Indian AAR recharacterizes capital gains arising on buyback of shares as dividends

Transcription

1 International Tax World Tax Advisor 13 April 2012 In this issue: Indian AAR recharacterizes capital gains arising on buyback of shares as dividends... 1 Chile: Tax benefits for R&D liberalized... 3 Germany: Draft Taxation Act 2013 incorporates AOA approach to taxing PEs... 4 Greece: VAT refund procedure modernized... 5 India: Mandatory tax reporting by liaison offices... 5 Thailand: Measures to promote investment after flood crisis... 7 In brief... 8 Are You Getting Your Global Tax Alerts?... 8 Indian AAR recharacterizes capital gains arising on buyback of shares as dividends India s Authority for Advance Rulings (AAR) issued a ruling on 22 March 2012 in which it denied the benefits of the India- Mauritius tax treaty for a share buyback by a Mauritius shareholder of an Indian company. The AAR invoked the substanceover-form doctrine to disregard the legal form of the buyback scheme and to treat it as a distribution of accumulated reserves. In effect, capital gains arising in the hands of the shareholders on the buyback of shares were recharacterized as dividends. The taxation of cross-border transactions involving the transfer of shares of an Indian company to a Mauritius-based shareholder and the applicability of the India-Mauritius treaty has been a controversial and divisive issue for many years. Article 13(4) of the treaty provides that capital gains derived by an entity are taxable only in the state in which the recipient is resident. Thus, gains derived by a Mauritius company from the sale of shares in an Indian company are not taxable in India under the treaty. Such gains are not taxable in Mauritius either because Mauritius does not tax capital gains under its domestic law. Many investors in India have relied on the Mauritius route, and the Indian tax authorities have challenged exemption claims by Mauritius companies, resulting in the denial of treaty benefits on the grounds that the companies were not the beneficial owners of the shares and, therefore, not entitled to the exemption. In certain cases, the tax authorities have sought to deny treaty benefits on the grounds that treaty shopping is not permissible. Indian courts and the AAR, however, have allowed the exemption in most cases on the basis of the beneficial circular issued by the government and a favorable Supreme Court decision. The new ruling is particularly significant because one of the benefits of investing into India through the Mauritius route is the ability to engage in a share buyback (redemption). Distributing profits through a share buyback can mitigate the Indian dividend distribution tax (DDT) of 16.22%, a levy payable by an Indian company on the declaration and payment of dividends. World Tax Advisor Page 1 of 9 Copyright 2012, Deloitte Global Services Limited.

2 Facts In 2012, Otis Elevator Company (India) Ltd. ( Otis India ), an Indian company, proposed a scheme to buy back its shares from existing shareholders in accordance with the relevant provisions in the Indian Companies Act. Otis India had three majority shareholders, Otis Elevators USA, Otis (Mauritius) Limited and Otis Elevator Company (S) Pte Ltd, Singapore; an insignificant amount of the shares (1.76%) were held by the general public. Of all the shareholders, only Otis Mauritius proposed to accept the buyback offer in return for cash consideration. Otis Mauritius, a tax resident of Mauritius, was incorporated in Mauritius in 2001 and had acquired the shares of Otis India in two tranches, during the years 2001 to In light of the contemplated transaction, Otis India approached the AAR for an advance ruling on the following issues: The taxability of capital gains in the hands of Otis Mauritius, a tax resident of Mauritius, pursuant to the tendering of shares of Otis India under the buyback scheme in the context of the capital gains article (article 13) of the India- Mauritius tax treaty; and The withholding tax obligation of Otis India in the case of remittances of the buyback proceeds to Otis Mauritius. The Indian tax authorities challenged Otis India s eligibility to request a ruling, arguing that the facts and circumstances preclude a ruling by the AAR, specifically because Otis India had undertaken an identical buyback scheme in 2008 and this case was pending determination by a tax officer; and in any event, the proposed buyback scheme was designed to avoid the payment of tax in India. The AAR noted that the 2008 buyback scheme and the proposed buyback were similar in nature, but they involved two separate transactions, so there was no issue pending determination before the tax officer with respect to the proposed buyback scheme. The AAR allowed the ruling application by Otis India, but qualified its decision by stating that the AAR may examine the tax avoidance aspect at a later stage if the circumstances so warrant. Arguments of the parties At the hearing, the tax authorities again contended that the proposed buyback scheme was a transaction designed to avoid the payment of tax in India. The authorities explained that the declaration and payment of dividends in the normal course by Otis India would have given rise to liability to DDT. However, rather than distribute dividends, the company had allowed reserves to accumulate, and now Otis India was attempting to distribute the accumulated reserves to its shareholders without attracting DDT by camouflaging the distribution as a buyback scheme. The tax authorities pointed out that, before the introduction of DDT in 2003, Otis India had a history of declaring and paying dividends to its shareholders. However, after the introduction of DDT, the company refrained from declaring, distributing or paying dividends and allowed its accumulated reserves to grow substantially. Thus, Otis India now was attempting by way of the proposed buyback scheme to distribute the accumulated reserves to Otis Mauritius without paying any tax in India. In this context, the authorities emphasized that Otis Mauritius was the only one of Otis India s major shareholders that accepted either buyback offer, and this was because capital gains derived by Otis Mauritius would not be taxable in India under article 13 of the India-Mauritius tax treaty. The buyback offer was not accepted by the other major shareholders because that would lead to capital gains being taxed in their hands. The Indian tax authorities implied that this fact cast more doubt on the credibility of the buyback scheme and the actual motives for the transaction. The public shareholding was 1.76%, which was insignificant and would not have a bearing even if someone from general public had accepted the buyback offer. The tax authorities also tried to argue that the place of management of Otis Mauritius was where the ultimate holding company, United Technologies Corporation, was located (United Technologies is incorporated in Delaware in the U.S.). In this context, the authorities contended that the control and management of Otis Mauritius was in the U.S., so the India-U.S. tax treaty, rather than the India-Mauritius treaty, should be applicable to the proposed buyback transaction. Relying on jurisprudence, the tax authorities contended that both it and the courts were free to disregard the legal form of the proposed buyback transaction because the scheme had been devised as a colorable transaction to avoid tax. In effect, the tax authorities urged the AAR to apply judicial anti-avoidance principles to ignore the legal form of the proposed buyback scheme and thereby to treat the distribution as a dividend for tax purposes. World Tax Advisor Page 2 of 9 Copyright 2012, Deloitte Global Services Limited.

3 The taxpayer, on the other hand, argued that the buyback of shares is sanctioned by law and there is no justification in going behind the transaction or questioning the motive for the transaction or its bona fides. The board of directors of Otis India was free to decide on whether a dividend is to be paid, and the board s decision is bona fide and valid. According to the taxpayer, taking advantage of legal and permissible means to arrange one s affairs could not be characterized as a scheme for the avoidance of tax. AAR ruling Based on the facts and circumstances, the AAR agreed with the tax authorities and concluded that the proposed buyback scheme was devised for tax avoidance purposes. The declaration and payment of dividends in the normal course by Otis India would have meant that it would have had to pay DDT. Instead of distributing dividends, Otis India had allowed reserves to accumulate. In effect, the company had devised a buyback scheme to transfer the reserves to its Mauritius shareholders without attracting DDT. In the context of DDT, Otis India was unable to offer a reasonable explanation as to why it discontinued declaring dividends after the introduction of DDT even though it continued to be profit-making. The AAR also found it significant that the other major shareholders of Otis India (i.e. Otis USA and Otis Singapore) did not accept the buyback offer because of the adverse tax implications they both would have been liable to capital gains tax in India. Otis Mauritius, on the other hand, accepted the offer because the capital gains would not be taxable in its hands under the India-Mauritius treaty. Thus, if the buyback scheme went through, the buyback proceeds would be remitted to Mauritius without any tax having been paid in India. In light of the above, AAR concluded that the buyback scheme was a tax avoidance mechanism. It accordingly ignored the legal form of the buyback and treated it as a distribution of dividends for tax purposes. Hence, the buyback proceeds under the proposed scheme were to be characterized as dividends in the hands of the shareholder, Otis Mauritius, which would be taxable in India under article 10 of the India-Mauritius tax treaty. Otis India, therefore, would be under an obligation to withhold tax on payments to Otis Mauritius. Conclusion This ruling highlights the determination of the Indian tax authorities to block attempts at treaty shopping, albeit in an indirect manner. Although India did not have a general anti-avoidance rule (GAAR) when the transaction took place, the tax authorities had argued that the transaction was an attempt at tax avoidance and should be termed colorable. The AAR s recharacterization of capital gains as dividends is the first of its kind and seeks to ignore the very form of the transaction. This is a last ditch attempt to tax a transaction that otherwise would have escaped the Indian tax net due to the Mauritius tax treaty. India s Finance Bill 2012 has proposed to introduce a GAAR to codify the substance-over-form doctrine. With a GAAR in its arsenal, the tax authorities will be fortified in their efforts to squash all attempts at tax planning. N.C. Hegde (Mumbai) Partner Deloitte Haskins & Sells nhegde@deloitte.com Vishal Palwe (Mumbai) Manager Deloitte Haskins & Sells vpalwe@deloitte.com Chile: Tax benefits for R&D liberalized New rules published in the Official Gazette on 6 March 2012 further liberalize and simplify Chile s tax incentive for research and development (R&D). The measures are designed to foster innovation, encourage investment in R&D and bring the country s overall R&D spend (0.4%) to a level similar to the average spent by OECD countries (2.26%). The rules become effective six months after the publication date (i.e. 7 September 2012) and will apply through 31 December Under current rules, which would have expired on 31 December 2017, a taxpayer that determines its taxable income through full accounting records and that invests in R&D is entitled to a tax credit equal to 35% of the R&D expense incurred. The credit, however, is capped at the lower of 15% of the gross income of the relevant year or 5,000 monthly tax units (MTU, a monetary unit linked to inflation and used for tax purposes). Any excess credit may be carried forward World Tax Advisor Page 3 of 9 Copyright 2012, Deloitte Global Services Limited.

4 indefinitely, but is not refundable. Instead, any portion of the R&D investment that is not available as a tax credit is tax deductible even if it is not directly related to the taxpayer s business. However, to be eligible for the deduction, the taxpayer must enter into an R&D contract with a value of at least 100 MTUs with an unrelated research center registered with CORFO, the Chilean government agency responsible for ensuring that the eligibility requirements for the credit are met. Under the new rules, the R&D tax benefit will be available to domestic companies and foreign companies carrying on activities in Chile (specifically, the benefits will only be available to companies that determine their Chilean taxable income on the basis of full accounting records foreign companies generally are not obliged to determine their Chilean taxable income in this manner, unless they have a permanent establishment in Chile). The rules provide as follows: The R&D tax benefit will not be limited to taxpayers that enter into an R&D contract with a duly registered research center. It also will be available to taxpayers that develop their own R&D projects (which will continue to require CORFO certification) and for R&D carried out by the taxpayer using its own resources or for R&D carried out by a third party. The research can be carried out either in Chile or abroad, but at least 50% of the total expenses must refer to activities undertaken in Chile. It will not be necessary for the research center and the taxpayer requesting the tax benefit to be unrelated parties, i.e. related parties can qualify. The maximum amount of the tax credit will be increased to 15,000 MTU (approximately USD 1,226,343), regardless of the percentage that such amount represents of the taxpayer s annual gross income. The remaining 65% of the R&D investment is tax deductible over a 10-year period. Taxpayers that already have a contract with a research center when the new rules become effective will continue to be governed by the old rules until 31 December As from 1 January 2013, such taxpayers can opt to either remain under the old regime or be subject to the new rules. Joseph Courand (New York) Client Service Executive Deloitte Tax LLP jcourand@deloitte.com Germany: Draft Taxation Act 2013 incorporates AOA approach to taxing PEs Germany s Federal Ministry of Finance issued a draft Taxation Act 2013 bill on 6 March 2013 that includes a number of changes to German tax law, and which, if adopted, will have an impact on transfer pricing. The draft tax act broadly adopts the authorized OECD approach (AOA) to the taxation of German permanent establishments (PEs) and includes provisions on the enhanced cooperation of the German and foreign tax authorities. According to the technical explanations included in the draft, proposed amendments to the Foreign Tax Act would standardize the German tax consequences regardless of the legal form of the investment (i.e. whether a subsidiary, partnership or branch). This would require, in particular, the alignment of the tax treatment of a PE to a greater extent with that of subsidiaries. The draft proposes changes so that German law would be in line with the AOA regarding the treatment of a PE. Under this approach, a PE would be treated like a separate and independent enterprise from a tax perspective, thus transposing new article 7 of the OECD model treaty into German domestic law. If the measure becomes effective as proposed, the functionally separate legal entity approach would be nearly fully adopted, with only minor differences remaining. The draft tax act also would implement into domestic law the EU directive on administrative cooperation in the field of taxation, which should result in improved cooperation of the German tax authorities with their foreign counterparts. This move could mean that more information on foreign entities (including transfer pricing information) would be made available to the German tax authorities, so it would become more important that transfer pricing arrangements comply with the arm s length principle and be consistent at the group level. World Tax Advisor Page 4 of 9 Copyright 2012, Deloitte Global Services Limited.

5 Stephan Rasch (Munich) Partner Deloitte Germany Marc Schnell (Munich) Director Deloitte Germany Greece: VAT refund procedure modernized Greece s Ministry of Finance published a decision on 2 April 2012 that aims to modernize the VAT refund procedure by allowing the online submission of refund requests and the introduction of a new procedure for the evaluation of such requests by the tax authorities. Further guidance is expected to be issued on the implementation of the new rules. The decision provides as follows: Credit VAT amounts that entrepreneurs do not wish to carry forward for set off against output VAT in the next fiscal or accounting period will be refunded after a taxpayer submits an electronic application (through TAXISnet). The General Secretariat of Informative Systems (GSIS) will process the refund application to verify the taxpayer s compliance with its tax obligations and to cross-check the VAT refund amounts requested with the information on the submitted VAT returns. Using a risk analysis method, the GSIS will prepare and forward to the competent tax office electronic files indicating the applications with respect to which a provisional audit needs to be carried out. The file must be transmitted by the 15th day of the month following the month in which the VAT refund application was submitted. An audit will be conducted whenever the refund application is for an amount of EUR 100,000 or more. VAT refunds will be granted as follows: o If no audit is required, within 15 days after the tax office receives the file from the GSIS. o If a provisional VAT audit is required, within one month following completion of the audit. Such an audit must be finalized within two months after the tax office receives the file from the GSIS. o If a regular tax audit is required, within one month following completion of the audit. Such an audit must be completed within five months following submission of the VAT refund application (or within five months from the deadline for filing the corporate income tax return, subject to certain conditions). A similar procedure will be followed for pending refund claims. Amounts to be refunded will be set off against any existing debts to the Greek state. Subject to public finance limitations, the VAT refund will be paid within 15 days from the date the refund is recorded in the refund book held by the competent tax office if the amount concerned does not exceed EUR 300,000 (otherwise, within four months from the date the refund is recorded in the refund book held by the competent tax office). Pending refundable amounts will be paid subject to public finance limitations in accordance with the schedule to be drafted for years Maria Trakadi (Athens) Partner Deloitte Greece mtrakadi@deloitte.gr Kyriaki Dafni (Athens) Senior Manager Deloitte Greece kdafni@deloitte.gr India: Mandatory tax reporting by liaison offices The Indian Central Board of Direct Taxes (CBDT) has issued Notification No. 9/2012 (dated 17 February 2012), detailing the information that nonresidents with representative or liaison offices (collectively, LOs ) in India must provide in accordance with legislation passed in The new rules are effective as from 1 April World Tax Advisor Page 5 of 9 Copyright 2012, Deloitte Global Services Limited.

6 Background One of the most common forms of doing business in India is to set up an LO. An LO is comparatively easier than other entities to establish, maintain and terminate. Under Indian exchange control regulations, an LO may not engage in business or commercial activities or earn revenue. LO structures, however, are frequently used by foreign entities to test the Indian market, source products from India or engage in information gathering activities. Under most of India s tax treaties, an LO is normally considered as engaging in preparatory and auxiliary activities and, therefore, does not create a permanent establishment (PE) or taxable presence for the foreign entity in India. New reporting rules The Indian tax authorities increasingly have been challenging the no PE status of certain LOs, including arguing that the activities of the relevant LO extend beyond being preparatory and auxiliary in nature. The courts have confirmed in certain cases that the LOs constitute a taxable presence of the foreign entity. Separately, India s transfer pricing authorities have taken an aggressive approach by attributing significant profits to such LOs. To improve the government s ability to obtain information on LOs in India, the tax law was amended in 2011 (effective 1 June 2011) to require nonresidents having an LO in India to file an annual statement. The CBDT notification prescribes rules and the specific form for the statement (Form No. 49C). The salient features of the rules are as follows: Signing of annual statement The annual statement must be verified by a chartered accountant or signatory duly authorized by the nonresident. Format for filing of annual statement The annual statement must be furnished in electronic form with a digital signature following the forthcoming procedure to be prescribed by the Director General of Income Tax (Systems). Prescribed information The form prescribes detailed information that must be provided about LOs to include: India-specific details for the financial year, i.e. receipts, income and expenses of the nonresident from or in India (this is not information related to the LO only); Details of all purchases, sales of materials and services from/to Indian parties during the year by the nonresident person (not limited to transactions entered into by the LO); Details of salary or compensation of any sort payable outside India to any employee working in India or for services rendered in India; Total number of employees working in the LO during the year; Details of agents, representatives and distributors of the nonresident person in India and names and addresses of the top five parties (under criteria that has not been specified) in India with whom the LO has liaised; Details of products or services for which liaising activity is carried out by the LO and details of any other entity for which liaising activity is carried out by the LO; Details of group entities present in India, such as a branch office, company, limited liability partnership, etc., established in India (and including the nature of their business activities); Details of other LOs of group entities in India; and Other group entities operating from the same premises as the office of the LO. The above reporting is in addition to the separate requirement under the exchange control regulations that an LO must furnish an Annual Activity Certificate to the designated authorized bank in India, with a copy provided to the jurisdictional Directorate General of Income Tax (International Taxation). The statement must be submitted within 60 days from the close of the LO s financial year World Tax Advisor Page 6 of 9 Copyright 2012, Deloitte Global Services Limited.

7 Comments The filing requirement emphasizes the need for foreign entities to re-examine the operations carried out by their LOs in India and analyze any potential PE exposure. Even if such analysis leads the foreign entity to conclude that there is no PE risk, robust documentation of the operations remains crucial in managing the risk of tax litigation. Further, where there may be a risk of a PE, voluntary disclosure by filing a corporate tax return may help mitigate the level of interest and penalties imposed. Rajesh H. Gandhi (New York) Client Service Executive Deloitte Tax LLP rajegandi@deloitte.com Thailand: Measures to promote investment after flood crisis Thailand s Board of Investment recently issued guidance that sets out the tax measures aimed at revitalizing investment after the flood crisis. A number of benefits are available for promoted projects that suffered flood damage to their machinery or buildings and that still enjoy a corporate income tax (CIT) exemption. The following benefits are available where these projects invest in non-current assets, such as the construction of buildings and factories, machinery and equipment, in the repair of such items and/or the importation of machinery/equipment to replace the damaged/lost machinery/equipment: Current status Receiving capped CIT exemption in proportion to the investment amount Receiving uncapped CIT exemption New benefits Investment in province affected by floods Eight-year tax holiday, 150% exemption for investment amount, plus the remaining CIT exemption for each project Option 1 Eight-year tax holiday, 150% exemption for investment amount, plus the remaining CIT exemption for each project Investment in other provinces Eight-year tax holiday, 100% exemption for investment amount, plus the remaining CIT exemption for each project Eight-year tax holiday, 100% exemption for investment amount, plus the remaining CIT exemption for each project Option 2 - If the remaining period of the CIT exemption is less than five years, a CIT exemption will be granted for three additional years, up to a total of eight years. - If the remaining period of the CIT exemption exceeds five years, an additional 50% CIT reduction will be granted For two additional years where there are five to six years exemption remaining; For four additional years where there are six to seven years exemption remaining; For five additional years where there are more than seven years exemption remaining. An import duty exemption is granted for every promotional area on imported machinery, whether new or old, that has not been in use for more than 10 years from the date of production to the date of import. Original and substitute machinery used for the project qualify for the promotional measure. Industrial estates or zones that invest in flood prevention systems will be granted an eight-year CIT exemption, although the exemption cannot exceed 200% of the investment amount. Auyporn Tanlamai (Bangkok) Partner Deloitte Thailand atanlamai@deloitte.com World Tax Advisor Page 7 of 9 Copyright 2012, Deloitte Global Services Limited.

8 In brief European Union The European Commission has announced that it intends to conduct a comprehensive assessment of the tax legislation of the EU member states to determine whether domestic legislation creates any unfair advantages for workers that live in one member state but work in another. Countries with legislation that is considered to violate the EU fundamental freedoms potentially will be subject to infringement procedure if they do not comply with the Commission's request to change the discriminatory rules. World Trade Organization On 14 March 2012, the WTO launched a new publically available database on non-reciprocal preferential schemes implemented by WTO members to create greater transparency in trade policies. The database aims to increase members and the public s understanding about the legal nature, history and background of each preferential trade arrangement, the range of products covered, the types of preferential treatment offered and the countries eligible for preferential market access. Are You Getting Your Global Tax Alerts? Throughout the week, Deloitte provides commentary and analysis on developments affecting cross-border transactions on a free subscription basis delivered straight to your . Read the recent alerts below or visit the archive. Subscribe: Archives: Brazil Government makes major changes to transfer pricing legislation The government has published a provisional measure that includes significant changes to the country s transfer pricing regime by amending the rules applicable to imports of goods, setting profit margins for certain sectors and creating two new transfer pricing methodologies. [Issued: 12 April 2012] URL: b56f00aRCRD.htm URL: World Tax Advisor Page 8 of 9 Copyright 2012, Deloitte Global Services Limited.

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