Business Reorganisation and Issues

Transcription

1 Business Reorganisation and Issues 1 Sanjay Tolia

2 Presentation Outline Introduction and Relevance Expanded definition of international transactions Rationale for restructuring and concerns Subscription of shares Applicability of Transfer Pricing in non taxable event M&A and Transfer Pricing Case Studies on Transfer Pricing issues post Business Reorganisation Business Restructuring OECD Guidelines General Anti Avoidance Rule Way forward 2

3 Introduction and Relevance 3

4 Introduction and Relevance 4

5 Expanded definition of international transaction 5

6 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 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 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? 6

7 Rationale for restructuring and concerns 7

8 Rationale for restructuring DriversActions Benefits Business Drivers Profitable growth Globalization Customer demands Lower costs Shareholder value Financial Drivers High domestic tax rates Complex transfer pricing Tax incentives More aggressivetax 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 8

9 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. 9

10 Subscription of shares 10

11 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. 11

12 Applicability of Transfer Pricing in non taxable event 12

13 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. 13

14 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 14

15 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. 15

16 M&A and Transfer Pricing 16

17 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 Slump Sale Outbound 17

18 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 18

19 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 19

20 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 20

21 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 Tax Implications No Deemed Dividend Tax implication in the hands of Company 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 21

22 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 New provisions The fair valuation done by a Chartered The fair valuation of shares would be Accountant as per the erstwhile undertaken by a SEBI registered Controller of Capital Issues (CCI) Merchant banker or a Chartered guidelines 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

23 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 23

24 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 24

25 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. 25

26 Case studies on Transfer Pricing post merger 26

27 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 27

28 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 28

29 Business Structuring OECD Guidelines 29

30 OECD Guidance - TP aspects of Business Restructuring Final Report Released on 22 July 2010 (Ch.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 30

31 Business restructurings Case studies Conversion of full-risk manufacturer into Contract Manufacturer Pre restructuring Company A Entrepreneur manufacturer - Owns IP Export sales Export sales India Outside Distribution Co. X Distribution Co. Y 31

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

33 Part I:. Post restructuring Company A Contract manufacturer India Contract Manufacturing Transfer of IP and Functions Outside Company Z Entrepreneur Owns IP Export sales Export sales Distribution Co. X Distribution Co. Y Restructuring carried out to achieve centralized management & control in a regional headquarter 33

34 Part II: Allocation of Risks Steps Post restructuring Contract Conduct Comparables Hypothesise India Outside Company A Contract manufacturer Contract Manufacturing Company Z Entrepreneur Owns IP Transfer of IP and Functions Control Financial Capacity Economic significance of Risks Export sales Distribution Co. X Export sales Distribution Co. Y 34

35 Part III: Post Restructuring Apply normal TP principles to avoid competitive distortion Identify relationship between: - Compensation for restructuring and - Compensation for postrestructuring India Outside Post restructuring 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 35

36 Part IV: Recognition Transfer of functions/ip to a shell company Pre restructuring Company B Contract manufacturer Company A Entrepreneur Mfg Physical flow of goods Company C Distributors 36

37 Part IV: Recognition Transfer of functions/ip to a shell company Post restructuring Company A Service Provider Transfer of Brand name, Technology AND `KEY EMPLOYEES` Company Z Entrepreneur Company B Contract manufacturer Physical flow of goods ALP for central services Company C Distributors 37

38 Good and Worrisome Impact of OECD s Guidance - Tax authority to respect commercially rational restructuring transactions that have economic substance - Restructuring may be disregarded in exceptional situation - Non-arm s length behaviour to be addressed through price adjustment - Restructuring to be evaluated not from group s perspective but each entity s perspective 38

39 Good and Worrisome Impact of OECD s Guidance (contd..) - Post restructuring to be addressed under normal TP rules - Tax authorities may want to look at entirety of arrangements - Presence of Tax motive is not sufficient for non-recognition - Documentation requirements are stringent 39

40 General Anti Avoidance Rule ( GAAR ) under Chapter X-A of the Act 40

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

42 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 42

43 Way Forward 43

44 Way Forward People Management and Tax team closer interaction Public Documents Website Annual Reports Other publications Pricing Policy and Documentation Dispute Resolution Strategies 44

45 Questions 45

46 Thank You