer of shares……..
FEMA and Companies Act
Pricing / Valuation -Governance
Interplay between multiple Sections –
Section 56(2)(x), 56(2)(viib), 50CA, 43CA,
2(24)(iv), indirect transfers, withholding
obligations
10
Tax overriding commercial rationale……..
No exception under Section 56(2)(x) and
56(2)(viib) to address genuine business
situation (e.g., transactions between
independent parties; real estate transactions etc.)
Section 56(2)(x) applies to Issue of shares? Proportionate Vs
Disproportionate issue? Bonus issue? Buy-back?
Capital reduction?
Timing of testing 56(2)(x) fair value – Agreement date vs Actual date of
transfer/ receipt of shares. Possibility of
increase in fair valuation in future / actual receipt
date
11
Structuring through other instruments like CCD, CCPS, OCRPS etc. – GAAR?
Goodwill on Demerger/ Merger – Tax Depreciation
Common control merger where IND-AS applies to the
merged company –
Goodwill not recognized
Other cases –Purchase
method as per AS 14 –
Goodwill recognized in
books
Significant mismatch in
taxable income and book profits
for MAT –Impact on
decision to opt for lower tax
rate
Practical experience (Schemes &
assessments) -Approval with Tax rider; Tax office denying
claim in assessments
Appointed Date uncertainty now removed by MCA. Such date can be as mentioned in the Scheme and can also be retrospective 12
International trends….
Focus on Substance
•Holding Company jurisdictions gearing up to the changing world –Substance check while issuing TRC’s
SAAR/substance tests being applied
•Canadian ruling disregarding separate existence of Companies for lower Tax regime (Small business tax exemption)
•CJEU has provided guidance on a reference by Denmark Court to it to disregard the intermediary EU Company for not being a beneficial owner
Innovative business models, newer Taxes
•Parliament discussion subject
•Digital Tax
13
Corporates in cross border ….
Multi layer structures,
Roundtripping, overdue
creditors/debtors, capital
regularization
Trading companies, IPR
companies, Financing
companies
SPV/IHC structures – POEM?
14
Individuals in cross border ….
Invisible law on Roundtripping now introduced through an FAQ in May 2019
Individual migrating from India – Tax rate
on disposal as an NRI, non-repatriable
investment, limits on remittance from
India
Migration of Families – Financial
support, Gifting while being a NR
(Trusts?)
15
Family Office ….
Investment instruments – Tax
consequences thereof (e.g.,
NCDs)
Issues concerning holding structures (NBFC/CIC issues in Companies) /
Investment LLPs / Trust / AIF
Investing in securities/ real
estate abroad by Individuals – Fund pooling, LRS/ ODI, compliances; Tax
scrutiny
16Is SEBI approval mandatory for settling Family Trusts for Promoters of Listed Cos?
Key Action Points - India
Following is the progress made so far by India on implementation of the BEPS action plans
•- On 7 June 2017, India along with 67 other countries signed the Multilateral Instrument (MLI) to modify existing tax treaties
•- Ratified instrument submitted with the OECD
Introduction of the interest deduction limitation rule in
2017
Re-negotiation of tax treaties to ensure greater source-based
taxation/ prevention of treaty abuse
•Introduction of Equalization Levy at the rate of 6% on certain digital
advertising transactions in
2016
Introduction of Country by
Country Reporting (CbCR) and Master
File TP documentation in
2016
Committed to minimum
standards for improving
effectiveness on Mutual Agreement Procedures (MAP)
•Introduction of the concept of “significant economic presence” in 2018 to bring certain digital transactions in the tax net
India has been a frontrunner in the global tax transition
MLI Articles - Impacting investments transactions
Article 6 & 7 - Preamble and Prevention of Treaty Abuse
LOB Rule
PPT Rule
Preamble
Article 6 of MLI that mandates inclusion of preamble as a minimum standard
Article 7 of MLI allows to opt for any of the following alternatives:• PPT Only• PPT + LOB (Detailed or
simplified)• Detailed LOB + mutually
negotiated anti-conduit Rule
India has accepted to apply PPT as an interim measure along with Simplified Limitation of Benefit clause
Scope of Principal Purpose Test (‘PPT’) – Article 7(1) of MLI
Para 7(1): Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit,
- Unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”
Benefit’ includes all limitations on taxation imposed on the State of source. Example -Lower rate of WHT, restricted definition of royalty / FTS, Non-applicability of beneficial Permanent Establishment provisions, Capital gain tax exemption, etc.
The terms “arrangement or transaction” should be interpreted broadly and include any agreement, understanding, scheme, transaction or series of transactions, whether or not they are legally enforceable. It includes creation, assignment, acquisition or transfer of the income itself or of property or right in respect of which income accrues
Imperative to demonstrate substance and commercial rationale
Scope of Principal Purpose Test (‘PPT’) – Article 7(1) of MLI
Second limb of PPT Clause –reads as “Unless it is established that granting benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the CTA”
Article 31 of Vienna Convention -A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.
SC in case of Azadi Bachao Andolan (supra) observed : similar to deficit financing, treaty shopping, though at first blush might appear to be evil, but is tolerated in a developing economy, in the interest of long-term development.
“…..Despite the sound and fury of the respondents over the so called 'abuse' of 'treaty shopping', perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations…...”
• Which Object and Purpose to be analysed? –Original treaty? Protocol? MLI? Impact on protocol to India-Singapore Treaty?
• Whether principles upheld by SC in Azadi Bachao Andolon still hold good?• PPT v/s GAAR?
• PPT V/s Existing LOB clause in tax treaties?
Impact on investment transactions –Principal Purpose Test (‘PPT’) and SLOB
Case Study 1 - PPT
RCo
State X State YState S (Actual
Facility)
State R
Developing Countries
No DTAA with State R
DTAA with State R
Facts:
R Co is a manufacturing entity and has the option of setting up a manufacturing unit in three states i.e. State X, State Y and State S
All three locations were comparable economically and politically, however only State S has a Treaty with State R
R Co decided to set up the facility in State S due to the presence of treaty
BEPS Recommendation:
Given that a general objective of tax conventions is to encourage cross-border investment, obtaining the benefits of the State R-State S convention for the investment in the plant built in State S is in accordance with the object and purpose of the provisions of that convention
Treaty Benefit may not be denied if the commercial action is aligned to treaty objective
Case Study 2 - PPT
Facts:
R Co, a resident of State R, holds 24% in S Co, a resident of State S. There was no treaty between State S and State R
Subsequently R-S Treaty was entered into which provided for 5% WHT rate on dividends subject to shareholding of 25%
R Co increased its holding to 25% to avail concessional rate
BEPS Recommendation:
The facts suggest one of the principal purposes is clearly to obtain the benefit of the lower WHT rate provided by Article 10(2)(a) of a treaty.
However, granting benefit under this Article is permitted to a taxpayer who genuinely increases its participation in a company in order to satisfy the arbitrary threshold of 25%.
No treaty
RCo(State R)
SCo(State S)
24% Holding
Post entering
into treaty
RCo(State R)
SCo(State S)
25% Holding
Any commercial action to comply with treaty conditions should not result in denial of treaty benefit
Case Study 3 - PPT
Facts:
T Co has subsidiaries in different countries, but State T does not have treaty with any of these countries
R Co is established in State R for the purpose of providing managerial services to group companies. State R has treaties with each of the countries where the subsidiaries are located
The decision to invest in State R is driven by the skilled labour force, reliable legal system, business friendly environment, and the comprehensive double taxation treaty network of State R which provide lower WHT rates
BEPS Recommendation:
PPT rule not to apply if R Co undertakes significant FAR for providing services through its own personnel
TCO(PTC & Resident of
State T)
X Y Z
Subsidiaries in different countries
RCO(Resident of
State R)
Management etc. services
Subsidiaries
Commercial substance would prevail to conclude over any alleged treaty abuse measure
Case Study 4 - Holding/financing company structures
Facts:
Foreign parent (‘FP’) intends to make investment in Local Operating Company (‘LOC’)
FP has invested into Regional Holding Company (‘RHC’) through hybrid instruments that is considered as equity in FP jurisdiction and considered as debt in RHC’s jurisdiction.
RHC has in-turn invested into LOC that as per RHC’s jurisdiction is considered as equity and considered as debt as per LOC’s jurisdiction
There is very low or no substance in RHC
Taxability in FP’s jurisdiction
– Dividends from subsidiaries taxable only when dividend is received/declared
– 100% exemption on capital gains, dividend income (subject to conditions)
Taxability in RHCs jurisdiction
– 100% exemption on capital gains, dividend income (subject to conditions)
Taxability in LOCs jurisdiction
– Reduced WHT on dividend, interest payments and capital gains tax protection (subject to DTAA conditions)
Regional holding company (RHC)
ForeignParent (FP)
Asia-PacOperations
Asia-PacOperations
Asia-PacOperations
Local Operating Company (LOC)
Loan/Hybrid instrument
Low to no substance
Loan/Hybrid instrument
Case Study 4 - Holding/financing company structures
Potential Watch out areas post MLI:
FP’s jurisdiction
Can 100% exemption of dividend received from RHC be denied because of a hybrid instrument?
Can CFC Rules be applied for income earned by RHC?
RHC’s jurisdiction
Can deduction for payment to FP be denied because of Hybrid instrument?
Will the interest limitation rule apply?
Can 100% exemption of dividend received from LOC be denied because of a hybrid instrument or lack of substance?
LOC’s jurisdiction
Can tax treaty benefit be denied as per PPT Rule?
Can deduction for payment to RHC be denied because of Hybrid instrument?
Will the interest limitation rule apply?
Regional holding company (RHC)
ForeignParent (FP)
Asia-PacOperations
Asia-PacOperations
Asia-PacOperations
Local Operating Company (LOC)
Loan/Hybrid instrument
Low to no substance
Loan/Hybrid instrument
Need to Re-look legacy structures in light of emerging tax policies
Case Study 5 – Intellectual Property structures
Facts:
Foreign parent (‘FP’) is owning an Intellectual Property (‘IP’) that it want to exploit in various countries
FP forms an IP company in say Country A (tax favoured location) and transfer the ownership of IP to such IP Company
IP Company forms a Regional Holding Company (‘RHC’) in say Country B (low substance) and transfer the right to use the licenses for IP to RHC
RHC forms a Local Operating Company (‘LOC’) in say Country C and sub-license the IP to LOC
LOC would use such IP for commercial purpose (i.e. give it on license to third party) and earn royalty income
Taxability
– LOC would expense out the majority of royalty received for IP licenses to RHC and therefore, there would be very minimum profit taxable in Country C. Further royalty income earned by RHC is taxable at lower rate in Country C as per tax treaty.
– RHC would in turn pay the majority of the license fee received from LOC to IP Company and therefore, there would be very minimum profit taxable in Country B
– Tax rate in Country A on royalty is low
Regional holding company
(Country B)
IP company(Country A)
Foreign Parent
Asia-PacOperations
Asia-PacOperations
Asia-PacOperations
Local Operating Company
(Country C)
IP license
IP license
Low to no substance
Cost-sharing agreement/buy-in of existing IP
No substance
No taxable presence in the tax-favored location
Royalty
Royalty
Case Study 6 – Intellectual Property structures
Potential Watch out areas post MLI :
Will DEMPE (i.e. development, enhancement, maintenance, protection and exploitation of intangibles) rules of BEPS Action Plan 8 apply and maximum profit would be taxable in the jurisdiction where there is economic substance i.e. FP or LOC?
Can the preferential tax regime of low tax rate on royalty in Country A be denied as per BEPS Action Plan 5?
Can tax treaty of Country B and Country C be denied to RHC as per PPT/LOB rules?
Regional holding company
(Country B)
IP company(Country A)
Foreign Parent
Asia-PacOperations
Asia-PacOperations
Asia-PacOperations
Local Operating Company
(Country C)
IP license
IP license
Low to no substance
Cost-sharing agreement/buy-in of existing IP
No substance
No taxable presence in the tax-favored location
Royalty
Royalty
Case Study 7 – Typical outbound investments
Facts:
India Co acquires target through borrowing from banks
SPV set up in a jurisdiction where Underlying tax credit (‘UTC’) benefit is granted under tax treaty
Operating Co is formed through Debt and Equity
Withholding tax in Operating Co jurisdiction is 5% due to favorable domestic withholding provisions
Dividend received by SPV is taxable @15% in SPV’s jurisdiction but relief by way of tax sparing and UTC can be claimed in SPC jurisdiction
Indian Co taxed u/s 115BBD against which UTC is claimed
Indian Co also claims benefit of roll over exemption u/s 115O on distribution of dividend to shareholders
Potential Watch out areas post MLI :
Can PPT be applied to deny UTC or tax sparing credit
Can PPT/GAAR be applied by Indian tax authority questioning the existence of SPV and disallowing UTC
Operating Co
SPV
India Co
Debt + Equity
Dividend withholding - Nil
Headline tax rate – 15%
Business
Bank Borrowing
Equity
Impact on transactions – Others
Case Study 8 – Dual resident entities (Article 4 of MLI)
Facts:
X Co. is dual resident of India (under POEM) and Netherlands (based on incorporation)
Article 10(2) of India-Netherlands tax treaty reads as follow:
“However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the dividends”
Tie-breaker residency of X Co. to be decided by way of Mutual Agreement Procedure (‘MAP’) by Competent Authorities of both the Countries
If residency cannot be determined under MAP then treaty benefit would not be available
Potential Watch out areas post MLI :
One of the method for determining tie-break residency is POEM. Can MAP apply the Indian POEM guidelines for the same?
If competent authorities is unable to determine residency by mutual agreement, can Indian shareholder claim the benefit of Article 10(2) of India-Netherlands tax treaty?
X Co. (India &
Netherlands)
Indian shareholder
Dividend
Case Study 9 – Dual resident entities (Article 4 of MLI)
Facts:
X Co. is dual resident of India (under POEM) and Singapore (based on incorporation)
Singapore Shareholder has acquired shares of X Co. before 1st April 2017
Article 13(4A) of India-Singapore tax treaty reads as follow:
“4A. Gains from the alienation of shares acquired before 1 April 2017 in a company which is a resident of a Contracting State shall be taxable only in the Contracting State in which the alienator is a resident”
Tie-breaker residency of X Co. to be decided by way of Mutual Agreement Procedure by Competent Authorities of both the Countries
If residency cannot be determined under MAP then treaty benefit would not be available
Potential Watch out areas post MLI :
If competent authorities is unable to determine residency by mutual agreement, can Singapore shareholder claim the grandfathering provision’s benefit of Article 13(4A) of Singapore tax treaty?
X Co. (India &
Singapore)
Singapore shareholder
Sale of shares
Key Drivers going forward……..
Commercial reason vis-à-vis Tax Reason to drive investment holding structures
Increased documentation imperative to demonstrate substance for investment decisions
Profit allocation would be based on economic substance vis-à-vis legal form of entities
Relook of existing structures to minimize litigation considering the open-ended law of PPT
35
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