0 Presentation on tax issues – Inbound & Outbound December, 2013

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Presentation on tax issues – Inbound & Outbound

December, 2013

Agenda

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Setting the context1

Key Challenges 2

Key Considerations for inbound investments3

Forms of business presence for foreign companies4

Capital structuring5

Cross border tax issues6

Agenda…. (Contd.)

3

Indirect transfer of shares7

Acquisition tax issues8

Key considerations for outbound investments9

Forms of business presence overseas 10

Use of International holding company11

Proposed Direct Tax Code - Impact on outbound investments

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Setting the Context

Setting the Context… the Indian tax climate

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Dynamic and evolving tax environment to impact present and future investment cycle

Tax on indirect transfer – ambiguity in provisions

Transfer pricing legislations/ litigations – impact on structures

Proposed CFC Regulations – planning future investments?

Eligibility to Treaty benefits and unilateral treaty override

Retrospective amendments – uncertainty on investment structure

Introduction of GAAR provisions – substance over form

Key Challenges

Key Challenges

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Effective tax rate of 33.99% for domestic companies and 43.26% for foreign companies

Additionally levy of Dividend distribution tax 16.99% on domestic companies brings the ETR to 43.5%

Use of tax treaties for planning investments Vs. eligibility of benefits

Capital structuring Vs. tax impact of returns

Withholding tax obligations in India on interest, royalties, fee for technical services, requirement of obtaining a PAN in India

Tax incentives available under the domestic tax regime

Key Challenges

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Acquisition tax issues where presence is via inorganic route

Exit taxes on share sale @ 20% Vs. 30%

Tax laws in the home country of the investor relating to outbound investments viz. CFC, tax credits

Retrospective amendments impacting established structures

Rising litigation and uncertain tax positions

Ambiguity surrounding new laws and lack of well defined rules

Key considerations – planning inbound investments

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EconomicPolitical Cultural Legal Financial Technology

System

Stability

Philosophy

Risk Social System

Ethics

Religion

Diversity Resources

Purchasingpower

Exchange rates

Demographics

Corporate Laws

Regulations

Tax Laws

JudiciarySystem

Fund availability

Investor value

Banking System

Growth rate

Savings

Capital formation

Labour Laws

Environment

Factors impacting decision making

Key considerations

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RepatriationExit

GroomingStructuringGetting Started

• Entry Strategy

– Appropriate jurisdiction planning

– Eligibility to claim tax treaty benefits

• Available Entry Routes – FDI, FII, FVCI

• Time Frame

• Regulatory Outlook

• Deal pricing

– Adherence to prescribed benchmark price/ floor price

• Tax efficiency

– Availability of business losses and unabsorbed depreciation

• Instruments/ Modes of funding – Equity, Convertibles, Debt, Warrants, FCEBs, FCCBs

• Commercial objectives

• Modes of Repatriation

– Periodic/ steady cash flows – Dividends, Interest

– Periodic/ selective buy-back

– Growth capital with bullet payment at the end of the investment horizon

• Planning tax efficiency

• Timing

• Income characterization – a critical determinant

• Exit options

– Floatation

– Buy-back

– Secondary market/ trade sale

• Pricing

• Planning tax efficiency

• Regulatory implications

Inbound investment life cycle

Questions to be answered?

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Form of entity to be established – business presence in India?

Form of Instrument in which investment to be made – Equity, Debt, Preferred Capital

Whether to invest directly or through an Intermediate Holding Company (‘IHC’)

Structure the tax considerations effectively during the lifecycle of the India investment

Repatriation and exit strategies

Key Challenges

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Maximising shareholder value

Minimising global tax costs

Alignment with investor objectives

Ease in intra-group funds flow

Determination of efficient intermediate jurisdictions for positioning of SPVs

Compliance with tax, regulatory and legal framework in India and in the relevant host country

Considerations for fundraising

Forms of business presence

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Wholly owned subsidiary Joint VentureBranch Office /

Project OfficeLiaison Office

Technology Transfer & Licensing Agreement

Services Agreement

Entity options

Other Options

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Particulars Liaison Office Project Office Branch OfficeWholly owned subsidiary/

Joint Venture

ActivitiesRepresentation/ communication

only

Execution of specific projects

Specified permissible

activities

Automatic/ prior approval route

TaxationGenerally a non-taxable presence

43.26% 43.26% 33.99% plus DDT 16.995%

Unincorporated entities Incorporated entities

Limited Liability Partnership Act, 2008 enacted in 2009

LLPs combine limited liability of companies and flexibility of partnerships

FDI in LLP permitted subject to prior FIPB Approval

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Forms of business presence – a comparison

Particulars Liaison Office Project Office Branch OfficeWholly owned

subsidiary/ Joint Venture

PurposeLiaison activities i.e. it acts as a channel of

communication

Executing a project in India

Permitted RBI activities - export, import, consultancy

research etc.

Permitted to carry out wide number of activities subject

to FDI guidelines

Legal form Extension of the ParentExtension of the

ParentExtension of the

ParentSeparate legal entity

Taxable presence

Does not per se result in taxable presence

Taxable presence Taxable presenceTaxed as an independent

legal entity

Tax ratesNA - Purpose is not

income earningRates applicable to Foreign company

Rates applicable to Foreign company

Rates applicable to Foreign company

Exit taxes

NA - since not permitted to carry out

any income generating activities

Required to file tax clearance certificate

Required to file tax clearance certificate

No requirement of filing tax clearance certificate as tax arrears are recovered on

winding up

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Case Study 1 – Form of business presence

F Co. (UK)

India China Sri Lanka

Exports finished goods

Ideal form of business presence? – Establishment of Liaison Office

F Co. is an exporter of finished goods. Contracts executed in home

country

Requires temporary space for executing marketing activities in

exporting countries

Capital structuring

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Funding instruments

Equity Shares – same class or different classes of sharesA

Compulsorily Convertible Preference Shares (‘CCPS’)B

Compulsorily Convertible Debentures (‘CCDs’)C

External Commercial Borrowings (‘ECB’)D

Based on the commercial tax and regulatory considerations the capital structure can be in the form of any of the above or a mix of the above

instruments

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Funding instruments

Impact of Financials

Income Tax Act, 1961

FEMA

Companies Act, 1956

Stamp Duty

KEY PARAMETERS

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Funding instruments

Equity Shares

Equity Instruments

Compulsorily Fully Convertible

Debentures (‘FCD’)

Compulsorily Convertible Preference

Shares (‘CCPS’)

Debt Instruments

External Commercial

Borrowings (‘ECB’)

Withdrawal of funds

Generally not possible during

company’s lifespan

Cannot be redeemed prior to

conversion

Cannot be redeemed prior to

conversion

Minimum average maturity period

prescribed

End-use restrictions None None None

Generally permitted for capex purposes in real/

industrial/ infrastructure sector.

Not permitted for working capital etc.

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Funding instruments - Comparison

Parameters Equity CCPS CCD(Quasi-debt)

ECB

Nature of instrument

Essentially considered as a part of Share Capital

Essentially considered as a part of Share Capital

A debt instrument with a right to convert into Equity

Debt instrument

Nature of return

Dividend exempt for shareholders

Dividend received if any will be exempt in the hands of investors (Shareholders)

• Interest received if any till conversion would be taxable

• Dividend received post conversion to equity will have same treatment as for an equity instrument

Interest received be taxable

Deductibility of cost of raising capital

Non tax deductible Non tax deductible • Interest allowed as deduction (arm’s length- as per transfer pricing principle)

• Dividend not deductible

Interest allowed as deduction (arm’s length- as per transfer pricing principle)

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Funding instruments

Parameters Equity CCPS CCD(Quasi-debt)

ECB

Tax rate • DDT payable @ 16.995% by distributing company on the amount of dividends

• Not taxable in the hands of shareholders

Same as for equity Interest – as per treaty rates

Dividend post conversion - same as equity

Interest – as per treaty rates or 10%

Deductibility Dividends and DDT not deductible

Same as equity Interest tax deductible

Interest tax deductible

Tax implication in the hands of shareholder at the time of repayment of capital

• Buyback – results in distribution tax of 22.66% on the company; Exemption to shareholder

• Capital reduction – deemed dividend tax to extent of profits and balance taxed as capital gains for shareholder

• Capital Gains tax liability at the time of redemption in the hands of shareholders

• No DDT at the time of redemption if redeemed at issue price

Post conversion to equity – same as for equity

No tax implications on repayment

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Case Study 2 – Funding through Convertible Debentures

F Co.

I Co.

Denial of interest benefit to I Co. on re-characterization of debt to equity ?

F Co. to infuse funds in form of CCDs in I Co.

Can excessive use of CCDs as part of capital structure come under GAAR

scrutiny Infusion of funds through CCDs

Interest paid on CCDs

Overseas

India

Repatriation strategies

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Repatriation strategies

Dividend distribution1

Royalty/ Fee for Technical Services2

Interest3

Share transfer4

Buy back of shares5

Capital reduction6

Various modes of cash repatriation to Parent Company

Imperative to evaluate the tax implications under respective treaties

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Cash repatriation

Buy BackCapital

ReductionPurchase of asset from

overseas company

• DDT applicable

@ 16.995%

• Tax applicable

on the company

distributing such

dividend

• Tax on

distributed

income @

22.66%

(consideration

less amount

received by

company on

issue of shares)

• Tax applicable

on the company

carrying out such

buyback

• DDT @ 16.995%

to the extent of

accumulated

profits / Capital

gains tax

as per applicable

rates

• Requires

sanction of the

High Court

• Could be tax

efficient subject to

eligibility of treaty

benefits (e.g. –

sale of shares by a

Singapore tax

resident company)

• Feasibility from a

commercial

perspective will

need to be

evaluated?

2 3 4Dividend

Distribution

1

Distribution tax applicable to the company carrying out buy back

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Cash repatriation

Traditionally, MNCs have used shares buyback as a profit repatriation tool

Window of tax free repatriation on “Buyback” closed on account of introduction of Tax on Share

Buyback under section 115QA of the Income Tax Act

Tax to be levied with effect from 1.6.2013, on share buyback undertaken in accordance with the

provisions of section 77A of the Companies Act, 1956

Tax to be levied on the company undertaking the share buyback at 22.66% on ‘Distributed

Income’

Computation mechanism - Consideration paid by the company for buy back of shares less:

Issue price at which company had issued shares to its shareholders i.e. amount received by the

company on original issue

Indian Company shall be liable to pay tax on the income distributed by way of Buy Back; No tax in the hands of the shareholder

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Case Study 3 – Buyback of shares from a treaty country

F Co.

I Co.

Distribution tax applicable on buyback – Finance Act 2013

IHC to buyback its shares from I Co.

Intermediate Holding Company (IHC)

Overseas

India

Favorable tax jurisdiction Buyback of shares

IHC can claim the benefit of the applicable tax treaty

As per applicable tax treaty(favorable tax jurisdiction),capital gain may not be

taxable in India

However capital gain will be taxable in India in case of buyback of shares from a non

treaty country

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Case study 4 – Inbound lifecycle

Transaction

Company headquartered in UK with global operations wants to enter

into India in the logistics space with an Indian Joint venture partner

Objectives

What form of business presence should it establish in India?

Should it invest directly or through an intermediate jurisdiction?

Minimization of capital gains tax costs relating to the funds/ earnings

from future divestments or exit from the JV

Structure the flow-back of returns in a tax efficient manner

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UK Co.

Indian Co.

Setting up a presence in the form of a subsidiary

Overseas

India

JV Partner

UK Co.

LLP

Setting up a presence in the form of a LLP, which would be subject to approvals

Overseas

India

JV Partner

Step 1 – Deciding the form of presence to be established in India


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UK Co.

Indian Co.

Overseas

India

Step 2 – Funding the Indian Co. viz. capital structure

Deciding the capital structure (%) between

the Foreign and Indian partner – Equity Vs.

Convertible

Returns expected – Dividend Vs. Interest

Deductibility for Indian Co.

Transfer pricing the interest payments

Structuring further funding requirements

and Target shareholding between partners

Valuations on exit - FDI Vs. Tax

• Max is DCF

• Min is BNW

JV Partner

X%

y%


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UK Co.

Indian Co.

UK Co.

Indian Co.

UK directly investing into Indian Co. UK investing via Singapore

Overseas

India

Overseas

India

Step 3 – Deciding the need for an intermediate jurisdiction

Singapore


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India - UK Vs. India -Singapore

1. Withholding rates for revenue streams – Dividend, Royalty/ FTS, Interest

Treaty CGT Royalty/ FTS Interest

Singapore Only in Singapore 10% 10%-15%

UK Both states 10%-20% 10%-15%

1. Corporate tax rates – 17% Vs. 23%

2. Evaluate exemption for foreign dividends

3. WHT on dividends paid further – no WHT in Singapore

4. Evaluate CFC laws for parent company

Taxability under local laws


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UK Co.

Indian Co.

UK Co.

Indian Co.

Stake sale by UK Vs. buy back Stake sale by Singapore Vs. buy back

Overseas

India

Overseas

India

Step 4– Repatriation and exit taxes

Singapore


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Case study 5 – Inbound presence via Acquisition

Shareholder

Indian company

Acquirer

Shares

Transfer of shares

Consideration

• Acquirer purchases shares from

existing shareholders

• Consideration flows directly to

shareholder

Transaction – Acquisition of shares Vs. business

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Acquirer perspective

• Accumulated tax losses, if any, may be lost consequent to change in shareholding

• In case of listed company, Takeover Code provisions could be attracted, depending

on percentage stake being acquired

Seller perspective

• Capital gains = Sale consideration – cost of acquisition (inflation shelter available

where holding period exceeds 12 months)

Transaction cost

• Stamp duty at 0.25% of total consideration; exemption for dematerialised shares


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Shareholder

Indian company

Acquirer• Acquirer incorporates a new

Indian company and infuses

equity

• The New company acquires the

business from the seller company

(going concern basis)

• Alternately, one could acquire

assets and liabilities


New Company

Consideration

Transfer of business under slump sale


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• Depreciation to be claimed on the basis of valuation

• Accumulated tax losses, if any, will not be available for acquirer; continue in Indian

Company

Seller perspective

• Capital gains = Sale consideration – net worth of business

Transaction costs

• Sales tax may not be payable on sale of business as going concern

• Stamp duty on consideration subject to evaluation


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Shareholder

Indian company

Acquirer• Instead of acquiring the

operations (lock, stock and

barrel), the acquirer purchases

specific assets/ liabilities


New Company

Consideration

Transfer of assets & liabilities


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• Depreciation claimed on the basis of consideration allocated to assets

• Accumulated tax losses, if any, will not be available for acquirer; continue in Indian

Company

Seller perspective

• Taxed as business income Vs. capital gain depending on nature of asset

Transaction costs

• Sales tax could be levied

• Stamp duty on consideration subject to evaluation


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1 Open to dispute2 Based on type of entity and extent of acquisition

Shares Business Assets

Step-up of depreciation

No Yes Yes

Availability of benefit of tax losses

Conditional No – continues in Seller co

No – continues in Seller co

Sales Tax No No Yes

Stamp duty Yes – on shares Yes – subject to evaluation

Yes - subject to evaluation


Cross border tax issues

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Key Challenges

Exit taxes – Capital gains

Incom

e

Characte

risat

ion

Deputation issues

Withholding tax

Taxable presence - PE

Cross border tax

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What is the position / taxability under domestic law?

Is there a tax treaty with the country of the NR?

Is the treaty / applicable provision in effect?

Is the NR a ‘person’ under the treaty?

Is the NR a ‘resident’ of the foreign country under the treaty?

Are other eligibility criteria (e.g. LOB article) met?

Are the relevant taxes covered in the treaty?

Read and apply the relevant article

Check for Protocols / Technical Explanations / MoU

Is there an MFN Article? If yes, are there beneficial provisions in qualifying later

treaties that can be applied?

Tax treaty network

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What investors look for

Country Capital gains – sale of shares

Royalty FTS Interest

Singapore Alienator State 10% 10% 10%/15%

Mauritius Alienator State 15% No article Rate not prescribed

UK Taxable in both States 15%-20% 15%-20% 0%-15%

Netherlands • Taxable in both States on transfer of 10% or more shares to resident

• Taxable in Alienator State in case of corporate reorganization (Subject to holding of at least 10%)

10% 10% 10%

Luxembourg Alienator State 10% 10% 10%

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Royalty & FTS

Taxable under the Act?

DTAA need not be applied

Analyze DTAA

Taxable under DTAA

Not taxable under DTAA

Opt for DTAA if more beneficial

Opt for Act if more beneficial

No

Yes

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Royalty rates as per domestic tax laws

Under existing provisions of Section 115A, rate of deduction of tax at source for royalty and Fee for

Technical Services (‘FTS’) were based on the date of contract;

Section 115A of the Act has been amended by the Finance Act, 2013 to enhance the rate of deduction of

tax at source;

Nature of income Contract entered before May 31, 1997

Contract entered on or after May 31, 1997 but

before June 1, 2005

Contract entered on or after June 1, 2005

New rate pursuant to amendment by

Finance Act, 2013

Royalty 30% 20% 10% 25%

FTS 30% 20% 10% 25%

Note: All rates are exclusive of applicable surcharge and education cess

Enhanced withholding tax rate of Royalty and FTS payments (Finance Act, 2013)

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Royalty & FTS

Primary right to tax with the country of residence

Most treaties provide the country of source to levy tax up to a maximum level on a gross basis

Where the right, property or contract giving rise to royalty is effectively connected to PE of foreign company, then taxable as business profits (on net income basis)

Resident State

Source State

PE in source state

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Royalty & FTS

• Royalties arising in a Contracting State and paid to a resident of the other

Contracting State may be taxed in that other State.

• However, such royalties may also be taxed in the Contracting State in which

they arise and according to the laws of that State but if the recipient is the

beneficial owner of the royalties, the tax so charged shall not exceed ----- percent

(the percentage is to be established through bilateral negotiations) of the gross

amount of the royalties. The competent authorities of the Contracting States shall

by mutual agreement settle the mode of application of this limitation.

Right of the states to tax

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Royalty & FTS

• ‘Royalties’ is typically defined to mean payments of any kind received as a consideration for use of or right to use:

o any copyright of literary, artistic or scientific work including cinematograph films, or films or tapes used for radio or television broadcasting

o any patent, trade mark, design or model, plan, secret formula or process

o or for the use of, or the right to use, industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience

• Term ‘fees for technical services’ is typically defined to mean payments of any kind received as a consideration for rendering of any managerial, technical or consultancy services including provision of services by technical or other personnel but does not include payments for services mentioned in Article 14 (Independent Personal Services) and 15 (Dependent Personal Services)

Article 12 - Royalties and fees for technical services

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Royalty & FTS

Rate Arbitrage

Definition arbitrage

Rates under the respective DTAA may be lower than the

rates under the Act

Definition under the DTAA may be narrower than the definition under the Act

Act or DTAA whichever is more beneficial

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Royalty & FTS

o Income Tax Act o DTAA

40% on net basis, if PE exists

25% on gross basis

40% on net basis, if PE exists

Rate as applicable

Rate Arbitrage

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Royalty & FTS

Transfer of all rights

Patent, invention, model, design, secret formula, or process or trade mark or

similar property

Only use of or right to use is covered

or similar property is not used

Copyright or copyrighted material Only copyright is covered

Absence of make available clause Presence of make available clause

Definition Arbitrage

Income Tax Act DTAA

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Royalty & FTS – make available as a concept

• “Included Services” defined narrowly to mean services which “make available” technical

knowledge, experience, skill, know-how or processes or which consist of development

and transfer of technical plan or technical design

• MoU of the India USA Tax Treaty:

o Technology will be considered "made available" when the person acquiring the

service is enabled to apply the technology

o Provision of requiring technical input by the person providing the service does not

per se mean that technical knowledge, skills, etc., are made available

o Use of a product which embodies technology shall not per se be considered to

make the technology available

• If the services do not “make available” technical knowledge, etc., then, they are outside

the ambit of FIS Article and not taxable

• Plethora of decisions on the subject

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F Co.

I Co.

‘Make Available’ should enable the person acquiring the service to apply the technology contained therein – India Singapore DTAA

I Co. is engaged in business of prospecting and mining of minerals

Singapore

India

I Co. enters into agreement with F Co. for providing geophysical data for

extracting minerals

Case Study – FTS in case of treaty country

Payment of consideration

Rendering of technical services

Extraction of minerals

However, no technical expertise/ skills rendered by F Co. to attract tax liability

(CIT vs. De Beers India Minerals Pvt. Ltd.)

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F Co.

Branch Office

Granting of copyright is in nature of royalty vis-à-vis transfer of copyrighted article is in nature of sale

Indian branch office of F Co. licensed the customized software's to the Indian

customers

US

India

Case Study – Transfer of software (a copyrighted article)

Import of software package as floppy/ CD

Customers

Payment

Revenue taxed the payment received from customers as royalty

Court observed that license was non-exclusive and non transferable and

licensee was permitted to make only one copy of the software

A mere case of transfer of copyrighted article without any transfer of copyright and hence cannot be taxed as royalty

(DIT v. Infrasoft Limited)

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Permanent Establishment issues

Article 5 - Permanent Establishment (‘PE’)

Paragraph 1: General definition of a PE:

“A ‘fixed place of business’ through which the business of an enterprise is wholly or partly carried

on…”

Above definition indicates following:

There must be a place of business - eg: premises, facilities, installations etc; The premises etc may not

be necessarily owned

Place of business must be fixed and there must be a certain degree of permanence; Long duration of

18 to 24 months would comply with the ‘permanence’ test and any duration lesser than 6 months can

not be considered sufficient

Business of enterprise must be carried on through this ‘fixed place of business’ - Persons who are

dependent on enterprise carry on business of enterprise through a fixed place of business in the

country

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Paragraph 2 - Examples of a PE

Place of management

Branch

Office

Factory

Workshop

Mine, an oil & gas well, a quarry or any other place of extraction of natural resources

Warehouse in relation to persons performing storage facilities for others

Farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on

Store or premises used as sales outlet

Services PE: In some treaties like India-UK, India-US etc furnishing of services (other than those

categorized as royalty or fee for technical services) through employees or other personnel provided for a

period longer than 90 days within any 12 month period result in a PE

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Paragraph 3 - Exclusions from definition of PE

Use of facilities solely for purpose of storage or display of goods or merchandise belonging to

enterprise

Maintenance of a stock of goods or merchandise belonging to enterprise solely for purpose of storage

or display

Maintenance of a stock goods or merchandise belonging to enterprise for purposes of processing by

another enterprise

Maintenance of a fixed place of business solely for purpose of purchasing goods or merchandise or of

collecting information, for enterprise

Maintenance of a fixed place of business solely for purpose of advertising, for supply of information,

for scientific research or for carrying on for enterprise any other activity of a preparatory or auxiliary

character

Deputation issues – Inbound

63

Characteristics of Secondment

Obligation to complete• Warranty for quality of work• Service arrangement• Add cost to complete

unfinished work

Right, Responsibility, Risk, Rewards

Power to disqualify, replacement and recall

Cost or mark-up

Supervision, Control, Direction, Authority to

instruct, Review

Commercial justification:• Specific or general• Qualification of Secondee

Right of Lien on foreign employment

IPR ownership

Economic Employer

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Deputation issues

Facts

• Parent Co (P Co) enters into a Technical Support Agreement with Subsidiary Co (Sub Co)

• Also seconds its permanent staff as executive directors / senior management (qualified

engineers) for routine operations and administration of Sub Co

• No formal Secondment agreement is executed

• Salary of seconded staff paid by P Co, subsequently reimbursed by Sub Co

• Basic employment agreement between seconded staff and Sub Co

Issue

• Seconded employees treated as ‘technical support/services’ from parent company and thus

reimbursement of salary/expenses gets treated as ‘fee for technical services’ which is subject to

withholding tax

• Potential risk of Permanent Establishment (PE) for parent company since employees posted in

India

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Deputation issues

Some pointers

Through the secondment agreement, the P Co,

• relinquishes its key rights (viz. termination, determination of salary and job responsibilities,

renewal of employment, reporting) in favour and at behest of Sub Co;

• indicate that secondments are not consequent to the TSA between P Co and Sub Co.

• agree that salary/ expenses paid by P Co will be reimbursed on a cost to cost basis

The TSA must specify scope of services/nature of support to be provided by P Co, in a manner

that the support services are mutually exclusive to secondment

Through the employment agreement, the Sub Co must exhibit that it

• Possess sole right to fix or agree to specific scope of work, salary, termination criteria,

reporting norms for the seconded employee

• Treats the seconded employee at par with other employees

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Deputation issues

Substance of the agreement and intention of the parties

Whether the arrangement can be termed as a FTS

Scope of FTS under the Treaty

Whether the activity results in a PE

67

Deputation issues

Rendering of services Vs. provision of services

Provision of services – to be considered under Fees for technical services

Rendering of services – to be considered under Dependent Personal Services

Tests

Which entity bears the responsibility or risk for the results produced by the individuals work;

Which entity has the authority to instruct the individual;

Which entity controls and has responsibility for the place at which the work is performed;

.Which entity bears, in an economic sense, the cost of the remuneration paid to the individual;

Which entity provides the tools and materials required to perform the work at the individual's

disposal and

Which entity determines the number and qualification of the individuals performing work

Test of Real employer

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Deputation issues

A typical secondment arrangement

• The overseas employer remains the legal employer, to maintain continuity of employment for

purpose of social security schemes or other employment benefits;

• Indian company becomes the economic employer, which means that employee works under direct

control and supervision of the Indian Subsidiary.

• The overseas company is not responsible for the work and performance of the employee. The risk

and reward of the work done by the seconded employee would go to the Indian Company.

• The Indian Company has the right to demand the replacement of the employee and parent

company also retains the right to replace or terminate the employee.

• However, for administrative convenience the seconded employee remains on the payroll of the

overseas company.

• The parent overseas company pays salary to the seconded employee which is reimbursed on cost-

to-cost basis by the Indian Subsidiary. Certain local benefits, such as accommodation, local

conveyance, etc., are provided locally by the Indian Subsidiary to such seconded employee.

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Deputation issues

Contentions of revenue

• That reimbursement of salary by the Indian Subsidiary to the parent overseas company is actually

payment for technical or managerial or consultancy services

• That services performed by the seconded employee are actually performed on behalf of the parent

company and not as an employee of the Indian Company

• That the amount received by the parent company is, in fact, receipt of income and further, that

payment of the salary is only application of the income on which employee is liable to tax as per his

nature of income and residential status

• That Indian subsidiary is not legal employer and, therefore, payment by the Indian company to

overseas company could not be construed to be reimbursement of the salary.

• That the parent company has the right of dismissal and further, in the absence of obligation of the

Indian company to pay salary to the employee, it cannot be said to be an economic employer.

• Right of the seconded employees to seek their salaries is against the parent overseas company and

they cannot claim it as a right against the Indian Company.

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Deputation issues

Favourable rulings

• That agreement between the Indian Company and overseas parent company is an agreement for

secondment of staff and not agreement for rendering of services by the parent overseas company

• Reimbursement of salary on cost-to-cost basis cannot be regarded as Fees for Technical services.

• Seconded employee works under direct control, supervision and instructions of the Indian Company

which exercises the right to - hire or accept secondees, right to control, supervise, instruct and

terminate secondees from secondment and is liable on its own account for their performance

• Real and economic employer Vs. legal employer.

• That in this context, substance should prevail over the form, i.e., employer should be the person who

is having the rights on the work produced and bearing the relative responsibility and the risks.

• That parent company opts to remain legal employer to protect their interest relating to benefit of

pension contributions, social security and other benefits under laws of the home country

• That overseas parent company does not render any service to the Indian enterprise and is only

paying salary to the seconded employee for administrative convenience

71

Service PE

Service PE under the OECD Model Tax Convention and the UN Model Tax Convention

OECD Model Tax Convention – No specific provision for service PE

UN Model Convention – Does not use the expression “service PE” – Article 5(3)(b) of the UN Model

Convention reads as follows: The furnishing of services, including consultancy services, by an

enterprise through employees or other personnel engaged by the enterprise for such purpose, but only

if activities of that nature continues (for the same or a connected project) within the country for a

period or periods aggregating more than six (6) months within any twelve (12) month period

Service PE under DTAAs between India and other countries

Rationale is to tax the enterprise of the home country for its economic activities in the host country

beyond a threshold limit

When is a service PE deemed to be concluded?

72

Service PE

Service PE is included in the DTAAs

between India and other countries:

• Australia – Article 5(3)

• Canada – Article 5(2)(l)

• China – Article 5(2)(k)

• United States of America – Article

5(2)(l)

• United Kingdom – Article 5(2)(k)

• Switzerland – Article 5(2)(l)

• Singapore – Article 5(6)

• Norway – Article 5(3)(b)

• Indonesia – Article 5(5)

73

Service PE

Country Services provided to a non-related enterprise

Services provided to a related enterprise

Australia More than ninety (90) days within any twelve (12) month period

One (1) day

Canada More than ninety (90) days within any twelve (12) month period

One (1) day

Singapore more than ninety (90) days within any fiscal year

More than thirty (30) days in a fiscal year

China More than one hundred and eighty-three (183) days

Not provided

Norway Six (6) months within any twelve (12) month period

Not provided

United Kingdom More than ninety (90) days in a twelve (12) month period

More than thirty (30) days in a twelve (12) month period

United States of America More than ninety (90) days in a twelve (12) month period

One (1) day

74

Service PE

• DTAAs signed by India with the following countries specifically exclude certain categories

of services from the Service PE Clause:

United Kingdom – excludes services covered under Article 13 of the DTAA (Royalties and

fees for technical services)

Singapore – excludes supervisory activities in relation to building sites, etc., covered under

Article 5(4) and services in relation to exploration covered under Article 5(5)

Australia – excludes services in respect of which payments or credits that are royalties as

defined in Article 12

Canada – excludes services covered under Article 12 (Royalties and fees for included

services)

China - excludes technical services as defined in Article 12 (Royalties and Fees for

Technical Services)

Verizon US GTE

India

USReimbursement

Personnel

Case Study- Verizon Data Services

Verizon (India)

Background

Verizon India is a wholly owned subsidiary of Verizon Data

Services LLC, US (“Verizon US”), was engaged in business of

software development and maintenance for the telecom industry

and certain information technology enabled services.

All such services rendered by Verizon India were exported to

Verizon US. For optimizing efficiency and productivity in the system

Verizon India entered into a secondment agreement with the

Verizon US

Such employees were seconded by GTE Overseas Corporation,

US (“GTE-OC”), an affiliate of Verizon US.

The first employee was appointed as the managing director and the

role of the other two were to liaise between the applicant and

Verizon US

GTE US would remunerate the employees, and in turn the

applicant was to reimburse GTE US for the salary paid or provided

to the employee..

75

Payments not in the nature of reimbursement

o Receipt in the hand of GTE Company and personnel are of different character from different sources

o By correlating the two payments, the substance of the transactions would not change to give it the character of reimbursement

o Receipt taxable as ‘salary’ for personnel by virtue of employment with GTE Company.

All such services rendered by Verizon India were exported to Verizon US.

o GTE Co has rendered managerial services to Indian Company

o Managerial services performed by the personnel as employees of GTE US and not that of Indian company

o Payment would be FTS under Indian Tax Law as well as FIS under tax treaty

Existence and taxability of PE not addressed as amount taxable under FTS/FIS.

Case Study - Verizon Data Services (contd.)

Ruling

76

Indirect transfers

78

Indirect Transfers

• India makes retrospective changes to the law that would effectively reverse the decision of the Supreme Court in the Vodafone case

• Allows India to tax non-residents on gains arising from the disposal of share or interest if such share or interest derives its value “substantially” from Indian assets

• A validation clause has been introduced to legitimise recovery of tax on such indirect transfers (Clause 119 of the Finance Act)

• Withholding tax obligation to extend to all persons, resident or non-resident, irrespective of the presence of non-resident in India

Supreme Court held that Indian Tax authorities have no basis to tax the sale of indirect interests held in the Indian Company

Mitsui – Vedanta deal – Sale of 51% in Sesa Goa to Vedanta

SABMiller’s acquisition of 100% stake in Fosters India

Sanofi Aventis’ acquisition of majority stake in the Indian vaccine company Shanta Biotech

Major Transactions impacted by such retrospective amendments

Dampened Enthusiasm for

International Investment in

IndiaKraft – Cadbury takeover deal

Vodafone Wins $2 bn Tax Case in Supreme Court January 20, 2012

Finance Act 2012- India Imposes Tax on indirect transfer of Indian assets May, 2012

The Vodafone Litigation :: The Transaction

79

HTIL (Cayman Islands)

Vodafone (VIH B.V) Netherlands

HEL, India

CGP (Cayman Islands)

SPA for sale of

shares of CGP

HTI (BVI) Hldgs (BVI)

3 GSPL (Mauritius)

(Indirect)

International Holding

Company

Mauritius Cos.

(Indirect)

51.96%Option to acquire 15.03%

In February 2007, VIH B.V acquired 100% shares in CGP Holdings, Cayman Islands

for USD 11.1 billion from HTIL

CGP through various intermediate companies/contractual arrangements

controlled 67% of HEL, India

The acquisition resulted in VIH acquiring control of CGP and its downstream

subsidiaries including HEL

HEL was a joint venture between Hutchinson Group & Essar Group

The Transaction

The Vodafone Litigation :: Background

80

2006-2007

• Open offer made by Vodafone for HTIL’s stake in HEL

• VIH gave binding offer for acquiring entire shareholding in CGP

• VIH entered into SPA with HTIL through which VIH would own 42% direct interest in HEL. Through CGP it would own indirect interest in HEL

September 2007

• Notice was issued by the Tax Authorities to VIH for failure to withhold tax u/s 195 on payment made to HTIL indirectly

• Notice also included claim that VIH be treated as agent of HTIL u/s 163

October 2007

• Writ Petition filed stating that the Tax Authorities do not have jurisdiction over sale of shares between two non-residents

• Claimed it to be Not-Taxable in India

December 2008

In relation to the petition filed, the Bombay High Court held that the tax authorities had made out a prima facie case that the transaction was one of transfer of capital asset situated in India

January 2009

• In response to Writ filed with Supreme Court, the Supreme Court directed the tax to first determine the jurisdictional challenges raised by Vodafone

• It also permitted Vodafone to challenge the decision of the tax authorities on the preliminary issue of jurisdiction before the High Court

September 2010

• Bombay High Court dismissed petition of VIH• Vodafone files appeal with Supreme Court • Supreme Court directs Vodafone to discharge tax

demand of INR.2500 crores • 3 member bench led by Chief Justice of India

pronounced order with majority in favor of Vodafone on 20th January 2012

The Vodafone Litigation :: Key Issues & SC Observations

81

Key Issues

Presently, indirect transfer of an asset in India is not Taxable under the Income Tax Act

Whether any source of Income or Capital Asset said to be situated in India?

Whether transfer of rights is incidental to a share transfer and only the situs of such shares should prevail?

Section 9(1)(i) of the Income Tax Act (“IT Act”) does not have ‘look through’ provisions, and it cannot be extended to cover indirect transfers of capital assets/ property situated in India

The situs of the shares would be where the company is incorporated and where its shares can be transferred. A controlling interest is an incident of ownership of shares, which flows out of the holding of shares and hence is not an identifiable or distinct capital asset independent of the holding of shares

Whether Courts can lift the corporate veil in the absence of any look through provisions in the law or in the absence of a fraud?

Interposing foreign holding / operating companies is a common practice. Before lifting corporate veil, transaction should be looked at in a holistic manner viz. time duration for which the holding structure exists, period of business operations in India etc

Contd…..

SC Observations

82

Key Issues

Whether the sale of CGP share can be said to be a transaction which was designed to avoid tax in India?

Does section 195 have extra territorial jurisdiction?

Sole purpose of CGP was not only to hold shares in subsidiary companies but also to enable a smooth transition of business. Therefore, it could not be said that CGP had no business or commercial substance

Whether India Mauritius treaty would be applicable where Vodafone had divested directly at Mauritius level?

In the absence of LOB clause and presence of CBDT circular 789 of 2000 and TRC, tax department cannot deny benefits of treaty to Mauritius Cos. TRC can be ignored if treaty is abused for the fraudulent purpose of tax evasion

SC Observations

Applies only to payments made from a resident to a non-resident

The Vodafone Litigation :: Key Issues & SC Observations

Supreme Court ruled that the transaction was structurally valid and the tax authorities in India had no jurisdiction to tax such an overseas transaction

Finance Act Rewrites Legislation Retrospectively :: Taxing Indirect Transfer of Indian Assets

83

Non-residents are liable to tax on indirect transfers of Indian assets, including transfers of shares in companies which derive their value “substantially from assets located in India”, and covering transfers back to 1 April 1962...

‘Capital Asset’ to include management & control rights

‘Transfer’ to include parting with or creation of right, notwithstanding that such transfer flows from transfer of shares of an

offshore entity

Scope of term ‘through’ clarified to include ‘by means of’, ‘in consequence of’, or ‘by

reason of’

Widens the scope of taxation of income under Section 9 of the ITA and bring into tax net, the gains derived from transfer of share or

interest if such share or interest derives either directly or indirectly its value substantially from assets located in India

Transfer would now include indirect transfer of shares if rights in such shares are effected and dependent upon transfer of shares

even of a foreign company

Transfer of shares (at any level) which result in transfer of controlling interest of an Indian Company could give rise to a

taxable event in India

Key Amendments Key Impact

Witholding tax provisions applicable to non-residents irrespective of residence/ place of business/ connection in India

The amendment widens the withholding tax provisions of Section 195 of the ITA by applying it to all persons whether resident or non-

resident


84

Key Amendments Key Impact

Despite the fact that the law is amended retrospectively from 1961, the Revenue authorities can go back only 7 years to initiate

proceedings against a company. In other words, only transactions from 1 April 2005 will be open to scrutiny after 31 March 2012,

unless proceedings have already been initiated in the past.

Retrospective Amendment applicable from 1962

Tax authorities allowed to issue notice to examine the taxability in India, of income arising in respect of “Financial interest in

an entity” located outside India for an extended period of sixteen years

This amendment could enable the tax authorities to reopen cases for the aforesaid extended period.

The Central Board of Direct Taxes (“CBDT”) has issued clarification with regards to the reopening of completed assessments on account of clarificatory amendments introduced by the Finance Act 2012 viz. Section 2(14), Section 2(47), Section 9 and Section 195 with retrospective effect

The Board has directed that in case where assessment proceedings have been completed under section 143(3) of the Act, before 1st April 2012, and no notice for reassessment has been issued prior to that date, then such cases shall not be reopened under section 147/148 of the Income Tax Act on account of the abovementioned clarificatory amendments introduced by the Finance Act, 2012`

Clarification Provided by CBDT


85

Clarifications Required……

No threshold defined to determine what constitutes “substantial” with regards to taxing offshore transfers with substantial asset base in India

Computation mechanism not prescribed

o Taxability based on the proportion of the value of the India business to the global value

o Whether gross or net value of India assets to be considered?

Applicability of Treaty provisions?

International Trends

International Trends

87

PERU

US

SOUTH KOREA

AUSTRALIA

CHINA

Taxing Indirect

Transfers

Indonesia, Mexico etc….

• A non-resident entity that transfers shares of another non-resident entity that holds an interest in Chinese companies may become subject to Chinese capital gains tax if the latter non-resident entity is deemed to have engaged in a transaction involving an abuse of organizational form and having no business purpose

• Under the guidance, a non-resident transferor is required to make a tax filing to the Chinese tax authority to disclose certain required information, within 30 days of signing an equity transfer agreement

• The Chinese tax authority will review the disclosed information and determine whether the transferred non-resident entity could be disregarded for tax purposes in order to tax the capital gain of the non-resident transferor

China modified its tax code to tax “Indirect Transfers” of local companies and assets....(2008)

Chinese Tax authorities received $25 mn capital gains tax payment resulting from an

indirect stock transfer, in 2010….

GAAR Provisions

GAAR – Basic Provisions

89

Main purpose or one of the main purposes is to obtain a tax benefit

Not at arm’s-length

Misuse/abuse of tax provisions

Lacks commercial substance

Not for bona-fide purposesOR OR

AND

Impermissible Avoidance Arrangement (IAA)

Consequences

Disregard / combine / re-characterize

whole / part of the arrangement

Disregard corporate structure

Deny treaty benefit

Re-assign place of residence / situs of assets or transaction

Re-allocate income,

expenses, relief, etc.

Re- characterize Equity- Debt, Income, Expenses, relief, etc.

OR

Acquisition Tax Issues

Modes of Acquisition

91

Acquisition

Business PurchaseBusiness Purchase

SlumpSale

SlumpSale

ItemizedSale

ItemizedSale

Share Purchase

Share Purchase

Acquisition through the Slump Sale route

92

• Slump sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration

without values being assigned to the individual assets and liabilities in such sales.

• Consideration - can be discharged by issue of shares / payment of cash

o Consideration is received by company which is transferring the undertaking and not its shareholders

• Can be achieved through shareholder resolution and a business transfer agreement

• Special provisions for computation of capital gains in case of slump sale – Section 50B

• No Indexation benefit for undertaking

Others

Meaning

• Business sold as a whole on a going concern

• Documents not to indicate item-wise value of the assets transferred

Tests to Satisfy


93

• Capital gains = Slump Price – Networth of the transferred undertaking

Computation Mechanism ~ Capital Gains

• Networth of the Undertaking = Tax WDV of depreciable assets + Book value of other assets – Book value of

liabilities

• Revaluation of assets to be ignored while calculating networth

Computation Mechanism ~ Net Worth

94

A Pvt. Ltd.

Business A Business B

B Pvt. Ltd.

• Undertaking

o What will constitute as an undertaking?

• Consideration

o Whether lump sum consideration is to be discharged in

cash or shares can be issued?

• If networth of the undertaking transferred is negative

o Whether to be considered as zero?

• Carry forward of losses

o Whether the losses pertaining to the undertaking can be

transferred?

• Section 50B v/s Section 50C

o Whether the provisions of Section 50C would be

attracted in case of land being the only asset in the

undertaking proposed to be transferred?


Slump sale

95

Acquisition through Itemised Sale

• Sale of assets & liabilities with values assigned separately for each item of assets and liabilities

• Benefit of indexation would depend on the character of the asset.

• Brought forward losses & unabsorbed depreciation related to the undertaking not transferred

• Cost of acquisition to the Purchaser - consideration paid for each asset

Others

Meaning

• Depreciable assets - as per provisions of Section 50 (Short Term Capital Gains)

• Capital assets - as per provisions of Section 45 read with Section 48

• Current assets - Business profits

Tax Implications

96

Acquisition through Share Purchase

Acquirer

Target

sharesConsideration

Seller Perspective

Buyers Perspective

• Price paid for shares would be the buyers cost of acquisition of shares

• Preservation of tax losses - In case of unlisted companies, the change

in shareholding cannot be in excess of 49% vis-à-vis the shareholding

in the year in which the losses were incurred, in order to protect carry-

forward benefits

Nature of share Long Term Capital Asset (>12 months)

Short Term Capital Asset

Equity share of a listed company subject to STT

Exempt 15.45%

Equity Shares of a listed company without payment of STT

20.6%(with indexation) 30.9%

Any other shares 20.6%(with indexation) 30.9%

*Surcharge as applicable

Other Modes of Acquisition

97

Acquisition

Merger Demerger

Acquisition through the merger route

98

• Merger of one or more companies into another

• Merger of two or more companies to form a new company

• Transfer of all properties and liabilities

• Allotment of shares to shareholders holding not less than 3/4th in value of the shares in the amalgamating

company (other than the shares already held by the amalgamating company or nominees for the amalgamated

company or subsidiary)

Prescribed Conditions

Meaning

• Cost of acquisition = cost of acquisition of shares in amalgamating company

• Period of holding = Period of holding of shares in amalgamating company to be counted

Cost of Acquisition & period of holding


99

• In the hands of amalgamating company - Depreciation in year of transfer – available on pro-rata basis

• In the hands of amalgamated company - the basis of tax written down value in the hands of amalgamating

company

• No capital gain on transfer of capital assets both in the hands of amalgamating company and its shareholders

• Expenses incurred on amalgamation are tax deductible

• Losses of amalgamating company available to the amalgamated company subject to compliance with

conditions of Section 72A of Income tax Act (“ITA‟)

Implications

Depreciation


100

A Pvt. Ltd.

B Pvt. Ltd.

100%Merger

Merger of B Ltd. Into its holding

company A Ltd.

• No issue of shares on merger

• Whether qualifies the test on s.

2(1B)

Impossibility of performance of conditions

A Pvt. Ltd.

B Pvt. Ltd.

Merger

Loss of Rs. 10 cr

Merger of A Ltd. Into B Ltd.

• Carry forward of losses ~ s. 72A

vs. s.79 – Which section to

apply?

A Pvt. Ltd.

B Pvt. Ltd.

Merger

Mat Credit ~ Rs. 10 cr

Merger of A Ltd. Into B Ltd.

• Whether B Ltd. can utilise MAT

credit of A Ltd.?

• Continuity of Tax holiday?

Tax holiday under S. 80IA

Acquisition through the De-merger route

101

• Demerger involves transfer of identified business from one company to another and in consideration, the

company which acquires the business issues shares to shareholders of the selling company

• Transfer of all properties and liabilities at book values

• Discharge of consideration by issue of shares on proportionate basis

• Allotment of shares to shareholders holding not less than 3/4th in value of the shares in the demerged company

(other than the shares already held by therein)

• Transfer to be on going concern basis

Prescribed Conditions

Meaning

• Cost of shares in resulting company = (Cost of shares in demerged company)* (net book value of assets

transferred / Net worth of demerged company prior to demerger)

• Cost of shares of demerged company = Original cost - Cost attributable to shares of Resulting Co.

• Period of holding = Period of holding of shares in demerged company to be counted

Cost of Acquisition & period of holding


102

• Depreciation allowable in the ratio of the actual number of days

• Cost of acquisition and Written Down Value (WDV) of depreciable assets

o Actual cost = Cost to the demerged company.

o Block of assets (for resulting company) = WDV of the transferred assets as appearing in the books of

account of the demerged company immediately before the demerger

o Block of assets (for demerged company) = WDV of the block as on the date of transfer minus the WDV of

the assets demerged into the resulting co.

• Losses - Available to the resulting company

o Directly relatable to undertaking being transferred

o Not directly relatable –proportionate to the assets transferred

Losses

Depreciation

103

A Pvt. Ltd.(Demerged Co.)

Business A Business B

B Pvt. Ltd. (Resulting Co.)

• Undertaking

o What will constitute as an undertaking? Can single

“investment‟ constitute undertaking?

o Whether the residual business i.e. the assets and

liabilities remaining with the demerged company ought

to be an undertaking?

• Discharge of consideration

o Can the resulting company issue preference shares as

consideration for demerger?

• Continuity of benefits of tax holiday

o Whether the tax benefits availed by A Ltd. in respect of

the undertaking being demerged can also be availed by

B Ltd. on demerger?

• Carry forward and set off of losses

o Whether the demerged undertaking to be an industrial

undertaking?


Demerger

Outbound Investment

Key Questions while going outbound

105

How much can I invest overseas

How to optimize exit

What should be my global tax structuring approach

How can I reduce the effective tax rate

How do I reduce burden arising from repatriation of funds

Should the IP be migrated to a tax efficient jurisdiction

What are the regulations in the host country

Where should I source acquisition

finance from

Key objectives

106

Maximising shareholder value

Minimising global tax costs

Ease in intra-group funds flow

IPO considerations

Alignment with investor objectives - strategic or financial investors

Compliance with regulatory framework

Some Deciding factors

107

Foreign Country RisksExit Tax Planning

Global Transfer Pricing India Considerations

Key Considerations Complex tax environment in U.S./

Europe

Foreign Exchange regulations

Mode of investing

Increase in inter company transactions as

Indian company acquire foreign companies

TP documentation requirement

Multi jurisdiction documentation compliance

required

India regulatory aspect

Achieving tax efficient circulation of cash within

foreign structure

Repatriation planning for mitigating India tax cost

Foreign tax credit issues

Entity structuring

Structuring International acquisition

International holding purposes

Post acquisition structuring

The ‘tax’ effect

108

Overall effective tax rate of Global Business

33.99 percent

Intermediate Holding Company

Choice of Jurisdiction

Funding Options

Transfer Pricing

IP Holding Company

Appropriate Acquisition Structure

Tax – Pivot to business decisions !



110

JV

Joint venture company (JVC)

WOS

Greenfield or Acquisition

Branch

Modes of investing overseas

Unincorporated Incorporated

CompanyLiaison Office


111

Losses can be consolidated but

inability to defer India tax

Income attribution issues

Can combine benefits of corporate form

with flexibility of partnerships

Taxation in India deferred until

repatriation

Economic double taxation on repatriation

Choice of Entity

Structures

Hybrid

Branch

Legal

112

Limited Liability Partnership

Treated as a normal partnership for tax purposes.

Taxability of partnership firm vis-à-vis partner share

Corporation

Taxed in accordance with domestic laws of the country of

incorporations

Some countries prescribe different tax rates for Global

business companies

Limited Liability Companies (LLC)

Entitled to same tax and limited liability benefits as a

Corporation

Branch Office

Generally gives rise to taxable presence in foreign country

Double Taxation Avoidance Agreement (DTAA) to

determine the existence of Permanent Establishment (PE)

in foreign country

Losses can be consolidated but inability to defer India tax

Income attribution issues

Partnership

Taxability of partnership firm under the domestic tax laws

vis-à-vis taxability of partner share

Trust

Taxability of trust varies according to the governing domestic

tax laws

Generally, income of trust bears tax in the hands trustees

Forms of business presence – a brief comparison

113

Case Study – Forms of business presence

Indian Company

UAE IHC

India

Outside India

Turkey

Qatar

Oman

Kuwait

Bahrain

Saudi

Iraq

Iran

Tax Rate- 10%Dividend – NilInterest – 7%

Tax Rate- 15%Dividend – NilInterest – Nil

Tax Rate- 20%Dividend – 5%Interest – 5%


Tax Rate- 20%Dividend – 10%*Interest – 10%

Tax Rate- 12%Dividend – NilInterest – Nil

Tax Rate- NilDividend – NilInterest – Nil


UAE to set up company in the Targets

UAE IHC

India

Outside India

Turkey

Qatar

Oman

Kuwait

Bahrain

Saudi

Iraq

Iran

Tax Rate- 10%Interest – 7%

Tax Rate- 15%Interest – Nil

Tax Rate- 20%Interest – 5%Branch profit- 5%


Tax Rate- 20%Interest – 10%Branch profit- 15%

Tax Rate- 12%Interest – Nil

Tax Rate- NilInterest – Nil


UAE to set up a branch in Targets

Indian Company

Taxability of a BranchTaxability of a Company

Use of IHC

Direct Investment from India into Target Co.

115

Direct Investment leads to immediate

taxation

No flexibility to time dividend/interest and

capital gains to be received back in India

Increased tax burden if Target in high tax

jurisdiction

Limited capacity to borrow

Borrowing’s Interest to effect

EPS/market capitalization of Indian Co.

Subsidiary

India

Target country

Dir

ect

Inv

estm

ents

Indian Company

Harnessing the benefits of an IHC

116

Subsidiary

India

Target country

Investment

Indian Company

Investment

Jurisdiction of intermediate company

International Holding Company

Flexibility to up-stream returns

Possibility of reducing withholdings on

paybacks

Minimise tax incidence on exit

Deduction of funding costs at IHC level

Enhanced ability to leverage on group

strength

Minimise overall group tax rate

Provisions of DTC

New regulations

GAAR

Direct Tax Code

CFC

PO

EM

General Anti-Avoidance Rules (“GAAR’)

Wide sweeping in nature - Encompass all kinds of

schemes, structures, transactions that could be used

to avoid taxes

Guidelines on GAAR notified – covers all

transactions post August 2010 with certain

exceptions prescribed

Controlled Foreign Corporations (‘CFC’)

Income of Holding Company taxed in India without

actual distribution where Holding Company qualifies

as a CFC under the proposed DTC

Place of Effective Management (‘POEM’)

Taxability of the worldwide income of foreign

company where the POEM is demonstrated in India

118

CFC

119

Residency test for foreign companies based on Place of Effective Management (POEM)

o Income of foreign company with POEM in India will be taxable in India

o Dividends declared by such foreign company will be liable to DDT in India

Introduction of CFC provisions

Residency test for foreign companies

Report of Working Group on Non- Resident Taxation (2003) recommended enacting of CFC provisions

CFC provisions were not part of original DTC 2009

Introduction of CFC provisions hinted in RDP in June, 2010

CFC provisions introduced in Twentieth Schedule in DTC 2010

o Income attributable to a CFC proposed to be taxed in the hands of the resident tax payer

o Actual subsequent distribution by CFC not to be taxed in the hands of the resident tax payer

o Equity / preference shares held in a CFC liable to Wealth-tax

Imperative to evaluate impact of CFC on outbound structure

CFC tests

120

CFC

Conditions for qualifying as CFC

Control

• Direct or indirect control by Indian residents, i.e. 50% or

more voting power, or Application of 50% or more of income

or asset for its benefit or dominant influence in decisive in

shareholders meeting.

Low tax territory:

• Taxes paid in a Foreign country < 50% of taxes payable in

India.

Residency:

Based on place of effective management/ location of assets.

Exemption

1. “Specified income” of CFC - Rs.25 lakhs or below; or

2. CFC engaged in active trade/business and passive & other

related party income < 50%; or

3. CFC is listed on a stock exchange in the country of

residence.

Outside India

Indian Company

India

Turkey

Qatar

Oman

Quwait

Bahrain

Saudi

Iraq

Iran

Trading cum Holding Company

Passive Income - Dividend, Interest,

Royalty, sale to related parties

Profits of Trading cum Holding Company taxed in hands of the Indian parent without actual distribution if the qualified as a CFC

Computation mechanism

121

CFC to impact overseas investments / intra-group supply chain arrangements

Computation mechanism encompasses “Active” as well as “Passive” income !!

Income attributable to CFC = A * B * C 100 D

“Specified income” = (M+N–O–P) * Q / R of CFC

A – “Specified Income” of CFC

B - Higher of % of value of capital

% of voting shares or interest

C – No of days voting shares / capital / interest held by resident in CFC

D – No of days Foreign Co was a CFC

M – Net Profit as per P&L A/c (as per IFRS / GAAP / IAS / As notified under Cos Act)N - Prov for unascertained liab / diminution in

value of assetsO – Interim Dividends paidP – Losses of Prior yearsQ – No of days Foreign Co was a CFCR - No of days in accounting period

Case Study – Computation of Passive Income

122

Amount in Rs. CroresIllustrative projections

Important to establish active income test for qualifying for CFC exemption

Particulars FY 12 FY 13 FY 14 FY 15 FY 16

Export of Goods to Third party A 1,500 1,650 1,815 1,997 2,196

Passive Income - Dividend/ Interest etc B 100 120 144 187 262

Sales to group concerns C 300 360 1,800 655 983

Total Income 1,900 2,130 3,759 2,839 3,441

Passive Income B+C 400 480 1,944 842 1,245

Passive Income/ Total Income 21.05% 22.54% 51.72% 29.67% 36.18%

Note:

1. Sales to related parties is counted as Passive income

2. Interest/ Dividend etc is accounted for as Passive income

3. Test requires that Passive income should be <50% of Total income

4. In FY 14, as the passive income > 50% of Total income , the income of the overseas Trading cum Holding Company would be taxed in the hands of the Indian parent.

POEM

123

Outside India

Indian Company

India

Turkey

Qatar

Oman

Quwait

Bahrain

Saudi

Iraq

Iran

Trading cum Holding Company

Income earned by the Trading cum Holding company to be taxed

DTC 2010 proposes to tax the worldwide income of foreign company where the Place of Effective Management (‘POEM’) is demonstrated in India

Residency Rule:

• A company is resident in India if its “place of effective

management, at any time in the year, is in India

Definition:

• the place where the board of directors of the company or

its executive directors, as the case may be, make their

decisions; or

• in a case where the board of directors routinely approve

the commercial and strategic decisions made by the

executive directors or officers of the company, the place

where such executive directors or officers of the

company perform their functions

• Expression ‘at any time’ very wide.

• Meaning of the expressions ‘routinely’ / ‘commercial and

strategic decisions’?

Impact / Issues

Imperative to hold Board meetings, have local directors, make business decisions in Trading Company

124

I Co.

F Co.

CFC like taxation of the income of IHC in India- Invoking the GAAR provisions on deferral of income?

I Co. holding F Co. through IHC

Overseas

India Use of SPV/ IHC designed to delay/avoid Indian taxes on the dividend income to

be received from F Co.

Case Study – Use of SPVs (Controlled Foreign Company)

Intermediate Holding Company (IHC)

Deputation issues – Outbound

Why secondment

126

Companies seeking to do business in world markets - can be successful by having its appropriate talent placed globally

Sending employees overseas is a great talent management / retention tool

Number of outbound assignees - increased considerably, mainly fuelled by growth in IT outsourcing

Large number of outbound employees - junior management and technology personnel

Major outbound population – IT, Healthcare, Banking, Retail, etc.

Tax considerations

127

Country-wise evaluation of Permanent Establishment (“PE”) exposure for Indian company resulting from presence of its personnel in various locations

Examination of availability of “tax credit” in India on foreign taxes

Evaluation of contracting model for assignment of personnel to mitigate PE exposure

Transfer pricing legislation

Compliance with tax filing requirements by Indian company based on foreign tax laws

Employer – Employee

128

• Departure formalities

• Residential status

• Tax filings

• Reporting overseas income

o Tax credit on overseas income

o Tax Refunds

Host Country tax registration

– Tax filings

– Reporting of Indian income

Employment income

Bonus

Stock options

Other income

– Tax credit

HOME COUNTRY HOST COUNTRY

Case Study- Global E-Business Operations

ABC Company

Seconded Employees

India

Overseas

Services to the Overseas Company

Employees seconded to Overseas – Remuneration paid by ABC Co.

Reimbursement by Overseas Company of the remuneration

paid by ABC Co

Overseas Company

Facts

Under a Secondment Agreement, ABC

Company seconded its employees to the

Overseas Company

ABC Co. shall pay remuneration to the

seconded employees and the Overseas

Company shall reimburse ABC Co to the

extent of salaries paid to the seconded

employees

Issues for ABC Company

Taxability of the payment received from

Overseas Company?

Questions?

Questions & Answers

Questions

&

Answers

Thanks