Business Restructuring – A Primer Why Business Restructure? - Only thing constant is CHANGE- Business Restructuring enables coping with change- Business Restructuring required for survival- Buisness Restructuring required for growth- Essential Strategy – Core and Non Core- Global Customers- Wide Spread Technology- Increasing Fixed Costs- Value Capture and Value Creation- Acquiring Resources
Business Restructuring – A Primer What is Business Restructure? - Restructure means to organize differentlyRestructuring is the corporate management term for the act ofreorganizing the legal, ownership, operational, or other structures of acompany for the purpose of making it more profitable, or better organizedfor its present needs. Restructuring includes a change of ownership or ownershipstructure, demerger, or a response to a crisis or major change in thebusiness such as bankruptcy, repositioning, or buyout. Restructuring may also be described as corporate restructuring, debtrestructuring and financial restructuring.
Business Restructuring – A Primer Types of Restructuring Debt RestructuringPortfolio & Asset Capital Investment Pattern Restructuring Restructuring FDI Participation Mergers & Acquisitions Joint Ventures DivestituresAmalgamations Management Buyouts Spin Offs Horizontal Cogeneric Negotiated /Hostile Takeover Splits Vertical Takeovers Leverage Buyout Equity Carve Outs Asset Buyout Disinvestment Conglomerate
Business Restructuring – A Primer Features of Business Restructuring• Reorganistaion of ownership structure• Sale of Non Core / underutilized assets, such as patents or brands• Reorganization of functions such as sales, marketing, and distribution• Moving of operations such as manufacturing to lower-cost locations• Refinancing of corporate debt to reduce interest payments• Outsourcing of operations such as payroll and technical support• Renegotiation of labour contracts to reduce overhead• Forfeiture of all or part of the ownership share by pre restructuring stock holders
Business Restructuring – A Primer Need of RestructuringIn the following circumstances Business Restructuring would required.• Lack of economies of scale• Absence in growth segments of the market.• Changes in business structures . both domestic and global.• Poor efficiency in operations.• Declining competitiveness of the product, technology and value creation process.• Lack of funds to support brand and distribution network.• Changes in environment in areas like technology, competition, regulations etc.• It may entail less risk and even less cost• High cost structure and high cost of capital & Mismanagement of fixed and working capital.
Business Restructuring – A Primer Benefits of Business Restructuring• Combination benefits• Operational Resource Sharing – Functional Skills & General management• Domain strengthening / Domain Extension/Domain Exploring• Acquiring Capability / Acquiring Platform/ Acquiring Business Position• Restructuring results in more efficient economic activity.• Restructuring results in a great deal of competition for business assets.• Creates value for shareholders• Helps in capturing new opportunities in the evolving economies
Tax Issues in Business RestructuringThe Income Tax Act contemplates and recognizes the following types of mergers and acquisitions activities.• Amalgamation (i.e. a merger which satisfies the conditions specified)• Slump sale/asset sale.• Transfer of shares• Demerger or spin-off.Tax Related Issues is Business Restructuring - Carry Forward of Losses - Capital Gains on Corporates and Shareholders - Expenditure / Income Allocation - Valuation related issues - Tax Allocation / Credits in MNE - Stamp Duty - Indirect Taxes and Carry forward of Credits
Taxability of Indirect TransferThe Background – Vodafone Issue HTIL Transfer of shares of CGP Vodafone NV Hongkong Netherlands 100% 100% CGP Investments Cayman Islands 100% 3GSPL. 100% India Indian Holding Co. Mauritius 51.96% HEL. India•HTIL held the controlling stake in HEL, Vodafone acquired shares of CGP from HTIL•Agreement entered into by HTIL and Vodafone for acquiring business in India.•Income Tax Authorities treated transfer of shares as transfer of capital assets inIndia, hence liable to deduct tax on payment made to HTIL.•Supreme Court held that the transaction not taxable in India.
Taxability of Indirect Transfer Retrospective amendment by the Government to neutralize the impact of the landmark Supreme Court decision. Major amendments in this regard are as follows• The Finance Act, 2012 introduced Explanation 5 to Section 9(1)(i) of the Income Tax Act, 1961, “clarifying” that an offshore capital asset would be considered to have a situs in India if it substantially derived its value (directly or indirectly) from assets situated in India. The amendment is currently retroactively applicable from 1961.• Amend section 2(14) to clarify that ‘property’ includes and shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever.
Taxability of Indirect Transfer• Amend section 2(47) by adding Explanation 2 to clarify that ‘transfer’ includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India.• Amend section 195(1) by adding Explanation 2 to clarify that obligation to comply with sub-section (1) and to make deduction there under applies and shall be deemed to have always applied and extends and shall be deemed to have always extended to all persons, resident or non-resident, whether or not the non resident has:- (a) a residence or place of business or business connection in India; or (b) any other presence in any manner whatsoever in India.
Taxability of Indirect Transfer-Shome CommitteeShome Committee Recommendations Despite of amendment of the act the government had missed out important issues including questions relating to the applicability of indirect transfer provisions to listed companies, issues on the attribution of value, adjustment of cost of acquisition, availability of treaty benefits and foreign tax credits, etc. The Prime Minister set up the Committee (Shome Committee) to engage with stakeholders and examine the implications of the new rule to tax indirect share transfers. Key Draft Recommendations• The Committee has stated that retrospective amendments should not be made to expand the tax base as that would affect certainty and rule of law. It should only be in rarest of rare cases only• the withholding tax obligation should not be retrospectively applied for payments that have already been made
Taxability of Indirect Transfer-Shome Committee • For threshold test on Substantiality and valuation at least 50% of the total value should be derived from assets located in India. Further, to this extent, the value of the Indian assets should be more than 50% of the global assets to determine whether the 50% test has been met. • Attribution of value: The Committee has recommended that a proportional basis of taxation should be adopted for the purpose of calculation of the tax liability of the transfer of shares of a foreign company (covered by the amendment) in India. Thus, in this regard the Committee recommended that only that portion of the gains should be taxable in India which is proportional to the total gains which the Indian assets bear to the global assets. Eg; US Holding Company with 51% Value from India, 34% for Australia and 15% from UK. Then only 51% of Capital Gain to be taxed in IndiaUnder DTC, indirect transfer of shares of Indian company taxable if FMV of Indian assets exceeds50% of FMV of all assets of foreign company, whose shares are transferred.
Taxability of Indirect Transfer-Shome Committee• Minority Shareholders concern : To be made applicable only where the share holding is more than 26% in the holding company• Listed companies: Exemptio to be provided to listed companies as they would not be sham / paper companies• Exemption in case of Business Restructuring if such restructuring exempt from tax in home country• Conflicts with Indian Tax Treaties : Should be exempt unless the treaty gives right to tax as per domestic law or gives India right to tax transfer of shares of foreign company
Proposed Transaction Group Company USA Indian Co. US operation Co Europe AfricaConsidered Substantial onbasis of assets (30% value) Buyer Propose Transfer of Group Co. In the above hypothetical transaction if the proposed transaction happens on transfer of group company shares to the buyer then the tax implication of such transaction will attract Indian Tax Law, since Indian company having substantial assets when compared to the group. The Full value received by Group Co shareholders will be liable for tax in India
How to avoid Indirect Transfer Group Company USA Indian Co. US operation Co Europe AfricaConsidered Substantial on basis of assets Phase 1 of Transaction Phase 2 of Transaction Buyer . 1. To avoid Indirect transfer the buyer can structure the transaction in such a way, where in the first phase of the transaction Indian company will be acquired and shares will be transferred to the buyer based on valuation done according to section 56 (2) (viia). • In the second phase of the transaction the buyer can propose the transaction with group company which will not have tax impact in India. 2. Break up of Valuation by Country wise, which would help to distribute the value through all segments over the group.
How To Determine Value US Co India Co Which has more value ? What if IP / Architects with India? What if CEO/Promoter is located in India? Substance over Form
Sanofi Case – Treaty is unaffected by IT Amendment on Indirect TransfersIn August, 2009 M/s Sanofi Pasteur Holding SA, France acquired the entire share capital of M/s Shanh ParteurHolding SA, France from M/s Merius Alliance, France and M/s Groupe Industriel Marcel Dassault. On the date ofacquisition Shan H held about 80% for the shares in Shanta Biotechnics Ltd, Hyderabad.The Income Tax Authorities after the recent explanation added to Income Tax regarding capital gain on sale of IndianCompanies due to takeover / sale of foreign holding company, issued tax demand notices to Sanofi.In this case the Honourable Andhra Pradesh High Court has held that the capital gain on sale of Shan H to Sanofiwould not be taxable in India, even though it held 80% shares of SBL, India due to the following reasons.• Shan H is an independent Corporate Entity registered and resident in France and is conducting business independently.• Shan H is not a mere nominee or holding company for MA and/or MA/GIMD.• Shan H is not a device for tax avoidance.• There is no reason to lift corporate veil of Shan H as there is no material to conclude that there is any intention or design to avoid tax• The capital gain arising from the transaction is chargeable to tax in France as per the provisions of DTAA• The retrospective amendments in Income Tax have no impact on DTAA and the transaction falls within Article 14(5) of DTAA and the resulting tax is allocated exclusively to France
Sanofi vs. VodafoneThe question arises why Sanofi was not liable to tax as compared to Vodafone. This is basically due tothe intention of the transaction as well as the taxability of the transaction. Vodafone Sanofi Intention The Mauritius subsidiary was In this case there was no intention created with the only intention to to avoid taxes. avoid tax Tax on Capital Gains No capital gain tax was levied In Sanofi case the capital gain is either in Mauritius or in India liable for tax in France.(Treaty Provision) Importance of Commercial The Mauritius company may be ShanH is a genuine business entity Substance treated as a sham company and not a company created to created to save tax and may be a avoid taxes. case fit for lifting the corporate veil
Anti Treaty Shopping Provisions• Tax Residency Certificate (TRC)( Sec 90(4)): In order to claim tax treaty benefit, TRC containing prescribed particulars would be required to be obtained by the non-resident FB 2013 : TRC by itself may not be sufficient for availing tax treaty benefits.• Withholding of taxes by non-resident (Explanation 2 to Sec 195 (1)) : It is clarified that payment by one NR to another NR are also liable to withhold tax as per the domestic laws whether or not they have presence in India.• Application for determining TDS rate (195(7)): CBDT to specify a class of persons or cases who shall make an Application u/s 195(1) to AO to determine the appropriate proportion of sum chargeable even if the payment to non-resident is not chargeable to tax
Impact of GAAR –Chapter X-A• Any Tax planning even with in the law with an objective to save tax , can now be challenged• GAAR over rides Tax Treaties• Transaction undertaken based on settled law can now be challenged under GAAR.• GAAR to create significant uncertainty and litigation on taxation• No objective criteria to determine genuine transaction - very widely worded and subjective.• No limit prescribed for coverage of transactions under GAAR.• Scope of ‘Advance Ruling’ widened to include impermissible arrangement under GAAR• Substance over Form takes more importance
Example -1 Subsidiary A Subsidiary B Non Tax Jurisdiction Holding Co. India Indian Co.In the above case, when dividend are accumulated in Hold Co. and not repatriated to India for a number of yearsand subsequently, Hold co is merged into Indian Co. through a cross border merger. Can GAAR be invoked on theground that the merger route has been adopted to avoid payment of tax on dividend in India?It is true that if Hold co declares dividends to Indian co before merger, then, such dividend would have been taxable in India. But thetiming or sequencing of an activity is a business choice available to the taxpayer.Moreover, section 47 of the Act specifically exempts capital gains on cross border merger of a foreign company into an Indiancompany. Hence, GAAR cannot be invoked when taxpayer makes a choice about timing or sequencing of an activity to deny a taxbenefit granted by the statute.
Example -2 Profit Making Co. Loss Making Co. Merged Co. Lower Profit & Low Tax The merger of a loss making company into a profit making one results in losses setting off profits, a lower net profit and lower tax liability for the merged company. Would the losses be disallowed under GAAR? As regards setting off of losses, the provisions relating to merger and amalgamation already contain specific anti-avoidance safeguards. Therefore, GAAR would not be invoked when SAAR is applicable.
Example -3 G Ltd H ltd Non Tax Jurisdiction A Ltd Country (C1) India V Ltd X ltd • V ltd an asset owning Indian company held by another Indian Co. X Ltd. • X Ltd was held by two companies G Ltd & H Ltd incorporated in C1 • The India – C1 tax treaty provides for non – taxation of cap. Gains in the source country & C1 charges no tax on capital gains under domestic laws. • Later X ltd. Was liquidated by consent. This resulted in transfer of the assets/shares from X ltd to G ltd & H ltd • Subsequently G Ltd & H ltd sold the shares of V ltd to A ltd of C1 • The companies G ltd & H ltd claimed benefit of tax treaty. Can GAAR be invoked to deny treaty benefit?
The alternative courses available to taxpayer to achieve the same result (with or without the tax benefit) are:• (i) Option 1 (as mentioned in facts) : X Ltd. liquidated, G Ltd. and H Ltd. become shareholders of V Ltd.; A Ltd. acquires shares from G Ltd. and H Ltd.; and becomes shareholder of V Ltd.• (ii) Option 2: A Ltd. acquires shares of X Ltd. from G Ltd. and H Ltd.; X Ltd. is liquidated; and A Ltd. becomes shareholder of V Ltd.• (iii) Option 3: X Ltd. sells its entire shareholding in V Ltd. to A Ltd. and subsequently, X Ltd is liquidated.• In Options 1 & 2, there is no tax liability in India except the deemed dividend taxation to the extent reserves are available in X Ltd. This is because of the treaty between India and country F1. In option 3, tax liability arises to X Ltd., an Indian company, on sale of shares of V Ltd. Subsequently, when X Ltd. is liquidated, tax liability arises on account of deemed dividend to the extent reserves are available in X Ltd.• The taxpayer exercises the most tax efficient manner in disposal of its assets through proper sequencing of transactions.• The Revenue cannot invoke GAAR as regards this arrangement.
Example -4 Company X borrowed money from Company Y and used it to buy shares in three 100% subsidiary companies of X. Though the fair market value per share was Rs.100, X paid Rs. 600. The amount received by the said subsidiary companies was transferred back to another company connected to Y. The said shares were sold by X for Rs. 100/5 each and a short-term capital loss was claimed. This was set off against short-term capital gains from other sources. All the companies are Indian companies. Can GAAR be invoked? By the above arrangement, the tax payer has obtained a tax benefit and created rights or obligations which are not ordinarily created between persons dealing at arm‘s length. Since transactions of purchase and sale of shares of a closely held company at a price other than the fair market value are covered under section 56 of the Act, GAAR may not be invoked as section 56, being SAAR, is applicable. However, if SAAR is not applicable considering the limited scope of section 56 to the shares of closely held companies only, then GAAR may be invoked.
Tax on Excessive Share Premium – Sec 56(2)(viib)The Amendment as ‘a measure to deter the generation and use of unaccounted money, Positioned as a weapon to curb money laundering and tax evasion.Section 56 (2) (viib) states that Where a closely held company receives in any previous year from any person being a resident any consideration for issue of shares that exceed the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to tax.This provision shall not apply to funds received from• Venture Capital Company/Fund.• Persons to be notified by the Central Govt.• Non – Resident.FMV for the purpose of 56 (2) (viib)• The fair market value of the shares will be considered as the higher of the following values –• (i) as may be determined in accordance with the method as may be prescribed ( NAV or DCF at option of the assessee ); or• (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets.
Comparison of 56(2) (viia) & (viib) 56 (2) (viia) 56 (2) (viib) Transfer of Shares Issue of SharesApplicable where a closely held company receives Applicable where a closely held company receivesshares, of another closely held company from any any consideration for issue of shares that exceed theperson, either without consideration or for inadequate face value.considerationAggregate Value of sum of money received exceed There is no such limit prescribed.Rs.50,000 is the limit to attract chargeability.FMV of Equity shares which are unquoted in stock FMV of Equity shares which are unquoted in stockexchange , in accordance with rule 11UA(1)(c)(b) (Net exchange , in accordance with rule 11UA(2) at theAsset Value Method) option of the assessee.FMV = (A-L) x (PV) / (PE) Net Asset Value Method or Discounted Cash Flow method
Instances of 56(2) (viib) Face Value Rs .10 Fair Market Value Fair Market Value Fair Market Value Issue Price Rs.8 Rs.10 Rs.15 Rs. 10 Nil Nil Nil Rs.12 Rs.4 Rs.2 Nil Rs.18 Rs.10 Rs.8 Rs.3Income = Issue price – FMVWhere, Issue price must be more than Face Value FMV must be greater than Issue price
Issues & Challenges – Sec 56(viib)• The Amendment poses significant challenges for the domestic M&A or PE deals, especially in acquisitions through a competitive bidding process, where the transaction price is over and above the fair market value.• This issue is more pertinent to the start-up companies which generally do not have substantial assets. For a start-up company Section 56(viib) may result in a situation where the company will be liable to pay tax not only on the premium received by it, but also on the amount contributed towards paid up capital of the company. Aggregate amount is taxable if issue price exceeds FMV.• Where the prescribed method for computing the fair market value of the shares is not followed, could result in a state of uncertainty regarding the valuation of shares done by the Company. This is because the Company will not be able to determine till the assessment stage whether it’s computation of Fair Market Value of the shares, on which the taxability of the excess consideration depends, is correct and acceptable to the Assessing Officer.• Discrimination would arise in between Resident Investors and Foreign investors.
Issues & Challenges• Valuation methods to determine FMV prescribed ( apart from DCF ) are historical and rely on net assets of the company and does not take into consideration of future earning prospect of the company and also for start up companies there will be no considerable assets. The investment is made by investors keeping in mind long term prospects of the company.• The promoters would normally issue shares to Investors at a premium to control the dilution of the ownership in the company, since this section has impact on taxability of the premium, the company will be in dilemma on Tax outflow and Dilution of ownership.• Non prescribed method : Based on value on date of issue of shares . Based on assets ,including intangible assets being goodwill, know –how, patents. Copy rights or any other business or commercial rights of similar nature .• Can DCF or Future Earnings (Royalty based ) be used for valuing the intangibles .
Issues & Challenges in JV• Issues in Joint venture. Consider the following case JV for New Emerging Business The JV agreement would provide 50:50 with No Investment by Foreign Partner (only brand , business capability and networking ) , hence Indian company may have to go in for premium in this structure with no options.• Can Indian company invest through a Foreign JV instead of Indian JV ( Round Tripping issues) (Substance over form )• Can it invest in Indian company through Compulsory Convertible Debentures (CCD) Indian Company UK Company Strategic Investor Business Capability & Brand- Nominal investment Joint Venture to do Business in India 50:50
Issues & Challenges-U/s 56(viib)• When CCD is converted to equity . FMV comparison to be made The issue is whenthe valuation to be done, On issue of original instruments or on the date of conversion.? (Refer Valuation date as per Rule 11U)• Date of valuation when loan is converted into equity?• Will provisions of Sec 56(viib) applicable to issue of preference shares / convertiblepreference shares ? ( Definition of Share specified sec 2(47) Of The companies act : A share includesequity as well as preference. Hence preference shares also covered in this section.)• What is the valuation method for preference shares? As specified in 11 UA of IT rules any securities other than equity shares in a companywhich are not listed shall be estimated to be the price it would fetch if sold in the openmarket on the valuation date.
What is Open Market Value?- Market Value is defined as followsMarket Value is the estimated amount for which a property should exchange onthe date of valuation between a willing buyer and a willing seller in an arm’s lengthtransaction after proper marketing wherein the parties had each actedknowledgeably, prudently, and without compulsion.- Market based valuation Vs DCF valuation- Valuation of Prefernce shares , Compulsorily Convertible , Optional Convertibleetc.
Issues & Challenges-56(viib) Issues When Shares are issued at Differential Rights? When Shares Issued Normally Share Holders Amount Face Value Issue Price No of shares Holding Premium FMV Income Voting X 100000 10 10 10000 75% 0 20 0 75% Y 300000 10 90 3333 25% 80 20 233333 25% When Shares Issued FMV Share Holders Amount Face Value Issue Price No of shares Holding X 100000 10 10 10000 40% Y 300000 10 20 15000 60% When Shares at Differential Rights Share Holders Voting No. of Shares Holding Voting % X 1 share 4.5 Vote 45000 75% 75% Y 1 share 1 vote 15000 25% 25%Similar rights can be given in terms of Dividend Distribution and Capital Distribution
Other Issues -56(2) (viib)• Can DCF value be accepted to the satisfaction of Assessing Officer?• DCF related valuation issues : - Existence of Different Future Cash Flows - Pre Money Value or Post Money Value - Projections Vs History• Set of off Carry forward Loss for income u/s 56(2) (viib) : Business Loss Vs Depreciation Loss• MAT vis a vis Sec 56(viib) Income• Can it be routed through alternative investment fund?• Valuation under FEMA for Non Resident Investment Vs Valuation u/s 56(2)(viib) for Residents
Structures using 56(2)(viib)• Issue of shares instead of writing of loan payable-MAT, Capital Loss etc.• Change in Control to Defacto Promoter and issue of shares to investors at Premium (56(2)(viib) and (viia)
Amendments - Venture Capital• Section 10(23FB) provides that income of venture capital fund (VCF) and venture capital company (VCC) is exempt from tax, provided the venture capital undertaking (VCU) is engaged in the following specified businesses: - – Nanotechnology; – Information technology relating to hardware and software development; – seed research and development; – bio-technology; – research and development of new chemical entities in the pharmaceutical sector; – production of bio-fuels; – building and operating composite hotel-cum-convention centre with seating capacity of more than three thousand; – developing or operating and maintaining or developing, operating and maintaining any infrastructure facility as defined in the Explanation to clause (i) of sub-section (4) of section 80-IA; – dairy or poultry industry.• We can see below a total of $762 Million across 206 deals in 2012, the major investment happened in IT/ITES (50%) sector and healthcare, since IT sector and health sectors were included in the exempt list, these sectors are boosted with the funds. VC Investments IT/ITES Health Care Other
Impact on Venture Capital• It is amended by Finance Act 2012, section 10 (23FB) by removing the sectorial restriction in which VCU is required to carry on its business.• Therefore, it is amended that income of eligible VCU’s carrying on activities other than the ones earlier specified under section 10 (23FB) will not be taxable.• The amendment in section 10 (23FB) seeks to do away with restrictions on the activities which a VCU can carry out and instead all activities permitted by the relevant SEBI guidelines.• Doing away with restrictions on areas of business of VCU would help in attracting the VC investments in various sectors which are in the need of funding. – This is a good movement to encourage the venture capital funds to invest across the industries with no restriction for exempt from tax.• In Finance bill 2013 this exemption has been extended even to category 1 alternative Investment fund registered Venture capital fund. This is applicable where it is not listed, 2/3rd of its investible funds are invested in unlisted securities and where their directors or related parties do not hold more than 10% equity i n companies where they invest.
Impact on Venture CapitalIt is also amended that to section 115U to provide that :• Income accruing to VCF/VCC shall be taxable in the hands of investor on accrual basis with no deferral. Earlier the income was taxed in the hands of the investor on receipt basis and not on accrual basis.• The exemption from applicability of TDS provisions on income credited or paid by VCF/VCC to investor continues.• Amendments in section 115U are aimed at preventing deferral of tax by taxing the income in the hands of investor on accruals basis which will now be subject to TDS as may be applicable.Impact of the Amendment Before Amendment After AmendmentThe VC’s were taxed on receipt basis, hence Now due to introduction of accrual taxationthe funds were rotated and tax was deferred. rotation of funds would be stopped since the VC would withdrawn the funds.
Alternative Investment Fund Regulations• A group of angel investors or high net worth individuals would form a VCC/VCF, and this should be registered with the SEBI.• The SEBI AIF Regulations 2012 even make it difficult for angel investors to register as VC Funds with it.• The minimum fund size increased from INR 5 Crores to INR 20 Crores .• The minimum amount that can be accepted from an investor from increased from INR 5 lakh to INR 1 crore.• Can the issue of 56 (2) (viib) be solved through the AIF ?.
Dividends – 115BBD• As a result of diversification the Investors invested abroad through creating subsidiary companies abroad, and the investors continue to remain invest in abroad with accumulated funds instead of repatriation which would result full rate of tax.• This provision was introduced as an incentive for attracting repatriation of income earned by residents from investments made abroad.• Section 115BBD of Income Tax Act provides for taxation of gross dividends received by an Indian company from a foreign subsidiary ( shareholding of 26% or more) at the rate of 15% .• In Finance Act 2012 the above section was amended to extend the benefit for one more year.• And as well in Finance Bill 2013 it is proposes to continue the benefit for one more year and will apply in relation to the AY 2014-15.
Dividends - Removal of Cascading Effect - 115 O• As each company has to pay DDT on distribution of dividend, there can be a cascading tax effect on essentially the same income in a multi-layered corporate structure.• To remove the cascading effect the law was amended from July 1st 2012 in the hands of multi layered corporate structure. Under this provision was not extended to holding cum subsidiary companies.Thus there still remained a cascading effect of tax, though to a lesser extent.• To remove this cascading effect an amendment is brought into by the Government. As per the amendment even if the company is a subsidiary of any other company, it can still get the benefit of deduction of dividend received from its own subsidiary. This removes the cascading effect of DDT H Ltd S1 Ltd S2 Ltd Dividend Rs.150 Dividend Rs.120 Dividend Rs.100 H is the main holding company. S1 is the subsidiary of H & S2 is a subsidiary of S1. Sl.No. Particulars After Amendment Before Amendment 1 DDT to be paid by S1 ltd. 15 15 (Rs. 100 * 15/100) 2 DDT to be paid by S2 ltd. 3 18 New - (Rs. 120 - Rs. 100) * 15/100 Old - (Rs. 120 * 15/100) 3 DDT to be paid by H ltd. 4.5 4.5 (Rs. 150 - Rs. 120) * 15/100 Total DDT paid by group companies 22.5 37.5
Lower Tax rate for Non Residents –Sec 112(1)(c ) (iii)• s. 112(1) Where the total income of an assessee includes any income, arising from transfer of a long-term capital asset, which is chargeable under the head ‘Capital gains’, the tax payable by the assessee on the total income shall be aggregate of : a) ……. b)….. C) in the case of a non-resident (not being a company) or a foreigncompany (i)… (ii)… (iii) the amount of income-tax on long-term capital gains arising fromtransfer of a capital asset, being unlisted securities, calculated at the rate often per cent on the capital gains in respect of such asset as computed withoutgiving effect to the first and second proviso to section 48.
Lower Tax rate for Non Residents –Sec 112(1)(c ) (iii)• The intention behind this amendment is clearly to provide the benefit of 10 per cent tax rate to all non-resident investors, specifically including private equity (‘PE’) investors. This intention has been clearly spelt out in the opening remarks made by the then Finance Minister Shri Pranab Mukherjee at the beginning of the discussion on the Finance Bill 2012• The expression “securities” has been defined as under:“Explanation – the expression ‘Securities’ shall have the meaning assigned to it inclause (h) of section 2 of the Securities Contracts (Regulations) Act, 1956 (32 of 1956)”• In SCRA: Section 2(h) - Securities include – shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;• ……………” (emphasis supplied)
Expansion in scope of Transfer Pricing applicability [Section 92B] Section 92B : An explanation is inserted with retrospective effect from 01.04.2002 to clarify the meaning of the expression “ International Transaction “.The Expression “ International Transaction” shall include –• A transaction of Business restructuring or reorganization, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income ,losses or assets of such enterprises at the time of the transaction or at any future date. This has been done in light of recent judicial precedents in Goodyear Tire and Rubber Company  11 taxmann.com 43 (AAR) Dana Corporation  186 Taxman 187 (AAR) Amiantit International Holding Ltd  189 Taxman 149 (AAR)Facts : 1.Transfer of shares from Indian company to foreign company is without consideration 2. As the full value consideration received on transfer of shares of Indian co. is Nil the mechanism to charge the capital gains to tax, as provided under Section 48 of the Act fails. 3. Since there is no income chargeable under the ITA, the transfer pricing provisions also cannot be made applicable.• Capital Financing, including any type of long term or short term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business.
Transfer PricingSection 92BA – Specified Domestic Transaction“specified Domestic transaction in case of an assessee means any of the following transaction, not being an international transaction,• Any expenditure in respect of which payment has been made or is to be made to a person referred to in section 40(2) (b).• Any transaction referred to in section 80A.• Any transfer of goods or services referred to in sub – section 8 of 80 –IA.• Any business transaction between the assessee and other person as referred to in sub section 10 of 80 – IA.• Any transaction, referred to in any other section under chapter VI-A or section 10AA to which provisions of sub section 8 & 10 of 80 –IA are applicable• Any other transaction as may be prescribedAnd where the aggregate of such transaction entered into by the assessee in the previous yearexceeds a sum of 5 crore rupees.
Transfer Pricing Intent of Indian TP Regulations… (Domestic transactions)India Shifting of expenses/losses India Indian Co. Related Enterprise in Tax Holiday Domestic Tariff Area undertaking (DTA) Tax Exemption Tax @32.45% Shifting of income/profits Tax Saving for the Group – Loss to Indian revenue
Transfer Pricing Intent of Indian TP Regulations…(Domestic transactions)Particulars (Ordinary Situation) Co. X (SEZ) Co. Y (DTA)Income 500 1000Income from related party 100 -Expenses 300 800Expense to related party - 100Profit/ Loss 300 100Tax rate applicable 0% 32.45%Tax - 32.45 (100*32.45%)Particulars (Planned Situation) Co. X (SEZ) Co. Y (DTA)Income 500 1000Income from related party 200 -Expenses 300 800Expense to related party - 200Profit/ Loss 400 -Tax rate applicable 0% 32.45%Tax - NIL – Loss to Revenue Tax saving to the group
Transfer Pricing Intent of TP Regulations… (Domestic transactions)India Shifting of expenses India Indian Co. Related Enterprise Loss making Profit making Tax @ 32.45% Tax @ 32.45% Reduced tax due to No tax or reduced tax due to loss shifting of profits Shifting of income Tax Saving for the Group – Loss to Indian revenue
Transfer Pricing Intent of TP Regulations… (Domestic transactions) Particulars (Ordinary Situation) Co. X (DTA) Co. Y (DTA) Income 500 1000 Income from related party 100 - Expenses 700 800 Expense to related party - 100 Profit/ Loss (100) 100 Tax rate applicable 32.45% 32.45% Tax - 32.45 (100*32.45%) Particulars (Planned Situation) Co. X (DTA) Co. Y (DTA) Income 500 1000 Loss to Revenue & Income from related party 150 - tax saving to the Expenses 700 800 group Expense to related party - 150 Profit/ Loss (50) 50 Tax rate applicable 32.45% 32.45% Tax - 16.23 (50*32.45%)* By shifting of income from a profit making company to a loss making company, the group could reduce its tax liability by 16.23 for thecurrent year, though the impact will be reversed in future years given carry forward of losses.
Transfer Pricing Overview of Provisions of Section 92BA Inter unit transfer of goods & services by undertakings to which profit-linked deductions apply Expenditure incurred Any otherbetween related transaction that SDTparties defined may be under section specified 40A Transactions between undertakings, to which profit- linked deductions apply, having close connection
Transfer PricingSec. 92 C – Computation of ALPThe words “specified domestic transaction” has been inserted appropriately in various sub-sec.(1) Any of the following methods, being most appropriate method : (a) Comparable uncontrolled price method; (b) Resale price method; (c) Cost plus method; refer rule 10B (d) Profit split method; (e) Transactional net margin method; (f) other method of determination of arm’s length price(any method that takes in to account the price which has been charged or paid or would have beencharged or paid for same or similar uncontrolled transaction with or between non – associatedenterprises) (2) Most appropriate method as per criteria laid down in rule 10C considering FAR analysis also.FAR : Functions performed, Assets employed, Risks assumed [Rule 10C(2)]
Transfer PricingTax Payers covered under Specified Domestic TransactionAny taxpayer incurring any expenditure with specified domestic related parties arerequired to comply with the regulations.Which other tax payers are covered under Specified Domestic Transactions? Location based Undertakings having a unit in a Special Economic Zone – Sec 10AA tax holiday Undertakings located in industrial backward district (Jaisalmer in Rajasthan, Bhojpur in Bihar, etc) – Sec 80-IB Undertakings located in Himachal Pradesh, Uttaranchal, or notified areas in North Eastern States (Assam, Tripura, etc) – Sec 80-IC Undertakings engaged in business of hotel/ convention centre in specified areas/ districts – Sec 80-ID Sector based tax Generation/ transmission or distribution of power or developing, operating, maintaining of infrastructure holiday facilities, etc – Sec 80-IA Company/companies engaged in refining oil, undertakings engaged in developing and building housing projects, etc – Sec 80-IB
Service TaxFinance Act 2012 introduced Negative List by which many transactions that may not have been under ambit of Service Tax has also come under Service TaxService tax may arise in the following cases:• On contingent payouts ( Payments to be made on achieving benchmark levels)• For non - compete fee• Domain Name of the Business• Assignments of contracts• Any other settlements
Section 43CA – Immovable property held as Stock in Trade Investors Builder Land as Transfer As Sale of asset through SPV stock SPV Buyer stock • The provisions contained in Sec. 50C could not have been applied to transfer of land or building or both which are stock in trade. • It is proposed to provide by inserting a new section 43CA that where the consideration for the transfer of an asset (other than capital asset), being land or building or both, is less than the stamp duty value, the value so adopted or assessed or assessable shall be deemed to be the full value of the consideration for the purposes of computing income under the head “Profits and gains of business of profession”. • Date of agreement to fixing the value of consideration for transfer of the assets & the date of registration of the transfer of the asset are not same, the stamp duty value may be taken as on the date of the agreement for transfer and not as on the date of registration for such transfer. ( This part is applicable only when consideration(in part or full) received in other than cash) • As affect of this, the projects which are already started before this amendment but not completed, would go under this section without any option.
Section 43ca – Immovable property held as Stock in Trade Key Issues • Can difference between fictional value and consideration be treated as business loss ? • Whether 43CA can apply to slump sale? • Whether applicable in cases of transfer of business undertakings? • Whether 43CA can apply to transfer of Stock in Trade to Partnership firm? • 43CA value vis a vis Percentage completion method?
Higher Rate of TDS on Royalties & FTS for Non-Residents• Section 195 of the Income Tax Act, 1961 states that: The income earned by non-residents in the form of royalties, technical fees etc. is subjected to TDS by the person who is responsible to make such payment to the non-resident Assessee.• For the rate we refer to the section prescribed for the same i.e. Section 115A.• It is proposed to increase the TDS rates of payments made to non residents in the nature of “Royalties” and “Fees for Technical Services” from 10% to 25%.• However where there is a tax treaty and the rates as specified in the treaty is lower the beneficial rate can be adopted.• TRC avilability more important now• TDS rate till FA bill 2013 gets assent of President?
Lower Rate of Tax on Foreign Company Dividends Foreign Dividends Indian Distribution No DDT u/sCompany Company 115 O Tax @ 15 % The Finance Bill, 2013 proposes to extend the concessional tax rate of15% (plus surcharge of 10% and education cess of 3%) on dividendreceived from specified foreign company for one more year i.e. for thefinancial year ending 31 March 2014. Further, it is to be noted that anydividend distributed by the Indian company in the same year, to the extentof dividends received from the foreign company, shall not be subject toDividend Distribution Tax.
Tax on Buy Back of shares by unlisted domestic companyWhy Buy Back is more favorable than Dividend ? (for non resident investors) Indian Company Profits DDT by Dividend Capital Gain Tax byIndian Co. Buy Back Non Resident Distribution Tax Credit on Buyback No Tax Credit on DDT is Available in Resident in Resident Country Country Nil or nominal tax Results Tax outflow outflow
Tax on Buy Back of shares by unlisted domestic company• Under the existing provisions of the income tax buy back of shares would result into capital gains in India, however in case of a non –resident shareholder the tax treaty provisions would apply to the extent they are more favorable.• Typically, under the tax treaties entered into with Mauritius, Cyprus and Singapore capital gains is not taxable in India, and these countries do not levy capital gains under their domestic laws.• Consequently, buy back of shares may not be subject to tax in India or in the foreign country . This route has been commonly used by non-residents to mitigate the dividend distribution tax.• In Finance Bill 2013-14, a new chapter titled Chapter XII-DA special provisions relating to tax on distributed income of domestic company for buyback shares is proposed to be inserted.
Tax on Buy Back of shares by unlisted domestic company• Accordingly, besides the standard corporate income tax will be charged on any amount of distributed income of unlisted companies. The company implementing the buy back scheme shall be liable to pay the taxes at the rate of 20% on the difference between consideration received by the shareholder on buyback as reduced by the amount received by the company for issue of such shares.• With this new proposal the shareholder is exempt from tax on such capital gains [Section 10(34A)].• Hence the non –resident shareholders shall be liable to get taxed in India.
Tax on Buy Back of shares by unlisted domestic companySection 115QA defines distributed income “the consideration paid by thecompany on buy back of shares as reduced by the amount which received bythe company for issue of such shares”.Case 1 - Determination of Distributed Income When shares issued at par Face Value Issue Price Buy Back Distributed Income Tax @ 22.66% Rs. 100 Rs.100 Rs.1000 Rs.900 Rs.204Case 2 - Determination of Distributed Income When shares issued at premium Face Value Issue Price Buy Back Distributed Income Tax @ 22.66% Rs.100 Rs.250 Rs.1000 Rs.750 Rs.170
Tax on Buy Back of shares by unlisted domestic company Case 3 - Determination of Distributed Income When shares are transferred Issue Price Transferred at Buy Back Distributed Income Tax @ 22.66% Rs.100 Rs.500 Rs.1000 Rs.900 Rs.204 ( In the above case we can observe that the distributed income will be calculated using the original issue price and not the transferred price since the original issue price was received by the company for issue of such shares.) Case 4 - Determination of Distributed Income When shares issued through conversion of other instruments Issue Price of Conversion Price Buy Back Distributed Income Tax @ 22.66%Original Instrument Rs. 100 Rs.300 Rs.1000 The issue in the above case – 4 whether to consider original issue price or conversion price?
Tax on Buy Back of shares by unlisted domestic company1. Will Non – Resident shareholders get tax credit in foreign country ? A mechanism to claim in the foreign country may be explored. This could be evaluated either in terms of provisions of underlying tax credit under certain tax treaties or depending on the domestic tax laws of the non – residents.2. Where the issue price is high will Buy Back Tax be better than DDT3. BBT does not consider Basic exemption, carry forward loss, specified exemptions like 54EC, 54F etc
Tax on Buy Back of shares by unlisted domestic companyWill Buy Back Tax be better than DDT? Case -1 Issue Price Rs. 10 Available Surplus Rs. 50 When Dividend is Paid When Buy Back Dividend Paid Tax @ 16.22% Distributed Income Tax @ 22.66% 50 8.11 40 9.1 In the above case Dividend is better as tax outflow is lower. Case -2Issue Price Rs. 35Available Surplus Rs. 50 When Dividend is Paid When Buy Back Dividend Paid Tax @ 16.22% Distributed Income Tax @ 22.66% 50 8.11 15 3.4 In the above case Buyback is better option as low tax outflow
Tax on Buy Back of shares by unlisted domestic company1. Impact on investment by Realty Fund in Projects2. Any Alternates : - Capital Reduction ( Deemed Dividend & Capital Gains) - Third Party buy out - Promoter buy out ( funding issue?)