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International Tax International Tax Conference, 2009
International tax structuring – Investing in India
Pranav Sayta
December 5, 2009
Foreign investments in India*
20
30
40
50
For
eign
inve
stm
ent i
n bi
llion
US
D
Direct Investment Portfolio Investment
Page 2 International Tax Conference, 2009 – Investing in India
** Up to Aug’09 – extrapolated for 12 months* Source: RBI website
-20
-10
0
10
For
eign
inve
stm
ent i
n bi
llion
US
D
Year
Key considerations
Regulatory framework
governing the investment
Inbound investments
Page 3 International Tax Conference, 2009 – Investing in India
Key considerations
Return on investment /
profit repatriation
Efficiency in case of future
exit
Forms of business entities in IndiaForeign Investor
Unincorporated entities Incorporated entities
Branch OfficeBranch OfficeProject OfficeProject OfficeLiaison OfficeLiaison Office SubsidiarySubsidiaryJoint VenturesJoint Ventures
Partnerships
LLPLLPUnlimited Unlimited
Page 4 International Tax Conference, 2009 – Investing in India
Branch OfficeBranch OfficeProject OfficeProject OfficeLiaison OfficeLiaison Office SubsidiarySubsidiaryJoint VenturesJoint Ventures LLPLLPUnlimited
partnershipUnlimited
partnership
Preferred form of business entity
► Operating flexibilities
► Tax efficiencies
► Regulatory
compliances
► Efficiency in capital raising
Relevance of choice of business entity
Investment instrument
Equity / ADRs / GRDs
Foreign investor
ECBFCCBs / FCEBs
Hybrid instruments Debt
Optionally convertible pref shares / debentures
Compulsorily convertible pref shares / debentures
Equity instruments
Page 5 International Tax Conference, 2009 – Investing in India
No end use restriction Specified end use restrictions
► Tax arbitrage may be available on interest payouts► No tax break on payment of dividends
► Commercial objectives► Regulatory constraints► Tax considerations
Relevance of choice of instrument
Typical inbound investment structure
FOREIGN INVESTOR
In tax favourable Cyprus
Mauritius
Typical inbound jurisdictions Typical inbound struct ure
Page 6 International Tax Conference, 2009 – Investing in India
INDIAN COMPANY
INTERMEDIATE HOLDING COMPANY
INTERMEDIATE HOLDING COMPANY
In tax favourable jurisdiction
Singapore
Netherlands
Treaty taxation for typical income streams
Income streams Mauritius Cyprus Singapore # Netherlands
Dividends Tax exempt – DDT of 16.995% paid by Indian company
Capital gains Not taxable Not taxable Not taxable Not taxable*
Interest 20%/ 40%** 10% 15% 10%
Page 7 International Tax Conference, 2009 – Investing in India
Royalty 10%** 10%** 10% 10%
Fees for technical services
10%** 10% 10% 10%
# Subject to fulfillment of conditions (LOB)* In certain cases** Surcharge and educational cess additionally appl icable
Case study – Inbound investment through IHCs
Facts and objectives
► Foreign investor (InvestorCo) intends to invest in an Indian company (IndCo) and get desired stake
► InvestorCo intends to receive a steady flow of income from IndCo
► InvestorCo desires to structure investment in IndCo considering:► Tax efficiency of recurring income streams
In order to reduce overall tax cost, investor could consider the structure depicted below
MCo
InvestorCo
100%Mauritius
Dividend
Facts and challenges
Page 9 International Tax Conference, 2009 – Investing in India
Tax efficiency of recurring income streams
► Tax efficiency of future divestment
► Minimum regulatory hurdlesCypCo
IndCo
100%Cyprus
FCDsIndia
Interest
Dividend
Key challenges
► Distribution of profits by way of dividends entails high tax cost:► In India – DDT at 17%
► In the US – Corporate tax at 30%-35%
► Achieving desired shareholding
► FCDs to be convertible into equity shares at a futu re date
► FCDs to carry arm’s length interest
CypCo to infuse FCDs in IndCo
Regular funds flow to investors
► Investor Co to MCo – Equity capital
► MCo to CypCo – Equity capital
InvestorCo to invest into IndCo through chain of ho lding companiesFlexibility to raise funds
/ make further investments
Key mechanics and implications
Page 10 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
► Interest to be tax deductible expense for IndCo
► Total tax cost of repatriation – 10%► IndCo to withhold tax at 10%
► CypCo corporate tax at 10%
► CypCo eligible for credit of tax paid in India
IndCo to pay interest to CypCo till conversion of FC Ds
Funds repatriated out of India at 10%
► Additional tax in Mauritius at 3% (presuming MCo ho lds GBL 1 licence)
► Possible to reduce this cost to nil► MCo structured as GBL2 company
► Structuring investment in CypCo through redeemable preference shares
If required, CypCo to repatriate interest received t o MCo by way of dividends
Flexibility to accumulate funds at MCo / CypCo level
Compliance with FEMA pricing guidelines
FCDs to be converted into equity shares
Obtaining pre agreed
Key mechanics and implications
Page 11 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
► Liquidation not taxable in Cyprus / Mauritius
► MCo should not be taxable in India, presuming MCo i s eligible for treaty benefits
Going forward, CypCo may be liquidated, if investor does not intend to have a holding company at Cyprus
Structure clean up
► Compliance with FEMA pricing guidelines► At the time of infusion or conversion
Obtaining pre agreed stake
► CypCo level – by selling shares of IndCo
► MCo level – by selling shares of CypCo
► Capital gains tax should be exempt under treaty
Future divestments could be at
Tax efficient exit strategy
Key mechanics and implications
Page 12 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
Cash repatriation strategies
Cash repatriation – Broad options
Interest/ Royalty/Fees/
Recharges
Dividends
Capital reduction
Repatriation of cash
Page 14 International Tax Conference, 2009 – Investing in India
Acquisition of group co stake
Buy-back of shares
Outbound Investment
of cash to Parent
Cash repatriation – Specific cases
Share buy-back – Multiple financial years
Share buy-back – Classical approach
Share drop down and merger
Page 15 International Tax Conference, 2009 – Investing in India
Share buy-back – Multiple financial years
Share drop down and merger
FCo
IndCo1
Brief description
► FCo has two WOSs in India, ICo1 and ICo2
► ICo2 has surplus cash
► FCo transfers its shareholding in ICo1 to ICo2 at fair value for cash
► Going forward, ICo1 could merge with ICo2
► Commercial considerations / business purpose
Key Mechanics
IndCo2
Pay
men
t of c
ash
Page 16 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
► Commercial considerations / business purpose to be demonstrated
Key implications
► Capital gains tax on transfer of shares of ICo1 to ICo2
► May not be taxed if FCo is tax resident of a tax favourable jurisdiction
Mer
ger
Transfer of shares
IndCo1
Share buy-back – Classical approach
MCO
Parent Co
Brief description
► IndCo is held by a Mauritius company, MCo
► IndCo undertakes share buyback using free reserves
Key benefits
► Release of cash without tax charge
Key Mechanics
Page 17 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
MCO
IndCo
Con
side
ratio
n
Buy
-bac
k
► No DDT
► No capital gains tax
Key limitation
► Limitation on amount to be repatriated
► Corporate laws restriction – 25% of net worth
Share buy-back – Multiple financial years
MCO
Parent Co
Brief description
► IndCo is held by a Mauritius company, MCo
► IndCo adopts a financial year (FY) of 3 months, instead of current 12 month period (say, Jan-Mar, Apr-Jun, etc.)
► IndCo undertakes share buyback in each of the FY (of 3 months) using free reserves
► CRR created on buy back can be issued as bonus shares
Key Mechanics
Page 18 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
MCO
IndCo
Con
side
ratio
n
Buy
-bac
k
bonus shares
Key implications / benefits
► Company law permits change in FY to a period which is less than 12 months
► Company law restrictions on buy back (25% of paid up capital) applicable for each FY
► Buy back treated as capital gains, not taxable under India-Mauritius tax treaty
► Multiple audits and AGMs
Tax planning through LLPs
Inbound investment regulations for LLPs
► Presently FEMA / FDI policy is yet to recognize LLP as an entity for purpose of inbound investment
► Prior approval from Government of India / RBI required for foreign investment in LLP
Direct or indirect foreign investment
by foreign entity currently not
Assuming that, going forward, foreign investments in LLPs are liberalized, ensuing slides
Page 20 International Tax Conference, 2009 – Investing in India
by foreign entity currently not
envisaged under inbound investment
regulations/ FDI Policy
forward, foreign investments in LLPs are liberalized, ensuing slides discuss few planning avenues using LLPs
MAT / DDT planning – Greenfield inbound investment
Brief description
► FCo to setup LLP in India (India LLP)
► FCo is partner in LLP
► LLP earns and distributes profits to FCo
FCo
Pro
fit d
istr
ibut
ion
Key Mechanics
Page 21 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
Key benefits
► No MAT
► No DDT
► Profits exempt in hands of partners of LLP
India LLP
Pro
fit d
istr
ibut
ion
MAT planning – existing business
Brief description
► IndCo is WOS of FCo
► IndCo transfers its tax holiday business (STP/ EOU Unit) to India LLP
► IndCo and FCo are partners in India LLP
Key benefits
Profits earned by LLP eligible for tax
FCo
IndCo
Key Mechanics
STP Unit
Pro
fit d
istr
ibut
ion
Page 22 International taxation conference, 2009 – Investing in IndiaDecember 5, 2009
► Profits earned by LLP eligible for tax holiday
► MAT not applicable to LLP
► Distribution by LLP tax exempt in the hands of partners
Key challenges
► Eligibility of transferee / successor LLP to claim deduction under incentive provision
India LLP
Tran
sfer
to L
LP
STP Unit
STP Unit
Pro
fit d
istr
ibut
ion
Thank youThis presentation is intended to provide only a gen eral outline of the subjects This presentation is intended to provide only a gen eral outline of the subjects covered and to form the basis for future discussion s. It was written at the date specified and has not been reviewed or updated sinc e to take account of tax changes etc. that have taken place in the interim. The presentation should not be regarded as comprehensive or sufficient for making decisions, nor should it be used in place of professional advice, which should always have regard for the particular commercial facts and circumstances. Acco rdingly, Ernst & Young Private Ltd. accepts no responsibility for loss ari sing from any action taken or not taken by anyone by relying on this presentation