Opportunites for Chinese companies investing in India · Introduction Opportunites for Chinese companies investing in India 3 In recent years, India’s economy has been one of the

Opportunites for Chinese companies investing in India.

Asia Pacific International Core of Excellence

Contents

2 Glossary 3 Introduction 4 Overview of India's inbound rules 11 Issues from a Chinese perspective when investing in India 21 Conclusion 22 Contact details for Deloitte's China Practice 23 Contact details for Deloitte's offices in India

Opportunites for Chinese companies investing in India 1

Glossary

AOA Articles of Association •

DDT Dividend Distribution Tax •

DIN Director’s Identification Number •

DSC Digital Signature Certificate •

ECB External Currency Borrowing •

FDI Foreign Direct Investment •

FEMA Foreign Exchange Management Act, 1999 •

FII Foreign Institutional Investor •

FIPB Foreign Investment Promotion Board •

Act Indian Income-tax Act, 1961 •

MOA Memorandum of Association •

NRI Non Resident Indian •

PIO Person of Indian Origin •

PF Provident Fund •

EIT Enterprise Income Tax •

VAT Value Added Tax •

BT Business Tax •

DDT Dividend Distribution Tax •

SAT State Administration of Tax •

CFC Controlled Foreign Company •

GAAR General Anti-avoidance Rule •

FTC Foreign Tax Credit •

PE Permanent Establishment •

OECD Organisation of Economics, Cooperation and Development •

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Introduction


In recent years, India’s economy has been one of the fastest growing economies in the world. It is now the 11th largest economy in terms of nominal GDP and the fourth largest in terms of purchasing power parity. From 2004 to 2010, India's average quarterly GDP growth rate was 8.4 percent. The expansion of the economy has been reinforced by market reforms, a large influx of foreign direct investment (FDI), rising foreign exchange reserves, booming information technology and real estate sectors, and a flourishing capital market.

Cumulative FDI inflow into the Indian economy from April 2000 to November 2010 exceeded US$186 billion, with the top five sectors being services (both financial and non-financial), computer software and hardware, telecommunications, housing and real estate, and construction activities. Mauritius continues to be India’s number one investor, with a participation of 42 percent. With China’s FDI in India being only 0.04 percent (US$53 million) and Hong Kong’s FDI a little more at 0.54 percent (US$666 million), there are enormous opportunities for China to grow its investment in the booming sectors of India’s economy, such as infrastructure, telecommunications, power, automobiles, heavy industry, etc.

India’s exports to China were approximately US$12 billion in the period 2009-2010, constituting about 6.5 percent of total exports, and China’s exports to India were approximately US$31 billion or about 10.7 percent of total imports. China can therefore be considered an important trading partner for India.

Country 2009-2010 % of total 2010-2011 (Apr -Jun)

% of total

Exports to China 11,618r 6.5 3,027 5.7

Imports from China 30,824 10.7 9,332 11. 6

*Note: Amounts are expressed in US$million.

This booklet looks at some of the regulatory, business and tax issues that potential Chinese investors into India need to consider, from both an Indian and a Chinese perspective.

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Foreign Direct Investment rulesFDI into India is, broadly speaking, governed by the Indian government’s FDI policy and regulations prescribed under the Foreign Exchange Management Act, 1999.

There are two possible FDI routes: the automatic route and the approval route. The main difference between the two is that the approval route requires advance approval from the Foreign Investment Promotion Board, the clearing agency established under the Ministry of Commerce and Industry; the automatic route does not require advance approval.

Overview of India'sinbound rules

Foreign investment is prohibited in specific activities/sectors:

Agriculture (subject to certain conditions) •

Retail trading (except single brand retail) •

Lotteries •

Manufacturing of cigarettes •

Real estate business/construction of farm houses (as defined) •

Atomic energy, railway transport industry (other than Mass Rapid Transport Systems), etc. •

FDI

Automatic route(no prior approval required)

Investment in sectors requiring

government approval

Previous venture in India in "same" field as stipulated

FDI in excess of 24% for

manufacturing items reserved for small-scale sector

Investment exceeding caps for automatic

route to the extent permitted

Approval route(requires prior approval of FIPB)


The chart below sets out the types of investors that are eligible for FDI.

Foreign investment in India

Foreign Direct Investment (FDI)

Investments on non-repatriable

basis

Other investments

Foreign Venture Capital Investor

(FVCI)

Porfolio Investment

Scheme

Automatic route

Approval route

Person resident outside India

FII NRI, PIO FII NRI, PIO NRI, PIO

There are two types of companies in India: the private company and the public company. A private company requires a minimum paid-up capital of INR 0.1 million and its articles of incorporation will provide restrictions on the following:

Maximum of 50 members •

Transferability of shares •

Invitation to the public to subscribe to shares or debentures •

Invitation or acceptance of deposits from any person other than its members, directors or their •relatives.

There are no such restrictions for a public company. The minimum paid-up capital for a public company is INR 0.5 million.

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Foreign exchange control regulationsAll investments in, and any acquisitions of, the shares of an Indian company and transactions involving the purchase or sale of foreign exchange by a nonresident must be in compliance with the Foreign Exchange Management Act, 1999 and the regulations thereunder.

External Corporate Borrowing (ECB) is one method used by an Indian entity to raise funds from abroad. The ECB policy of the Ministry of Finance includes guidelines on the following:

Eligibility criteria for accessing international •financial markets

Total amount/limit on funds that can be raised •through an ECB

Maturity period and costs involved •

End use of funds raised •

ECBs can be accessed under either the automatic route or the approval route.

Branch office in IndiaA foreign entity may set up a branch office in India provided it obtains approval from the Reserve Bank of India (RBI). An approved branch office may undertake the following activities in India:

Exporting/importing of goods (on a wholesale •basis)

Rendering of professional or consultancy •services

Carrying out research in areas in which the head •office is engaged

Promoting technical or financial collaboration •between Indian companies and a head office or overseas group company

Representing the head office in India and acting •as a buying/selling agent in India

Rendering information technology services and •services relating to the development of software in India

Rendering technical support for products •supplied by the head office/group companies

Acting as a branch office of a foreign airline or •shipping company

Additional specific approval from the RBI is required for a branch of a foreign company to undertake or carry on any other activities. However, approval will not be granted for carrying on retail activities or manufacturing or processing activities in India through a branch office.

An Indian branch office must comply with Indian rules, including registration under the Indian Companies Act, 1956. For income tax purposes, a branch office is considered an arm of the foreign entity of which it is a branch and, therefore, the corporate income rate applicable to a branch office is 40 percent (plus the applicable surcharge and cess). No further income tax is levied on distributions of profits made by a branch to its head office, so that such distributions may be remitted freely. As compared to an Indian subsidiary, an Indian branch is not significantly disadvantaged because, in addition to being subject to a 30 percent corporate income tax rate (plus the applicable surcharge and cess), an Indian subsidiary is liable to Dividend Distribution Tax (DDT) at an effective rate of 15 percent (plus the applicable surcharge and cess) on dividends distributed/declared.

As it has other commercial advantages, setting up an Indian branch is considered a suitable alternative for establishing a presence in the country.

Direct taxes in IndiaUnder the Indian Income tax Act 1961, income that arises, accrues, is received or is deemed to accrue or arise in India is subject to income tax at a rate of 30 percent or 40 percent (plus the applicable surcharge and cess) depending on the type of entity.

A company also may be liable to a minimum alternate tax (MAT) at a rate of 18 percent (plus the applicable surcharge and cess) of the adjusted book profits where the tax liability is less than


the tax payable on the book profits. MAT may be carried forward and set off against tax payable for the following 10 years. As noted above, Indian companies declaring and paying dividends to their shareholders are also required to pay DDT on the dividends at a rate of 15 percent (plus the applicable surcharge and cess).

Capital gains tax is levied on the transfer of assets (including shares of an Indian company) and a wealth tax is levied on certain assets.

A person earning income chargeable to tax is liable to pay advance tax/self-assessment tax on the income it earns and is required to file a tax return within the time specified. India also has comprehensive withholding tax provisions that place an onerous responsibility on payers that are obliged to withhold tax.

India’s transfer pricing provisions, which govern transactions between related parties, are generally based on the OECD guidelines. India has a broad tax treaty network - currently more than 75 treaties - including one with China (but not Hong Kong). Indian domestic tax law entitles a qualifying taxpayer to benefit from reduced rates under a tax treaty if the treaty rates are more beneficial than the rates under domestic tax law.

Indirect taxes in IndiaThe indirect tax regime in India is comprised of numerous transaction taxes, which are levied by the central and state governments. Under the Constitution, the central government levies taxes on the import and manufacturing of goods and the provision of services, while the state governments levy tax on the sale of goods.

The indirect taxes largely follow the principles of Value Added Tax (VAT), which allow tax paid at the input stage to be credited against the output tax liability of a business. The input credit for central taxes and state VAT may be taken and utilised only against the output liabilities for that tax.

State VAT. Each state in India has its own VAT legislation, with rates that vary from 12.5 percent to 15 percent (a lower VAT rate of between 4 percent and 5 percent applies to specific goods). State VAT is payable on the sale of goods (but not services) within the same state, and VAT paid on the purchase of goods is generally available as an input tax credit to the buyer.

The sale of goods from one state to another attracts Central Sales Tax (CST). CST paid on the purchase of goods is not available as an input tax credit and therefore represents a real cost. The CST rate is either equal to the VAT rate in the state in which the sale takes place, or 2 percent if the buyer provides a statutorily prescribed concession form. That form is available where an interstate purchase of goods is intended for resale or for use in the manufacture and processing of goods. Certain states also levy an Entry Tax on the entry of prescribed goods into the state. Entry tax generally is available as an input credit for the buyer.

The states currently do not levy State VAT on the importing of goods.

Export of goods and services. Export of goods and services is generally zero rated. An exporter of goods or services is able to claim a refund/rebate of the input excise duties/Service Tax or VAT paid on the purchase of goods by following the prescribed procedure under the relevant legislation.

Customs duty. Customs duties are levied on the import of goods into India and comprise the following:

Basic Customs Duty (BCD) (maximum rate 10 a. percent, with some exceptions)

Additional Duty of Customs in lieu of b. Central Excise Duty (commonly referred to a countervailing duty or CVD) (maximum rate 10.3 percent, with a few exceptions)

Education Cess (EC) of 2 percent and Secondary c. and Higher Education Cess (SHEC) of 1 percent

Additional Duty of Customs (ADC) in lieu of d. sales tax/VAT (4 percent).

The effective rate of customs duty on most goods is 26.85 percent.

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Excise duty. Excise duties are payable on the manufacture/production of goods in India. The packaging and/or repackaging of goods, the affixing of the manufacturer’s retail price (MRP) or an alternative, and such other activities as may be prescribed also are deemed to constitute manufacturing for these purposes. Excise duty is generally levied at an ad valorem rate of 10.3 percent (including the 2 percent EC and 1 percent SHEC on the excise duty). Some goods are charged with specific excise duties. Excise duty paid on inputs and capital goods is generally allowed as an input credit that may be offset against the output excise duty/Service Tax liability.

Service Tax. The Indian government has identified approximately 115 activities as taxable services that attract Service Tax, at a rate of 10.3 percent (including the 2 percent EC and 1 percent SHEC on the Service Tax). The service provider typically is liable to pay Service Tax at the time it receives the agreed upon consideration, although there are a few situations in which the service recipient is liable for the tax under the ‘reverse charge mechanism’. Service Tax paid on input services may be offset against the output service tax/excise duty liability.

Octroi duty. Octroi duty is levied by the municipal corporations on the entry of goods in prescribed municipalities. Currently, it is levied only in the State of Maharashtra.

Tax incentives in IndiaThe Indian government has provided many incentives for doing business in India. The following are the most important and should be considered when executing contracts in India:

A unit set up as a • 100 percent Export-Oriented unit or in a Special Economic Zone (zone for exporting goods and/or services) is exempt from customs duty, excise duty, CST on imports and domestic purchases and in the case of SEZs, even Service Tax on identified ‘input services’

Imports of machinery, appliances, instruments, •apparatus, etc. for specified projects enjoy concessional BCD rates under ‘Project Imports’ status

Either an exemption from ADC on the import •of goods for retail sale or a refund is granted if certain requirements are met

Manufacturing units set up in the North-Eastern •States of Jammu, Kashmir, and Sikkim are exempt from excise duty (by way of a refund)

Indian service providers (with some exceptions) •that have foreign exchange earnings qualify for a ‘Duty Credit Scrip’ as a percentage of their free foreign exchange earned

Export manufacturers may import raw materials •without paying customs duties or may import capital goods at concessional customs duties rates, subject to the fulfillment of a prescribed export obligation

Exporters of goods or taxable services are •allowed to claim a refund of input excise duty paid on inputs or capital goods and on Service Tax paid on input services procured for the manufacture of export goods or the provision of taxable services exported

Trading with IndiaExemptions: With a view to creating better infrastructure facilities in India, facilitating the establishment of new projects or the expansion of existing projects of special importance and ensuring easy access to cutting-edge technology, the Indian government provides a customs duty exemption for the import of specified goods, including machines, tools and instruments required for the above purposes. The government recently granted exemptions for goods needed to set up solar power plants, metro rail projects, water supply projects, oil and gas projects, road construction, ports, airports, and cold storage or cold room facilities when such goods are imported into India.

India is a member of the World Trade Organization (WTO) and has signed an Information Technology Agreement (ITA) that obliges the government to eliminate tariff barriers on the import of identified Information Technology (IT) goods. Under this agreement, the government has exempted many IT goods from customs duty when imported into India.


Anti-dumping or safeguard duties: In many cases, goods originating from a particular country or exported by companies in a particular country are dumped in India at a price that is lower than the price at which similar goods are produced in that country or in India. To protect Indian industry from such low priced imports and to create a level playing field, the government imposes anti-dumping duties and safeguard duties on identified goods. These duties generally are levied for a prescribed period of time and are reviewed periodically (recent examples include anti-dumping duties on bus/truck tires and flaps, specific nylon yarn, transparent cellophane film imported into India).

Free Trade Agreements (FTA): To enhance bilateral trade, the Indian government has concluded FTAs with many countries and trade blocs. FTAs provide for concessional import tariffs on a reciprocal basis on specified traded goods, subject to prescribed rules. India currently has FTAs with Bhutan, Chile, the ASEAN countries, Finland, Korea, Nepal, Singapore, Sri Lanka and Thailand, as well as with certain South Asian, Asia Pacific and South Asian Association for Regional Cooperation countries (for services). FTAs are being negotiated with Australia, Japan, Malaysia and the U.S. and the European Union.

Permanent Account Number: The Indian Income- tax Act 1961 requires every person that is liable to pay income tax in India to obtain a permanent account number (PAN), or Indian tax identification number. Thus, for example, a Chinese company providing services to an Indian company which is subject to income tax in India would need to obtain a PAN. A penalty is imposed for failure to obtain a PAN. Further, if a PAN is not provided to a payer that is required to withhold tax, the payer must withhold tax at a minimum rate of 20 percent. A refund of any excess tax payment would have to be claimed by requesting a refund on the income tax return (for which a PAN is also required).

Tax treatment of employment income of Chinese nationals working in IndiasIn India, the tax liability of an individual taxpayer depends on the individual’s residence status, not on citizenship/nationality. Residence status, in turn, depends on physical presence in India in the tax year concerned and prior tax years. Regardless of the residence status of an individual in India, his/her employment income is taxed in India under domestic tax law if the services are rendered in India. The place where the employment contract was concluded and the place where salary is received are irrelevant. However, foreign nationals providing services in India for a short period of time may be eligible for a “short stay exemption” from tax during that period. This exemption is available under either the Indian Income tax Act 1961 or under an applicable tax treaty (provided certain requirements are met).

Social security in IndiaThe Indian government made fundamental changes to the Provident Fund (PF) rules in 2008 by introducing a new category of employee, known as an ‘international worker,’ who is required to join the PF scheme. The PF requirement applies to non-Indian passport holders who are employed by an establishment that is governed by the PF Act. The PF Act applies to an establishment that has at least 20 employees at any time during the year or that voluntarily elects to be governed by the PF Act. Participation generally requires that an employee contribute 12 percent of pay (which includes the base salary, a “dearness allowance”, i.e. cost of living allowance, retention allowance, cash value of food concessions). An employer is required to make a contribution equal to 8.33 percent of the employee’s pay to the pension fund and 3.67 percent of the pay to the PF. A nominal administration charge is also payable.

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An international worker who contributes to a social security programme in his/her country of origin (either as a citizen or resident) with which India has concluded a Social Security Agreement (SSA) on a reciprocal basis and who enjoys the status of a “detached worker” for the relevant period and terms specified in the SSA does not have to contribute to the Indian social security scheme. India currently does not have an SSA with China, so Chinese nationals working in India must contribute to the PF in India. Further, in the absence of an SSA between India and China, a Chinese individual will not be able to withdraw his/her pension fund contribution at any time, although the individual will be able to withdraw the balance in the PF account upon retirement from service in the organisation or at any time after the he/she turns 58, whichever is later.

Work permit and other registration requirementsForeign nationals coming to India for work must hold a valid employment visa upon arrival. The Indian Embassy/High Commission in the home country will provide information on the documentation and other requirements for obtaining an employment visa.

Foreigner nationals who hold a visa that is valid for more than 180 days are required to register with the FRRO (Foreigners’ Regional Registration Office) within 14 days of their first arrival in India.


In addition to a careful analysis of the tax and regulatory requirements in India, Chinese companies looking to invest in India also need to examine China’s own tax and regulatory rules.

Supply chain planningSome of questions that commonly need to be addressed in connection with the supply chain as it relates to a potential investment in India are:

How can the relevant product be moved out of •China and into India efficiently and in a timely manner?

Is it necessary to set up any infrastructure in •India to distribute goods/services?

How can the Chinese company maintain control •of the distribution of the goods/services in India?

The issues involved can be illustrated by looking at the construction industry (although these are by no means unique to the construction industry). A large number of Chinese companies are now obtaining construction and, more specifically, infrastructure contracts in India. In an industry where multiple groups of persons (e.g. engineers, architects, tradesmen) interact and where a wide range of building materials, both locally and foreign sourced, is required, it is important to be able to bring the key pieces together at the right time, in the right quantity and with the right quality. Without an efficient supply chain, construction projects can become mired in serious delays that cost money as well as time.

Supply chain planning is designed to make the most of synergies within a company's supply chain to increase the profitability of the company’s goods/services. If supply chain planning is to be successful, there must be a clear conception of where the additional value will arise - within the Indian investment group that is being acquired and/or in the current group.

Issues from a Chinese perspective when investing in India

Value Added Tax Any meaningful examination of a company’s supply chain risks inevitably calls for an examination of the taxes that could arise in relation to the supply chain. One of the main taxes that companies located in China will have to deal with is VAT.

Unlike in India where VAT is levied and administered at the state level, in China VAT is a national tax, with a single rate imposed regardless of the location of the VAT taxpayer. Chinese VAT is generally levied on any person engaged in the sale of goods and the provision of processing, repair and replacement services within China, as well on the importation of goods into China. The VAT rate charged is 17 percent. Chinese companies exporting their goods to India will need to ensure that they obtain the refund of VAT that is available when goods are exported.

An export VAT refund is granted to taxpayers that export goods from China, the refund rate depending on the nature of the goods exported as determined by their Customs classification. It is therefore important to ensure that the products intended for export are properly classified to maximise the amount of the VAT refund.

Business Tax and the provision of servicesChinese companies that provide services in India need to be aware of the Business Tax. Business Tax is a turnover tax imposed on activities involving intangible goods and services that are not subject to VAT. In 2009, the principle governing the levying of the Business Tax changed from the place where the service is performed to the place where the recipient (entity or individual) is located. However, the Chinese government recently has made it clear that entities located in Mainland China that render services outside China are "temporarily" exempt from Business Tax with respect to construction, cultural and athletic activities. It should be noted that the exemption is temporary and could be eliminated in the future.

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The rates of Business Tax range from 3 percent, for the provision of construction services (if not exempt), communications and transportation; 5 percent for servicing, royalties and interest; and 5 percent to 20 percent for the provision of entertainment services (as determined by the provincial level tax authorities). Thus, a Chinese company providing services to India or to an Indian entity in the form of management services, or earning royalty or interest income may be subject to Business Tax on income from these sources, in addition to Enterprise Income Tax (EIT).

Business Tax is calculated simply by multiplying the gross income from taxable activities by the applicable tax rate. As there is no creditable mechanism, the cost of the Business Tax cannot be passed on to the customer (as can the cost of VAT), so that it represents a real additional expense.

Customs Duty on exported goodsIn addition to properly classifying products that are being exported to India to maximise the export VAT refund, it is equally important to understand Indian customs duty liabilities. Delays in exporting goods can have a significant impact on a Chinese company’s ability to ensure that the product is in the hands of its Indian customers in a timely fashion.

Transfer pricing on exported goods and provision of servicesEven though not directly supply chain related, transfer pricing is always a component of any cross- border transaction. Chinese companies need to be aware of China’s relatively new transfer pricing rules, as well as the corresponding rules in India. In adopting transfer pricing policies and preparing documentation for cross-border transactions with its Indian business, a Chinese company must consider how the prices set will impact its customs duty and Business Tax liabilities in China, as well the tax consequences in India when the goods are imported.


StructuringCash repatriation: Additional value arising from the acquisition of an Indian company or making a greenfield investment in India may be extracted through the payment of dividends, interest, royalties for the use of intellectual property or service fees, or by disposing of the shares of the Indian company, or a combination thereof. Each of these "cash flows" has a tax impact on the Indian investment and each should be examined separately to identify the available options, as well as the costs, benefits and risks associated with each option.

The results should then be reviewed and a course of action selected by measuring the tax-related costs, benefits and risks against the company’s objectives and preferences. For example:

Structure 1 Structure 2

Dividends Withholding tax rate 10%

Withholding tax rate 5%

Gain on exit Exempt Taxed

A strategic investor looking to derive most of its profits through dividend payments would prefer Structure 2 to Structure 1. However, a private equity investor looking to derive most of the profits by selling its investment in India in the medium term would find Structure 1 more attractive.

Advantages of using a holding company: From a tax perspective, there are broadly two reasons to use an intermediary holding company to acquire a Target company:

Using an offshore intermediary holding •company may produce a better tax result by reducing or eliminating withholding tax on dividends and/or tax on gains arising on a future exit;

Using an offshore intermediary holding •company offers flexibility as to the timing of the receipt by the investor of dividends and exit gains from the underlying investment.

Many countries have tax treaties that reduce (or eliminate) the withholding tax on qualifying dividends or interest received by taxpayers that are resident of the treaty partner country. Treaty rates can vary from treaty to treaty. For example, the withholding tax on interest paid by an Indian company to a Chinese company is 10 percent on a gross basis under the China-India treaty. The withholding tax rate on dividends is 0 percent under Indian law because the DDT is imposed on the distributing Indian company and would not be affected by the treaty provisions. Consequently, reduced treaty rates on dividends typically would not give rise to any tax savings with respect to dividends distributed by an Indian company, so any tax savings will have to be sought from a tax treaty that contains a source country exemption for capital gains.

Similar considerations apply to exit gains. For example, most foreign investments into India are held via Mauritius holding companies because, under the India-Mauritius treaty, gains on qualifying investments would be exempt from tax in India. A similar benefit is available under the India-Singapore treaty.

Foreign tax credit in China and India's DDT: Dividends received by a Chinese company already may have borne tax in the foreign country of residence of the distributing company at a rate equal to or exceeding the Chinese EIT rate of 25 percent. In the latter case, any dividend withholding tax borne would be in excess of the Chinese tax on the dividends and effectively wasted. The company’s effective tax rate on the dividends received accordingly would be increased to the level of dividend withholding tax suffered.

As discussed above, the Indian tax system relating to the payment of dividends is unique in that an Indian company paying dividends is not obliged to withhold tax, but instead the company itself pays additional income tax on distributed profits (i.e. the DDT) on the amount declared, distributed or paid. Such dividends are tax exempt in the hands of the shareholders and, thus, there is no additional Indian income tax liability at the shareholder level.

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For Chinese tax purposes, the DDT should be a creditable tax, because under Indian tax law, it is considered a tax on income. However, confirmation of creditability should be obtained from the State Administration of Taxation (SAT).

Table 1 illustrates the impact of the DDT on a return on investment. The facts are as follows:

Acquisition price: US$1 billion •

Basic corporate tax rate in India: 30 percent (the surcharge and cess are ignored for the sake of •simplicity)

Annual EBIT: US$100 million •

DDT rate: 15 percent on the amount declared, distributed or paid •

No offshore holding company

India company

Chinese investor

15% DDT

Dividend paid: $100

Offshore holding company

Offshore Hold Co

India company

Chinese investor

15% DDT

Dividend paid: $100

0% WHT


Table 1

Direct investment Investment via Hold Co

India Taxation

EBIT 100 100

Corporate income tax rate 30% 30%

Corporate income tax payable (30) (30)

Post-tax profits available for distribution 70 70

DDT rate on amount distributed as dividend 15% 15%

DDT (10.5) (10.5)

Net dividend to China/holding company 59.5 59.5

PRC Taxation

Dividend income (gross) 59.5 59.5

Deemed foreign tax credit* 40.5 40.5

Net income 100 100

Income tax due (before FTC) 25 25

Foreign tax already paid* (40.5) (40.5)

Further PRC tax to pay 0 0

Total tax paid 40.5 40.5

Effective tax rate (%) 40.5 40.5

After tax proceeds (US$m) 59.5 59.5

* This is the tax paid in India and is referred to as an "underlying foreign tax credit". In the example, it is assumed that there is no tax in the holding company jurisdiction.

The table shows that, because of the DDT, it makes no difference whether a holding company is used insofar as dividend withholding taxes are concerned. However, if there was even a small withholding tax in the jurisdiction of the offshore holding company, the after-tax proceeds would decrease.

Foreign tax credit in China and minimising tax on exit gain: Flexibility as to the time the exit gain is received and subsequently subject to tax in China can be achieved by using an offshore holding company to make the acquisition and hold the investment in India. Ideally, an offshore holding company resident in a jurisdiction that does not tax exit gain would be selected. In such cases, the exit gain tax savings achieved represents an immediately available cash flow benefit.

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Disadvantages to using intermediate holding company: There are certain disadvantages to using an intermediate holding company, including the following:

Additional costs of forming and maintaining the holding company; •

Depending on the holding company place in the group structure, the Chinese investor’s ability to •claim a tax credit in China for foreign underlying tax may be jeopardised because the Chinese foreign tax credit rules may limit the credit to foreign tax paid by companies that are no more than three tiers below the Chinese entity.

Potential pitfalls of using an offshore holding company: The benefits discussed above will need to be weighed carefully and systematically against the risks of using an intermediate holding company. The relevant rules of both China and India need to be examined, particularly anti-avoidance rules.

China tax considerations India tax considerations

Residence: When setting up an offshore holding company, care must be taken to ensure that the company does not fall foul of the rules that can deem a Chinese-controlled offshore company to be a tax resident of China (see Guoshuihan [2009] No. 82).

Treaty considerations and specific and general anti-avoidance rules: The Chinese investor will need to ensure that the offshore holding company can withstand any scrutiny and potential challenge with respect to entitlement to treaty benefits, e.g. beneficial ownership, residence for treaty purposes, limitation on benefits provisions, if any.

Controlled foreign company (CFC) rules: Care must be taken to ensure that the profits and gains derived by the offshore holding company are not deemed to be subject to tax on a current basis in China under the CFC rules.

General Anti-Avoidance Rules (GAAR): Indian does not currently apply a general anti-avoidance rule, although it is expected that one will come into effect. The Chinese investor will need to ensure that the structure can withstand any challenge under the new GAAR rules.

General Anti-Avoidance Rules (GAAR): The Chinese investor needs to be confident that the structure can withstand any challenge by the tax authorities under the GAAR.


To mount a successful defense against many, if not most, potential challenges by the tax authorities, there would have to be a bona fide business purpose for the existence of the offshore holding company. In other words, the company needs to have substance and its purpose should be more than simply to obtain a tax advantage. A bona fide business purpose can be demonstrated by reference to a range of factors, including the ability to achieve better management oversight by using a regional holding company (offshore holding company) for the Chinese company’s investments in a particular region. The mix of purposes would vary from taxpayer to taxpayer and would depend on the particular facts and circumstances.

The substance requirement generally would be addressed:

In the case of • financial substance, by ensuring that the offshore holding company has the financial capacity to assume the relevant risks.

In the case of • managerial substance, by ensuring that the company has employees or directors who make the key decisions affecting assets and risks:

Assets: - whether to spend money (and how much) to acquire the assets, how much to spend to maintain the assets, how best to exploit or deploy the assets, etc.

Risks: - whether to assume the risks, how to best manage the risks, etc.

In the case of • operational substance, by ensuring that the company has employees or directors to perform functions such as procurement, finance, accounting, HR, etc., and placing as many activities as possible in the company.

There is a short list of jurisdictions that Chinese companies generally would consider as potential locations for setting up an offshore holding company; these include Hong Kong, Luxembourg, Mauritius, Netherlands and Singapore, and, as a result of changes to their tax laws, Australia and the U.K. In short, the decision should ultimately depend on an intent (and a willingness) to create an actual "presence" in the chosen location.

The vast majority of investments into India are made using a Mauritius investment holding company because of the exemption from Indian tax under the India-Mauritius tax treaty of gains arising on the disposal of shares of an Indian company by a Mauritius resident company. A similar benefit is available under India’s treaty with Singapore (although this benefit would be terminated if the India-Mauritius treaty were to be re-negotiated), but there is also a limitation on benefits provision in the India-Singapore tax treaty.

FinancingThe acquisition of an Indian Target will need to be financed offshore. A Chinese company can borrow or use its own funds to purchase the Target and then inject the funds directly in the form of equity into the company that will be used for the acquisition. The borrowed funds will create an interest expense for the Chinese company, which may be deducted in computing the Chinese company’s taxable income, subject to the normal limits on the deductibility of interest under the thin capitalisation rules where interest is paid to a related party. The Chinese company will need to have sufficient income to absorb the interest expense deductions to avoid creating losses that could expire unutilised.

Certain acquisition structures will not be appropriate in the context of the acquisition of an Indian Target because of India’s exchange control regulations (which prohibit Indian companies from obtaining offshore debt to purchase shares of Indian companies) and the denial of deductions for expenditure incurred to produce exempt income.

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Benefits under China-India Tax TreatyThe 1995 tax treaty between China and India (which generally follows the OECD model treaty, even though China is not an OECD member) eliminates the double taxation of income arising from cross-border economic activities and provides certainty as to tax liabilities associated with cross-border transactions. Chinese companies that intend to invest in India should take the following treaty-related considerations into account:

Treaty benefits: To claim treaty benefits, a Chinese investor may be required to submit a residence certificate issued by the Chinese tax authorities to the Indian tax authorities.

Withholding tax: Withholding tax applies to interest, royalties and technical service fees paid by Indian resident taxpayers to Chinese resident companies. The tax is imposed on the gross amount of the payment at a rate of 10 percent. According to the treaty, technical service fees mean any payments for the provision of managerial, technical and consultancy services by a Chinese company that does not have a permanent establishment in India. It should be noted that the treaty does not exempt or reduce the tax on gains arising to a Chinese company from the sale of property located in India, with potential consequences for a Chinese investor’s exit strategies. As mentioned above, Mauritius or Singapore holding companies are often used by Chinese companies wishing to invest in an Indian resident company. The following chart summarises the withholding tax position under the China-India tax treaty with respect to payments made by an Indian company to a Chinese company:

Type of income Withholding tax

Dividends received by a Chinese company from an Indian company

10% (India does not levy any shareholder level withholding tax on dividends; instead, the Indian company must pay DDT)

Interest, except for interest received by the government, a political subdivision, a local authority or the central bank or a financial institution wholly owned by the government

10%

Royalties and technical service fees 10%

Gains from the sale of property, including shares of an Indian resident company and immovable property located in India and movable property forming part of a branch in India

No exemption


Foreign tax credits available to Chinese investors: Generally, Chinese resident companies are subject to EIT on their worldwide income. Chinese resident companies that derive foreign-source income are therefore subject to EIT on any foreign-source income they derive. To avoid double taxation, the foreign tax credit mechanism in the EIT Law allows a Chinese taxpayer to claim a tax credit for foreign tax paid. The foreign tax credit is limited to the EIT payable in respect of the foreign-source income as calculated under the EIT Law. Creditable foreign tax likely will include the withholding tax directly paid on foreign-source passive income (e.g. dividends, interest and royalties) and also the foreign income tax indirectly borne by the Chinese taxpayer as a result of the imposition of tax (i.e. India DDT) when profits are repatriated in the form of dividends. However, further clarification from the Chinese tax authorities is required to determine whether DDT is a creditable tax. With respect to the indirect tax credit, the treaty requires a minimum 10 percent shareholding, so that an indirect credit can be claimed only where the Chinese investor holds more than 10 percent shares of the Indian subsidiary.

Permanent establishment (PE): The treaty defines a PE as a fixed place of business owned by a Chinese company in India for purposes of generating income. A PE also will be created if a Chinese company sends its employees to India to provide services (other than technical services as defined in the treaty) and those services continue for a period or periods aggregating more than 183 days. If a Chinese company is considered to have a PE in India, the income derived from the PE, whether directly or indirectly, would be subject to income tax in India.

Mutual Agreement Procedure (MAP): The MAP provision in the treaty allows a Chinese or Indian company to request an agreement between the competent authorities of India and China if an action of one jurisdiction results in the taxation of the company that may cause double taxation that should be relieved by the treaty. There is a three-year time limit for initiating a MAP, starting from the date of the first notification of the action resulting in taxation not in accordance with the treaty.

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Branch vs legal entity rulesThe most common legal forms for making an outbound investment are a branch, subsidiary or joint venture. From a Chinese EIT perspetive, a foreign branch established by a Chinese investor does not have independent tax status. Thus, the Chinese investor must include the branch’s current year profits and income in its total taxable income when it calculates its EIT payable in China. However, the Chinese investor can claim a foreign tax credit for the income tax paid by the branch in India. On the other hand, if the Chinese investor establishes a subsidiary or joint venture in India, the Chinese investor will recognise taxable foreign-source income only at the time dividends are declared by the Indian subsidiary. As in the case of a branch, a credit for foreign underlying tax may be claimed with respect to the dividends. This in essence puts the Chinese investor in the same position regardless of whether the investment is made through a branch or a subsidiary.

A Chinese company making an outbound investment through a foreign subsidiary or joint venture will always need to determine whether the Chinese CFC rules will apply to treat the income derived by the foreign subsidiary/joint venture as taxable income in China. Under the CFC rules, a foreign company is considered a CFC if all of the following factors are present:

The foreign company is controlled by a Chinese •resident enterprise, or collectively by a Chinese resident enterprise and Chinese resident individuals;

The foreign company is established in a country •(or region) that has an effective tax rate lower than 12.5 percent (i.e. half of the statutory EIT rate in China); and

The foreign company does not distribute profits •without a reasonable business justification.

A company is deemed to be "controlled" where a resident enterprise or an individual resident in China holds, directly or indirectly, 10 percent or more of the total voting shares of the foreign company, or jointly holds more than 50 percent of the total shares of the foreign enterprise. If the percentage tests are not met, a substantial control provision will apply, i.e. control will be deemed to exist if the Chinese resident exerts substantial control over the foreign enterprise with respect to shareholding, financing, business, purchases and sales, etc. If a CFC exists, the Chinese shareholders may be taxed in China on their proportionate share of undistributed profits of the CFC, unless exceptionally:

The CFC is located in a white list country, •including Australia, Canada, France, Germany, India, Italy, Japan, New Zealand, Norway, South Africa, the U.K. and the U.S.;

The CFC's income is derived mainly from active •business activities; and

The annual profits of the CFC are lower than •RMB 5 million.

Both direct and indirect foreign tax credits are allowed with respect to CFC income, subject to certain limits. Income that already has been attributed and taxed under the CFC rules will not be subject to Chinese tax when it is subsequently distributed by the CFC to the shareholders in the form of a dividend.

According to the Chinese tax authorities, a Chinese resident company is required to file an annual reporting form on its overseas investments, together with its annual tax return. The competent tax authority will issue a confirmation notice where a CFC is identified based on a review of the reported information.


While opportunities for Chinese companies to invest in India are abundant, Chinese investors need to consider a host of regulatory and tax issues in both countries.

On the Indian side, there should be a careful examination of the sectors in which investment is permitted or requires approval. How the Indian operations are to be funded will also have to be evaluated from various perspectives - repatriation of funds, management of capital and type of instrument to be used. Funding through debt is highly regulated and restricted to certain specified purposes. A detailed location analysis should be undertaken to determine the best area in the country for setting up manufacturing facilities, taking into account the availability of raw materials, skilled labor and the necessary infrastructure; the potential market; the ability to obtain local debt; direct and indirect tax benefits offered by the central and state governments; what industries are encouraged in that location, etc.

Conclusion

When executing projects in India, it is necessary to consider the approval requirements of the regulatory authorities, expatriate visa and tax filing requirements, PE exposure risks, the implications of forming a joint venture, the appropriate structuring of contracts, the pricing of goods, duties payable on imports, etc.

It is of course equally important to examine the Chinese tax and regulatory implications of Indian investments/projects.

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How Deloitte can help

Investment structuring •

Agreement structuring •

Incorporation of company in India •

Structuring of tax efficient supply chains •

Advisory and compliance •

Audit •

Detailed market assessment and feasibility study for products •

Location analysis for setting up an office and manufacturing base •

Business plan/financial model for setting up operations in India •

Manpower ramp-up plan, roll out approach, IT requirements, Capex requirements, balance sheet/ •profit and loss/cash flow statement, etc.

Assist with timely set up of a structured PMO process •

Identify suppliers and vendors for manufacturing and required services •

Process definition and implementation including IT setup •

Assist with organisational structure and HR •

Run the F&A and payroll processes until an internal team is in place •

Advise on tax benefits •

Obtain tax and regulatory approvals and registrations •

Assist with exchange control, direct and indirect tax compliance •

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About Deloitte Asia Pacific International Core of ExcellenceThe Deloitte Asia Pacific International Core of Excellence (“AP ICE”) was established in June 2010 to provide international tax consulting services to Asia Pacific based companies investing abroad as well as multinational companies investing in Asia Pacific. AP ICE is based in Hong Kong and has a team of 20 senior tax professionals from 13 tax jurisdictions, including Canada, China, France, Germany, India, Japan, Luxembourg, the Netherlands, Singapore, South Korea, Taiwan, United Kingdom and the United States.

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