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C h a l l e n g e U s
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Income stream
Entry strategy
Financing options
Debt structuring
Cash repatriation
Exit considerations
Case Study
Business reorganisations
Transaction imperatives
Leasing transactions
Business Dynamics
Business Environment
Cultural Issues
Accounting treatment
Cultural Differences:
In a multi-disciplinary context, sparked in the wake of globalization, various issues concerning inter-country cultural differences have assumed significant importance. A lack of an optimum level of understanding of the contracting parties’ spoken language, its culture, the traditions, its local business practices and customs, can have an adverse impact on an effective completion and implementation of the project/transaction resulting in the ultimate break down of the business relationship.
Business Strategies:
A successful business venture is dependant on a number of factors and strategies. These include factors driving demand and customer loyalty, level of quality of service, industrial practices, or distribution channels. All of which would differ on a country-to-country basis depending upon the extent of liberalization and privatization and the model of governance being followed there. These issues, therefore, gain significance at the early stages of implementation of a cross border transaction.
Accounting Treatments:
Differences exist across countries, on the varying accounting treatments practiced such as financial reporting and the quantity of financial information made available. In cross border transactions, such issues must be addressed at an early stage so as to address the risk quotient of the transaction.
Identifying and Delivering Synergies
Cross border transactions may be structured in numerous forms, however, the ultimate objective of all such transactions is to achieve synergies by benefiting from each other’s expertise and exploiting maximum available potential on either side. Thus, any cross border transaction must be structured keeping a synergies plan in mind prior to its implementation so that maximum benefits may be reaped at a later stage.
Laws and Regulations:
The level of corporate governance varies from country-to-country as also the willingness to open its markets to foreign investors. The legal and regulatory framework varies across the globe, some being more stringent than others. Local expertise is therefore essential to provide an in depth understanding of the relevant local laws and regulations.
Tax regimes and treaties
Local laws and regulations when juxtaposed against relevant cross border tax treaties, offer a complete understanding of the legal liabilities and duties of an entity, entering into a cross border transaction. Principally designed to avoid double taxation, these tax treaties often give rise to complex issues and tackling the same may require expertise and specialization.
Environment:
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Cross border transactions
Entry Strategy
Financing options
Others: royalty / brand fees / technical services / management services
Dividends
Interest, TS and royalty can flow independent of ownership pattern
TS and royalty would typically flow to an operating entity, which possess technical capabilities
Principal drivers are tax costs associated with dividend flows and gains on disposal of shares
Brand fee would flow to the IPR company
Income streams
1
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*DDT @ 14.025%
Note Nil in case of transfer of shares by one non-resident to another non-resident
Jurisdiction
Mauritius
Dividends
Nil*
Nil*
Nil*
Nil
Nil
Note
Interest
0/10/15%
10/15/20%
USA
1
Financing options
No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets commercial requirements
Leveraging Indian company using overseas debt subject to restrictions in ECB Guidelines (see next slide)
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Parameters
Equity
Term
DDT would be payable @ 14.025%
Tax credit
Not available under most Treaties (check domestic laws of home country)
Tax withholding on interest available
Not available under most Treaties (check domestic laws of home country)
Usage
Restriction on usage as per ECB guidelines (see next slide)
No restrictions
Interest allowed as deduction (arm’s length principle)
Dividends and DDT not deductible; consider double dip deduction
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Foreign equity holder if:
ECB up to 5 MUSD – minimum equity of 25%
ECB above 5 MUSD – minimum equity of 25% and debt-equity ratio not exceeding 4:1
Upto 20 MUSD – Minimum average maturity of 3 years, can have call / put option
Over 20 MUSD to 500 MUSD – Minimum average maturity of 5 years
ECBs outside the above limits/ maturity period need specific approval
Investment in real sector (capital goods, new projects, modernization/ expansion of units)
Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)
Not to be utilized in capital market transactions, real estate, acquisition, working capital, repayment of Rupee loans
ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR
ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR
ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum average maturity period
Lenders
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Cash repatriation
Dividend distribution
Broad mechanics of each of the above options have been discussed in detail in Annexure 1
Simplest and most common
Capital reduction
Court regulated process, involving repayment of share capital – comparatively complex and time consuming – amount paid to the extent of accumulated profits of the company would be taxable as dividend in India
Cash rich company with low reserves
Loss making company with cash reserves
Maximum amount of repatriation desired
Share buyback
Repurchase of shares – restricted amount of repatriation – income taxable as capital gains in hands of the shareholder
Profit making company
Foreign Co desires to classify the income as ‘capital gains’ instead of ‘dividend’ – possible treaty benefits
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Right of First Refusal; Tag Along rights; Drag Along rights
No Objection Certificate requirement for setting up new venture – Press note 1 of 2005 (refer Annexure 2 for process)
Liquidation process – long drawn and Court approval process
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US Corp
Aggressively targeting Asian foods markets
Has significant experience in the foods business and commands a powerful brand name
Target Co
Leading exporter to Asia
Mauritian Co
US Corp’s strategic holding company for Asian investments
Has a wholly owned Indian subsidiary, F&P, engaged in two businesses - foods and packaging
F&P has accumulated tax losses
Leading Indian company (not part of US Corp group)
Holds majority equity in Target Co
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100%
Case Study to suggest mechanism to achieve business objectives of US Corp & Indian Partner
Phase I
Asian strategy - acquire control of Target Co
Foods business of F&P to be consolidated with Target Co
Phase II
US Corp receives royalty
Exit non-core business
Increase in stake
Acquisition of shares
Share buyback
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Mauritius
Co
Dissolution of F&P under Court order without winding up
Broadly tax neutral on satisfying conditions
Transfer of tax losses and tax benefits of F&P
Tax losses available for fresh lease of 8 years
Stamp duty costs significant
No cash outflow for Mauritian Co
No consideration to Indian Partner on indirect dilution of its stake
Fiscal and regulatory implications of merger
Issue of shares to Mauritius Co. as consideration of food business
Merger
Mauritian Co
Target Co
Sale of trademark – capital gains
License of trademark – royalty income
Target Co transfers its Trademark (‘TM’) to Mauritian Co. Subsequently Mauritian Co licenses TM back to Target Co
Mechanics
51%
Arm’s length nature of sales and licensing of trademark
May entail service tax and Value Added Tax
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Lease of equipment with resources to operate the equipment
Lessor continues to control the operation of the equipment and its maintenance
Example– Lease of an aircraft along with flight crew; lessor responsible for selection/ hiring of flight crew, operation and maintenance of aircraft, etc
Lessor merely provides the equipment at a particular location
Lessee operates the equipment using his own resources
Example – Lease of aircraft without crew
Forms of dry lease:
Wet lease
Dry lease
Lessor is the legal and the economic owner
Lessor is the legal owner
Lessee is the economic owner
Risks and rewards associated with the asset not substantially transferred
Risks and rewards associated with the asset are substantially transferred
Operating lease
Finance lease
Risks include losses due to idle capacity, technological obsolescence & changing economic conditions. Rewards include expectation of profitable operation over economic life of asset and gain from appreciation in value or realisation of residual value
Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India
Ernst & Young Global
Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions.
Rewards may be represented by the expectation of profitable operation over the economic life of the asset and of gain from appreciation in value or realization of residual value.
According to AS 19, whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than its form.
Examples of situations stated in AS 19 which would normally lead to a lease being classified as a finance lease are:
 
 
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Lessor
Lessee
Depreciation allowed to lessor
Lessee
Depreciation would be allowed to the lessor
Section 10(15A) – exemption from tax withholding extended
Wet lease
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Section 9(1) (vi) –
Royalties defined to include payments received for use of equipment by the lessee
It may be argued that in a wet lease the lessee does not use the equipment
However, in a Satellite taxation ruling, it has been mentioned that ‘use’ does not refer to physical use of the equipment
44B/ 44BBA –
These sections apply to non residents engaged in operation of ships and aircrafts and who derive income from carriage of passengers, goods, etc.
Operator not defined with reference to this section but lessor may be held to be the operator because even though aircraft/ ship are operated under the name of the lessee –all functions pertaining to operation of the aircraft/ ship are performed by the lessor such as:
actual flying of the aircraft,
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Article 12 Royalties includes consideration for use of equipment
Article 7 – Business Profits applies where Article 12 does not cover payments for use of equipment
Klaus Vogel‘s commentary - If enterprise lets or leases facilities, equipment, buildings or intangibles to enterprise of other state without maintaining a fixed place of business for such letting or leasing activity in the other state, the lessee’s facilities, equipment, buildings or intangible property, as such, will not constitute PE of lessor, if contract limited to leasing of equipment
Article 8 (1) - Profits from operation of ships or aircraft in international traffic taxable only in state of residence
OECD Commentary of Article 8 of model tax treaty - “Profits obtained by leasing a ship or aircraft on charter fully equipped, manned and supplied must be treated like the profits from the carriage of passengers or cargo
Dry lease
Wet lease
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Amount restricted to positive distributable reserves
14.025 % Dividend Distribution Tax (DDT) Income exempt in recipient’s hands Tax treaties with some countries provide for Underlying Tax Credit (UTC) on DDT
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Capital repayment or capital reduction
Positive distributable reserves are not a pre-requisite Capital repayment not possible at amount higher than par value of shares Possible to increase cash pay out by capitalizing reserve
Funds paid to the extent of accumulated profits (including capitalized profits) taxable as dividend (dividend tax @ 14.025 % For public listed companies if Securities Transaction Tax applies, Long term - NIL Short term @11.22% Tax rate for private companies Long term - 22.44% (in case of foreign company 20.91%) Short term - 33.66% (in case of foreign company 41.82%) Tax withholding Treaty consideration Possible Stamp duty exposure @ 0.25%
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Capital re-purchase or buyback through tender offer
Amount restricted to 25 per cent of (share capital+free reserves) Max 25 per cent of equity share capital permitted to be repurchased in an year Post buyback Debt-equity ratio not to exceed 2:1 Minimum 12 months gap between two consecutive buyback
Capital gains tax for shareholder on consideration less acquisition cost (after adjusting for exchange fluctuations) For public listed companies if Securities Transaction Tax applies, Long term – NIL Short term @11.22% Tax rate for private companies Long term - 22.44% (in case of foreign company 20.91%) Short term - 33.66% (in case of foreign company 41.82%) Possible stamp duty exposure @ 0.25%. ‘Appropriate’ tax to be withheld by Indian Co Provisions of applicable treaty to be considered
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Cash repatriation strategies (contd)
Under exchange control regulations, cap on per share amount payable on buyback is the higher of the price based `on the NAV per share linked with stock exchange or as per valuation of statutory auditor/ merchant banker
Disclosure in offer document, if the promoters to tender shares, for public listed companies
Criteria/ Option
Capital re-purchase ie buyback through tender offer
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Regulatory compliances
No Objection Certificate from Indian partner has been a key negotiation point for foreign company having existing JV relationship in India – In certain cases MNC have to sacrifice by accepting low JV exit price
Does the Foreign company have an existing venture?
Is the existing venture in ‘same’ field?
(this includes equity holdings, technical collaboration, brand collaboration, etc)
NOC from Indian partner required
Prior approval from FIPB required for financial/ technical investment in India
No prior approval required – investment can be made by foreign company
Yes
No
What do the prevailing Foreign investment regulations provide?
FDI restrictions for the particular sector to apply
NOC has been made inapplicable to past ventures as also relaxing the “allied” field condition