Outbound investments -Tax issues 21 April 2012 CA. N.C.Hegde
Key takeaways of the session Key tax objectives and challenges Scenarios Funds to be repatriated to India Funds not to be repatriated to India (retained outside India) Devising a checklist Holdco location: Tax Characteristics Key non-tax considerations Current and Proposed legislation 2
Characteristics Tax and regulatory efficiency Acceptable set-up / operational costs Efficient use of funds in the group Ease and speed of implementation Flexibility Ability to bring in new investors Listing 3
Key Tax Objectives Optimizing global tax cost Minimum tax leakage on repatriation / exit options Tax relief for external and intragroup debt Flexibility to cope with change of law 4
Key Tax Challenges Tax burden on investments Tax efficiency of funding Double taxation Challenges Interposing/using an intermediary company in the home country or another jurisdiction Availability of tax credit in investor/home country Access to debt and equity capital from both domestic and international capital markets Legal and regulatory framework for commercial transactions Compliance level in the investee country and investor country 5
Scenarios Outbound investments Funds to be repatriated to India Funds not to be repatriated to India Direct investment Investment in a company Direct investment Investment in a company 6
Funds to be repatriated to India
Investment in a Co India Investee country I Co. F Co. Key points: Investment can be made up to 400% of the net worth of India Co. I Co. can borrow to invest Borrowings from Bank and Financial Institutions Borrowings from group entities Overseas Borrowing also permitted Interest on loan deductible in India F Co. profits not taxable in India Dividends from F Co. to I Co. taxable in India Availability of credit for taxes paid in the foreign countries restricted in India Refer checklist Flow of income Flow of investment 8
Direct investment Key points: India Investee country I Co. I Co. direct investment exposure to risk and liabilities Income may be in form of business profits, royalty, FTS, interest, etc. The said income will be liable to tax in India @ 32.44% whether repatriated or not as the world income is taxable The provisions of section 93 of the ITA to be considered while executing transactions Refer checklist Services / Investment Flow of income Flow of investment 9
Investment via IHC India IHC jurisdiction I Co. Important Considerations: Investment from India can be Equity/Debt ECB permitted for this investment Return on investment Taxability Availability of tax credit Need for unlocking investments in a separate company Investee country F Co. IHC Services / Investment Steps: Incorporate a new company in tax haven If I Co. had made investments in F Co. Migrate investment to IHC Such transfer will be liable to capital gains tax at the time of transfer of investments If I Co. to make fresh investments Investments to be made from IHC Refer checklist Flow of income Flow of investment 10
Funds not to be repatriated to India
Investment in a Co. I Co. Important Considerations: I Co. will be liable to pay tax in case F Co. distributes dividend. However, in case no dividend is distributed by F Co. there is no tax liability India Investee country F Co. 12
Investment via IHC India IHC jurisdiction Investee country I Co. IHC Important Considerations: Certain on non-repatriation The benefit of the loss will not be available to the company in this case Since no income is repatriated to India, there will not be any India tax payable in respect thereof. Introduction of CFC regulations Direct Taxes Code Advantages Possibility of tax savings depending the IHC jurisdiction Disadvantages Taxes paid in investee country no credit available in India In case funds repatriated to India fully taxable in India F Co. Services / Investment Flow of income Flow of investment 13
Devising a checklist (Invt in a Co.) Whether funds needs to be repatriated to India? No (funds to be accumulated outside India) Invest through IHC Yes Whether Withholding Tax Certificate available? No Yes Whether withholding tax rate on dividends in investee country is more than corporate tax rate in IHC? Yes No Direct Investment 14
Good Holdco Location: Tax Characteristics CGT exemption Controlled Foreign Corporation (CFC) rules Foreign source dividends not taxable WHT on payment out of dividends /interest Tax Characteristics Good tax treaty network no LOB Stable, certain tax rules - no anti-avoidance legislation Capital duty or stamp duty Preferential Government legislation - e.g. EU directives 15
Key Non-Tax Considerations Political stability Time zone Banking/commercial laws Key Non-Tax Considerations IP protection law Corporate law e,g., no restrictions on distributions Good governance Acceptable cost 16
Transfer Pricing 17
Inter-company loan transactions Interest free Loan Subsidized Loan Market rate Different rates Domestic v/s International 13
Inter-company loan transactions Ideal TP Analysis Key factors for consideration in pricing intra-group transaction are: Tenor, Principal amount, Credit rating of borrower, Currency of the loan, Market conditions, Options, Securities, Seniority, existence of guarantees 19
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Inter-company guarantees What Is It? Assurance for credit support; projects; meeting future payment obligations Assurance generally provided by the entity having stronger financial profile Financial profile measured by credit quality credit rating grade assigned to the borrower which measures the risk associated with its borrowing capacity i.e., probability of default and loss given default Rating agencies international rating agencies like SandP, Moody s and Fitch India agencies like CRISIL, ICRA local ratings may not be relevant for cross border transactions Letters of credit Comfort letter 21
Types of intangibles (including rights) Less value INTELLECTUAL ASSETS Infra structure Design Brand License More value Network Tacit Knowledge Internal process Internal Training Supplier Relationships Customer / OEM relationships In-process Technology Best Practices Know-how Patents Trademarks, Designs Database rights Copyrights Neighboring rights Brand / Goodwill Secret know-how Corporat e Culture A strong Board of Director s Industrial Organization Intangible Operational Guidelines Human Capital Innovation Employee Know-how Mining rights Power rights Toll rights INTELLECTUAL PROPERTY by rule of law, or registration INTELLECTUAL CAPITAL IP License Network Fee Valuation methods Market approach Income approach Cost approach In India - DCF valuation 22
Transfer Pricing Advance Pricing Arrangement [APA] is proposed to be introduced in India with effect from 1July 2012 The key features of APA are: Board empowered to enter into an APA with any person undertaking an international transaction The arm s length price may be determined under any method whether prescribed or not Validity of the APA to not exceed 5 consecutive years APA to be legally binding on the taxpayer and the Income-tax authority for the international transaction to which the APA applies unless there is change in law or facts APA to be void in case of fraud or misrepresentation Taxpayer to file modified return within 3 months from the end of the month in which APA was entered for applicable fiscal years where return of income has already been filed Assessments / reassessments which are pending or completed for the years to which APA applies to be completed / reassessed by tax authorities in accordance with the APA Detailed rules, forms and procedure are to be prescribed by the Board 23
General Anti Avoidance Rule 24
GAAR Backdrop Tax avoidance v. Tax evasion Avoidance: An attempt to reduce tax liability through legal means, i.e. to regulate your affairs in such a way that you pay the minimum tax imposed (as opposed to the maximum) Evasion: Use of illegal means to reduce tax liabilities, i.e. falsification of books, suppression of income, overstatement of deductions, etc. Principle laid down by English Courts and accepted and reiterated by Indian Courts: Within the framework of the law, a taxpayer has the right to arrange his affairs in the most tax efficient manner Legal form of a transaction respected by judiciary Introduction of General Anti Avoidance Rule [GAAR] to provide for taxation based on the real nature of a transaction Principle of substance over legal form sought to be introduced 25
GAAR Proposed provisions (1) Impermissible arrangement Arrangement Objective of obtaining tax benefit (including intangible benefits) Creates rights and obligations not normally created in arm s length transactions Results in direct or indirect misuse or abuse of the provisions Lacks or is deemed to lack commercial substance in whole or part Is not bonafide Consequences Disregarding, combining or re-characterising the whole or part of the arrangement Treating the arrangement as if it has not been entered into Disregarding any party or treating parties as one and the same person Deeming connected persons to be one Reallocating any income / receipt and expenditure / deduction Determining the place of residence or situs of asset or transaction Disregarding any corporate structure Treatment of equity as debt and vice versa 26
GAAR Proposed provisions (2) Treaty will be overridden when GAAR is invoked Arrangement resulting in tax benefit shall be presumed to be for the main purpose of obtaining a tax benefit, unless proved otherwise Burden of proof on the taxpayer Arrangement deemed to lack commercial substance if: Arrangement as a whole differs significantly from individual steps It involves round trip financing, an accommodating party, offsetting or cancelling transactions, disguising the transaction Location of asset or transaction or place of residence is for obtaining a tax benefit Reference by jurisdictional Commissioner to Approving Panel (of at least three members of the rank of Commissioner or above) before invoking GAAR Taxpayer can file appeal to the Tribunal against order of Approving Panel; tax authorities cannot challenge the order 27
GAAR Implications and key issues (1) Implications Every tax planning measure potentially open to challenge by the Revenue Key issues The cornerstone of GAAR is determining the motive of a taxpayer Determination of motive is highly subjective and open to diverse interpretations Clear and unambiguous guidelines need to be prescribed in order to provide protection against arbitrary application of the GAAR Guidelines will be critical on the following issues: Distinction between tax planning and tax avoidance Threshold limits? 28
GAAR Implications and key issues (2) Key issues (continued) Can GAAR provisions be invoked against arrangements entered into prior to the implementation, but resulting in a tax benefit after introduction of GAAR? Investments into India through holding companies likely to be subjected to detailed scrutiny under GAAR Adequate economic and commercial substance would need to be built into intermediary holding companies Tax authorities may seek to re-characterise of buyback proceeds as dividend Prolonged litigation and uncertainty for taxpayers 29
Controlled Foreign Company ( CFC ) Regulations
Why introduce CFC regime now? CFC Regimes are mainly a feature of developed economies where capital outflows are greater than inflows. India is essentially a capital importing country with major exports being goods and services. India s priority is to attract significant inward FDI to continue sustainable development. Introduction of the CFC regime in India was first recommended in the Report of the Working Group on Non- Resident Taxation ( Report ) submitted in January 2003.
Mechanics of taxation of CFC income in India Will probably apply from 1 April 2013 Income attributable to a CFC is taxable for resident taxpayers who exercise control. Taxed in the financial year in which the CFC earns the income. Such income is taxed as Income from residuary sources based on a formula. Formula based on Net Profit as adjusted for certain items.
Mechanics of taxation of CFC income in India Provision for time apportionment based on ownership of CFC in an accounting period. Resident taxpayers to furnish details of investments and interest in such entities outside India Impact on tax provisioning in consolidated accounts Specified Assets for Wealth tax purposes include equity and preference shares in CFC.
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