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Outbound Investments – Tax and regulatory perspectives Jatin Kanabar October 6, 2013.

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Presentation on theme: "Outbound Investments – Tax and regulatory perspectives Jatin Kanabar October 6, 2013."— Presentation transcript:

1 Outbound Investments – Tax and regulatory perspectives Jatin Kanabar October 6, 2013

2 Contents Overview and key aspects Relevant FEMA regulations Relevant tax considerations Structuring outbound investments Profit alignment Group financing company IPR holding company Concluding remarks 2

3 Overview and key aspects 3

4 Commercial reasons for outbound presence Access to newer market / product / technology/IP Expanding distribution network Raw material sourcing (Africa, SE Asia etc) Global scale of operation – Global footprint and market share Managing / spreading risk, fund raising – Overseas listing (NYSE, LSE, Luxembourg, etc) Proximity to global customer Primary reasons 4

5 Outbound deal summary Source: Grand Thorton Deal Tracker Report, Annual Addition, 2012

6 Business considerations for outbound 6 Significant business considerations Long term business outlook Administration and Compliance Cost Access to international capital markets Ease of transfer of funds Perception in international markets Exchange control regulations Foreign Regulatory aspects Political stability Commercial dispute resolution mechanism Membership of Free Trade Agreements Labour / immigration laws – ease of movement of people Cost of inputs – employee cost and operating cost Incentives made available under the local laws Availability of educated resources Technology preparedness Country blacklisted or not Liability protection

7 Key elements of outbound structuring 7 TREASURY MANAGEMENT PROFIT ALIGNMENT ATTRIBUTE MANAGEMENT Manage Foreign Exchange Cash Management & Redeployment Tax Efficient Lending OUTBOUND CFC/ Participation Exemption Planning Holding Companies Transfer Pricing Planning In-country Planning IP & Royalty Planning Foreign Tax Credit & Loss Utilisation Business & Supply Chain Planning Manage Deferral Positions

8 Relevant FEMA regulations 8

9 9 Relevant FEMA regulations (1/4) ParametersRegulations in brief Financial Commitment Total financial commitment not to exceed 100% of the net worth as on date of last audited Balance Sheet and beyond 100% cap shall require prior approval Limit of 400% will be retained for financial commitment funded by ECB Investment can be made by way of equity or equity and debt/guarantee Only debt not permitted Limitations All Indian entities are prohibited from investing in real estate and banking business under automatic route Must be engaged in bonafide business activity Investor should not be on RBI’s caution list / list of defaulters Should not be under investigation by investigation / enforcement agency Investment in un-incorporated entities – not permitted (except Oil & Gas sector) Indian companies are also permitted to participate in a consortium with international operators to construct and maintain submarine cable systems Other aspects Investment in shares of existing company – mandatory valuation requirements where the investment is more than USD 5 million Investment by way of swap of shares Mandatory valuation of shares by Merchant Banker / overseas regulated Investment Banker irrespective of amount of investment Prior approval of FIPB required

10 10 Relevant FEMA regulations (2/4) ParametersRegulations in brief Guarantee Provisions Prior equity participation necessary to extend loan / guarantee Guarantee can be in any form viz corporate, personal, primary or collateral, guarantee by promoter company / group company / sister concern / associate company in India Guarantee to be included while calculating the limit of 400% No guarantee to be open ended Guarantees issued by banks in India on behalf of JV/WOS would be subject to prudential norms issued by RBI from time to time Guarantees given to step-down subsidiaries will be considered under the Approval Route, provided the Indian Party indirectly holds 51 per cent or more stake in the overseas subsidiary Multilayer SPV’s 2013 Master circular on Outbound Investments Investments in JV/WOS abroad by Indian party through the medium of a Special Purpose Vehicle (SPV) are also permitted under the Automatic Route,….. setting up of an SPV overseas under the Automatic Route is permitted only for the purpose of investment in JV/WOS overseas No restrictions on entities having JVs/WOSs abroad setting up second generation companies (step-down subsidiaries) within the overall limits applicable for investments under the Automatic Route. However, companies wishing to set up step-down subsidiaries to undertake financial sector activities will have to comply with the additional requirements for direct investment in the financial services sector

11 11 Relevant FEMA regulations (3/4) ParametersRegulations in brief Valuation in partial / full acquisition Partial / Full acquisition of foreign company – Valuation norms to be followed: Investment more than USD 5 Million :- Category I Merchant Banker registered with SEBI / Approved Investment Banker / Merchant banker in host country; Other cases: Chartered accountant or a Certified Public Accountant Consideration other than cash Investment by way of swap of shares would require approval from the Foreign Investment Promotion Board Valuation mandatory by a Category I Merchant Banker registered with SEBI or an Investment Banker registered in the host country ADR/GDR exchanged for shares of foreign company – the holding of non-resident in the Indian company represented by underlying shares cannot exceed the permissible sectoral cap Divestment under Automatic Route Transfer by way of sale of shares of JV/WOS No write-offs Sale is effected through a stock exchange where the shares of JV / WOS are listed In case shares are not listed and they are disinvested by a private arrangement, the share price should not be less than the fair value certified by a Chartered Accountant / Certified Public Accountant based on the latest audited financial statements of the JV / WOS; No outstanding dues from JV/WOS JV / WOS is for operation for atleast one year and APR has been filed Indian Promoter Company is not under investigation from regulatory authorities (Contd..)

12 12 Relevant FEMA regulations (4/4) ParametersRegulations in brief Divestment under Automatic Route Transfer by way of sale of shares of JV/WOS involving write-offs, following additional conditions to be satisfied- in case where the JV / WOS is listed in the overseas stock exchange; Indian Company listed on stock exchanges with net-worth of Rs 100 crs. Indian unlisted Company with a overseas investment of less than USD 10mn Indian listed company with net worth of less than Rs.100 crore but investment in an overseas JV/WOS does not exceed USD 10 million.

13 Relevant tax considerations 13

14 14 Outbound investment – key tax considerations Subsidiary v Branch Local tax structure, incentives, etc. Withholding tax Treaty Network Investment structure Treaty protection, LOB clause CFC regulations Holding country environment Substance requirement Holding structure Sources of funding- own funds v borrowed funds Funding instruments – debt v equity Thin Capitalisation rules Foreign exchange Control Mode of funding Dividend / Interest / Royalty Service fee Capital gains Foreign tax credit Repatriation/ Exit

15 Relevant domestic tax provisions 15 No provisions for allowing underlying tax credit (except in few tax treaties) CFC & PoEM rules proposed in DTC Transfer pricing regulations GAAR Provisions – Proposed to be made effective from FY Deemed dividend provisions * Tax rate plus 10% plus 3% (On the presumption that taxable income exceeds Rs.10 Crores) ** Dividends received from a foreign subsidiary to be reduced in computing dividend distribution tax payable by the Indian holding company # Foreign dividends to be taxed on gross basis without deduction of any expenses. Lower tax rate to apply for FY in case dividend is received from foreign company in which such Indian company holds atleast 26% of nominal-value of equity share capital. Taxation of foreign sourced income Anti-abuse provisions

16 Structuring outbound investments 16

17 Mode of outbound investments 17 Outbound investments Branch route Entity route No deferment of Profit/loss of the foreign entity Possible view that branch profits not taxable under certain treaties Implication under Transfer Pricing critical – profit attribution Ideal where the overseas business will be incurring losses for a longer period of time Ordinarily no tax on distribution of profit – lower tax outflow- Branch tax may apply Deferment of profit/loss – consolidation for tax purpose not recognized Proposed CFC regulations Profit attribution may not be a significant issue Accumulation of profit possible for future investment Higher tax outflow on account of subsequent remittance of profit to the Indian Company

18 Direct investment v Investment through IHC (1/2) 18 Direct investment may not be very tax efficient  Income received by the Indian Company would be subjected to corporate 16.99/ 33.99%  No ability to time dividend/ interest and capital gains to be received in India  Cash flow issues: o Dividend/ interests may be subject to high withholding tax in the source country o Capital gains on sale of shares of subsidiary may be subject to high tax in country where the subsidiary is located Target Country Sub Co Indian Company India Direct Investment

19 Direct investment v Investment through IHC (2/2) 19 Investment though IHC is beneficial  Dividend, interest and capital gains income may be received with low/ nil withholding tax and accumulated in low tax jurisdiction  Ability to time receipt of dividend, interest and capital gains in India  Overall group level taxation could be minimised by consolidating group losses  Debt borrowings at the Holding Company level could enable interest cost deduction from an overall tax perspective  Consolidate group strength in the IHC and tap external sources of finance (leveraging on group strength)  Holding IPR’s for group and carrying out other functions such as marketing and distribution  Accumulate and use the existing group funds with greater flexibility  Act as a borrowing and lending intermediary for the group  Manage adverse currency fluctuations and exchange controls  Centralise control over funds through treasury management Sub Co Indian Company India Target Country IHC Jurisdiction of IHC Investment

20 Key Considerations for identifying IHC jurisdictions 20 Political & economical scenario Investment climate Exchange control regulations Financial and banking facilities Access to international capital markets Ease of transfer of funds Deductibility of borrowing costs paid Mitigate taxation of profits of operating cos. in the hands of an IHC Minimize double taxation Obtain withholding and underlying tax credits Enhance tax efficiency of international transactions entered into with other group entities On receipt of dividends, interest and capital gains On income streams On subsequent redistribution of passive income Continuity of past losses of Target Companies Lower corporate tax and withholding tax rate Effective treaty network Other factors Thin Capitalization norms & Existence of CFC Regulations

21 Setting up IHC - Illustrative jurisdiction summary (1/2) 21 ParametersSingaporeMauritiusUnited Kingdom NetherlandsCyprusLuxembourg ESTABLISHING HOLDING COMPANY – BUSINESS CONSIDERATIONS CFC regulationsNot applicable ApplicableNot applicable Number of jurisdictions with active income tax treaties (Minimum) Effective corporate tax rate 17%Maximum 3%/15% 24%25%10%22.47% (including unemployment fund surcharge & municipal business tax) TAX TREATMENT OF PAYMENTS BY HOLDING COMPANY Withholding tax rate on dividends paid to non-resident 0% 0% (Governed by EU directives) 0%/15%/ 0%-15% (Governed by EU directives) 0% (Governed by EU directives) Withholding tax rate on interest paid to non-resident 15%/ 0- 15% 0%0%/ 20%/ 0-20% 0% Thin capitalization rules Not applicable Applicable Not applicableApplicable

22 Setting up IHC - Illustrative jurisdiction summary (2/2) 22 ParameterSingaporeMauritiusUnited Kingdom NetherlandsCyprusLuxembourg TAXATION OF HOLDING COMPANY Taxability of dividend received Exempt/ Taxable with credit for foreign withholding tax and underlying tax (first tier subsidiaries only) Taxable on gross dividend basis with credit for withholding and UTC Exempt (Participation exemption) Exempt (Participation exemption) Exempt (Participation exemption) Taxability of gains on sale of shares held in subsidiary companies Exempt (Participation exemption) Exempt (Participation exemption) Exempt (Participation exemption) Joint taxation for group companies Not available AvailableNot availableAvailable

23 Profit alignment 23

24 Business Model Optimisation Income in low tax jurisdiction- Concentrating profits for the Entrepreneur company in low tax jurisdiction Expenses in high tax jurisdiction- Eg,leveraging by use of debt and equity- leveraging Riding the tax arbitrage- Withholding tax v Corporate tax Intangible Planning Own intangibles in low tax jurisdiction allows efficient licensing Defer income recognition and accelerate expense deduction- Use of IHC 24 Opportunistic reduction of Global Effective Tax Rate Tax considerations cannot dictate business but tax efficiency can provide significant competitive edge.

25 Group financing company 25

26 Group financing company 26 Key Considerations Domestic regime for Finance Co. Withholding tax Consideration of CFC rules Benefits Debt pushdown Tax arbitrage- deduction of borrowing costs on Minimum tax cost of profit repatriation to ultimate parent company 26 IHC Indian Company India Outside India Op.Co.1 Country B Op.Co.1 Country A Fin Co. Equity Debt Dividend Interest

27 IPR holding company 27

28 Objectives of IPR restructuring 28 Preserve legal rights and protect tax incentives granted to R&D activities Consideration to CFC rules, exit strategy etc. Reduce exit costs in migrating economical rights in IPR Reduce taxation of royalty income To enhance deductibility of royalty payments

29 IPR holding company - Illustration 29 Key considerations  Capital gain tax on relocation of IPRs  IP protection Acts  Patent works regime  Transfer pricing aspects Potential tax benefits  Reduction of the effective tax rate (ETR) incurred on royalty income and capital gains resulting from the sale/disposal of the IPR  Minimization of the withholding tax on the royalty flows paid by the various subsidiaries of the group or external parties.  Full deduction of royalty payments at the level of all operational entities that use any of the group’s intangible assets. Popular jurisdictions for setting up IPR holding company  Switzerland  Luxembourg  Ireland IPR holding Co Indian Company India Op.Co.2 Outside India Equity Investment Op.Co.3Op. Co.1 License Fees

30 Illustrative IPR holding regimes 30 ParametersSwitzerlandLuxembourgIreland Tax benefitNo special IP regime but ordinary regime produces low effective rates with planning Exemption – 80% of net incomePatent regime – upto € 5 exempt income IP regime- allowances upto 80% of net profit ETR7.8% to 11% Under Nidwalden royalty box model, ETR is reduced to 1%- 3% Up to 5.8%Up to 12.5% Qualifying assetsAny IP which can be licensedPatents, trade marks, designs, models, software copyrights, domain names Patents (filed), brands, trade names, copyrights and associated rights Can acquire IP benefit regime YesYes but not from- Direct parent (10%+ holding) or asset subsidiary (10%+ holding) or sister company (10% common parent). Patent should be acquired/ credited post 31 December 2007 Yes OtherWill require substance in a branch where tax rates are low; Swiss anti-abuse rules to be considered Advance ruling procedure provides certainty IP regime requires an active trade

31 Concluding remarks 31

32 Conclusions 32 Selection of Hold Co jurisdiction depends upon the key objectives / needs of an investor Tax and commercial considerations often dictate a selection Hold Co jurisdiction Tax is an important consideration for selecting the Hold Co. jurisdiction but it cannot be the only consideration Proper tax planning in any outbound investment proposal is imperative to optimize post tax profits in the hands of the Indian investor The tax planning exercise would require a detailed study of the relevant tax provisions and other regulations of the host country together with the business objectives and the given parameters of the business model Once the structure is in place one has to consider the possibility of profit alignment by suitable allocation of functions and risks

33 Open house … 33


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