Tax Structuring – Recent Developments

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Dinesh Kanabar

1 8 F e b r u a ry 2 0 1 5

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1. T h e S c e n a r i o

2. I n b o u n d S t r u c t u r i n g

3. O u t b o u n d S t r u c t u r i n g

4. B E P S – a n o v e r v i e w

5. K e y T a k e a w a y s

A g e n d a

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The Indian Scenario

• Economy on the cusp of recovery – potent ia l for double dig i t growth seen

• Investor sent iment on the upswing

• High expectat ion of economic reform

• Fal l ing global o i l pr ices and weakening domest ic inf lat ion – create room for

large scale reform

• Posi t ive developments on the tax front :

• GAAR slated to come into force on 1 Apr i l 2015

• I n c re as ed e n g a g e me n t w i t h t a xp a ye r s

• F o c u s o n a vo i d i n g p r o l o n ged l i t i g a t i on

• I m p r ove m en t i n o ve r a l l t a xp a ye r e xp e r i e n c e t a r g e t ed

Uncertainty and litigation on key issues continue

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The Global Scenario

• Governments fac ing signi f icant f iscal pressures

• Increased pol i t ica l and publ ic focus on perceived tax avoidance by

mul t inat ional companies

• Widespread recognit ion that the internat ional tax regime is inadequate to

address current chal lenges faced by developed and developing countr ies

• Aggressive dr ive to reform underway as part of the OECD‟s BEPS ini t iat ive –

Ind ia playing a key ro le in the del iberat ions

• I n c reased sc ru t i ny o n c ross -bo rde r t r ansac t ions and s t ruc tu res in seve ra l

coun t r i es

Tax Structuring – now a challenging, dynamic and multi-faceted exercise

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Inbound Structuring – Issues and Developments

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Key Considerations - Inbound

Choice of entity

Foreign Tax Credit

Availability

Use of Holding Companies

Exit StrategyCash

Extraction

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Choice of Entity: LLP v. Company

Private company LLP

Income Tax

Corporate Tax Rate applicable –32.45% / 33.99%

DDT @ 19.994 %* on distribution of profit by way of dividend; Dividend exempt in hands of shareholder

MAT @ 20.96% applicable on Book profits

BBT @ 22.66% applies on share buyback

Corporate tax rate applicable – 33.99%

DDT & BBT is not applicable; Share of profit is exempt in hands of partner in India

AMT @ 20.96% on Adjusted Total Income (typically, applies where tax holidays are claimed)

Deemed Dividend provisions under s. 2(22)(e) not applicable

Foreign Direct Investment (FDI) & Foreign Exchange

Management Regulations

(FEMA)

No FIPB approvals required for FDI at the time of entry or exit as long as activities are covered under the automatic route

Foreign investment can be done by way of cash consideration, swap of shares, conversion of receivables etc.

FDI permitted only for activities covered under automatic route & subject to prior approval from FIPB

Foreign capital participation in LLP –by way of cash contribution only

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Choice of Entity: LLP v. Company

Private company LLP

Governance Framework

Higher statutory reporting requirements

CSR spend of 2% of net profits compulsory

Requirements for holding minimum number of board meetings

Decisions subject to shareholders / Board approval

Related party transactions are subject are subject to board / shareholder’s approval and arm’s length pricing

Relatively limited reporting requirements

LLP not required to comply with CSR obligations

Greater flexibility for conduct of business

Governed by LLP agreement - No requirement for approvals / minimum meetings

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Choice of Entity: LLP v. Company

Key Advantages of LLPs

• Tax Eff ic ient st ructure as no MAT, DDT & BBT appl icable

• No mandatory CSR spend of 2% of prof i ts .

• Operat ional f lexib i l i ty and reduced compl iance costs

Key Considerations

• New ven tu res can be housed in a n LLP ins tead o f ex i s t i ng co rpo ra te

en t i t i es

• Conve rs i on o f ex i s t i ng compan ies in to LLPs poss ib l e :

• S t r i n gen t c o n d i t i ons f o r t a x - n e u t ra l i t y - I N R 6 0 L a k h s t u r n o ve r c r i t e r i a

• A r g u m en t s f o r n o n - t axa b i l i t y b a s e d o n f i r s t p r i n c i p l es p o s s i b l e –

p o s i t i on l i t i g a t i ve

LLPs – a key component of inbound tax structuring

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Use of Holding Companies

Direct Investments in India

Foreign Investor

Indian Co.

• Capita l gains on sale of shares of Indian

company taxable in India

• Treaty benef i t avai lab le in respect of capital

gains avai lable only in to select countr ies

• Risk of double taxat ion due to conf l ict ing

„source‟ ru les

i .e. Foreign Investor ‟s jur isd ict ion may

consider capita l gains on sale of Indian Co.

shares as „domest ic ‟ sourced income not

e l ig ib le to fore ign tax credi ts (e.g. US)

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Use of Holding Companies

Use of intermediate holding companies

Foreign Investor

Hold Co.

• Risk of double taxat ion can be mit igated

through Holding companies si tuated in

countr ies wi th favourable treaty provis ions

(e.g. Maur i t ius, Singapore, Nether lands etc . )

• Claim for treaty benef i ts in India under

increased scrut iny – need for careful

s t ructur ing

• Claim to be backed up by:

a) Substance in jur isdic t ion of Hold Co.

b) Commercial ra t ionale for use of Hold Co.

c) Avai lab i l i ty of Tax Residency Cert i f icates

d) Compl iance wi th LOB Art ic le ( i f any)

Indian Co.

Boilerplate structures involving holding companies – no longer advisable

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Use of Holding Companies

Use of mult i - t ier structures – addit ional considerations

Foreign Investor

Hold Co. 1

• Retrospect ive amendments to s. 9(1)( i ) –

Foreign Investor Co., HoldCo 1 and HoldCo

2 shares deemed to be situated in India i f

they derive value substant ia l ly from assets

located in India

• Meaning of „substant ia l ly‟ under Sect ion

9(1)( i ) not certa in – Delhi HC‟s cr i ter ia >

50%

• No pro-rata taxat ion or exemption for l isted

foreign co shares, group restructur ing under

current law

• Taxabi l i ty in India of dividends paid by Hold

Co. 2 and Hold Co. 1 – an area of concern

• No clar i ty on appl icabi l i ty of treaty benef i ts

in case of sale of shares of HoldCo 1 or

HoldCo 2

Hold Co. 2

India Co.

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Cash Extraction

Tax Implications

• Dividend Distr ibut ion Tax @ 19.994 payable on

dividends declared, distr ibuted or paid by domest ic

companies

• Buyback Tax @ 22.66% on „d ist r ibuted income‟

payable by domestic companies on buyback of unl isted

shares

• Interest payments l iable to withhold ing @ 10%

Concessional tax @ 5% on interest avai lab le in certain

cases

• 25% rate on royalt ies / FTS under domest ic law –

lower rates may be avai lable under t reat ies

• Dividends

• Buyback of Shares

• Interest

• Royalties

• Fees for Technical

Services

Significant tax costs associated with cash extraction – proper planning needed

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Other Considerations

• Foreign Tax Credit avai lab i l i ty in home jur isd ict ion on income-streams from

India to be evaluated

• For e.g. credi tabi l i ty of DDT and Buyback tax could pose content ious as:

• Non-avai labi l i ty of credi ts could s igni f icant ly affect tax costs and overal l

f inancial pro ject ion

• App l i cab i l i t y o f MAT to cap i t a l ga ins ea rned b y fo re i gn compan ies in

favou rab le t r ea t y j u r i sd i c t i ons - a l i t i ga t i ve i s sue

• Con f l i c t i ng dec i s i ons o f AAR o n the above :

• Timken Co . I n r e (3 2 6 ITR 1 9 3 )

• Cas t l e ton In r e (3 4 8 ITR 5 3 7 ) (SLP pend ing be fo re the SC)

Need for clarificatory amendments

• D D T / B u yb a c k t a x i s l e v i e d o n t h e c o m p a ny a n d n o t o n t h e s h a r e ho ld e r

• D D T / B u yb a c k t a x i s n o t p a i d o n b e h a l f o f s h a r e ho l de r s

• U n d e r l y i n g t a x c r e d i t s m a y n o t b e a l wa ys a va i l a b l e

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Outbound Structuring – Issues and Developments

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Outbound Investments – Regulatory Aspects

• Under the Automat ic Route, an Indian Party does not require any pr ior

approval f rom the RBI for set t ing up a JV/WOS abroad

• The cr i ter ia for d i rect investment under the Automatic Route are as under :

• Certain addit ional condit ions to be ful f i l led in case investment by an Indian

Party engaged in Financia l Services Sector

• Investment in foreign companies engaged in real estate, trading in TDRs and

banking business requires pr ior approval of RBI

Investments up to 400% of Net worth

Valuation requirements to be complied with respect to the value of investments

All transactions relating to a JV / WOS routed through one branch of an AD bank

Indian Party not on RBI’s caution list / under investigation by enforcement agency

Submission of APR in respect of all overseas investments

Indian subsidiary is required to report its investments in form ODI to the AD bank

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Key Considerations - Outbound

Need for SPVs

IPR Regime

Holding Company Regimes

Withholding tax provisions

Participation exemption /

thin cap rules

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Use of SPVs – Some Benefits

Flexibility in borrowing

JV Private Equity Funding

Bilateral Agreements

Tax Efficiency Ease in Exit Overseas Listing

Flexibility in corporate

structuring

Ring fencing of Risk

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Key Considerations

Part ic ipat ion Exempt ion

• Exempt ion in SPV‟s jur isd ict ion for dividend income and capital gains from

downstream investments upon fu l f i lment of cer ta in condi t ions

• Condit ions typical ly pertain to sharehold ing pattern, jur isd ict ion of parent

ent i ty and percentage of hold ing

IPR Regime

• Specif ic incent ives, deduct ions and exemptions avai lable in some jur isd ict ions

in re lat ion to IPR hold ings

• Patent Box regime (i .e. concessional rate for royalty incomes from certain

IPRs) and deduct ion for c inematographic f i lms given in UK

• Accelerated Deduct ion al lowed on R&D spends in Singapore and Switzer land

Withholding tax provis ions

• WHT exempt ions on dividends / royal t ies / in terest (e.g. under EU direct ives)

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Key Considerations

Favourable Hold ing Company Regimes

• Lower income-tax rates for hold ing companies under specif ic holding company

regimes (e.g. UK, Singapore)

• Existence of CFC provis ions

• Good Treaty Network

Thin capi tal izat ion ru les

• Companies said to be thin ly capita l ised when its capita l is made up of a much

greater proport ion of debt equi ty

• Tax eff ic ient cash repatr iat ion possible by cla iming tax deduct ion for interest

on debt

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BEPS – an overview

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BEPS – An Overview

• On 19 July 2013 the OECD released an Act ion Plan

on Base Erosion and Prof i t Shif t ing (BEPS) which

was presented to the meet ing of G20 Finance

Minis ters in Moscow..

• The purpose of the Act ion Plan is “ to prevent

double non-taxat ion, as wel l as cases of no or low

taxat ion associated with pract ices that art i f ic ia l ly

segregate taxable income from act ivi t ies that

generate i t . ”

• The report indicates that “no or low taxat ion is not

per se a cause for concern, but i t becomes so when

it is associated wi th pract ices that art i f ic ia l ly

segregate taxable income from the act ivi t ies that

generate i t . ”

• The Act ion Plan covers 15 specif ic Act ions which

are broadly to be achieved with in a two year t ime

f rame ( i .e . by the end of 2015).

Thecoherence of corporate tax

at the international

level

Transparency, coupledwith certainty and

predictability

Realignment of taxation and substance

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BEPS – An Overview

Focus on key i tems

• Transfer pr ic ing, hybr ids, in terest deduct ions, t reaty abuse and the d ig i ta l

economy

Wide ranging act ions, for example:

• Changes to the Model Tax Convent ion (e.g. in re lat ion to hybr ids, t reaty abuse)

• Recommendations regarding the design of domest ic law (e.g. CFC ru les, in terest

deduct ions)

• Changes to the TP guidel ines (e.g. in re lat ion to ensur ing TP outcomes are in

l ine wi th value creat ion)

A number of the act ions are l inked, for example:

• The act ions on CFCs, in terest deduct ions, and hybr ids wi l l be c losely l inked

BEPS outcomes to have a significant impact on cross-border structures

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BEPS – An Overview

June 2012Project

announced / started

February 2013Document released „Addressing Base Erosion and Profit

Shifting’

July 2013Release of Action

Plan with 15 separate

actions/work streams

September 2014Project Completion

of approximately 1/3 of Action Plan

September 2015

Completion of

remainder action plan

2016 onwardsMonitoring, additional /

ongoing actions

Coherence

• Action Item 2*: Hybrid mismatch arrangement

• Action Item 3: Controlled Foreign Company rules (CFC)

• Action Item 4: Interest deductions

• Action Item 5*: Harmful Tax practises

Substance

• Action Item 6*: Preventing tax treaty abuse

• Action Item 7: Avoidance of permanent establishment status

• Action Item 8*: Transfer Pricing aspects of intangibles

• Action Item 9: Transfer Pricing/risk and capital

• Action Item 10: Transfer pricing/high risk transactions

Transparency

• Action Item 11: Methodologies and data analysis

• Action Item 12: Disclosure rules

• Action Item 13*: Transfer pricing documentation

• Action Item 14: Dispute resolution

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BEPS – Key Risk areas and

Actions

• Digi ta l economy

• Hybr ids

• Treaty abuse

• Dependence on speci f ic PE except ions

• Signi f icant in terest deduct ions

• In tangibles, and which group company has an in terest

• Contractual a l locat ion of r isk and capi tal versus Key enterpr ise

r isks /Signi f icant People Funct ions

• Does TP pol icy overa l l make economic sense?

• Operat ional s t ructures – does income ref lect economic act ivi ty?

Part icular focus should be p laced on the use and explo i tat ion of

in tangib les

• Transfer pr ic ing pol icy A renewed focus on APAs?

• Robust documentat ion and evidences to be mainta ined –

especia l ly qua conduct of par t ies

• In ternat ional f inancing and organisat ional s t ructures – are they

sustainable in l ight of the BEPS recommendations?

• Consider potent ia l impact on p lanning arrangements current ly

being contemplated

Key Risk

areas

Actions

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Substance and BEPS

• The „substant ia l act ivi ty‟ factor: whether a regime “encourages pure ly tax -dr iven

operat ions or arrangements”

• Are taxpayers der iving benef i ts f rom the regime whi le engaging in operat ions

that are pure ly tax-dr iven and involve no substant ia l act ivi t ies.

• Regimes that meets the “no or low ef fect ive tax rates” test wi l l be considered

harmful i f there is no substant ia l act ivi ty in the country grant ing the regime.

• Determining the locat ion of substant ia l act ivi ty - a subject ive determinat ion

The interim report titled „Countering Harmful Tax Practices More Effectively, Taking into

Account Transparency and Substance‟ released by OECD on 16 September 2014 reflects

consensus on the importance of having appropriate “substantial activity” requirements in

preferential regimes and on the need for increased transparency.

New substance requirements formulated in various jurisdiction - companies required to adhere to specific substance requirements for satisfying the substance test

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Substance and India

• Long standing b ias towards „ form‟ increasingly under chal lenge

• General Ant i -Avoidance Rule enacted – proposed to be made ef fect f rom 1 Apr i l

2015

• Ant i -abuse pr inc iples increasingly invoked by the tax author i t ies and Courts

• Key pr inc iples emerging f rom the landmark SC decis ion in the Vodafone case:

• Tax p lanning wi th in the f ramework of law is permissible unless i t is a sham

or co lorable device

• Onus on the tax author i ty that the t ransact ion is sham

• True nature to be ascerta ined by „ look ing at ‟ the legal arrangement actual ly

entered in to and carr ied out

Era of conventional tax planning over – need for a more sophisticated approach

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Key Takeaways

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Key Takeaways

• BEPS – a game changer in the coming years

• Need to focus on domest ic ant i -abuse tax legis lat ions in var ious

jur isdict ions

• Transparency and Exchange of In formation – here to s tay

• Fast changing g lobal tax regimes

• Need for longevi ty and f lexib i l i ty in cross -border s t ructures

• Tax and Moral i ty debate – l ike ly to cont inue