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MOST FAVOURED JURISDICTION FOR INBOUND AND OUTBOUND

INVESTMENT

- Sandeep Tandon

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Introduction

Liberalization has boosted Foreign Direct Investment (FDI) in India.

India attractive due to its advantages of low cost of production and large size of potential markets.

Availability of qualified and skilled manpower prompts MNCs in IT sector, FMCG sector, service sector to set up base in India.

Trend of Indian companies setting up operations abroad picking up.

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OUTBOUND INVESTMENT

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Outbound Investment Prevailing exchange control regulations permit investments in

JV/WOS abroad upto 200% of net worth of Indian Party under automatic route.

Why a holding company for investing out of India is tax efficient

• Dividend income of Indian corporate shareholders from foreign companies taxed in India at a high rate of 33.66%.

• Long term capital gains and short term capital gains from sale of shares of foreign companies by Indian shareholders taxed at a high rate of 22.44% and 33.66% respectively

• High rate of tax in India makes it imperative for Indian entrepreneurs to look for tax efficient jurisdiction to locate holding company.

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Factors to be considered for outbound investment No double taxation of income

Easy access to debt and equity capital from both domestic and international capital markets.

Proper legal and regulatory framework for commercial transactions.

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Participation exemption

Fiscal incentives which an Indian entrepreneur would require for locating a holding company in a particular jurisdiction :

• Benefit of participation exemption for income accruing to corporate shareholder from its substantial shareholding (generally between 5% to 20%) in another company.

• Participation exemption provisions exempt from tax dividend income, capital gains, bonus shares etc. in the hands of the corporate shareholder.

• No tax on foreign source income of holding company in holding company’s jurisdiction.

• Wide double tax treaty network.• Exemption from withholding and other taxes on dividends declared

by, as well as capital gains income from sale of shares of, holding company by the Indian parent.

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PREFERRED JURISDICTIONSFOR

OUTBOUND INVESTMENT

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Netherlands

Dutch tax law provides the benefit of participation exemption; subject to following conditions:

• Participation of minimum 5% of paid-up capital of subsidiary which should not be held as inventory.

• Subsidiary should be subject to profit tax in foreign country.• Participation should not be mere portfolio investment.

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Netherlands

Under EU Parent-Subsidiary Directive, dividends distributed by Dutch company to qualifying entity in EU Member State not subject to dividend withholding tax, provided:

• Participation of minimum 20% (reduced to 15% from January 1, 2007) in qualifying entity held for uninterrupted period of 1 year

• Qualifying percentage reduced to 10% for participation in countries like Austria, Finland, Germany, Ireland, UK, Luxembourg and Spain

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Netherlands

Since India is not EU Member State, dividend withholding tax of 10% to apply on dividends declared by Dutch subsidiary to Indian parent

Advance Tax Rulings can be obtained by foreign investors on issues covering applicability of participation exemption, permanent establishment etc. which provides certainty of tax consequences

Foregoing advantages make Netherlands tax effective jurisdiction for routing investments to foreign countries, especially in the EU.

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Singapore

Tax exemption provided for foreign source dividend, foreign branch dividend and foreign source service income received in Singapore, if the following conditions are fulfilled:

• Highest rate of corporate tax in country from which foreign income received should be minimum 15%

• Foreign income should be taxed in country of source

No withholding tax on dividends in Singapore

Offshore income taxed in Singapore only when remitted to Singapore

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Singapore

Foreign source income of Singaporean holding company can either be retained outside Singapore or remitted to Singapore if above conditions for availing tax exemption are fulfilled

Indian entrepreneur can set up a Singaporean holding company which earns dividends and capital gains income from foreign subsidiaries or income from foreign branches without any liability to tax in Singapore

Singaporean Holding Company can declare dividends to Indian parent without any incidence of withholding tax in Singapore

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Singapore

Singapore also provides tax holiday for periods from 5 to 15 years in respect of specified business activities under the Pioneer Scheme offered by Economic Development Board, Singapore (EDB)

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Luxembourg

Tax regime provides for 2 types of holding companies to be set up:

• Resident company (SOPARFI) which is entitled to Double tax treaty benefits and benefits of all EU Directives including Parent Subsidiary Directive

• Holding 29 companies with limited activity of holding investment which are exempt from income and capital gains taxes, but cannot avail of the benefits of EU Parent Subsidiary Directive and Double Tax Treaties

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Luxembourg

Exemption from tax on dividend income and capital gains is provided to a SOPARFI (or a Luxembourg branch of a company resident either in a EU Member State or country with which Luxembourg has a Double Tax treaty), subject to fulfillment of following conditions:

• Participation of minimum 10% of subsidiary’s capital or acquisition of investment at minimum cost of Euro 1.2 million (Euro 6 million for exemption from capital gains)

• Participation in EU member state or country which levies corporate tax comparable to Luxembourg corporate tax at a rate of minimum 11%

• Participation to be held for minimum 12 months’ period

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Luxembourg

Dividend withholding tax is not applicable to dividends distributed by SOPARFI, provided following conditions are fulfilled:

• Recipient must hold minimum 10% participation in SOPARFI or has invested minimum Euro 1.2 million

• Recipient should have held participation in SOPARFI for minimum 12 months

• Recipient should be a company resident in EU Member State or Luxembourg branch of company resident either in EU Member State or country with which Luxembourg has a Double Tax Treaty

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Luxembourg

Luxembourg an attractive jurisdiction for holding company for investment in EU and other countries with which Luxembourg has a Double Tax Treaty

Dividends declared by Luxembourg holding company to Indian parent would suffer withholding tax @ 20% in Luxembourg

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Ireland

Participation exemption from capital gains tax introduced in 2004 making Ireland a jurisdiction to consider for locating holding company

No withholding tax on dividends distributed by Irish resident company, provided recipient is:

• Company resident in another EU Member State or tax treaty country and which is not controlled more than 50% by Irish residents; or

• Under ultimate control of persons resident in another EU Member State or tax treaty country; or

• Company whose shares are substantially and regularly traded on a recognized stock exchange

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Ireland

Foreign dividends received by Irish company are however subjected to a 25% tax, although impact is mitigated due to onshore single basket pooling of all foreign tax credits including foreign underlying tax

Attractive corporate tax rate of 12.5% applicable to trading profits

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Spain

Participation exemption for qualified foreign source dividend and capital gains income of holding company (ETVE), if the following requirements are met :

• ETVE holds direct or indirect participation of minimum 5% or investment amount is minimum Euro 6 million

• ETVE must hold shares for uninterrupted period of 1 year• Foreign entity should be resident in country having double tax treaty

with Spain with exchange of information provision• Foreign entity must not be resident in a tax haven and 85% of its

profits must be derived from business activities in countries other than tax havens

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Spain

ETVE can redistribute qualifying foreign source income without any incidence of withholding tax in Spain, subject to fulfillment of following conditions:

• Existence of reasonable and adequate substance in ETVE• Dividends are distributed to non-resident shareholders (except

those resident in tax haven) out of exempt dividend income of ETVE

Capital gains income accruing to non-resident shareholders on transfer of participation in ETVE not liable to tax in Spain to the extent gains do not exceed undistributed profits of ETVE comprising of exempt dividends, capital gains income and appreciation in value of foreign qualifying participated subsidiaries

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Spain

ETVE tax regime allows Indian entrepreneurs to remit profits earned in operating companies in EU to parent in India without any tax incidence in Spain

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Limitation of benefits provision

Use by residents of third states of legal entities established in Contracting State with principal purpose of obtaining benefits of tax treaty between that Contracting State and another Contracting State is “treaty shopping”.

All recent US tax treaties contain comprehensive limitation on benefits provision to ensure that source based tax benefits granted by a Contracting State are limited to intended beneficiaries i.e. residents of other Contracting State

Series of objective tests laid down in US tax treaties to ensure that third country residents having substantial business reasons for establishing a structure do not fall within mischief of these provisions

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INBOUND INVESTMENT

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Inbound Investment

Foreign Direct Investment (FDI) under automatic route upto 100% in manufacturing sector and capped at levels between 26% and 74% in sectors like telecommunication, banking, insurance etc.

Policy relating to issue of GDRs, FCCBs etc., relaxed to allow easy access to international capital markets

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Major direct tax incentives available to foreign investors in India Tax Holiday for a specified number of years to specified business

activities in infrastructure sector, housing sector, telecom and information technology sector etc.

Special Economic Zones Act, 2005 provides major direct and indirect tax incentives to developers of Special Economic Zones (SEZs) and units set up in SEZs

Interest and capital gains income from long term investment in infrastructure projects exempt from tax

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Factors driving FDI in India

No double taxation of profits

No withholding or other taxes on dividend income and capital gains income derived from the operating subsidiary located in India

Exemption from withholding taxes in respect of dividends declared by the holding company to the ultimate parent

Access to capital markets

Proper legal and regulatory framework

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Why a holding company for investing in India is tax efficient ?

To mitigate the Indian income tax liability on capital gains income arising on sale of unlisted shares of an Indian Company, foreign investors need to locate holding company in tax efficient jurisdiction

Double Tax Treaties entered into by India with various countries to be analyzed to identify tax efficient jurisdiction

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PREFERRED JURISDICTIONSFOR

INBOUND INVESTMENT

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Singapore

Comprehensive Economic Co-operation Agreement (CECA) signed between India and Singapore a landmark step

Under the amended Double tax treaty between India and Singapore, capital gains income accruing to a Singaporean company in respect of sale of shares of an Indian company are fully exempt from tax in India

Capital gains tax exemption to continue to be in force so long as a similar provision exists in Indo-Mauritius Double Tax Treaty

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Singapore

Anti-abuse provisions built in the Treaty to ensure that the above benefit is denied to residents whose affairs are primarily arranged to take advantage of above provisions

No tax on capital gains income in Singapore

Complete exemption from capital gains tax both in India and Singapore coupled with the fact that Singapore has highly developed financial markets makes Singapore attractive for investment into India

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Mauritius

Under Mauritian tax law, Global Business License 1 (GBL1 companies) can conduct offshore business activities and are entitled to lower corporate tax-incentive rate of 15%

Deemed foreign tax credit equal to 80 per cent of Mauritian tax chargeable on foreign source income is allowed bringing the effective rate of corporate tax for GBL1 companies down to 3%

GBL1 companies can claim benefits of India-Mauritius Double Tax Treaty which provides complete tax exemption to Mauritian tax residents in respect of capital gains income arising on sale of shares of an Indian company

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Mauritius

No capital gains tax in Mauritius enabling Mauritian tax residents to earn completely tax free capital gains income from sale of shares of Indian company

Indian Supreme Court’s ruling in Azadi Bachao Andolan’s case has laid down the clear law that where a Mauritian entity has been issued “tax residency certificate” by Mauritian tax authorities, benefits of Indo-Mauritian tax treaty would be available

No withholding tax on distribution of dividends to parent

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Cyprus

Full exemption from tax on capital gains income accruing to a Cyprus resident from sale of shares of an Indian company under the Indo-Cyprus Double Tax Treaty

No withholding tax on distribution of dividends to parent

Corporate rate of tax of 10 per cent

No major investment into India from Cyprus due to lack of advanced regulatory and financial controls and political climate

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UAE

Under the Indo-UAE Double Tax Treaty, no tax in India on capital gains income earned by a UAE resident from disposal of shares of Indian company

No corporate tax and capital gains tax in UAE

No withholding tax on distribution of dividends to parent

Advance Ruling in Cyril Eugene Pereira’s case has created uncertainty as to whether holding company in UAE, which has no tax liability in UAE, would be entitled to the benefit of the Indo-UAE Double Tax Treaty

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Conclusion

Netherlands, Singapore and Spain are tax effective jurisdictions for outbound investments from India

Singapore and Mauritius are tax effective jurisdictions for inbound investments into India

Urgent need to review current Indian tax laws relating to taxability of income earned by Indian resident from overseas investments

Concept of participation exemption should be introduced in India

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THANK YOU