Private Equity Handbook Tax & Regulatory Reckoner

7/26/2019 Private Equity Handbook Tax & Regulatory Reckoner

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Private equity

handbookTax and regulatory reckonerJanuary 2013


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A. Foreign investment in India 04

B. Types of instruments 12

C. Repatriation and exit 18

D. Tax rates 20

E. Domestic fund structuring 26

Contents


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Private equity handbook Tax and regulatory reckoner4

Alternative routes forinvesting in India

Foreign investment in India is permitted

under the direct investment and portfolio

investment routes.

Direct investment route

Any person resident outside India (subjectto a few limitations) can invest in India

under the direct investment route (FDI

route). Persons resident outside India

registered as Foreign Venture Capital

Investors (FVCI) with the Securities and

Exchange Board of India (SEBI) are also

allowed to make direct investments in

India with some concessions (FVCI route).

Portfolio investment route

This route is available to persons resident

outside India registered with SEBI as

Foreign Institutional Investors (FII)/

sub-accounts, and to Qualied Foreign

Investors (QFI) and non-resident Indians

(NRIs).

Foreign investmentframework

The Foreign Direct Investment (FDI)

regime has been progressively liberalized

in India over the last two decades, with

most restrictions on foreign investment

being removed and procedures being

simplied. With limited exceptions,foreigners can invest directly in India

either on their own or as part of a joint

venture.

The FDI policy in India is formulated

by the Department of Industrial Policy

and Promotion within the Ministry of

Commerce and Industry, Government of

India. The consolidated FDI policy is issuedannually and is updated for press releases

and clarications issued during the year.

The FDI policy framework is notied by

the Reserve Bank of India (RBI) under the

Foreign Exchange Management (Transfer

or Issue of a Security by a Person Resident

Outside India) Regulations, 2000 and is

amended from time to time.

Foreign investmentsin India


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Private equity handbook Tax and regulatory reckoner 5

Entities into which

foreign investment can be

made

Foreign investment in Indian companies is

typically permitted subject to conditions(where applicable). Foreign investment

in partnerships and proprietary concerns

is restricted only to NRIs and persons of

Indian origin1. Further, foreign investment

in trusts is prohibited unless the trust is

a SEBI registered venture capital fund

(VCF)2. Investment in VCF (other than

by FVCIs) requires prior approval of the

Foreign Investment Promotion Board

(FIPB)3. Foreign investment in limited

liability partnership (LLP) is allowed only

under the FDI route and only in sectors

where FDI is allowed under the automatic

route and where there are no FDI-linked

performance conditions (such as minimum

capitalization, lock-in conditions, etc.)

under the approval route.

1 Investments by NRIs/PIOs in partnerships and

proprietory concerns on a non-repatriation

basis are under the automatic route. However,

investments by NRIs/PIOs in partnerships and

proprietory concerns require prior approval of the

RBI.

2 VCF is a domestic venture capital fund set up

as a company or trust that primarily invests

in domestic unlisted companies in accordance

with SEBI (Venture Capital Funds) Regulations,

1996. The said regulations were repealed in May,

2012 and SEBI (Alternative Investment Funds)

Regulations, 2012(SEBI AIF Regulations) were

notied in May 2012.

3 FIPB considers proposals for foreign investment

that do not qualify for automatic approval. The

FIPB is empowered and chaired by the Secretary

of the Ministry of Finance and has been set up

specically to expedite the approval process for

foreign investment proposals.

FDI routeForeign investments under the FDI

route can be made either under the

automatic route or under the approval

route depending on the sector/activities

in which the Indian company is engaged.

Foreign investment in most sectors is

permitted under the automatic route

without any ownership restrictions or

conditions. Foreign investment caps,

minimum capitalization norms and lock-in

requirements are specied for certain

sectors/activities. Further, certain sectors

are prohibited4from FDI.

4 Prohibited sectors include lottery business,

gambling and betting, chit funds, nidhi company,

trading in transferable development rights

(TDRs), real estate business or construction

of farm house, activities/sectors not open for

private sector investments ( e.g., atomic energy,

railway transport)

Foreign investments in India


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Sectors Sectoral

caps

Caps

applicable to

Entry route Additional

conditions*

Broadcasting 26% to

74%

FDI, NRI, PIO,

FII#

Approval Yes

Banking-Public sector 20% FDI and FII Approval Yes

Banking-Private sector 74% FDI and FII Automatic upto49%

Yes

Cash and carry

wholesale

100% FDI Automatic Yes

Courier 100% FDI Approval

Construction

development of

townships, built-up

infrastructure

townships, etc.


Defence 26% FDI Approval Yes

E-commerce activities 100% FDI Automatic Yes

Education 100% FDI Automatic

Hospital 100% FDI Automatic

Hotel & Tourism 100% FDI Automatic

Industrial parks 100% FDI Automatic Yes

Infrastructure 100% FDI Automatic

Insurance 26% FDI Automatic Yes

FDI norms for select sectors:


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Sectors Sectoral

caps

Caps

applicable to

Entry route Additional

conditions*

Multi-brand retail 51% FDI Approval Yes

Non-banking nancial

services companies


Pharmaceuticals 100% FDI Automatic

(Green-eld)

/ Approval

(Browneld)

Print media 26% FDI, FIIs, NRIs,

PIOs

Approval Yes

Single brand retail 100% FDI Approval Yes

Special economic zone 100% FDI AutomaticTest marketing 100% FDI Approval Yes

Telecommunications

(Other than

manufacturing of

equipments)

74% FDI Automatic up

to 49%

Yes

* For detail conditions applicable on each sector, please refer to The Consolidated FDI Circular dated

April, 2012 and subsequent Press Notes issued by Department of Industrial Policy and Promotion till date.

# NRI and PIO investments are allowed only in certain activities under the broadcasting sector



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Pricing norms

Pricing guidelines for investment under

the FDI route for issue/transfer of

capital:

Issue ortransfer ofcapital listed ona recognizedstock exchangein India

Price is worked outin accordance withSEBI guidelines, asapplicable

Issue ortransfer ofcapital not

listed on anyrecognizedstock exchangein India

The fair valuation ofshares is undertakenby a SEBI registered

Category I MerchantBanker or a CharteredAccountant as per thediscounted free cashow method

The price of shares issued/transferred to

persons resident outside India under the

FDI policy cannot be less than the value

determined as per the above guidelines.

Further, in the case of the issue of CCPS

and CCDs, the price/conversion formula

is to be determined upfront at the time of

the issue of instruments. In such cases,

Eligible instruments

Investments under the FDI route

can be made only by way of equity

shares, compulsorily and mandatorily

convertible preference shares (CCPS), and

compulsorily and mandatorily convertibledebentures (CCD). Investments by way

of warrants and partly paid shares of an

Indian company are allowed subject to

prior approval of the FIPB. Further, listed

Indian companies can also issue American

depository receipts/global depository

receipts as per the prescribed5guidelines.

Other types of preference shares/debentures, i.e., non-convertible, optionally

convertible, or partially convertible, are

considered as debt and need to comply

with external commercial borrowing (ECB)

norms pertaining to eligible borrowers,

recognized lenders, amount and maturity,

end-use stipulations, etc. Instruments such

as foreign currency convertible bonds and

foreign currency exchangeable bonds are

also considered as ECBs and are required

to comply with ECB norms.

5 Issue of Foreign Currency Convertible Bonds and

Ordinary Shares (Through Depository Receipt

Mechanism Scheme), 1993 and guidelines issued

by the Government of India


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the price at the time of conversion should

not be lower than the valuation worked

out at the time of the issuance of such

CCPS/CCD.

The transfer of shares of an Indian

company by a person resident outsideIndia to a person resident in India cannot

be undertaken at a price that is higher

than the value determined as per the

pricing guidelines. Pricing guidelines do

not apply to the transfer of shares of

an Indian company between two non-

residents.

Downstream investment6

Downstream investments by an Indian

company owned7or controlled8by non-

resident entities are required to comply

with sectoral caps, entry conditions,

pricing norms, etc, as specied under the

FDI route. LLPs with FDI are not allowed

6 Downstream investment means indirect foreign

investment by one Indian company into another

Indian company by way of subscription or

acquisition

7 A company is considered as owned by non-

resident entities if more than 50% of the capital

in it is benecially owned by non-resident citizens

and/or entities, which are ultimately owned and

controlled by non-residents.

8 Control has been dened to mean power to

appoint the majority of directors

to make any downstream investments.

A methodology has been prescribed to

determine the level of foreign investment

in a multi layered investment structure.

FVCI route

FVCIs are persons resident outside India

and registered with the SEBI as FVCIs.

They make investments in India under the

applicable SEBI regulations.

SEBI has been granting approvals to FVCI

only for investments in certain specied

sectors9and in SEBI-registered VCFs.

Further, SEBI regulations have beenrecently amended to permit FVCIs to

invest in Category I Alternative Investment

Funds (AIF)10.

FVCIs can invest in units of VCFs

and Category I AIFs or investment in

equity or equity-linked instruments,

debt instruments of Venture Capital

Undertakings (VCUs)11/ Non-VCUs subject

9 Specied sectors include (i) infrastructure sector

(as dened under ECB norms), (ii) biotechnology,

(iii) information technology relating to hardware

and software development, (iv) nanotechnology,

(v) seed research & development, (vi) research

and development of new chemical entities in

pharmaceutical sector, (vii) dairy industry, (viii)poultry industry, (ix) production of bio-fuels and

(x) hotel-cum-convention centers with seating

capacity of more than 3,000.

10 AIFs are domestic pooling vehicles that are

governed by SEBI (Alternative Investment Funds)

Regulations, 2012 (SEBI AIF Regulations). They

are discussed in detail in a subsequent chapter.

11 VCU means a company incorporated in India

whose shares are not listed on a recognized stock

exchange in India and which is not engaged in an

activity specied under the negative list specied

by the SEBI.



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Portfolio investment route

FII route

FII investments are governed by SEBI

regulations. FIIs are institutions established

or incorporated outside India that proposeto make investments in India. Sub-accounts

are persons resident outside India on whose

behalf investments are proposed to be made

in India by the FII. Qualifying conditions

have been specied for FII registration.

Apart from entities that can register as

FIIs, other foreign investors could choose

to register as sub-accounts. These may be

collective investment funds and institutions,proprietary funds, or foreign corporations

and nationals meeting certain conditions.

No sector restrictions are typically

applicable to investments under the FII

route, unless specically provided for

within sectoral caps prescribed under the

FDI route12. FIIs are allowed to invest in

recognized stock exchange only through aregistered broker. FIIs are also permitted

to invest through private placement/initial

public offers.

FIIs are allowed to invest in shares or

debentures of an unlisted company or a

company that is listed on a recognized stock

exchange in India, as well as government

securities/treasury bills, listed non-convertible bonds/debentures, listed/

unlisted non-convertible infrastructure

bonds, commercial papers, units of domestic

mutual funds, security receipts (only for

FIIs) and perpetual debt instruments.

12 Please refer to the table on page 6-7 relating to FDI

norms on select sectors

to specied conditions by way of private

placement/purchase from third party.

FVCIs are not subject to pricing guidelines

or ceiling on dividends. The valuation on

purchase/transfer can be mutually decided

between the buyer and seller.

FVCIs enjoy certain additional regulatory

advantages:

The transfer of shares from FVCIs to

promoters is exempted from public

offer provisions under SEBI takeover

regulations.

FVCIs are granted the status of aqualied institutional buyer and enjoy

certain relaxations on pricing norms

and longer conversion period for

securities under SEBI regulations.

FVCIs are not subject to lock-in

requirements post the initial public

offering of an Indian company under

SEBI regulations subject to certain

conditions.


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Specic overall monetary limits are

prescribed for investments in listed

corporate debt, unlisted long-term

infrastructure bonds and government

securities (including treasury bills).

QFI route

QFIs are persons resident in a country

that is compliant with Financial Action

Task Force (FATF) standards (including

residents of countries that are part of agroup that is a member of FATF) and that

is a signatory to the IOSCO13multilateral

memorandum of understanding, European

Union (EU) or Gulf Cooperation Council

(GCC) or a signatory of a bilateral MOU

with SEBI. Further, such person should not

be registered as FII/sub-account or as FVCI

with SEBI.

Unlike FIIs, QFIs are not required to be

registered with SEBI. However, they are

required to open a demat account with a

qualied depository participant14and are

13 International Organization of Securities

Commission

14 Qualied depository participants are thosedepository participants registered with SEBI who

also required to obtain permanent account

number from Indian tax authorities.

QFIs are permitted to invest in the equity

shares of listed companies on a recognized

stock exchange, listed corporate debt, as

well as in the units of equity and debt-

oriented mutual funds.

QFIs are permitted to invest in listed

equity shares up to an individual limit of

5% of the paid-up capital of the company(overall limit of 10% of the paid-up capital

of the company). Further, separate overall

monetary limits have been prescribed for

investments by QFIs in listed corporate

debt, equity-oriented mutual fund

schemes and debt mutual fund schemes

(including infrastructure debt funds).

fulll the eligibility criteria specied by SEBI to act

as a depository participants for QFIs

Total holding by each

FII / sub-account

10% of the paid-up equity capital or paid-up value of each

series of debentures

Total holding by all FII /sub-account

24% of the paid-up equity capital or paid-up value of each

series of debentures (the limit can be increased to the FDIsectoral cap by a special resolution at the general body

meeting of the investee company)

Foreign corporate and

individuals registered as

sub-accounts

5% of the total paid-up equity capital or 5% of the paid-up

value of each series of convertible debentures subject to

the overall ceiling of 24%


Investment limits for FIIs in shares and convertible debentures:


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Debt securities that are issued bycompanies are called debentures or

bonds. Debenture is an instrument of debt

executed by a company acknowledging

its obligation to pay interest on the

debt at a xed rate at regular intervals.

Debentures do not carry any voting

rights and are generally secured against

property. Additionally, debentures can

be redeemed or converted into equity

or a combination of both. Debt funding

from non-resident lenders [excluding

compulsorily convertible instruments and

listed non-convertible debentures (NCDs)]

is generally referred to as ECB and is

closely regulated specically with respect

to end use, party from whom lending

is sought, interest payment, amount offunding, maturity period, etc.

Either of the above mentioned instruments

or their combination could be used for

investing in an Indian company.

From a regulatory perspective, a resident

can invest in an Indian company using

any of the instruments mentioned above

Types of instruments

An Indian company can raise fundsby way of shares or debt. Shares of a

company are categorized as equity or

preference shares. Equity shares have the

fundamental characteristic of representing

ownership interest in a company and

carrying voting rights. While a public

company may create classes of shares

having differential rights as to voting,

dividend, etc., subject to applicable

restrictions, a private company can issue

shares with differential rights without any

restriction. Preference shares are entitled

to a xed rate of dividend, do not typically

carry any voting rights and get a priority

over equity shares in the distribution of

assets in event of liquidation. Preference

shares can be converted into equity(either optional or mandatory) and/or

can be redeemed (period not exceeding

20 years). Redemption can only be out

of accumulated prots, which would

otherwise be available for dividend or

out of fresh issue of shares made for

redemption.


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without any restrictions. However, a non-

resident is subject to several restrictions,

depending on the type of instrument.

For example, funds brought in as equity

(including instruments mandatorily

convertible into equity) are generally

permitted automatically under the

FDI policy, subject to sector-specic

restrictions. All other instruments would

be considered as debt and would require

compliance with ECB guidelines.

Equity sharesEquity

shares

Hybrid

instruments

Debt

Compulsorily

convertible

debentures

Compulsorily

convertible

preference shares

Optionally

convertible

preference shares

Non-convertible

preference shares

Non-convertible

debentures

Optionallyconvertible

debentures

Shareholders

loan

FDI - No

end use

restriction

ECB -

Specifiedend use

restrictions

Future profit

repatriation

possible Tax

efficient

interest

payout

possible

Tax

arbitrage

may be

available

on

interest

payouts

Tax

efficient

profit

repatriation

could be

factored


Pictographic representation of the types of instruments for foreign investment

in India:


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Criteria Equity

shares

CCPS CCDs Optionally

convertible/

redeemable

preference shares

Shareholder

loans/other

debentures15

Treated as FDI ECB

Restriction

on amount

NA Automatic route up to USD 750

million16Approval route USD 750 million16

End Use

restrictions

NA17 NA17 NA17 Cannot be usedfor specied

purposes18

Cannot beused for

specied

purposes18

All in cost Not

specied

Maximum

dividendthat can be

paid is SBIPLR + 300

bps

Not

specied(possible

view);interest

rate cannotexceed rate

prescribedfor CCPS)

For maturity of 35 years 6 month

LIBOR + 350 bps

For maturity > 5 years 6 monthLIBOR + 500 bps

Pricing

guidelines

Pricing

guidelines

prescribedby theRBI to be

compliedwith at the

time of issueof shares or

acquisitionof shares

from aresident

Price/

Conversion

formulato bedetermined

upfront atthe time of

issue basedon pricing

guidelinesprescribed

by the RBI;price at

the time of

conversioncannot

Price/

Conversion

formulato bedetermined


issue basedon pricing

guidelinesprescribed

by the RBI;price at

the time of

conversioncannot

Optionally

Convertible

PreferenceShares (OCPS) pricing guidelines

prescribed by theRBI to be complied

with at the time ofconversion

Optionally

Convertible

Debentures(OCDs) pricing

guidelinesprescribed by

the RBI to becomplied with

at the time ofconversion

15 Excluding listed NCDs

16 To be read as USD 200 million for corporates in

services sector viz. hotel, hospital and software.

17 Downstream investment into Indian companies

is permissible if compliant with the regulatory

framework

18 Specied purposes:

- On-lending, investment in capital market,

acquiring a company in India or a part thereof

(except for specied companies)

- In real estate

- For working capital, general corporate purpose

and repayment of existing rupee loans (except forspecied companies subject to specied conditions)

Key tax and regulatory features pertaining to each type of instruments:


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Criteria Equity

shares


convertible/

redeemable

preference shares

Shareholder

loans/other

debentures15

Pricing

guidelines

(contd.)

be lower

than the

minimumpricedetermined


issue

be lower

than the

minimumpricedetermined


issue

Non Convertible

Preference Shares

(NCPS) pricingguidelines notapplicable

NCDs pricing

guidelines not

applicable

Shareholder

loans pricingguidelines not

applicable

Right of

dividend/

interest

Can be

paid onlyfrom prot

after tax

(PAT) andafter thepayment of

preferencedividend

Right to

receivedividend

over equity

shares andcan be paidout of PAT

Interest

can be paidirrespective

of the

availabilityof prots

Right to receive

dividend overequity shares and

can be paid out of

PAT

Interest

can be paidirrespective of

the availability

of prots

Voting rights Available

Further,exibility for

differentialvoting rights

available,subject to

conditions

Available if

dividend isnot paid for

two yearsor post

conversioninto equity

shares

Available

postconversion

into equityshares

Available if

dividend is not paidfor two years and

in respect of partconverted into

equity shares

Not available

except inrespect of part

converted intoequity shares

Prepayment /

Repatriation

Equity share

capital canbe cancelled

by way ofa buyback/

capitalreduction

Possible

view:Buyback/

Capitalreduction

of CCPSnot possible

before theconversion

of CCPSinto equity

shares

Possible

postconversion

into equityshares

throughcancellation

by way ofbuyback/

capitalreduction

ECB up to USD 20

million = minimumaverage maturity

3 years

ECB > USD 20million and up to

USD 750 million =minimum average

maturity 5 years

Preference shares maximum time

20 years from thedate of its issue

ECB up to USD

20 million= minimum

averagematurity 3

years

ECB > USD20 million and

up to USD500 million

= minimumaverage

maturity 5years

Minimum

time

period for

redemption

NotApplicable

Preferenceshares -

Maximumtime - 20

years from

the date ofits issue

No timelimit for CCD



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Criteria Equity

shares


convertible/

redeemable

preference shares

Shareholder

loans/other

debentures15

Withholding

on dividend /

interest

Not required

An Indian

companyis requiredto pay DDT

at 15%19onthe amount

of dividenddistributed

Not required

An Indian

companyis requiredto pay DDT

at 15%19onthe amount


Tax

required to

be withheldon interestat lower of

the rates, asspecied in

tax treatyor the

domestictax law

Not required An

Indian company

is required topay DDT at 15%19on the amount


Tax required

to be withheld

on interestat lower ofthe rates, as

specied in

tax treaty or

the domestictax law

Tax

deductibilityof dividends/

interest

Equity

dividend notdeductiblefor tax

purposes

Preference

dividend notdeductiblefor tax

purposes

Interest

is taxdeductiblesubject to

appropriatewithholding

of tax

Preference

dividend notdeductible for taxpurposes

Interest is tax

deductiblesubject toappropriate

withholdingof tax

Applicability

of Indian

transfer

pricing

regulations

Notapplicable

Notapplicable

Applicable Not applicable Applicable

Taxation on

conversion

Notapplicable

No clearprovisions

arguablymay be

exempt

Exempt No clear provisions arguably may be

exempt

NA/Exempt

19 Tax rates are excluding the applicable surchargeand education cess


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Warrant:A warrant is a security that

entitles the holder to buy the underlying

stock of the issuing company at a

xed exercise price until the expiry

date. Warrants can be issued to non-

residents under the approval route. The

government, at the time of granting

approval, may prescribe the minimum

amount to be brought upfront and the

period within which the warrants holder

needs to exercise his right. The upfront

payment for the issue of warrants is

forfeited if the warrants are not converted

into equity shares.

Furthermore, the following instruments

could also be considered:

ADRs/GDRs: Depository receipts are

securities issued by a bank or depository

outside India against underlying Rupee

shares of a company incorporated in India.These are treated as foreign securities

issued by an Indian company and are

usually denominated in USD. Holders

of ADR/GDR have the right to sell these

instruments outside India or convert them

into equity shares at any point of time.

Listed NCDs: Under this route, any

private or public company could list NCDson the wholesale debt market segment of

any recognized stock exchange. Any FII

or any sub-account of an FII entity could

purchase these NCDs subject to prescribed

allocation methodology. For an exit, these

debentures may either be sold on the oor

of the stock exchange or redeemed by the

issuing company. The terms of listed NCDs

are not subject to ECB or FDI guidelines.



18/32


Alternative options for

repatriation of capital andreturns

Dividend

Dividend distribution is the typical

route for the repatriation of prots

by a company. Dividend payments

are considered as an appropriation of

prots rather than as an expense for taxpurposes. Dividend payment is required

to be made to all shareholders of a

company. In case the companys capital is

divided into different classes of share, the

company may distribute dividend only to a

specic class of shareholders.

Buyback

Buyback of shares is a scheme whereinan Indian company re-purchases its own

shares from its shareholders. Under the

Indian tax laws, buy back is treated as the

sale of shares by the shareholder. Offer

for buy back is required to be made to

all shareholders (holding shares of the

same class) and is at the discretion of

the shareholder to accept or reject. For

listed companies, in certain situations, aspecied class of shareholders may not be

eligible to tender their shares in the offer

for buyback.

Capital reduction

Capital reduction is a court regulated

process of cancellation of subscribed

capital of an Indian company or reduction

of the face value of shares. From a tax

perspective, capital reduction typically

involves distribution of capital and

accumulated prots.

Repatriation and exit


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20 - In light of a recent judicial precedent, there is a

risk that the ITA may consider the buy-back as

payment of dividend.

- Availability of treaty benets subject to

applicability of GAAR to the transaction.

21 Tax rates are excluding the applicable surcharge

and education cess

22 Unless dispensed by the Court.

Criteria Dividend Buyback undersection 77A of the

Companies Act, 1956

Capital Reduction undersection 100 of the

Companies Act, 1956

Taxation in the hands

of shareholder

No Subject to capital gain

tax, shareholders can

claim tax exemption

under an applicable tax

treaty20

Subject to capital gain tax

on distribution in excess

of accumulated prots;

shareholders can claim

tax exemption under the

applicable tax treaty20

Taxation in the handsof the company

At the rateof 15%21on

dividend

distributed

No At the rate of 15%

21

to theextent of accumulated prots

distributed

Court process No No Yes

Approval of creditors No No Yes22

Selective distribution No Depends on response

to buyback offer20Yes

Applicability of RBI

pricing guidelines

NA Yes Yes

Requirement of

regulatory approval

No No No

Key aspects relating to each of the above repatriation options:


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rates mentioned are base rates, to beincreased by applicable surcharges. For

Indian residents, rates are provided in the

context of a corporate tax payer.

The table below enumerates the applicabletax rates under the domestic tax law on

income derived from investments in Indian

securities (shares and debentures). The

Tax rates

Income Foreign

investors

QFI/ FVCI FII Indian

residents

Interest on foreign

currency borrowing by

Indian concerns

20% Not

applicable

20% Not

applicable

Interest on approved

long-term infrastructure

bonds/loan agreements

5% 5% 5% Not

applicable

Dividends on equity

shares

Exempt;

however,

subject to

dividend

distribution

tax at 15%

Exempt;

however,

subject to

dividend

distribution

tax at 15%

Exempt;

however,

subject to

dividend

distribution

tax at 15%

Exempt;

however,

subject to

dividend

distribution

tax at 15%

Interest on Rupee-

denominated debt

40% 40% 20% 30%

Tax rates on interest and dividend income under various routes23


and education cess


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Other key aspects

Direct sale

On sale of shares of an Indian company,

the difference between the cost of

acquisition and the value of considerationreceived would be deemed to be capital

gains. Capital gains on the sale of shares

affected on stock or through an offer for

sale in an IPO are either exempt or taxable

@15% depending on whether there is

LTCG or STCG, respectively. Capital gains

tax can be mitigated if investment is made

through a tax-efcient jurisdiction. Key

jurisdictions considered while investing

in India are Mauritius, Singapore, Cyprus

and the Netherlands. Subject to thefulllment of certain conditions, rights to

tax capital gains on the transfer of shares

of Indian companies by tax residents of the

mentioned countries have been granted

only to the mentioned countries. Refer to

the table provided in the next chapter for

tax rates under select tax treaties.

However, recently, the tax department

has been questioning tax exemption on

the exit of investments made through

the mentioned jurisdictions. The lack of

commercial substance has been the main

concern of tax authorities.

Indirect sale

As per the recent amendments in tax laws,

any indirect transfers, i.e., situations

where shares of a foreign company are

transferred with substantial underlying

assets in India, would be taxable in

India, subject to the availability of treaty

benets.

However, there is lack of clarity on several

parameters related to the taxation ofindirect transfers. For example, what

would constitute as substantial is not

mentioned; date as on which substantial

value criteria needs to be determined is

not claried; whether the entire gains on a

transaction would be taxable or only gains

proportional to the Indian element will be

taxable is not clear, and so on.


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General Anti Avoidance Rules

(GAAR)

GAAR provisions were introduced in

the Income-tax Act, 1961 by Finance

Act 2012 to deal with aggressive tax

planning. Consistent with international

practice, GAAR provisions seek to codify

the substance over form doctrine.

These provisions would empower tax

authorities to declare an arrangement

to be an impermissible avoidance

arrangement if the main purpose or one

of the main purposes of an arrangement

(or step or part thereof) is to obtaina tax benet. These provisions are

applicable to all tax payers and are

equally applicable to domestic, as well

as international transactions. Once an

international transaction is declared to be

an impermissible avoidance arrangement,

the provisions of GAAR would override

the benecial provisions of the relevant

tax treaty.

Expert Committee (EC) appointed

by Prime Minister of India to review

GAAR provisions has given its nal

recommendations, which have mostly

been accepted by the Finance Ministry.

Some of the major changes include

clauses pertaining to GAAR provisions

coming in effect from nancial year201516 instead of 201314 and an

arrangement would be impermissible

if the main purpose of the same is to

obtain a tax benet; however, it would

not merely be one of the main purposes.

Further, investments made prior to 30

August 2010 would be grandfathered.

However, the consequential changes in

law are still to be effected.


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Capital gains tax rate24

Particulars Resident company Non-resident company

LTCG25 STCG26 LTCG25 STCG26

Sale of listed shares SE

transaction27

Exempt 15% Exempt 15%

Sale of listed shares

off-market transaction

(i.e., sale of listed shares

through private deal)

10%28/20%29 30% 10%30/20% 40%31

Sale of unlisted shares offer

for sale to public under IPO27Exempt 15% Exempt 15%

Sale of unlisted shares 20%29 30% 10%32/20% 40%31

Sale of listed debentures 10%28/20%29 30% 10%30/20% 40%31

Sale of unlisted debentures 20%29 30% 10%32/20% 40%31


and education cess

25 Period of holding more than 12 months for shares

and specied securities

26 Period of holding less than or equal to 12 months

for shares and specied securities

27 STT payable on the value of transaction

28 Without indexation benet

29 With indexation benet

30 Foreign exchange adjustment possible along with

10% rate. However, there are conicting judicial

precedents on the availability of lower rate of 10%.

31 30% for FIIs

32 Without foreign exchange rate adjustment.

Further, it is unlikely that the concessional rate

of 10% would be available on sale of shares of a

private limited company

Tax rates


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Tax rates under select tax treaties:

Particulars Treaty in force Capital gain on

sale of shares

Capital gains

on sale of

debentures

Interest

Mauritius Yes Not taxable Not taxable Taxable at

20%33/40%34

Singapore Yes Not taxable

subject to the

limitation of

benet clause

(LOB clause35)

Not taxable

subject to LOB

clause35

Taxable at 15%

Cyprus Yes Not taxable Not taxable Taxable at 10%

The

Netherlands

Yes Not taxable

subject to

conditions36

Not taxable Taxable at 10%

Luxembourg Yes Taxable Not taxable Taxable at 10%

The United

States of

America

Yes Taxable Taxable Taxable at 15%

The United

Kingdom

Yes Taxable Taxable Taxable at 15%

Cayman Islands No Taxable Taxable Taxable


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33 On borrowings in foreign currency. Tax rates are

excluding the applicable surcharge and education

cess

34 On borrowings in Indian currency. Tax rates are

excluding the applicable surcharge and education

cess

35 A Singapore resident availing the capital gain

exemption under the India-Singapore tax treatymust satisfy the following conditions:

i. Its affairs are not arranged with the primary

purpose to take advantage of the benets of

the LOB clause under the treaty; and

ii. It should not be a shell/ conduit company

i.e. its annual expenditure on operations

in Singapore is equal to or more than SG$

200,000 in the immediately preceding

24 months from the date on which capital

gain arise from the transfer of shares/

debentures;or

iii. It is listed on a recognized stock exchange inSingapore.

36 Capital gains from the sale of shares in an Indian

company would not be taxable in India under

the India-Netherlands tax treaty, if the following

conditions are satised:

i. In case of shares of an unlisted real estate

company in India, the shares form part of less

than 25% interest in the capital stock in the

company

ii. In case of shares of any other company in India;

a. The shares are sold to a non-resident;

b. The shares are sold to a resident and the

shares form part of less than 10% interest

in the capital stock in the company; or

c. The shares are sold pursuant to a

corporate organization, re-organization,

amalgamation, division or similar

transaction.

Tax rates


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India has a regulatory framework for

raising an alternative investment fund.

The framework is contained in the AIF

Regulations, which were notied in May

2012 and repealed the erstwhile SEBI

(Venture Capital Funds) Regulations, 1996

(VCF Regulations). Funds registered under

the VCF Regulations are grandfathered

until they are wound up and are prohibited

to launch any new scheme or increase the

targeted corpus.

Under AIF Regulations, funds are

mandatorily required to obtain registration

and comply with the investment and other

conditions.

An AIF has been dened as a privately

pooled investment vehicle that collects

funds from investors, whether Indian

or foreign37, in accordance with a

dened investment policy. An AIF can be

established as a company, a trust or a

LLP, or any other body corporate. AIFs are

segregated into the following categories

for the purpose of registration:

Domestic fundstructuring

37 Guidelines for foreign investments in AIFs

(excluding FVCI investment into Category I AIF)

are yet to be notied by the Government.


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All AIFs are required to mandatorily seek

registration in one of the categoriesmentioned in the table above. In case of

Category I AIF, they also need to register

under one of the sub-categories as

prescribed. An AIF can launch schemes

without seeking prior SEBI approval.

Various eligibility criteria such as minimum

commitment, minimum investmentper investor, sponsor commitment,

minimum maturity, track record for key

investment team manager, term of the

funds and conditions as to open ended

and close ended have been prescribed for

registration.

Category I AIF Category II AIF Category III AIF

Funds that invest in startup or

early-stage ventures or social

ventures or Small and Medium

Enterprises (SMEs) or infrastructure

or other sectors or areas that the

government or regulators consideras socially or economically desirable

Include venture capital funds,

SME funds, social venture funds,

infrastructure funds and such other

AIFs, as may be specied

Funds that do not fall

in Category I and III

AIF and that do not

undertake leverage or

borrowing other than

to meet the permitteddaily operational

requirement

Include private equity

funds and debt funds

Funds that employ

diverse or complex

trading strategies and

may employ leverage

including through

investment in listed orunlisted derivatives

Include hedge funds


28/32


Investment conditions and restrictions

AIF Regulations prescribe detailed conditions/restrictions for each category/

sub-category of AIF:

Category I AIF

Venture Capital

Fund

Minimum 66.67% of its corpus in equity and equity-linked

instruments of VCUs and SMEs and balance 33.33% in debt

instruments, public offer/preferential allotment of listed

companies (subject to conditions)

Infrastructure Fund At least 75% of its corpus in VCUs or investee companies

engaged in infrastructure and balance also in listed securitized

debt instruments, as well as listed debt instruments

Social Venture Fund At least 75% of its corpus in social venture funds

Small and Medium

Enterprise Fund

At least 75% of its corpus in VCU and/or investee companies38

that are SMEs

Category II AIF

Private Equity Fund Primary investment in equity and equity-linked instruments of

unlisted companies

Debt Fund Primary investment in debt or debt securities of unlisted

securities

Category III AIF

Hedge Funds etc. Permitted to invest in securities of listed or unlisted investee

companies or derivatives or complex or structured products

38 Company, SPV, LLP, or other body corporate

Furthermore, Category I AIFs are

permitted to invest in units of Category I

AIFs of the same sub-category. Category

II and Category III AIFs are permitted toinvest in units of Category I and Category

II AIFs. AIFs are not permitted to invest in

fund-of-funds.


29/32


Other key aspects

AIF Regulations prescribed conditions

for investment in associate companies,

borrowing, leveraging/hedging, listing of

AIFs, and valuation of units of AIFs. They

also prescribed certain governance normspertaining to conict of interest, duciary

responsibility of the investment manager,

transparency, etc.

Taxation

Category I AIFs have been granted pass-

through status. Specied income received

by such funds is taxed directly in the hands

of beneciaries. However, Category I (for

non-specied income), Category II and

Category III AIFs are not accorded a pass-

through status. Tax implications for such

funds would be based on the legal status

of such funds, i.e., whether such funds are

set up as companies, LLPs or trust.

Domestic fund structuring


30/32

ContactsIf you would like to discuss any of the insights in this report or opportunities in India,please contact your Ernst & Young advisor or any of the contacts below.

Sudhir Kapadia

National Tax Leader

Email: [email protected]

Avinash Narvekar

Private Equity Tax Leader


For any private equity related enquires, please contact:

Mayank Rastogi


Amrish Shah

National Leader - Transaction Tax

Email : [email protected]

Subramaniam Krishnan

Partner, Tax and Regulatory Services

Email : [email protected]


31/32

Our ofces

Ahmedabad2ndoor, Shivalik Ishaan

Near C.N. VidhyalayaAmbawadi

Ahmedabad - 380 015Tel: + 91 79 6608 3800

Fax: + 91 79 6608 3900

Bengaluru

12th& 13thoor

UB City, Canberra BlockNo.24 Vittal Mallya Road

Bengaluru - 560 001Tel: + 91 80 4027 5000

+ 91 80 6727 5000Fax: + 91 80 2210 6000 (12thoor)

Fax: + 91 80 2224 0695 (13thoor)

1st Floor, Prestige EmeraldNo. 4, Madras Bank Road

Lavelle Road Junction

Bengaluru - 560 001Tel: + 91 80 6727 5000Fax: + 91 80 2222 4112

Chandigarh

1stFloor, SCO: 166-167Sector 9-C, Madhya Marg

Chandigarh - 160 009Tel: + 91 172 671 7800

Fax: + 91 172 671 7888

Chennai

Tidel Park, 6th& 7thFloor

A Block (Module 601,701-702)No.4, Rajiv Gandhi Salai, Taramani

Chennai - 600113Tel: + 91 44 6654 8100

Fax: + 91 44 2254 0120

HyderabadOval Ofce, 18, iLabs Centre

Hitech City, MadhapurHyderabad - 500081

Tel: + 91 40 6736 2000Fax: + 91 40 6736 2200

Kochi

9thFloor, ABAD NucleusNH-49, Maradu PO

Kochi - 682304Tel: + 91 484 304 4000

Fax: + 91 484 270 5393

Kolkata

22 Camac Street

3rdoor, Block CKolkata - 700 016

Tel: + 91 33 6615 3400Fax: + 91 33 2281 7750

Mumbai14thFloor, The Ruby29 Senapati Bapat Marg

Dadar (W), Mumbai - 400028

Tel: + 91 022 6192 0000

Fax: + 91 022 6192 1000

5thFloor, Block B-2Nirlon Knowledge Park

Off. Western Express Highway

Goregaon (E)Mumbai - 400 063Tel: + 91 22 6192 0000

Fax: + 91 22 6192 3000

14, Mittal Chambers, 1st oor

Opp Inox Mall, Nariman Point

Mumbai - 400021Tel: + 91 22 619 20040

NCRGolf View Corporate Tower B

Near DLF Golf CourseSector 42

Gurgaon - 122002Tel: + 91 124 464 4000

Fax: + 91 124 464 4050

6thoor, HT House18-20 Kasturba Gandhi Marg

New Delhi - 110 001Tel: + 91 11 4363 3000

Fax: + 91 11 4363 3200

4th& 5thFloor, Plot No 2B,Tower 2, Sector 126,

NOIDA 201 304Gautam Budh Nagar, U.P. India

Tel: + 91 120 671 7000Fax: + 91 120 671 7171

PuneC-401, 4thoorPanchshil Tech Park

Yerwada(Near Don Bosco School)

Pune - 411 006Tel: + 91 20 6603 6000

Fax: + 91 20 6601 5900


32/32

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