BBSR & Co. LLP. Business Restructuring. Munjal Almoula Nikhil Dhariwal. 11 April 2015

Transcription

1 BBSR & Co. LLP Business Restructuring 11 April 2015 Munjal Almoula Nikhil Dhariwal

2 Contents 1 Introduction and Relevance 2 Rationale for restructuring 3 Types of Restructuring 4 Transaction, Benchmarking and Documentation 1

3 Introduction and Relevance 2

4 Introduction and Relevance 3

5 Rationale for Restructuring 4

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 and Management Shared Services Integrated Supply Chain Management Global/regional business units Aligned tax and business structure Risk Management Optimized Supply Chains Improved Cash Flow Lower effective tax rate Facilitate global/regional customer demands Less transfer pricing risk 5

7 Expanded definition of international transaction 6

8 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 cooperative banks business reorganisation means the reorganisation of business involving the amalgamation or demerger of a co-operative bank 7

9 Types of Restructuring 8

10 Types of Restructuring Restructuring Internal* External Conversion of fullfledged manufacturer to limited risk manufacturer Issue of shares Scheme of Arrangement Acquisitions Capital Re-organization Conversion of fullfledged distributor to limited risk distributor Merger Asset Purchase Stock Purchase Buy-back Transfer of Intangible property rights to a central entity Demerger Itemized Sale Inbound Capital Reduction Slump Sale Outbound * Internal restructuring primarily consist of internal re-allocation of functions, assets and risks within a multinational enterprise 9

11 External Restructuring 10

12 External Restructuring Issue of shares [Post Vodafone Bombay High Court Ruling] Issue before Bombay High Court Whether alleged shortfall in share premium arising out of shares issued by Vodafone India to its AE constitutes chargeable income in hand of Vodafone India and thereby result in application of transfer pricing provision? Ruling of Bombay High Court A precondition for application of Transfer Pricing provision (i.e. Chapter X of the Act) is that there should be income arising from International Transactions. The amount received on account of issue of shares to AE was a capital account transaction not separately brought within the definition of Income under the Act. Therefore, in absence of express legislation, the amount received, accrued or arising on account of capital account transaction could be subjected to tax as Income. Thus, nether the capital receipt received by Vodafone India on issue of equity share to its AE nor the alleged shortfall between so called fair market value of equity share vis-à-vis its issue price could be considered as Income under the Act. Chapter X of the Act is machinery (i.e. computational) provision to arrive at ALP of transactions 11

13 External Restructuring Issue of shares with AE and it is not a charging section (such as section 15 Salaries, section 22 Income from House Property, etc.). In absence of charging section in Chapter X of the Act, it was not possible to read charging provision into Chapter X of the Act. Based on above Bombay High Court concluded that there is no need to invoke transfer pricing provisions (i.e. Chapter X of the Act) in case of issue of shares Based on the above principles and rulings, Bombay High Court in the following rulings deleted adjustment on account on Issue of Shares: Shell India Markets Pvt. Ltd (TS-380-HC-2014(BOM)-TP); Essar Projects (India) Ltd. (TS-399-HC-2014(BOM)-TP); S.G. Asia Holdings (India) Pvt. Ltd (TS-401-HC-2014(BOM)-TP) Essar Power Ltd. (TS-402-HC-2014(BOM)-TP) 12

14 External Restructuring 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. Applicability of transfer pricing Merger of F Co A and F 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: Shareholders F C0 A Co A Shareholders F Co B Co B atleast 25% of the shareholders of F Co A continue to remain shareholders of F Co B; and the merger needs to be tax neutral in other country. I Co 100% In case above conditions are not fulfilled - TP would apply Merger of I Co A with I Co B - TP will not apply, transaction entered into between two domestic companies Merger of F Co (WOS of I Co), with I Co - Tax neutral, accordingly, TP will not apply 13

15 External Restructuring 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 Business A Demerged Business B 14

16 External Restructuring 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 15

17 External Restructuring Buyback of shares Buyback is acquiring its own shares from the existing shareholders by the company to reduce its paid-up capital I Co is an unlisted company, which is 100% subsidiary of In case of an unlisted company F Co. F Co I Co A 100% Buyback of shares I Co. buy-backs its shares from F Co. On the buy back transaction, I Co. will be liable to pay an additional 20% on distributed income on buyback of shares as per Section 115QA of the Act The income would be exempt in the hands of the shareholders under Section 10(34A) of the Act There is no income generated in the hands of Indian company, therefore, no transfer pricing would apply In case of a listed company Investors F Co 50% 50% I Co A Buyback of shares I Co is a listed company, of which 50% shares are held by F Co. and 50% by other investors I Co. buy-backs its shares On the buy back transaction, the shareholders would be liable to pay tax under Section 46A of the Act (Short term rate at applicable tax rates and long term 20% with indexation and 10% without indexation) I Co do not have to pay tax on the buy-back There would be transfer pricing implications in the hands of shareholders 16

18 External Restructuring 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 Utilization of securities premium for purpose other than provided u/s 78 of the Company s Act 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 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 17

19 Transaction, Benchmarking and Documentation 18

20 Transaction, Benchmarking and Documentation Taxable Transaction: Capital Gain on Buy back / Capital Reduction of Shares Issue of Equity/Preference shares (CCPs, NCCPs) - Whether international transaction? Benchmarking: Whether one needs to carry-out a functional analysis and characterize the entities involved? Which method can be used? Documentation: Business objective of re-organisation / restructuring Documents supporting the transfer price i.e. DCF valuation Negotiation between the parties 19

21 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 VIHI, LLC The Chennai Tribunal held DCF method for determining ALP for issue price of share 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 20

22 Case studies on Transfer Pricing post merger 21

23 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 22

24 Case 1 R. Co and T. Co are independent MNCs having operations in India through 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 `` 23

25 Case 2 A Co India Merger (say w.e.f April 2014) 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? 24

26 Internal Restructuring 25

27 Internal restructurings Conversion of full-risk manufacturer into Contract Manufacturer Pre restructuring Company A Entrepreneur manufacturer - Owns IP Pre-Restructuring Scenario Company A, Indian company, is an entrepreneur manufacturer, owning all the IPRs i.e. technical know-how, brand name, etc. Export sales Distribution Co. X Export sales Distribution Co. Y India Outside It has appointed Company X and Company Y as its distributors in different markets Under the present arrangement, Company X and Company Y would retain return on sales undertaken by them The balance is remitted back to the Company A as a return for its manufacturing activities, owning technical know-how, brandname, etc. 26

28 Internal restructurings Functional Analysis of Company A - Pre restructuring Particulars Owns technology & conducts R&D Owns Raw Materials & Finished Goods Manufactures for himself (right to sell) Marketing Activities Particulars Tangible assets: manufacturing facility, work force, office premises, etc Intangibles: technical know-how, brandname Particulars Market Risk Inventory Risk Capacity Utilisation Risk Product Liability / Warranty Risk Technology / R&D Risk Functions Assets Risks 27

29 Internal restructurings Conversion of full-risk manufacturer into Contract Manufacturer Contract Manufacturing Export sales Company A Contract manufacturer Company Z Entrepreneur Owns IP Export sales Transfer of IP and Functions India Outside Post-Restructuring Scenario Post restructuring, Company A became a contract manufacturer Company A transfers its technical know-how, brandname/ tradename, etc to Company Z, central management entity Company A would be manufacturing products for Company Z using technical know-how and brandname of Company Z For its activities, Company A would be remunerated on a Cost Plus Basis Distribution Co. X Distribution Co. Y Company Z would earn return for owning brandname, technical know-how, etc Restructuring carried out to achieve centralized management & control in a regional headquarter 28

30 Internal restructurings Functional Analysis Post restructuring Particulars Owns technology & conducts R&D Owns raw materials Manufactures for himself (right to sell) Marketing activities Particulars Tangible assets: manufacturing facility, work force, office premises, etc Intangibles: technical know-how, brandname Particulars Market Risk Inventory Risk Capacity Utilisation Risk Product Liability / Warranty Risk Technology / R&D Risk Functions X X X Assets X Risks X X X X 29

31 Internal Restructurings Part I: Allocation of Risks Steps Post restructuring Contract Conduct Company A Contract manufacturer Contract Manufacturing Transfer of IP and Functions India Comparables Hypothesise Outside Company Z Entrepreneur Owns IP Export sales Export sales Control Economic significance of Risks Financial Capacity Distribution Co. X Distribution Co. Y 30

32 Internal Restructurings Part II: Compensation for restructuring Profit Potential Post restructuring Compensation required when transfer of rights and / or assets No compensation for mere reduction in profit To determine compensation Review of FAR before and after restructuring Evaluate Business reasons Consider options realistically available India Outside Company A Contract manufacturer Contract Manufacturing Company Z Entrepreneur Owns IP Transfer of IP and Functions Export sales Export sales Distribution Co. X Distribution Co. Y 31

33 Internal Restructurings Part III: Remuneration of post restructuring controlled transaction Apply normal TP principles to avoid competitive distortion Identify relationship between: Post restructuring Company A Contract manufacturer Contract Manufacturing Transfer of IP and Functions - Compensation for restructuring and - Compensation for post-restructuring Compare pre and post restructuring scenario India Outside Company Z Entrepreneur Owns IP Export sales Export sales Distribution Co. X Distribution Co. Y 32

34 Internal Restructuring Part IV: Recognition of the actual transactions undertaken Pre restructuring Company A Entrepreneur Owns IP Pre-Restructuring Scenario Company A, Indian company, is an entrepreneur manufacturer, owning all the IPRs i.e. technical knowhow, brand name, etc. India Outside It has appointed Co. X as Limited Risk Distributor and Co. Y as contract manufacturer in respectively. Co. X and Co. Y return the realized amount on sale of group products after retaining their respective margins. Distribution Co. X Supply of goods Contract manufacturer Co. Y The difference between realized amount and cost of product is the margin of Company A taxable in India. This return consists of two factors return for supply of services and return for the IPRs 33

35 Internal Restructuring Part IV: Recognition of the actual transactions undertaken Transfer of functions/ IP to Company B Post restructuring Return for services Company A Service Provider Company B Entrepreneur Owns IPs Transfer of IP India Outside Post-Restructuring Scenario Company A transfers the technical know-how, brandname, etc to Company B under the process of restructuring Company B would be dealing with Contract manufacturer and limited risk distributors for manufacturing and selling of goods respectively Post transfer, Company A becomes a routine service provider and Company B becomes an entrepreneur manufacturer Distribution Co. X Supply of goods Contract Manufacturing Co. Y Company A would now receive return for rendering services and balance would be passed on to Company B 34

36 Internal Restructuring Part IV: Recognition of the actual transactions undertaken Transfer of functions/ IP to a Shell Company Post restructuring Return for services Company A Service Provider Company B Entrepreneur Owns IPs Transfer of IP India Outside Post-Restructuring Analysis Company B does not have people who have the authority and capabilities to perform functions in relation to the risks associated with the strategic development of the brandnames Company B does not have financial capacity to assume these risks Key/ Strategic decisions are prepared in Company A s office by employees of Company A and validated in Company B s office by employees of Company A Distribution Co. X Supply of goods Contract Manufacturing Co. Y Development, maintenance and execution of the worldwide marketing strategy are still performed by Company A Therefore, Company B does not have the real capabilities to take the risks Based on the above facts, the tax authorities could reject the re-structuring due to lack of economic substance and business reasons for such structuring 35

37 Key Takeaway 36

38 Key Takeaway The business team and tax team should work more closely to align business and tax structures The taxpayer should maintain robust documentation to capture the commercial reasons of restructuring The taxpayers should undertake valuations (wherever required) of assets/ shares, etc based on acceptable valuation methods Set up appropriate transfer pricing policies with respect to international transactions post restructuring Prepare and document appropriate dispute resolution strategies with respect to the international transactions to be undertaken post restructuring 37

39 BBSR & Co. LLP Thank you Munjal Almoula Partner Global Transfer Pricing Services T: E: munjalalmoula@bsraffiliates.com Nikhil Dhariwal Senior Manager Global Transfer Pricing Services T: E: ndhariwal1@bsraffiliates.com B B S R & Co. LLP is a member entity of B S R & Affiliates, a network of firms, registered with the Institute of Chartered Accountants of India. The other entities which are part of the B S R & Affiliates network include B S R & Associates LLP, B S R & Company, B S R and Co, B S R and Associates, B S R and Company, B S R R & Co and B S S R & Co B S R & Co. LLP is registered in Mumbai, Gurgaon, Bangalore, Pune, Kolkata, Hyderabad, Chandigarh, Kochi & Chennai. Other BSR firms have offices in Ahmedabad B S R & Co. LLP, a LLP of Chartered Accountants, duly registered under the Limited Liability Partnership Act, All rights reserved. Ahmedabad Safal Profitaire B4 3rd Floor, Corporate Road, Opp. Auda Garden, Prahlad Nagar Ahmedabad Tel +91 (79) Fax +91 (79) Bangalore Solitaire, 139/26, 3 rd Floor, Inner Ring Road, Koramangala, Bangalore Tel Fax Chandigarh SCO st floor. Sector 8 C Madhya Marg Chandigarh Tel : Fax Chennai No. 10, Mahatma Gandhi Road, Nungambakam, Chennai Tel Fax Delhi / NCR Building No.10, Tower B,8th Floor, DLF Cyber City, Phase II Gurgaon Haryana Tel Fax Hyderabad /2 Reliance Humsafar, 4th Floor Road No. 11, Banjara Hills Hyderabad Tel Fax Kochi 4/F, Palal Towers, M. G. Road, Ravipuram, Kochi Tel +91 (484) Fax +91 (484) Kolkata Unit No , 6th Floor, Tower 1, Godrej Waterside, Sector V, Salt Lake, Kolkata Tel: Mumbai Lodha Excelus, 1st Floor, Apollo Mills Compound, N.M. Joshi Marg, Mahalakshmi, Mumbai Tel Fax Pune 703, Godrej Castlemaine Bund Garden Pune Tel: / 65 Fax: