Investments In India State Fo Art And Law

© Nishith Desai Associates1

Investments in India: State of the Art and Law

Nishith M Desai Nishith Desai Associates

Legal and Tax Counseling WorldwideMumbai Silicon Valley Bangalore Singapore

June 22, 2007


Are we headed towards a

‘Digital Divide’?


Worlds largest democracy GDP growth rate for 2006-07:

9.2% Rising young population Parliamentary form of

Government World-class recognition in IT and

bio- technology Services sector contributing

approximately 55.1% 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


Science of investments into

India


USA

India


Art of investments into India



Key Considerations

Tax

LawStrategy

Environment

Operations

Exchange Control

Corporate

Domestic Treaty


How do we Invest?


Investment Regime

Foreign Direct Investor (FDI)

Foreign Institutional Investor (FII)

Foreign Venture Capital Investor (FVCI)

Non-resident Indian Investor (NRI)


FDI

– 100% foreign investment permitted in almost 95% sectors on automatic basis except:

Banking (74%) Telecom services (74%), Civil Aviation (49%), Insurance (26%), etc.

– 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 (19 activities – fee based and fund based)

Real estate construction and development projects


Investment Management Agreement

Cayman Co Delaware LLC

U.S. taxable investors

Investment SPV

Investment SPV / JV

FDI / FVCI Compliant Investments

Investment Manager

Mauritius

U.S. tax-exempt investors &Non-U.S. investors

Cayman Feeder Delaware Feeder

Mauritius Master Fund MASTER FUND (FDI)

India

InvestmentManager

Investment AdvisorIndian

Advisor

100%

Advisory Agreement

100%

100%

100% 100%

Management Fees / Carry

FVCI Subsidiary

100%

Cyprus-based subsidiary (Debt)

Cyprus

STRUCTURING… FDI/FVCI


Types of Instruments

Compulsorily Convertible - FDI

Equity

Preference Shares

Compulsorily Convertible - FDI

Optionally Convertible - ECB*

Non – Convertible - ECB

Debentures

Optionally Convertible - ECB Non – Convertible - ECB

*ECB – External Commercial Borrowings


FII Primarily used for investing into public securities

Holding up to 10% of the company Aggregate holding capped at 24% / sectoral caps

Investment in listed and unlisted securities

No co-mingling of proprietary and client funds

Types of sub-accounts – broad based, proprietary, foreign corporation, foreign individual

FIIs cannot issue participatory notes to unregulated entities*

* The SEBI has issued a circular stating that the following entities are deemed to be regulated entities:

An entity incorporated in a jurisdiction that requires the constitutional documents with a regulatory authority, an entity that is regulated or supervised by a central bank, a security or futures commission, is a member of a security or futures commission or whose investment advisory function is managed by a regulated entity.


NRI Regime

Press Note 2 (2005) restrictions on real estate not applicable to NRI’s

NRI’s can acquire immoveable property in India

No Restrictions on transfer of shares by an NRI

NRI and NRI owned companies (OCB’s) registered with the RBI cannot invest through the FII route


What are entity options in India?


Entity Options

Foreign Investor

Investment

Unincorporated entity Incorporated entity

Company

India

Project Office

Branch Office

Offshore Jurisdictions

TrustLiaison Office


Entity Options; New Vehicles

India is proposing to introduce a Limited Liability Partnership regime. The LLP legislation is

currently in draft form.


Taxes -Is India

backtracking?


Domestic company : 33.99%;

Foreign company : 42.23%

Dividend distribution tax : 16.995%

Capital gains tax on

exit or restructuring : 0% to 42.23% (long/short-term)

Withholding taxes : nagging problems

Minimum Alternate Tax :Domestic companies: raised from 11.22% to 11.33%

Foreign companies: raised from 10.46% to 10.558%

Fringe Benefits Tax : 31.37% on specified value of certain fringe

benefits

Indian Tax Overview

Disallowance of expenses+


49.31= Dividends distributed to Shareholder

10.10Less: Dividend Distribution Tax (16.995%)

59.41= Profits available for distribution

6.60Less: Transfer to reserve (10% of PAT)

66.01= Profits After Tax (“PAT”)

33.99Less: Corporate Tax on the same (33.99%)

100Taxable income

Amt (US$)Particulars

Flow of Dividends

Tax Treatment in India


49.31= Dividends distributed to Shareholder

10.10Less: Dividend Distribution Tax (16.995%)

59.41= Profits available for distribution

6.60Less: Transfer to reserve (10% of PAT)

66.01= Profits After Tax (“PAT”)

33.99Less: Corporate Tax on the same (33.99%)

100Taxable income


Flow of Dividends to US

32.05= Profits After Tax

17.26Less: US Corporate Tax on the same (35%)#

49.31Taxable income


# Underlying tax credit may not be available in the US for US resident individuals and corporate shareholder holding less than 10% of the voting stock of the Indian company

Tax Treatment in India

Tax Treatment in the US


How do you mitigate the Indian tax impact?

Push Debt into Indian Company


Can you push Debt into Indian company?


No! Unless you comply with

External Commercial Borrowings Guidelines

under Exchange Control Laws


Eligible Borrower – Any company, except an NBFC

Eligible Lender – 25% Equity Shareholder or any Bank, etc.

Rate of interest – 150/250 basis point over 6 month LIBOR, depending on the tenure

End Use restrictions – cannot be used for working capital, on lending, towards real estate (except for development of industrial park, SEZ etc.)

Borrowings From Abroad


What about tax on interest?


On monies lent in Foreign currency – 21.115%

On Foreign Currency Convertible Bonds – 10.558%

On monies lent in Indian Rupees - 42.23%

Tax Rates on Interest on Foreign Companies


How do you reduce tax on interest?


Consider CyprusTax Rate reduced to 10%

Use Cyprus for equity too?


Capital Gains

30/40% STCG

10%Listed shares off the stock exchange: LTCG

0%Listed shares on the stock exchange#: LTCG

30/40% STCG**

10% STCG

20% Unlisted shares: LTCG*

Tax^ Type of Gains

^These rates are exclusive of the currently applicable surcharge on tax and education cess

* 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

# Sale on the stock exchange shall attract Security Transaction Tax at applicable rates


Potential double taxation of capital gains tax in the US due to systemic differences.... Credit for Indian tax paid may not be available in the US


How do you avoid double taxation on Capital Gains?


USE:

MauritiusCyprus (?)Singapore

Or Netherlands


Mauritius

USA

UK

Netherlands

Japan

Germany

Singapore

France

South Korea

Switzerland

0 20000 40000 60000 80000 100000

US$ in mn

Series1

Flow of Funds into India**dipp.nic.in/fdi_statistics/india_fdi_dec_2006.pdf


Venture Capital Funds


Alternative 1: Pure Domestic and Offshore Structures

TAX STRUCTURING…

Fund (VCF)Fund (VCF)

VCUVCU

TrusteeTrustee ManagerManager

VCUVCU AdvisorAdvisor

Offshore Investors

Feeder Fund

Master FundMaster Fund

Tax

Haven

Treaty

Jurisdiction

India


ManagerManager


Alternative 2: Unified Structure

VCUVCU

ManagerManagerVCFVCF

TrusteeTrustee

Offshore Investors

FundFund

Domestic Investors

Treaty Jurisdiction


India

TAX STRUCTURING…


Alternative 3: Co-investment Structure

Advisor /ManagerAdvisor /Manager

VCFVCF

TrusteeTrustee

Domestic Investors

ManagerManagerFundFund

VCUVCU

Offshore Investors

India

Treaty Jurisdiction


TAX STRUCTURING…


How are Earn-outs taxed?


Taxation of Earn – Outs

Acquiring Co

Target Founder-employees

ACQUISITION

Earn out paymentsPurchase Price


Taxation of Earn Outs

Surge in M & As - ‘Earn outs’ becoming a popular mode of making payment

Complex issues relating to taxation

– Capital Gains taxed in the year of transfer of asset

• Whether contingent / un-quantified capital gains are taxable in the year of transfer?

• How such tax will be payable?

– Whether Earn outs can be considered to be salary? (AAR ruling in the case of In Re Anurag Jain)


Taxation of Earn Outs…

– In Re Anurag Jain

Share Purchase Agreement - Consideration in form of upfront payment + Earn out (paid by Acquirer)

Earn out linked to continued employment + EBITDA of the company

Held: Earn out has a direct nexus with the employment being rendered and would be characterised as salary

Analysis: – No Employer- Employee relationship between the Acquirer

and key managerial personnel– Earn out should be taxable as “Other Income” but not

salary


How do you flip a US Parent with an Indian

subsidiary?


Flipping a structure: Inversion

US Parent

India Sub

US

INDIA

100%

Founders Employees

VCsOthers

Current structure


Flipping a structure: Inversion

Significant US Tax Impact

US Sub

India Parent

US

INDIA

100%

Founders Employee

s

VCsOther

s

After Flip


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Investments In India State Fo Art And Law