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Latest developments in optimal structuring of Inbound Investments including FDI, NRI Investments – FEMA and Taxation issues 

CA N.C. HEGDE5 July 2015

Discussion points

• Key decision metrics for inbound investments in India

• Forms of entity and funding alternatives

• Overview of Indian Exchange control and Tax regulations

• Recent developments impacting NR investments in India

• Parting thoughts

Structuring of Inbound investments in IndiaKey decision matrix

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INDIA INBOUND Growth rationale &

Mode

Preferred Industry &

Investment cap

Entity forms and & Investment holding

Investment Horizon, funding &

returns

Ease of exit

These decisions are primarily functions of extant tax and regulatory laws in India besides India’s political and overall socio-economic landscape – Global tax initiatives like BEPS do also have bearing

Broad Tax & Regulatory framework impacting inbound investments in India

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INDIA BUSINESS

IMMIGRATION LAWS(VISA Regulations/

Passport Act)

INDUSTRIAL LAWS(Industrial Disputes Act,

Factories Act)

COMPANY LAW(Companies Act, SICA)

COMPETITION LAW(COMPETITION ACT)

SECURITIES LAWS SCRA, SEBI, ICDR

EXCHANGE CONTROL LAWS

(FEMA, FDI Policy)

TAX LAWS(Income Tax Act, Customs

Act)

EMPLOYMENT LAWS(PF Act / Wages Act)

Businesses in India require understanding of the interplay between various applicable commercial laws –understanding of the civil and criminal laws become pertinent on specific

situations

Principal Forms of Business entities

Forms of entities

LO

BO

PO / SO

WOS / IJV

UJV (AOP)

LLP

Liaison Office (‘LO’)•Acts as channel of communication•Can’t undertake commercial activities

Branch Office (‘BO’)•Export / import of goods•Professional service•Representing parent•Research activities•No manufacturing

Project Office (‘PO’) / Site Office (‘SO’)•Execute specific projects

Wholly Owned Subsidiary (‘WOS’) / Incorporated Joint Venture (‘IJV’)•Any activity subject to FDI policy

Unincorporated Joint Venture (‘UJV’)•Any activity subject to specific approval

Limited Liability Partnerships (‘LLP’)•Any activity under automatic route subject to specific approval

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General funding alternatives

Price/Conversion formula of convertible capital instruments to be determined upfront at the time of issue of the instruments

• Indian Companies can issue capital / debt / hybrid instruments besides ADR /GDR / IDR subject to pricing guidelines / valuation norms and reporting requirements

• Issue other types of preference shares such as non-convertible, optionally convertible or partially convertible, which have to be in accordance with the External Commercial Borrowings (ECB) guidelines

Profit repatriation alternatives

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Options

Interest

Dividend

Royalty / FTS

1. Jurisdiction analysis2. Commercials3. Tax considerations (local &

overseas)4. Withholding tax obligations5. Tax compliances6. Regulatory implications7. Transfer pricing

Cost sharing arrangements Overseas

investments

Buyback of shares

Capital Restructuring

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Gains from sale of CCDs in Joint Venture Company by foreign partner to Indian partner amounted to capital gains and not “interest” u/s 2(28A) - Zaheer Mauritius – Delhi High Court

Zaheer Mauritius vs. DIT(IT) (Delhi – HC) (1/3)

Facts of the case:

Vatika(Engaged in the

business of developing and dealing in real

estate)

JV Co.(100% subsidiary of

Vatika)

Transferred interest in the land to the JV Co for development of the land

Entered into a Securities Subscription Agreement (SSA) and a Shareholder's Agreement

(SHA) with Vatika and the JV Co.

Assessee(engaged in

construction and development

business in India)

India

Mauritius

Zaheer Mauritius vs. DIT(IT) (Delhi – HC) (2/3)

Facts

• As per the SSA, the assessee agreed to acquire 35 per cent ownership interest in the JV Co by subscribing to equity shares and Compulsorily Convertible Debentures (‘CCD’) of JV Co

• SHA provided for a call option given to Vatika - by the assessee; to acquire all the aforementioned securities during the call period; and

• Likewise, a put option given by Vatika to the assessee to sell to Vatika all the securities during the determined period

• Vatika partly exercised the call option and purchased a part of equity shares and CCDs from the assessee

• The assessee filed an application before AAR seeking ruling on question of taxability of amount received on sale of equity shares and CCDs

• The AAR held that the gains arising on the sale of CCDs being interest within the meaning of Section 2(28A) of the Act and Article 11 of the DTAA, was taxable as such

• Assessee filed a writ

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Zaheer Mauritius vs. DIT(IT) (Delhi – HC) (3/3)

Issues:

•The principal dispute between the assessee and the revenue was whether the gains arising in the hands of the assessee from transfer of its investments in the JV Co was 'interest' or 'capital gains‘•Further, that the transaction between the assessee and Vatika is a sham transaction and is essentially a transaction of loan to Vatika (camouflaged as an investment in shares and CCDs of the JV Co)

Held that

•The terms of the arrangements between Vatika and the assessee revealed that the JV was a genuine commercial venture, in which both partners had management rights•The call and put options were defined commercial options capable of being elected by the parties•There was no reason to ignore the legal nature of the instrument of a CCD or to lift the corporate veil to treat the JV company and Vatika as a single entity•In view of the above, the writ petition was allowed and the impugned ruling was set aside

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Overview of exchange control regulations in India

• Consolidated Foreign Direct Investment (FDI) Policyo FDI policy is formulated by the Department of Industrial Policy and Promotion (‘DIPP’),

Ministry of Commerce & Industryo The DIPP regulates FDI through Press Notes (PNs) and now consolidated under the

Consolidated FDI policy which includes definitions

• FEMA Notification and RBI Circularso The FEMA 1999 and FEMA Notification No. 20 is statutory framework / legal edifice which

enacts PNso RBI’s Master Circular (issued 1 July and updated from time to time), FAQs and Regular

Circulars

• Portfolio Investment Schemes under FEMA ( Notification No. 20)

Portfolio Scheme is for NRIs, FIIs, QFIs, FVCI is distinct though they can also invest under FDI Scheme

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For FIIs, QFIs FVCIs and investments into listed companies IVCUs in India, provisions of relevant SEBI regulations would additionally need to

be adhered to

Foreign Investments

Foreign Portfolio

Investments

FIIPersons Resident outside India

NRI, PIO

AIF (VCF), IVCUs

NRI, PIO

Foreign Investments in India – Schematic Representation

Foreign Direct

Investments

Foreign Venture Capital

Investments

Other Investments (G-Sec, NCDs etc.)

Investments on non-repatriable

basis

RFPIFIIs

Govt. Route

Automatic Route

SEBI regd. FVCIs

Investments made by QFI

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Investments in LLP

RFPI

QFIs NRI, PIO

The E-BIZ Platform recently launched by the DIPP is a step towards ease of doing business in India. Information technology coupled with the intent of simplification of existing rules and approval process led to the integration of

14 services by Government ministries on the E- BIZ (Government 2 Business) portal

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The transaction of routing FDI through the newly interposed company is a colourable device not permitted under the FDI Policy and FEMA regulations – IDBI Trusteeship Services Ltd vs. Hubtown Limited - Bombay High Court

IDBI Trusteeship Services Ltd vs. Hubtown Limited

Facts •Nederlandse Financierings- Maatschappiji Voor Ontwikkelingslandeo N.V. (FMO), a Netherlands corporation held 10% of the shareholding + 3 Compulsorily Convertible Debentures (CCDs) in Vinca Developers Private Limited (Vinca or Hold Co). The CCDs were convertible within a period of 60 months and upon conversion FMO would hold 99% of Vinca’s equity.).•The Hubtown Ltd. (Defendant) and individual promoters held the balance 90% shareholding in Vinca which was to be diluted upon conversion of the CCDs.Tax office valued each equity share at Rs. 53,775 as against the aforesaid valuation done under the Capital Issues (Control) Act, 1947 •Vinca was involved in the construction development sector and had an FDI eligible township project. Vinca had contractually agreed that the investment by FMO would be used to purchase Optionally Convertible Debentures (OCDs) issued by Amazia Developers Private Limited (Amazia) and Rubix Trading Private Limited (Rubix), wholly owned subsidiaries (WOS) of Vinca. •Accordingly, the amounts invested by FMO were infused into Amazia and Rubix •The IDBI Trusteeship services Ltd. (Plaintiff) was Debenture Trustee in regard to OCDs. The Articles of Association (AoA) of Vinca were amended such that FMO Nominee Directors on Vinca’s Board of Directors would alone be entitled to take all decisions regarding the OCDs and the Debenture Trustee. •The Defendant provided a guarantee in favour of Vinca for the performance of the obligations by the Subsidiaries with respect to the OCDs. Upon failure by the Subsidiaries to make the payments on the OCDs, the guarantee provided by Hubtown was invoked. •Subsequently, upon its failure to make the payments pursuant to the invocation of the guarantee, the Debenture Trustee filed a petition for winding up Hubtown and also a summary suit for recovery of the dues which was sought to be defended by Hubtown.

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NV FMO

VINCA

RUBIXAMAZIA

HUBTOWN

IDBI TRUSTEESHIPSERVICES

10% Equity + 3 CCDs (convertible into 90% equity

Outside India

India

OCDS100% 100%

90% Equity + Performance

Guarantee to Vinca

Debenture Trustee for OCDs issued by Amazia/ Rubix

IssueWhere an Indian Company receives FDI and the proceeds are invested in OCDs of companies operating in the construction development sector, such downstream investment by the FDI recipient company violates the FDI Policy and FEMA regulations.

Ruling Vinca was only a nominal recipient of investment from the foreign investor and the FDI amount was routed by Vinca to Amazia & Rubix against issue by them of OCDs bearing a return of 14.5% per annum. The downstream investment by Vinca in its subsidiaries was contractually predetermined. Since the foreign investor could convert its CCDs into 99% shareholding in Vinca, in effect, the foreign investor would receive an assured return on its investment, which was not permitted under the FDI regulations. The FDI regulations only permit FDI by way of equity or compulsorily convertible instruments (CCDs) in Indian companies. Accordingly, while the foreign investor could have directly invested in CCDs bearing interest of Amazia and Rubix the amounts invested would be compulsorily required to be converted into equity shares of Amazia and Rubix and the foreign investor could not have required Amazia or Rubix to repay the amounts invested. The Court, relying on the 2012 decision of the Supreme Court of India in Vodafone International Holdings BV v. Union of India, held that whilst ascertaining the legal nature of the transaction it is the task of the court to look at the entire transaction as a whole and not to adopt a dissecting approach. Further, a device which was colourable in nature has to be ignored. In the present case, on facts, prima facie, the structure was devised to circumvent the restrictions imposed by the FDI regulations.

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IDBI Trusteeship Services Ltd vs. Hubtown Limited

While the ‘look at’ test was adopted by the Bombay High Court, the judgment reflects that under such approach the courts are willing to scrutinize the transaction and its various elements to ascertain if the structure is in spirit compliant with the FDI Policy & FEMA Regulations.

NRI Investments in India and Recent changes

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Repatriation basisRepatriation basis Non repatriation basisNon repatriation basis

Amendment vide press note no. 7 (2015 Series) dated: 3-6-2015– NRI investments on non repatriable basis in Schedule 4 deemed to be domestic investment at par with investment made by Indian residents

Amendment vide press note no. 7 (2015 Series) dated: 3-6-2015– NRI investments on non repatriable basis in Schedule 4 deemed to be domestic investment at par with investment made by Indian residents

9th January every year is celebrated as NRI day

NRI meaning & non-repatriable investments better aligned for attracting more FDI

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Amendment in FDI Policy

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PORTFOLIO INVESTMENT SCHEME

Application to AD banker for investment in Indian listed shares / convertible debentures on repatriable / not repatriable basis

Post one time permission by AD bank, NRI may have permissible credits and debits in his NRE/NRO/FCNR(B) accounts

NRI investment ceiling in listed equity shares

NRI investments under PIS cannot be gifted to relatives / cannot be pledged for loan to third party (without prior RBI approval)

INDIAN FIRM / PROPRIETORY CONCERNS

Investment on repatriation basis subject to prior Government of India / RBI approval

Investment on non-repatriation basis possible by way of capital contribution if

i. amount invested via inward remittance through normal banking channels or NRE/NRO/FCNR (B) account debit

ii. Firm not engaged in agricultural / real-estate activity

PURCHASE / SALE OF SHARES OR CONVERTIBLE / NON

CONVERTIBLE DEBENTURES No limit on purchase on non-repatriation

basis through inward remittance of funds from normal banking channels or NRE/NR/FCNR(B) accounts

Sale proceeds of shares / convertible debentures to be credited to NRO account

NRIs can invest in NCDs both on repatriation / non-repatriation basis

GOVERNMENT SECURITIES/PSU BONDS / IDRs

No limit on purchase on repatriation basis Government securities, treasury bills, PSU bonds, Domestic mutual funds, PSE shares in accordance with disinvestment scheme conditions

IDRs issued in accordance with the Companies Deposit Rules / SEBI ICDR regulations, can be subscribed by NRIs

Forms of NRI Investments in India

NRIs can pledge Indian company’s shares in favour of Indian AD banks / overseas banks in order to secure credit facilities to the investee company / itself subject to prescribed conditions

Indian transfer pricing caution areas

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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;

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;

INTERNATIONAL TRANSACTIONS ALSO LEADING TO TRANSFER PRICING DISPUTES CURRENTLY

Share capital issuance / business reorganization transactions increasingly come under Indian tax authorities scanner for demonstration of arms length principle - valuation critical for such

transactions for abundant caution against transfer pricing disputes

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Amount received towards share premium from non resident holding company does not give rise to any income from an admitted International Transaction - Vodafone India Services (P.) Ltd – Bombay High Court

Vodafone India Services (P.) Ltd

Facts

•The assessee was a wholly owned subsidiary of a non-resident company, Vodafone Tele-services (India) Holdings Ltd. (the holding company).

•During relevant assessment year, the assessee issued shares of the face value of Rs. 10 each on a premium of Rs. 8,509 per share to its holding company. The fair market value of the issue of equity shares at Rs. 8,519 per share

•Tax office valued each equity share at Rs. 53,775 as against the aforesaid valuation done under the Capital Issues (Control) Act, 1947

•The learned AO & TPO applied Chapter X and held that said amount of Rs. 1308.91 crores was income.

•As a result ,amount in question was required to be treated as deemed loan given by the assessee to its holding company and periodical interest thereon was to be charged to tax as interest income.

•DRP upheld the AO order.

•Assessee also filed the writ petition before the Bombay High Court challenging the ‘jurisdiction’ of the Union of India, TPO, AO and DRP (‘Respondents)’ to tax the issue of shares under Chapter X of the Act

Issue

Whether issue of shares at a premium by assessee to its non-resident holding company does give rise to any income as per transfer pricing provisions?

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High Court Ruling

•‘Income arising from international transaction’ is condition precedent for application of Chapter X

•Capital receipts not ‘taxable’ unless specifically included u/s 2(24) – e.g. capital gains

•Share premium is taxable u/s 56(2)(viib) of the Act as is an income u/s 2(24)(xvi) – This is not applicable in the instant case as it relates to issue of shares to “residents” only

•Neither capital receipts received by Vodafone India on issue of equity shares to its holding company nor alleged shortfall can be considered as income under the Act

•By disclosing the transaction in 3CEB Vodafone India only ‘informed’ the tax authorities about the transaction out of abundant caution to avoid penal consequences

•The transaction of capital financing or business restructuring would be applicable to the extent it impacts the income by under reporting of income and over reporting of expenses

•On section 92(2) interpretation – Reading a provision by omitting words is not workable and not a permitted mode of interpretation

•Chapter X of the Act is a ‘machinery provision’ to arrive at ALP of an international transaction.

•Charging provisions are section 4, 5, 15 (salaries), 22 (income from house property), 28 (Profits and losses from business & profession, 45 (capital gain) and 56 (income from other sources)

•Income arising from international transaction must fulfil the test of chargeability

•“For all the above reasons, we find that in the present facts issue of shares at a premium by the Petitioner to its non resident holding company does not give rise to any income from an admitted International Transaction. Thus, no occasion to apply Chapter X of the Act can arise in such case”

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Vodafone India Services (P.) Ltd

Key Holding Company Jurisdictions for India investment-

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Income stream Mauritius Netherlands Singapore Cyprus

Capital gains on sale of shares

• Nil • Nil • Nil • Nil (Subject to substance tests)

LOB Provisions

• No LOB provision. However commercial substance would be essential in light of BEPS

• No LOB provision. However commercial substance would be essential in light of BEPS

• Yes • No LOB provision. However commercial substance would be essential in light of BEPS

Interest received from Indian Companies

• 5% on foreign currency denominated debt subject to fulfillment of certain conditions

• 40% for Rupee denominated debt (including CCD)

• 5% on foreign currency denominated debt subject to fulfillment of certain conditions

• 10%, for Rupee denominated debt (including CCD)provided the recipient is the beneficial owner of the interest

• 5% on foreign currency denominated debt subject to fulfillment of certain conditions

• 15%, for Rupee denominated debt (including CCD)provided the recipient is the beneficial owner of the interest

• 10% on gross basis, provided the recipient is the beneficial owner of the interest

Dividend• Exempt in the hands of shareholders under the Act. However, company paying dividend, liable to pay DDT @20.36%

on divided paid

Buyback of shares• Exempt in the hands of shareholders under the Act. However, company paying buyback, liable to pay tax on

buyback consideration less amount received @23.072%

Treaty override is currently permissible. GAAR provisions proposed from 01.04.2017 restrict treaty override in case of impermissible tax avoidance arrangements

Cyprus is notified jurisdictional area for the purpose of Act – All transacting parties deemed to be associated parties, transactions deemed to be international transactions, payments to Cyprus subject to withholding tax @

higher of 30% / rates in force / applicable rates as per provisions India Mauritius DTAA under renegotiation primarily on LOB provision – Foreign investors bearish on Mauritius

route to India

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Base Erosion & Profit Shifting (BEPS) refers to transaction maneuvering taking advantage of tax rules difference leading to double non-taxation or erosion of profit base in the place of economic activity

Addressing BEPS critical to taxpayers and governments across the globe to achieve tax fairness and prevent national under-funding.

The purpose of the Action Plan is to prevent double non-taxation, as well as cases of no or low taxation associated with practices that artificially segregate taxable income from activities that generate it.

The BEPS project enlists 15 action points which are targeted to be achieved by end of 2015

The focus areas include hybrid instruments and entity forms,

treaty abuse provisions, digital economy taxation,

transfer pricing implications etc. through various modes of

reporting and automatic information exchange

In India GAAR provisions deferred for better alignment with BEPS provisions as may

be accepted globally

BEPS Project – set to revolutionize international taxation

Indian Government has laid considerable emphasis on automatic information exchange to curb tax evasion and hence tracking key developments around the BEPS project assumes significance –

BEPS & GAAR provisions to compliment each other

Recent developments impacting Non Resident investments

Recent developments impacting NR investments

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Beneficial ownership testmaterial for treaty benefitsLook through and look at

approach

SEBI easing delisting &M&A norms

(Buyback of shares) for ease of doing business in India

New Government’s scorecard against Tax terrorism

Increased reporting obligation for foreign remittances

Deputation Arrangements

in IndiaICDS – a move towards

simplification orcomplication?

Controversy around concessional Long term capital gains

tax rate for unlisted securities

GST roadmap

All these aspects and many more which incessantly emerge pose opportunities and challenges for business in India

Parting thoughts

Indian regulatory & tax landscape barometer

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Inclination of regulators and government authorities towards E-connectivity paves way for better integration and casts onerous responsibility of true disclosures by business – teething troubles continue

Parting thoughts

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Parting thoughts

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Questions?

Thank You

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