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

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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 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

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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 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

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FLOW OF INVESTMENT INTO INDIA

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Legal Entity Considerations

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ENTITY OPTIONS

Foreign Investor

Investment

Unincorporated entity Incorporated entity

Company

India

PO BO

Offshore Jurisdictions

TrustUJV P’shipLO

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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%

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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

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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 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

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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

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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 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%

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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 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

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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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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

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



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


• debt incurred / monies borrowed and used for purposes of business or profession carried on 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





10/20%(gross)

40%(net)

10/20%(gross)

40%(net)

INDIAN TAX REGIME… WITHHOLDING TAXES

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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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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

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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”)

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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 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

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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

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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


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 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

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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 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


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)


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 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

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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 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

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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 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

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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’

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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 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

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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.

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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

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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 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

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RefreshmentBreak

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Structuring Issues and Opportunities

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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

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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

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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 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

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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

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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 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”

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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?

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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

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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

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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


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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

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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


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

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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

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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

58


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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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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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]

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...