Investments in India:  State of the Art and Law Nishith M Desai  Nishith Desai Associates Legal and Tax Counseling Worldwi...
<ul><li>  Are we headed towards a ‘Digital Divide’?   </li></ul>
<ul><li>Worlds largest democracy </li></ul><ul><li>GDP growth rate for 2006-07: 9.2% </li></ul><ul><li>Rising young popula...
<ul><li>Science of investments into India </li></ul>
USA India
<ul><li>Art of investments into India </li></ul>
 
Key Considerations Tax Law Strategy Environment Operations Exchange Control  Corporate Domestic Treaty
<ul><li>How do we Invest? </li></ul>
Investment Regime <ul><li>Foreign Direct Investor (FDI)  </li></ul><ul><li>Foreign Institutional Investor (FII)‏ </li></ul...
FDI <ul><ul><li>100% foreign investment permitted in almost 95% sectors on automatic basis except: </li></ul></ul><ul><ul>...
Investment Management Agreement Cayman Co  Delaware LLC U.S. taxable investors Investment SPV Investment  SPV / JV FDI / F...
Types of Instruments   Compulsorily Convertible    - FDI  Equity  Preference Shares  Compulsorily Convertible  - FDI  Opti...
FII <ul><li>Primarily used for investing into public securities </li></ul><ul><li>Holding up to 10% of the company </li></...
NRI Regime <ul><li>Press Note 2 (2005) restrictions on real estate not applicable to NRI’s </li></ul><ul><li>NRI’s can acq...
<ul><li>What are entity options in India? </li></ul>
Entity Options Foreign Investor Investment   Unincorporated entity Incorporated entity Company India Project Office  Branc...
Entity Options; New Vehicles <ul><li>India is proposing to introduce a Limited Liability Partnership regime. The LLP legis...
<ul><li>Taxes - </li></ul><ul><li>Is India  </li></ul><ul><li>backtracking?   </li></ul>
<ul><li>Domestic company : 33.99%;  </li></ul><ul><li>Foreign company : 42.23% </li></ul><ul><li>Dividend distribution tax...
Flow of Dividends  Tax Treatment in India 49.31 = Dividends distributed to Shareholder 10.10 Less : Dividend Distribution ...
Flow of Dividends to US # Underlying tax credit may not be available in the US for US resident individuals and corporate s...
<ul><li>How do you mitigate the Indian tax impact? </li></ul><ul><li>Push Debt into Indian Company </li></ul>
<ul><li>Can you push Debt into Indian company? </li></ul>
<ul><li>No!   </li></ul><ul><li>Unless you comply with External Commercial Borrowings Guidelines under Exchange Control La...
<ul><li>Eligible Borrower  – Any company, except an NBFC </li></ul><ul><li>Eligible Lender  – 25% Equity Shareholder or an...
<ul><li>What about tax on interest? </li></ul>
<ul><li>On monies lent in Foreign currency – 21.115%  </li></ul><ul><li>On Foreign Currency Convertible Bonds – 10.558% </...
<ul><li>How do you reduce tax on interest? </li></ul>
<ul><li>Consider Cyprus </li></ul><ul><li>Tax Rate reduced to 10% </li></ul><ul><li>Use Cyprus for equity too?   </li></ul>
Capital Gains   ^These rates are exclusive of the currently applicable surcharge on tax and education cess * Long term cap...
<ul><li>Potential double taxation of capital gains tax in the US due to systemic differences....  Credit for Indian tax pa...
<ul><li>How do you avoid double taxation on Capital Gains? </li></ul>
<ul><li>USE: </li></ul><ul><li>Mauritius </li></ul><ul><li>Cyprus (?)‏ </li></ul><ul><li>Singapore </li></ul><ul><li>Or Ne...
Flow of Funds into India * * dipp.nic.in/fdi_statistics/india_fdi_dec_2006.pdf
<ul><li>Venture Capital Funds </li></ul>
<ul><li>Alternative 1: Pure Domestic and Offshore Structures </li></ul>TAX STRUCTURING… Fund (VCF)‏ VCU Trustee Manager VC...
Alternative 2: Unified Structure VCU Manager VCF Trustee Offshore  Investors Fund Domestic Investors Treaty Jurisdiction O...
Alternative 3: Co-investment Structure Advisor / Manager VCF Trustee Domestic Investors Manager Fund VCU Offshore Investor...
<ul><li>How are Earn-outs taxed?   </li></ul>
Taxation of Earn – Outs   Acquiring Co Target Founder-employees ACQUISITION   Earn out payments Purchase Price
Taxation of Earn Outs <ul><li>Surge in M & As - ‘Earn outs’ becoming a popular mode of making payment </li></ul><ul><li>Co...
Taxation of Earn Outs… <ul><ul><li>In Re Anurag Jain </li></ul></ul><ul><ul><ul><li>Share Purchase Agreement - Considerati...
<ul><li>How do you flip a US Parent with an Indian subsidiary?   </li></ul>
Flipping a structure: Inversion   US Parent India   Sub US INDIA 100% Founders Employees VCs Others Current structure
Flipping a structure: Inversion Significant US Tax Impact US Sub India Parent US INDIA 100% Founders Employees VCs Others ...
www.nishithdesai.com Any [email_address]
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Investments In India State Fo Art And Law

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Investments In India State Fo Art And Law

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