Practical issues in international tax - Bangalore ICAIPage 4 Change in corporate tax rates Country...

Practical issues in international taxInstitute of Chartered Accountants of India22 January 2010

Agenda

► Global trends in international tax

► Part I – inbound investment ► Foreign investments into India► Choice of legal entity► Choice of investment instrument► Choice of holding structure► Practical Issues

► Part II – outbound investment► Outbound market in India► Exchange control aspects► Key considerations ► Entity structuring

► Part III – transfer pricing ► Global trends► Key challenges► Managing challenges

Global trends in international tax policy

► Reduction in corporate tax rates ► 90% of OECD countries (27 of 30) reduced their top corporate tax rate

since 2000. US and Japan remain exceptions.► Two-thirds of the top 50 countries have reduced their corporate tax rate in

the last eight years.► The average corporate income tax rate for the top 50 countries has fallen

from 37.5% in 2000 to 32.5% in 2008, an average drop of 13%.

► Move towards territorial approach of taxation.► Within the last six months, both the UK and Japan have replaced their

worldwide tax systems with territorial tax systems.► Recent US international tax proposals go against this trend.

Change in corporate tax rates

Country 2009 statutory corporate tax rate

2000 statutory corporate tax rate

Percent change

US 39.5 39.4 0%Japan 41.3 43.3 (5%)Germany 33.0 52.0 (37%)China 25.0 33.0 (24%)UK 28.0 30.0 (7%)France 34.4 37.8 (9%)Italy 30.3 39.5 (23%)Spain 30.0 35.0 (14%)Canada 33.0 43.6 (24%)Brazil 34.0 34.0 0%Russian Federation 20.0 35.0 (43%)India 34.0 42.0 (19%)

Global fiscal stimulus

► Accelerated tax depreciation► Designed to improve cash flows through accelerated write-off of

investments► Some countries have targeted certain type of investment activity, or

allowed enhanced “bonus” depreciation allowances► Loss carry forward and loss carry back provisions

► Designed to provide cash flow assistance to loss making companies ► Countries have increased the period of carry forward of tax losses / loss

carry back provisions have been enhanced► Increase in research and development incentives

► Designed to attract investment in innovation and to ensure that companies do not reduce their R&D activity in recessionary times

► Most countries have increased the rate of credit / added carry back and refund provisions to their R&D provisions

Global fiscal stimulus

► Reduced tax rates or tax rebates for individuals► General measures designed to increase after tax pay, and thereby overall

demand► Most countries expanding the range of deductible items while some

countries have lowered personal tax rates

► Lower indirect taxes and enhanced payment schedules► Countries have sought to lower the cost of goods and services by

temporarily lowering indirect taxes such as VAT► Some countries have undertaken targeted cuts (Brazil and China have

enacted special measures related to purchase of Automobiles)► Some countries have focussed on improving cash flows through more

efficient grant of VAT credit

Global tax enforcement

► Governments' need for tax revenues to fund their stimulus packages.► The US stepping up enforcement of international tax compliance under

the new Obama government.► OECD and G20 commitments made to impose sanctions on tax havens

and jurisdictions that have not adopted the internationally agreed tax standard

► Increasing trend for countries to independently legislate against overseas tax havens – Spain, Italy etc

► Trend of increased scrutiny on perceived abusive tax transactions (e.g., India and China).

► Countries like Austria, Switzerland and Luxembourg have initiated measures to bring their bank secrecy laws in line with OECD and G-20 standards

Part I – Inbound Investment

** Up to Aug’09 – extrapolated for 12 months

► Over the past 10 years,

there has been significant

in crease in the foreign

investment inflow

► However, in 2008-09, due

to economic crisis, foreign

investment in India has

significantly reduced on

account fall in portfolio

investments. Data for

2009-10 shows the revival

of investment

Foreign investments in India*

* Source: RBI website

-20

-10

0

10

20

30

40

50

Fore

ign

inve

stm

ent

in b

illio

n U

SD

Year

Direct InvestmentPortfolio Investment

► Legal consideration

► Foreign Exchange regulations

► Mode of investing: FDI, FVCI

► Cap on FDI

► Choice of Entity Structure

► Choice of Investment Instrument

► Withholding Tax Planning

► Indirect Tax Planning

► Transfer pricing challenges

► Permanent establishment (PE) and profit attribution risks

► Treaty shopping and anti-avoidance rules

► International Holding Structures

► Direct Holding v Use of Intermediate Holding

► Choice of jurisdiction for Holding Company

Regulatory Aspects Operations Tax Planning

Managing Tax Risks Exit Tax Planning

Inbound Investment Involves

Choice of legal entity

Foreign Investor

Unincorporated entities Incorporated entities

Branch Office

Project Office

Liaison Office SubsidiaryJoint Ventures

Partnerships

LLPUnlimited partnership

► Flexibility in carrying out operations

► Tax efficiencies

► Regulatory compliances

► Efficiency in capital raising

Relevance of choice of business entity

PE and Income Attribution issues Dividend Distribution Tax Issues Exchange Control Issues

Choice of investment instrument

Hybrid instruments Debt

No end use restriction Specified end use restrictions

► Tax arbitrage may be available on interest payouts► No tax break on payment of dividends

Equity / ADRs/GRDs

Foreign investor

ECBFCCBsOptionally convertible

preference shares / debentures

Compulsorily convertible preference

shares / debentures

Equity instruments

► Commercial objectives► Regulatory constraints► Tax considerations

Relevance of choice of instrument

Choice of holding structure

Foreign investor

Indian company

Intermediate holding company

In tax favourable jurisdiction

Mauritius

Netherlands

Singapore

Cyprus

Sample of inbound jurisdictions Typical inbound structure

Treaty taxation in tax favored jurisdictions

Income streams Mauritius Cyprus Singapore# Netherlands

Dividends Tax exempt – DDT of 16.995% paid by Indian company

Capital gains Not taxable Not taxable Not taxable Not taxable*

Interest 20%/ 40%** 10% 15% 10%

Royalty 10%** 10%** 10% 10%

Fees for technical services 10%** 10% 10% 10%

# Subject to fulfillment of anti-abuse conditions* In certain cases** Surcharge and educational cess additionally applicable

► Increased focus of tax authorities on transactions with tax haven entities

► Business purpose and substance

► Transfer pricing challenges

► PE and income attribution risks

► Withholding tax risks

► Treaty eligibility issues

► Income classification conflicts

► Section 195 certification

► PAN requirement

► Indirect tax costs

Practical Issues

Part II – Outbound Investment

Case Study

► Indian company exploring sales in the US market. Indian Co hires a full-time sales representatives in the U.S. These representatives will identify potential customers and refer to Indian company but they will not any authority to bind Company contractually. The Company will not provide any office space, either directly or through reimbursement. The representatives must submit all their orders to Indian Company for review and shipping with approvals. They will also not perform any services related to training, warranty or repair, account collection or after-sales activities.

What are the practical obligations of the Indian Company in the U.S.?

Case Study

► Because Indian Company is eligible for treaty benefits, the PE requirements of the Treaty would apply to determine whether there is a US tax liability. In the present case, the activities should not rise to a PE even though sales representatives are employees of the Company on the US soil.

► Company must do the following:

► Establish a US payroll, generally by opening US bank account and hiring a US payroll service provider to handle disbursements, withholdings and filings

► Obtain US and appropriate state taxpayer identification numbers

► File annually a treaty-based (information disclosure only) Form 1120-F

► Collect and remit sales tax on tangible property unless the goods are resold by each of its customers

► Review state and local tax liabilities

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Outbound Market – An Overview

► India: Moving away from inbound to outbound market.

► Changing Investment Trends!► From back office to main stage

► From agents and distributors to direct presence with a footprint in Europe through M&A’s for strategic reasons

► Deals making headlines..► Tata Motors’s acquisition of Land

Rover and Jaguar US $2.3B

► Tata Steel’s acquisition of Corus US$12B

► Hindalco’s Acquisition of Novellis US$6B

► Wipro’s Acquisition of Info crossing US$600m

Exchange Control Aspects

► Investment in companies outside India would constitute Overseas Direct Investment (ODI) and would be subject to exchange control regulations.

► Direct Investment by Residents in JV/ WOS

► ODI is permitted in every activity except real estate and banking

► Investment possible through automatic route and approval route

► ODI** investments upto 400% of Net Worth* (i.e. paid up capital and free reserves) as on date of last audited balance sheet is permitted under the automatic route. The Indian company is required to make an Application to the AD in form ODI

► In case of existing foreign company, valuation of shares by a merchant banker/chartered accountant is required

* Limit not to apply if the ODI is funded through balances in EEFC A/c or from ADR/ GDR proceeds

** ODI includes the amount of direct investment outside India by way of contribution to equity and loans and100% of the amount of guarantee issued by an Indian party on behalf of its overseas entity.

21

1. Should I use a company, branch, partnership or other type of entity to make the acquisition?

2. Should the acquisition be done as a share purchase or as an asset purchase?

3. How am I going to fund the acquisition?

4. Can I get a tax deduction in more than one jurisdiction for my borrowings?

5. Do I need to consider setting up a holding company outside India? In deciding this I need to consider whether I am going to use profits from my acquisitions to fund further acquisitions outside India or whether I intend bringing funds back to India.

Top 10 Questions

22

6. Will I get tax depreciation for goodwill and other Intellectual Property Rights I acquire?

7. Do I need to consider consolidating my Intellectual Property Rights?

8. How do I integrate my newly acquired subsidiaries and my existing operations in a manner that gives me maximum operational and tax benefits?

9. If I am going to integrate my supply chain what tax efficiencies can I achieve in the process?

10. How do I best structure my transfer price to maximize business and tax benefits while minimizing the risk of time consuming and costly Transfer Pricing audits?

Top 10 Questions

Janu

ary

22, 2

010

23

• Complex international tax environment in U.S./ Europe

• International tax environment in most Asian countries still evolving

• Increased tax/ transfer pricing risks as Indian companies globalize operations

• Entity Structuring

• Structuring of International Acquisitions

• International Holding Structures

• Post-acquisition Structuring

• Increase in inter-company transactions as Indian companies acquire foreign groups

• TP documentation requirements in most countries

• Need to align TP policies and practices across entities

• Multi-jurisdiction documentation compliance requirements

• Indian regulatory aspects

• Achieving tax-efficient circulation of cash within foreign structure

• Repatriation planning for mitigating India tax costs

• Foreign Tax Credit Issues

• Phase-out of export related (non-SEZ) incentives

Foreign Country Risks Outbound Structuring

Global Transfer Pricing India ConsiderationsKey Considerations

Entity Structuring

LegalEntityBranch

Hybrid Entity

Choice of Entity Structures

► Losses can be consolidated but inability to defer India tax

► Income attribution issues

► Taxation in India deferred until repatriation

► Economic double taxation on repatriation

► Can combine benefits of corporate form with flexibility of partnerships

► Opportunities for tax arbitrage on account of conflict in classification

25

Taxation of Dividends

Foreign Sub Tax

Profit 100

Tax 35

Net Dividend 65

ParentParent

Foreign SubForeign Sub

Foreign Sub Tax

Profit 100

Tax 35

Net Dividend 65

Parent Tax

Taxable Profit 100

Tax (34%) 34

Double Tax Credit (35)

Additional Tax Nil Dividend 65

INDIAN SYSTEMParent Tax

Taxable Profit 65

Tax (34%) 22

Double Tax Credit (0)

Additional Tax 22

“TYPICAL” SYSTEM

Total Tax 35 Total Tax 57

26

Branch Vs Subsidiary

IndiaIndia

Foreign BranchForeign Branch

IndiaIndia

Foreign SubForeign Sub

FOREIGN TAXProfit 100Tax 35Net Dividend 65

FOREIGN TAXBranch Profit 100Tax 35Net Branch Profit 65

INDIA TAXProfit 65Tax 22Distributable Profits 43

ETR 57%

INDIA TAX

Branch Profit 100India Tax 34

Credit 34 (max)

Additional India Tax NILETR 35%

Holding Co Strategy

Indian Parent

WOS/ Branch

Direct investment

Indian Parent

Regional Holding Companies

Operating Company/ies in US/UK/Europe

Step down investment

Indian Parent

Regional Holding Companies

OperatingCompany/ies in US/UK/Europe

Double step down investment

Super Holding Company

Why use a Holding Company?

Tax Considerations Commercial Considerations

– Regional management of operations

– Pooling of funds for reinvestment

– Access to regional capital markets (listing, borrowing, etc.)

– Central ownership of important assets (e.g. IPs)

– Overcome the difficulties due to different time zones, cultures, etc.

– Consolidating and enhancing the overall efficiency and shareholder value

– Reduce WHT on income from subsidiary

– Reduce/ defer tax liability on divestments

– Maximise foreign tax credits/minimise excess credits

– Extended deferral of tax– Exit efficiency

Part III – Transfer Pricing

Most important tax issues for tax directors*

*Ernst &Young Transfer Pricing Survey, 2009

Global trends

► Changing environment► “New wave” of entrants to enforcement of transfer pricing► “Old guard” making significant changes to approaches

► Importance of risk management► Focus of tax authorities on practices and industries perceived to

have greatest revenue leakage

► Trends► Towards OECD norms and guidelines in principle► Major divergence of approaches in practice► Threatens resolution of bilateral disputes► Increase in number of cases going for litigation

Global trends (cont’d.)

► Tax authority approaches► Increased sophistication in data gathering

► Scrutiny more sophisticated – complex transactions

► Resource and training enhanced

► Recent OECD developments► Profit based methods & comparability issues

► Dispute resolution

► Income attribution to PE

► Transfer pricing aspects of business re-structuring

► Overall► TP continues to be, and will remain, the most important tax issue facing

Multinational Enterprises (MNEs)

Key challenges

► Intangibles

► Intra-group charges for use of IP/ Services

► Use of secret comparables

► Impact of economic downturn

► PE income attribution

► Business re-structuring issues

Managing challenges

► Need for comprehensive documentation for all inter-company transactions

► Exceptions to global transfer pricing policy/common structures may be required

► Aggressive Revenue approach and punitive interest & penalty provisions will present a formidable challenge in coming years

► Full range of dispute resolution mechanisms, including MAP and DRPs, need consideration

► Review of existing supply chain structures from a PE exposure/ Income Attribution perspective

Thank you

Pramod Kumar SAssociate Director, International Tax & Transfer Pricing

► Pramod has over 12 years of professional experience as Indian tax advisor.

In last couple of years, Pramod led the Indian Tax Desk based out of San Jose, USA and served the Ernst & Young’s North American clientele on Indian transfer pricing and tax issues. Before joining the US practice to set up India tax desk, Pramod worked with Ernst & Young’s Transfer Pricing practice and supervised several large international tax structuring and transfer pricing projects out of Bangalore, Hyderabad and Chennai.

► He served a wide range of Indian and global companies in different industry verticals during his career. He advised clients on Indian ownership structures, tax efficient financing, and repatriation structures for doing business in India.

BackgroundEducation Chartered Accountant;

Bachelors in Commerce

Specialty areas

International TaxTransfer Pricing Supply chain planningCross border structuring

Direct +91 80 4027 5273

Board +91 80 4027 5000

Email [email protected]

► His experience includes Indian planning for IP licensing structures, transfer pricing design and tax-efficient supply chain structures in India. He has also been involved in Indian mergers and acquisitions (M&A) planning and group re-structuring projects for many years.

► He has considerable experience in advising companies on transfer pricing planning, documentation and controversy management.

mailto:[email protected]

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