cross boarder transactions written by mukesh bhutani good learning

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Cross border transactions

Mukesh Butani

November 17, 2005

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Agenda

Key tax and financial considerations Income stream Entry strategy Financing options Debt structuring Cash repatriation Exit considerations

Case Study Business reorganisations

Transaction imperatives

Leasing transactions


Cross border transaction imperatives

Cross Border Transactions

Cross Border Transactions

Legal & regulatory framework

Identifying and delivering synergies

Tax regimes & treaties

Business Dynamics

Business Environment

Cultural Issues

Accounting treatment


Key tax and financial considerations


Key tax and financial considerations



Exit considerations

Cash repatriation

Debt Structuring

Income flows and their taxability

Entry Strategy

Financing options

1

2

3

4

5

6


Others: royalty / brand fees / technical services / management services

Income stream and their taxability

Dividends

Capital gains

Interest

Interest, TS and royalty can flow independent

of ownership pattern

TS and royalty would typically flow to an

operating entity, which possess technical

capabilities

Principal drivers are tax costs associated with

dividend flows and gains on disposal of

shares

Brand fee would flow to the IPR company

Income streams Principles for evaluation

1

Key elements – arm’s length principle, documentation, overall tax costs and foreign tax credits


Comparison between various tax regimes

*DDT @ 14.025%

Note Nil in case of transfer of shares by one non-resident to another non-resident

JurisdictionMauritius

Dividends Nil* Nil* Nil*

Capital gains on disposal of shares

Nil Nil Note

Interest 0 / 20.91% 10% 10%

Royalty 10.46% 10.46% 10.46%

Cyprus NetherlandsNature of Income

Nil*

Nil

10%

10%

Singapore

Nil*

As per Indian tax Laws

0/10/15%

10/15/20%

USA

1


Entry strategy

US Parent

WOS/ Branch

Direct investment

US Parent

European / Netherlands sub

WOS/ Branch

Step down investment

Overseas

India

US Parent

Singapore / Mauritius sub

WOS/ Branch

Double step down investment

European / Netherlands sub

2


Financing options

Dividends and DDT not

deductible; consider double dip

deduction

Interest allowed as deduction

(arm’s length principle)

Dividends and DDT not

deductible

Deductibility

Not available under most

Treaties (check domestic laws

of home country)

Tax withholding on interest

available

Not available under most Treaties

(check domestic laws of home

country)

Tax credit

DividendInterestDividendPay outs

No restrictionsRestriction on usage as per ECB

guidelines (see next slide)

No restrictionsUsage

DDT payable @ 14.025%

Long Tem

Equity

DDT would be payable @

14.025%

Withholding tax @ 0 / 10 / 15 /

20%

Tax rate

Medium to long termMedium to long termTerm

Quasi Debt (Preference stock

– mezzanine instrument )

Debt (related & third party)Parameters

No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets commercial requirements

Leveraging Indian company using overseas debt subject to restrictions in ECB Guidelines (see next slide)

3


Debt structuring

• Internationally recognized sources (international banks, capital markets, multilateral financial

Institutions, equipment suppliers, foreign collaborators)• Foreign equity holder if:

ECB up to 5 MUSD – minimum equity of 25% ECB above 5 MUSD – minimum equity of 25% and debt-equity ratio not exceeding 4:1

• Upto 20 MUSD – Minimum average maturity of 3 years, can have call / put option

• Over 20 MUSD to 500 MUSD – Minimum average maturity of 5 years

• ECBs outside the above limits/ maturity period need specific approval

• Investment in real sector (capital goods, new projects, modernization/ expansion of units)

• Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)

• Not to be utilized in capital market transactions, real estate, acquisition, working capital, repayment of Rupee loans

• ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR

• ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR

• ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum

average maturity period

Lenders

End use

Total cost of debt

Amount/ maturity

Prepayment

4

MUSD means million United States Dollars


Cash repatriation

Dividend distribution

Broad mechanics of each of the above options have been discussed in detail in Annexure 1

Simplest and most common

Suitability

Profit making company

Ease of repatriation

Capital reduction

Court regulated process, involving repayment of share capital – comparatively complex and time consuming – amount paid to the extent of accumulated profits of the company would be taxable as dividend in India

Cash rich company with low reserves

Loss making company with cash reserves

Maximum amount of repatriation desired

Share buyback

Repurchase of shares – restricted amount of repatriation – income taxable as capital gains in hands of the shareholder

Profit making company

Foreign Co desires to classify the income as ‘capital gains’ instead of ‘dividend’ – possible treaty benefits

5


Exit considerations

Capital gains

Shareholder’s agreement and implications thereof – Right of First Refusal; Tag Along rights; Drag Along rights

No Objection Certificate requirement for setting up new venture – Press note

1 of 2005 (refer Annexure 2 for process)

Liquidation process – long drawn and Court approval process

6


Case study – business reorganization


Case Study – acquisition of business

US Corp

Global conglomerate engaged in diversified businesses

Aggressively targeting Asian foods markets

Has significant experience in the foods business and commands a powerful brand name

Target CoIndian

Indian Partner

Controls significant share of the Indian foods market

Leading exporter to Asia

Strong track record and substantial reserves

Mauritian Co

US Corp’s strategic holding company for Asian investments

Has a wholly owned Indian subsidiary, F&P, engaged in two businesses - foods and packaging

F&P has accumulated tax losses

Leading Indian company (not part of US Corp group)

Holds majority equity in Target Co


Overview of the structure

*Consider Singapore jurisdiction

Mauritian Co*

Target Co(Foods)

43%

US Corp(conglomerate)

100%USA

Mauritius

India

Foods & Packaging

100%

Case Study to suggest mechanism to achieve business objectives of US Corp & Indian Partner

Phase I

• Asian strategy - acquire control of Target Co

• Foods business of F&P to be consolidated with Target Co

Phase II

• Target Co sells trademark to US Corp

• US Corp licenses trademark to Target Co

• US Corp receives royalty

Redefining strategy

Focus on core business - auto ancillary

Exit non-core business

US Corp

Indian Partner

Business strategy

57%

Indian Partner

Auto ancillary


Case study - modes of acquisition

Increase in stake

Acquisition of shares

Merger

Demerger

Sale of business undertaking/sale of assets

Directincrease

Passive increase

Business restructuring

Preferential allotment of shares

Capital reduction of identified shares

Share buyback

The case study however discusses the implications arising under the merger option, in detail in following slides


Phase I - Mechanics of merger

Mauritius Co

Post Merger

Foods & Packaging

43%

Target Co

IndianPartner

57%

100%51%

49%Present scenario

Company Law Implications Tax Implications Other Implications

Special resolution

Court approved process

Dissolution of F&P under Court order without winding up

Broadly tax neutral on satisfying conditions

Transfer of tax losses and tax benefits of F&P

Tax losses available for fresh lease of 8 years

Stamp duty costs significant

Valuation of companies

No foreign investment approvals, subject to conditions

No cash outflow for Mauritian Co

No consideration to Indian Partner on indirect dilution of its stake

Fiscal and regulatory implications of merger

Issue of shares to Mauritius Co. as consideration of food business

Merger


Phase II – Sale and license back of trademark

Mauritian Co

Target Co

Mauritius

India

Sale o

f tradem

ark – cap

ital gain

s

Lic

en

se o

f tr

ad

emar

k –

ro

yalt

y i

nco

me

Target Co transfers its Trademark (‘TM’)

to Mauritian Co. Subsequently Mauritian Co

licenses TM back to Target Co

Mechanics

51%

Arm’s length nature of sales and licensing of trademarkMay entail service tax and Value Added Tax


Leasing transactions

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Salient features of leasing transactions

Lease of equipment with resources to operate the equipment

Lessor continues to control the operation of the equipment and its maintenance

Example– Lease of an aircraft along with flight crew; lessor responsible for selection/

hiring of flight crew, operation and maintenance of aircraft, etc

Lessor merely provides the equipment at a particular location

Lessee operates the equipment using his own resources

Example – Lease of aircraft without crew

Forms of dry lease:

Operating lease

Finance lease (for detailed discussion, refer next slide)

Wet lease

Dry lease


Operating Lease vs. Finance Lease

Lessor is the legal and the economic owner

Lessor is the legal owner

Lessee is the economic owner

Risks and rewards associated with the asset not substantially

transferred

Risks and rewards associated with the asset are substantially

transferred

Operating lease Finance lease

Risks include losses due to idle capacity, technological obsolescence & changing

economic conditions. Rewards include expectation of profitable operation over economic

life of asset and gain from appreciation in value or realisation of residual value

Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India


Taxation of leases – domestic law

Lessor

• Royalties - Section 9(1)(vi)

Or

• Section 44BBA - 5% of deemed profits

Lessee

• Lease rentals allowed as deduction

• Depreciation allowed to lessor

Dry lease

Lessor

• Royalties - Section 9(1)(vi)

Or

• Section 44BBA – 5% of deemed profits

Lessee

• Resident - Lease rentals would be allowed to the lessee

• Depreciation would be allowed to the lessor

• Section 10(15A) – exemption from tax withholding extended

Wet lease

May entail service tax and Value Added Tax


Taxation of leases – treaty law

Article 12 Royalties includes consideration for use of equipment

Article 7 – Business Profits applies where Article 12 does not cover payments for use

of equipment

Klaus Vogel‘s commentary - If enterprise lets or leases facilities, equipment, buildings

or intangibles to enterprise of other state without maintaining a fixed place of business

for such letting or leasing activity in the other state, the lessee’s facilities, equipment,

buildings or intangible property, as such, will not constitute PE of lessor, if contract

limited to leasing of equipment

Article 8 (1) - Profits from operation of ships or aircraft in international traffic taxable

only in state of residence

OECD Commentary of Article 8 of model tax treaty - “Profits obtained by leasing a ship

or aircraft on charter fully equipped, manned and supplied must be treated like the

profits from the carriage of passengers or cargo

Dry lease

Wet lease


Thank you


Annexure 1


Can be paid from current year profits subject to transfer to reserves

Dividend can also be paid out of past accumulated profits subject to a maximum limit of 10% of paid up share capital

Board/ shareholder approvals required

Generally no regulatory approvals required

14.025 % Dividend Distribution Tax (DDT)

Income exempt in recipient’s hands

Tax treaties with some countries provide for Underlying Tax Credit (UTC) on DDT

Amount restricted to positive distributable reserves

Distribution of

dividend

Other issuesKey fiscal costsLimitationsCriteria/ Option

Cash repatriation strategies


Board/ shareholder approvals required

Court/ creditor approval required

Allowed without regulatory approvals from an exchange control perspective subject to certain conditions

Funds paid to the extent of accumulated profits (including capitalized profits) taxable as dividend (dividend tax @ 14.025 %

For public listed companies if Securities Transaction Tax applies, Long term - NIL Short term @11.22%

Tax rate for private companies Long term - 22.44% (in case

of foreign company 20.91%) Short term - 33.66% (in case

of foreign company 41.82%)

Tax withholding

Treaty consideration

Possible Stamp duty exposure @ 0.25%

Positive distributable reserves are not a pre-requisite

Capital repayment not possible at amount higher than par value of shares

Possible to increase cash pay out by capitalizing reserve

Capital

repayment or

capital

reduction


Cash repatriation strategies (contd)


Board approval if buyback is less than10% of total paid-up equity capital and free reserves/ shareholder approval required if buy-back more than 10%

Buy back price would need to be in consonance with “fair valuation principles” enunciated in transfer pricing legislations

Capital gains tax for shareholder on consideration less acquisition cost (after adjusting for exchange fluctuations)

For public listed companies if Securities Transaction Tax applies, Long term – NIL Short term @11.22%

Tax rate for private companies Long term - 22.44% (in case of

foreign company 20.91%) Short term - 33.66% (in case of

foreign company 41.82%)

Possible stamp duty exposure @ 0.25%.

‘Appropriate’ tax to be withheld by Indian Co

Provisions of applicable treaty to be considered

Amount restricted to 25 per cent of (share capital+free reserves)

Max 25 per cent of equity share capital permitted to be repurchased in an year

Post buyback Debt-equity ratio not to exceed 2:1

Minimum 12 months gap between two consecutive buyback

Capital re-

purchase or

buyback

through tender

offer




Under exchange control regulations, cap on per share amount payable on buyback is the higher of the price based on the NAV per share linked with stock exchange or as per valuation of statutory auditor/ merchant banker

Disclosure in offer document, if the promoters to tender shares, for public listed companies

Capital re-purchase ie buyback through tender offer

Other issuesKey fiscal costsBroad time frame

LimitationsCriteria/ Option


Under exchange control regulations, cap on per share amount payable on buyback is the higher of the price based `on the NAV per share linked with stock exchange or as per valuation of statutory auditor/ merchant banker

Disclosure in offer document, if the promoters to tender shares, for public listed companies


Annexure 2


Regulatory compliances

No Objection Certificate from Indian partner has been a key negotiation point for foreign company having existing JV relationship in India – In certain cases MNC have to sacrifice by accepting low JV exit price

• Does the Foreign company have an existing venture?• Is the existing venture in ‘same’ field?

(this includes equity holdings, technical collaboration, brand collaboration, etc)

NOC from Indian partner required

Prior approval from FIPB required for financial/ technical

investment in India

No prior approval required – investment can be made by

foreign company

Yes No

What do the prevailing Foreign investment regulations

provide?

FDI restrictions for the particular sector to apply

• NOC has been made inapplicable to past ventures as also relaxing the “allied” field condition

• Ventures existing on January 12, 2005 would be treated as existing ventures

• For ventures after January 12, 2005, parties are free to contractually agree a “conflict of interest” clause – accordingly, it is advisable to incorporate easy exit clause for future independence, while entering into a JV relationship

cross boarder transactions written by mukesh bhutani good learning

Economy & Finance

withholding tax

musd minimum average

indian tax laws

musd minimum equity

company foreign

foreign tax credits

agenda key tax

capital markets