A discussion on Inbound structuring Taxation, Foreign Direct Investments and Exchange Control Regulations

CA Rachana Kapadia CA Janhavi Sharma

24 January 2010

Why Inbound Investments?

Business strategy

Advantages of low cost & skilled labour Utilising the funds raised for growth Investing in Indian economy due to liberalisation of Foreign Direct Investment Policy Greater transparency & clarity in capital market reforms

Key elements

Repatriation / Exit Strategies Implications on various capital structures Implications on acquisition of shares / Investment Strategy Tax attribute planning

Destination India This January

Caltex Gas India acquired by SHV Group

Micromax sells minority holding to PE investor TA Associates

Coffee Day is final phase of talks with Temasek, KKR, Standard Chartered

One Access acquires BA Systems

Contents

FEMA and exchange control regulations

Recent cases

Key Considerations

Inbound structuring

Decision Points.

Domestic tax incentives

Choice of an appropriate structure

Jurisdiction planning

India
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Entry vehicles
Can only undertake liaising / representing / promoting / communicating activities

Liaison Office

Not allowed to have any income Local expenses have to be met through inward remittances
Can undertake activities export / import of goods, professional / consultancy services, research work, technical / financial collaborations, buying / selling agent, IT services / development of software, technical support, foreign airline & shipping company Cannot undertake retail trading activities, manufacturing / processing activities. Can acquire property but not for leasing / renting

Branch Office

Cleared by an appropriate authority

Project Office

Company or entity in India awarding the contract has been granted Term Loan by a Public Financial Institution or a bank in India for the project.

Funded directly by inward remittance / bilateral or multilateral International Financing Agency

Can carry out any activity specified in the memorandum of articles (subject to FDI guidelines) Funding may be through equity, other forms of permitted capital infusion or internal accruals

Indian Company
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Foreign Direct Investments

Key exchange control regulations

Foreign investment into India

Foreign Direct Investment (FDI)

Portfolio Investment Scheme

Foreign Venture Capital Investor (FVCI)

Automatic route

Approval route

Foreign Institutional Investor (FII)

Foreign Direct Investment

Automatic Route

Foreign Direct Investment

Approval Route
Prior government approval is needed (from FIPB) The approval required for FDI

No prior permission required. The only requirement is to inform the RBI within 30 days of inflow/ issue of shares This route covers - Investment within sectoral caps listed in the FDI policy - Sectors that are not prohibited and for which sectoral caps are not specified

in the following cases:

Prohibited Sectors
Foreign investment is not permitted in companies engaged in sectors such as Retail trading (except single branded retail) Agriculture (permitted with exception) Lottery business Atomic Energy.

Where the foreign investor has an existing joint venture or technology transfer/ trademark agreement in the same field Proposals for foreign equity beyond 24% in the small scale industry reserved sector Proposals outside sectoral caps

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Portfolio Investment Scheme

FIIs registered with SEBI eligible to purchase shares & convertible debentures
Investment in an Indian Company not exceed 10% of the total paid up capital or 10% of the paid up value of the each series CCDs issued Total holding of FIIs not exceed 24% of the paid up capital / paid up value of each series of debentures NRIs can purchase upto 5% of the paid up capital of the ICo. Shares Total investment of all NRIs in a ICo. to not exceed 10% / 24% of paid up capital Prohibition on investments in shares of: Asset Reconstruction company Nidhi company / Chit Fund company Agricultural / plantation activities Real estate business* / construction of farm houses Trading in Transferable Development Rights
*Real estate to exclude construction of housing / commercial premises, educational institutions, recreational facilities, city and regional level infrastructure, townships.

Caution List 2% below the sectoral cap; Ban List reaches the sectoral cap
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Foreign Venture Capital Investor

Investment can be made with specific approval from RBI
Investments in : Equity / Equity Linked instruments Debt / debt instruments Debentures

FVCI

By way of Initial Public Offer or; Private placement in units of schemes / funds set up by a VCF.

VCF

VCU

Price to be mutually acceptable by the buyer & seller

VCU

IVCU an unlisted company incorporated in India which is not engaged in an activity under the negative list specified by SEBI VCF - a fund established in the form of a trust, a company including a body corporate and registered with SEBI which has a dedicated pool of capital raised in a manner specified under the said Regulations and which invests in Venture Capital Undertakings in accordance with the said Regulations.
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Fema and Exchange Control Regulations

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Funding for the investment

Equity Shares / Preference shares / CCDs
Investments can be made upto FDI limit prescribed
- Government approval in case of investment exceeding sectoral cap or conversion of ECB / royalty / lump sum fee into shares

External commercial Borrowing (ECB)

Eligible lenders International banks , Foreign equity holder Maximum amount USD 500 mn per company per year Minimum maturity period 3 to 5 years with all-incost ceiling of 300 basis points (6 months over LIBOR) End-use restrictions exist for foreign currency borrowing
Working capital General corporate purposes Repayment of existing rupee loans On-lending to another entity Investment in capital market Acquiring a company in India

Rate of dividend for preference shares not exceed 300 basis points over PLR of SBI as on board meeting date Shares / CCDs to be issued within 180 days from the receipt of inward remittance Pricing guidelines applicable
Listed company shares As per SEBI guidelines

Unlisted company shares At fair value as per CCI guidelines

Conversion of royalty / lump sum fee / ECB amount due for payment

Issuance of guarantee, etc. relating to ECB by banks, financial institutions and NBFC not permitted Prepayment up to USD 200 Mio permitted, subject to certain conditions being satisfied

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Acquisition of shares

Acquisition of Right shares

The overall issue of shares to the non residents does not exceed the sectoral caps. Offer price of the right shares to the non residents is not lower than the offer price made to resident shareholders

Shares are acquired pursuant to a Court approved scheme of merger / demerger

Merger / Demerger / Amalgamation

Overall percentage of shares held by the non residents does not exceed the sectoral caps Transferor / Transferee / New Co does not engage in agriculture, plantation, real estate business or trading in TDRs

I Co. can issue rupee denominated shares to the depository for issuing ADR / GDR

ADR / GDR

I Co. is eligible to issue ADR / GDR or has obtained approval from MoF I Co. is not otherwise ineligible to issue shares to persons resident outside India ADR / GDR to be issued at a decided price in consultation with Lead Manager / as per Pricing Guidelines

Transfer of Shares
Resident to Non - resident
Transfer by way of gift requires prior RBI approval Transfer by way of sale of shares does not require prior Government / RBI approval, subject to: I Co. whose shares are transferred is not engaged in rendering financial services; Transfer does not fall within the purview of SEBI (Substantial Acquisition of Shares and Takeovers) Regulation, 1997; and Pricing guidelines, documentation and reporting requirements are adhered to

PROI to PRI
No prior permission of RBI required Pricing guidelines, documentation and reporting requirements are adhered to

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Press Notes 2, 3 & 4 (2009 series)

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Press Note No 2 Guidelines for calculating total foreign investment

Direct Investment Indirect Investment A Co. A Co.
Outside India India Outside India

I Co.
Owned / control

India

B Co. B Co.

Owned & control

C Co.
Total foreign investment = Direct investment + Indirect investment
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Press Note No 2 Guidelines for calculating total foreign investment

Exception A Co.
Outside India India

75%

I Co.

B Co.
100%

75% counted as Indirect Foreign Investment

C Co.
Clarified : The downstream investment of a 100% owned subsidiary of the holding company is akin to investment made by the holding company and the downstream investment should be a mirror image of the holding company.
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Press Note No 2 Guidelines for calculating total foreign investment

Additional Conditions: Details of ownership and control to be furnished to the GoI at the time of seeking approval In sector / activity requiring government approval inter-se agreement between the shareholders to be informed to the approving authority In sectors attracting sectoral caps balance equity to be held by resident Indian citizens & Indian companies In I&B and Defence sector the company to be owned and controlled by resident Indian citizens and Indian companies At least 51% of the total equity to be held by largest Indian shareholder.

Individual shareholder individual, relative, company / group of companies where the individual shareholder / HUF has management & controlling interest
Indian company Indian company and the group of Indian companies under the same management and ownership control If the beneficial interest is held by a non resident entity even though investment is made by resident Indian citizen, the same to be treated as foreign investment
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Press Note No. 3 Guidelines for transfer of ownership or control from Indian citizens to non resident entities
Investment requires Government approval / FIPB approval
Sectors with caps, including Defence production, air transport services, ground handling services, asset reconstruction companies, private sector banking, broadcasting, commodity exchanges, credit information companies, insurance, print media, telecommunications and satellites

Applicable to

Indian company is being established with foreign investment and is owned or controlled by non resident entity; or

Applicable when

The control or ownership of existing Indian company currently owned or controlled by resident Indian citizens and Indian companies is being transferred / passed to non resident entity through amalgamation, merger or acquisition

Not applicable to sectors / activities where 100% FDI is allowed

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Press Note No 4 Clarificatory guidelines on downstream investment by Indian companies

Operating Companies To comply with relevant sectoral conditions

Operating cum investing companies

To comply with relevant sectoral conditions Companies in which downstream investment is made to comply with relevant sectoral conditions Require prior Government / FIPB approval, regardless of the amount or extent of foreign investment Companies in which downstream investment is made to comply with relevant sectoral conditions

Investing companies

Infusion of foreign investment into companies without any operations / downstream investments require government / FIPB approval
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Press Note No 4 Clarificatory guidelines on downstream investment by Indian companies

Conditions for downstream investments by operating cum investment companies and investing companies:

To notify SIA, DIPP and FIPB of its downstream investment within 30 days of
such investment Equity investment in existing Indian company to be duly supported by Board resolution Issue / transfer / pricing / valuation of shares to be in accordance with

applicable SEBI / RBI guidelines

Investing companies to invest from funds outside India and not leverage funds from domestic market

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Direct Tax Implications

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Typical Transaction Structures

Particulars Taxable Income Amount (INR) 100

Less: Corporate Tax on same

Profit after tax Less: Transfer to reserves Profit available for distribution Less: Dividend Distribution tax (16.995%) Dividend distributed to shareholders
India

(33.99)
66.01 (6.60) 59.41 (8.63)

Outside India

50.77

Direct Investment

Typical Transaction Structures

Equity/ Debt Funding

US, UK, Australia Tax efficient jurisdictions - Mauritius - Cyprus - Netherlands - Singapore

India

Indirect Investment

Income streams Tax perspective

Nature of the income stream Dividend Interest Royalty (trademarks & brand name) Tax rates DDT @ 17% WHT can be as high as 42.23% WHT @ 10.56%

Fees for technical services

Management Fees Capital gains

WHT @ 10.56%
WHT @ 10.56% WHT can be as high as 42.23%

Pay outs to be at arms length subject to transfer pricing study Rates are as per domestic tax laws treaty relief generally available DDT - Dividend distribution tax WHT Withholding tax

Tax Treaty Provisions

Indian Government has entered into agreement (Double Taxation Avoidance Agreement/ Treaty Agreements) with Governments of various other countries/contracting state Treaties often provide lower tax rates and exemptions in addition to those available under the domestic tax provisions A non-resident may choose to be governed by the domestic tax provisions or provisions under the treaty whichever are more beneficial A person is entitled to claim application of treaty provisions only if he is a tax resident of either of the country/contracting state.

Taxation under tax treaty

Jurisdictions Income streams

Dividend Capital gains Interest Royalty

Mauritius

Cyprus

Singapore#

Netherlands

Tax exempt DDT @16.995% is paid by Indian Company Not taxable 20%/ 40%** 10%** Not taxable 10% 10 %** Not taxable 15% 10% Not taxable* 10% 10%

# Subject to fulfillment of anti abuse provisions * In certain cases ** Plus surcharge and education cess as applicable

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Cash Repatriation - scenarios:

Cash Repatriation Current Account transactions
Cash Repatriation scenarios

Dividend

Interest

Royalty for use of trade mark

Fees for managerial services

Interest on fully and compulsorily convertible debt, Royalty for use of trademark and fees for managerial services can be paid independent of shareholding pattern. Royalty for use of trademark would be payable to the entity owning the trademark. Fees for managerial services would be payable to the entity providing the services. Key elements Transfer pricing regulations (including arms length principle and documentation) and overall tax cost.

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Exit strategies

Buyback

Capital Reduction

Sale of shares
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Case study

Cash Repatriation Case study

Investment - Equity Co X Investment - Equity and Preference
CO X

Dividends

Equity & preference shares

Equity shares

WOS

WOS

Redemption of preference shares + buyback of bonus equity shares

Co X proposes to invest in a wholly owned subsidiary (WOS) in India

Co X would invest in equity share capital of WOS in India

Return on equity capital in the form of dividend is subject to payment of dividend distribution tax (DDT) in India

Cash Repatriation Case study Illustration

Particulars

Investment in WOS As equity As equity & preference 100

Profits available for distribution with WOS DDT @ 16.995%1 Dividend/redemption proceeds

(a)

100

(b) = (a) x 17/117 (c) = (a) - (b)

14.52 85.48

NIL 100

Including surcharge and education cess

02/5/ 34 2010

QUESTIONS??

Thank you