Business Reorganisation and Issues

Transcription

1 Business Reorganisation and Issues Arun Saripalli Rachesh Kotak

2 Presentation Outline Introduction and Relevance Rationale for restructuring and concerns Expanded definition of international transactions Subscription of shares M&A and Transfer Pricing Case Studies on Transfer Pricing issues post Business Reorganization General Anti Avoidance Rule Way forward 2

3 Introduction and Relevance 3

4 Introduction and Relevance 4

5 Rationale for restructuring and concerns 5

6 Rationale for restructuring Drivers Actions Benefits Business Drivers Profitable growth Globalization Customer demands Lower costs Shareholder value Financial Drivers High domestic tax rates Complex transfer pricing Tax incentives More aggressive tax authorities Trapped tax losses Centralization of planning & mgmt Shared services Integrated supply chain management Global/regional business units Aligned tax and business structure Risk centralization Optimized supply chains Improved cash flow Lower effective tax rate Facilitate global/ regional customer demands Less transfer pricing risk 6

7 Business restructuring common concerns Exit tax - Goodwill disposition - Local IP - Agreement termination Substance requirements PE risk Implication from a Indirect tax perspective Commercial rationale of restructuring Arm s length nature of new TP policy Treatment of issues by OECD Vs Non- OECD Countries Specific local requirements The risk assessment and risk mitigation strategy will enable to anticipate the most likely queries that could be raised by the Tax Authorities. Being prepared and having the correct documentation available helps with the discussions with the Tax Authorities. 7

8 Expanded definition of international transaction 8

9 Explanation (i)(e) to 92B(1) (e) a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date Section 44DB on computing deductions in the case of business reorganization of co-operative banks business reorganisation means the reorganisation of business involving the amalgamation or demerger of a co-operative bank Definition? 9

10 Impact Advance rulings in case of Vanenburg, Dana Corporation, Amiantit, etc overruled? - No tax, no transfer pricing does hold good? Disclosure requirements in Form 3CEB irrespective of the fact that it no has bearing on the profit, income, losses or assets - at the time of the transaction or at any future date Issue Identification of transactions in the nature of business restructuring or reorganisation? 10

11 Subscription of shares 11

12 Subscription of shares Taxable Transaction (Revenues contention) : Foreign entity subscribed to shares of its Indian arm at prices much lower than the market price or fair price; Market price of unlisted shares that the Revenue is taking recourse to Discounted Cash Flow ( DCF ) Methodology ; DCF method is very subjective on growth projections and various assumptions providing an opportunity to the Revenue to challenge the valuation done by the tax payer M/s Vijai Electricals. The Hyderbad Tribunal held that for such transactions transactions are not in the nature of transactions referred to section 92-B of the IT Act and the transfer pricing provisions are not applicable as there is no income. 12

13 M&A and Transfer Pricing 13

14 Modes of M & A Restructuring Scheme of Arrangement Acquisitions Capital Re-organisation Merger Asset Purchase Stock Purchase Buy-back Demerger Itemized Sale Inbound Capital Reduction Conversion Slump Sale Outbound 14

15 Merger A merger involves the union of 2 or more legal entities into 1 legal entity accompanied by pooling of all financial and other resources of the entities. Merger of F Co A and F Co B Applicability of Transfer Pricing Shareholders F C0 A Co A Shareholders F Co B Co B Merger of F Co A with F Co B - Transfer of shares of an I Co pursuant to the said merger, TP will not apply if atleast 25% of of shareholders of the F Co A continue to remain shareholders of F Co B. The merger needs to be tax neutral in other country. I Co 100% Merger of I Co A with I Co B TP will not apply Merger of F Co with I Co (WOS of I Co) Tax neutral, accordingly TP will not apply 15

16 Demerger Demerger involves transfer of identified business from one company to another and in consideration, the company which acquires the business issues shares to shareholders of the selling company Demerger of Business B F Co I Co A 100% Business A Business B I Co B 100% Applicability of Transfer Pricing Demerger of one of the undertakings of I Co A (WOS of F Co) into I Co B (WOS of F Co) - Issue of shares by I Co B to F Co. Tax neutral scenario, accordingly TP will not apply Demerger of one of the undertakings of I Co A into I Co B TP will not apply Business A Demerged Business B 16

17 Acquisitions Acquisitions Asset Purchase Stock Purchase Slump Sale Sale of business on a going concern basis for a lump sum or slump consideration Itemized Sale Sale of assets & liabilities with values assigned separately for each item of assets & liabilities F Co needs to interpose I Co to carry out slump sale / itemised sale and accordingly, Transfer Pricing provisions will not apply 17

18 Buy-back Buyback is acquiring its own shares from the existing shareholders by the company to reduce its paid-up capital On Buyback/ Sale of shares the shareholder is liable to tax based on the following criteria: Shares held for 12 months or less = Short Term Shares held for more than 12 months = Long Term Short Term Unlisted Applicable tax rate * Short Term Listed & subjected to STT 15% * Long Term Unlisted 20% * Long Term Listed & subjected to STT Exempt ** Plus applicable Education Cess & Surcharge, if applicable Tax Implications Company will be liable to pay an additional on distributed income on buy-back of shares as per Section 115QA Transfer Pricing regulations, applies, unless the transaction is not taxable in India Under Income-tax Act, Section 47(iv) exempts capital gains on transfer of capital assets by a Holding company to its WOS - Holding WOS relationship to be retained for eight years 18

19 Buy-back Exchange Control provisions Pricing norms specified by regulatory authorities to be complied with - Maximum consideration payable as per RBI pricing guidelines - Listed shares: Price to be average quotations (average of daily high & low) for one week preceding the date of application with 5% variation - Unlisted shares : Old provisions The fair valuation done by a Chartered Accountant as per the erstwhile Controller of Capital Issues (CCI) guidelines New provisions The fair valuation of shares would be undertaken by a SEBI registered Merchant banker or a Chartered Accountant as per the Discounted Free Cash Flow (DCF) method 1. 1 Reserve Bank of India (RBI) has, by a notification dated 7 April 2010 amended the FDI Regulation with regard to pricing guidelines. The amendments are made effective from 21 April

20 Capital Reduction Reduction of capital may be achieved in the following manner: Reduce liability on shares in respect of unpaid capital Extinguish liability on shares in respect of unpaid capital Pay paid-up capital in excess of wants of the company Cancel paid up capital which is lost or is not represented by available assets of the company Utilisation of securities premium for purpose other than provided u/s 78 In the hands of the Company Sec 2(22)(d) of Income-tax Act, 1961 provides that distribution on account of reduction of capital will be regarded as deemed dividend to the extent of accumulated profits. DDT payable by the company on such dividends Transfer Pricing provisions will apply In the hands of shareholder To the extent of accumulated profits, dividend is exempt in the hands of shareholders (since DDT paid by company on the deemed dividend) Excess over accumulated profits - chargeable as capital gains Transfer Pricing provisions will apply 20

21 Transaction, Benchmarking and Documentation Taxable Transaction: Capital Gain on Buy back / Capital Reduction of Shares Issue of Equity/Preference shares (CCPs, NCCPs) Whether a transaction? Benchmarking: Whether one needs to carryout a functional analysis and characterise the entities involved? Which method can be used? Documentation: Business objective of re-organisation / restructuring Documents supporting the transfer price Negotiation between the parties 21

22 Valuation Independent valuer s certificate Generally considered for benchmarking the transaction of purchase / sale of shares / assets Assumptions taken while valuing the shares / assets should be reasonable in the given circumstances Intel Asia Electronics Inc. The Bangalore Tribunal held that for assets sold to associated enterprises, third party valuation could be the most appropriate means under the Comparable Uncontrollable Price Method. Tally Solution Private Limited. The Bangalore Tribunal upheld use of Excess Earning Method ( subject to adjustments) while determining ALP for sale of IPR. Ascendas (India) Private Limited. The Chennai Tribunal upheld the use of upheld use of DCF method to compute ALP for sale of shares to AE. 22

23 Case studies on Transfer Pricing post merger 23

24 Case 1 R. Co and T. Co are independent MNCs having operations in India thru their respective subsidiaries Both have outsourced ITES to their respective Indian subsidiaries. R. Co is cost +15% and T. cost + 10%. R. Co gets acquired by T.Co overseas As a result of the global acquisition, to consolidate operations, ITES activity of R. Co is transferred to T.Co by way of a slump sale Aligning TP policies post acquisition to integrate with business changes 24

25 Case 1 R. Co UK Worldwide acquisition T. Co Canada 100 % Shareholding 100 % Shareholding Outside India India R. Co India T. Co India Distribution Business ITES activities (cost+15%) ITES activities (cost+10%) IT Others Slump Sale 25

26 Case 2 A Co India Merger (say w.e.f April 2009) B Co India AE of A Co UK AE of B Co UK Whether a revised Transfer Pricing Study Report needs to be prepared and a revised Accountants Report is required to be filed? Which benchmark should be used? 26

27 General Anti Avoidance Rule ( GAAR ) under Chapter X-A of the Act 27

28 GAAR Deferred by two years Main purpose to obtain tax benefit Onus on tax-payer! Treaty override Independent Approving Panel 28

29 Why GAAR? Shareholders Issue of shares India Co Hold Co Other investments Demerger of India investments Mauritius Co Buy-back 1. Hold Co incorporates Mauritius Company 2. Hold Co demerges its investment in India to Mauritius Co 3. India Co buys back own shares India Co 29

30 Impermissible avoidance arrangement An arrangement whose main purpose is to obtain a tax benefit Not at arm s-length Lacks commercial substance Misuse / Abuse of the Act Not for bona fide purposes Disregard, combine recharacterise any step Treats arrangement as void, or treat in any other manner Disregard accommodating party Treat connected persons and other party as one and the same Reallocation amongst parties to an arrangement Re-characterize Equity -Debt, Income, expenses, relief, etc 30

31 Lacks commercial substance Definition: where there is a significant tax benefit without a significant effect upon business risk / net cash flows where legal substance or effect differs from legal form involves or includes: - round trip financing - an accommodating or tax indifferent party - any element that has the effect of offsetting or cancelling each other - transactions conducted through disguised intentions 31

32 Not for Bona fide purpose Bonafide purpose excludes any purpose: which creates rights / obligations that would not be normally created between persons dealing at arm s length; or would result (directly / indirectly) in the misuse / abuse of the Act 32

33 Way Forward 33

34 Way Forward People Management and Tax team closer interaction Public Documents Website Annual Reports Other publications Pricing Policy and Documentation Dispute Resolution Strategies 34

35 Questions 35

36 Thank You! 36

37 Definitions of Business Restructuring As per Taxmann s Dictionary for CA/CS and other corporate professionals It gives the meaning of Corporate restructuring as follows: Corporate Restructuring. It refers to the process by means of which a firm makes an assessment and evaluation of itself at a point of time and alters what it owes and owns, and refocuses itself to specific tasks of performance for improvements. Such restructuring is usually radical in design and starts with an analysis of the business environment and the acceptance of the fact that revolution (or at best fundamental rethinking) is necessary for the survival of the corporation. Corporate restructuring is sometimes termed as business process re-engineering in the sense that it involves consideration of at least three important aspects: 1) Business portfolio revaluation; 2) Financial engineering; and 3) Organisational design. 37

38 Definitions of Business Restructuring As per Black s Law dictionary It gives the meaning of the corporate reorganisation as follows: Reorganization. An Act or process of organizing again or anew. General term describing corporate amalgamations or readjustments occurring, for example, when one corporation acquired another in a merger or acquisition, a single corporation divides into two or more entities, or a corporation makes a substantial change in its capital structure. The exchange of stock and other securities in corporate reorganization can be effected favourably for tax purposes if certain statutory requirements are followed strictly. 38

39 OECD Guidance - TP aspects of Business Restructuring Final Report Released on 22 July 2010 (Chapter IX of TP Guidelines with 4 Parts) Guidance Special considerations for risks Arm s length compensation for restructuring itself Remuneration of post restructuring controlled transactions Recognition of the actual transactions undertaken 39

40 Definitions of Business Restructuring OECD TP Guidelines for MNEs Para 9.1 In the context of this chapter, business restructuring is defined as the cross-border redeployment by a multinational enterprise of functions, assets and/or risks. A business restructuring may involve cross-border transfers of valuable intangibles, although this is not always the case. It may also or alternatively involve the termination or substantial renegotiation of existing arrangements 40

41 Transfer of Shares - Dana Corporation (A.A.R. No. 788 of 2008) AAR Ruling: Section 45 must be read with section 48 and if computation provision cannot be given effect to for any reason, the charge under section 45 of the Act fails. There was no consideration for the transfer and therefore the charging provisions under section 45 of the Act became inapplicable Section 92 is not intended to bring in a new head of income or to charge the tax on income which is not otherwise chargeable under the Act. 41

42 Transfer of Shares - Amiantit International Holding Ltd. (A.A.R. No. 817 of 2009) 70% Indian Company Foreign Company (Bahrain) Contribution / Gift of shares of Indian Company without consideration 100% Foreign Company (Cyprus) AAR Ruling: When the computational provisions (section 48) cannot be applied at all, the case is not intended to fall within the charging section (section 45) If the consideration is such that it is incapable of being valued in definite terms or is unascertainable on the date of transfer, section 45 read with section 48 of the Act cannot be applied As regards the applicability of section 92 of the Act to this transaction, relying upon its view in the case of Dana Corporation, the AAR held that in a case where income was not chargeable to tax at all, the provisions of Chapter X (TP provisions) are not attracted 42

43 Section 92 in case of non-taxable event Section 92 is a machinery provision and not the charging section. Accordingly, in case the transaction is not taxable, the Transfer Pricing provisions would not apply. Vanenburg Group B.V. (A.A.R. No. 727 of 2006) VNU International B.V. (A.A.R. No. 871 of 2010) Transfer of Shares Castleton Investment Ltd (TS -607-AAR -2012) AAR Ruling: AAR emphasized that TP provisions do not automatically become inapplicable if there is no liability to pay tax. 43