investments in india state fo art and law
TRANSCRIPT
© Nishith Desai Associates1
Investments in India: State of the Art and Law
Nishith M Desai Nishith Desai Associates
Legal and Tax Counseling WorldwideMumbai Silicon Valley Bangalore Singapore
June 22, 2007
© Nishith Desai Associates2
Are we headed towards a
‘Digital Divide’?
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Worlds largest democracy GDP growth rate for 2006-07:
9.2% Rising young population Parliamentary form of
Government World-class recognition in IT and
bio- technology Services sector contributing
approximately 55.1% to GDP Largest English speaking nation
in the world India-China, rising powers in Asia India could emerge as the
world's fastest growing economy by 2020
Bold and independent judiciary
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Science of investments into
India
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USA
India
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Art of investments into India
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Key Considerations
Tax
LawStrategy
Environment
Operations
Exchange Control
Corporate
Domestic Treaty
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How do we Invest?
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Investment Regime
Foreign Direct Investor (FDI)
Foreign Institutional Investor (FII)
Foreign Venture Capital Investor (FVCI)
Non-resident Indian Investor (NRI)
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FDI
– 100% foreign investment permitted in almost 95% sectors on automatic basis except:
Banking (74%) Telecom services (74%), Civil Aviation (49%), Insurance (26%), etc.
– Certain sectors where FDI is prohibited: Atomic Energy, Lottery business, Gambling and Betting
– Certain sectors where there are minimum capitalisation requirements:
Non-banking financial services activity (19 activities – fee based and fund based)
Real estate construction and development projects
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Investment Management Agreement
Cayman Co Delaware LLC
U.S. taxable investors
Investment SPV
Investment SPV / JV
FDI / FVCI Compliant Investments
Investment Manager
Mauritius
U.S. tax-exempt investors &Non-U.S. investors
Cayman Feeder Delaware Feeder
Mauritius Master Fund MASTER FUND (FDI)
India
InvestmentManager
Investment AdvisorIndian
Advisor
100%
Advisory Agreement
100%
100%
100% 100%
Management Fees / Carry
FVCI Subsidiary
100%
Cyprus-based subsidiary (Debt)
Cyprus
STRUCTURING… FDI/FVCI
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Types of Instruments
Compulsorily Convertible - FDI
Equity
Preference Shares
Compulsorily Convertible - FDI
Optionally Convertible - ECB*
Non – Convertible - ECB
Debentures
Optionally Convertible - ECB Non – Convertible - ECB
*ECB – External Commercial Borrowings
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FII Primarily used for investing into public securities
Holding up to 10% of the company Aggregate holding capped at 24% / sectoral caps
Investment in listed and unlisted securities
No co-mingling of proprietary and client funds
Types of sub-accounts – broad based, proprietary, foreign corporation, foreign individual
FIIs cannot issue participatory notes to unregulated entities*
* The SEBI has issued a circular stating that the following entities are deemed to be regulated entities:
An entity incorporated in a jurisdiction that requires the constitutional documents with a regulatory authority, an entity that is regulated or supervised by a central bank, a security or futures commission, is a member of a security or futures commission or whose investment advisory function is managed by a regulated entity.
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NRI Regime
Press Note 2 (2005) restrictions on real estate not applicable to NRI’s
NRI’s can acquire immoveable property in India
No Restrictions on transfer of shares by an NRI
NRI and NRI owned companies (OCB’s) registered with the RBI cannot invest through the FII route
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What are entity options in India?
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Entity Options
Foreign Investor
Investment
Unincorporated entity Incorporated entity
Company
India
Project Office
Branch Office
Offshore Jurisdictions
TrustLiaison Office
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Entity Options; New Vehicles
India is proposing to introduce a Limited Liability Partnership regime. The LLP legislation is
currently in draft form.
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Taxes -Is India
backtracking?
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Domestic company : 33.99%;
Foreign company : 42.23%
Dividend distribution tax : 16.995%
Capital gains tax on
exit or restructuring : 0% to 42.23% (long/short-term)
Withholding taxes : nagging problems
Minimum Alternate Tax :Domestic companies: raised from 11.22% to 11.33%
Foreign companies: raised from 10.46% to 10.558%
Fringe Benefits Tax : 31.37% on specified value of certain fringe
benefits
Indian Tax Overview
Disallowance of expenses+
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49.31= Dividends distributed to Shareholder
10.10Less: Dividend Distribution Tax (16.995%)
59.41= Profits available for distribution
6.60Less: Transfer to reserve (10% of PAT)
66.01= Profits After Tax (“PAT”)
33.99Less: Corporate Tax on the same (33.99%)
100Taxable income
Amt (US$)Particulars
Flow of Dividends
Tax Treatment in India
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49.31= Dividends distributed to Shareholder
10.10Less: Dividend Distribution Tax (16.995%)
59.41= Profits available for distribution
6.60Less: Transfer to reserve (10% of PAT)
66.01= Profits After Tax (“PAT”)
33.99Less: Corporate Tax on the same (33.99%)
100Taxable income
Amt (US$)Particulars
Flow of Dividends to US
32.05= Profits After Tax
17.26Less: US Corporate Tax on the same (35%)#
49.31Taxable income
Amt (US$)Particulars
# Underlying tax credit may not be available in the US for US resident individuals and corporate shareholder holding less than 10% of the voting stock of the Indian company
Tax Treatment in India
Tax Treatment in the US
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How do you mitigate the Indian tax impact?
Push Debt into Indian Company
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Can you push Debt into Indian company?
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No! Unless you comply with
External Commercial Borrowings Guidelines
under Exchange Control Laws
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Eligible Borrower – Any company, except an NBFC
Eligible Lender – 25% Equity Shareholder or any Bank, etc.
Rate of interest – 150/250 basis point over 6 month LIBOR, depending on the tenure
End Use restrictions – cannot be used for working capital, on lending, towards real estate (except for development of industrial park, SEZ etc.)
Borrowings From Abroad
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What about tax on interest?
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On monies lent in Foreign currency – 21.115%
On Foreign Currency Convertible Bonds – 10.558%
On monies lent in Indian Rupees - 42.23%
Tax Rates on Interest on Foreign Companies
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How do you reduce tax on interest?
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Consider CyprusTax Rate reduced to 10%
Use Cyprus for equity too?
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Capital Gains
30/40% STCG
10%Listed shares off the stock exchange: LTCG
0%Listed shares on the stock exchange#: LTCG
30/40% STCG**
10% STCG
20% Unlisted shares: LTCG*
Tax^ Type of Gains
^These rates are exclusive of the currently applicable surcharge on tax and education cess
* Long term capital gains means gains on sale of shares held for a period of more than 12 months
** Short term capital gains means gains on sale of shares held for a period of 12 months or less
# Sale on the stock exchange shall attract Security Transaction Tax at applicable rates
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Potential double taxation of capital gains tax in the US due to systemic differences.... Credit for Indian tax paid may not be available in the US
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How do you avoid double taxation on Capital Gains?
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USE:
MauritiusCyprus (?)Singapore
Or Netherlands
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Mauritius
USA
UK
Netherlands
Japan
Germany
Singapore
France
South Korea
Switzerland
0 20000 40000 60000 80000 100000
US$ in mn
Series1
Flow of Funds into India**dipp.nic.in/fdi_statistics/india_fdi_dec_2006.pdf
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Venture Capital Funds
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Alternative 1: Pure Domestic and Offshore Structures
TAX STRUCTURING…
Fund (VCF)Fund (VCF)
VCUVCU
TrusteeTrustee ManagerManager
VCUVCU AdvisorAdvisor
Offshore Investors
Feeder Fund
Master FundMaster Fund
Tax
Haven
Treaty
Jurisdiction
India
Offshore Jurisdictions
ManagerManager
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Alternative 2: Unified Structure
VCUVCU
ManagerManagerVCFVCF
TrusteeTrustee
Offshore Investors
FundFund
Domestic Investors
Treaty Jurisdiction
Offshore Jurisdictions
India
TAX STRUCTURING…
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Alternative 3: Co-investment Structure
Advisor /ManagerAdvisor /Manager
VCFVCF
TrusteeTrustee
Domestic Investors
ManagerManagerFundFund
VCUVCU
Offshore Investors
India
Treaty Jurisdiction
Offshore Jurisdictions
TAX STRUCTURING…
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How are Earn-outs taxed?
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Taxation of Earn – Outs
Acquiring Co
Target Founder-employees
ACQUISITION
Earn out paymentsPurchase Price
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Taxation of Earn Outs
Surge in M & As - ‘Earn outs’ becoming a popular mode of making payment
Complex issues relating to taxation
– Capital Gains taxed in the year of transfer of asset
• Whether contingent / un-quantified capital gains are taxable in the year of transfer?
• How such tax will be payable?
– Whether Earn outs can be considered to be salary? (AAR ruling in the case of In Re Anurag Jain)
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Taxation of Earn Outs…
– In Re Anurag Jain
Share Purchase Agreement - Consideration in form of upfront payment + Earn out (paid by Acquirer)
Earn out linked to continued employment + EBITDA of the company
Held: Earn out has a direct nexus with the employment being rendered and would be characterised as salary
Analysis: – No Employer- Employee relationship between the Acquirer
and key managerial personnel– Earn out should be taxable as “Other Income” but not
salary
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How do you flip a US Parent with an Indian
subsidiary?
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Flipping a structure: Inversion
US Parent
India Sub
US
INDIA
100%
Founders Employees
VCsOthers
Current structure
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Flipping a structure: Inversion
Significant US Tax Impact
US Sub
India Parent
US
INDIA
100%
Founders Employee
s
VCsOther
s
After Flip