TAB 5 Bassett, Desai, Gill, Malik
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Transcript of TAB 5 Bassett, Desai, Gill, Malik
7/31/2019 TAB 5 Bassett, Desai, Gill, Malik
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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
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Overview of Economy and Key Regulations
Legal Entity Comparison
Indian Tax Regime
Refreshment Break
Structuring Issues and Opportunities
Agenda
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Overview of Economy and
Key Regulations
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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 economyWorld-class recognition in IT and bio-technology
Services sector contributing 54% to GDP
Largest English speaking nation in theworld
India-China, rising powers in Asia
India could emerge as the world's fastestgrowing economy by 2020
Bold and independent judiciary
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KEY CONSIDERATIONS
Tax Corporate
Exchange Control
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ExchangeControl
laws
Income taxAct
Investments
KEY REGULATIONS
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FOREIGN INVESTMENT REGULATIONS
Foreign Institutional Investment (FII)
Foreign Venture Capital Investment (FVCI)
Foreign Direct Investment (FDI)
Non-Resident Indian Investment (NRI)
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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 EnergyLottery businessGambling and Betting
Certain sectors where there are minimum capitalisationrequirements:Non-banking financial services activity (certain activities – fee based andfund based)Real estate construction and development projects
FDI REGIME
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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 residentPricing 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-residentIn case of unlisted companies, valuation shall be done in accordance with the guidelines issued by the erstwhileController 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 willrequire 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
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FLOW OF INVESTMENT INTO INDIA
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ENTITY OPTIONS
Foreign Investor
Investment
Unincorporated entity Incorporated entity
Company
India
PO BO
Offshore Jurisdictions
TrustUJV P’ship LO
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ENTITY OPTIONS
Taxation of EntitiesLiaison 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%
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PARTNERSHIPS
Only General Partnerships allowed and structures such as LLPs or LPs not currentlyallowed 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 fromtax 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
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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 theIndian 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 isdistributed by the registered trusts
Unregistered trusts are usually taxed at the rate of 33.66% if the share of thebeneficiaries are indeterminate or if the trust is irrevocable
Unregistered trusts may also be accorded pass-through status if the share of thebeneficiaries are determinate or if the trust is revocable
Trusts are not subject to Minimum Alternate Tax applicable to companies
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Deemed Public Company:Check-the-Box Issue
Under prior law, section 43A treated a private limited company as a deemedpublic company under certain circumstances (U.S. check-the-box regulationstreated as non -per se )
Current law treats an Indian private limited company that is a subsidiary of anIndian 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
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Indian Tax Regime
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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 restructuringWithholding 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 taxholiday
Business Connection : Tricky issuesThe above taxes could decrease on account of:
Use of tax incentives available under the local tax lawsUse 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%
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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
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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 outputservice and finished product respectively.
• VAT introduced in most Indian states from April 1, 2005
• VAT implementation expected tostreamline 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 importedinto India
• R&D cess imposed on payment made for import of technology
• Certain tariff concessions on imports fromSingapore, Sri-Lanka, etc as a result of free trade agreements
EXCISE DUTY SERVICE TAX• Excise duty levied on manufacture
• Packing/re-packing, labeling / re- labelingof certain products amount to manufacture
• Excise duty is payable on transactionvalue i.e. usually sale price.
LEVIES ON IMPORTS / EXPORTS VALUE ADDED TAX
INDIAN TAX REGIMEINDIRECT TAXES: OVERVIEW
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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
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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)
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Royalty income• Payable by Government• Payable by resident• Payable by non-resident• If PE in India
• for the purposes of business carried onoutside India
• for making or earning any income fromany source outside India
10/20%(gross)
40%(net)
10/20%(gross)
40%(net)
Particulars Exceptions Rate ofTax
Interest income• Payable by government• Payable by resident• Payable by non-resident• If PE in India / loan in INR
• debt incurred / monies borrowed andused for purposes of business or profession carried on outside India
• for making or earning any income fromany source outside 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 onoutside India
• for making or earning any income fromany source outside India
10/20%(gross)
40%(net)
INDIAN TAX REGIME… WITHHOLDING TAXES
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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)
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INDIAN TAX REGIME…
Separate Chapter introduced to tax employee benefits where attribution toemployees 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
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INDIAN TAX REGIME… TRANSFER PRICING REGULATIONS
Introduced in 2001 for regulating prices at which the international transactionsbetween 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 todomestic transactionsOnerous documentation requirements prescribed under Rule 10D of theTransfer Pricing Rules
All entities having an aggregate value of international transactions in a financialyear exceeding INR 15 crs (i.e. approx. US$ 3.3 mn) subject to compulsorytransfer pricing scrutiny by the Indian tax authoritiesThe 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”)
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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 questionedCost sharing arrangements challengedInformation asked for by the TPOs beyond Rule 10D documentationrequirementsReview of the assumptions made and benchmarks used for determination of transaction prices (for e.g., in royalty transactions, benefits derived from thetechnology questioned)Global arrangements challenged if proper documentation not submitted
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INDIAN TAX REGIME…
Issues
Aggregation of transactions in applying TNMMContract manufacturersUse of Foreign ComparablesUse of secret comparables not available in public domainUse of loss-makers as comparablesCost allocations / reimbursements
TRANSFER PRICING AUDITS
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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
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INDIAN TAX REGIME… Software Technology Park Special Economic Zone (SEZ)
Direct tax holiday
Eligibility conditions
100% of export profits exemptfrom tax
Sunset clause: March 31, 2009
Indirect tax benefits
Customs duty
Sales taxStamp duty
Other local taxes
Direct tax holiday
Eligibility conditions
Phased Income-tax Holiday for 15 years [100% for first 5 yearsand 50% for next 5 years andanother 50% for next 5 yearssubject to certain conditions]
Indirect tax benefits
Customs duty
Sales taxStamp duty
Other local taxes
Special Tax Holiday for 10 years for R&D Companies
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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 andhigh anticipated returns on investment
150 formal approvals (18 notified) and 117 in-principle approvals given till dateMore 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 additionaleconomic activity generated in the SEZs - SEZ scheme expected to create 500,000 jobs andattract FDI of USD 5-6 bn by December 2007*
Finance ministry expects revenue losses of more than U.S. $20 billion. Suggestion to capnumber 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
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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
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HOT ISSUES
Characterization of income
Royalties and fees for technical services
Capital gains
Permanent Establishment / Business Connection
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LEGAL REMEDIESLitigation process
under ITAAuthority for
Advance RulingAdvance Pricing
Agreements
Not yet available inIndia
Income Tax Officer
Commissioner of
Income Tax (Appeals)
Income Tax AppellateTribunal
Time: 5-6 years
• Special mechanismunder ITA
• Chairman – retired judge of SupremeCourt
• Ruling is binding onapplicant and taxauthorities
• To be effective untilchange in law /facts
• No appeal againstruling
Time: 3-6 months
High Court
Supreme Court
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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 ConsultancyServices under Sales Tax law
Sonata/ PSI Data Systems (2005) - Shrink-wrapped software importedfor 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
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CASE LAW UPDATE…
ATTRIBUTION OF INCOME TO PE
Summary of facts
Finnish company held as having a “fixed place” PE under India/ Finland treaty onaccount of activities carried on by its subsidiary
Activities included network planning & installation, negotiation & signing of contractsIssue before Tribunal was extent of income attribution to PE
Ruling
Worldwide net profit margin of foreign company applied to revenues earned fromIndia
20% of net profit attributed to PE for functions performed by PE
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CASE LAW UPDATE…
AZADI BACHAO ANDOLAN & OTHERSSummary of facts
1994 – Central Board of Direct Taxes (“ CBDT ”) Circular , clarification on Treatyprovision – surge in FII investment2000 – Circular No. 789 (on April 13, 2000) (“Circular ”), clarifying that capital gainsderived 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 IndiaCircular challenged in the High Court in a Public Interest Litigation2002 – Special Leave Petition in the Supreme Court filed by the Government of Indiaand CBDT
Ruling
Supreme Court upheld the India-Mauritius treaty (“Treaty ”) for avoidance of doubletaxation by upholding that the benefits of treaty should be available to third countryresidents 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‟
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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 CoQuestion before Authority for Advance Ruling (AAR) on whether USCo had aPE in India
Ruling
USCo does not have a “fixed place of business” PE as business of USCo is notcarried out through premises of BPO CoUSCo would have a PE under “Service PE” rule on account of deputationarrangement
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RECENT ADVANCE TAX RULINGS…
DUN & BRADSTREET ESPANA S.A.
Summary of facts
Dun & Bradstreet (“ DB”)- a business information database which providesproducts including Business Information Reports (“ BIR”s) to businessesworldwideDB India, a subsidiary of DB SAME which is a tax resident of Spain,electronically purchased BIRs from DB SAME for sale in the Indian marketQuestions 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 copyrightTherefore, income of DB SAME from electronic sale of BIRs to be treated as thebusiness profits of DB SAME in India, and not taxable in the absence of a PESeparately, it was held that DB India could not be said to be a PE of DB SAMEin India.
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RECENT ADVANCE TAX RULINGS… AGENCY PE
Summary of facts
USCo engaged in business of international transportation servicesTransportation agreement between USCo and JVCo (India) for movement of packages within and outside IndiaJVCo to provide services to USCo for delivery of packages within India (inboundconsignment) and USCo to provide services to JVCo for delivery of packagesoutside India (outbound consignment)Question before AAR was if USCo would have a PE in India under the agencyrule
Ruling
JVCo would be regarded as an agent of USCo as it is acting for and on behalf of USCoDescription of the relationship as independent contractors in agreement notconclusiveJVCo “secures orders” for USCo both with regard to outbound consignments andinbound consignmentsUSCo would therefore have an agency PE on account of its relationship withJVCo
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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 nottaxable in India in the absence of a PE in IndiaDeterminative tests:
If seller holds security as stock-in-trade & not as capital investmentSubstantial nature of transactions, manner of maintaining books of accounts, magnitude of purchases & sales, purchases & sales ratiomotive 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
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Refreshment
Break
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Structuring Issues and
Opportunities
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STRUCTURING OF INVESTMENTSGeneral 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 – arelosses expected?
Management of contributions to IndCoWhat 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
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STRUCTURING OF INVESTMENTSGeneral 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 businessstandpoint?
Influences type of investment
Debt/ Equity/Hybrids
What functions will IndCo perform with respect to the U.S. investor‟sbusiness operations?
R&DServices – direct/outsourced/combination
Sales
Manufacturing/production
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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 fromIndCo
Transfer pricing – competing issues.
Consider length of holiday.
Advantage vs. disadvantages of maximizing IndCo‟sprofits
FTC issues
Exit concerns – no treaty protection on capital gains
US Co
IndCo
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STRUCTURING OF INVESTMENTSSTRUCTURING – U.S. Perspective
General U.S. Out-bound considerationsProvides 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 IndCoCheck-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 madeat 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
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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 gainsreceived 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 taxesin respect of dividends. Credit in India for taxes “payable”
S C G O S S
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STRUCTURING OF INVESTMENTS… COMPARISON OF COMMONLY USED TREATIESSingapore
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 ariseMauritius
Continues to be preferred from a U.S. perspectiveChina-Mauritius developmentsIndian Supreme Court validated use of Mauritius
Amendment/withdrawal of India-Mauritius Treaty?
STRUCTURING OF INVESTMENTS
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STRUCTURING OF INVESTMENTS… USE OF MAURITIUS AS A SPV
OffshoreCompany
No dividendWHT atMauritius level
Corporate tax @ 33.66%;0% if enjoys tax holiday
Dividend distributiontax @ 14.025%
3% tax onincome,effective rate0%
IndianSubsidiary
No CGT
No CGT
Offshore Jurisdictions
Mauritius
India
MauritiusHoldCo
STRUCTURING OF INVESTMENTS
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STRUCTURING OF INVESTMENTS… PROFIT REPATRIATION STRATEGIES
Dividends
Only out of profitsUp to 10% transfer to reservesDividend distribution taxCreditability
Royalty/Fees for technical (included) servicesWithholding tax of 10% on gross amountRemittance subject to exchange control
Interest
Buy-back of equity shares25% of paid-up capital in one financial year
No fresh issue of same kind of shares for 6 monthsShares to be cancelled within 7 days of buy-back
Redemption of preference shares
Deferral of income recognition in the home country and maximum benefit inhome country for foreign tax credits, tax sparing and foreign losses
STRUCTURING OF INVESTMENTS
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Group Company
Mauritius Groupentity
Share
buy- backEquity
Equity Dividends
Mechanics
Group Company holds Indian operations througha Mauritius entity
Dividend payment by the Indian Company to theMauritius entity would attract Dividend DistributionTax (“DDT”) at 14.025% in India
Indian Company uses its profits to buy-back partof the equity held by the Mauritius entity (insteadof distributing dividends)
Applicable Regulations
To be made out of free reserves, securitiespremium account or proceeds of any shares/other specified security, subject to certain limits
Consideration received on buy-back of sharesordinarily taxed as capital gains
Indian Company
PROFIT REPATRIATION – BUY BACK OF SHARES
STRUCTURING OF INVESTMENTS…
STRUCTURING OF INVESTMENTS
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MechanicsInvestment structured using two holdingcompanies
HoldCo1 invests <10% of the total capitalby 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 costbasis
Buy-back of equity shares at fair value
IndCo
HoldCo2 HoldCo1(Netherlands)
EquityPreferenceRedemption
at par
Buy-back
at fair value
STRUCTURING OF INVESTMENTS… PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
STRUCTURING OF INVESTMENTS
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Benefits
Share buy-back classified ascapital gains in India
Capital gains from alienation of 10% or less participation in capitalnot taxable in India under the treaty
No taxable gains on redemption of preference shares at cost basis
Implementation IssuesStructuring of preferenceshares terms
Company law provisions
relating to share buy-backBuy-back and redemption tobe carried out in a manner toensure that HoldCo1‟sparticipation remains less
than 10%Section 902 must bemanaged
STRUCTURING OF INVESTMENTS… PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
STRUCTURING OF INVESTMENTS
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FINANCING – HYBRID INSTRUMENT
IndCo(India)
DutchFinance
Co
US Co/Holding
Co
Hybrid Debt
Interest
Equity
STRUCTURING OF INVESTMENTS…
Mechanics
US/ Hold. Co sets up/ has an existing company inIndia i.e. IndCo
IndCo is “thinly capitalized” IndCo issues “convertible debentures” to DutchFinance Co
IndCo pays arm‟s length interest to DutchFinance Co
IndCo uses debt for funding requirements
STRUCTURING OF INVESTMENTS
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Implementation Issues
Structuring of Hybrid Debt from anIndian corporate law & exchangecontrol perspective
Cost - 10% withholding tax oninterest under Dutch treaty
Possible solution in Netherlandspost January 1, 2007
“Term sheet” of the hybrid notewould be vital for effectiveimplementation
U.S. tax classification
Benefits
Convertible Debentures notsubject to External CommercialBorrowing guidelines
End-use restrictions and other
limitations not applicableIndCo eligible for interestdeduction
Participation exemption oninterest earned in Netherlandsmay also be possible
STRUCTURING OF INVESTMENTS… FINANCING – HYBRID INSTRUMENT
US STRUCTURING CONSIDERATIONS
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US STRUCTURING CONSIDERATIONS
Direct from US Defer from US tax (likely not check-the-box (CTB))Impact of DDTTransfer pricing structure
From US through Intermediary Jurisdiction Repatriation generally negates benefitof deferral, but consider CFC to CFClook-throughCTB
Profit repatriation disregardedFBC services income and impactthereof
Direct from US CTB may be beneficial but confirmability to utilize foreign tax creditsLosses can offset US taxable incomesubject to DCL and branch lossrecaptureSourcing issues on intercompanytransactions
From US through Intermediary Jurisdiction Base erosion opportunities (whether part of CTB deferral structure or usingCFC to CFC look-throughCheck the box
FBC services incomeFacilitates elimination of related partytransactions
India Tax Holiday India Full Taxation
STRUCTURING OF INVESTMENTS
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STRUCTURING OF INVESTMENTSManaging U.S. Deferral
A popular planning option for managing Subpart F has been to makea disregarded entity election for IndCo in SPV structure
Enables taxpayer to maintain deferral with respect to dividenddistributions from IndCo to SPV
This planning technique can give rise to issues with respect to theapplication and management of §954(e) with respect to related partyservice activities
Potentially problematic with respect to the application of the Branchrule of §954(d)(2)
Also applicable to “Super Holdco” structures
STRUCTURING OF INVESTMENTS
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STRUCTURING OF INVESTMENTSManaging 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 withrespect to dividends, interest, rents, and royalties received fromrelated 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 extentthere is an exposure to §954(e)
STRUCTURING OF INVESTMENTS
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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 canpresent 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 theperformance of contract R&D functions
Issues can arise under proposed §482 service/intellectual propertyregulations
Services can be transmuted into deemed IP transfers
Consider the use of cost-sharing structuresProposed cost-sharing regulations are problematic, even with respect toforeign-to-foreign cost-sharing structures
STRUCTURING OF INVESTMENTS
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STRUCTURING OF INVESTMENTSTAX EFFICIENT EXIT
Sale of shares of the Indian entityConsider “check -and- sell” option in SPV structure if IndCo notcharacterized 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 globalrestructuring
Buy-back of equity shares by the Indian entity
Redemption of preference shares
Liquidation of the Indian entity
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Acquisition Planning
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Acquisition Planning… INDIAN CONSIDERATIONS
Regulatory IssuesCarryover of incentives/holidays and other tax attributes
Special rulesMergersDemergersSlump sales
Legal integration into global structureSale of assets followed by liquidationMerger / amalgamation
Acquisition Planning
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Acquisition Planning… Growing Interest in Inversion Transactions
Recent trend of private U.S. companies seeking access to Indian capitalmarket, which applies lower-thresholds for public offerings
U.S. tax issues under §§ 367 and 7874 need to be managed
US Private
Co
IndCo
Shareholders
RestructuringUS Private
Co
IndCo
Shareholders
New IndCo
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THANK YOUNishith DesaiNishith Desai & AssociatesMumbai, [email protected]
Barton BassettFenwick & West LLPMountain [email protected]
David GillErnst & Young LLPSan [email protected]
Gagan MalikErnst & Young LLPSan [email protected]