Bombay Chartered Accountants’ Society...Demerger between unrelated parties SellerCo owns 100% shares in DCo which has two business undertakings BuyerCo proposes to acquire UT2 by

Bombay Chartered Accountants’ Society

Tax Issues in Business Re-organisation-LLP / Companies

Pinakin Desai

13 July 2016

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Content

Section 115BA - Manufacturing company – 25%

Case studies on LLP

Demerger accounting under Ind-AS

Merger of Companies under Court scheme : GAAR?

Retrospective impact of GAAR – Is it a possibility?

Business reorganisation: s. 92B(1) and s. 92B (2)

Indirect transfer of assets

Case studies on ReIT

Evaluating impact of GAAR grandfathering

Tax neutrality of demerger

POEM, Liquidation of overseas IHC and tax implications


Tax Issues in Business Re-Organisation – LLP / Companies

413 July 2016


Mechanics:

► Step 1: ICo1 to set up new company ICo2 on

or after 1 March 2016, lets say 1 April 2016 (ie

FY 2016-17)

► Step 2 – Demerger or slump sale of old

manufacturing undertaking to ICo2

Issue:

► Whether ICo2 at its option to be exercised in

first year eligible to benefit of reduced tax rate

under s. 115BA ?

► Assuming not eligible for 115BA, whether

ICo2 can avail benefit of reduced tax rate of

29% available ?

ICo1

U2 –

mfg.

100%

U1 -

trading

ICo2


j

k

513 July 2016


► Benefit under 115BA available subject to

following subject to s. 111A and a. 112:

► Setup of company after 29 February 2016

► Such company engaged solely in manufacturing

goods or connected R&D.

► Option is irrevocable

► No benefit of specified deductions/ exemptions/

losses attributable thereto

► EM and budget speech refers “Newly set up

companies”

► No requirement of new manufacturing units

► No condition on split/ reconstruction


ICo1

U2 –

mfg.

100%

U1 -

trading

ICo2

j

k

613 July 2016

Reduced rate of 29%

If not 115BA, whether benefit of 29% tax

rate available ?

► Reduced rate of tax of 29% as per Finance Act

Schedule, applicable subject to following:

► Total turnover or gross receipt of FY 2014-

15 does not exceed 5 Cr.

► Dilemma – ICo2 was not in existence in FY

2014-15, hence condition deemed to be fulfilled

or in the absence of existence in FY 2014-15

condition not fulfilled ?

► Arguable that if turn over or gross receipts in

FY 2016-17 does not exceed 5 Cr. then benefit

of 29% may be availed

ICo1

U2 –

mfg.

100%

U1 -

trading

ICo2


j

k

Case studies on LLP


813 July 2016

Carry forward of losses in case of conversion of firm into LLP

► X Co is firm and has been incurring

losses

► Firm has incurred business loss and

depreciation loss

► FMV of the assets of X Co is

substantially higher than BV

► X Co is converted into X LLP under

second Schedule of LLP Act

► Will there be exposure for capital gains

tax?

► Whether the business loss and/or

depreciation loss will be allowed set

off/carry forward in the hands of LLP?

► Can unabsorbed depreciation step up the

value of block of assets? [Hindustan

Petroleum (187 ITR 1 (Bom)]

X Co

20%

45%

35% 20%

45%

35%

X LLP

Conversion of Company into LLP


913 July 2016

Demerger of company, conversion of company into LLP and subsequent withdrawal from LLP

► X Co is Pvt Ltd company having

two business units (UT A and UT

B)

► Company is having liquid

investment having FMV of Rs. 10

Crores

► Company merely had rental income

> Rs. 60L

Step 1: Demerger of UT B in New

Co

UT A Liquid

Inv.

UT B New Co Pvt. Ltd.

UT B

Demerger

X Co Pvt. Ltd.

BV: 1 Cr

FV: 6 Cr

Issue shares

BV: 1 Cr

FV: 10 Cr

BV: 2 Cr

Indian Promoters


1013 July 2016

Demerger of company, conversion of company into LLP and subsequent withdrawal from LLP

Step 2: X Co (with UT A and liquid

investment will be converted into LLP

(tax compliant conversion)

Step 3: Withdrawal of cash from LLP

after three years

► CBDT Circular 1 of 2011 dated 6 April

2011 : sales/turnover/gross receipts is

amount taxable under the head PGBP

► Section 47(xiiib)(ea) : total value of

assets appearing in the books of

account in any three previous years

shall not exceed Rs. 5 crores

UT A Liquid

Inv.

X Co Pvt. Ltd.

BV: 1 Cr

FV: 10 Cr

BV: 2 Cr

Indian Promoters

X LLP


Indian Promoters

Tax Issues in Business Re-Organisation – LLP / Companies 1113 July 2016

► Mau Co is Mauritius resident company

► ICo has net assets of Rs. 100 and cash surplus

of Rs. 900 reflected as free reserve (AP test)

► There could be DDT exposure on repatriation

► ICo has turnover > Rs. 60 lacs in business

► FMV of assets of I Co > Rs. 5 crores (BV: 1

crore)

Proposed sequence:

Step 1: FCo incorporates NewCo

Step 2: ICo merges into NewCo

► Shares are issued to FCo at face value of

Rs. 100 and share premium of Rs. 900

Step 3: NewCo is converted into LLP u/s. 47(xiiib)

Step 4: FCo withdraws balance standing in reserve

account of LLP

Balance Sheet of NewCo and LLP

Liability New Co LLP Asset New Co LLP

Share 100 Net

asset

100 900

Partner’s

capital

100 Cash 900 900

Share

premium

900

Reserves 900

Total 1000 1000 Total 1000 1000

Merger and subsequent conversion into LLP

ICo

Merger

New Co

Mau Co Mau CoIssue of shares

Conversion

India

AbroadWithdrawal

New Co set up

l

k

k

j m

LLP

Demerger accounting under Ind-AS



Demerger between unrelated parties

► SellerCo owns 100% shares in DCo

which has two business

undertakings

► BuyerCo proposes to acquire UT2

by demerger of UT2 into RCo

► RCo to issue shares to SellerCo as

consideration for demerger

► Appointed date for demerger is 1

April 2017

DCo

UT1 UT2

RCo

UT2

Demerger

SellerCo

BV: 100

FV: 500

Issue shares

BuyerCo


Demerger accounting in books of DCo under IND-AS (Even assuming demerger is tax compliant)

► Accounting is as per Appendix A of Ind-AS 10

– “Distribution of Non-cash Assets to Owners”

► UT2 is fair valued by passing following entry:

Balance sheet extract of DCo

Liability Rs. Assets Rs.

Assets of UT2 100

Add: FV appreciation

credited to P&L

400

Less: Dividend

distribution

(500)

P&L extract of DCo

Expense Rs. Income Rs.

To Dividend

distribution

500 By FV appreciation in 400

DCo

UT1 UT2

RCo

UT2

Demerger

SellerCo

BV: 100

FV: 500

Issue shares

BuyerCo

UT2 A/c Dr. 400

To P&L A/c Cr. 400

► Demerger is reflected as distribution of non-

cash asset to shareholder by passing

following entry:

► Will DCo be liable to pay tax, MAT and/or

dividend distribution tax?

► Will shareholders be liable to pay tax as

dividend receipt?

► Can mandate of court scheme to record

transfer at BV override IND-AS?

P&L (Dividend) A/c Dr. 500

To UT2 A/c Cr. 500


Demerger accounting in books of Rco under IND-AS?

Balance sheet extract of RCo

Liability Rs. Assets Rs.

Share capital 500 Assets of UT2 recorded 500

DCo

UT1 UT2

RCo

UT2

Demerger

SellerCo

BV: 100

FV: 500

Issue shares

BuyerCo► Under IGAAP regime, RCo would have recorded

assets and liabilities of UT2 at BV

► This also ensures that demerger is tax

compliant under s.2(19AA) which inter-alia

requires transfer of property and liabilities

at BV

► Under Ind-AS, RCo is mandated to:

► Record assets and liabilities of UT2 at FV

► Record consideration issued in form of

shares at its FV

► Consequentially record the difference, if

any, as Goodwill/Capital Reserve

► Issue may arise on tax neutrality of demerger in

view of recording of assets and liabilities by RCo

at FV instead of BV

► Can, mandate of Court Scheme override Ind-

AS?

Merger of Companies under Court scheme: GAAR?


1713 July 2016


Facts

► P Co holds shares in A Co and B Co

► A Co and B Co are Indian companies

► A Co has carried forward tax losses. Value of A

Co is eroded. (Rs. 9 crore)

► B Co is highly profitable company in a mature

business which consistently generates cash

surplus (Average PBT Rs. 3 crore)

► A Co, if it is to survive, will need huge cash

investments and business support till its

business matures. (Not a going concern)

► No business synergy between the business

activities of companies

A Co

(loss making)

P Co

B Co

(Profitable)

Merger

100%


1813 July 2016


The Arrangement:

► After deliberations, B Co is merged

with A Co

► Upon merger of B Co with A Co, shares

of nominal value are allotted to PCo.

► Scheme is approved by the Court.

► Merger satisfies the conditions of

S.2(1B) of the Act

► Conditions of S. 79 are also satisfied

► During process of merger and post

merger, there has been considerable

down sizing of operations of A Co

A Co

(loss making)

P Co

B Co

(Profitable)

Merger

100%


1913 July 2016


Issues for consideration

► Can GAAR be invoked on any ground?

► What could be the consequences in case GAAR is invoked by tax

authorities?

► Can merger be disregarded?

► Can merger be re-characterised as if it is a forward merger of ACo with BCo?

► If GAAR is invoked, what could be the impact on:

► Set-off of carried forward losses of A Co

► Set-off of future losses of A Co against profits of B Co

► In computation of tax benefit, how would tax deferral be valued?


Retrospective impact of GAAR – Is it a possibility?



Share Acquisition followed by Capital Reduction and Merger

► On 1 April 2012, BuyerCo acquires shares of

TargetCo, now, a loss incurring entity

► On 1 January 2017, TargetCo undergoes

capital reduction for nominal consideration,

resulting in capital loss in the hands of

BuyerCo

► TargetCo merges into ICo with appointed

date of 1 April 2017

► Merger is bona fide for consolidation of

business

► GAAR provisions are effective from 1 April

2017

► Can GAAR be applied to deny set off of

capital loss post 1 April 2017?

BuyerCo

Sale of shares

Seller

TargetCo

BuyerCo

Capital reduction

TargetCo

Payment

BuyerCo

TargetCo

Merger



2313 July 2016


► Business of ICo is highly profitable and is

driven primarily by self-generated intangibles

► ICo is proposing to transfer business at book

value to LLP which is recently formed by FCo

► ICo is advised that:

► ITL does not permit taxation of notional gain

except when international transfer pricing

provisions apply

► Transaction between two residents is beyond TP

provisions.

► S.92B(2) : inapplicable, all are AEs

► Are above contentions valid

► S. 92F(v): understanding, action in concert

whether oral, informal and not enforceable

FCo

ICo

India

Outside India

LLP

Sale of business

Step 1: F Co to Form LLP

Step 2: I Co transfer its business to LLP


2413 July 2016

Business reorganisation: s. 92 r.w. s. 92B (2)

► ICo had made an overseas investment by

floating a company in Singapore

► Over years, SingCo made significant

profits

► SingCo acquired shares of Op Co (I Co 1)

which is an Indian company

► Business of Op Co (I Co 1) has synergy

with business of ICo2 which is a sister

subsidiary of SingCo

► The group has decided to transfer of

business of Op Co to ICo2 at book value

► Is the transfer likely to trigger implications

of S.92 r.w. S.92B(2)?

ICo

Sing Co

Op Co

I Co 1SingCoICo2

Sale of business


Indirect transfer of assets


2613 July 2016

Tax neutrality to foreign amalgamating company

► S.47 (viab) neutralises ‘indirect transfer’ of

shares of an Indian company for

amalgamating foreign company

► Exemption for foreign amalgamating company

(F Co) if

► 25% parity of shareholding continues in

amalgamated company

► F Co triggers no tax in its country of

incorporation

► No tax neutrality, however, for shareholder of

amalgamating company

► No tax neutrality if underlying Indian assets

are not shares (for instance - interest in LLP,

project office, etc.)

SPV

ICo

India

Outside India

Transfer

/ merger

FCo Buyer

Shareholders



Indirect transfer of India assets: Non qualifying

Amalgamation

FCO1

ICo

FCo2

Issuance of FCo2 shares

Outside India

India

Shareholders

Amalgamation

FCO1

SPV(company)

LLP

FCo2


Outside India

India

Shareholders

SPV(LLP)

Exemption denied to FCo1 for transfer of

interest in LLP pursuant to merger?

Exemption denied to FCo1 if underlying

India assets are not shares?


Indirect transfer of shares of ICo

► Is the value derived substantially from

assets in India?

► S.47(viab) exempts FCo1 if -

► Continuity of 25% of shareholding and

► No taxation in the jurisdiction of FCo1

► No protection to shareholder of

amalgamating company (FCo1)

► Exemption available to shareholders u/s.

47(vii), only if amalgamated company is an

Indian company

► Explore: Whether substantial value

from India?

: Small shareholder exemption

: Treaty exemption

Amalgamation

FCO1

SPV

ICo

FCo2


Outside India

India

Shareholders

Project

office

Outside India

FMV = 100

FMV = 60

USA = 2%

France = 20%

Mauritius = 78%

2913 July 2016

Indirect transfer mitigation

► Shares of I Co to yield 10,000 on exit

► Dividend payment by SPV from

revaluation of assets

► Company law of SPV jurisdiction

permits such dividend payment

► SPV borrows 6,000 to pay dividend

► F Co does not trigger tax in India by

virtue of Circular 4 of 2015

► Post dividend pay-out, share sale to

yield 4,000

SPV

ICo

India

Outside India

Dividend

pay-out from

reserves

FCo

Transfer

Buyer


Case studies on ReIT


3113 July 2016

ReIT – Where SPV is a company

► No WHT on amount paid by SPV to ReIT

[194A (3)(xi)], so long as ReIT has

controlling interest

► Interest received by ReIT from SPV will

have pass through status

► Distribution of interest income to unit

holders subject to withholding of taxes

(earlier of credit or payment)

► Withholding on interest income in case of NR

► Withholding @ 5% [194LBA(2)]

► Final liability (Refer s. 115A (1)(iiac) and s. 194LBA)

► Withholding on interest income in case of

resident (earlier of credit or payment)

► Withholding @ 10% [194LBA (1)]

► Not a final liability

Real estate

Project

Company

SPV

ReIT

Indian

SponsorOther resident

unitholders

HK Co

(FII – Hong Kong)

Outside India

India

40%25%

35%

Equity DebtInterest


3213 July 2016

ReIT – Where SPV is a company

Particulars (in the hands of SPV) INR Cr.

Income of SPV before interest 10

Less: Interest expenses (paid to ReIT) (7)

Net Income 3

Particulars (in the hand of ReIT) INR Cr.

Interest income of ReIT 7

Tax payable by ReIT Nil

Distributed Income (pass through) 7

Tax WHT

Resident unit holders @10%

(subject to tax)

Tax WHT

HK – FII @5%

Rs. 2.45 crore

(Final liability)

Real estate

Project

Company

SPV

ReIT

Indian


unitholders

HK Co

(FII – Hong Kong)

Outside India

India

40%25%

35%

Equity DebtInterest


3313 July 2016

ReIT – Where SPV is a LLP

Particulars (in the hands of SPV) INR Cr.

Income of SPV before interest 10

Less: Interest expenses (paid to ReIT) (7)

Net Income 3

Particulars (in the hand of ReIT) INR Cr.

Interest income of ReIT 7

Tax payable by ReIT (@ 34.608%) 2.42

Share of post tax profit 4.58

No Tax WHT

[share of profit

distributed]

Resident / Non-

Resident

Real estate

Project

ReIT

Indian


unitholders

HK Co

(FII – Hong Kong)

Outside India

India

40%25%

35%

Equity DebtInterest

SPV

LLP


3413 July 2016

ReIT – Capital gains to unitholders

► Capital gains on sale of ReIT units

► Listed units of ReIT (which has suffered

STT)

► If classified as short term, benefit of lower rate of

15% available (Section 111A) (treaty benefit can

be claimed)

► If classified as Long Term Capital Asset,

exemption will be available [10(38)]

► Is it capital gain from immovable property?

► Capital gains on sale of ReIT units by

Sponsor

► At the stage of exchange of sponsor shares

for units of ReIT

► Qualifies for exemption under normal provisions

► MAT liability deferred till the point of sale of units

► At the stage of disposal of ReIT units

► Taxable under normal provisions as also MAT

(date and cost of acquisition relates back)

Real estate

Project

Company

SPV

ReIT

Indian


unitholders

Mau Co

(FII – Mauritius)

Outside India

India

40%25%

35%

Equity Debt Interest






► US Head-quartered Group has

holding entities in Mauritius and

Singapore

► Mau Co and Sing Co hold 3

operating Indian entities

► Mau Co and Sing Co hold

TRC/COR certificate and each is

eligible for respective treaty

benefit

► The Group has resolved for

phased exit, in view of change in

business plans

US

Mau Co Sing Co

ICo 1

• Formed (2008)• Rights – April

2017• Bonus- April

2017

ICo 2

• Formed (2009)• Partly paid (2016)• CC Converted in

April 2017• On merger

ICo 3

• Gift by MauCoto Sing Co in April 2016

50% 100% 100%

Proposed Exit (FY)

2018-19 2018-19 2019-20

3713 July 2016


► GAAR not to apply in respect of ‘income from transfer’ of ‘investments made

before 31 March 2017’

► As per Draft I-M Protocol, residence based taxation continues with regard to

shares acquired before 31 March 2017

► I-S Protocol of 2005, residence based taxation ‘so long as I-M Treaty’ provides that

“‘any’ gains from alienation of resident company shares shall be taxable only in

the country of residence”

► Questions for consideration:

► Which of the entities, arrangements or investments will be grandfathered as per

Rules / protocol?

► What meaning would one assign to “acquired” / “investments”?

► Does denial of grandfathering automatically result in non-applicability of?


3813 July 2016

Transaction I-M Protocol

(Acquired)

GAAR

(Invested)

Remarks

Rights issue at Par

value after 1 April 2017

Acquired prior to

March 2017?

Invested prior to

March 2017?

Suppose rights

issued at FMV?

Bonus issue after 1

April 2017

-do- -do-

Issuance of shares

post 1 April 2017 upon

conversion of CCD

-do- -do- Suppose not

converted, but

sold as CCD



3913 July 2016

Transaction I-M Protocol

(Acquired)

GAAR

(Invested)

Remarks

Shares subscribed prior

to 31 March 2017 are

partly paid and calls are

made after the said date

Acquisition complete as on date

of allotment?

Does investment

align with payment

of calls?

Shares acquired

pursuant to a gift

transaction before 1 April

2017 (Singapore

Company)

Acquired prior to March 2017,

but, status of Singapore treaty.

Is there at all an

investment?

GAAR can

still be

invoked?

Shares acquired

pursuant to merger:

Appointed date: 1 April

2016

Effective date: 1 May

2017

Date of acquisition

• If vested in favour of

amalgamated company.

• If vested in favour of

shareholders

Is it an investment?

If yes, the date of

investment



Tax neutrality of demerger


4113 July 2016

Tax neutrality of demerger – Consideration by parent company

Mechanics:

► Step 1: Demerger of BU2 to ICo3 under 391-

394 of Cos Act

► Step 2 – Issue of shares by ICo4 to ICo1 as

consideration for demerger

Issues:

► Shares issue by parent of ICo3 (transferee

company), whether demerger tax neutral

under s. 2(19AA) r.w.s. 391-394 of Cos Act ?

► Availability of exemption under Section

47(vib)

► Exemption if transfer of assets to

resulting company

ICo1

ICo2

BU1

ICo4

(Listed)

ICo3

100%

100%


j

k

4213 July 2016

Tax neutrality of demerger – Consideration discharged by foreign parent of transferee company

Mechanics:

► Step 1: Demerger of BU2 to ICo1 under

391-394 of Cos Act

► Step 2 – Issue of shares by FCo1 to FCo

as consideration for demerger

Issues:

► Shares issue by foreign parent of ICo1,

whether demerger tax neutral under s.

2(19AA) r.w.s. 391-394 of Cos Act ?

► Availability of exemption under Section

47(vib)

► 47(vib) requires resulting company to

be an Indian company

FCo

I Co

BU1

FCo1

ICo1

100%

100%


j

k

4313 July 2016

Issue 1 - Whether 2(19AA) compliant?

Impact under Cos Act – s. 394

► Transferee company’ is the company to which undertaking is

transferred; and excludes foreign companies

► Transferee is Indian Company (ie ICo1)

► Bombay HC in Thomas Cook and GlobeOp - Consideration may

be by holding company of the transferee company

► Does not compel allotment of shares by ‘transferee company’.

Shares may be allotted by Foreign Parent.

Impact under ITL – s. 2(41A) – “Resulting Company”

and 2(19AA)

► 2(19AA) – No distinction between Indian or foreign company

independent of s. 394 of Cos Act

► Reference in 2(41A) is to transferee entity holding wholly owned

by another

► Reference of WOS may not be to WOS of ICo1 since issue

of shares by such WOS may not capture value of

undertaking transferred to ICo1

FCo

I Co

BU1

FCo1

ICo1

100%

100%


j

k

4413 July 2016

Issue 2 – Eligibility of exemption under section 47(vib)

► 47(vib) exempts transfer of capital assets by

demerged company to resulting company, if

resulting company is an Indian company

► 2(41A) includes one or more companies

► 2(41A) r.w. 47(vib), exemption condition

fulfilled, if transferee is an Indian company

(ie ICo1)

► 47(vib) – No specific requirement for issue

of consideration by Indian company.

Specific provisions needed for the same

FCo

I Co

BU1

FCo1

ICo1

100%

100%


j

k

POEM, Liquidation of overseas IHC and tax implications


4613 July 2016

Liquidation of IHC and tax implications

► I Co had invested in various operating

entities through holding company IHC in BVI

► BVI has POEM in India

► BVI had issued shares to I Co which are

expressed in USD and BVI made investment

in entities in local currency

► Operating entities have incurred

profits/losses

► As part of group reorganisation, I Co

transfers UK Cos to AE at book value

► Subsequently, decision is taken to wind up

BVI

► The liquidator has distributed shares of US

Co before 31 March 2016 while shares of SA

entities were distributed in April 2016

USCos

$

ICo

BVI

US Cos

($)

South

Africa

(ZAR)

India

Outside India


USCos

$UK Cos

(GBP)

Appreciation + 10,000

Appreciation + 10,000

Decrease -(30,000)

Appreciation + 5000

4713 July 2016

Liquidation of IHC and tax implications

Questions for consideration:

► Consequence of BVI Co POEM in India

► Tax/DDT liability of BVI Co on liquidation

► Tax liability of I Co on liquidation of BVI

Co

► Admissibility of capital loss to I Co

► Whether in March 16/March 17?

► Liabilities of a defaulting liquidator

► Computation of capital gain/loss having

regard to cross currency


USCos

$

ICo

BVI

US Cos

($)

South

Africa

(ZAR)

India

Outside India

USCos

$UK Cos

(GBP)

Thank you !“This Presentation is intended to provide certain general information existing as at the time of

production. This Presentation does not purport to identify all the issues or developments. This

presentation should neither be regarded as comprehensive nor sufficient for the purposes of

decision-making. The presenter does not take any responsibility for accuracy of contents. The

presenter does not undertake any legal liability for any of the contents in this presentation. The

information provided is not, nor is it intended to be an advice on any matter and should not be

relied on as such. Professional advice should be sought before taking action on any of the

information contained in it. Without prior permission of the presenter, this document may not be

quoted in whole or in part or otherwise.”

Documents

Bombay Chartered Accountants’ Society...Demerger between unrelated parties SellerCo owns 100% shares in DCo which has two business undertakings BuyerCo proposes to acquire UT2 by