foreign direct investments and exchange control regulations
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A discussion on Inbound structuring
Taxation, Foreign Direct Investments and
Exchange Control Regulations
24 January 2010
CA Rachana Kapadia
CA Janhavi Sharma
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Why Inbound Investments?
Advantages of low cost & skilled labour
Utilising the funds raised for growth
Investing in Indian economy due to liberalisation of
Foreign Direct Investment Policy
Greater transparency & clarity in capital market
reforms
Repatriation / Exit Strategies
Implications on various capital structures
Implications on acquisition of shares /
Investment Strategy
Tax attribute planning
Key elements
Business strategy
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Caltex Gas
Indiaacquired bySHV Group
Micromaxsells
minorityholding to
PE investorTA
Associates
Coffee Dayis final
phase of
talks withTemasek,
KKR,StandardChartered
One Accessacquires BA
Systems
Destination India This January
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Contents
4
FEMA and exchange control
regulations
Recent cases
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Key Considerations
Inbound
structuring
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Decision Points.
India
Jurisdictionplanning
Domestictax
incentives
Choice ofan
appropriatestructure
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Entry vehicles
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Liaison Office
Can only undertake liaising / representing / promoting / communicating
activities
Not allowed to have any income
Local expenses have to be met through inward remittances
Branch Office
Can undertake activities export / import of goods, professional / consultancy
services, research work, technical / financial collaborations, buying / selling agent,
IT services / development of software, technical support, foreign airline & shipping
company
Cannot undertake retail trading activities, manufacturing / processing activities.
Can acquire property but not for leasing / renting
Project Office
Cleared by an appropriate authority
Company or entity in India awarding the contract has been granted Term Loan
by a Public Financial Institution or a bank in India for the project.
Funded directly by inward remittance / bilateral or multilateral International
Financing Agency
Indian
Company
Can carry out any activity specified in the memorandum of articles (subject to
FDI guidelines)
Funding may be through equity, other forms of permitted capital infusion or
internal accruals
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Foreign Direct Investments
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Foreign investment
into India
Foreign Direct
Investment (FDI)
Foreign Venture
Capital Investor(FVCI)
Foreign
Institutional
Investor (FII)
Automatic route Approval route
Key exchange control regulations
Portfolio
Investment Scheme
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Foreign Direct Investment
Foreign Direct Investment
No prior permission
required.
The only requirement is to
inform the RBI within 30
days of inflow/ issue of
shares
This route covers
- Investment within sectoral
caps listed in the FDI policy- Sectors that are not
prohibited and for which
sectoral caps are not
specified
Automatic Route
Prior government approval
is needed (from FIPB)
The approval required for FDI
in the following cases:
Where the foreign investorhas an existing joint venture
or technology transfer/
trademark agreement in the
same field
Proposals for foreign equity
beyond 24% in the small
scale industry reserved
sector
Proposals outside sectoral
caps
Approval Route
Foreign investment is not
permitted in companies
engaged in sectors such as
Retail trading (except
single branded retail)
Agriculture (permitted
with exception)
Lottery business
Atomic Energy.
Prohibited Sectors
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Portfolio Investment Scheme
FIIs registered with SEBI eligible to purchase shares & convertible debentures
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Investment in an Indian Company not exceed 10% of the total paid up capital or
10% of the paid up value of the each series CCDs issued
Total holding of FIIs not exceed 24% of the paid up capital / paid up value of each
series of debentures
NRIs can purchase upto 5% of the paid up capital of the ICo. Shares
Total investment of all NRIs in a ICo. to not exceed 10% / 24% of paid up capital
Prohibition on investments in shares of:
Asset Reconstruction company
Nidhi company / Chit Fund company
Agricultural / plantation activities
Real estate business* / construction of farm houses Trading in Transferable Development Rights*Real estate to exclude construction of housing / commercial premises, educational institutions, recreational facilities, city
and regional level infrastructure, townships.
Caution List 2% below the sectoral cap; Ban List reaches the sectoral cap
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Foreign Venture Capital Investor
IVCU an unlisted company incorporated in India which is not engaged in an activity under the negative list specified by SEBI
VCF - a fund established in the form of a trust, a company including a body corporate and registered with SEBI which has a
dedicated pool of capital raised in a manner specified under the said Regulations and which invests in Venture Capital
Undertakings in accordance with the said Regulations.
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FVCI
VCU
VCF VCU
Investments in : Equity / Equity
Linked instruments
Debt / debt
instruments
Debentures
Price to be mutually
acceptable by the
buyer & seller
Investment can be made with specific approval from RBI
By way of
Initial Public Offer
or;
Private placement
in units of schemes
/ funds set up by a
VCF.
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Fema and ExchangeControl Regulations
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Funding for the investment
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Equity Shares / Preference shares / CCDs
Investments can be made upto FDI limit prescribed
- Government approval in case of investment
exceeding sectoral cap or conversion of ECB /
royalty / lump sum fee into shares
Rate of dividend for preference shares not
exceed 300 basis points over PLR of SBI as on
board meeting date
Shares / CCDs to be issued within 180 days from
the receipt of inward remittance
Pricing guidelines applicable
- Listed company sharesAs per SEBI guidelines
- Unlisted company sharesAt fair value as per
CCI guidelines
- Conversion of royalty / lump sum fee / ECB
amount due for payment
External commercial Borrowing (ECB)
Eligible lenders International banks , Foreign
equity holder
Maximum amount USD 500 mn per company per
year
Minimum maturity period 3 to 5 years with all-in-
cost ceiling of 300 basis points (6 months over
LIBOR)
End-use restrictions exist for foreign currencyborrowing
- Working capital
- General corporate purposes
- Repayment of existing rupee loans
- On-lending to another entity
- Investment in capital market
- Acquiring a company in India
Issuance of guarantee, etc. relating to ECB by
banks, financial institutions and NBFC not
permitted
Prepayment up to USD 200 Mio permitted, subject
to certain conditions being satisfied
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Acquisition of shares
Acquisition of
Right shares
The overall issue of shares to the nonresidents does not exceed the sectoral
caps.
Offer price of the right shares to the non residents is not lower than the offer
price made to resident shareholders
Merger /Demerger /
Amalgamation
Shares are acquired pursuant to a Court approved scheme of merger / demerger
Overall percentage of shares held by the non residents does not exceed the
sectoral caps
Transferor / Transferee / New Co does not engage in agriculture, plantation, real
estate business or trading in TDRs
ADR / GDR
I Co. can issue rupee denominated shares to the depository for issuing ADR /GDR
I Co. is eligible to issue ADR / GDR or has obtained approval from MoF
I Co. is not otherwise ineligible to issue shares to persons resident outside India
ADR / GDR to be issued at a decided price in consultation with Lead Manager /
as per Pricing Guidelines
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Transfer of Shares
Transfer by way of gift requires prior RBI
approval
Transfer by way of sale of shares does not
require prior Government / RBI approval,
subject to:
I Co. whose shares are transferred is notengaged in rendering financial services;
Transfer does not fall within the purview
of SEBI (Substantial Acquisition of
Shares and Takeovers) Regulation, 1997;
and
Pricing guidelines, documentation andreporting requirements are adhered to
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No prior permission of RBI required
Pricing guidelines, documentation and
reporting requirements are adhered to
Resident to Non - resident PROI to PRI
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Press Notes 2, 3 & 4(2009 series)
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Press Note No 2 Guidelines for calculating total foreign
investment
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A Co.
B Co.
India
Outside India
Direct Investment
A Co.
B Co.
India
Outside India
Indirect Investment
C Co.
I Co.
Total foreign investment = Direct investment + Indirect investment
Owned & control
Owned / control
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Press Note No 2 Guidelines for calculating total foreign
investment
Exception
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A Co.
B Co.
India
Outside India
C Co.
I Co.75%
100%
75% counted asIndirect Foreign
Investment
Clarified : The downstream investment of a 100% owned subsidiary of the holding company is akin to
investment made by the holding company and the downstream investment should be a mirror image of the
holding company.
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Press Note No 2 Guidelines for calculating total foreign
investment
Additional Conditions:
Details of ownership and control to be furnished to the GoI at the time of seeking approval
In sector / activity requiring government approval inter-se agreement between the
shareholders to be informed to the approving authority
In sectors attracting sectoral caps balance equity to be held by resident Indian citizens &
Indian companies
In I&B and Defence sector the company to be owned and controlled by resident Indian
citizens and Indian companies
At least 51% of the total equity to be held by largest Indian shareholder.
Individual shareholder individual, relative, company / group of companies where the
individual shareholder / HUF has management & controlling interest
Indian company Indian company and the group of Indian companies under the same
management and ownership control
If the beneficial interest is held by a non resident entity even though investment is made
by resident Indian citizen, the same to be treated as foreign investment
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Press Note No. 3 Guidelines for transfer of ownership or
control from Indian citizens to non resident entities
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Applicable to
Applicable
when
Sectors with caps, including
Defence production, air transport services,
ground handling services, asset reconstruction companies,
private sector banking, broadcasting, commodity exchanges,
credit information companies, insurance, print media,
telecommunications and satellites
Indian company is being established with foreign investment and
is owned or controlled by non resident entity; or
The control or ownership of existing Indian company currently
owned or controlled by resident Indian citizens and Indian
companies is being transferred / passed to non resident entity
through amalgamation, merger or acquisition
Investment requires Government approval / FIPB approval
Not applicable to sectors / activities where 100% FDI is allowed
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Press Note No 4 Clarificatory guidelines on downstream
investment by Indian companies
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OperatingCompanies
To comply with relevant sectoral conditions
Operating
cum
investingcompanies
To comply with relevant sectoral conditions
Companies in which downstream investment is made to comply with
relevant sectoral conditions
Investing
companies
Require prior Government / FIPB approval, regardless of the amount or
extent of foreign investment
Companies in which downstream investment is made to comply with
relevant sectoral conditions
Infusion of foreign investment into companies without any operations / downstream
investments require government / FIPB approval
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Press Note No 4 Clarificatory guidelines on downstream
investment by Indian companies
Conditions for downstream investments by operating cum investment
companies and investing companies:
To notify SIA, DIPP and FIPB of its downstream investment within 30 days of
such investment
Equity investment in existing Indian company to be duly supported by Boardresolution
Issue / transfer / pricing / valuation of shares to be in accordance with
applicable SEBI / RBI guidelines
Investing companies to invest from funds outside India and not leverage funds
from domestic market
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Direct Tax Implications
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Typical Transaction Structures
Particulars Amount (INR)
Taxable Income 100
Less: Corporate Tax on
same
(33.99)
Profit after tax 66.01
Less: Transfer to
reserves
(6.60)
Profit available for
distribution
59.41
Less: Dividend
Distribution tax
(16.995%)
(8.63)
Dividend distributed to
shareholders
50.77
Direct
Investment
Outside India
India
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Typical Transaction Structures
Tax efficient
jurisdictions
- Mauritius- Cyprus
- Netherlands
- Singapore
US, UK, Australia
India
Equity/ Debt Funding
Indirect
Investment
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Nature of the income stream Tax rates
Dividend DDT @ 17%
Interest WHT can be as high as 42.23%
Royalty (trademarks & brand name) WHT @ 10.56%
Fees for technical services WHT @ 10.56%Management Fees WHT @ 10.56%
Capital gains WHT can be as high as 42.23%
Income streams Tax perspective
Pay outs to be at arms length
subject to transfer pricing study
Rates are as per domestic tax laws treaty relief generally available
DDT - Dividend distribution tax
WHT Withholding tax
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Tax Treaty Provisions
Indian Government has entered into agreement (Double Taxation
Avoidance Agreement/ Treaty Agreements) with Governments of
various other countries/contracting state
Treaties often provide lower tax rates and exemptions in addition
to those available under the domestic tax provisions
A non-resident may choose to be governed by the domestic tax
provisions or provisions under the treaty whichever are more
beneficial
A person is entitled to claim application of treaty provisions only ifhe is a tax resident of either of the country/contracting state.
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Jurisdictions
Income streams
Mauritius Cyprus Singapore# Netherlands
Dividend Tax exempt DDT @16.995% is paid by Indian Company
Capital gains Not taxable Not taxable Not taxable Not taxable*
Interest 20%/ 40%** 10% 15% 10%
Royalty 10%** 10 %** 10% 10%
# Subject to fulfillment of anti abuse provisions* In certain cases
** Plus surcharge and education cess as applicable
Taxation under tax treaty
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Cash Repatriation - scenarios:
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Cash Repatriation -
scenarios
Dividend Interest
Royalty for
use of trademark
Fees for
managerialservices
Interest on fully and compulsorily convertible debt, Royalty for use of trademark and
fees for managerial services can be paid independent of shareholding pattern.
Royalty for use of trademark would be payable to the entity owning the trademark. Fees for managerial services would be payable to the entity providing the services.
Key elements Transfer pricing regulations (including arms length principle and
documentation) and overall tax cost.
Cash Repatriation Current Account transactions
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Exit strategies
Buyback
Capital Reduction
Sale of shares
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Case study
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Investment - Equity
Co X
WOSEquity
shares
Dividends
CO X
WOS
Equity &
preference
shares
Redemption of
preference
shares +buyback of
bonus equity
shares
Investment - Equity and Preference
Cash Repatriation Case study
Co X proposes to invest in a wholly owned subsidiary (WOS)
in India
Co X would invest in equity share capital of WOS in India
Return on equity capital in the form of dividend is subject to
payment of dividend distribution tax (DDT) in India
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02/5/
2010
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Particulars Investment in WOS
As equity As equity &preference
Profits available for distribution
with WOS
(a) 100 100
DDT @ 16.995%1 (b) = (a) x 17/117 14.52 NIL
Dividend/redemption proceeds (c) = (a) - (b) 85.48 100
Illustration
1 Including surcharge and education cess
Cash Repatriation Case study
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QUESTIONS??
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Thankyou