22nd ANNUAL SJSU/TEI HIGH TECHNOLOGY INSTITUTE
TAX IMPLICATIONS
OF
DOING BUSINESS IN INDIA
NOVEMBER 6, 2006
Nishith Desai
NISHITH DESAI ASSOCIATES
David Gill
Gagan Malik
ERNST & YOUNG LLP
Barton Bassett
FENWICK & WEST LLP
1
Agenda
 Overview of Economy and Key Regulations
 Legal Entity Comparison
 Indian Tax Regime
Refreshment Break
 Structuring Issues and Opportunities
2
Overview of Economy and
Key Regulations
3
INDIA ADVANTAGE
 GDP growth rate for 2005-06: 8.1%
 Inflation rate for 2005-06: 4.1%
 Rising young population
 Parliamentary form of Government
 Worlds largest democracy
 Worlds 4th largest economy
 World-class recognition in IT and biotechnology
 Services sector contributing 54% 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
4
KEY CONSIDERATIONS
Tax
Corporate
Exchange Control
5
KEY REGULATIONS
Income tax
Act
Investments
Exchange
Control
laws
6
FOREIGN INVESTMENT REGULATIONS
Foreign Direct Investment (FDI)
Foreign Institutional Investment(FII)
Foreign Venture Capital Investment (FVCI)
Non-Resident Indian Investment (NRI)
7
FDI REGIME
 100% foreign investment permitted in most sectors on automatic
basis except:
 Banking (74%)
 Telecom services (74%)
 Civil Aviation (49%)
 Insurance (49%), etc.
 Retail trading – Single Brand up to 51% with prior approval
 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 (certain activities – fee based and
fund based)
 Real estate construction and development projects
8
ENTRY AND EXIT PRICING

Entry Pricing: Price at which a non-resident can subscribe into or purchase shares of an Indian company

Exit Pricing: Price at which a non-resident can sell shares of an Indian company to an Indian resident

Pricing Restrictions
 Exchange Control Laws

RBI Pricing guidelines applicable for transfer of shares by a non-resident to an Indian resident and transfer of
shares by an Indian resident to a non-resident
 In case of unlisted companies, valuation shall be done in accordance with the guidelines issued by the erstwhile
Controller of Capital Issues and based on CA certificate or certificate issued by a merchant banker
 External Commercial Borrowings: end use restrictions, terms, approvals, etc.
 Corporate Laws

Allotment of shares on preferential basis shall be as per the requirements of the Companies Act, 1956, which will
require special resolution in case of a public limited company
 Securities Laws

In case of listed companies, valuation of shares issued on a preferential basis shall be as per the SEBI guidelines
 Tax Laws

Pricing of international transactions pertaining to transfer of shares to be at an arm’s length price
9
FLOW OF INVESTMENT INTO INDIA
10
Legal Entity Considerations
11
ENTITY OPTIONS
Foreign Investor
Offshore Jurisdictions
Investment
Unincorporated entity
LO
PO
BO
India
Incorporated entity
UJV
Trust
P’ship
Company
12
ENTITY OPTIONS
Taxation of Entities
 Liaison Office: Taxed at 41.82% only if the foreign company has a BC/ PE in India
 Project Office: Taxed at 41.82% only if the foreign company has a BC/ PE in India
 Branch Office: Taxed at 41.82% since BO would result in BC/ PE in India
 Unincorporated Joint Venture: May be taxed as “Association of Persons” at 33.66%
 Trust: May be taxed at 33.66% or may get a pass-through status
 Partnership: Partnership is usually taxed at the rate of 33.66%
 Company: Company is taxed at the rate of 33.66%. DDT at 14.025%
13
PARTNERSHIPS
 Only General Partnerships allowed and structures such as LLPs or LPs not currently
allowed in India
 Partnerships are taxed at the rate of 33.66% and are not pass-through entities under
the Indian tax laws if certain conditions are satisfied
 Once the Partnership is taxed, the share of profit derived by the partners is exempt from
tax and hence only one level of taxation
 If certain conditions are not satisfied, the partnership is considered as an “Association of
Persons” and the partners will be taxed at the rate of 33.66%
 Partnerships are not subject to Minimum Alternate Tax applicable to companies
14
TRUSTS
 Typically used for making Venture Capital / Private Equity investments
 Trusts may be taxed at the rate of 33.66% or could be pass-through entities under the
Indian tax laws if certain conditions are satisfied
 Registered trusts (i.e. Venture Capital Funds registered with SEBI) are accorded passthrough status for tax purposes and the investors are taxed when the income is
distributed by the registered trusts
 Unregistered trusts are usually taxed at the rate of 33.66% if the share of the
beneficiaries are indeterminate or if the trust is irrevocable
 Unregistered trusts may also be accorded pass-through status if the share of the
beneficiaries are determinate or if the trust is revocable
 Trusts are not subject to Minimum Alternate Tax applicable to companies
15
Deemed Public Company:
Check-the-Box Issue
 Under prior law, section 43A treated a private limited company as a deemed
public company under certain circumstances (U.S. check-the-box regulations
treated as non-per se)
 Current law treats an Indian private limited company that is a subsidiary of an
Indian public company as a deemed public company (> 50% ownership by
Indian public shareholder)
 Lack of certainty as to whether per se or non-per se for U.S. tax purposes
(since section 43A withdrawn, U.S. regulation no longer directly relevant)
 Informal discussions with IRS
16
Indian Tax Regime
17
INDIAN TAX REGIME
DIRECT TAXES: OVERVIEW

Domestic company : 33.66%; Foreign company : 41.82%

Dividend distribution tax : 14.025%

Capital gains tax : on exit or restructuring

Withholding taxes: nagging problems
The above taxes could increase on account of:

Minimum Alternate Tax : 10.46% on book profits

Fringe Benefits Tax : 33.66% on specified value of certain fringe
benefits provided to employees, payable by the employer

Transfer pricing : New regulations, strict penalties (up to 300% of the tax
sought to be evaded by way of concealment of income or furnishing of
inaccurate particulars), transfer pricing adjustments not covered by the tax
holiday

Business Connection : Tricky issues
The above taxes could decrease on account of:
 Use of tax incentives available under the local tax laws
 Use of tax treaties entered into by India with foreign countries
* These rates are inclusive of the applicable surcharge of 2.5% /10% on tax and education cess of 2%
18
INDIAN TAX REGIME…
FLOW OF DIVIDEND INCOME FROM INDIA
[1]
Particulars
Amt (US$)
Taxable income
100
Less: Corporate Tax on the same (33.66%)
33.66
= Profits After Tax
66.34
Less: Transfer to reserve (10% of PAT)[1]
6.63
= Profits available for distribution
59.71
Less: Dividend Distribution Tax (14.025%)
8.37
= Dividends distributed to Shareholder
51.34
As per the Indian Companies Act, up to 10% of Profits After Tax need to be transferred to reserves before an Indian company can declare dividends
19
INDIAN TAX REGIME
INDIRECT TAXES: OVERVIEW
LEVIES ON IMPORTS / EXPORTS
VALUE ADDED TAX
• Customs duty leviable on goods imported
into India
• VAT introduced in most Indian states from
April 1, 2005
• R&D cess imposed on payment made for
import of technology
• VAT implementation expected to
streamline multi point levies
• Certain tariff concessions on imports from
Singapore, Sri-Lanka, etc as a result of
free trade agreements
• Tax credit mechanism for VAT paid on
inputs against tax due on outputs
EXCISE DUTY
• Octroi / entry tax also levied in certain
states on purchases from other states
Indirect taxes
• Excise duty levied on manufacture
• Packing/re-packing, labeling / re- labeling
of certain products amount to manufacture
• Excise duty is payable on transaction
value i.e. usually sale price.
SERVICE TAX
• Payment of services tax at 12.24 % on
certain services availed
• Service Tax paid on input service is
available as credit to discharge either
service tax or excise duty liability of output
service and finished product respectively.
20
INDIAN TAX REGIME…
TAXATION OF CAPITAL GAINS
Type of gains
Tax^
Long term capital gains*: listed shares on the stock exchange#
0%
Long term capital gains: listed shares off the stock exchange
10%
Long term capital gains: unlisted shares
20%
Short term capital gains**: listed shares on the stock exchange#
10%
Short term capital gains: listed shares off the stock exchange
30/40%
Short term capital gains: unlisted shares
30/40%
* 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
^These rates are exclusive of the currently applicable surcharge on tax and education cess
# Sale on the stock exchange shall attract Security Transaction Tax at applicable rates
21
INDIAN TAX REGIME…
TAXATION OF CAPITAL GAINS: Treaty Considerations






USA (taxable in India as per domestic laws and tricky issues)
Cyprus (tax-exempt in India)
Singapore (tax-exempt in India subject to LOB conditions)
Netherlands (tax-exempt in India subject to certain conditions)
Mauritius (tax-exempt in India)
UAE (tax-exempt in India but tricky issues)
22
INDIAN TAX REGIME…
WITHHOLDING TAXES
Particulars
Exceptions
Royalty income
• Payable by Government
• Payable by resident
• Payable by non-resident
• If PE in India
• for the purposes of business carried on
outside India
• for making or earning any income from
any source outside India
Fees for technical Services
• Payable by Government
• Payable by resident
• Payable by non-resident
• If PE in India
• for the purposes of business carried on
outside India
• for making or earning any income from
any source outside India
Interest income
• Payable by government
• Payable by resident
• Payable by non-resident
• If PE in India / loan in INR
• debt incurred / monies borrowed and
used for purposes of business or
profession carried on outside India
• for making or earning any income from
any source outside India
Rate of
Tax
10/20%
(gross)
40%
(net)
10/20%
(gross)
40%
(net)
10/20%
(gross)
40%
(net)
23
INDIAN TAX REGIME…
WITHHOLDING TAXES: Treaty Considerations
 USA, UK and Singapore (narrow definition of “fees for
technical services”)
 Mauritius (no Article on “fees for technical services” and hence
exempt from tax in India in absence of a PE in India)
 Tax Havens (certain problems on payment made by a nonresident to another non-resident)
 Sweden and Israel (the Article pertaining to Royalty
excludes royalty paid for use of equipment from the definition of
Royalty)
24
INDIAN TAX REGIME…
FRINGE BENEFITS TAX
 Separate Chapter introduced to tax employee benefits where attribution to
employees is difficult
 Tax payable by employer at 30% (plus surcharge and education cess) on value
(as prescribed) of such benefits
 Tax not allowable as deduction to employer
 Separate provisions for advance tax, filing of return and assessment
ISSUES
 Position for foreign companies
 Availability of tax credit in home country for foreign companies
 Position of business expenses with no element of ‘personal benefit’
25
INDIAN TAX REGIME…
TRANSFER PRICING REGULATIONS





Introduced in 2001 for regulating prices at which the international transactions
between two related enterprises are undertaken
Applicable only to international transactions wherein at least one party is a nonresident of India unlike UK and US where transfer pricing is applicable even to
domestic transactions
Onerous documentation requirements prescribed under Rule 10D of the
Transfer Pricing Rules
All entities having an aggregate value of international transactions in a financial
year exceeding INR 15 crs (i.e. approx. US$ 3.3 mn) subject to compulsory
transfer pricing scrutiny by the Indian tax authorities
The following methods prescribed for benchmarking the international
transactions





Comparable Uncontrolled Price Method (“CUP”)
Cost Plus Method (“CPM”)
Resale Price Method (“RPM”)
Profit Split Method (“PSM”)
Transactional Net Margin Method (“TNMM”)
26
INDIAN TAX REGIME…
TRANSFER PRICING AUDITS
Revenue’s reactions
 Preference to CUP method
 Comparison with external data regarding charge-out rates
 Wide spread choice of TNMM questioned




 Basis of rejection of CPM / RPM questioned
Cost sharing arrangements challenged
Information asked for by the TPOs beyond Rule 10D documentation
requirements
Review of the assumptions made and benchmarks used for determination of
transaction prices (for e.g., in royalty transactions, benefits derived from the
technology questioned)
Global arrangements challenged if proper documentation not submitted
27
INDIAN TAX REGIME…
TRANSFER PRICING AUDITS
Issues
 Aggregation of transactions in applying TNMM
 Contract manufacturers
 Use of Foreign Comparables
 Use of secret comparables not available in public domain
 Use of loss-makers as comparables
 Cost allocations / reimbursements
28
INDIAN TAX REGIME…
TAX INCENTIVES RELEVANT FOR IT/ITES COMPANIES
 For Software Technology Park (“STP”) / Electronic Hardware Technology Park
(“EHTP”) – section 10A of Income-tax Act (“ITA”)
 For Units set up in Special Economic Zones (“SEZ”) – section 10AA of ITA
 For Export Oriented Units (“EOU”) – section 10B of ITA
 For companies undertaking exclusive R&D – section 80-IB(8A) of ITA
29
INDIAN TAX REGIME…
Software Technology Park
Special Economic Zone (SEZ)
Direct tax holiday
Direct tax holiday
 Eligibility conditions
 Eligibility conditions
 100% of export profits exempt
from tax
 Phased Income-tax Holiday for
15 years [100% for first 5 years
and 50% for next 5 years and
another 50% for next 5 years
subject to certain conditions]
 Sunset clause: March 31, 2009
Indirect tax benefits
Indirect tax benefits
 Customs duty
 Customs duty
 Sales tax
 Sales tax
 Stamp duty
 Stamp duty
 Other local taxes
 Other local taxes
Special Tax Holiday for 10 years for R&D Companies
30
INDIAN TAX REGIME…
SEZ - RECENT DEVELOPMENTS
Host of incentives proposed for SEZ developers and units under the SEZ Act and SEZ Rules
Frantic rush for setting-up SEZs and obtaining approvals – Cheap land, minimal taxes and
high anticipated returns on investment
150 formal approvals (18 notified) and 117 in-principle approvals given till date
More than 200 applications pending with Central Government
26 formal approvals and 19 in-principle approvals in Maharashtra
Finance ministry expects revenue losses of more than U.S. $20 billion. Suggestion to cap
number of SEZs at 150 and introduce stringent norms for developers and units
Commerce ministry expects significant gains to the Government on account of the additional
economic activity generated in the SEZs - SEZ scheme expected to create 500,000 jobs and
attract FDI of USD 5-6 bn by December 2007*
Cap of 150 SEZs removed--Government to review the matter once 75 SEZs are operational
*Press release dated September 1, 2006
31
INDIAN TAX REGIME…
SEZ approvals - formal
Punjab: Total – 5: IT SEZ - 2
Uttar Pradesh: Total – 6: IT SEZ -5
Haryana: Total – 8: IT SEZ - 5
Rajasthan: Total – 3: IT SEZ - 1
Gujarat: Total – 13: IT SEZ - NIL
West Bengal: Total –7: IT SEZ -6
Maharashtra: Total – 26: IT SEZ -11
Karnataka: Total – 19: IT SEZ -16
Andhra Pradesh: Total – 27: IT SEZ -17
Kerala: Total – 8: IT SEZ -5
Tamil Nadu: Total – 20: IT SEZ -17
Others: Total – 8 (Madhya Pradesh, Delhi, Goa,
Jharkhand, Pondicherry, Uttaranchal)
32
HOT ISSUES
 Characterization of income
 Royalties and fees for technical services
 Capital gains
 Permanent Establishment / Business Connection
33
LEGAL REMEDIES
Litigation process
under ITA
Supreme Court
High Court
Income Tax Appellate
Tribunal
Commissioner of
Income Tax (Appeals)
Authority for
Advance Ruling
• Special mechanism
under ITA
Advance Pricing
Agreements
Not yet available in
India
• Chairman – retired
judge of Supreme
Court
• Ruling is binding on
applicant and tax
authorities
• To be effective until
change in law /
facts
• No appeal against
ruling
Income Tax Officer
Time: 5-6 years
Time: 3-6 months
34
CASE LAW UPDATE
TAXATION OF SOFTWARE TRANSACTIONS
 Position gradually evolving in light of favorable rulings
 Lucent Technologies - Software bundled with H/W not royalty
 Samsung Electronics - Shrink-wrapped software imported by end-user
held as “sale” - relied on Supreme Court decision on Tata Consultancy
Services under Sales Tax law
 Sonata/ PSI Data Systems (2005) - Shrink-wrapped software imported
for re-sale by distributor held as “sale” and not royalty
 Motorola, Ericsson, Nokia (2005) - Recognized the concept of “copyright
article” and copyright right” for distinguishing between “sale” and
“royalty” classification
35
CASE LAW UPDATE…
ATTRIBUTION OF INCOME TO PE
Summary of facts
 Finnish company held as having a “fixed place” PE under India/ Finland treaty on
account of activities carried on by its subsidiary
 Activities included network planning & installation, negotiation & signing of
contracts
 Issue before Tribunal was extent of income attribution to PE
Ruling
 Worldwide net profit margin of foreign company applied to revenues earned from
India
 20% of net profit attributed to PE for functions performed by PE
36
CASE LAW UPDATE…
AZADI BACHAO ANDOLAN & OTHERS
Summary of facts
 1994 – Central Board of Direct Taxes (“CBDT”) Circular , clarification on Treaty
provision – surge in FII investment
 2000 – Circular No. 789 (on April 13, 2000) (“Circular”), clarifying that capital gains
derived by a Mauritius resident from the sale of shares of an Indian company, shall in
view of the Treaty be taxable only in Mauritius and not in India
 Circular challenged in the High Court in a Public Interest Litigation
 2002 – Special Leave Petition in the Supreme Court filed by the Government of India
and CBDT
Ruling
 Supreme Court upheld the India-Mauritius treaty (“Treaty”) for avoidance of double
taxation by upholding that the benefits of treaty should be available to third country
residents investing in India via Mauritius.
 Judgment discusses important international tax issues of ‘double non-taxation’, ‘treaty
shopping’, ‘tax avoidance v. tax planning’, ‘form and substance in tax law’
37
RECENT ADVANCE TAX RULINGS
MORGAN STANLEY & CO INTERNATIONAL LTD
Summary of facts
 USCo had outsourced certain services to an affiliate “captive” BPO Co in India
 USCo was to send personnel to provide “stewardship” services to BPO Co as
well as to work under direction of BPO Co
 Question before Authority for Advance Ruling (AAR) on whether USCo had a
PE in India
Ruling
 USCo does not have a “fixed place of business” PE as business of USCo is not
carried out through premises of BPO Co
 USCo would have a PE under “Service PE” rule on account of deputation
arrangement
38
RECENT ADVANCE TAX RULINGS…
DUN & BRADSTREET ESPANA S.A.
Summary of facts
 Dun & Bradstreet (“DB”)- a business information database which provides
products including Business Information Reports (“BIR”s) to businesses
worldwide
 DB India, a subsidiary of DB SAME which is a tax resident of Spain,
electronically purchased BIRs from DB SAME for sale in the Indian market
 Questions raised as to the characterization of income of DB SAME from India
Ruling
 BIRs were copyright protected
 Transaction involved sale of copyrighted good and not transfer of copyright
 Therefore, income of DB SAME from electronic sale of BIRs to be treated as the
business profits of DB SAME in India, and not taxable in the absence of a PE
 Separately, it was held that DB India could not be said to be a PE of DB SAME
in India.
39
RECENT ADVANCE TAX RULINGS…
AGENCY PE
Summary of facts
 USCo engaged in business of international transportation services
 Transportation agreement between USCo and JVCo (India) for movement of
packages within and outside India
 JVCo to provide services to USCo for delivery of packages within India (inbound
consignment) and USCo to provide services to JVCo for delivery of packages
outside India (outbound consignment)
 Question before AAR was if USCo would have a PE in India under the agency
rule
Ruling
 JVCo would be regarded as an agent of USCo as it is acting for and on behalf of
USCo
 Description of the relationship as independent contractors in agreement not
conclusive
 JVCo “secures orders” for USCo both with regard to outbound consignments and
inbound consignments
 USCo would therefore have an agency PE on account of its relationship with
JVCo
40
RECENT ADVANCE TAX RULINGS…


Fidelity Advisors Series VIII
General Electric Pension Trust
Key Outcomes of the Rulings


Gains from trading in shares by FIIs may be regarded as business income which is not
taxable in India in the absence of a PE in India
Determinative tests:
 If seller holds security as stock-in-trade & not as capital investment
 Substantial nature of transactions, manner of maintaining books of accounts, magnitude of
purchases & sales, purchases & sales ratio
 motive of earning a profit versus objective to derive income by way of dividend, etc

Treaty benefits not available to a tax exempt US pension trust since it is not subject to
tax in US
41
Refreshment
Break
42
Structuring Issues and
Opportunities
43
STRUCTURING OF INVESTMENTS
General Structuring Considerations
 Deferral vs. U.S. tax deductions?
 Is U.S. investor interested in maximizing deferral planning?
 Is U.S. investor more interested in obtaining U.S. tax deductions – are
losses expected?
 Management of contributions to IndCo
 What assets/cash? Consider § 367 issues.
 Which entities in the group will make contributions?
 Management of IP

Will IndCo own any IP?

License/royalty issues with respect IndCo
44
STRUCTURING OF INVESTMENTS
General Structuring Considerations
 What are the U.S. investor’s cash needs?
 Is there a need to maximize flexibility in terms of the movement of
funds?
 Can the U.S. investor tolerate a cash build-up in India from a business
standpoint?
 Influences type of investment

Debt/ Equity/Hybrids
 What functions will IndCo perform with respect to the U.S. investor’s
business operations?
 R&D
 Services – direct/outsourced/combination
 Sales
 Manufacturing/production
45
STRUCTURING OF INVESTMENTS
STRUCTURING – U.S. Perspective
 General U.S. Out-bound considerations
 Full Indian tax vs. tax holiday.
 Utilization of deferral vs. flow-through of income/losses.
US Co

DCL issues with loss flow-through.
 Management of Subpart F provisions
 Cash management constraints if first-tier sub has tax holiday.
IndCo

Holiday benefits eliminated when dividends paid – loss of
deferral.

Consider other mechanisms for extracting profits from
IndCo
 Transfer pricing – competing issues.

Consider length of holiday.

Advantage vs. disadvantages of maximizing IndCo’s
profits
 FTC issues
 Exit concerns – no treaty protection on capital gains
46
STRUCTURING OF INVESTMENTS
STRUCTURING – U.S. Perspective
 General U.S. Out-bound considerations
US Co
 Provides blocker for distributions out of IndCo.
 Full Indian tax vs. tax holiday
 Cash management and base erosion
 Greater flexibility as of May 2006 with respect to check-the-box
decision for IndCo
Foreign
SPV
IndCo


Check-the-box election for IndCo can give rise to §954(e)
issues with respect to related party services

Check-the-box election with respect to IndCo can be made
at later date if §954(c)(6) is not extended

Check-and-sell exit structure available if IndCo is later
sold. See Dover v. Commissioner
SPV considerations

Local tax considerations in SPV’s country

Ease of cash movement/cash build-up considerations
47
STRUCTURING OF INVESTMENTS…
COMMONLY CONSIDERED JURISDICTIONS FOR SPVS
 Singapore
No tax on incoming or outgoing dividends. CECA with India
 Netherlands
Participation exemption - no tax on incoming dividends and on sale of shares of
the subsidiary
 Cyprus
International Business Company regime. No tax on dividends and capital gains
received and no withholding tax on dividends and interest distributed
 UK
Substantial shareholding (based on % of holding and length of ownership) –
underlying tax credit is available
 Mauritius
GBC 1 regime, effective 3% tax. Tax credit available in India for underlying taxes
in respect of dividends. Credit in India for taxes “payable”
48
STRUCTURING OF INVESTMENTS…
COMPARISON OF COMMONLY USED TREATIES
 Singapore
LOB issues
Buy-Back could raise §301(c) type concerns in Singapore
 Netherlands
Can provide repatriation benefits
Complexity on capital gains
Removal of capital duty makes more attractive
 Cyprus
Benefits for debt push-down in India
Access to EU directives
U.S. business concerns can arise
 Mauritius
Continues to be preferred from a U.S. perspective
China-Mauritius developments
Indian Supreme Court validated use of Mauritius
Amendment/withdrawal of India-Mauritius Treaty?
49
STRUCTURING OF INVESTMENTS…
USE OF MAURITIUS AS A SPV
Offshore
Jurisdictions
Offshore
Company
Mauritius
No dividend
WHT at
Mauritius level
No CGT
Mauritius
HoldCo
India
No CGT
Indian
Subsidiary
3% tax on
income,
effective rate
0%
Dividend distribution
tax @ 14.025%
Corporate tax @ 33.66%;
0% if enjoys tax holiday
50
STRUCTURING OF INVESTMENTS…
PROFIT REPATRIATION STRATEGIES

Dividends
 Only out of profits
 Up to 10% transfer to reserves
 Dividend distribution tax
 Creditability

Royalty/Fees for technical (included) services
 Withholding tax of 10% on gross amount
 Remittance subject to exchange control

Interest

Buy-back of equity shares
 25% of paid-up capital in one financial year
 No fresh issue of same kind of shares for 6 months
 Shares to be cancelled within 7 days of buy-back

Redemption of preference shares

Deferral of income recognition in the home country and maximum benefit in
home country for foreign tax credits, tax sparing and foreign losses
51
STRUCTURING OF INVESTMENTS…
PROFIT REPATRIATION – BUY BACK OF SHARES
Mechanics
Group Company
Equity
Dividends

Group Company holds Indian operations through
a Mauritius entity

Dividend payment by the Indian Company to the
Mauritius entity would attract Dividend Distribution
Tax (“DDT”) at 14.025% in India

Indian Company uses its profits to buy-back part
of the equity held by the Mauritius entity (instead
of distributing dividends)
Mauritius Group
entity
Equity
Share
buy- back
Applicable Regulations

To be made out of free reserves, securities
premium account or proceeds of any shares/
other specified security, subject to certain limits

Consideration received on buy-back of shares
ordinarily taxed as capital gains
Indian Company
52
STRUCTURING OF INVESTMENTS…
PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
Mechanics
HoldCo2
 Investment structured using two holding
companies
HoldCo1
(Netherlands)
 HoldCo1 invests <10% of the total capital
by way of equity
 HoldCo2 invests balance 90% by way of
preference shares
Equity
Preference
Redemption
Buy-back
at par
at fair value
 HoldCo1 located in Netherlands
(Other possible jurisdictions –
Belgium, Denmark, Spain, France)
 Profit repatriation structured as follows:
IndCo
 Preference share redemption at cost
basis
 Buy-back of equity shares at fair
value
53
STRUCTURING OF INVESTMENTS…
PROFIT REPATRIATION – HOLDING COMPANY STRUCTURE
Benefits
Implementation Issues
 Share buy-back classified as
capital gains in India
 Structuring of preference
shares terms
 Capital gains from alienation of
10% or less participation in capital
not taxable in India under the treaty
 Company law provisions
relating to share buy-back
 No taxable gains on redemption of
preference shares at cost basis
 Buy-back and redemption to
be carried out in a manner to
ensure that HoldCo1’s
participation remains less
than 10%
 Section 902 must be
managed
54
STRUCTURING OF INVESTMENTS…
FINANCING – HYBRID INSTRUMENT
Mechanics
Dutch
Finance
Co
US Co/
Holding
Co
Equity
Interest
Hybrid Debt
IndCo
(India)

US/ Hold. Co sets up/ has an existing company in
India i.e. IndCo

IndCo is “thinly capitalized”

IndCo issues “convertible debentures” to Dutch
Finance Co

IndCo pays arm’s length interest to Dutch
Finance Co

IndCo uses debt for funding requirements
55
STRUCTURING OF INVESTMENTS…
FINANCING – HYBRID INSTRUMENT
Benefits
 Convertible Debentures not
subject to External Commercial
Borrowing guidelines
 End-use restrictions and other
limitations not applicable
 IndCo eligible for interest
deduction
 Participation exemption on
interest earned in Netherlands
may also be possible
Implementation Issues
 Structuring of Hybrid Debt from an
Indian corporate law & exchange
control perspective
 Cost - 10% withholding tax on
interest under Dutch treaty
 Possible solution in Netherlands
post January 1, 2007
 “Term sheet” of the hybrid note
would be vital for effective
implementation
 U.S. tax classification
56
US STRUCTURING CONSIDERATIONS
India Tax Holiday
Direct from US
 Defer from US tax (likely not checkthe-box (CTB))
 Impact of DDT
 Transfer pricing structure
From US through Intermediary Jurisdiction
 Repatriation generally negates benefit
of deferral, but consider CFC to CFC
look-through
 CTB
 Profit repatriation disregarded
 FBC services income and impact
thereof
India Full Taxation
Direct from US
 CTB may be beneficial but confirm
ability to utilize foreign tax credits
 Losses can offset US taxable income
subject to DCL and branch loss
recapture
 Sourcing issues on intercompany
transactions
From US through Intermediary Jurisdiction
 Base erosion opportunities (whether
part of CTB deferral structure or using
CFC to CFC look-through
 Check the box
 FBC services income
 Facilitates elimination of related party
transactions
57
STRUCTURING OF INVESTMENTS
Managing U.S. Deferral
 A popular planning option for managing Subpart F has been to make
a disregarded entity election for IndCo in SPV structure
 Enables taxpayer to maintain deferral with respect to dividend
distributions from IndCo to SPV
 This planning technique can give rise to issues with respect to the
application and management of §954(e) with respect to related party
service activities
 Potentially problematic with respect to the application of the Branch
rule of §954(d)(2)
 Also applicable to “Super Holdco” structures
58
STRUCTURING OF INVESTMENTS
Managing U.S. Deferral
 Significantly greater flexibility following the introduction of §954(c)(6)
in May of 2006
 Exception to FPHCI provisions – provides look-through treatment with
respect to dividends, interest, rents, and royalties received from
related party CFCs
 Impacts check-the-box decisions with respect to SPV structures
 Now consider delay of check-the-box elections until §954(c)(6) sunsets.
 Consider restructuring out of prior check-the-box elections to the extent
there is an exposure to §954(e)
59
STRUCTURING OF INVESTMENTS
U.S. Issues with Respect to Managing IP Ownership
 IP ownership with respect to R&D functions performed by IndCo can
present issues from both a business and U.S. tax standpoint
 Will IndCo own any IP rights?
 What entities within the corporate group will contract with IndCo for the
performance of contract R&D functions
 Issues can arise under proposed §482 service/intellectual property
regulations
 Services can be transmuted into deemed IP transfers
 Consider the use of cost-sharing structures
 Proposed cost-sharing regulations are problematic, even with respect to
foreign-to-foreign cost-sharing structures
60
STRUCTURING OF INVESTMENTS
TAX EFFICIENT EXIT
 Sale of shares of the Indian entity
 Consider “check-and-sell” option in SPV structure if IndCo not
characterized as a disregarded entity for U.S. purposes
 Sale of assets of the Indian entity
 Sale of shares of the immediate Parent company in case of global
restructuring
 Buy-back of equity shares by the Indian entity
 Redemption of preference shares
 Liquidation of the Indian entity
61
Acquisition Planning
US CONSIDERATIONS

Consideration and Financing
 US or offshore cash
 Debt and at what level
 Stock – likely at US parent level

Section 338

Ownership of IP and integration

Legal integration into global structure
 Sale of assets followed by liquidation
 Merger / amalgamation

Change in related and unrelated party transaction flows?
62
Acquisition Planning…
INDIAN CONSIDERATIONS

Regulatory Issues

Carryover of incentives/holidays and other tax attributes

Special rules
 Mergers
 Demergers
 Slump sales

Legal integration into global structure
 Sale of assets followed by liquidation
 Merger / amalgamation
63
Acquisition Planning…
Growing Interest in Inversion Transactions
Shareholders
Shareholders
US Private
Co
New IndCo
Restructuring
US Private
Co
IndCo
IndCo

Recent trend of private U.S. companies seeking access to Indian capital
market, which applies lower-thresholds for public offerings

U.S. tax issues under §§ 367 and 7874 need to be managed
64