taxation in india 2010 11 ecopy

A compilation of our published thought leadership

Taxation in India 2010-11

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Corporate tax

Corporate tax��

�� discussion paper on DTC.

�� is to arrest the increase in tax litigation, says Prashant Khatore.

12 | Need for re-look at GAAR and CFC Instead of removing ambiguity in the tax structure, the GAAR and CFC have created uncertainty amongst the business community. Ajit Krishnan writes about the need for a reassessment of these provisions.

�� !��"��#�� Budget 2011-12 is perhaps, just the “holding” policy statement that India needs right now, writes Srinivasa Rao.

Employment tax

�$�� %&��!��'�� Amitabh Singh provides answers and detailed explanations to all possible questions and queries on sweat equity.

�� (��)�*��+�&�� ,��)�� Amitabh Singh lists down some of the tax implications of holding a US green card, and helps with some timely damage control.

�� .�� &��/��0�� Who is responsible for contract labour — the contractor or the principal employer? Amitabh Singh answers this pertinent question in this article.

�� "�&�� Budget 2011 didn’t introduce key provisions of the DTC to bring cheer for the common man. Sonu Iyer lists some of the hits and misses of the Budget for the aam aadmi.

Indirect tax3�� 4� �� #��54%"�� &��

Harishanker Subramaniam provides a sectoral analysis of the application of GST in India.

33�� 54%��,��/��&� �� Satya Poddar insists on getting rid of the CST — the tiny but unjust tax — the root of many distortions and ineffeciencies in our current tax system.

Feature articles

Contents

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37�� "��0��&��&��&�� Bipin Sapra hopes to see more changes in the Indian indirect tax system especially the much needed phasing out of tax exemptions.

38�� 9��54%�/��&��:��9�/��00��#�� !!��"��#��$��!��!��bringing in the much awaited indirect tax reform by implementation of GST in 2012. Heetesh Veera explains the current status quo of the biggest indirect tax reform.

�� ;��,�� Adoption of Point of Taxation Rules for services is a step to prepare the ground for GST. Bipin Sapra discusses the impact of these Rules on your business.

International tax

�3�� <��=��&��> This treaty has witnessed some bad weather in the past, however, do the recent developments indicate a brighter future? Sudhir Kapadia discusses the Indo-Mauritius trade treaty.

�?�� @��/��,��4��0�� Nico Derksen and Sushant Nayak shed some light on the comprehensive economic cooperation agreement signed between India and Singapore.

�8�� %��0��/�� The Delhi High Court ruling has confounded the opinion of companies with subsidiaries conducting marketing in India. Srinivasa Rao and Rajendra Nayak analyse the implications.

7?�� %��0�� "��&> If used properly, management fees are one of the important tax planning tools at an MNC’s disposal. Sanjay L Kapadia discusses how MNCs are “managing” their management fees.

7$�� %��&��0�� 0� With 2011 heralding a decade since transfer pricing provisions were introduced in India, Srinivasa Rao and Rajendra Nayak explain how recent landmark decisions �� $��!��%'�$��!�� the country.

Transaction tax

?$�� B�� &�� The Finance Act, 2010, as well as recent circulars issued by the RBI regarding pricing of share transfers between residents and non-residents is bound to ��!��()��!��*��+� Amrish Shah analyses these legislative changes and assesses their implications on transactions.

�� (�� '�� Amrish Shah highlights opportunities of raising more money from PE now, but cautions companies about costlier M&A deals.

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Corporate tax

�3�� 0�� D�� Sudhir Kapadia discusses the implications of Vodafone ruling and the degree of uncertainity it will create with respect to past transactions of a similar nature.

�?�� /�� #��/��&��/�� 0�� <E� India is the second most targeted nation among the BRIC nations for M&A activities. Narendra Rohira and Tejas Mody discuss the trends indicating Indian companies going shopping abroad and global companies scouting for M&As in the country.

�8��%&��<E�� Amrish Shah outlines the increasing role that tax is playing in M&A and how recent developments in India will impact future corporate transactions in the country.

Tax and regulatory policy

87�� (��#��6(�� With FDI permitted up to 26%, the country continues to rely heavily on imports for its defence requirements. Ganesh Raj discusses how India’s defence sector has not been able to exploit opportunities offered by the liberalization of the economy.

8$�� &�� FDI in multi-brand retail is per se prohibited and is permitted only in surrogate forms of the wholesale cash and carry model. Prashant Khatore provides the different viewpoints on the opening of this sector.

$�� J��6(��#��0��J�69 The Government has been recently consulting public to further aid in advancing the FDI policy and enhancing its lucidity. Hiresh Wadhwani discusses the consolidated FDI policy (Circular 2) on few long-standing open issues, relevant for NBFCs operating in India.

$7�� #�� Sudhir Kapadia aims to turn the perspective of India as a “complex tax destination” on its head and seek the silver lining in the Indian tax system.

$$�� K��#��0��*�� A compilation of direct and indirect tax and regulatory developments in the year 2010, previously published in the Ernst & Young Tax Focus, year-end special edition 2010.

��L#��&�� Due to globalization, technological progress and the risk-based approach by tax authorities the role of the tax function in the corporate sector has changed dramatically. Albert Lee and Sameer Gupta elaborate key trends that have propelled a shift in the role of the tax head.

Specials

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Foreword

Sudhir Kapadia

Rajendra Nayak

Prashant Khatore

Editorial board

Rahul Kashikar

Gajendra Maheshwari

Ganesh Pai

Tejas Mody

Shalini Mathur

Assistant editors

Nikhil Pradhan, Publisher

Pallavi Thakur, Assistant Publisher

Jerin Verghese, Corporate Communications

Purnopoma Debnath, Design

Tripti Panda, Logistics

Production team

Websites

ey.com/in/TaxServices

ey.com/in/BudgetPLUS2011

[email protected]

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Corporate tax

Across the globe, the tremors of ��

pose new and serious challenges before countries. Governments are increasingly focusing on ��!��and designing tax structures that are growth oriented.

India, despite the dismal global environment, continues to have robust, broad based growth although ��<�� $=��>��+��enhancing the tax-GDP ratio and strengthening tax administration are today a part of the Government’s priority list. Towards this end, the ��$��moves by the Government to bring in legislative and administrative tax reforms along with some landmark judiciary decisions.

To enable a deeper understanding of some noteworthy tax and regulatory developments in the year gone by, we are glad to bring forth to you Taxation in India 2010-11. It is a select compilation of opinions and analysis that our thought leaders and experts shared with the market in some of the leading tax and business publications on the developments between April 2010 and March 2011.

This issue deals with the Government’s two key proposed reforms – Direct Tax Code (DTC) and Goods and Service Tax (GST). The Government remains committed

to implementing the DTC from April 2012. However, certain proposals in the DTC continue to be contentious, for instance provisions relating to GAAR and CFC. On GST, though the tabling of the Constitutional Amendment Bill in the Parliament is a step forward to its implementation, the proposed model is yet to gain acceptability among the stakeholders. Concurrently, the Government has announced many changes in the indirect tax structure to prepare the ground for GST, including the adoption of Point of Taxation rules for services to harmonize the basis for tax collection (accrual) with Central Excise duty.

Strengthening of double taxation avoidance treaties and checking the rampant tax litigation are the other dimensions, which are under active discussion. The landmark Court decisions on transfer pricing provisions and the much discussed Vodafone ��!��the contours of international taxation in India. Policy issues such as FDI in defense and multi-brand retail sectors, and the bar on withdrawal of provident fund proceeds by an international worker until he reaches the age of 58 years, have also prompted active debate.

With the scale of the changes that are underway, we hope this publication stimulates your thoughts, helps you ��>��!��prepare for the dynamic future ahead of us.

Sudhir Kapadia Tax Markets Leader Ernst & Young India

Srinivasa Rao National Tax Leader Ernst & Young India

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Corporate taxThe Indian corporate tax arena has witnessed several developments in ��$��+�X��!��!��$��Z��Budget 2011-12 was considered only a ‘middling’ budget, one that did not see any substantial changes or introductions. The revised DTC was placed before the Parliament on 30 August 2010 and is now expected to be effective 1 April 2012. One of the key features of the DTC, which is under deliberation, is the anti-avoidance rules i.e. the Controlled Foreign Company and the General Anti-Avoidance Rules.

Stakeholders have enjoyed a steady budget and wait patiently for the expected policy reforms, the progress of which is discussed in the following section. Insights on protracted litigation in India and possible solutions to the same are also discussed here.

� [�\� ��$�� 10 | Arresting rise in tax litigation12 | Need for re-look at GAAR and CFC14 | Budget 2011-12: steady overall

In this section

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Corporate tax

Industry can look forward to an �� Ganesh RajMint, 31 August 2010

The Direct Taxes Code (DTC) bill has been tabled in Parliament

and straightaway referred to a parliamentary standing committee on ��+��replacing the archaic income tax act has been shifted from 1 April 2011 to 1 April 2012, which seems imperative because the select committee will �� aspects of smooth transition to the new regime. The deadline shift is a relief for investors because it would allow more time for evaluating the tax cost of doing business in the DTC regime.

The Bill proposed a northward revision of tax rates vis-à-vis the original proposals in the DTC. The change had been much anticipated on account of restoration of the Minimum Alternate Tax on companies �� !��and on account of dropping the contentious proposal for taxing long-term savings such as provident funds at the time of withdrawal.

The original code had proposed the levy of a gross asset tax (GAT) ��^_��assets. The proposal had attracted

maximum resistance as it was not �� !��resulted in taxation of loss-making companies. Thanks to the aggressive representations against the GAT proposal, the MAT regime has been �� !��`�"�#��has been kept at 20%, against an effective tax rate of 19.93% (20.01% as per Finance Act 2011) under the current act. At the same time, the corporate tax rates are proposed at 30% for all taxpayers, including Indian ��!��!��against the original proposal of 25%.

��!��!��(BPT), which was introduced in the original DTC, whereby “every foreign company” shall be liable to pay a BPT of 15%, has been retained in the bill. BPT on total income is comparable to the dividend distribution tax (DDT) !�$��$��the rate of 15% on the amount of dividends distributed. While DDT is payable at the time of distribution of dividends, BPT is not linked to ��!��+��$��!��tax liability imposed on a foreign company would be 40.50%.

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The capital gains tax regime seems to be a sandwiched version of the ��!��of the DTC. While there is no concept of long-term or short-term gains, a graded taxation for listed securities has been introduced depending upon the period of holding, and, at the same time, the securities transaction tax (STT) shall continue. If the period of holding of listed securities is more than a year and STT is paid, there will be no capital gains tax. For holdings of less than a year, 50% of the effective tax rate would be applicable on capital gains. For example, individuals shall be subject to effective slabs of 5%, 10% or 15% on such gains. All other kind of capital gains shall be taxable as any other income.

While the DDT scheme is largely unchanged, except for a marginal reduction from 16.61% (16.22% as per Finance Act 2011) to 15%, the DTC bill proposes to levy tax at the rate of 5% on income distributed by a mutual fund to the unitholders of equity-oriented funds or a life insurer to policyholders of an approved equity-oriented insurance scheme, which under the current tax laws is exempt from distribution tax. This additional levy is likely to increase the tax costs and equity-oriented mutual funds may be less lucrative now.

The proposed DTC has introduced the concept of controlled foreign

corporations (CFCs), which inter alia provides that the total income of a ��$��shall include an income attributable ��"{"+��!��in the DTC purports to capture the income earned by the CFC during ��!!��stakeholder to the extent of its ��!��"{"��$��year as a dividend from such an entity.

Lastly, the much debated general anti-avoidance rules (GAAR) have been retained, which seek to give wide powers to authorities to declare any transaction as impermissible or reclassify a transaction which is deemed to have been entered for tax avoidance. A detailed guideline on GAAR provisions would be prescribed for implementation of the provisions in the right spirit.

While the Indian tax system for tomorrow would look at a tax-GDP (gross domestic product) ratio in the range of around 25% with a higher share of direct taxes to ensure a more progressive tax structure, this can only be achieved through a broader base and improved administration and compliance. The direction of the government’s tax reforms and the stated objective in the original discussion paper — to establish an ��$��

Industry can look forward to an

��

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Corporate tax

Industry can look forward to an ��

equitable direct tax system — is only partially achieved for the time being. The dilution of provisions has led the potential tax base to shrink and affected the transition to a lower tax regime. However, as the new system settles, the industry can look forward ��that also provides it a competitive edge in the international arena.

Reprinted with the permission of Mint © 2010. All rights reserved throughout the world.

Ganesh Raj is a partner at Ernst & Young ��*��}��$�Advisory Group* as one of his multiple leadership roles. His functional experience includes corporate tax planning, structuring cross-border investments and transactions, and joint venture negotiations. He is based in our ��+

You can write to Ganesh at: [email protected]

*Ernst & Young India’s Tax Policy Advisory Group houses a specialized team of experienced resources including senior retired bureaucrats from the Government of India that advises clients across industries, and governments on diverse policy issues focusing on taxation.

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W&��&�#��/��&�� /�&��&��

��>

Though there are several reasons for the rise in tax litigation, the primary reason appears to be the lack of clarity in the language of the provisions to meet various situation and issues.

Another reason for protracted litigation is the existence of multiple appellate levels through which a disputed issue has to pass before attaining certainty. A tax dispute may take anywhere up to 20 years to attain certainty depending on the level to which it is escalated, and this is much beyond the international standards. Inadequate number of appellate benches exacerbates this problem.

"��>��!��appellate forums across the country also add to the uncertainty. Though it is within the powers of the Government to proactively amend the statute to bring it in sync with judicial interpretations, or the intention of the lawmaker, and thereby clarify the legal position and put to rest any pending and future litigation, it takes time to happen.

Mostly, litigation continues ��+��goes against the Revenue, the ��$�retrospectively amending the statute in the garb of bringing the provision in line with the legislative intention. This only results in a heightened sense of uncertainty, apart from huge

litigation costs becoming sunk.

Wouldn’t ��#��0��/��&��0>�

Although alternative dispute redressal mechanisms exist, most tax disputes are dealt with under the traditional route, as the alternative mechanisms have not proved to be very successful on account of certain inherent limitations.

The Authority for Advance Rulings ��!��$�disposal and a ruling in advance lends certainty to the tax angle, but the ��$��$��resident and public sector companies and the ruling is binding only on the applicant and the tax authority.

The Dispute Resolution Panel – set up with in 2009 to resolve transfer pricing cases and those relating

Arresting rise in tax litigationPrashant KhatoreHindu Business Line, 14 February 2011

Today, the tax compliance cost of Indian companies is huge, much of which goes into litigation. The greatest casualty of tax litigation is certainty in tax-related matters and ��

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Corporate tax

to foreign companies – appears to be now riddled with independence issues along with the perception of being biased towards the Revenue and limited as regards the eligibility criteria.

The scope and powers of the Settlement Commission, another dispute resolution body dealing with complex and protracted tax cases, have been substantially curtailed through amendments in recent years.

Yet another mechanism to resolve international tax disputes through the competent authorities of respective jurisdictions, viz. the Mutual Agreement Procedure, has resulted in very few takers because of factors including the absence of a time limitation, the general perception of competent authorities lacking adequate authority and conviction to negotiate and conclude issues.

B&�� /��&��0��/�� >�

��to reduce litigation is to free the statute from ambiguities as far as possible. The language of the provisions should be simple, clear and �!��+�"��ambiguous matters should come as a matter of routine as and when the issues come to light.

Any legislative process should be thrown open for public feedback before the law is enacted, so that ��!��right away.

A possible reduction in the number of appellate levels along with an increase in the number of appellate

benches can go a long way in reducing the number of pending tax disputes and the time for disposal.

Another possible measure could be the constitution of specialised benches of appellate authorities to ��!��+�

The CAG of India has recently suggested the setting up of a separate dispute settlement mechanism for small taxpayers, who constitute the majority of litigants (around 66%). It is suggested that differentiating corporate tax disputes from smaller ones will help in faster disposal of pending cases and speedy release of locked-up funds.

Safe Harbour rules for transfer pricing issues, envisaged in the tax ��^''�� the earliest.

Reprinted with the permission of The Hindu Business Line © 2011. All rights reserved throughout the world.

Arresting rise in tax litigation

Prashant Khatore is a partner at Ernst & Young India. A Corporate Tax* specialist, he has extensive experience in tax planning and structuring. He also actively contributes to thought leadership in the areas of direct ��+�X��+

You can write to Prashant at: [email protected]

*Our Corporate Tax practice provides integrated solutions across income and wealth taxes, corporate and allied laws, exchange control, FDI and regulatory matters besides specialized tax litigation advisory services.

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Need for relook at GAAR and CFCAjit KrishnanFinancial Express, 23 February 2011

With the budget round the corner, there are few expectations from

an income tax perspective given the sweeping changes proposed by the Direct Tax Code 2010, scheduled to be implemented from 1 April 2012, if passed by the Parliament and receives President’s assent. While the Code attempts to improve ��$��$��$��distortions in tax structure, some provisions have created uncertainty amongst the business community.

��proposed is General Anti-Avoidance Rules (GAAR), which would be a deterrent against tax avoidance and tax evasion. GAAR have the effect of invalidating an arrangement entered into by the taxpayer (domestic or international) with the objective of obtaining a tax ��+��is invoked, the Commissioner of Income Tax gets wide discretionary powers to declare such arrangement as an impermissible avoidance arrangement. There is no dispute that it is the government’s duty to protect the interests of the exchequer by ensuring that tax legislation is, as far as possible, proof against contrived tax avoidance. However, GAAR itself

cannot become a revenue-raising measure. It could damage commercial activities of many companies who wish to conduct commercial ��$+�

Since current IT law and code provide ��!��rules, the need for GAAR stands diluted. And keeping in mind the adverse implications described above, it is strongly recommended ��+�However, if GAAR is to be introduced, it’s important to reduce its rigour by writing in clear language ensuring that its purpose is readily apparent. It should state how the tax authority would treat a scheme caught up by the GAAR. The authority’s power to re-characterise transactions should be clear.

Another proposal which has created uncertainty amongst Indian MNCs is the concept of Controlled Foreign Company (CFC). The CFC rules are designed to prevent tax deferral and tax avoidance by residents, by establishing foreign entities/subsidiaries, in low-tax jurisdictions. CFC rules seek to target the income earned and accumulated in non-��>��or control of its own tax resident,

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Corporate tax

who are subject to worldwide taxation. It is presumed that in such ��$��>��!��!��policies as shareholders. Once a ��!��$��"{"�(and none of the exemptions apply), entire income of the CFC is taxed in the hands of the resident-controlling shareholder on a proportionate basis.

CFC rules pose a hindrance to free capital movement and will hinder international investment and result in a competitive disadvantage for Indian MNCs. Improving international competitiveness of our economy should be a major policy goal. This can be improved if Indian businesses headquartered here and operating abroad are able to effectively compete abroad. In India, in the absence of capital account convertibility and exchange control regulations still inhibit outbound investment. Also, outbound investment is still not comparable to the levels in countries with a free foreign exchange regime. Therefore, a CFC regime is not appropriate especially when Indian MNCs strive to become global players.

While the introduction of the code is welcome given the intent to simplify tax laws, provide stability and provide for best international practices, it is extremely important to address

some of these concerns which could dampen the spirit of the business community as a whole.

Reprinted with the permission of The Indian Express Limited © 2009. All rights reserved throughout the world.

Need for relook at GAAR and CFC

�*��K��&��is a partner at Ernst & Young India and leads the Infrastructure and Real Estate Industry !��+�X��our Japan Business Services Desk** in India. Ajit specializes in direct tax issues, Double tax Avoidance Agreements and in investment and transaction structuring. X��+

You can write to Ajit at: [email protected]

*Our 7,000-strong real estate practice operates as a global team delivering high-quality service to more than 4,000 real estate, hospitality and leisure, construction and infrastructure clients across the world.

**The Japan Business Services desk is based in Delhi and as part of a Global Business Network adds dual area expertise to industry and domain specializations. Our experienced global network of project teams provide multinationals with the real-time advice they need on tax issues, wherever their operations are based.

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Budget 2011-12: steady overallSrinivasa RaoCFO Connect, 1 March 2011

Tax policy is emerging as a key lever globally, as countries across

the world try and resuscitate and re-set their economies on a much-needed growth trajectory, after three painful years of economic carnage. While India did not suffer as acutely as many other countries, there was still some element of expectation that the Union Budget 2011 will hold pointers on India’s commitment to market, tax, and regulatory reform. In this regard the budget has neither enormously helped, nor has it hurt sentiment in any way. It is typically a “middling” budget, and perhaps the kind of “holding” Policy statement one needs at this stage as the dark clouds gradually lift away from the global economy.

Direct taxOn the direct tax front, it has marginally reduced the surcharge applicable on domestic companies from 7.5% to 5%, and on foreign companies from 2.5% to 2%, resulting in an effective tax rate of 32.4% and 42%, respectively.

In line with the emerging global policy axis of stimulating and incentivising innovation, the availability of weighted deductions for contributions made for approved ��!��been increased from 175% to 200%. Perhaps as a one-time initiative on the lines of a recent US tax policy initiative, dividends received by an Indian company from its foreign subsidiaries are proposed to be taxed at a reduced gross rate of 16.2%. The Minimum Alternate Tax (MAT) rate is proposed to be increased marginally from 18% to 18.5% of �� !��effective tax rate of 20%.

There was some element of expectation that the Union Budget 2011 will hold pointers on India’s commitment to market, tax, and regulatory reform. In this regard the Budget has neither enormously helped, nor has it hurt sentiment in any way.

15

Corporate tax

Much against popular expectations, ��$��the STPI scheme have not been extended, and Special Economic Zone (SEZ) developers and units will now also have to reckon with a tax. The exemption from MAT which was hitherto available for developers and units in a SEZ, has been done away with. The availability of exemption from payment of dividend distribution tax (DDT) for dividends distributed by SEZ developers has also been done away with. Any dividends distributed by SEZ developers on, or after 1 June 2011 will attract DDT at the rate of 16.2%. With this, some of the income tax policy advantages that SEZs enjoy stand more-or-less neutralized.

Limited Liability Partnerships (LLPs) will now be subject to an alternate minimum tax (AMT) at the rate of 18.5% of its adjusted total income, where such tax is less than regular Income Tax payable under normal provisions. The AMT provisions are similar to MAT provisions applicable to companies, and are quite a logical plug to what might have otherwise emerged as some kind of an unintended loophole. The credit in respect of tax paid under the AMT provisions is available for a 10-year period.

The Finance Bill, 2011 (Bill), has proposed a number of changes relating to transfer pricing regulations ��$�disputed and litigated pages of our ��+��>��$�of a 5% variation has been done away with, and the provisions have been amended to provide for a variation up to such percentage as the central government may notify. The transfer !��}��granted powers of survey to conduct ��!��$��as well as to determine the arm’s length price in respect of international transactions which are uncovered by them in the course of proceedings, but which may not have been necessarily referred to them by the Assessing ��+� ��$��!�$��in accessing contemporaneous comparable data, and furnishing the accountant’s report in respect of international transactions before the �!��'��!��has been recognized, and the due ��$��corporates has been extended to 30 November of each year. The due date for maintenance of transfer pricing documentation as well as furnishing the accountant’s report, linked to

Budget 2011-12: steady overall

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��accordingly stands extended to 30 November.

In order to seek regular information from non-residents regarding the ��#��annual information in the prescribed format within 60 days from the end ��$��+��!��!��to introduce certain anti-avoidance measures to review and enquire into transactions by resident taxpayers with persons located in any country or jurisdiction which does not have effective information exchange arrangements with India. Among others, transactions with such !��will attract the application of transfer pricing provisions and a higher withholding tax.

Indirect taxOn the indirect tax front, the central excise duty has been maintained at 10%, while certain changes in the central excise rate structure have been proposed to align it with the GST regime. On the service tax front, while the standard rate of service tax is retained at 10%, the tax base has been expanded by including certain additional services in the tax net to achieve some broad alignment between the current legislation and GST. Also, the Point of Taxation Rules are proposed to be made effective 1 April 2011. Under these rules, point of taxation will be determined based on provision of service, date of billing or receipt of payment, whichever is ��+��!��!��for service tax refunds for SEZ units and a new scheme for exporter of ��challenges currently being faced by IT service exporters do not appear to have been fully addressed. Further, the demand for clarity on taxation of packaged software has only been partially dealt with by providing an exemption from excise and customs duty on the value of licences for packaged software without MRP.

The one area that might have ��Budgetary Policy Statement is the FDI policy. While there are obviously several avenues, channels, and timing opportunities for announcing reforms

It also proposes to introduce certain anti-avoidance measures to review and enquire into transactions by resident taxpayers with persons located in any country or jurisdiction which does not have effective information exchange arrangements with India.

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Corporate tax

or intended reforms to the FDI policy, the annual Budgetary platform does serve as a grand, even if partly ceremonial, platform to signal such ��!��$��the much-watched sectors such as insurance and retail.

All in all, this is a steady and solid Budget, as we round the corner towards the more comprehensive DTC and GST policy and legislative reforms that will come through in the coming months.

Reprinted with the permission of CFO Connect © 2010. All rights reserved throughout the world.


4��#��O4��Q�S�� is a partner at Ernst & Young India and the National Director of our Tax & Regulatory Services practice*. In recent years, he has been serially rated as amongst the leading tax and transfer pricing advisors in the country by Euromoney and the Legal Media Group. Srini has worked with some of the world’s leading multinational companies across a range of Direct Tax specializations. He now specializes in cross-border structuring and transfer pricing/supply chain planning. He is based ��#��+

You can write to Srini at: [email protected]

*Ernst & Young India’s Tax & Regulatory services practice comprises 60+ tax partners and 1,400+ tax professionals in 9 cities across India. Consecutively rated the past 8 years as India’s ��$��$*��Review, it has also emerged as the Most Reputed Tax Firm in India for the second consecutive year in the TNS Global Tax Monitor Survey, December 2010.

Union Budget proposals i.e. the Finance Bill 2011, has been approved by the Parliament and obtained Presidential assent, and is now the law.

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Employment taxIndia follows a progressive system of taxation for individuals, where income is taxed on the basis of residence of the taxpayer and source of income. Tax revenue (both direct taxes and indirect taxes) in India accounted for 17.7% of the GDP in 2010.

In the recent past, the Indian Government has taken multiple measures to liberalize the tax laws thereby ensuring greater compliance and hence an increase in the tax revenue. Our personal tax experts have opinioned regularly on some of the critical aspects of employment and personal taxation in the country.

In this section you can read about sweat equity shares; obligations of a company employing contract workers; the implications of holding a US green card from a tax perspective and how to ensure timely damage control. The ��>$��!!��$��$��Z��Budget 2011 in the area of employment and personal taxation.

19 | The nitty-gritty of sweat equity^%�\� `��*��>��$��*��24 | How to reduce the labour pain of contract workers27 | Budget 2011: hits and misses

In this section

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Employment tax

The nitty-gritty of sweat equity Amitabh SinghHindu Business Line, 26 April 2010

A��T��'��U�&��T� ��0��U>

Not exactly. They are similar to the extent that both are means of providing non-cash incentive or compensation to individuals. However, sweat equity, as widely understood, are real shares allotted to individuals upfront.

Stock options, on the other hand, is merely a right given to the individual to acquire shares of the company at a future date at a pre-agreed price.

Cognisant of the inherent differences between the two, the Securities and Exchange Board of India (SEBI) has issued separate guidelines for sweat equity and stock options.

These guidelines are applicable to all Indian listed companies.

��&�� '��&�� 0��>

Yes. Sweat equity is governed by Section 79A of the Companies Act. To regulate sweat equity in case of unlisted companies, the Department

of Company Affairs (DCA) has issued the “Unlisted Companies (Issue of Sweat Equity Shares) Rules, 2003”.

%��&�� '�� /��>

In a broader sense, sweat equity can be issued to anyone who has rendered services to the company. Sweat equity can be issued to an

employee, consultant or a vendor. That is the reason start-up companies use sweat equity as currency to pay for services that they cannot pay for in “hard” cash.

However, in India, as per SEBI and DCA regulations, sweat equity shares can be issued only to employees or directors.

B&��0��&��0�� 0�&�� &,��0� ��!�0� ��0��&��0��0� �� >

The whole concept of using company shares as remuneration or reward has its origins in the famous Silicon Valley. Employees and vendors joined together to build an ecosystem that

Sweat equity, very literally put, are equity shares that the company issues to an individual in consideration of his services, knowhow or any other value addition that the company has �� can be issued free of charge or at a concession to their prevailing value.

20

6��

allowed technology start-ups to access talented resources and high quality services in return for company stock. Many of these start-ups are Fortune 100 companies and many of these employees who took stock instead of cash are millionaires, if not billionaires.

At the same time, all start-ups do not go on to become a Microsoft or HP. If the company fails, the stocks are worthless and that is the risk-reward judgment an individual has to grapple with.

Reprinted with the permission of the Hindu Business Line © 2011. All rights reserved throughout the world.

The nitty-gritty of sweat equity

��/&�4��&�is a partner at Ernst & Young India and the leader for our Human Capital Global Mobility Services practice*. His functional expertise includes tax effective compensation structuring, payroll outsourcing, design and implementation of stock based incentive plans, as well as exchange control related advisory and litigation. He is based in our ��`��+

You can write to Amitabh at: [email protected]

*Our Human Capital Global Mobility services practice includes 100+ dedicated professionals located across India who assist our clients on end-to-end employment tax matters.

21

Employment tax

�� it’s taxing Amitabh SinghEconomic Times, 23 May 2010

I had never seen Chiradeep, my next door neighbour, as happy

and excited as he was the other day. He was beaming with joy and looked 10 years younger than his actual age of 52. Deep, as we called him due to his intense demeanour, had taken early retirement, his savings and stock options having generated enough wealth to allow him to take this step. Deep spent time pursuing his philanthropic interests and making astute investments in stocks, bonds and mutual funds.

Seeing him so happy, I could not resist asking, “Deep, what’s up? Have you hit a jackpot or something?”

“You could say that my friend,” he said. “At last, my dream has been ��$��!��$��!!��+=�

My tax practitioner alarm immediately started ringing. “Deep”, I said, “Congratulations. But have you thought about the tax implications? I am not a US tax expert, but I know that the US taxes its residents on a global basis. You have so many investments in India, have you taken an expert’s guidance?”

“Don’t worry my friend, I have done my homework,” Deep said. “Since Indian tax rates are over 30%, the same as US rates, I do not see any major issues.”

Deep’s casual approach got me so worried that I had to suspend my walk and insist that he come home with me. Based on whatever little I knew, and without professing to be an expert on US tax norms, I outlined the implications of holding a green card:

�� A US green card holder is considered a US tax resident and is subject to taxation in USA on his worldwide income. It does not matter that the individual holding a green card lives outside the US and earns all his income outside the US. He has to report his income and pay taxes to the US authorities on his worldwide income.

�� Many incomes in India are exempt from tax or taxed at lower rates, but will get taxed at normal rates in the US. For example, a dividend distributed by an Indian company is tax free in the hands of the shareholder. However,

22

6��

this dividend is subject to tax in the US. If you have substantial dividend income, your effective tax rate will suddenly shoot up from zero to something as high as 15% or even 35%. A similar situation could arise on long-term capital gains from sale of Indian listed equity shares that are tax exempt in India, if securities transaction tax has been paid on them. Hence, even with similar tax rates, differences in rules for arriving at taxable income could �� tax liabilities.

�� Investments in Indian MFs can become potential tax traps for a green card holder. According to the US tax laws, most Indian ��as passive foreign investment companies or PFICs. Investing in PFICs by US taxpayers can be quite costly as PFICs are subject to onerous taxation rules. Hence, one may need to actively review one’s portfolio and consider divesting from all PFICs.

�� If your wife or children are US–permanent residents by virtue of citizenship or a green card, they could under certain circumstances be required to report any gift or inheritance received from you to the US IRS, and if they fail to do so, they could be subject to very ��!��+��for anyone who acquires a green card, there is a risk that the US will consider them to be domiciled in the US, and if so, they could be required to pay tax when they give gifts or leave inheritances to other family members-even if the property was situated in India!

��green card, it’s taxing

If you have held your green card for eight taxable years (which could even be six years) and then decide to surrender it, you could end up paying special exit or expatriation taxes on a deemed basis assuming that you sold all your assets at fair market value on the date of surrender of green card. And if that isn’t enough, if you expatriated and then wanted to give a gift or leave an inheritance to one of your children who has a US green card, your child would have to pay a succession tax of up to 55%!

23

Employment tax

��green card, it’s taxing

Deep was looking distinctly morose with all his ebullience having disappeared by now. “Does it mean that I cannot hold a green card unless I also pay taxes through my nose?”

“Well,” I said, trying to be comforting, “the privilege of having US permanent residency has its costs. However, before you accept your green card, maybe there are a few things you can do with your assets and property to legitimately protect them from US taxes. With some amount of planning and professional advice, a lot of rigour can be mitigated. If nothing works, you could look at permanent residency of

another country, say Canada, where the tax consequences are not so devastating.”

“You have given me enough to chew upon. Let me think over this and not act in haste,” Deep said and slowly started walking towards his home, disappointed, but at the same time relieved that not much damage had been done.

Reprinted with the permission of The Economic Times © 2011. All rights reserved throughout the world.




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6��

How to reduce the labour pain of contract workers Amitabh SinghEconomic Times, 19 September 2010

As I came home from my Sunday morning walk-cum-milk errand,

��!�� who runs a technology company, sitting on the porch, sipping �$�!��>��+�He looked quite worried.

“Have you read this?” He said, waving a newspaper cutting, as I took the chair next to him. I put on my reading glasses and peered at the cutting. It carried a news item of the recent travails of the head of a renowned business group due to some alleged violation of provident fund laws.

“Yes, I am aware of this, but why does it worry you?” I said. “Of course it worries me, if the rich and famous can be hounded like this, then I am a sitting duck!” Anand said. “Only if you have violated any of the labour laws,” I said. “Have you not been complying?” Anand said nervously, “Well, I have tried to be as compliant as possible for my employees, but there are so many laws, how can I keep track of all of them? Moreover, I have so many vendors whose

��!��$�� $��!�� $��canteen, housekeeping, drivers. We ��builder has his own set of workers and sub-contractors. Am I responsible for their compliance as well?”

What Anand was stating, I had to admit, was true for so many companies today. It was now commonplace and convenient for companies to outsource many of the non-core functions to contractors who used their own employees to provide the said set of services. However, the labour laws in India have generally been designed with a view to protect contract workers from exploitation and this has led to regulations that fasten the liability for many contract labour related violations not just on the contractor, but on the principal employer as well.

“Well, the short answer is-Yes. If you engage vendors that provide services to your company through their employees, then to a great extent you are liable for any omissions that

25

Employment tax

the vendor may commit in respect of his employees.” “This is terrible!” Anand wailed. “How am I to ensure all this?” “Anand, I am not a labour law expert, but I will give you some pointers,” I said, secretly enjoying ��+��!��share my tulsi-chai with if he goes to jail, the devil in me thought.

I continued, “To start with, you need to ensure that the full payment of salary is made to the contract workers on the due date. One of your employees should be personally present whenever salary is being distributed in cash. Make sure that the full salary, as due to the contract worker, is paid and his receipt obtained. The pay sheet should be

counter-signed by your employee and a copy kept for your records. Any shortfall in the payment of salaries to the contract workers is liable to be made good by the principle employer.

Since the workers are eligible for ��$��}{��among others, you should ensure that the contractor is deducting as well as making his part of the contributions accurately and depositing the same with the government on or before the due date.

Any lapses will make you, as the principle employer, to all punitive measures as are applicable to the contractor and you cannot plead ignorance as an excuse. Hence, your employees should verify the PF and ESI calculations and also verify the original deposit receipts. Copies of all such documents should be retained by you.

Many companies do not release the contractor’s payments unless and until he has furnished all supporting documentation along with an undertaking of full compliance to all applicable labour laws. In case the principle employer has to make good any shortfall due to the contractor’s non-compliance, the law permits him to recover the same from the contractor.

How to reduce the labour pain of contract workers

<��who is a contract worker. In a broad sense, any worker, doing skilled, semi-skilled, unskilled or manual work, if employed by a contractor or sub-contractor to provide services to you at your premises would be a contract worker. However, this excludes workers performing managerial or supervisory activities. In other words, it’s the people at the very bottom of the chain.”

26

6��

The last one year has seen many changes to labour laws and you should make sure that not only are they being applied for your employees, but for your contract workers as well. For example, the exemption threshold for ESI has been increased from `10,000 to `15,000 per month. The amount of compensation under the Workmen’s Compensation Act has also been increased.”

Anand, who had been taking notes, said, “These are most helpful. Any other tips you would give to a dear friend?” “Considering the dreadful consequences, these tips I would not hesitate to give even to my enemy,” I continued. Generally, one should avoid contract employees for work that are carried out throughout the year and are intrinsic to your business. The wages paid to your contract workers should be similar to what your employees get for the same kind of work.

Make sure that there is proper death and accident insurance for your contract workers and that they have access to facilities such as rest rooms, canteen, drinking water, et al. while they are present at your premises. In other words, treat them no less than your employees.

How to reduce the labour pain of

contract workers

Also, if you have a large number of contractors, do carry out an annual compliance audit to ensure that you have not missed anything. Last, but not the least, pray to God daily for His protection!





27

Employment tax

Budget 2011: hits and missesSonu IyerEconomic Times - Wealth, 3 January 2011

Mr Das, my next door neighbour, a major cricket enthusiast decided

to summarise for me the ‘Hits’ and ‘Misses’ very much in the passionate style of Cricket Commentators visible on TV channels as the World Cup crescendo builds up.

Dropped again

��>�� !��basic commodity like onion to new heights, common man was looking to Budget 2011 for some respite.

Further, in the backdrop of Direct Tax Code (DTC) becoming effective from 1 April 2012, it was expected that some of the key provisions will ��!��#��^'%%+�One such key expectation was that the basic tax exemption limit of Rs.2 lakh for personal tax, as proposed in DTC should be implemented. Unfortunately, just a revision in exemption slab to Rs.1.8 lakh has been disappointing for masses given that the relief involved is minor.

“Senior citizen” — the man of the match!

Throughout our lives, we get to hear that ‘old is gold’, but I realized it better after I heard the special

changes announced in the budget for the senior citizens. Not only the basic tax exemption limit has been hiked from Rs. 2.4 lakh to Rs.2.5 lakh, but the age for qualifying as a senior citizen has been brought down to 60 years from 65 years.

Further, separate category of ‘very senior citizens’ has been provided under the income tax law who will be eligible for exemption of Rs.5 lakh, provided they have completed the age of 80 years on 31 March of the ��$��+�

Broadly, tax saving for an individual will fall in either of the categories mentioned below:

Wide ball!

Though basic exemptions may have scored less, but some extra deduction may bring cheer, especially for individuals who contribute to New Pension Scheme (NPS).

Currently, both the employee’s and employer’s contribution to NPS are considered for overall ceiling of deduction of `100,000 under Sections 80C/CCC/CCD for tax saving instruments. The budget proposes that employer’s contribution to NPS will no longer be a part of the ceiling.

28

6��

Additionally, the employer can claim tax deduction for the contribution up to 10% of employee’s salary.

Therefore, larger contribution by the ��!��$��!��$��with higher tax deduction and the employee with tax saving.

Additionally, deduction of `20,000 !��investment in infrastructure bonds will ��$�� as well.

House that!

With many fold rise in real estate prices, buying a house still remains dream for millions of people like Mr Das. Finance Minister in his Budget addressed this issue and raised the priority sector home loan limit from `20 lakh to `25 lakh. Also, the interest subvention of one per cent on home loans up to Rs 15 lakh, up from the previous limit of `10 lakh, will come as a relief to the lower income group.

Accordingly, Mr Das seeking a house loan of up to `15 lakh on a house costing not more than `25 lakh, will be entitled to interest rate subsidy of 1% and therefore, will have a potential saving of `15,000 p.a on a loan of `15 lakh (at 10% rate of interest).

However, the above provision may not ease the pain in the metropolitan cities, where real estate prices and demand for affordable housing is the highest.

{��!��!��on interest payment up to `1.5 lakh on home loans can breathe easy as this continues. Such positive moves will not only encourage investment in housing, but also brings down their personal tax liability.

Clean bold!

Service tax is another juicy fruit, which Finance Ministry is harvesting $��$��$�in the budgeted revenue. Though the service tax has been retained at 10.3%, new services have been added to the list of taxable services where one needs to shell out more.

No return-caught behind

Every year many others like Mr Das have to decipher the new tax return form prescribed by the authorities ��+��well, then as per the budget, salaried ��!�$��year onwards. This will make life of

Budget 2011: hits and misses

Category Current (`) Proposed (`) Savings (p.a.) (`)Individual < 60 years 160,000 180,000 2,060Resident women< 60 years 190,000 190,000 NilSenior citizens (men) 60–64 years

160,000 250,000 9,270

Senior citizens (women) 60–64 years

190,000 250,000 6,180

Senior citizens 65–79 years 240,000 250,000 1,030Very senior citizens =>80 years

240,000 500,000 26,780

29

Employment tax

Budget 2011: hits and misses

Sonu Iyer is a partner at Ernst & Young India and part of our Human Capital Global Mobility Services practice*. She has over 15 years of experience in the area of Human Capital-Global Mobility covering Employee Taxation and Advisory with key focus on Global Mobility Risk Advisory Services and Accidental Expatriates. She is ��`��+

You can write to Sonu at: [email protected]


millions of tax payers easy as they ��tax return, which is generally a complicated process for many.

However, the practical implementation of the amendment is required to be looked at as the same may become unworkable. For instance, if the rules provide that an employee should have no other taxable income to be eligible, in practice, no employee may actually ��$��!��as most of them will earning at least some amount of interest on their savings bank account, which is taxable.

It’s a six!

Soon the days of chasing tax authority tirelessly for your tax refunds will be over, if web based facility, an interface with the income tax department, to track resolution of refunds and credit for prepaid taxes, sees the light of the day. However, one need wait and watch how soon the system is implemented and the tax authorities are equipped with skills to use them effectively.

By the time I and Mr Das completed our last round, I realised life after budget was similar to match between India vs. England where one is neither worse off, if not better off.

Reprinted with the permission of Money Today © 2011. All rights reserved throughout the world.

Category Current (`) Proposed (`) Savings (p.a.) (`)Hotel accommodation (with rent above Rs.1,000 per day)

1,100 On 50% of value 1,100+55=1,155

Air-conditioned restaurants cum bar

7,00 On 30% of value 700+22=722

Air-conditioned hospitals (with more than 25 beds)

6,000 On 50% of value 6,000+309=6,309

Regular health check-up 5,000 On 50% of value 5,000+258=5,258ULIP premium 25,000 At the

composition rate of 1.5%

25,000+375=25,375

30

6��

Indirect tax��$��$��transition from a multiple tax regime to a common GST. The foundation for the same has already been laid by the introduction of the Constitution Amendment Bill in the Parliament. Stakeholders understand the need to carefully implement changes in the current laws, and keep a close vigil on the likely structure to ensure a smooth shift to GST when it is implemented.

The Government is rightly attempting to make the current laws GST friendly, with the introduction of the Point of Taxation Rules in the Service tax law being a step in this direction. These Rules change the liability to deposit service tax from payment to accrual method and align the Service tax law with the other indirect tax laws such as VAT and CENVAT.

This section provides a detailed analysis of the issues being deliberated in the purview of GST, among other developments that may impact your business.

31 | Sectoral coverage of GST: issues and challenges33 | GST or not, abolish central sales tax35 | Budget 2011: tax exemptions should now enter their twilight years38 | Constitutional GST bill gets the Union Cabinet approval40 | Point of taxation rule, 2011

In this section

31

Indirect tax

Sectoral coverage of GST: issues and challenges Harishanker Subramaniam Financial Express, 9 April 2010

Internationally, the application of GST on a vast majority of sectors

has been without any substantive hurdles. But, applying GST to a few ��!��and public bodies has been complex. Additionally in India, treatment of sectors like petroleum as well as alcohol under GST is controversial.

Traditionally, real property transactions have been exempted from VAT (as under the European Union) on the grounds that land did not constitute value added and real property are already subject to stamp duties and/or registration charges. However, under modern VAT/GST systems (such as that in Canada, Australia, New Zealand and South Africa), real estate transactions are within the purview of GST.

The Report of the Task Force of the Thirteenth Finance Commission (Task Force) proposes integration of the real estate sector into the GST framework. This is planned to be done by subsuming the stamp duty levied by the states to facilitate input credit and eliminate cascading. However, the

report released by the Empowered "��(EC) is silent on the inclusion of real property within the ambit of GST. It would be wise to follow the modern VAT approach, as exclusion of real estate leads to tax cascading through blockage of input taxes on construction materials and services.

��$��the European Union have been conventionally exempted from VAT. The exemption is mainly because of ��where the consideration for service is not an explicit amount but a margin. As there are no compelling economic or social policy reasons for exempting ��appropriate to continue this approach under GST.

Another sector that is knotty is the petroleum sector. Currently, taxation of this sector is complicated as certain products enjoy subsidies, while others are subject to multiple taxes at both the Central and the state level. Further, there are restrictions on availing credit of taxes paid on fuels. It has been proposed by

32

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the EC that the basket of petroleum products, i.e., crude, motor spirit (including aviation turbine fuel) and high speed diesel should be kept outside GST as is the prevailing practice. Such a move is likely to result in cascading of taxes, which is avoidable.

In countries like Australia, Canada and Singapore, GST/VAT applies generally to all supplies of crude oil and other petroleum products barring a few deviations. As a result input tax credit is available for set off against the output GST liability. The Task Force has recommended that emission fuels, products may be levied to dual levy of GST and excise duty with restricted credit and GST ��input credit like any other good. It is imperative that the Centre and State governments develop consensus on coverage of petroleum under GST.

The Task Force has recommended a dual levy of GST and excise on tobacco and alcohol with restrictions on credit. The EC is aligned with the Task Force on tobacco, however, in case of alcohol they suggested that it should be out of the ambit of GST, while VAT and excise duty should be continued.

On the aspect of determination of taxable goods and services under GST, internationally the practice has been to maintain a negative list of goods and services, so that it is easier to monitor and administer. However, the GST regime in India may have a positive list for services

and a negative list for goods. Such a move would perpetuate existing ��!��+�

While the government treads towards implementation of GST by April 2011, it is bound to experience various challenges. In an ideal world, GST should be levied on all goods and services at a single rate to achieve simplicity and neutrality. However, deviations occur as there are concerns regarding the distribution of tax burden. We trust the Government shall consider various pros and cons, while deciding upon the taxation of the diverse sectors under the GST system.


Sectoral coverage of GST: issues

and challenges

.��&��4�/�� is a partner at Ernst & Young India and our Northern region leader for Indirect tax services*. �� has 25 years of experience in industry and consulting. His areas of expertise are customs and international trade, and service tax, VAT and excise duty. He is also currently involved in assisting companies for the impending introduction of Goods and Services Tax in India. He is based in our ��+�

You can write to Hari at: [email protected]

*Our Indirect Tax services practice is the largest in the country with 300 dedicated professionals who assist clients across India with their indirect tax policies, administration, compliance and litigations.

33

Indirect tax

GST or not, abolish central sales tax Satya Poddar Economic Times, 16 February 2011

The tiny, but unjust tax must go

The Central Sales Tax (CST) is the root ��$��in the current tax system. It is a tiny ��>��!�� +��enforce and prone to evasion. The states pour vast sums of money in setting up inter-state checkposts to enforce the tax, which are a useless ��!��!��than to supplement the incomes of those manning them. The barriers they create are a blot on the common market of India. Being an origin-based tax, CST violates the principle of interjurisdictional equity. It is an extra-territorial tax by the producing states on the residents of the consuming states. It is also a major contributor to tax cascading as no credit is allowed by any government for the tax paid on inter-state purchase of inputs. The enhanced costs create a competitive disadvantage for the Indian suppliers. To avoid the tax, ��

the goods to their own depots in other states and then make a local sale. But that makes the supply chain complex and expensive. In one recent study, an electrical manufacturer had set up 26 distribution centres, which could ��"��+�Despite this, the states want to hang on to the CST only for the revenue consideration. However, the loss in CST revenues can be more than offset by a suitable adjustment in VAT rates, broadening the tax base and enhanced compliance. To illustrate, when CST was reduced from 4% to 2%, the reported inter-state sales in some states (e.g., Delhi) shot up by more than 100%! Some states have argued that reduced CST creates much larger arbitrage opportunities for the dealers to show intra-state sales (taxable at 4% to 15%) as inter-state sales (taxable at 2%). Such activities can be controlled through IT-enabled mechanisms like Trade Information Exchange System (TINXYS) that allow proper reporting and monitoring of inter-state transactions and for collection of tax

34

6��

on them. TINXYS has already been developed, but it’s accumulating dust on the shelf for want of attention from state bureaucracies. GST can provide an impetus, but is not essential, for the adoption of such technologies.


GST or not, abolish central sales tax

Satya Poddar is a partner at Ernst & Young India and a core member of our Tax Policy Advisory Group*. He has over 30 years of experience in advising clients on tax policies, VAT and international taxes, and is a noted international thought leader on Goods & Services Tax and VAT. He has advised the European Commission, World Bank, Ministry of Finance in India and multiple ��$��+�X��+

You can write to Satya at: [email protected]

*Ernst & Young India’s Tax Policy Advisory Group houses a specialized team of experienced resources including senior retired bureaucrats from the government of India that advises clients across industries, and governments on diverse policy issues focusing on taxation.

35

Indirect tax

Budget 2011: tax exemptions should now enter their twilight years Bipin SapraEconomic Times, 24 February 2011

The indirect tax system in the country has seen far-reaching

changes during the last decade. The key objective of these tax reforms has been to minimize the cascading effect on taxes. Tax exemptions have been the chosen method of providing tax incentives in the country and, over a period, these exemptions have grown disproportionately. In the last few years, efforts have been made to streamline and reduce the list of exemptions. Even then, today, more than 350 exemptions exist in central excise and more in customs and service tax.

A major roadblock to minimising the cascading effect on taxes is the manner in which these tax exemptions are granted. The existing exemption schemes are based on the type of goods and services, industry sectors, value of clearances and are also available in the form of tax-free zones such as special economic zones, export-oriented

��!��which have concessional or no excise duties. In most cases, the exemptions prescribe that the assessee is not required to pay tax on the procurement or supply of goods and services. The basic model of these exemptions is such that by exempting ��!��!��the inputs and input services, they ��!��>��the supply chain, which results in the cascading effect on taxes. For instance, at the central level, there are numerous exemptions that allow the manufacturer and the service !��!�$��product or the output service.

The credit rules do not allow the manufacturer of the exempted goods and the provider of exempted services to take credit of the inputs and input services used. This result in inclusion of these taxes in the ��!��!��to the end-customer. This is clearly

36

6��

against the spirit of the goods and services tax (GST). The GST envisages a broader and uniform tax base across states and, hence, the present exemptions need to be rationalised. It is expected that the exemptions would be limited to the present list of exemptions available in value added tax (VAT), which does not exceed 100. As a step towards the GST, the government is reviewing the status of existing exemptions, so as to identify the ones that have achieved their purpose and the ones that are still essential.

Many exemptions are still expected ��!��+�The threshold-based exemption is one such exemption. In the present regime, the threshold limit prescribed under the excise law is `1.5 crore, whereas in VAT law, it is `10 lakh.

Currently, the calibration of the threshold limit in the GST is a topic of debate.

It is expected that the threshold limit may be rationalised to a lower number to ultimately reach the expected result. The small units may be given an option of paying duty under a composition scheme of, say, 1% of the turnover. Though this may not be the ideal from a tax ��$�!��!��$��the present system of exemption to the proposed system in GST. The service sector has also witnessed rationalisation of exemptions in the last few years. Services that have been exempted or were nontaxable have been brought under the tax net. Currently, more than 100 services are being taxed and more may be taxed with this budget.

Last year, the health sector, which had enjoyed the exemption till then, was also brought partially under the tax net by taxing the services provided by the hospitals to corporates and insurance companies. The aim is to broaden the tax base and, hopefully, transition to a small negative list of exempted services in future. Worldwide, exemptions are not the most preferred method of granting incentives. If an industry ��!��zero-rating of goods is allowed. Zero-rating allows recovery of taxes used in these goods or services by way of refunds or rebates. It is expected that zero rating, which is limited to export

Budget 2011: Tax exemptions should

now enter their twilight years

Budget 2011 is seen as a starting point for the phasing out of certain exemptions. A number of items such as processed food, footwear, ice-cream and so on are being considered for removal of exemptions, as most of these goods are being taxed by states under the VAT regime. However, given ��>��$��unlikely that goods, which have an impact on the common man, would be touched.

37

Indirect tax

Budget 2011: Tax exemptions should now enter their twilight years

goods, may be extended to some goods and services in the GST regime. This is only possible if the number of exempted goods and services is small. Budget 2011 may be a small step in ��+


��0��4�0�� is a partner at Ernst & Young India and anchors Indirect Tax for our Technology, Communications and Entertainment industry practice for the national capital region. An ex. Additional Commissioner with the Department of Revenue, Ministry of Finance in India, he has been part of various committees in the Indian Government for drafting legislations on Indirect tax policy in India. X��+

You can write to Bipin at: [email protected]


38

6��

Constitutional GST bill gets the Union Cabinet approval Heetesh Veera DNA Money, 23 March 2011

Inspite of various hurdles and opposition faced by the Central

Government, the introduction of Goods and Service Tax (GST) has been the dream of the Central Government. Till now, States have been disapproving to the road map of GST by displaying their disagreement on account of revenue sharing, power to increase or decrease taxes with the Centre exemption list etc. Inspite of the disagreement from the States, the Finance Minister (FM) Mr. Pranab Mukherjee had announced in the Budget 2011 that the Constitutional Amendment Bill would be introduced in the Parliament in the ongoing Session.

A step forward has been taken in this direction on Thursday when the Union Cabinet, chaired by Prime Minister Manmohan Singh, approved the Constitution Amendment Bill (‘Bill’). The same has been tabled before the Parliament today, 22 March 2011 by the FM.

GST seeks to subsume indirect taxes like central excise duty and service tax at the Central level and VAT at the state level also subsuming some other local levies also. GST is expected

��!��$��uniform pricing of products across the country. Petroleum products and alcohol are likely to be outside the ambit of GST. Further, the District Councils and Regional Councils are empowered to levy entertainment tax on entertainment and amusement.

The present regime of indirect tax has two components — one levied by the Centre (i.e. Central Excise and Service tax) and the other levied by the States (ie Value Added Tax), implying that both will need to have concurrent powers to tax a goods or service. Presently, the Centre can impose taxes on goods (at the factory gate) and on services while states can only tax goods on sale. At present, States does not have the power to levy tax on services. It was therefore required

��$��!��!�towards bringing in the much awaited indirect tax reform by implementation of GST in 2012. This was one of the major hurdles/ bottleneck due to disagreement from the States. The next crucial step ��#��$��'_��the states.

39

Indirect tax

�� !��$��a Constitutional Amendment Bill and allow the Centre and States to levy tax simultaneously on goods and services. The Bill empowers the Parliament to levy GST on interstate trade and imports.

In view of the objections raised by many States, FM has worked on ��Constitutional Amendment Bill. The three earlier drafts were rejected by States, citing autonomy issues. The fourth draft of the Constitutional Amendment Bill which is a hybrid of the second and third draft has been approved by the Union Cabinet on Tuesday, paving the way for rolling out of GST. The Bill has proposed that a GST Council be formed through a presidential order for taking decisions on all important matters. GST Council would be the main body for taking �� $�� of tax rates, exemption list, threshold limit, and any other matter related to GST. In addition, composition of the GST Dispute Resolution Authority, proposed to be a part of the Constitution Amendment Bill, will be decided by the Parliament.

The Centre has not discussed the fourth draft with the Empowered Committee of State Finance Ministers ��$��Standing Committee of Parliament, which comprises members of many political parties. After its passage in Parliament, the Bill would have to be cleared by not less than half of state assemblies and legislations. Further, each state has to approve the Bill with

two-third majority. This would be a crucial step as well as a hurdle, given the past rejections of the States to the earlier three drafts of the Bills fearing ��$��!��+

Finally, though FM has showed a substantial progress towards implementation of GST in 2012, it would be interesting to watch whether the fourth draft Bill attains the requisite political consensus from the States thereby enabling FM to meet its deadline for GST implementation.

Reprinted with the permission of DNA Money © 2011. All rights reserved throughout the world.

Constitutional GST bill gets the Union Cabinet approval

.��&�D��is a partner at Ernst & Young India and our Western region leader for Indirect Tax services*. He has over 20 years of consulting and corporate work experience in Indian indirect taxation and specializes in VAT laws/sales tax, excise, customs, entry tax, service tax and also in SEZ and FTP rules and regulations across India. He is based ��(��+

You can write to Heetesh at: [email protected]


40

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Point of taxation rule, 2011 Bipin SapraCNBC The Firm website, 4 April 2011

The Government introduced the Point of Taxation Rules (POT

Rules) in the Union Budget tabled last month to replace the traditional method of payment of Service tax on receipt basis. Heeding certain objections voiced by the industry, the POT Rules have now been amended ��!��$��and crystallize the implementation of the Rules in tandem with the existing Cenvat Credit Rules and Service tax Rules.

X��}��!��!��The concept of payment of Service tax has been changed from payment basis to an accrual methodology. This is in line with the implementation of GST to bring parity in the way goods and services are taxed.

The general rule of taxation in the }��the earlier of the date of invoice or receipt of payment and if the invoice is not issued within 14 days from the date of completion of service, then the date of completion of service. The concept of completion of service is ambiguous and subject to interpretation.

Continuous supply of services ��contracts exceeding three months and there too the liability to deposit tax is prescribed as the earlier of issue of invoice or receipt of consideration or completion of service. However, for continuous services involving milestone payments, the date of completion ��!��$��service receiver is liable to make payment on milestone/ periodic basis. Using contractual milestones as point of taxation has its own pitfalls for the Industry as all past and future contracts need to be carefully evaluated.

��}��!��taxation for export and import of service on the date of payment, as it existed in the erstwhile regime. Accordingly, export will ��!��foreign exchange and import of services would attract Service tax only on payment basis. The above relaxation is available only in cases, where the export remittances are ��!��$�RBI or when payment for import of

41

Indirect tax

services is made within six months to the overseas vendor. In the event the ��trigger shifts to the general rule i.e. earlier of date of invoice or receipt of payment.

A major relief provided to the taxpayers in the recent changes includes the amendment of Service tax Rules to provide adjustment of Service tax in case the value of service ��$��provision of service or any other terms of the contract. Accordingly, if an amount is renegotiated and a credit note issued, the excess tax paid on accrual would be available as credit for future payments. However, no provisions for bad debt has been made.

The Cenvat Credit Rules have also been amended to facilitate their working with the POT Rules. Credit of input services has now been allowed on the date of receipt of invoice from vendor instead of payment date. However, if payment is not made to the vendor within three months of receipt of services, the amount of credit will have to be reversed. Thus, a robust mechanism will have to be implemented to track invoice payments, identify unpaid invoices existing beyond three months and reverse the credit accordingly. However, for reverse charge payments of input services, the credit will be allowed on the date of payment.

The POT Rules and parallel changes in the existing legislation are steps to smoothly transition to the proposed GST regime. If only these rules had been kept simple, these would have been a harbinger of a simple and ��+

Reprinted with the permission of CNBC The Firm. All rights reserved throughout the world

Point of taxation rule, 2011

��0��4�0�� is a partner at Ernst & Young India and anchors Indirect Tax for our Technology, Communications and Entertainment industry practice for the national capital region. An ex. Additional Commissioner with the Department of Revenue, Ministry of Finance in India, he has been part of various committees in the Indian Government for drafting legislations on Indirect tax policy in India. He is based in our ��+

You can write to Bipin at: [email protected]


42

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International taxWith economic growth and globalization, Indian companies are increasingly seeking to organize their business structures in a manner that will help ��minimize the downsides associated with others. Matters such as arriving at the correct arm’s length price on cross-border payments between associated enterprises, assumes a key challenge as the Indian tax authorities ramp up their enforcement efforts on the Transfer Pricing front.

This section on International Tax covers the business and tax advantages available for Indian multinationals wishing to structure their outbound investments through Singapore. Also discussed is the evolving scope of the Indian Transfer Pricing regulations, since its introduction in 2001. Notably, the Transfer Pricing issues relating to the taxation of marketing intangibles, intra-group management fees and IT services, are addressed. While the Organization for Economic Co-operation and Development (OECD), has provided guidance on treatment of such transactions, it is interesting to see how Indian courts have relied on the same while adjudicating on these issues.

43 | Mauritius treaty — sunshine again?46 | Outward bound, to Singapore 48 | Taxpayers must look at marketing intangibles again 56 | Transfer Pricing Management Fees: are you doing

it right?59 | Transforming the India transfer pricing landscape

In this section

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International tax

Mauritius treaty — sunshine again? Sudhir KapadiaHindu Business Line, 10 April 2010

The Mauritius treaty with India has had a chequered journey through

good and bad weather as if mirroring the climatic patterns of both the countries. It was widely believed that ��$��$��Supreme Court decision in the Azadi Bachao Andolan case where the court concluded that a valid tax resident of (��$��regardless of the fact that the entity concerned could arguably be a “conduit” company and the motive behind the transaction could be tax avoidance. This judgment, however, does not prevent tax authorities ��!��$�� to be denied.

E*Trade case

One of the well known cases post Azadi Bachao is the E*Trade case where the Mauritius subsidiary of a US company sold shares of an Indian company to another Mauritius company. The purchase price was funded by the US parent and the sale consideration received by the Mauritian company was remitted back to the US company by way of dividends; the transaction structure is depicted in the chart.

On the insistence of the purchaser, E*Trade approached the tax authority for a nil withholding tax order. The tax ��of 20% and E*Trade challenged this order before the Bombay High Court.

US Co 2

US Co 1

E*Trade

100% Sale consideration

Dividends and capital reduction

Sale of shares in Ind Co to Mauritus

Co

100%

U.S.

Mauritius

India

Mauritius Co

Ind Co

44

6��

The court declined to go into the merits but referred the matter back to the higher tax authority, that is, the Director of International Tax (DIT), which took the same view as the tax ��+

At this stage, E*Trade approached the AAR to determine treatment of capital gains under the Treaty. The AAR relied on the Supreme Court judgment in Azadi Bachao and upheld the application of Mauritius Treaty for capital gains exemption.

The AAR relied on the fact that the shares were registered in the name of E*Trade Mauritius and dividends received from shares were also credited in the accounts of E*Trade Mauritius.

It categorically concluded that merely because the source of funds for the purchase of shares was traceable to the holding company or that the holding company had played a role in negotiating the sale of shares or that the consideration received ultimately went to the parent company in the form of dividends did not lead to a legal inference that the holding company in reality owned the shares and/or the recipient of capital gains arising from transfer of shares is the holding company and not E*Trade Mauritius.

The AAR also categorically ruled that in view of the binding pronouncement of the Supreme Court, the motive of tax avoidance is not relevant so long as the act is done within the framework of law, that treaty shopping through conduit companies

is not against law and the lifting of corporate veil is not permissible to ��$��$+

Interestingly, the AAR concluded by noting that it looks odd that the Indian tax authorities are not in a position to levy capital gains tax on the transfer of shares in an Indian company but this is an inevitable fact of the peculiar provisions in the Treaty, Circular 789 issued by CBDT and the law laid down by Supreme Court in the Azadi Bachao case. The AAR also pondered whether the policy considerations underlining crucial Treaty provisions and the spirit of the circular issued by the CBDT would still be relevant and expedient ��debatable point and it was not for the AAR to express any view in this behalf.

Practical implications

The moot point for foreign investors routing their investments in India through Mauritius is whether the prospective purchaser of their Indian shares would be able to remit sale proceeds without any deduction of tax at source.

The bad news is that this may yet not happen as, technically speaking, a ruling by the AAR is only binding on the applicant and the tax authority in respect of that case and does not have general application.

Since the pattern of each transaction would be different, the tax authority ��$��facts to continue to refrain from issuing the nil withholding tax order.

Mauritius treaty — sunshine again?

45

International tax

The good news is that with a clarion ruling in E*Trade, the opportunity for a foreign investor to approach the AAR to get greater certainty has now become more realistic.

Another important aspect is the direction of tax policy in India as evidenced by the proposals in the Direct Taxes Code (DTC) in respect of tax residency rules, treaty override and general anti-avoidance rules.

Even if hopefully these proposals ��$�� version of the DTC, it is quite likely that, like other countries, Indian law may also contain enabling provisions for the Revenue to question tax avoidance motives behind such transactions routed through intermediary jurisdictions.

In the light of this, the need to maintain hygiene and ensure control and management of the Mauritian company still continues to be relevant. Thus, practical aspects like convening board meetings in Mauritius, presence of independent directors on the board of the Mauritian company, documentary evidence of decision making in Mauritius, etc., are of paramount ��+

Mauritius treaty — sunshine again?

To conclude, it’s now sunshine again over the Mauritius treaty but as all experienced travellers know, it’s always good to have a protective umbrella �� starts raining taxes again.

Reprinted with the permission of the Hindu Business Line © 2011. All rights reserved throughout the world.

In practice, therefore, a prospective buyer may still insist on the seller obtaining a nil withholding tax order from a tax authority.

4��&��K�0�� is a partner at Ernst & Young India and our Tax Markets Leader. He has functional specialization in International Tax and has over 20 years of varied experience in advising companies. Sudhir leads the client relationship management agenda for our tax practice and is the senior tax advisory partner ��*��+�He is a regular speaker at key national and international events and actively contributes to thought leadership in the areas of international taxation. He is based ��(��+

You can write to Sudhir at: [email protected]

The tax department has challenged the order of the AAR in the case of E*Trade before the Supreme Court under a Special Leave Petition.

46

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Outward bound, to Singapore Nico Derksen and Sushant NayakFinancial Express, 22 May 2010

Owing to its excellent infrastructure and pro-business

regulatory framework, the India-Singapore relationship has come a long way since 1934. Indian companies like TCS and HCL have set up regional headquarters in Singapore where more than 4,000 Indian companies are located, making it the largest foreign business community in the country. In fact, Singapore accounts for over 30% of outbound investments from India, putting it in the top spot. The strong trade relationship between the two countries is evident from ��comprehensive economic cooperation agreement with Singapore.

Singapore’s schemes include assistance in manpower development and technological upgrading, R&D and IP, etc. In addition to a stable political and economic environment, Singapore offers a very investor-friendly tax regime. Some of the key tax incentives for global businesses include a headquarters programme, R&D tax measures and productivity and innovation credit (PIC).

The headquarters programme awards ��use Singapore as a base. Currently, businesses that incur expenditure on R&D conducted in Singapore enjoy up to 150% deduction. The PIC will !��for investments in a range of six activities: R&D, registration of IP rights, acquisition of IP rights, design activities, automation through technology or software and training of employees. Under this incentive, companies can claim a 250% tax ��Z�`�''�'''�of qualifying expenditure on each of the activities covered by the PIC for ��$��+�

In spite of, or maybe because of the business friendly environment in Singapore, it does not want to be viewed as a place for basing companies merely to make use of its treaty network. Singapore holding companies can enjoy the treaty ��$��$��!��tax resident. Overall, it appears that

47

International tax

Singapore is perfectly poised to remain a top outbound investment destination from India for times to come.


Sushant Nayak is an associate director at Ernst & Young India. An international tax* specialist, he has extensive experience in advising companies on cross-border transactions, transfer pricing planning and international tax planning. He is based in our (��+

You can write to Sushant at: [email protected]

*Our International tax services practice in India comprises 500 professionals who provide Transfer Pricing Documentation & Advisory (including Litigation), Cross-border tax planning and Tax Effective Supply Chain Planning solutions and services to the largest multinationals operating in the country.

J� ��(��started his career in tax at the Dutch tax authorities (Belastingdienst/ Grote ondernemingen Rotterdam) in different roles, among which were that of ruling inspector, and that of chief-inspector responsible for new investments in the shipping industry. He has worked in the International Tax Services practice of Ernst & Young in Netherlands (Rotterdam), United States (Chicago), India and is currently in Singapore.

You can write to Nico at: [email protected]

Outward bound, to Singapore

1. The PIC scheme has been enhanced in the 2011 Singapore Budget to increase the quantum of tax �� ''_��!��!��^�'_��$��` ''�'''�spent on each qualifying activity (up from the SGD300,000 currently — note that there was a typo in the original article that it should be SGD300,000 and not USD300,000)

2. In addition, the PIC scheme has been broadened in the 2011 Singapore Budget to include R&D done abroad (where it is related to the taxpayer’s Singapore trade or business), not just R&D done in Singapore as is currently the case

The above enhancements are effective immediately from tax assessment year 2011 to 2015.

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6��

Taxpayers must look at marketing intangibles again Srinivasa Rao and Rajendra NayakInternational Tax Review, September 2010

One of the most challenging issues in transfer pricing is the taxation

of income from intangible property. The issues may arise in several contexts, such as the appropriate royalty to be charged to a licensee of unique intangibles or the appropriate inter-company transfer price for goods manufactured and sold to a controlled distributor when the manufacturer owns the trademark ��+�{��!��$��!��$�that cannot be explained merely by the functions performed in manufacturing and selling them, the key issues are identifying the intangibles that produce the extraordinary economic success, and the entities of the corporate group that own these intangibles for tax purposes.

An issue that commonly arises is when the promotional efforts of �� $�enhance the value of a trademark

that is legally owned by another ��+�� $��a trademark licensee or a distributor of trademark products, while the legal owner of the trademark is the licensor or the supplier of the trademark products.

A typical situation could involve a foreign parent (FP) distributing its trademark products in India. FP could set up an Indian subsidiary (Ind Co.) to distribute the products. Ind Co. could

incur substantial advertising, marketing and promotional (AMP) expenditure for successfully

distributing the products. A fundamental issue posed by this case, on which the Indian transfer pricing rules do not provide guidance, is whether the income attributable to the trademark should be allocated to the legal owner of the trademark, �{}�� developed the trademark’s economic value, (Ind Co.)

The Delhi High Court ruling in the Maruti Suzuki case has confounded the opinion of companies with subsidiaries conducting marketing in India.

49

International tax

In a recent ruling, the Delhi High Court in the case of Maruti Suzuki Ltd. has ruled on the transfer pricing aspects of marketing intangibles in respect of a licensing arrangement between the Indian company and its associated enterprise (AE), Suzuki Motor Corporation, Japan (Suzuki). In its ruling, the court provided guidance on the circumstances under which a legal owner of a marketing intangible, such as a trademark or a brand name, ��!��for its promotional efforts that has the effect of enhancing the value of the intangible.

The Delhi High Court ruling

The taxpayer, an Indian joint venture company of Suzuki, was engaged in the business of manufacture and sale of automobiles. The taxpayer entered into a license agreement with Suzuki for the manufacture and sale of certain models of Suzuki motor vehicles. Under the terms of the agreement, Suzuki agreed to provide the technical collaboration and license necessary for manufacture, sale and after sale service of the Suzuki products and parts. Suzuki also granted the taxpayer exclusive right to use its trademarks. The taxpayer was required to pay a recurring royalty as well as a one- time lump sum payment for use of the intangible property.

The tax authority proposed to make a transfer pricing adjustment by disallowing the royalty paid to Suzuki for use of trademark and by disallowing the AMP expenses incurred in promoting Suzuki intangibles. According to the tax authority, the taxpayer incurred huge AMP expenditure, in order to develop a market for the vehicles, which included promotion of the Suzuki trademark. Suzuki should have compensated the taxpayer for the assistance provided in developing the marketing intangibles. Accordingly, non-routine AMP expenditure was adjusted as being the value of the marketing intangibles accruing to the �� +

The taxpayer challenged the proposed adjustment by the tax authority by way of a writ petition in the high court.

With regard to the payment of royalty by the taxpayer to Suzuki, the court ruled that if a domestic entity irrespective of whether it is an independent entity or an AE of a foreign entity, feels that the use of a foreign trademark is likely to ��dispute about the business decision to use the foreign trademark on payment of a royalty. However, in the case of AEs, such royalty should satisfy the arm’s length test. The test is to determine what a comparable

Taxpayers must look at marketing intangibles again

50

6��

entity placed in the position of the taxpayer would have done. Only then can it be determined whether Suzuki had given any subsidy to the taxpayer in the payment of royalty or it got more than what it ought to have.

The high court also held that use of a trademark belonging to a foreign AE of a domestic enterprise, by itself, would not necessarily entail any payment from the foreign AE to the domestic enterprise, so long as ��to the Indian enterprise alone. The intention in such a case is not to ��trademark; but is to promote the products of the domestic enterprise �� +��if any, accruing to the foreign enterprise in such cases is only incidental for which no payment is warranted by the foreign AE to the domestic enterprise.

With regard to the AMP expenditure, the high court held that if the AMP expenses incurred by the �� are more than what a similarly situated and comparable enterprise would have incurred, the owner of the intangible needs to suitably compensate the licensed user for the advantage obtained by it in the form of brand building and increased awareness of the intangible. In such a situation the arm’s length price for the arrangement would need to be determined taking into

consideration all the rights obtained and obligations incurred by the AE. Further, to determine whether the AMP expenses incurred are more than what a similarly situated and comparable enterprise would have incurred, it would be necessary to identify appropriate comparables for the purpose of comparison.

Under the facts of the case, the court set aside the order of the tax authority and directed that a fresh assessment be made based on the principles laid down in its ruling.

Marketing intangibles

Transfer pricing aspects of marketing intangibles has been the focus of the Indian tax authority in transfer pricing audits over the last couple of years. A review of some recent transfer pricing adjustments reveals that a strong reliance is placed by the Indian tax authority on a number of international practices and precedents, such as the OECD Transfer Pricing Guidelines, US Treasury Regulations issued under section 482 of the Internal Revenue Code (including the so called cheese examples contained in the 1994 regulations), US Tax Court decision in the case of DHL Inc and Subsidiaries vs. Commissioner (TCM 1998-461), settlement between the US Internal Revenue Service and GlaxoSmithKline X��*��interpretative guidance and so on, to assert their positions.


51

International tax


@L9(��0��

The OECD guidelines recognise that ��!��!��arise when marketing activities are undertaken by enterprises that do not own the trademarks that they are promoting. In such a case, it would be necessary to determine how the marketer should be compensated for those activities.

According to the OECD, the analysis requires an assessment of the obligations and rights between the parties. The guidelines recognise that in a number of situations the return on marketing ��$��appropriate. Where, however, the distributor actually bears the cost of its marketing activities (where there is no arrangement for the owner to reimburse the expenditures), the issue is the extent to which the distributor should share in ��!��activities.

For example, a distributor may have ��$��investments in developing the value of a trademark from its turnover and market share where it has a long-term contract of sole distribution rights for the trademarked product. In such cases, the distributor’s share of ��on what an independent distributor would obtain in comparable circumstances. In some cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor with similar rights might incur for ��activities. An independent distributor in such a case might obtain an additional return from the owner of the trademark, perhaps through a decrease in the purchase price of the product or a reduction in royalty rate.

%&��/��&��

The US Tax Court decision in the case of DHL has often been relied upon by the Indian tax authority. The court in this case espoused the so called bright line test. According to this test, while a licensee or a distributor is expected to incur a certain amount of cost to exploit the intangible property which it is provided, it is when the investment crosses the bright line of routine expenditure into the realm of non-routine, that economic ownership, likely in the form of

In general, in arm’s length dealings the ability of a party that is not the legal owner of a marketing intangible to ��of marketing activities that increase the value of that intangible will depend principally on the nature of the rights of that party.

52

6��

marketing intangibles, is created. A reference to this case law and to the bright line test can be found in the decision of the high court in the Maruti Suzuki case as well.

The critical issue concerns the determination of when a distributor or a licensee will be deemed to be performing routine distribution or marketing functions, as opposed to providing services to a foreign owner of intangible property. The essential point is to determine under what circumstances such a distributor or licensee can be deemed to have developed a marketing intangible ��+��!��$��whether the distributor or licensee is performing the normal functions of a distributor or licensee or is providing assistance (services) to the foreign parent for the development of the parent’s marketing intangible or is the developer of marketing intangibles.

The high court ruling in the case of Maruti Suzuki appears to be broadly consistent with the OECD approach to these issues, even though the ruling does not make an explicit reference to the guidelines for reaching its conclusions. By holding that if the AMP expenses incurred is more, the foreign AE needs to suitably compensate the domestic enterprise in respect of the advantage obtained by it in the form of marketing intangible development the ruling also seems to recognise the bright line test.

The ruling therefore provides a useful paradigm for the evaluation of transfer pricing issues in the context of marketing intangibles, though there are a number of open ��>��the paradigm.

Practical challenges

Going by the above principles, income from the marketing intangible generally would need to be allocated among related parties in accordance with each party’s ��development or enhancement of the intangible’s value. Depending upon the contractual terms, the compensation for such contribution may be embedded in the royalty or tangible product pricing terms or may be covered by a separate service arrangement.

The key question which arises is identifying the return attributable to marketing activities or to the contributions for intangible development or enhancement. A marketing intangible may obtain value as a consequence of advertising and other promotional expenditures, which can be important to maintain the value of the trademark. However, ��whether these expenditures have contributed to the success of a product. It is also possible that a new trademark or one newly introduced into a particular market


53

International tax


may have no value or little value in that market and its value may change over the years as it makes an impression on the market (or perhaps loses its impact). In many cases higher returns derived from the sale of trademarked products may be due as much to the unique characteristics of the product or its high quality as to the success of advertising and other promotional expenditures.

The level and nature of AMP spending can also be affected by a variety of business factors, such as management policies, market share, market characteristics, and the timing ��!��+��AMP spend may also be realised over a period of time, even though from an accounting perspective the amounts are expensed in the year in which they are incurred. Further, the bright-line between routine and non-routine AMP expenses could vary for each industry and even within the same industry it could be quite company �!��+�� +

OECD considers intangibles

The OECD has recently completed its work on two transfer pricing projects which has resulted in the revisions to the transfer pricing guidelines. These revisions cover issues relating to ��!��$��!��transfer pricing aspects of business restructuring. In these two projects, transfer pricing issues pertaining ��key area of concern to governments ��!�$��international guidance in particular ��valuation of intangibles for transfer pricing purposes.

OECD guidance on the transfer pricing aspects of intangibles is found in the guidelines, especially in chapters VI and VIII. Intangibles are also addressed in the July 2008 ��!��!��permanent establishments.

Considering the importance of transfer pricing aspects of intangibles, the OECD is now considering starting a new project on this issue which could result in a revision of chapters VI and VIII of the guidelines.

54

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In the context of India’s nascent transfer pricing rules, answers to a number of challenges posed by intangibles are likely to evolve only gradually, even though the high court decision in the case of Maruti Suzuki has started the evolution process.

Multinational enterprises (MNEs) in India are likely to face disputes on these issues. Even though the high court decision could provide a broad analytical framework for examining the issues, disputes could arise in application of the principles to the factual matrix of taxpayers as well as on account of the practical challenges in economic benchmarking, discussed earlier. These issues can create ��!��disrupt a taxpayer’s transfer pricing policy and planning.

In light of the ruling, it would be useful for MNEs with Indian ��!�arrangements for India relating to trademarks and brand names. The key matters that would need to be examined include:

�� The contractual arrangements between the trademark or brand name owner and the Indian ��!��of the agreement, nature of the rights obtained and who bears the costs and risks of the marketing activities

�� Whether the level of marketing activities performed by the ��performed by comparable uncontrolled enterprises

�� The extent to which the marketing activities would be expected ��trademark or brand name and/or ��

�� is properly compensated for its marketing efforts or activities that result in development or enhancement of the intangible property

In the absence of a mechanism for advanced pricing agreements in the law for achieving upfront certainty on these issues, taxpayers may need to consider resolution of the dispute either by way of litigation or by way of mutual agreement procedure (MAP). Litigation can be costly and time consuming procedure. The ability to foresee winning in litigation, especially on these issues, is not always certain. If a complete win is not obtained, economic double taxation cannot be avoided. Therefore, resolution through the MAP may need to be given due consideration.

For the MAP to work effectively, the competent authorities should have common ground for transfer pricing


55

International tax





S�*��OS�*��Q�J��is a director at Ernst & Young India. He is an international tax specialist and a member of the Tax Knowledge & Solutions Group**. A widely respected tax professional, Rajen has considerable experience in advising companies on cross-border transactions, transfer pricing planning, controversy management and international tax planning. He is based in our #��+

You can write to Rajen at: [email protected]

**The Tax Knowledge & Solutions Group houses senior tax technical specialists focused around research, innovation, ideation and tax solutions for the India tax practice.

rules. With Indian transfer pricing ��!��!��!��$��to see how a common ground could emerge, especially if the negotiations involve a jurisdiction which has more detailed guidance.

The proposed project of the OECD could help in establishing this common ground on transfer pricing aspects of intangibles. In addition, the project may also help in

narrowing the disparity that may exist between countries that have substantial experience on these issues and countries such as India with limited experience.

Reprinted with the permission of Euromoney PLC © 2011. All rights reserved throughout the world.

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It is a common practice among group entities of a multinational

corporation (MNC) where one entity (not necessarily the ultimate parent) renders group shared services (in the nature of legal, administrative, human resources, information technology, ��¡�� +��shared services would typically not include within their ambit, activities performed by the MNC in the nature of “shareholder activities”, since the objective of performing such activities is more to safeguard its vested ownership interest and protect the investment, rather than !��!��+

By sourcing services from within the group, the MNC ensures that the skills/efforts that are required for performing the service are not necessarily acquired by each ��$��(�"��$�one entity specializing in providing the services and the other entities ��$�also reducing to a group extent

(if not eliminating altogether) the duplication of skills/efforts. Thus, while such intra-group services undoubtedly create a win-win situation for both the provider/recipient of the service, as with any other intra-group transaction, such intra-group service transactions also attract Transfer Pricing (TP) provisions.

Tax authorities’ approach

One of the important issues that draw the attention of the tax authorities worldwide is the arms length nature of the compensation paid for intra-group services to related entities by way of management or intra-group fees. If used properly, management fees are one of the important tax planning tools. Understandably, tax authorities are concerned that this issue may be open to be used by companies through an aggressive tax planning approach.

Transfer pricing management fees: are you doing it right? Sanjay L KapadiaCNBC The Firm website, 25 November 2010

57

International tax

A recent judgment of the Bangalore Bench of the Income tax Tribunal has brought into limelight the importance of this issue in the context of Indian TP scenario. In this case, the Hon’ble Tribunal upheld the approach of the �}��$��in respect of management fees paid ��!��!��taxpayer was unable to prove that it had indeed received economic/commercial value from such intra-group services.

��

For the purpose of justifying the arm’s length nature of a management fee, the service recipient would need to establish, through appropriate documentation, actual receipt of services, and that it has derived ��+��words, it needs to be demonstrated that the service recipient has received economic value from the services, and that it would have either sourced such services from a third-party service provider or would have developed such capabilities internally, had such services not been availed ��!��+�"��$��the entire onus to substantiate the payment and avail the tax break is on the tax payer.

How to defend in a tax/TP audit

A service agreement and the charge out methodology would be something which the tax authorities would want to examine. In addition, the authorities may also want to verify the authenticity of the cost base of the service provider so as to ensure that only those costs are pooled in (both direct and indirect costs) which have been actually incurred in providing the services. The authorities may question the reasons for not availing the services from third parties. In this regard, it would be essential to bring out the distinction between and quality and standard of the services that would have been obtained from the third parties vis-à-vis those ��!��+

It is essential to note that broad and general explanations offered by Indian service recipients relating to ��¡��allocation methodologies have not ��on detailed back-up calculations, workings and related documentation ��!��derived by the Indian entity. Tax authorities have not appreciated ��!�$��*�� at times, could be intangible and may not be always documented objectively.

Transfer pricing management fees: are you doing it right?

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4��*��\�K�0��is a partner at Ernst & Young India. An international tax* specialist, he focuses on Technology, Telecommunications and Entertainment sectors. He has co-authored BCAS’s Transfer Pricing Manual and actively contributes articles to International Tax Review, BNA etc. He is based in our (��+

You can write to Sanjay at: [email protected]

*Our International tax services practice in India comprises 500 professionals who provide Transfer Pricing Documentation & Advisory (including Litigation), Cross-border tax planning and Tax Effective Supply Chain Planning solutions and services to the largest multinationals operating in the country.

To summarize, while intra-group management services are common to MNC business models, the same may be looked upon with some measure of skepticism by the tax authorities as a planning tool. It would therefore be useful for MNCs not only to relook at intra-group services their transfer pricing models but also assess the need to strengthen the related ��the legislative requirements of the respective tax jurisdictions.

Reprinted with the permission of CNBC The Firm. All rights reserved throughout the world

Transfer pricing management fees:

are you doing it right?

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International tax

India’s transfer pricing provisions were introduced in 2001. Since its

introduction, the transfer pricing environment in India has moved on rapidly. Notably, the last 18 months ��the Indian transfer pricing landscape with the courts pronouncing some landmark judgments, the Indian government introducing or proposing ��changes to the transfer pricing laws, and the multinational enterprises (MNEs) experiencing ��increase in the audit activity. This article provides an overview of these developments.

Marketing intangibles

One of the most challenging issues in transfer pricing pertains to the creation and use of intangible property. A related issue is when the

promotional efforts of a marketing ��$��$�enhance the value of the trademark ��$��another country.

In a recent ruling, the Delhi High Court in the case of Maruti Suzuki Ltd has ruled on the transfer pricing aspects of marketing intangibles for

a licensing arrangement between the Indian company and its associated enterprise (AE). The taxpayer, an India joint venture

company of Suzuki, entered into a license agreement with Suzuki under the terms of which Suzuki agreed to provide technical collaboration and license necessary for manufacture, sale and after sale service of Suzuki products and parts. Suzuki also granted exclusive right to use its trademarks. The taxpayer was

Transforming India’s transfer pricing landscape Srinivasa Rao and Rajendra NayakInternational Tax Review, November 2010

With 2011 heralding a decade since transfer pricing provisions were introduced in India, Srinivasa Rao and Rajendra Nayak of Ernst & Young explain how recent landmark decisions are likely to have a �� years of transfer pricing in the country.

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required to pay a royalty for the use of the intangible property.

The tax authority proposed to make an adjustment by disallowing the royalty paid for the use of trademarks and by disallowing the advertising, marketing and promotional (AMP) expenses incurred in promoting Suzuki intangibles in India. According to the tax authority, the taxpayer had incurred huge AMP expenditure to develop the Suzuki brand in India and Suzuki should have compensated the taxpayer for the assistance provided in developing the marketing intangibles. Accordingly, non-routine AMP expenditure was adjusted as being the value of the marketing �� of Suzuki.

On an appeal to the high court by the taxpayer, the court held that in the case of AEs, payment of royalty should satisfy the arm’s length test. The test is to determine what a comparable entity placed in the position of the taxpayer would have done. The court also held that use of a trademark belonging to a foreign AE, by itself, would not entail a payment from the foreign AE to the domestic entity so long as the ��

to the Indian enterprise alone. With regard to the AMP expenditure, the court held that if AMP expenses ��$��the trademark are more than what a similarly situated and comparable enterprise would have incurred, the owner of the intangible needs to suitable compensate the licensed user for the advantage obtained by it in the form of brand building and increased awareness of the intangible. In such a situation the arm’s length price for the arrangement would need to be determined taking into consideration all the rights obtained and obligations incurred by the associated enterprises. Further, to determine whether the AMP expenses incurred are more than what a similarly situated and comparable enterprise would have incurred it would be necessary to identify appropriate comparables for the purpose of comparison.

The above ruling appears to be broadly consistent with the OECD approach to intangibles even though the ruling does not make an explicit reference to the guidelines in reaching the conclusion. The ruling therefore provides a useful paradigm for the evaluation of transfer pricing

Transforming India’s transfer pricing

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issues in the context of marketing intangibles, though there are a ��!��>��the elements of the paradigm. In a recent development, the Supreme "��!��!��$�Maruti, ordered the transfer pricing ��!��without considering the directions or observations of the high court. However, the Supreme Court does not seem to have commented or annulled the principles laid down by the high court on marketing intangibles.

Intra-group IT services

Globalization has led many MNEs �� services operations in India to take advantage of savings inherent in low-cost labour markets such as ��+��$��operate as captive service providers insulated from all kinds of business risks. Recent audit experience indicates that tax authorities expect the service providers to earn a margin in the range of 25% to 30% on operating costs as compared to the margins determined by the taxpayers which are in the range of 10%-15% on costs. The approach adopted by the tax authorities to justify these

margins is by adopting a different approach to accepting/rejecting comparable data as compared to that adopted by the taxpayer.

In a recent ruling, the Bangalore Tribunal in the case of SAP Labs India Pvt Ltd has adjudicated on the determination of the arm’s length price with respect to the software development services rendered by the taxpayer to its AE.

The taxpayer, a wholly-owned subsidiary of a German MNE is engaged in the business of software development and related services to the MNE at a cost plus 6% mark up basis. The taxpayer applied the transactional net margin method as the most appropriate method �(�(��!��margin to be within the arm’s length range. During the audit proceedings, the tax authority rejected the set of comparables that were selected by the taxpayer and undertook a fresh search for the comparable data and determined the arm’s length price to be at 22.24%. While undertaking such an assessment, the tax authority included companies having super !��$��!��excluded foreign exchange gain earned by the taxpayer in order to

Transforming India’s transfer pricing landscape

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��!��!��made an adjustment without giving ��_��+

The tribunal having regard to the ��!��!�$��that comparables having extreme results should neither be considered nor can their results be normalised for inclusion. The tribunal also held that as the taxpayer’s transfer pricing policy was cost plus 6%, comparable companies that have margins less than the taxpayer’s mark-up should be excluded, thereby creating bias in favour of comparables with higher ��!��$+��also ruled that foreign exchange gain arising from ordinary business activities should be considered as an operating item. The tribunal determined the margins at 20.57% on ��_�range under the erstwhile provisions of the income tax law.

While this ruling provides guidance on some transfer pricing issues faced by taxpayers, it also raises some questions on the approach to dealing with comparables that have extreme results, especially rejecting potentially comparable companies merely because they have margins lower than the tested party’s markup.

Legislative developments

The last 18 months has seen ��¡proposed to the country’s transfer pricing law through the Finance (No 2) Act, 2009 (FA 2009) and the Direct Taxes Code 2010 (DTC).

�00�� &��7]��

The provisions on the computation of the arm’s length price under the tax law provide that where more than one price is determined by the MAM; the arm’s length price shall be taken to be the arithmetic mean of such prices. Under the erstwhile provisions, the taxpayers were given the option to adopt a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean.

The interpretation of the 5% range has been subject to disputes between taxpayers and the revenue authorities. In cases where the revenue authorities proposed an adjustment to the transfer price, taxpayers would argue that the adjustment should be made upto the lower end of the 5% range of the proposed transfer pricing adjustment.


landscape

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However, the revenue authorities ��was not available where variance between the proposed adjustment and the taxpayer’s transfer price exceeded 5%. The taxpayer’s position was supported by various tribunal judgments. To illustrate, if the transfer price is USD100 and if the arm’s length price is determined as USD110, under the previous provision that the revenue authorities would determine the adjustment at USD10 (110-100) while the taxpayer could have limited the adjustment to USD4.5 (95% of (110-100)).

Under the new provisions introduced in the FA 2009, if the variation between the arithmetic mean of the comparable prices and the taxpayer’s transfer price is not more than 5% of the latter, the transfer price would be accepted as the arm’s length price. However, if such difference is greater than 5%, the taxpayer would not get ��_��arithmetic mean computed shall be deemed to be the arm’s length price. �� position of the revenue authorities. Thus in the example above, the new provisions would result in adjustment of USD10 (110-100).

However, there appears to be some ambiguity on the effective date of this amended provision. The memorandum introducing the FA 2009 suggests that the amended provision would apply

for orders passed after 1 October 2009. However, a subsequent administrative circular issued by the tax administration suggests that the provisions would apply for the assessment year 2009-10 onwards.

��0�� &��

��!!��the DRP are that the tax demand proposed by a tax authority is kept in abeyance until disposal of the matter by the DRP. The ADR mechanism provides a fast track to dispute resolution as the DRP is under an obligation to dispose the matter within nine months. Further, the `}��!��!!��

The law was amended by the FA 2009 to provide for an ADR mechanism. Under the ADR mechanism, a dispute resolution panel (DRP) comprising of three commissioners of income tax was constituted in various cities. The DRP now exists in eight cities with Mumbai and Delhi having two panels. An administrative instruction issued by the tax administration also ��`�mechanism is optional for the taxpayer.


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authority under the hierarchy of appeals under the tax law as the DRP orders are appealable before the tribunal. In case the DRP’s order is in favour of the taxpayer, the tax authority is bound by the order and is precluded from further appeal, while the taxpayer has right of further appeal in case of an adverse order.

Safe harbours

The Indian transfer pricing legislation already incorporates some administrative safe harbours such as the alleviation of documentation requirements and examination/scrutiny procedures for small taxpayers. To further provide administrative simplicity for small taxpayers and allocate more resources to the examination of larger transactions and taxpayers, safe harbour rules were proposed to be introduced under the transfer pricing regulations by the FA 2009, to provide for circumstances under which the income tax authorities will accept the transfer price declared by the taxpayer. The Central Board of Direct Taxes (CBDT), the apex authority for policy and administration of direct taxes in India has been empowered to notify the safe harbour rules in this regard. ��$��and it will be interesting to see the form and the manner in which these regulations are introduced.

Advance pricing agreement

To date, an APA programme has not been implemented in India and the taxpayer has to go through the normal compliance machinery available to him under the law, including the mutual agreement procedure of an applicable tax treaty.

Initial experiences before the DRP suggest that while taxpayers may be getting an additional opportunity to present their factual positions, especially on selection of comparable data by the tax authority, the panel may be reluctant to disturb any substantive or legal issues of dispute. Taxpayers may, therefore, need to consider evaluating alternative approaches to controversy management in case of adverse orders from the panel at an early stage. Suggestions have also been made to the government to introduce some structural changes in the ADR mechanism such as having independent and full time members as well as empowering the DRP to engage in a negotiated settlement of the dispute.


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Although a mechanism exists in India for advance rulings, transfer pricing being a valuation issue, is excluded from its scope. The DTC, which was tabled in parliament on 30 August 2010 and is proposed to come into effect from 1 April 2012, has empowered the CBDT to formulate a scheme for introducing APAs where the taxpayer can approach the CBDT for determination of the arm’s length price in relation to an international transaction which may be entered into by the taxpayer. Under the DTC, the APA would be binding only on the taxpayer and the transaction to which the agreement has been entered into. �}��!��!��years provided there are no changes on law on the basis of which the APA was entered into. The APA provisions also seem to provide a fair degree of >��$��making adjustments to arrive at an acceptable transfer price. However, at this stage, the provisions seem to envisage only a unilateral APA.

The rules and scheme for APAs are $��India. One expects the CBDT to give due consideration to all the aspects associated with the APA program before notifying the applicable rules to ensure successful implementation in India as well.

Administrative developments

��!:4� ��0��&��

The transfer pricing adjustments ��$��audit proceedings is often coupled with a time consuming dispute resolution mechanism for the taxpayer to seek any redress. Further, a transfer pricing adjustment in the ��potentially result in economic double taxation for the MNE, if the MNE is not able to obtain a correlative relief. These factors have made MNEs take the mutual agreement procedure (MAP) route. A MAP is an alternate dispute resolution mechanism where the competent authorities (CA) of both countries endeavour by mutual agreement to resolve any issue. Under the India-US tax treaty, the dispute is expected to be resolved within a period of two years and also provides for obtaining a stay on collection of the disputed taxes during the pendency of the MAP proceedings.

It has been reported in the media that pursuant to a MAP, the US and Indian CAs have proposed to resolve transfer pricing disputes involving provisions of intra-group information technology ��$��US MNE. The proposed resolution covers nearly 35-40 taxpayers relating to FY 2003-04 and 2004-05


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who were subject to transfer pricing adjustments in the range of 25% to 30% on operating costs, as against their transfer pricing policy of 10% to 15% on operating costs. It has been reported that the proposal involves the CAs agreeing to accept a mark-up on costs of in the range of 17% to 24%, depending upon the year and nature of activity.

Where a MAP resolution has been arrived at and accepted for a particular issue for a relevant tax year, it will have effect only for the �!��!�$��tax year and for that particular issue. A MAP resolution does not typically set a binding precedent for either the taxpayers or the tax authority for adjustments or issues relating to subsequent years or for CA discussions on the same issues for other taxpayers. Nevertheless, it does provide an indication of settlements that could be expected from MAP proceedings, especially, in a similar fact pattern. The taxpayers involved have the option to either accept the MAP resolution or follow the course of appeal prescribed under the country’s tax law.

OECD revisions

The OECD council, on 22 July 2010, approved the revision to the 1995 Transfer Pricing Guidelines. The OECD has issued revisions to the transfer pricing guidelines relating to hierarchy of transfer pricing methods, comparability analysis and application of transactional

!��+��!��providing detailed guidance on the transfer pricing aspects of business restructurings has also been included.

Indian transfer pricing rules are broadly based on the OECD standard, with some deviations, and over the years, courts in India have acknowledged the relevance of the OECD guidelines while interpreting Indian rules. The revisions introduce ��and should help in providing clarity to taxpayers as well as to the Indian tax authority on a number of issues where the Indian rules are silent or do not contain adequate detail/guidance. This is particularly true for issues pertaining to comparability, application of transaction net margin ��!��!��!��margin indicator. Taxpayers should review their transfer pricing practices in light of the revised guidelines and assess impact. Some of the guidance contained in the revisions has already been endorsed by recent case laws in India. One would also hope that the government could give due consideration to the revisions and look at aligning some aspects of the Indian rules with OECD thinking.

Pragmatic risk

Transfer pricing audits today go beyond pricing of products and include complex issues like services and intangibles. Recent trends in India indicate that transfer pricing will continue to be a contentious


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issue for taxpayers. Taxpayers are also concerned about the dispute resolution process. In recognition of this, the steps taken by the government to set up an ADR mechanism, provision for safe harbours and proposals to introduce APAs have been welcomed by taxpayers as this will help in reducing controversies and disputes and also provide for a resolution in a manner that is fair and impartial to both the tax administrators and the taxpayers. It would also be advisable for taxpayers to consider OECD’s risk management recommendation contained in the 2010 revision to the transfer pricing guidelines. According

to the OECD it is a good practice for taxpayers to set up a process to establish, monitor and review their transfer prices, taking into account the size of the transactions, their complexity, level of risk involved, and whether they are performed in a stable or changing environment. Such an approach would conform to a pragmatic risk management strategy.

Reprinted with the permission of International Tax Review. All rights reserved throughout the world.




S�*��OS�*��Q�J��is a director at Ernst & Young India. He is an international tax specialist and a member of the Tax Knowledge & Solutions Group**. A widely respected tax professional, Rajen has considerable experience in advising companies on cross-border transactions, transfer pricing planning, controversy management and international tax planning.

You can write to Rajen at: [email protected]

**The Tax Knowledge & Solutions Group houses senior tax technical specialists focused around research, innovation, ideation and tax solutions for the India tax practice.


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Transaction taxThis new phase of economic and corporate revival has arrived with a lot of changes in the regulations governing M&A. This includes changes to tax law which brings transfers of shares for inadequate consideration within the ambit of taxation for the recipient. Also, new pricing guidelines have been issued by RBI which governs prices for transactions involving transfer of shares between non residents and residents. The progress in the Vodafone case is making indirect transfer of assets in India an ‘eye-catcher’ for the multinationals having or proposing to do such transactions.

All this and more is discussed in the section on Transaction tax. Further, various new set of regulations impacting M&A are also under discussions. For instance, SEBI takeover regulations governing transactions in shares of listed companies are all set for a change with proposals like increasing the threshold limit for mandatory open offer from 15% to 25%, the Direct Taxes Code having far reaching consequences in the form of general anti-avoidance rules taxation of indirect transfer of capital asset in India, etc is proposed to replace the existing Income tax Act.

69 | Winds of change 72 | Draft acquisition norms continue to draw attention 73 | Implications of Vodafone Ruling76 | Inbound activity buoyant with global companies

scouting for M&As 78 | The role of taxation of M&A in India

In this section

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Winds of change Amrish ShahFinancial Express, 13 June 2010

The Finance Act, 2010, as well as recent circulars issued by the

Reserve Bank of India (RBI) regarding pricing of share transfers between residents and non-residents is bound ��!��and acquisitions (M&A) involving unlisted companies’ shares in India.

Given that the relevant provisions of The Finance Act, 2010, have become effective from 1 June and the RBI pricing guidelines have become operative since May, it is worthwhile to study these legislative changes and attempt to assess their implications on transactions.

Anti-abusive provisions of The Finance Act, 2010

The Finance Act, 2010, has introduced anti-abuse provisions to include within its ambit transactions involving the transfer of shares of a closely held company where ��$�partnership (LLP) or closely held company is a recipient. Earlier, the anti-abuse provisions were applicable only if an individual or a Hindu undivided family (HUF) was a recipient.

The provisions have been introduced to prevent the practice of transferring

unlisted shares at prices much below their fair market value — for no or inadequate consideration. These provisions have come into effect from 1 June this year.

Simply stated, post 1 June, the difference between “aggregate fair market value” of shares of a closely held company and the consideration paid would be taxed in the hands of “recipient” of such shares. At the same time, exceptions have been carved out in respect of share transfers through transactions like business reorganizations, amalgamations and demergers.

Central Board of Direct Taxes (CBDT) ��$��determination of “fair market value” of shares of closely held companies. ��!��for equity shares shall be determined as per the “net asset value” method whereas, for other shares/securities, it shall be at such price as may be fetched in the open market on the valuation date.

While the Explanatory Memorandum to The Finance Act, 2010, does mention the intention behind introduction of these provisions, the manner in which the relevant sections introduced in the Income

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tax Act, 1961, seems to indicate that these anti-abuse provisions would be triggered in any situation where ��$��!��$�“receives for less than fair market value” shares of a closely held ��!��$��exceptions). This has given rise to considerable debate as to applicability of these provisions to following types of transactions:

�� Transactions involving bonus issues, rights issues, preferential allotments, put/call options, etc.

�� Transactions which are exempt from tax (in the hands of transferor) under the current provisions of Income tax Act, 1961 (gift, transfer of capital asset (including shares) between parent companies and their 100% subsidiaries, etc.)

�� Transactions where a partner contributes shares of a closely held company to a partnership ��!��!��$��the value at which such shares are recorded in the books of !��!��be the transaction value for the purpose of computing capital gains tax in the hands of the contributing partner).

�� Transfer of shares of investee closely held companies by an amalgamating company to an amalgamated company as a part of the amalgamation (the present exceptions carved out from these

anti-abuse provisions exempt only the shareholders of the amalgamating company, but not the company itself).

�� Buy-backs, capital reductions, etc., at less than “fair market value”, where percentage shareholding of all shareholders remains same pre and post the transaction, etc.

However, it is hoped that the provisions shall be weighed in the background of the objects for which they were introduced, namely, to restrict taxability to cases where there is a deliberate attempt to evade/avoid tax and/or to accomplish value transfer from one person to another through transfer of shares. Further, it is also hoped that the interpretation may be relaxed in cases where the transaction is commercial and ��!��arms’ length.

It would only help if the legislative ��$�"#`��same may bind the tax authorities.

Impact of change in pricing guidelines by RBI

A certain amount of ambiguity has arisen with respect to valuing transfers of shares of closely held companies between residents and non-residents with the recent amendment to the pricing guidelines issued by the RBI.

The revised RBI pricing guidelines provide that, inter-alia, the price at

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which the shares of Indian unlisted companies can to be transferred by a non-resident to a resident shall not be more than the fair value determined by SEBI-registered merchant banker or a chartered accountant as per the <��>��=��+�

��$��$��cases where the pricing as per the "#`��is higher than the pricing as per the RBI circular (“discounted cash >��=��resident Indian purchaser will not be able to buy shares at the price ��"#`��and may hence end up being unfairly taxed on the difference. Again, there is currently no recourse available to settle the ambiguity.

In light of the above, it is but imperative that the transactions involving closely held companies shares be structured carefully, keeping in mind the paradigm shift in the governing legislations.

At the same time, it can only be hoped that the authorities would adopt a view that is likely to lean in favour of an interpretation which supports the object behind introduction of the anti-abuse provisions—which is to act as a counter-evasion mechanism to prevent laundering of unaccounted income, to curb bogus capital building and money laundering, etc.

However, until such issues are not �!��$��$��"#`��the sake of clarity, it shall continue to be a wait and watch syndrome!


Winds of change

��&�4&�&�is a partner at Ernst & Young India and leads our Transaction Tax practice*. Over the past 17 years he has advised clients in the areas of acquisitions, divestments, mergers, demergers, corporate restructuring, re-organizations, foreign investment consulting, and establishment of joint ventures, international/corporate tax and business reorganization. He is based in our (��+

You can write to Amrish at: [email protected]

*Our Transaction tax practice comprises 100 specialists who assist clients across the transaction life cycle. Services include structuring transactions, developing corporate re-organization plans, conducting tax due diligence and regulatory reviews, supporting post-deal integrations, and managing implementations and documentation.

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Draft acquisition norms continue to draw attention Amrish ShahEconomic Times, 25 July 2010

Two major positive takeways

The proposed increase in threshold limit for mandatory open offer from 15% to 25% gives a huge opportunity to corporates to raise money from private equity or other investor groups who did not want control, but had to restrict their investment to 14.99% to avoid open offer.

Secondly, the removal of non-compete payments as an additional consideration to promoters would !��!��$��minority shareholders and upholds the principle of equity and fairness.

Two major concerns

The proposed requirement of mandatory open offer for 100% from minimum 20% could place Indian acquirers in a disadvantageous position compared to foreign acquirers. The mandatory open offer of 100% would require large capital outlay by the acquirers and in the absence of availability of bank �� +�

Secondly, the proposed draft has done away with the existing exemption in respect to “white wash”

provisions i.e. in case of change in control an open offer would not be required if the shareholders of the target company pass a special resolution.




*Our Transaction Tax practice comprises 100 specialists who assist clients across the transaction life cycle. Services include structuring transactions, developing corporate re-organization plans, conducting tax due diligence and regulatory reviews, supporting post-deal integrations, and managing implementations and documentation.

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Implications of Vodafone ruling Sudhir Kapadia Economic Times, 11 September 2010

The much-awaited Bombay High Court judgement in the case of

Vodafones purchase of Hutchisons erstwhile telecom business interest in India has been pronounced. A number of interesting and rather novel issues were raised by Revenue, many of which seem to have found acceptances with the Bombay High Court.

In this case, Vodafone BV, a Dutch company acquired shareholding of a Cayman company in consequence of which the business interest of Hutchison in its joint venture telecom company in India got transferred to Vodafone. Vodafones contention has consistently been that this is a case of transfer of shares of a foreign company,which under current Indian law cannot be taxed in India as the location of the share is outside India. Accordingly, Vodafone argued that the value of the business enterprise

is captured in the sale price of the shares and the gain made by the sale is a capital gain in the jurisdiction where the share is situated. This being a case of transfer of shares of a Cayman company, the question of taxation in India should not arise.

The main argument of the Indian Revenue has been that the share purchase agreement (SPA) and other

transaction documents clearly establish that the subject matter of the transaction is not merely the transfer of shares of the Cayman company but includes transfer

of the composite rights in Indian joint venture,which clearly gives rise to a source of income arising in India and therefore is subject to tax in India. The Revenue also contended that in this case the transfer of share was merely a mode or vehicle to transfer the bundle of business rights and assets situated in India.

In the Vodafone case, the HC agreed with the Revenues contention that this is not a case of simpliciter transfer of shares. The ruling will create a degree of uncertainty in respect of past transactions of a similar nature. The DTC will need to factor in the court’s ruling on taxing cross–border transactions.

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Court’s decision

The Bombay High Court observed that the controlling interest does not constitute a distinct capital asset for the purpose of the Indian tax law. In other words,controlling interest arises ��number of shares in a company as would enable the shareholder to ��!��which would result in the control of the management of the company. The controlling interest is therefore not ��!��independent of the shareholding. Accordingly, the high court seems to imply that part of sale consideration which relates to the value of the share of the Cayman company including controlling interest should not be subject to tax in India as the share is located outside of India.

However, the court agreed with Revenues contention that this is not a case of simpliciter transfer of shares but the transaction involves a variety of business rights and interest which are all located in India. In arriving at this conclusion, the court has considered the commercial and business understanding between the parties and the various legal documents, which were entered into to consummate transfer of business ��+��!��$�held these bundle of rights and entitlements as capital assets and hence consideration attributable to such rights and entitlements situated

in India would be subject to tax in India. The high court has left it for the ��!!��between what is attributable to these business rights in India and what is attributable to the shareholding outside of India.

Impact on cross-border transactions

This ruling seems to suggest a fundamentally different approach to taxation of transactions where there is a transfer of controlling interest in India regardless of the fact that such transfer is effected by way of sale of shares of an overseas company. This will create a degree of uncertainty in respect of similar transactions, which have already taken place and where the revenue department will make an attempt to take support of the Bombay High Court judgement to tax those transactions. Having said this, in cases which can be distinguished on facts and especially in those situations where there is no transfer of business or other valuable commercial rights in India it will still be possible to argue against taxation arising in India. For example, where there is not an outright sale of business in India but a large interest in the Indian company is indirectly transferred through shares of a foreign company, the earlier position should prevail i.e., sale of a foreign company not being subject to tax in India.

Implications of Vodafone ruling

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Direct Taxes Code 2010 (DTC)

Interestingly, the DTC which will come into effect on 1 April 2012 �!��$��!��under which indirect transfer will be subject to tax in India. The tax policy direction seems to be to tax only those transactions where there is sale of substantial business interests in the Indian company and not where there is either portfolio sale or a sale of a block of shares not resulting in outright sale of the business in India. India has thus joined China, amongst

Implications of Vodafone ruling

other countries, in attempting to tax indirect transfers and to this extent cross-border transactions will need to factor in the current view of Revenue as well as proposed changes in the DTC so as not to be caught by surprise at a later stage.


4��&��K�0�� is a partner at Ernst & Young India and our Tax Markets Leader. He has functional specialization in International Tax and has over 20 years of varied experience in advising companies. Sudhir leads the client relationship management agenda for our tax practice and is the senior tax advisory partner ��*��+�He is a regular speaker at key national and international events and actively contributes to thought leadership in the areas of international taxation. He is based ��(��+


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Inbound activity buoyant with global companies scouting for M&As Narendra RohiraFinancial Express, 22 September 2010

India is the second most targeted nation among the BRIC nations,

after China, for M&A activities. The trend indicates that while investment bankers are upbeat about Indian companies going shopping abroad, the inbound activity is also expected to be buoyant with a lot of global companies scouting for acquisitions. In this backdrop, it is pivotal to analyse the impact of the direct taxes code (DTC) 2010, which is expected to be effective from April 2012, on M&A activity.

Currently, certain exemptions (ensuring tax neutrality) are available in relation to merger/demergers and ��even to merger/demerger of foreign company into an Indian company. DTC seeks to introduce the concept of “business reorganization” as one between “residents”. Technically, it seems the exemptions may not be available to merger/demerger of foreign company into an Indian company. Further, in case of demerger, the consideration now needs to be discharged in the form equity shares to shareholders of

demerged company for tax neutrality.

Some changes are proposed on conditions for carry forward of losses. The nature of business carried out by predecessor is now immaterial in an amalgamation, as carry forward of losses will not be restricted only to companies having industrial undertakings, but extend to service sector companies as well. The business continuity test, including ��years, currently, applicable only to amalgamation is now extended to demerger. This means demerged business may need to be continued, even if commercially not viable. For a closely held company, it shall be allowed if, at least 51% of the ��$��!��the end of immediately preceding ��$��$��+��to permit the carry forward and set off, even if there is a substantial change in shareholding compared to the year of incurrence of loss.

Taking clue from some of the recent transactions, it is proposed to cover

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indirect transfers under the Indian tax ambit, if at any time in preceding 12 months, fair market value (FMV) of the Indian assets owned by the foreign company represents at least 50% of the FMV of all assets owned. This gives an objective guidance and will reduce uncertainties and litigation around the controversy relating to indirect transfers.

Similarly, controlled foreign company (CFC) aims to provide for taxation of passive income earned by a foreign company that is directly or indirectly controlled by a resident in India. The income not distributed to the shareholders by such foreign company is deemed to be distributed and consequently, taxable as dividend in India in the hands of resident shareholders. Thus, Indian companies, which have subsidiaries abroad need to revisit their structures.

General anti-avoidance rule (GAAR) has been introduced to curb erosion of tax base on account of tax avoidance arrangements. This may cause considerable uncertainty and controversy, which seems to go against the avowed objective of reducing litigation. The taxpayer needs to be careful in documentation to enable him to demonstrate commercial substance. The provision stating that domestic tax law or tax ��$��taxpayer is to be applied is surely a sign of relief in-spite of exceptions — ��#��}�� CFC rules.

Cost of acquisition of any asset, if cannot be determined, will now be considered as “nil” for computing

capital gains. Current law provides for considering cost as “nil” only for certain �!��+�`��compete fees, which is currently based on facts and principles provided by judicial precedents, will now be available over a period of six years starting from the year of actual payment.

DTC, while providing certain reliefs, has also sought to make taxation aspects of M&A wider and more transparent. Thus, while planning their M&A, companies would now need to analyze the impact on their current structures as well as business models, accordingly take necessary and timely steps to avoid unnecessary tax burden.


Inbound activity buoyant with global companies scouting for M&As

J��S�&��is a partner at Ernst & Young India and a member of our Transaction Tax practice*. He focuses on conceptualizing, structuring and implementation of M&As. He has assisted various Private Equity players with acquisitions in India involving cross border structuring, funding and corporate tax �!��+�X��(��+

You can write to Narendra at: [email protected]

*Our Transaction Tax practice comprises 100 specialists who assist clients across the transaction life cycle. Services include structuring transactions, developing corporate re-organization plans, conducting tax due diligence and regulatory reviews, supporting post-deal integrations, and managing implementations and documentation.

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The role of taxation of M&A in India Amrish ShahInternational Mergers & Acquisitions Review 2011, 17 February 2011

The downturn in the transactions market created an environment

in which companies were forced to squeeze greater value from deals. In particular, for cross-border deals, there is a realization for deeper and earlier evaluation of the tax function. Of course, with the increasing complexity of cross-border tax legislation especially in emerging markets such as India and China, which in recent times have become the hotbed of cross-border transaction activity accompanied by heightened scrutiny by global tax authorities, this is no easy matter. Nonetheless, we believe that for a majority of such transactions, clear articulation of how tax can enhance the deal valuation and early involvement of the tax function in the process of transaction planning is well worth the effort and offers companies the best �!!��$��$+

This is as important (if not more important) for exits as it is for acquisitions. If left until an exit is already imminent or underway, tax issues cannot always be adequately addressed. While this is clearly a reality, sellers still need to devote more time and attention to tax issues well in advance of the launch of any

sale, carve-out or for that matter, a corporate reorganization or business restructuring leading to an eventual exit.

��in the market is recovering and global M&A activity is returning, all

these trends are likely to continue and intensify. It is therefore essential ��!��tax issues before doing M&As in the relevant market.

The Indian M&A environment

As one may be aware, investment into most emerging markets will ��!��

Through the roller coaster ride since 2007 in the global economy, we have been witness �� by design) the increasing role that tax has played therein. In this context it has become relevant to ��!��"��how widespread this phenomenon is and what it might mean for future corporate transactions.

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may be driven by various factors other than taxation such as currency convertibility, thresholds on foreign investment into certain sectors, capital market related compliances, availability and permissibility of using debt to ��+��forming a broad understanding of ��()��!��jurisdiction is of the essence. Thus from an Indian standpoint, the following key aspects and recent developments (both tax and non-tax) could be of relevance:

�� As of now, the Indian currency is not fully convertible. Therefore, foreign investors need to study and factor in prevailing exchange control regulations and Foreign Direct Investment (‘FDI’) Guidelines at the time of investing.

�� Forms of business in India are 100% subsidiary, joint venture, unlimited partnership, liaison ��!��+�Recently, limited liability partnerships (‘LLP’) have also been introduced in India. However, there is currently no clarity on the allowability of FDI in a LLP.

�� Acquisitions of businesses may be through share deals or asset deals. Key considerations could be cost step up of assets for tax depreciation, possibility of debt push down, continuity of tax holidays, transferability of tax attributes (such as tax losses, minimum alternate tax credit), stamp duty cost, time frame, etc apart from commercial objectives. In order to understand

the extent of potential liabilities and approach to tax compliance, a detailed tax due diligence prior to making investment decision is very important.

�� Current tax laws provide for certain area and sector based incentives which can be available on the set up of new businesses.

�� Indian Government has been taking measures for dealing with uncertainties to foreign taxpayers from an income-tax perspective and reduction in disputes. Accordingly, last year the Government announced that safe harbor rules will be prescribed for determining arms length price for international transactions. Further, the Government also announced creation of a dispute resolution panel to deal with disputes pertaining to transfer pricing and taxation of foreign companies for faster resolution. Option of obtaining advance rulings for international transactions has always been available.

Typical modes of M&A in India

Typically tax implications in Indian M&A ��the type of transaction:

(i) Business acquisition

The gains on transfer of an ��!��“slump sale” (i.e. transfer of a business undertaking for a lump sum consideration) are taxed as capital gains at 21.63%, if the business is held for three years or more; else they are taxed at 32.45%. For the purpose of

The role of taxation of mergers and acquisitions in India

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computing capital gains, “tax” net worth of the business is treated as cost and deducted from the slump sale consideration.

A business acquisition could alternatively be structured as an “itemized sale” which basically ��and liabilities with value being assigned to individual items of assets and liabilities. The taxation would then be linked to the individual assets i.e. capital gains (long-term/short-term) or business income.

(ii) Stock acquisition

Stock acquisition can be effected through infusion of cash into the target company (normally referred to as primary acquisition), which typically has no income-tax consequence either to the existing shareholders or the target company1 or by way of purchase of shares from existing shareholders of the target company (normally referred to as secondary acquisition) in which case, the selling shareholders are subject to capital gains tax as under:

Mode of Transfer

Listed shares held for < 12 months

> 12 months Unlisted shares held for < 12 months

> 12 months

Sale by a foreign company2

Off market 42.23% 10.56%/ 21.12% 3

42.23% 21.12%

Through market4

15.84% Nil Not applicable Not applicable

Sale by a domestic company5

Off market 32.45% 10.82%/ 21.63%6

32.45% 21.63%7

Through market4

16.22% Nil Not applicable Not applicable

1. Except possible income-tax issues for the subscriber of the shares, if the subscription price is below the net asset value per share. This has been discussed separately.

2. Non-applicability of minimum alternate tax (‘MAT’) under certain circumstances3. While there are differing views and judicial precedents with regard to the rate of tax, a preferred

view would be that the rate of tax should be 10.56%.4. Additionally, sale of shares through stock market would attract Securities Transaction Tax at

0.125% each in the hands of the buyer and seller5. (��¢�� !��*�£�^'+'%_6. 10.82% without indexation or 21.63% with indexation at the option of the tax payer7. Indexation available

The role of taxation of mergers and

acquisitions in India

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Transaction tax

Further, acquisition of a more than 49% stake in a closely held company could result in accumulated tax business losses of such company getting lapsed. However, unabsorbed tax depreciation would remain unaffected.

(iii) Mergers and demergers

Mergers and demergers could be of various kinds and the mechanics of consummating such merger/ demerger could vary depending on the commercial objectives of parties concerned.

Typically, pursuant to a merger, the entire business of the transferor company gets transferred to the transferee company, while !��business of the transferor company is transferred to the transferee company. In either case, the transferee company, in consideration thereof, issues shares to the shareholders of the transferor company. In case of merger, unlike demerger, the transferor company stands automatically dissolved.

In India, mergers and demergers are carried out under supervision of the High Court and require due approval of shareholders, creditors, stock exchanges (in case of listed companies), corporate regulatory authorities, and eventually of the High Court. Under the tax law, a ��¡��stipulated conditions is regarded as tax neutral from the following perspectives:

� Transferor company: transfer of assets is exempt from capital gains tax.

� Shareholders of transferor company: cancellation of shares of the transferor company (in the case of mergers) and receipt of shares of the transferee company is exempt from capital gains tax. In the case of mergers, the cost of acquisition of the shares of the transferee company would be regarded to be the same as that of the cost of shares of the transferor company, whereas in the case of demergers, the cost of acquisition of the shares of the transferor company would get split between the shares of the transferor company and the shares of the transferee company based on a stipulated formula.

� Transferee company: cost basis for tax depreciation purposes in the hands of the transferee company would be the same as it was in the hands of the transferor company. Further, in the case of mergers, entire accumulated tax losses of the transferor company get transferred to the transferee ��!��$��necessary conditions), whereas in case of demergers, accumulated tax losses of, or attributable to, the business of the transferor company that is transferred on demerger, get transferred to the transferee company. While in some cases, tax incentives/��


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transferor company may be continued in the hands of the transferee company in case of both mergers and demergers, in certain other cases the law is not as clear and the issue could be potentially litigative.

The direct taxes code

A new law, Direct Tax Code (‘DTC’) is proposed to be enacted with effect from 1 April 2012. While the DTC is presently a draft for public comments it proposes several new additions to the Indian tax legislation such as controlled foreign corporation (‘CFC’) ��!��+��also provisions which aim to look at the substance of transactions over their form such as the General Anti-Avoidance Rule (‘GAAR’). Even purely from an M&A taxation standpoint, certain key changes have been proposed. Some of these are as under:

�� `�"��reorganization to mean reorganization of business of two or more residents involving an amalgamation/demerger. On a plain reading the tax exemptions may not be explicitly available to amalgamation/demerger of a foreign company into an Indian company which was hitherto the case.

�� The current tax law does not specify the nature of shares to be issued in discharge of consideration for demerger which makes it is possible to issue even preference shares. The `�"��!��$�equity shares may be issued as a consideration for demerger.

�� “Capital assets” have been sub-divided into two classes, viz. “investment assets” and “business capital assets”. It is proposed to exempt gains arising only on transfer of “investment asset” by a company to its 100% subsidiary.

�� Provisions of restricting transition of capital and speculations losses to the transferee in case of amalgamation/demerger are proposed to be liberalized.

�� Unlike in amalgamation, in the case of demerger in order to claim set off of carry forward losses of the transferor company there is no condition of continuing the business of the transferor company by the transferee company. This disparity is proposed to be removed by imposing the condition of carrying on the business of transferor for ��$��+

Recent tax updates

The Central Board of Direct Taxes �"#`��$��!��release that they are currently scrutinizing a handful of cases related to takeovers, mergers and acquisitions based on a selection process that is risk-based and non-intrusive. The CBDT has however ��takeovers, mergers and acquisitions does not qualify as a case for tax scrutiny and that overall scrutiny level by tax authorities has never exceeded 1.5% in the last decade.

One such case that has attracted greater scrutiny by the High Court (HC) of Gujarat has been the issue of whether a scheme of demerger of



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infrastructure assets between group companies for “NIL” consideration could be sanctioned under the provisions of the Indian tax and company laws. The HC concurred with the objections placed before it by the tax authorities and rejected the scheme of demerger which was viewed as an attempt to evade taxes including income-tax, stamp duty, value added tax and to defraud the tax authorities for their legitimate right to recover dues out of the assets of the demerged company and its other group companies. The HC also went on to agree with the tax authorities and state that the assets were being demerged to a paper/ conduit company for a subsequent tax neutral transfer to another infrastructure company.

While the ruling enables the demerged company to approach a higher appellate authority, the case is one of its kinds and the conclusions drawn thereon by the HC with respect to tax abusive transactions in general ��number of taxpayers.

Another attempt by the tax authorities to plug potentially abusive transactions is the provision introduced by the Finance Act, 2010 for taxation (in the hands of the recipient) on receipt of shares of a company in which the public are not substantially interested for NIL or inadequate consideration. Separate ��determine “fair market value” in such transactions, which seek to treat “net asset value” as “fair market value”. Potential tax impact on applicability

of these provisions to various kinds of commercially driven transactions (such as exercise of put/call options, etc.) would need to be borne in mind.

Perhaps the biggest practical tax issue plaguing Indian M&As in recent times however, is that of withholding taxes. Under the Indian tax laws, any person responsible for making a payment to a non-resident (NR) which is chargeable to tax in India is required to withhold tax on such sums, at the applicable tax rates. However, the applicability of these provisions has been the subject matter of extreme controversy in recent times. In an earlier decision by the Karnataka HC in case of Samsung Electronics (320 ITR 209), these provisions were interpreted to mean that any payment to a NR will be subject to withholding tax under the tax laws, regardless of its chargeability to tax in India.

The Delhi HC, in the case of Van Oord (323 ITR 130) and the special bench of the Chennai Tribunal in the case of Prasad Production (3 ITR Trib 58 SB), had subsequently attempted to clarify that there should be no withholding tax obligation when the underlying payment was not taxable in India. However, in view of the adverse Karnataka HC decision, the controversy continued to remain. A number of taxpayers (GE Technology, X}��a special leave petition before the Supreme Court of India (SC) against the Karnataka HC decision. The SC in a batch of cases, with the lead case being that of GE India Technology Centre Pvt. Ltd. (327 ITR 456),


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reversed the decision of the HC by holding that any sum remitted to a NR, which is not chargeable to tax under the tax laws, does not require the payer to apply the withholding tax provisions. Further, the SC held that no nil/lower withholding application ��authority to determine the amount chargeable, if the payer is not in doubt that the payment is not taxable in India. The SC thereafter remanded the matter back to the Karnataka HC to determine the taxability of the payment, which in the present case pertained to software payments.

The SC decision has thus settled this controversy and should provide relief to many taxpayers and clarity in case of others to determine withholding tax obligations in respect of payments to NRs.

Exit taxation too has been a subject matter of major controversy in India. ��$��under the India-Mauritius Double Taxation Avoidance Agreement (DTAA) to a Mauritian company directly selling shares of an Indian company has been upheld, the Bombay HC held in the case of Vodafone International Holdings BV (311 ITR 46) that tax authorities have the jurisdiction to tax transactions involving an indirect transfer of shares in an Indian company and look at the substance of the transaction as opposed to its form.

As one would be aware, capital gains arising to a Mauritian tax resident on alienation of shares of an Indian

company are taxable only in Mauritius under the India-Mauritius DTAA. ��!��by an administrative circular as well as by a previous decision of the SC. However, there has been reluctance on part of the Indian tax authorities ��`��of withholding of taxes even where the Mauritian tax resident has a tax ��$��+

The Authority of Advance Rulings (AAR) in the recent case of E*Trade (��!��non taxability of capital gains in India in such cases. The AAR did not accept the tax authorities’ contention that, the taxpayer was merely a façade used to avoid capital gains tax, and ��of the capital gains is its US holding company. The fact that the source of funds for the purchase of shares was traceable to the US holding company or that the latter had played a role in suggesting or negotiating the sale or that the consideration received ultimately went to the US holding company in the form of dividends or the diminution of capital, do not lead to a legal inference that the US holding company, in reality, owned the shares.

The AAR made extensive references to the observations in the SC’s decision to infer that the motive to set up conduit companies and doing ��$�jurisdiction will not be material to judge the legality or validity of the transactions. The SC had held that



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Transaction tax

the design of tax avoidance itself is not objectionable if it is within the framework of law and is not prohibited by law. However, with regard to colorable device and sham arrangements, there is still scope to ignore such dubious methods.

The obstacles to a transaction created by the uncertainty surrounding such tax issues has prompted ��!��to introduce tax risk management solutions such as insurance which transfers the risk where parties to a transaction do not wish to take long term tax risk.

Conclusion

The above discussions reveal quite clearly that whether in the global or Indian context, tax issues, especially those that are unresolved, lead to uncertainty around the tax treatment which result in litigation between the taxpayers and tax authorities.

Parties to an M&A transaction must be mindful of the tax consequences of the transaction and also of the various tax issues surrounding it that may be ��+��!��heightened scrutiny by tax authorities and forging an understanding of recent tax developments appear to be key considerations.All rates are based on those proposed in the Finance Bill, 2011 introduced in the Parliament. Once the bill is passed and assented to by the President, the same would become effective from 1 April 2011.

Reprinted with the permission of Euromoney Trading Ltd, England. All rights reserved through out the world. This article was originally published within the International Mergers & Acquisitions Review 2011. Please visit www.euromoney-yearbooks.com for further information.



*Our Transaction tax practice comprises 100 specialists who assist clients across the transaction life cycle. Services include structuring transactions, developing corporate re-organization plans, conducting tax due diligence and regulatory reviews, supporting post-deal integrations, and managing implementations and documentation.


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Tax and regulatory policy��{`��>��{`��>��$��+��FDI, issues concerning the policy environment and the current sectoral restrictions have been under the lens of the policymakers. A consolidated FDI Policy by the government has been a progressive step towards bringing ��$��$��!��+��!��front, however, the government continues to be cautious about permitting FDI in multi-brand retail and raising the FDI cap in strategic and sensitive sectors like defence.

That the government is committed to strengthen the administrative ��!��>��budget announcements and the strategy plan outlined by the income tax department. However, the announcements must be given a concrete shape at the earliest.

��{`��and tax policy environment in India.

87 | Defensive towards FDI in defence 89 | Beyond cash and carry models�%�\�� {`��!��#{"�95 | India as a coveted tax destination

In this section

87


Defensive towards FDI in defence Ganesh Raj Economic Times, 15 June 2010

The country’s defence sector, despite its potential and

increasing budgetary allocation by the Centre, has not been able to keep pace with other sectors and exploit opportunities offered by liberalization of the economy.

With foreign direct investment (FDI) permitted up to 26%, the country continues to rely heavily on imports for its defence requirements and FDI in the sector is languishing at a cumulative USD0.15 million, as per latest FDI statistics published by the ministry of commerce and industry.

Though it is often argued that revision of the FDI policy by raising the limit on FDI would provide the requisite momentum to the defence sector, along with enabling the country to achieve its target of 70% self-��$��!��but this has always been a debatable issue and repeated discussions have not yielded a result given the sensitivity of the sector.

Going beyond the government corridors, the commerce ministry recently issued a discussion paper inviting comments from industry associations with regard to raising

FDI in defence up to 74%. The debate always brings us at the fore of deciding on “how much FDI is desirable for the defence sector and why”?

There is no denying that raising FDI limit in the defence sector is essential as most defence products involve use of advanced and state-of-the-art technology, which India lacks and can get transferred only when a foreign partner has a long-term stake in the company.

However, the FDI cap of 26% does not provide enough motivation to original equipment manufacturers (OEMs) to bring in proprietary technology to Indian joint venture partners.

It needs to be understood that a foreign company will not like to bring investments in the form of capital, people, skills and technology unless regulations allow it appropriate economic return and reasonable say in decision-making.

Further, with growth of the sector, the country’s reliance on import of defence equipment could also reduce, which would result in noteworthy savings in foreign exchange, besides strengthening the export potential.

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Further, the defence offset policy provides an alternative for infusion of funds to meet the offset requirement. So, an increase in FDI in the defence sector would create synergies with the offset policy. Consequently, there are several reasons for the government to contemplate an increase in FDI ceiling.

Also, as the commerce ministry has highlighted in its discussion paper, ��>�!��FDI in defence sector, which makes increasing FDI in defence sector a ��+��related to national security and how the increase in FDI limit would impact the same.

It is apprehended that allowing

Defensive towards FDI in defence

Ganesh Raj is a partner at Ernst & Young ��*��}��$�Advisory Group* as one of his multiple leadership roles. His functional experience includes corporate tax planning, structuring cross-border investments and transactions, and joint venture negotiations. He is based in our ��+

You can write to Ganesh at: [email protected]

*Ernst & Young India’s Tax Policy Advisory Group houses a specialized team of experienced resources including senior retired bureaucrats from the Government of India that advises clients across industries, and governments on diverse policy issues focusing on taxation.

foreign companies exercise control over the Indian defence companies would compromise with the country’s defence and security apparatus.


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Beyond cash and carry modelsPrashant KhatoreFinancial Express, 23 July 2010

FDI in the retail sector is and has been one of the most sensitive

areas with respect to liberalization of the Indian economy. FDI in multi-brand retail is per se prohibited and is permitted only in surrogate forms of the wholesale cash and carry model or single-brand retail model (albeit with an equity cap of 51%). Some of the concerns expressed are that the opening up of this sector would result in the large-scale exit of domestic family-managed outlets, thereby resulting in the loss of employment. Another argument put forth by those opposing liberalization is that the retail sector is currently unorganized and at a nascent stage. Hence, there is a need for consolidation in the domestic industry before FDI can be permitted.

It is interesting to note that studies by various industry associations and economic think tanks have stated that the opening up of retail would act as a catalyst for supply chain improvements, technological upgrades, greater availability of

funds for modernisation of the farm sector and so on. In fact, the Icrier study on the Impact of Organised Retailing on the Unorganized Sector in 2008, has emphasised that due to organised retail, the unorganized sector has not suffered. Instead, unorganized retailers have improved their business practices and incorporated technological upgrades. Further, the experience of opening up of retail in countries such as China, Russia, Thailand and Indonesia have demonstrated that there has been an increase in GDP, greater sourcing by foreign retailers from such countries, growth of their agro-processing industry and an increase in employment. In China, employment in retail and wholesale trade increased from 4% in 1992 to 7% in 2001. In the same period, the number of traditional retailers increased by approximately 30%.

Recently, PM Manmohan Singh, while expressing concern over rising food prices, stated that the gap between the price paid by the consumer

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and the farm gate price must be reduced and to achieve this, the economy needs greater competition. Subsequent to this, the Department of Industrial Policy and Promotion (DIPP) has released a discussion paper for public comment. One of the key rationales put forth by the DIPP is that such a move would lead to the development of post-harvest and cold chain infrastructure in ��!��$��$��$�� systems. The paper further states that liberalization could lead to the improvement in yield through contract farming and dissemination of superior technology and direct marketing, which will result in more predictable farm gate prices and steadier incomes.

The government may consider opening up FDI in the retail sector in tranches, as it will allow the industry to assess its impact in a gradual manner. The government may also initially put restrictions on opening up organised retail in selective cities, rather than rolling it out across India. The government should continue to keep FDI in single-brand retail under the approval route, as is the case currently, to keep track of the ��>��investor appetite. Further, instead of setting up an exclusive regulatory framework, it should consider incorporating conditions to protect the interest of small retailers.

The DIPP must be complimented for releasing this paper and it is now for the industry and other stakeholders to express their views and comment on the various highlighted areas. Although it would be prudent for the government to put in place measures and precautions while permitting FDI in retail, this should not be so onerous as to make it impractical for the foreign investors. In conclusion, as the age old axiom goes “too much and too little spoils everything,” the government should ensure that there are enough incentives along with adequate safeguards.


Beyond cash and carry models

Prashant Khatore is a partner at Ernst & Young India. A Corporate Tax* specialist, he has extensive experience in tax planning and structuring. He also actively contributes to thought leadership in the areas of direct ��+�X��+

You can write to Prashant at: [email protected]

*Our Corporate Tax practice provides integrated solutions across income and wealth taxes, corporate and allied laws, exchange control, FDI and regulatory matters besides specialized tax litigation advisory services.

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��"#�$�� %��''�+ to NBFCsHiresh WadhwaniCFO Connect, November 2010

Foreign direct investment (FDI) >��

quite robust in the past two years. However, a fairly complicated FDI policy framework in the past has ��in the Indian regulatory system.

Prior to 1 April 2010, FDI into India was administered primarily through rules and guidelines contained in the Foreign Exchange Management Act, 1999 and press notes, press releases and ��issued by the Department of Industrial Policy and Promotion (DIPP). Press notes on foreign investment spread over various years ��!��notes by issue of new ones, led to a lack of clarity and transparency with regard to Government policy on FDI.

Keeping in line with the Government’s intent to promote FDI in activities through a policy framework which is transparent, predictable, simple and clear and reduces regulatory burden, the DIPP, released the Consolidated FDI Policy – Circular 1 of 2010 (Circular 1) on 31 March 2010.

Circular 1, effective 1 April 2010, is a single comprehensive document containing all the policies relating to FDI in India.

At the time of the release of Circular 1, the Government had indicated that the policy would not be static and would be replaced every six months after incorporating the changes effected, during the intervening period. This system of periodic consolidation and

updation was introduced as an investor friendly measure. Further, after the issue of Circular 1 of 2010, the DIPP

��discussion papers on various aspects of the FDI policy. The Government’s initiative of public consultation will further aid in advancing the FDI policy and enhancing its lucidity.

Keeping to its commitment, the Government has now released Consolidated FDI Policy – Circular 2 of 2010 (effective 1 October 2010) (Circular 2), six months after the release of Circular 1. The policy circular is usefully accompanied by a Press Release explaining the key ��+��

The Government had indicated that the policy would not be static and would be replaced every six months after incorporating the changes effected.

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changes in the direction of the policy, Circular 2 seeks to address some of the open issues and ambiguities.

"��^��standing open issues, relevant for Non-Banking Finance Companies (NBFCs) operating in India.

Inclusion of share premium received along with the face value of the shares in calculating the “minimum capitalization”

The extant FDI guidelines for NBFCs, stipulate a minimum capitalisation norm (i.e. the amount of foreign investment required to be made by the foreign investor) that is linked to the sectoral cap on equity (i.e. the percentage of foreign ownership).

In this context, whether share premium was to be included while computing the minimum capitalisation requirements was the subject matter ��+��!��view had been expressed (though in respect of the real estate sector) that premium on issue of shares to a non-resident would not count towards the minimum capitalisation requirement. Subsequently, however, ��!��!!��given to NBFC applicants clarifying that premium infused into an Indian ��!��$��$��foreign investor should be counted ��capitalisation norms. As a ��>��!��being adopted.

"��^��¢��!��*�for the purposes of ‘minimum capitalisation’ includes share premium received along with face value of the shares only when it is received by the company upon issue of the shares to the non-resident investors. Any amount paid by a transferee post the issue of shares over and above the issue price of the shares cannot be taken into account for calculation of the minimum capitalization requirement.

Thus, while Circular 2 provides much-required clarity on the issue of circumstances where share premium can be counted towards minimum capitalisation, given the non inclusion of premium paid by a non-resident to acquire the existing shares of an Indian NBFC from the present shareholders, the same could require a substantial investment by the non-resident into a target company in addition to the amount paid to the seller, thus potentially having to lock-up capital in India, which may not be needed.

8'��;�+��+down subsidiaries without bringing in additional capital towards minimum capitalization

Another ambiguous issue was the permissibility of set up of subsidiaries by foreign owned Indian NBFCs. In the past, though there was no documented policy to this effect, it was understood that the FIPB always

New FDI norms to �%��''�+��=#8�

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permitted downstream investment without minimum capitalisation norms applying to the individual operating subsidiaries. However, there was lack of clarity as regards foreign investment into Indian operating subsidiaries made by a pure holding company, on introduction of press note 2 and 4 of 2009, which on a plain reading, seemed to suggest that the operating company in which downstream investments were made would need to comply with relevant sectoral conditions and other conditionalities. Thus, in response to requests for an explicit view, Circular ^��%''_��owned NBFCs, with a minimum capitalisation of USD 50 million, ��!��!��NBFC activities, without bringing additional capital towards minimum capitalization.

Downstream investment through internal accruals

Circular 1 stated that the ‘guiding principle’ is that downstream investments by companies ‘owned’ or ‘controlled’ by non-resident entities would require to follow the same norms as direct foreign investment. It also stated that for the purpose of downstream investment, operating cum investing companies and investing companies would have to bring in requisite funds from abroad and not leverage funds from the domestic market for such

investments. A question that arose was whether internal accruals of a foreign owned Indian company could be used for this purpose. Informal discussions from a policy standpoint were inconclusive. On account on this ambiguity, several companies had started accessing the Government approval route for downstream investments though internal accruals. Circular 2 now ��!��$��investments using internal accruals is not precluded, offering respite to ��!�� Indian companies proposing to set-up subsidiaries in India.

Thus, the explicit removal of doubts as regards the funding aspects of foreign owned Indian NBFCs, brings an end to the uncertainty and potential consequences of a change in the thought process of the regulators.

The consolidated FDI policy and the !��!��thereof is a step in the right direction to simplify the policy framework, thereby reiterating the Government’s intention to promote India as an attractive investment destination. The consolidated FDI policy and the initiative of stakeholder consultations on opening up sectors of defence, multi-brand retail, limited liability partnerships, etc would lead to the framing of an evolved policy which should largely be free of ambiguities.


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Conclusion

The Government should intensify its efforts to make the FDI regime comprehensible to foreign investors, so as to ��contribution of the global investing community in the India growth story.


.��&�B��&�� is a partner at Ernst & Young India and as Director, Financial Services group*, heads the ��+�X��!��in tax, regulatory and inbound structuring projects spans over 20 years and he has worked with variety of international �� brokerage houses, investment banks, asset management companies and PE ��+�X��(��+

You can write to Hiresh at: [email protected]

*Our Financial Services group comprises over 100 tax professionals specialising in providing tax advisory, compliance services as well as litigation advisory services to our clients from ��$+


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As the title of this article suggests, we need to turn the general

perspective of India as a “complex tax destination” on its head and seek the silver lining in our tax system. There is scope for considerable improvement in the tax administration to make India an attractive tax destination. Tax system with individuals: with the progressive reduction of personal tax rates in India — now down to a maximum rate of just 31% — the country boasts of one of the most moderate personal tax rates in the world.

Of course, there is merit in asking for a sizeable increase in the taxation threshold and at lower rates of tax ��>��digits. Interestingly, personal tax rate collections in the country have progressively increased in quantum despite the lower trajectory of tax rates. This seems to indicate greater voluntary compliance and higher disposable income with the growth in the economy.

It should also be borne in mind that long-term capital gains on listed securities — held for more than a year — is tax exempt and only a nominal securities transaction tax (STT) is leviable. This again is a tremendous wealth-building incentive for Indian tax residents as in most parts of the world, capital gains are moderately taxed and not tax-exempt. Coupled with the growth in equity markets over the last few years, Indian shareholders have certainly grown richer on an after-tax basis.

Also, for the last few years, India has got a dividend distribution tax (DDT) on companies distributing dividend to their shareholders and, correspondingly, dividend in the hands of shareholders is tax-exempt. ��higher tax bracket as the peak DDT rate has never exceeded 18% against the maximum marginal income tax rate of over 30%.

India as a coveted tax destinationSudhir KapadiaEconomic Times, 24 January 2011

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6��

Like many other countries, for several years now, India does not have any form of estate duty or inheritance tax. Coupled with the fact that wealth tax is very lightly levied on few assets — notably, shares are exempt — a high net-worth individual (HNI) residing in India has far superior personal wealth-building opportunity without worrying about asset-based wealth tax or estate duties or inheritance tax being fastened on his or her progeny who may be successors to the wealth. This contrasts sharply to the relatively higher rates of estate duties prevalent in developed nations around the world.

Even the gift tax law has been done away with for several years now and gifts to family, trusts or close relatives are generally exempt from any kind of deemed income tax as well. Even for the so-called most ��>��$��investing through equity in mutual funds instead of directly in the stock market, the complete tax exemption pass through mechanism has meant that neither the mutual fund pays tax nor the individual unit-holder on dividend received from the mutual fund or capital gains from transfer of units.

Even the direct taxes code (DTC) happily leaves the long-term capital gains exemption on listed securities unaltered while bringing parity in capital gains taxation with business income on all other asset classes.

There is merit in seriously considering extension of similar long-term capital ��in unlisted securities to encourage

investment in entrepreneurial startup companies either directly by individuals or through the venture capital or private equity route. Tax system for corporates: even on the corporate tax front, the rates have progressively been on the decline though the corporate surcharges have notoriously stuck out after having been introduced temporarily.

The government has a great opportunity to make a bold move and reduce corporate tax rate further to 25% — China and Russia notably among the Bric countries have headline corporate tax rate in this range. With the move towards investment-linked incentives instead ��!�� `�"��there should be an increase in the effective tax rate for the corporate sector, allowing a lower headline tax ��+�

What, however, would spoil the party for the coveted favoured tax destination tag as regards corporate taxation is concerned, is the unusually high level of unproductive litigation and uncertain basis by businesses broadly in the areas of transfer pricing and international tax.

It is noteworthy that even the income tax department has recognized this in its Vision 2020 strategy plan and has made its intent known to come out with a comprehensive proposal for reducing unwarranted litigation with taxpayers, faster disposal of appeals and prompt redressal of grievances in a consistent manner.

Some of the action points listed in the Vision document need to be implemented with alacrity, such as

India as a coveted tax destination

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India as a coveted tax destination

quicker disposal of disputes through mutual agreement procedure (MAP), make dispute resolution work ��$��$��proper administrative support and consider expansion of its scope, ��!��procedure for transfer pricing and issue revenue rulings on important legal issues having ��+�

India-headquartered multinationals

Ironically, this broad sector seems to be the most disadvantaged under the proposed DTC provisions, particularly in the context of stringent residency rules criteria for foreign place of effective management and current taxation of these kinds of income earned by a controlled foreign company (CFC) provisions. Here again, a bold approach is required to introduce CFC along with provisions for tax credits for taxes paid in the overseas jurisdictions.

Going forward, India should seriously consider introducing a “participation exemption” on the lines of the UK, the Netherlands, Switzerland and many other countries, whereby Indian companies are actively encouraged to set up a company in India itself, by exempting from tax, dividends and capital gains earned in respect of their overseas holding instead of Indian companies trying to achieve tax optimization by setting up such companies abroad.


9�� "�To summarize, India has arguably become a very attractive tax destination certainly for Indian citizens as well as non-resident Indians as far as individual taxation is concerned. However, a lot more in the area of administrative reform is required to make India an attractive tax destination as far as corporate tax systems is concerned. Going by the Vision 2020 document, after implementation in the earnest, ��India to make a corporate tax system also a very attractive proposition for doing business in India.

4��&��K�0�� is a partner at Ernst & Young India and our Tax Markets Leader. He has functional specialization in International Tax and has over 20 years of varied experience in advising companies. Sudhir leads the client relationship management agenda for our tax practice and is the senior tax advisory partner ��*��+�He is a regular speaker at key national and international events and actively contributes to thought leadership in the areas of international ��+�X��(��+


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Specials

99 | Key developments and landmark judgments in 2010120 | Evolution of the tax function

In this section

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Key developments and landmark judgements in 2010

Ernst & Young Tax Focus, year-end special edition, 22 December 2010

Direct tax

Direct taxes code 2010

The DTC marks a new era in the Indian tax regime after more than 50 years of operation of the current income tax law in India and is being viewed as the most awaited change in the Indian tax system. The proposed DTC 2010 is envisaged to replace the existing direct tax legislations constituted by the Income Tax Act, 1961 (ITA) and the Wealth Tax Act, 1957 with effect from 1 April 2012.

A draft DTC, along with a ��!�!��on 12 August 2009 for public comments. Based on feedback from various stakeholders, a revised discussion paper was released on 15 June 2010 addressing 11 of the ��+

The DTC 2010, was thereafter placed before the Indian parliament on 30 August 2010, and has presently been referred to the Standing Committee on Finance of Parliament for a detailed examination.

Though a lot of concerns expressed on the earlier draft DTC have been addressed in the DTC 2010, some proposals such as the introduction of general anti-avoidance rule (GAAR) continue to remain. In addition, DTC ^'%'�!��!��$��!��tax and also introduces Controlled Foreign Company rules apart from widening of source rules. The DTC 2010 also proposes to introduce an Advance Pricing Agreement (APA) regime, which, if properly implemented, could help in reducing transfer pricing uncertainty in India. These are some of the substantial changes that are likely to have ��!��cross-border transactions in India. Taxpayers will likely do well to assess its impact on their current structures and business models.

%��&��'�� &��&�� 0��

Finance Act 2010 (FA 2010) has also introduced a new provision in section 56(2) of the ITA wherein if ��!��$��$�

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shares of a company (in which public are not substantially interested) for inadequate or nil consideration, it will be taxed in the hands of the recipient in the following manner:

�� If transfer of shares is for nil consideration, and the fair market value (FMV) of such shares exceed `50,000, it will be taxed at the FMV of such shares.

�� If transfer of shares is for inadequate consideration and the difference between the FMV and the consideration exceeds `50,000, the FMV is in excess of the consideration paid.

��to determine the FMV in such transactions. An exclusion from taxation is provided in case of such transactions on amalgamation, demerger.

S��0� �#��&��&��#� �

Under the source rule (Section 9) in the ITA, any income by way of fees for technical services (FTS) is taxable in India based on the residential status of the payer of income. FTS ��as consideration for rendering any managerial, technical or consultancy services. The SC in the case of Ishikawajima Harima [(2004) 288 ITR 408] held that, for FTS to be taxable in India, the services should not only be utilized in India but should also be rendered in India. An amendment

introduced as an explanation to Section 9 in 2007 did not appear to have the desired result with many subsequent decisions continuing to rely on the SC decision to conclude on non-taxability of the transaction. The FA 2010 has substituted this explanation to clarify that FTS will be taxable in India irrespective of the place from where such services are rendered. This amendment is effective retrospectively with effect from 1 June 1976 (i.e., when these ��the ITA).

Post this amendment, the Mumbai Tribunal, in case of Ashapura Minichem Ltd., has reiterated that the law as amended and held that the legal proposition stated by the SC is no longer good in law. It is therefore not necessary that in order to attract taxability as FTS, services must also be rendered in India.

In the case of Ashapura Minichem Ltd. vs. ADIT [131 TTJ 291] [Refer EY Alert dated 31 May 2010]

Software controversy

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The controversy over software payments has principally focused on characterizing transactions as generating either “royalty”or “sales” income. A number of judicial precedents, with regard to the nature and extent of rights granted in a typical software transaction involving an end-user or a distributor, have

Key developments and landmark judgements

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characterized such transactions ��=��!��=��not taxable in the absence of a permanent establishment (PE) or any other taxable presence in India. For example, Authority for Advance Ruling (AAR) in the case of Geoquest Systems and Dassault Systems distinguished between transfer of “rights in copyrighted software” and transfer of a “copyrighted software” and held that mere transfer of computer software de-hors any copyright associated with it, will not amount to royalty. However, a recent ruling of the Delhi Tribunal in the case of Microsoft did not accept the distinction between “copyright right” and “copyrighted article”, on the basis that such distinction is not apparent from the plain language ��$��$��or the Double Taxation Avoidance Agreement (DTAA) between India and the US. Accordingly, it held that a right granted to use the computer software will be royalty.

A subsequent ruling of the Mumbai Tribunal in the case of Reliance Industries has reinforced the position taken in the earlier decisions that such characterization should be determined, with regard to the nature and extent of rights granted to the purchaser. Where the payment is to obtain rights limited to enabling effective operation of the software and not for the end-user to commercially exploit the underlying rights in the software, it will be inappropriate to classify the payment as royalty.

With similar issue expected to be decided by high courts in the near future, the controversy appears to be far from settled.

In the cases of Dassault Systems [322 ITR 125], Geoquest Systems BVI 327 ITR 1], Microsoft Corporation and Gracemac Corporation vs. ADIT [(2010) 47 DTR (Del)(Trib) 65] ;DDIT vs. Reliance Industries [2010-TII-154-ITAT-MUM-INTL] [Refer EY Tax Alerts dated 2 February 2010, 10 August 2010, 29 October 2010 and 10 November 2010]

Withholding tax obligation

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Under the ITA, any person responsible for making a payment to a non-resident (NR) which is chargeable to tax in India is required to withhold tax on such sums, at the applicable tax rates. However, the applicability of these provisions has been the subject matter of controversy. In an earlier decision by the Karnataka HC in case of Samsung Electronics, these provisions were interpreted to mean that any payment to a NR will be subject to withholding tax under the ITA, regardless of its chargeability to tax in India.

The Delhi HC, in the case of Van Oord and the special bench of the Chennai Tribunal in the case of Prasad Production, had subsequently attempted to clarify that there should be no withholding tax obligation when the underlying payment was not taxable in India. However, in view of


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the adverse Karnataka HC decision, the controversy continued to remain.

A number of taxpayers (GE Technology, HP, Sonata, Samsung), ��!��!��the SC against the Karnataka HC decision. The SC in a batch of cases, with the lead case being that of GE India Technology Centre Pvt. Ltd., reversed the decision of the HC by holding that any sum remitted to a NR, which is not chargeable to tax under the ITA, does not require the payer to apply the withholding tax provisions. Further, the SC held that no nil/lower withholding application ��Tax Authority to determine the amount chargeable, if the payer is not in doubt that the payment is not taxable in India. The SC also explained its earlier decision in the case of Transmission Corporation of A.P. Ltd., which has often been quoted out of context (including by the Karnataka HC). The SC thereafter remanded the matter back to the Karnataka HC to determine the taxability of the payment, which in the present case pertained to software payments.

The SC decision has thus settled this controversy and should provide relief to many taxpayers and clarity in case of others to determine withholding tax obligations in respect of payments to NRs.

In the cases of CIT vs. Samsung & Others [320 ITR 209], Van Oord ACZ India vs. CIT [323 ITR 130], ITO vs. Prasad Production Ltd. [129 TTJ 641]; GE India Technology Centre vs. CIT [327 ITR 456] [Refer EY Tax Alerts dated 18 November 2009, 25 March 2010, 12 April 2010 and 13 September 2010]

Cross-border M&A transactions

In September 2010, the Bombay HC, in the case of Vodafone NL (acquirer), considered whether the Tax Authority had jurisdiction under the ITA to tax the gains arising from the transfer of shares in a foreign holding company, which indirectly resulted in the acquisition of controlling interest in an Indian entity.

The HC, while accepting that the Tax Authority has jurisdiction to tax such a transaction, observed that the acquisition price and transaction documents, factored in and recognized independently the rights and entitlements to the Indian entity, which were transferred to the acquirer. In view of the special characteristics of the transaction, the arrangement has an Indian nexus and accordingly the jurisdiction of the Tax Authority cannot be faulted with. The HC also observed that a controlling interest in a company is a not a capital asset independent of shares in the company and that taxation of gains from share transfers is likely to arise where the situs of shares is situated.

��$��¦��§��SLP before the SC and the matter is now pending before the SC. Meanwhile, Vodafone has been asked to make a part payment of the tax demand that was computed by the Tax Authority.


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While it does not appear that the Bombay HC’s decision assumes a general principle for taxing all offshore share transactions, which indirectly involve Indian assets, multi-national enterprises (MNEs) will however, need to consider the implications arising from these developments while structuring their cross-border M&A transactions involving India. With the SC expected to decide the matter in 2011, this may arguably be India’s most awaited judicial decision in the coming year.

In the case of Vodafone International Holdings B.V. vs. Union of India [329 ITR 126] [Refer EY Tax Alert dated 9 September 2010]

Anti abuse

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Tax planning techniques have often come under the Revenue Authority’s scanner wherein the Tax Authority has alleged that such techniques are colorable devices used to evade taxes.

Sale of Indian shares by Mauritius company not taxable in India capital gains arising to a Mauritian tax resident on alienation of shares of an Indian company are taxable only in Mauritius under the India-Mauritius DTAA. This position has ��$��circular (Circular No. 789) as well as by the decision of the SC in the case of Azadi Bachao Andolan (263 ITR 706). However, there has been reluctance on part of the Indian Tax ��$��`��

the stage of withholding of taxes even where the Mauritian tax resident has a ��$��+

The AAR in the case of E*Trade (��!��non taxability of capital gains in India in such cases. The AAR did not accept the Tax Authority’s contention that, the taxpayer was merely a façade used to avoid capital gains tax, and that ��capital gains is its US holding company (US Co). The fact that the source of funds for the purchase of shares was traceable to the US Co or that the US Co had played a role in suggesting or negotiating the sale or that the consideration received ultimately went to the US Co in the form of dividends or the diminution of capital, do not lead to a legal inference that the US holding company, in reality, owned the shares.

The AAR made extensive references to the observations in the SC’s decision to infer that the motive to set up conduit companies and doing business in a ��$��not be material to judge the legality or validity of the transactions. The SC had held that the design of tax avoidance itself is not objectionable if it is within the framework of law and is not prohibited by law. However, with regard to colorable device and sham arrangements, there is still scope to ignore such dubious methods.

In the case of E*Trade Mauritius [324 ITR 1] [Refer EY Tax Alert dated 23 March 2010]


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@/��#��abuse of law

“Dividend stripping” was one tax planning technique, where the transaction of purchase of shares is undertaken just before the dividend is paid (record date). These shares are thereafter sold after encashing the dividend, when the share prices are reduced to the extent of dividends paid. While the dividend received is exempt from tax, short-term capital loss from this transaction can be utilized to set-off other gains resulting in a tax advantage.

A question, which came up for consideration before the SC, was whether such transactions are permitted under the tax laws. The SC, in the case of Walfort, held that the loss incurred by a taxpayer in such transaction cannot be disallowed as the use of a provision of the ITA to obtain a tax advantage, was not an

abuse of the law. Hence, the loss arising was admissible, as the transaction of purchase and sale was real.

It may be noted that the ITA has since been amended in 2001 to include an anti-abuse provision to regulate the admissibility of loss in such cases.

In the case of CIT vs. Walfort Share & Stock Brokers [326 ITR 1] [Refer EY Tax Alert dated 7 July 2010]

DTAA related issues

L��/��(%��/�� 0�� 00��

The taxpayer was a UK-based limited liability partnership rendering legal services to certain clients whose operations extend to India. The (��$�transparent entity can be regarded as “liable to tax” and, accordingly, ��`��the income is taxed in the hands of its members/partners.

Since the taxpayer’s personnel were present in India for a longer period ��!��the India UK DTAA, the Tribunal held that the taxpayer created a services permanent establishment (PE) in ��+�{��!��article of the DTAA provided for a PE ��!��<��$�attributable” to a PE, the Tribunal considered it as incorporating a wide force of attraction rule in the DTAA.Accordingly, it held that any income with respect to the services rendered to Indian projects, which were similar or relatable to the services rendered by the PE was also taxable in India, even if they were not provided or furnished in India.

In the case of Linklaters LLP vs. ITO [132 TTJ 20] [Refer EY Tax Alert dated 19 July 2010]


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9��;L��0��/�� #� �

Existence of a taxable presence in case of outsourcing of business process/IT services to an Indian ��$��!��thereon has been a contentious issue in India. Also, a subsidiary company is generally treated as a separate taxable entity and is distinct from its parent, which owns it.

In the case of eFunds Corporation and eFunds Solutions Inc., US (taxpayers), the Delhi Tribunal held that the relationship of the taxpayers with their Indian subsidiary to whom the Taxpayers had sub contracted/assigned provision of software development and call center services, resulted in a PE of the taxpayers in India under the India US DTAA. A PE was constituted on account of activities of the subsidiary, which effectively resulted in the taxpayers carrying on their business in India. The ruling however, does not throw much light on the factors the Tribunal considered decisive to determine that the place of business was regarded as being at the disposal of the foreign enterprise. The Tribunal, subject to some adjustments, broadly upheld the approach adopted by the Tax ��$��!��}��$��!��based on a proportion of Indian assets to global assets. It also held that the conclusions reached in a Mutual Agreement Procedure (MAP) ��!��$��

form the basis for the Tax Authority to reach a conclusion for other years, if there are no differences in facts for the years.

In the case of eFunds Corporation vs. ADIT [2010-TII-165-ITATDEL-INTL] [Refer EY Tax Alert dated 26 November 2010]

�� /��/�/��&��&��#�� &��&��/� �'��

The Mumbai Tribunal, in the case of Besix Kier Dabhol, SA, ruled on whether interest paid directly to shareholders by a permanent establishment (PE) of the taxpayer in India is allowable as deduction ��!��!��the PE in India under the provisions of the ITA and the India-Belgium DTAA. The Tribunal ruled that the DTAA only prohibits deduction of notional internal charge of interest ��}��and/not interest actually paid by a PE to the shareholder or another enterprise. The Tribunal further held that since neither the DTAA nor the ITA presently has any anti-abuse provisions in relation to thin capitalization, no such provision could be considered to restrict the amount of interest deduction. The Tribunal also considered the anti-abuse provisions under the proposed DTC 2010 and held that in the absence of such provisions in the ITA, debt from shareholder cannot be re-characterized as equity.


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In the case of Besix Kier Dabhol vs. DDIT [(2010) 47 DTR (Mumbai)(Trib) 450] [Refer EY Tax Alert dated 15 November 2010]

Transfer pricing (TP) updates

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One of the most challenging issues in TP pertains to creation and use of intangible property. A related issue is when the promotional efforts of �� $��$��the trademark that is owned by ��$+�The Delhi HC, in the case of Maruti Suzuki India Ltd. provides guidance on the circumstances under which a legal owner of a marketing intangible, such as a trademark or a brand name, ��!��for its promotional efforts that has the effect of enhancing the value of the intangible.

The HC held that in the case of associated enterprises (AEs), payment of royalty should satisfy the arm’s length test. Use of a trademark belonging to a foreign AE, by itself, will not entail a payment from the foreign AE to the domestic entity ��name accrues to the Indian enterprise alone. Further, if the advertising, marketing and promotion (AMP) expenses incurred by the licensed �� ¡��name are more than what a similarly situated and comparable enterprise is likely to have incurred, the owner of the intangible needs to suitably

compensate the licensed user for the advantage it obtained by in the form of brand building and increased awareness of the intangible. In such a situation the arm’s length price (ALP) for the arrangement need to be determined taking into consideration all the rights obtained and obligations incurred by the AE. Further, to determine whether the AMP expenses incurred are more than what a similarly situated and comparable enterprise is likely to have incurred, it will be necessary to identify appropriate comparables for the purpose of comparison.

��§}��$�(�� against the order of the Delhi HC, the SC has directed the matter to be proceeded “in accordance ��>��$��observations/directions given by the HC in the impugned judgment.” It however does not appear that the SC has annulled the principles laid down by the Delhi HC on the TP aspects of marketing intangibles.

In the case of Maruti Suzuki Ltd. vs. ACIT [192 Taxman 317] [Refer EY Tax Alert dated 5 July 2010]

India–US competent authorities’ resolution on TP matters TP disputes ��challenge faced by MNEs doing ��TP adjustments made by the tax ��!��+��a situation where income is subject to taxation not in accordance with the provisions of a DTAA, a taxpayer may seek to get the issue redressed under


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a mutual agreement procedure (MAP) route. A MAP is an alternate dispute resolution mechanism whereby the competent authority (CA) of both countries shall endeavor by mutual agreement to resolve such issue.

It has been reported that, pursuant to a MAP involving a number of US MNEs, the US and Indian CAs have agreed to resolve a TP dispute involving provision of intra-group information technology and business process outsourcing services by the ��Z��(��+��resolution involves the CAs agreeing to accept a mark-up on costs in the range of 18% to 24% as the arm’s length price as compared to an adjustment in the range of 25%–30% made by the Indian Tax Authority.

[Refer EY Tax Alert dated 13 May 2010 on India-US Competent Authorities’ negotiations on TP matters]

$�� $@Q

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The OECD, through its legal instrument of Tax Information Exchange Agreements (TIEAs), represents the standard of effective exchange of information for the purposes of curbing harmful tax

practices. India, which is a member of OECD’s Global Forum on Transparency and Exchange of Information, has been playing an active role to ensure that high standards of transparency and exchange of information are in place throughout the world.

In this backdrop, the ITA was amended in 2009 to enable India ��!��non-sovereign jurisdictions to promote transparency and exchange of information. Subsequently, the GoI, on 7 October 2010, signed its ��#��+��reported that negotiations for similar TIEAs have been concluded with Monaco, Argentina, British Virgin Islands, Cayman Islands and Isle of Man.

The TIEA is expected to allow the Indian Tax Authority to be better equipped to tackle tax evasion, especially with jurisdictions, which may be considered as tax havens and will also promote mutual exchange of information on matters relating to banking and ownership.

[Refer EY Tax Alert dated 15 April 2010 titled India on tax transparency and exchange of information]


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India perspective of OECD developments

As part of the ongoing process of revising and updating the OECD MC and Commentary, the OECD Council on 22 July 2010 approved the text of a new update (2010 update). An important aspect of the 2010 update is the replacement of Article [��!��!!��!��PE. The 2010 update has also made amendments to the existing OECD Commentary under Articles 5 (PE) and 12 (Royalty) to clarify PE and ��from certain “telecommunication transactions.”

India’s position, as a non-member economy on the OECD MC, and its commentary were included for the ��^''¨��!��OECD MC. The 2010 update contains additional positions of India on the amendments introduced in the 2008 update. In most of its positions in the current update relating to PE, ��!��$��$�taxation, India appears to have a disagreement with the OECD view. �!��$��the approach to the attribution of !��}��>��revised article and its commentary and in the consequential changes to the commentary on other articles.

Even though India is not yet a member of the OECD, the OECD MC and its commentary have been acknowledged by the Indian judiciary as a useful aid to interpret India’s tax treaties. One may also recall that India was granted an “observer status” by the OECD in July 2006 and offered enhanced engagement in May 2007, with a view of possible membership. India’s positions contained in the OECD MC will therefore, serve as a guide to taxpayers on the likely approach of the Indian Tax Authority. Some of the disagreements, which India has expressed on the OECD MC could be a cause for concern for taxpayers and could potentially expose the taxpayers to double taxation and the risk of litigation.

The OECD council also approved the 2010 version of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TP Guidelines). The 2010 version ��document since the TP Guidelines were released in 1995. It contains new and more detailed guidance on comparability issues. It also includes new guidance on how to select the most appropriate TP method. The revision also includes a new chapter providing detailed guidance on the TP aspects in business restructurings.


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The Indian TP rules are broadly-based on the TP Guidelines, with some deviations. The revisions introduce ��and should help in providing clarity to taxpayers as well as to the Indian Tax Authority on a number of issues where the Indian TP rules are currently silent or do not contain adequate detail.

Refer EY Tax Alert titled An Indian perspective of recent OECD developments on international taxation dated 26 July 2010

Social security contribution

B�&�� /��

On 11 September 2010, the GoI ��to the rules in relation to both employees provident fund (EPF) and employees pension scheme (EPS) involving International Workers (IW). ��non-Indian employees, not holding an India passport, and working for an establishment in India to which the EPF provisions apply. An IW can now withdraw the full amount standing in his EPF only when he retires or reaches the age of 58 years, whichever is later, or on account of permanent and total

incapacity. Previously, IWs were, able to withdraw the money from the EPF two months after leaving their Indian employment/following their departure from India. However, in respect of members covered under a social security agreement (SSA), withdrawal may be made on such ��$��!��SSA. Thus negotiating such an SSA ��+��!��$�has signed SSAs with Belgium, France, Switzerland, Netherland, Luxembourg, Hungary, the Czech Republic, Republic of Korea, Denmark, Norway and Germany.

These amendments appear to ��$��IWs as compared to the law applicable ��+�(��$��it hard to mitigate an additional 24% charge through an equalization policy. It is therefore important that all employers with cross-border workers involving India immediately review the impact of these changes and communicate the implications to their IW employee population in India.

[Refer EY HR alert dated 24 November 2010 Indian authorities �� social security rules for IWs]


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Indirect tax

Value added tax

4�0��9��

To examine whether mens rea is an essential element of offence under a taxing statute, regard must be had to the object of the statute Central Sales Tax Act, 1956; in favor of assessee

The question of law before the Court was whether mens rea (guilty mind) is an essential element for the levy of penalty under the Act. Held, that in order to determine whether mens rea is an essential element for an offence under a taxing statute, the following factors should be considered: a) Object and scheme of the act

b) Language of the section laying down the offence

c) Nature of penalty

Further, held that on the basis of the above and according to the language of section 10A of the Act, it was evident that mens rea is an essential condition precedent for levying penalty under this Section.

In the case of CCE, U.P. vs. M/s Sanjiv Fabrics [2010-VIL-13-SC] Refer to EY Tax Focus for October 2010

4�0��9��

Sale to be a valid ”sale in the course of import,” if goods imported exclusively pursuant to contract Central Sales Tax Act, 1956; in favor of assessee

��section 5(2) of the Act wherein an exemption is granted to sale incurred in the course of import. Disallowing ��that under the contract it was not obligatory for the assessee to import the goods to erect, design, supply and commission the plant according to the contract and thus the sale was not in the course of import. Held, that since the goods were imported on account of the contract and were used exclusively for the purpose as stated in the contract, the same will ��$��course of import.

In the case of The Indure Ltd. & Anr. ��+�"��+�[2010-TIOL-79-SC-CT] Refer to EY Tax Focus for November 2010

Service tax

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Entry Tax is not akin to Sales Tax: exemption from sales tax does not automatically qualify for exemption from entry tax

Uttar Pradesh Trade Tax Act, 1948; in favor of assessee

The assessee purchased goods for supply to the buyer under a lease agreement. The assessee gave instructions to a manufacturer of goods located outside the state, to deliver the goods to the lessee. Thus the ”movement of goods” originated from the manufacturer of the goods located outside the state. The question before the court was whether the lease constituted


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an inter-state sale. Held that the movement of goods originated due to the purchase order and not the lease, because in the absence of the purchase order there would not be any movement of goods. Thus, the levy of sales tax by the GoI under the Act will not be correct.

In the case of Telecommunication Consultants India Ltd. vs. CCE, Uttarakhand [2010-VI-18-HC-UTR] Refer to EY Tax Focus for April 2010

Service tax

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SLP dismissed on taxation of services abroad

Finance Tax Act, 1994; in favor of assessee

��!��!��$��authorities against the Bombay HC judgment has been dismissed by the SC. The Bombay HC in its judgment [Indian National Ship Owners Association vs. UOI, 2009 (13) STR (235)] held that the provision merely describes the services provided by a non-resident Indian to a resident in India as a taxable service and does not create a charge for levy of service tax. The taxable services received from abroad by a person belonging to India are liable to service tax in the hands of the Indian resident only from 18 April 2006.

In the case of Union of India & Ors vs. Indian National Ship Owner [2009-TIOL-129-SC-ST] Refer to EY Tax Focus January 2010

4�0��9��

[��%��'�%��'��'leasing services including leasing of hire-purchase of equipments

Finance Act, 1994; in favor of revenue

��company, opposed the imposition ��services on the ground that it is beyond the legislative competence ��}��deemed sale as per Article 366(29A) of the Constitution. It was held that ��leasing and equipment leasing, as the same was within the meaning ��=��=��=�� +=�{��the levy of service tax falls within Entry 97 of List I and therefore is within the legislative competence of the parliament. The same has been upheld in the case of T.N. Kalayana Mandapam Association, Gujarat Ambuja Cements Ltd. and All India Federation of Tax Practitioners.

In the case of Association of Leasing and Financial Services Companies vs. Union of India [Civil appeal no. 9344 of 2010] Refer to EY Tax Focus for November 201


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K��.��&�9��

Services to IT majors held to be manpower recruitment services

Finance Act, 1994; in favor of assessee

The assessee provided services taxable under the category of consulting engineer’s services, under a contract during the period 1997 to 2001. The question before the court, inter alia, was whether the assessee will be liable to deposit tax under this taxable service category during the period. Held, that since companies were brought within the purview of the service category of consulting engineer’s services in 2006, the assessee will not be liable to service tax. The other question was whether the assessee will be liable to be taxed under the works contract service. Thus held, that even though the contract will qualify as works contract, the assessee could not be made liable to service tax under the same, as it was introduced as a taxable service category only on 1 June 2007, being later than the period in question.

In the case of CST Bangalore. vs. Turbotech Precision Engineering [2010-18-STR-545 (Kar.)] Refer to EY Tax Focus for July 2010

9L4%�%,�J��(��&��O\�� &Q

Turnkey Contracts having service elements can be vivisected for the purposes levy of tax by different statutes

Finance Act, 1994; in favor of revenue

The question before the Larger Bench was whether turnkey contracts can be vivisected and the service aspect can be subjected to service tax. Held that turnkey contracts can be vivisected and the discernible service elements involved therein may be segregated ��the purpose of levy of service tax under the Act. Thus, Article 366 (29-A) (b) that allows severability of composite and turnkey contracts is held to be merely not for the purpose of levy sales tax and has equal application for the levy of service tax for the discernible service elements.

In the case of CCE, Raipur vs. M/s BSBK Pvt. Ltd. [2010-TIOL-646-DEL-LB] Refer for EY Tax Focus for June 2010


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9L4%�%�=�<��/��

Works contract not liable to service tax before the works contract service introduced

Finance Act, 1994, Central Excise Act, 1944 ; in favor of assessee

Aseesee executed lump sum indivisible turnkey contract prior to when works contract service was introduced and paid service tax on the said contract under erection, commissioning and installation service at that time. Subsequently, assessee sought refund of the service tax paid on the ground that service tax can be levied on service portion of the works contract after works contract service was made taxable and not earlier. The court upholding the decision in Daelim held that sales tax on works contract can be levied �$��$�the 46th Amendment. The deeming ��!!�$��tax and works contract will be liable to service tax only after the works contract service was introduced.

In the case of CCE, Raigad vs. Indian Oil Tanking Ltd. [2010-18-STR-577-Tri Mumbai]

Refer to EY Tax Focus for July 2010

Excise/CENVAT Credit

9L4%�%,�J��(��&��O\�� &Q

Cenvat Credit not allowed on cements and steel items used for laying foundation and for building support structures

Central Excise Tariff Act, 1985; in favor of revenue

The question before the Larger Bench, inter alia, was whether the term capital goods included plant and structures embedded in Earth. Held that, whether a particular plant or structure embedded in earth can be considered as capital goods or not depend on whether it was excisable under the Act. This was to be determined in light of SC decisions. Further held that goods such as cement and steel used for laying foundation and for building supporting structures cannot be treated as inputs used in manufacture of capital goods or as inputs used in relation to manufacture of ��!��+��foundations and supporting structures are not capital goods or ��!��+

In the case of Vandana Global Ltd. vs. CCE, Raipur [AIT-2010-167-CESTAT]

Refer to EY Tax Focus for June 2010


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Regulatory

Foreign direct investment policy

5�#�� &��!��6��#��;��/��00�� ^

��!��$��!��foreign investment applications with the Foreign Investment Promotion board (FIPB), the GoI launched an ��$��+�+�+�%��(��^'%'+�Henceforth, all fresh and amendment !��!��through a separate website launched for FIPB.

PIB Press Release, Cabinet Committee of Economic Affairs, 11 February 2010

9��6��(�� #��0�� "�9�� 9��

With the objective of providing comprehensive FDI Policy framework, the GoI issued Circular 1 of 2010 and Circular 2 of 2010. With the issue of consolidated FDI policy, all earlier Press Notes/Press Release/"��{`��$�`�}}�since 1991 stand rescinded. The FDI policy shall now be revised every six months.

The consolidated FDI policy for the ��and carry wholesale trading and prescribed the conditions for the companies undertaking such activity ��!��+��include issue of share warrants

and partly paid-up shares by Indian companies, FDI by way of share swap, ��conditions for agriculture sector, downstream investment through internal accruals and investment in construction development projects.

5�#��0��&�/��6(��

The GoI prohibited FDI in manufacturing of ”cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes” and accordingly included the same in the list of items prohibited for FDI.

Press Note 2 (2010) series, Department of Industrial Policy and Promotion, 10 May 2010

5�#�� 0�0��#��0�/�� /��_�� 6(��0��

Discussion paper on FDI in defence sector

In the discussion paper, the GoI has acknowledged that the present FDI cap of 26% discourages original equipment manufacturers (OEMs) from bringing in proprietary technology, as OEMs are reluctant to license their proprietary technology to a company in which their equity is restricted to a minority stake of 26%. This has resulted in India not being able to access the latest high-end technologies available. Raising the


in 2010

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{`��!��!��incentive for transfer of know-how/technology, leading to higher levels of technological expertise.

The GoI also highlighted concerns related to liberalizing the FDI regime for the defence sector and invited public comments as to whether 74% FDI under the approval route will be ��the defence industry.

Discussion paper on FDI in multi-brand retail trading sector

The discussion paper highlighted the fact that a number of issues needed to be resolved before opening up of retail trading section, including whether any new legislation will be needed or if a regulator needs to be constituted, protecting the public distribution system by ensuring that enough buffer stocks are maintained by the government.

6��`� &�� /�� #��`��!�0��

A discussion paper was released to invite views on whether the conditions imposed by the erstwhile Press Note 1 of 2005 series making it mandatory for the foreign investor to obtain prior approval of the Foreign Investment Promotion Board (FIPB) for starting any new venture in the ��$��India on or before 12 January 2005 should be completely abolished or substantially relaxed.

6�� #��/��0��&�0�

The discussion paper highlights the inherent issues related to FDI in LLPs such as determining ownership and control, applicability of valuation guidelines, treatment of non-cash and downstream investments and has sought comments on whether FDI in LLPs should be permitted up to 100% or restricted to sectors without a cap, conditionality or entry route restrictions, whether LLPs should be treated at par with the companies and whether investment should be permitted through the automatic or government route.

The GoI has noticed that the LLP model may be attractive to professional sectors and small entrepreneurs who are hesitant to use the corporate structure and ��!��!� structure viable.

��&�� other than cash

In a discussion paper the government has acknowledged that the FIPB is receiving a number of cases related to issue of shares against non-cash considerations such as trade payables, pre-incorporation expenses, import of capital goods/machinery etc., and it is necessary to evolve guidelines on this subject, which should be consistent with the overall FDI policy.


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The government has sought public comment and suggestions inter-alia on whether Indian companies should be permitted to issue shares to foreign entities against non-cash contributions, or whether such an approach dilute the objective of the {`��!��$��$��>��physical capital into the country and what regulatory safeguards should be prescribed to permit issue of shares for consideration other than cash.

Press Release, DIPP, Ministry of Commerce and Industry, 10 September 2010, http://www.dipp.nic.in/DiscussionPapers/DP_FTC_ExistingVenture_10September2010.pdf

Press Release, DIPP, Ministry of Commerce and Industry, 28 September 2010, http://dipp.nic.in/ipr-feedback/DiscussionPaper_LimitedLiabilityPartnerships_28September2010.pdf, http://dipp.nic.in/ipr-feedback/DiscussionPaper_IssueofShares_28September2010.pdf

Foreign exchange management Act

L�/��&��/�� &�� O�@Q`�� O\@Q��/��

With the objective of achieving greater transparency, RBI placed the eligibility criteria and the procedural guidelines for establishment of BO and LO in India in the public domain.

Henceforth, all applications by foreign companies, satisfying the minimum net worth and track record criteria, to establish BO/LO in India will need to be submitted through AD Category-I banks (AD bank) to the Reserve Bank of India along with the prescribed

documents. However, applications from foreign banks and insurance companies will continue to be directly received and examined by the Department of banking operations and development (DBOD), the ��#�� and the Insurance Regulatory and Development Authority (IRDA), respectively.

A. P. (DIR Series) Circular No. 23, 30 December 2009

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As a measure of liberalization, RBI amended the pricing norms for issue of shares by an Indian company to a person resident outside India with effect from 21 April 2010 as follows:

Pricing norms in case of rights issue to persons resident outside India

(i) In case of a listed company, issue price will be determined by the company.

(ii) In case of an unlisted company the issue price will not be less than the price at which the shares are issued to the resident shareholders.

Pricing norms in case of issue of shares to persons resident outside India

(i) In case of a listed company: at a price not less than the price calculated in accordance with the Securities and Exchange Board of India (SEBI) guidelines.


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(ii) In case of an unlisted public company: At a price not less than the fair valuation of shares done by a SEBI registered category-I merchant banker or Chartered Accountant as per ��>�w (DCF) method.

Pricing norms in case of issue of shares to person resident outside India on preferential allotment

(i) In case of a public company: At a price not less than the price as applicable to the transfer of shares from residents to non-residents according to the RBI guidelines.

(ii) In case of a private company: At a price not less than the fair value of shares done by a SEBI registered category-I merchant banker or Chartered Accountant as per the discounted free cash Flow (DCF) method.

#�� #��$%'*$%+%/34��Gazette of India, 21 April 2010

S��#��9��#��9��0��O9�9Q

The RBI, for effective monitoring ��introduced a regulatory framework for core investment companies (CICs), which provide a framework

to set up such companies. Henceforth, CICs with an asset size of INR10 million and above shall be treated as systemically important core investment for companies and accordingly will require mandatory registration with RBI.

Historically, there has been a lack of clarity on the applicability of the RBI Act and the directions requiring NBFCs to register as a NBFC by investment holding companies.

Circular No. DNBS (PD) CC.No. +56*%8�+%�%%+*$%+%9++�3��"�Bank of India, 12 August 2010.

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This law has the objective of rationalizing and streamlining the process and the procedure for compounding and enhancing transparency and effecting smooth implementation of the compounding process. The RBI has decided to put in place an updated procedure for compounding of contraventions under FEMA and has issued new directions in this regard, which supersede the directions contained in the compounding of contravention/s issued vide A.P. (DIR Series) Circular No.31 dated 1February 2005

��:��;<3=��>?��#��'@� 28 June 2010


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Securities and Exchange Board of India

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The SEBI has extended the ASBA ��$��buyers (QIBs) in public issues opening on or after 1 May 2010. Earlier in December 2009, SEBI had extended the ASBA facility to all investor categories except QIBs. Under the ASBA facility the bank account of the QIBs will be blocked to the extent of the application money and the application money will get debited from account only if their application is selected for allotment after the ��+

SEBI circular no. CIR/CFD/DIL/2/2010, 6 April 2010

%&��&��0�/�� &��&�� 0�� ]��7]�

��Contracts (Regulation) (Amendment) rules, 2010, the GoI has made it mandatory for all the listed companies to offer a minimum 25% shareholding to the public as opposed to 10% earlier.

Every listed company is required to maintain public shareholding of at least 25%. If the public shareholding in a listed company falls below 25% at

any time, such company shall bring the public shareholding to 25% within a maximum period of 12 months from the date of such fall. Existing listed companies with less than 25% public holding will reach the minimum 25% level by an annual addition of not less than 5% to public.

If the post issue capital of the company calculated at offer price is more than INR40 billion, the company may go to public with 10% public shareholding and comply with the 25% requirement by increasing its public shareholding by at least 5% per annum.

Securities Contracts (Regulation) (Amendment) Rules, 2010, Gazette Of India, Ministry Of Finance, 4 June 2010

��/�� &�� &��

SEBI has issued detailed guidelines for stock exchanges to provide an arbitration mechanism for settlement of disputes between a client and a member through arbitration proceedings, which interalia include the aspects related to maintenance of a panel of arbitrators, code of conduct for arbitrators, procedure of arbitration, appellate arbitration, arbitration fees, place of arbitration and implementation of arbitral award in favor of clients.

SEBI circular no. CIR/MRD/DSA/24/2010, 11 August 2010


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6�� 4L��O��9�0��(� ��S�'��Q�S��,��$

The SEBI has revised the monetary ��of SEBI under whose jurisdiction ��company is situated from INR500 million to INR1,000 million. Merchant bankers have been accordingly ��%��October 2010, all the draft offer documents/offer documents having estimated issue size of INR1,000 million with the concerned regional ��#�+

SEBI circular no. CIR/CFD/DIL/9/201, 13 October 2010

9�� &��

In order to facilitate merger of mutual fund schemes, SEBI has decided that merger or consolidation of schemes will not be considered as change in the fundamental attribute of the surviving scheme if the fundamental attributes of the surviving scheme, which remains in existence after the merger, as per SEBI Circular No- IIMARP/MF/CIR/01/294/98 dated 4 February1998 remains unchanged.

Mutual funds should be able to demonstrate that the circumstances merit merger or consolidation of schemes and the interest of the unitholders of surviving scheme is not adversely affected.

SEBI circular no. Cir/IMD/DF/15/2010, 5 October 2010


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Evolution of the tax functionAlbert Lee and Sameer GuptaCFO Connect, December 2010

Over the last decade, the role of the tax function in the corporate

sector has changed dramatically due to globalization, technological progress, a risk-based approach adopted by tax authorities, and the ��$��+�A tax function that adapts quickly to these new trends will minimize risks and create value for the business. To this end, tax directors and their teams have to master new skills such as an international outlook, risk management, and differentiated communications with tax authorities. The tax function also needs to be knowledgeable about processes and controls, and to integrate its work with business functions such as IT, ��+

Tax professionals have seen the content and context of their jobs change profoundly over the last decade, due to the impact of some important international trends. For one, the number and complexity of tax-relevant international transactions has increased sharply. What is more,

transactions originating in many different countries, each with their own national tax rules, are now often processed centrally, for example, in a shared service center (SSC). Not so long ago, local tax managers could view themselves as deep technical experts in their own countries. Nowadays, with the globalization and centralization of many tax-related

processes and transactions there is demand for a tax function with an international outlook and a capacity to coordinate and integrate peculiarities of many separate

tax jurisdictions. As businesses and processes globalize, so must the perspectives and skills of a company’s tax function.

Some key trends that have propelled a shift in the role of the tax head or the tax function in an organization are as follows:

Globalization and complexity in cross-border transactions

The shift in economic weight from West to East, has put the spotlight on

With the globalization and centralization of many tax-related processes and transactions there is demand for a tax function with an international outlook and a capacity to coordinate and integrate peculiarities of many separate tax jurisdictions

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India which has seen increasing M&A and private equity kind of, in-bound transactions’ activity, and increasing, outbound acquisitions by India-headquartered, corporate entities.

For instance, during the quarter July to September 2010, according to Ernst & Young’s India Transactions’ Quarterly Report, in-bound deal activity was strong as global companies continued to scout for acquisition targets in India. India’s relative resilience in the face of the global economic downturn, coupled with its expected growth potential make it a very attractive target destination. We witnessed in-bound deals which were cumulatively worth USD 10.1 billion.

Overseas investments by India headquartered corporates are also steadily growing and we have in recent years witnessed Foreign Direct ��{`��>��{`��>��+�`��released by the Reserve Bank of India (RBI) indicates that during the ��$��(��^'%'��outbound FDI totalled approximately USD 10.3 billion. With the global economy showing signs of revival, the interest in overseas investments will continue to rise.

A tax director today plays an important role in expansion plans and also in M&A activities. Companies aim to increase their earnings per share ��}��$��levers to achieve this objective.

Today a tax function in an organization cannot be isolated from the operational functions; rather it needs to be well integrated with

the business needs. As business operations become global, complexity increases. The tax director and his team have to be involved in the decision-making process to ensure that acquisitions, divestments, and expansions are all carried out in a tax-��+

Tax savings are no longer relegated to the domestic domain. A global ��!��$��effective supply chain management (TESCM) by reallocating the functions and risks within the group as a whole, in such a way that it allows, from a transfer pricing perspective, ��!��!��attribution to higher tax jurisdictions.

In this backdrop, proper tax analysis and planning, and a connection with business units emerge as important elements of a tax function. Tax decisions need to be backed by substance not only to ensure that these are not treated as a sham by the tax authorities but also to ensure that they truly meet business needs.

Increasing use of technology

Globalization is closely connected with a second trend impacting the tax function, which is technological progress. Digitalization and the internet revolution enable processing and instant worldwide distribution of vast amounts of tax-related data. The digital revolution has generated ��$��also increased the risk of inappropriate treatment of tax-related data during its electronic processing. Trivial mistakes in transaction processing

Evolution of the tax function

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can have grave consequences from a tax perspective. Therefore, the tax function needs to be aware of IT and should be involved at an early stage in the design and implementation ��$��+�(��can even be used to improve the effectiveness of the practice of tax by providing faster and more accurate information by which to plan and strategize.

New tax regulations and changing attitude of tax authorities

New tax regulations and the changing attitude of tax authorities constitute another challenge for the tax function. The old days of playing cat and mouse games are gone. It is becoming more ��!��rules and tax regulations to require a company to disclose tax contingencies or uncertain tax positions. In the international context, tax authorities of many countries including the UK and Australia, now explicitly take a risk-based approach. Tax authorities in countries such as Ireland and the Netherlands are exploring more cooperative relationships with companies, but this promising development will only prosper if companies can show they have a solid internal tax control framework in place; a framework that allows a company to assess potential tax risks.

Tax-risk management is becoming a key component of the overall risk management framework with Indian companies now articulating a tax-risk policy, with a focus on potential litigation. The likelihood of being handed out a high-pitched assessment by the Indian tax authorities and ensuing protracted litigation (and therefore, estimating potential tax

��>��litigation fees), is a key input that is considered crucial in planning out business transactions.

In fact, the provisions of the draft Direct Tax Code, 2010, as they now stand, for example, contain provisions for introducing General Anti-Avoidance Rules (GAAR). Wide discretionary powers have been given to tax commissioners to invoke these provisions, and to declare any transaction as an “impermissible, tax-avoidance, arrangement”.

These proposals make the introduction of a proper, tax-risk mechanism and documentation procedure even more vital for the Indian corporate sector.

��!��impending tax law changes, and the changing attitude of tax authorities, they have to adopt a risk-based approach themselves. It is clear that tax-risk management, including the measurement and weighing of uncertain tax positions, requires skills of the tax function that go beyond the interpretation of tax law and subsequent planning. The modern tax function should be capable of designing and implementing an explicit tax-risk strategy as a basis for work prioritization.

Conclusion

Over the last decade, the level of compliances mandated by tax laws has substantially increased. Tax professionals also feel the pressure ��with less, especially since the onset of the recession after the credit crunch. Within limited budgets, the tax function has to make tough choices, for example, dedicating time to shortterm


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tasks such as preparing returns or to long-term needs such as strategic tax planning.

The demands of all these trends on the tax function often reinforce one another. For example, demonstration by the tax function of robust controls is necessary to improve the relationship with tax authorities. Over the last decade, many tax authorities ��$��technological skills as well as their demands for information. They now routinely request downloads from accounting systems as part of an audit or enquiry process.

In order to adapt to, and stay ahead of, these new realities the tax function should have robust systems and processes capable of managing the compliances on time and meet the information and date requests by the tax authorities. What is more, strong systems and processes will not only help the tax function to reduce a company’s tax compliance risk, but also add value. Techniques such as data-mining can, and should also be

used by the tax function to improve its own tax-planning strategies, creating value for the company.

{��$��the tax function must integrate and leverage the infrastructure of the business which gives rise to the tax liability. Therefore, now, more than ever, the tax function should closely cooperate with other functions such as ��+

In short, a modern tax function has evolved from a domestic to an international scope; it needs ��audit, and its businesses; it needs to ��$��$��should adapt to tax law changes and build a positive relationship with tax authorities. This is the new challenge of a tax function.


4��5�0��is a partner with Ernst & Young India and national leader of our Corporate/Business Tax Services practice*. He focusses on the Financial Services industry and has over 15 years of experience in advising Indian ��!��including banks and private equity groups in investments and fund structuring, transfer pricing and tax planning and compliance.You can write to Samir at: [email protected]*Our Corporate Tax practice provides integrated solutions across income and wealth taxes, corporate and allied laws, exchange control, FDI and regulatory matters besides specialized tax litigation advisory services.

Albert Lee is the leader of Ernst & Young’s Tax Performance Advisory practice* for the EMEIA region (Europe, Middle East, India and Africa). He has 20 years’ experience in international taxation in both industry and consulting and is currently responsible for helping our clients across EMEIA with tax strategy, risk, process, data and technology matters. You can write to Albert at: [email protected]*Tax Performance Advisory (TPA) services assist business clients with the strategic and operational challenges facing their tax functions. Example services include advisory assistance with tax function reviews, process redesign, internal controls remediation, solution evaluation and implementation, tax sensitization of source systems, and related change management services.


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Taxation in India 2010-11

Ahmedabad^��>�� Near CN VidhyalayaAmbawadiAhmedabad — 380 015Tel: + 91 79 6608 3800Fax: + 91 79 6608 3900

Bengaluru“UB City”, Canberra Block%^��)�%��>��No.24 Vittal Mallya RoadBengaluru — 560 001Tel: + 91 80 4027 5000 + 91 80 6727 5000 {��¬� ��%�¨'�^^%'�®'''��%^��>��{��¬� ��%�¨'�^^^ �'®��%��>��

Chennai�}§�X��^��>��No. 3 Cenotaph RoadTeynampetChennai — 600 018Tel: + 91 44 6632 8400Fax: + 91 44 2431 1450

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�� 18, iLabs CentreMadhapur Hyderabad — 500081Tel: + 91 40 6736 2000Fax: + 91 40 6736 2200

Kochi9th Floor, Abad NucleusNH-49, Maradu POKochi, Kerala 682304, India��¬�� %� ¨ ��' '''�Fax: +91 484 2705393

Kolkata22 Camac Street#�� ¢"*��>��Kolkata — 700 016Tel: + 91 33 6615 3400Fax: + 91 33 2281 7750

Mumbai®��>��)�%¨��>��!��Nariman PointMumbai — 400 021��¬� ��%�^^�®®�[��^''��®��>��Fax: + 91 22 2287 6401 ��¬� ��%�^^�®®®��'''��%¨��>��Fax: + 91 22 2282 6000

The Ruby29 Senapati Bapat Marg,Dadar (W) Mumbai — 400028Tel: +91 022 61920000Fax: +91 022 61921000

��>��#�� #¯^Nirlon Knowledge ParkOff Western Express HighwayGoregaon (E)Mumbai — 400 063Tel: + 91 22 6749 8000Fax: + 91 22 6749 8200

NCRGolf View Corporate Tower – BNear DLF Golf Course, Sector 42Gurgaon – 122 002Tel: + 91 124 464 4000Fax: + 91 124 464 4050

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4th & 5th Floor, Plot No 2B, Tower 2, Sector 126, NOIDA - 201 304 Gautam Budh Nagar, U.P. India Tel: + 91 120 671 7000 Fax: + 91 120 671 7171

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