C h a l l e n g e  U s
Mukesh Butani  November 17, 2005 Cross border transactions
Agenda  <ul><li>Key tax and financial considerations </li></ul><ul><li>Income stream </li></ul><ul><li>Entry strategy </li...
Cross border transaction imperatives Cross Border Transactions Legal & regulatory framework Identifying and delivering syn...
Key tax and financial considerations
Key tax and financial considerations  Cross border transactions  Exit considerations Cash repatriation Debt Structuring  I...
Income stream and their taxability  Others: royalty / brand fees / technical services / management services Dividends Capi...
Comparison between various tax regimes *DDT @ 14.025%  Note Nil in case of transfer of shares by one non-resident to anoth...
Entry strategy  2 US Parent WOS/ Branch Direct investment US Parent European / Netherlands sub WOS/ Branch Step down inves...
Financing options <ul><li>No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets com...
Debt structuring  <ul><li>Internationally recognized sources (international banks, capital markets, multilateral financial...
Cash repatriation  Dividend distribution Broad mechanics of each of the above options have been discussed in detail in Ann...
Exit considerations  Capital gains Shareholder’s agreement and implications thereof –  Right of First Refusal; Tag Along r...
Case study – business reorganization
Case Study – acquisition of business US Corp <ul><li>Global conglomerate engaged in diversified businesses  </li></ul><ul>...
Overview of the structure  *Consider Singapore jurisdiction  Mauritian Co* Target Co (Foods)‏ 43% US Corp (conglomerate)  ...
Case study - modes of acquisition Increase in stake <ul><li>Acquisition of shares </li></ul><ul><li>Merger </li></ul><ul><...
Phase I - Mechanics of merger  Mauritius  Co Post Merger Foods & Packaging  43% Target Co Indian Partner 57% 100% 51% 49% ...
Phase II – Sale and license back of trademark Mauritian Co Target Co Mauritius India Sale of trademark – capital gains Lic...
Leasing transactions
Salient features of leasing transactions  <ul><li>Lease of equipment with resources to operate the equipment </li></ul><ul...
Operating Lease vs. Finance Lease Lessor is the legal and the economic owner <ul><li>Lessor is the legal owner </li></ul><...
Taxation of leases – domestic law <ul><li>Lessor   </li></ul><ul><li>Royalties  - Section 9(1)(vi)  </li></ul><ul><li>Or <...
Taxation of leases – treaty law  <ul><li>Article 12 Royalties includes consideration for use of equipment  </li></ul><ul><...
Thank you
Annexure 1
Cash repatriation strategies  <ul><li>Can be paid from current year profits subject to transfer to reserves </li></ul><ul>...
Cash repatriation strategies (contd)‏ <ul><li>Board/ shareholder approvals required </li></ul><ul><li>Court/ creditor appr...
Cash repatriation strategies (contd)‏ <ul><li>Board approval if buyback is less than10% of total paid-up equity capital an...
Cash repatriation strategies (contd)‏ <ul><li>Under exchange control regulations, cap on per share amount payable on buyba...
Annexure 2
Regulatory compliances  No Objection Certificate from Indian partner has been a key negotiation point for foreign company ...
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Cross Boarder Transactions Written By Mukesh Bhutani Good Learning

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  • Cross Boarder Transactions Written By Mukesh Bhutani Good Learning

    1. 1. C h a l l e n g e U s
    2. 2. Mukesh Butani November 17, 2005 Cross border transactions
    3. 3. Agenda <ul><li>Key tax and financial considerations </li></ul><ul><li>Income stream </li></ul><ul><li>Entry strategy </li></ul><ul><li>Financing options </li></ul><ul><li>Debt structuring </li></ul><ul><li>Cash repatriation </li></ul><ul><li>Exit considerations </li></ul><ul><li>Case Study </li></ul><ul><li>Business reorganisations </li></ul>Transaction imperatives <ul><li>Leasing transactions </li></ul>
    4. 4. Cross border transaction imperatives Cross Border Transactions Legal & regulatory framework Identifying and delivering synergies Tax regimes & treaties Business Dynamics Business Environment Cultural Issues Accounting treatment
    5. 5. Key tax and financial considerations
    6. 6. Key tax and financial considerations Cross border transactions Exit considerations Cash repatriation Debt Structuring Income flows and their taxability Entry Strategy Financing options 1 2 3 4 5 6
    7. 7. Income stream and their taxability Others: royalty / brand fees / technical services / management services Dividends Capital gains Interest <ul><li>Interest, TS and royalty can flow independent of ownership pattern </li></ul><ul><li>TS and royalty would typically flow to an operating entity, which possess technical capabilities </li></ul><ul><li>Principal drivers are tax costs associated with dividend flows and gains on disposal of shares </li></ul><ul><li>Brand fee would flow to the IPR company </li></ul>Income streams Principles for evaluation 1 Key elements – arm’s length principle, documentation, overall tax costs and foreign tax credits
    8. 8. Comparison between various tax regimes *DDT @ 14.025% Note Nil in case of transfer of shares by one non-resident to another non-resident Jurisdiction Mauritius Dividends Nil* Nil* Nil* Capital gains on disposal of shares Nil Nil Note Interest 0 / 20.91% 10% 10% Royalty 10.46% 10.46% 10.46% Cyprus Netherlands Nature of Income Nil* Nil 10% 10% Singapore Nil* As per Indian tax Laws 0/10/15% 10/15/20% USA 1
    9. 9. Entry strategy 2 US Parent WOS/ Branch Direct investment US Parent European / Netherlands sub WOS/ Branch Step down investment Overseas India US Parent Singapore / Mauritius sub WOS/ Branch Double step down investment European / Netherlands sub
    10. 10. Financing options <ul><li>No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets commercial requirements </li></ul><ul><li>Leveraging Indian company using overseas debt subject to restrictions in ECB Guidelines (see next slide)‏ </li></ul>3 Dividends and DDT not deductible; consider double dip deduction Interest allowed as deduction (arm’s length principle)‏ Dividends and DDT not deductible Deductibility Not available under most Treaties (check domestic laws of home country)‏ Tax withholding on interest available Not available under most Treaties (check domestic laws of home country)‏ Tax credit Dividend Interest Dividend Pay outs No restrictions Restriction on usage as per ECB guidelines (see next slide)‏ No restrictions Usage DDT payable @ 14.025% Long Tem Equity DDT would be payable @ 14.025% Withholding tax @ 0 / 10 / 15 / 20% Tax rate Medium to long term Medium to long term Term Quasi Debt (Preference stock – mezzanine instrument )‏ Debt (related & third party)‏ Parameters
    11. 11. Debt structuring <ul><li>Internationally recognized sources (international banks, capital markets, multilateral financial Institutions, equipment suppliers, foreign collaborators)‏ </li></ul><ul><li>Foreign equity holder if: </li></ul><ul><ul><li>ECB up to 5 MUSD – minimum equity of 25% </li></ul></ul><ul><ul><li>ECB above 5 MUSD – minimum equity of 25% and debt-equity ratio not exceeding 4:1 </li></ul></ul><ul><li>Upto 20 MUSD – Minimum average maturity of 3 years, can have call / put option </li></ul><ul><li>Over 20 MUSD to 500 MUSD – Minimum average maturity of 5 years </li></ul><ul><li>ECBs outside the above limits/ maturity period need specific approval </li></ul><ul><li>Investment in real sector (capital goods, new projects, modernization/ expansion of units)‏ </li></ul><ul><li>Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)‏ </li></ul><ul><li>Not to be utilized in capital market transactions, real estate, acquisition, working capital, repayment of Rupee loans </li></ul><ul><li>ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR </li></ul><ul><li>ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR </li></ul><ul><li>ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum average maturity period </li></ul>Lenders End use Total cost of debt Amount/ maturity Prepayment 4 MUSD means million United States Dollars
    12. 12. Cash repatriation Dividend distribution Broad mechanics of each of the above options have been discussed in detail in Annexure 1 Simplest and most common Suitability <ul><li>Profit making company </li></ul><ul><li>Ease of repatriation </li></ul>Capital reduction Court regulated process, involving repayment of share capital – comparatively complex and time consuming – amount paid to the extent of accumulated profits of the company would be taxable as dividend in India <ul><li>Cash rich company with low reserves </li></ul><ul><li>Loss making company with cash reserves </li></ul><ul><li>Maximum amount of repatriation desired </li></ul>Share buyback Repurchase of shares – restricted amount of repatriation – income taxable as capital gains in hands of the shareholder <ul><li>Profit making company </li></ul><ul><li>Foreign Co desires to classify the income as ‘capital gains’ instead of ‘dividend’ – possible treaty benefits </li></ul>5
    13. 13. Exit considerations Capital gains Shareholder’s agreement and implications thereof – Right of First Refusal; Tag Along rights; Drag Along rights No Objection Certificate requirement for setting up new venture – Press note 1 of 2005 (refer Annexure 2 for process)‏ Liquidation process – long drawn and Court approval process 6
    14. 14. Case study – business reorganization
    15. 15. Case Study – acquisition of business US Corp <ul><li>Global conglomerate engaged in diversified businesses </li></ul><ul><li>Aggressively targeting Asian foods markets </li></ul><ul><li>Has significant experience in the foods business and commands a powerful brand name </li></ul>Target Co Indian Indian Partner <ul><li>Controls significant share of the Indian foods market </li></ul><ul><li>Leading exporter to Asia </li></ul><ul><li>Strong track record and substantial reserves </li></ul>Mauritian Co <ul><li>US Corp’s strategic holding company for Asian investments </li></ul><ul><li>Has a wholly owned Indian subsidiary, F&P, engaged in two businesses - foods and packaging </li></ul><ul><li>F&P has accumulated tax losses </li></ul><ul><li>Leading Indian company (not part of US Corp group)‏ </li></ul><ul><li>Holds majority equity in Target Co </li></ul>
    16. 16. Overview of the structure *Consider Singapore jurisdiction Mauritian Co* Target Co (Foods)‏ 43% US Corp (conglomerate) 100% USA Mauritius India Foods & Packaging 100% Case Study to suggest mechanism to achieve business objectives of US Corp & Indian Partner <ul><li>Phase I </li></ul><ul><li>Asian strategy - acquire control of Target Co </li></ul><ul><li>Foods business of F&P to be consolidated with Target Co </li></ul><ul><li>Phase II </li></ul><ul><li>Target Co sells trademark to US Corp </li></ul><ul><li>US Corp licenses trademark to Target Co </li></ul><ul><li>US Corp receives royalty </li></ul><ul><li>Redefining strategy </li></ul><ul><li>Focus on core business - auto ancillary </li></ul><ul><li>Exit non-core business </li></ul>US Corp Indian Partner Business strategy 57% Indian Partner Auto ancillary
    17. 17. Case study - modes of acquisition Increase in stake <ul><li>Acquisition of shares </li></ul><ul><li>Merger </li></ul><ul><li>Demerger </li></ul><ul><li>Sale of business undertaking/ sale of assets </li></ul>Direct increase Passive increase Business restructuring <ul><li>Preferential allotment of shares </li></ul><ul><li>Capital reduction of identified shares </li></ul><ul><li>Share buyback </li></ul>The case study however discusses the implications arising under the merger option, in detail in following slides
    18. 18. Phase I - Mechanics of merger Mauritius Co Post Merger Foods & Packaging 43% Target Co Indian Partner 57% 100% 51% 49% Present scenario Company Law Implications Tax Implications Other Implications <ul><li>Special resolution </li></ul><ul><li>Court approved process </li></ul><ul><li>Dissolution of F&P under Court order without winding up </li></ul><ul><li>Broadly tax neutral on satisfying conditions </li></ul><ul><li>Transfer of tax losses and tax benefits of F&P </li></ul><ul><li>Tax losses available for fresh lease of 8 years </li></ul><ul><li>Stamp duty costs significant </li></ul><ul><li>Valuation of companies </li></ul><ul><li>No foreign investment approvals, subject to conditions </li></ul><ul><li>No cash outflow for Mauritian Co </li></ul><ul><li>No consideration to Indian Partner on indirect dilution of its stake </li></ul>Fiscal and regulatory implications of merger Issue of shares to Mauritius Co. as consideration of food business Merger
    19. 19. Phase II – Sale and license back of trademark Mauritian Co Target Co Mauritius India Sale of trademark – capital gains License of trademark – royalty income Target Co transfers its Trademark (‘TM’) to Mauritian Co. Subsequently Mauritian Co licenses TM back to Target Co Mechanics 51% Arm’s length nature of sales and licensing of trademark May entail service tax and Value Added Tax
    20. 20. Leasing transactions
    21. 21. Salient features of leasing transactions <ul><li>Lease of equipment with resources to operate the equipment </li></ul><ul><li>Lessor continues to control the operation of the equipment and its maintenance </li></ul><ul><li>Example– Lease of an aircraft along with flight crew; lessor responsible for selection/ hiring of flight crew, operation and maintenance of aircraft, etc </li></ul><ul><li>Lessor merely provides the equipment at a particular location </li></ul><ul><li>Lessee operates the equipment using his own resources </li></ul><ul><li>Example – Lease of aircraft without crew </li></ul><ul><li>Forms of dry lease: </li></ul><ul><ul><li>Operating lease </li></ul></ul><ul><ul><li>Finance lease (for detailed discussion, refer next slide)‏ </li></ul></ul>Wet lease Dry lease
    22. 22. Operating Lease vs. Finance Lease Lessor is the legal and the economic owner <ul><li>Lessor is the legal owner </li></ul><ul><li>Lessee is the economic owner </li></ul>Risks and rewards associated with the asset not substantially transferred Risks and rewards associated with the asset are substantially transferred Operating lease Finance lease Risks include losses due to idle capacity, technological obsolescence & changing economic conditions. Rewards include expectation of profitable operation over economic life of asset and gain from appreciation in value or realisation of residual value Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India
    23. 23. Taxation of leases – domestic law <ul><li>Lessor </li></ul><ul><li>Royalties - Section 9(1)(vi) </li></ul><ul><li>Or </li></ul><ul><li>Section 44BBA - 5% of deemed profits </li></ul><ul><li>Lessee </li></ul><ul><li>Lease rentals allowed as deduction </li></ul><ul><li>Depreciation allowed to lessor </li></ul>Dry lease <ul><li>Lessor </li></ul><ul><li>Royalties - Section 9(1)(vi)‏ </li></ul><ul><li>Or </li></ul><ul><li>Section 44BBA – 5% of deemed profits </li></ul><ul><li>Lessee </li></ul><ul><li>Resident - Lease rentals would be allowed to the lessee </li></ul><ul><li>Depreciation would be allowed to the lessor </li></ul><ul><li>Section 10(15A) – exemption from tax withholding extended </li></ul>Wet lease May entail service tax and Value Added Tax
    24. 24. Taxation of leases – treaty law <ul><li>Article 12 Royalties includes consideration for use of equipment </li></ul><ul><li>Article 7 – Business Profits applies where Article 12 does not cover payments for use of equipment </li></ul><ul><li>Klaus Vogel‘s commentary - If enterprise lets or leases facilities, equipment, buildings or intangibles to enterprise of other state without maintaining a fixed place of business for such letting or leasing activity in the other state, the lessee’s facilities, equipment, buildings or intangible property, as such, will not constitute PE of lessor, if contract limited to leasing of equipment </li></ul><ul><li>Article 8 (1) - Profits from operation of ships or aircraft in international traffic taxable only in state of residence </li></ul><ul><li>OECD Commentary of Article 8 of model tax treaty - “Profits obtained by leasing a ship or aircraft on charter fully equipped, manned and supplied must be treated like the profits from the carriage of passengers or cargo </li></ul>Dry lease Wet lease
    25. 25. Thank you
    26. 26. Annexure 1
    27. 27. Cash repatriation strategies <ul><li>Can be paid from current year profits subject to transfer to reserves </li></ul><ul><li>Dividend can also be paid out of past accumulated profits subject to a maximum limit of 10% of paid up share capital </li></ul><ul><li>Board/ shareholder approvals required </li></ul><ul><li>Generally no regulatory approvals required </li></ul><ul><li>14.025 % Dividend Distribution Tax (DDT) </li></ul><ul><li>Income exempt in recipient’s hands </li></ul><ul><li>Tax treaties with some countries provide for Underlying Tax Credit (UTC) on DDT </li></ul><ul><li>Amount restricted to positive distributable reserves </li></ul>Distribution of dividend Other issues Key fiscal costs Limitations Criteria/ Option
    28. 28. Cash repatriation strategies (contd)‏ <ul><li>Board/ shareholder approvals required </li></ul><ul><li>Court/ creditor approval required </li></ul><ul><li>Allowed without regulatory approvals from an exchange control perspective subject to certain conditions </li></ul><ul><li>Funds paid to the extent of accumulated profits (including capitalized profits) taxable as dividend (dividend tax @ 14.025 % </li></ul><ul><li>For public listed companies if Securities Transaction Tax applies, </li></ul><ul><ul><li>Long term - NIL </li></ul></ul><ul><ul><li>Short term @11.22% </li></ul></ul><ul><li>Tax rate for private companies </li></ul><ul><ul><li>Long term - 22.44% (in case of foreign company 20.91%) </li></ul></ul><ul><ul><li>Short term - 33.66% (in case of foreign company 41.82%) </li></ul></ul><ul><li>Tax withholding </li></ul><ul><li>Treaty consideration </li></ul><ul><li>Possible Stamp duty exposure @ 0.25% </li></ul><ul><li>Positive distributable reserves are not a pre-requisite </li></ul><ul><li>Capital repayment not possible at amount higher than par value of shares </li></ul><ul><li>Possible to increase cash pay out by capitalizing reserve </li></ul>Capital repayment or capital reduction Other issues Key fiscal costs Limitations Criteria/ Option
    29. 29. Cash repatriation strategies (contd)‏ <ul><li>Board approval if buyback is less than10% of total paid-up equity capital and free reserves/ shareholder approval required if buy-back more than 10% </li></ul><ul><li>Buy back price would need to be in consonance with “fair valuation principles” enunciated in transfer pricing legislations </li></ul><ul><li>Capital gains tax for shareholder on consideration less acquisition cost (after adjusting for exchange fluctuations)‏ </li></ul><ul><li>For public listed companies if Securities Transaction Tax applies, </li></ul><ul><ul><li>Long term – NIL </li></ul></ul><ul><ul><li>Short term @11.22% </li></ul></ul><ul><li>Tax rate for private companies </li></ul><ul><ul><li>Long term - 22.44% (in case of foreign company 20.91%) </li></ul></ul><ul><ul><li>Short term - 33.66% (in case of foreign company 41.82%) </li></ul></ul><ul><li>Possible stamp duty exposure @ 0.25%. </li></ul><ul><li>‘ Appropriate’ tax to be withheld by Indian Co </li></ul><ul><li>Provisions of applicable treaty to be considered </li></ul><ul><li>Amount restricted to 25 per cent of (share capital+free reserves)‏ </li></ul><ul><li>Max 25 per cent of equity share capital permitted to be repurchased in an year </li></ul><ul><li>Post buyback Debt-equity ratio not to exceed 2:1 </li></ul><ul><li>Minimum 12 months gap between two consecutive buyback </li></ul>Capital re-purchase or buyback through tender offer Other issues Key fiscal costs Limitations Criteria/ Option
    30. 30. Cash repatriation strategies (contd)‏ <ul><li>Under exchange control regulations, cap on per share amount payable on buyback is the higher of the price based `on the NAV per share linked with stock exchange or as per valuation of statutory auditor/ merchant banker </li></ul><ul><li>Disclosure in offer document, if the promoters to tender shares, for public listed companies </li></ul><ul><li>Under exchange control regulations, cap on per share amount payable on buyback is the higher of the price based on the NAV per share linked with stock exchange or as per valuation of statutory auditor/ merchant banker </li></ul><ul><li>Disclosure in offer document, if the promoters to tender shares, for public listed companies </li></ul>Capital re-purchase ie buyback through tender offer Other issues Key fiscal costs Broad time frame Limitations Criteria/ Option
    31. 31. Annexure 2
    32. 32. Regulatory compliances No Objection Certificate from Indian partner has been a key negotiation point for foreign company having existing JV relationship in India – In certain cases MNC have to sacrifice by accepting low JV exit price <ul><li>Does the Foreign company have an existing venture? </li></ul><ul><li>Is the existing venture in ‘same’ field? </li></ul><ul><li>(this includes equity holdings, technical collaboration, brand collaboration, etc)‏ </li></ul>NOC from Indian partner required Prior approval from FIPB required for financial/ technical investment in India No prior approval required – investment can be made by foreign company Yes No What do the prevailing Foreign investment regulations provide? FDI restrictions for the particular sector to apply <ul><li>NOC has been made inapplicable to past ventures as also relaxing the “allied” field condition </li></ul><ul><li>Ventures existing on January 12, 2005 would be treated as existing ventures </li></ul><ul><li>For ventures after January 12, 2005, parties are free to contractually agree a “conflict of interest” clause – accordingly, it is advisable to incorporate easy exit clause for future independence, while entering into a JV relationship </li></ul>

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