Leveraging Tax Opportunities with India: W hat you need to know !

Leveraging Tax Opportunities with India: What you need to know!

June 2010

© 2010 Deloitte S.A.India - Luxembourg2

Agenda

Cash Tax Savings ideas and opportunities generated by the recent Double Tax Treaty3

a

India Tax update 1

Opportunities for Indian inbound investments

Opportunities for Indian outbound investments

2 Opportunities for investment funds

Update on India’s treaty with Mauritius

Treaty benefits

Draft Direct Tax Code

FDI policy and recent amendments

Salient features: India – Luxembourg treatya

c

b

d

e

b


Part 1: Indian Tax Update

Update on India’s treaty with Mauritius2

Treaty benefits3

Draft Direct Tax Code4

FDI policy and recent amendments5

Salient features: India – Luxembourg treaty1

© 2010 Deloitte S.A.

Salient features: India – Luxembourg treaty


Treaty benefits under India - Luxembourg treaty

Effective Date• The Double Taxation Avoidance Agreement (“DTAA”) between India and

Luxembourg is effective from 1 April 2010

Interest, Fees for Technical Services and Royalties• The DTAA provides for taxation of interest, royalties and fees for technical

services, both in the country of residence as well as the country of source• However, the rate of tax in the source country shall not exceed 10% of the gross

amount of payment in case the beneficial owner of the payments is a resident of the other Contracting State

• Under the DTAA the scope of income taxable as fees for technical services is very wide as it has been defined to mean consideration for managerial or technical or consultancy services including provision of services of technical or other personnel

Capital GainsThe DTAA provides that capital gains from alienation of shares of a company shall be taxable in the country where the company(whose shares are sold) is a resident


Treaty benefits under Indo - Luxembourg treaty

Business Profits• The DTAA provides that business profits of an entity will be taxed in the country

of its residence unless such entity carries on its business in the other country through a Permanent Establishment.

• PE includes service PE, warehouse PE, construction PE

Tax Credit• In case of a Luxembourg resident, the credit method would be available only

where the income has been taxed in India as dividend, interest, royalty or fees for technical services and of Artistes and Sportsperson. Such credit shall be available to the extent of Luxembourg tax on such income.

• In all other cases double taxation shall be eliminated by the exemption method whereby the income taxed in India shall be excluded from the taxable income in Luxembourg. It is provided that such income can be included for rate purposes.

Limitation of benefit Clause• ‘Limitation of Benefits’ under the DTAA is intended to prevent misuse of the

provisions of the DTAA. No specific limits has been prescribed.


Update on India’s treaty with Mauritius


India re-negotiating the Mauritius treaty

• India has been attempting to negotiate changes to the 28-year-old tax treaty, to restrict its benefits to genuine residents of Mauritius

• Presently, there is no limitation of benefit clause in the Indo-Mauritius treaty

• India is keen on inserting a clause similar to the limitation of benefit clause in the India-Singapore treaty, which provides for an expenditure test as a rule for demonstrating commercial substance

• The cumulative foreign fund flow of $81 bn came into India between April 2000 and May 2009 from Mauritius

• Circular Nos. 682 dated 30-3-1994 and 789 dated 13-4-2000 issued by the Central Board of Direct Tax, India have clarified that based on tax residency certificate issued by the Mauritius tax authorities one could claim treaty benefits

• Further, the Supreme Court in India in the case of Azadi Bachao Andolan has also affirmed the above and clarifies that in the absence of the limitation of benefit clause, tax planning through the Mauritius route is permissible

• A recent ruling in the case of E*Trade Mauritius Limited by the Authority for Advanced Rulings has also confirmed that the capital gains on sale of shares of Mauritius company is not taxable in India


E*Trade Mauritius Limited - AAR

Facts• E*Trade is incorporated in Mauritius and holds a Tax

Residency Certificate issued by the Mauritius Tax Authorities

• E*Trade sold shares held in IISL, an Indian company, to HSBC Mauritius and realised long term capital gains on the same

• E*Trade thereafter approached the Authority for Advance Rulings to seek a ruling on the taxability of the said transaction

• The AAR observed that :− Outcome of Azadi Bachao Andolan case is that there

is no legal prohibition against “treaty shopping”− If a resident of a third country, in order to take

advantage of a tax treaty sets up a conduit entity; the legal transactions entered into by that conduit entity cannot be declared invalid and therefore tax avoidance is not objectionable if it is within the framework of law and not prohibited by law

• AAR held that the fact that E*Trade USA provided the funds and played a role in negotiating the transaction of sale did not lead to the legal inference that the shares were in reality owned by E*Trade USA

E*Trade USA

Converging USA

E*TradeHSBC

IISL

WOS

WOS

WOSMauritius

India

USA

Sale of shares

Not Liable for tax In India


India looking from a different angle now

• Presently, the foreign investments into India through Mauritius stands at • The tax authorities at lower levels are questioning the treaty benefits – are mostly

concerned about treaty shopping, the practice of routing third country investment through tax havens to avoid paying taxes

• The urgency to amend the rules came after Vodafone’s acquisition of Hutch a couple of years ago

• Income tax officials are being posted at Port Louis, Mauritius to facilitate greater exchange of information between the two countries

• The Indian Government has also expressed its intentions to curb treaty shopping in the recently proposed draft Direct Tax Code

“A team is going to Mauritius... we are on the job” finance minister


Treaty benefits


Relief under the tax treatiesCriteria Singapore Mauritius Cyprus Netherlands Luxembourg

Appropriation of profits -

Taxability of dividends

Indian company declaring dividends is liable to pay DDT

of 16.61% is payable in India;

Tax credit i.r.o DDT may not be available in Singapore

DDT of 16.61% is payable in India;

Tax credit i.r.o DDT may be available in

Mauritius


Tax credit i.r.o DDT may not be

available in Cyprus


Tax credit i.r.o DDT may not be available in Netherlands


Tax credit i.r.o DDT may not be available in

Luxembourg

Capital Gains of sale of Indian company shares

Not subject to capital gains tax in

India and Singapore

Not subject to capital gains tax in India and

Mauritius

Not subject to capital gains tax in India and Cyprus

Not subject to capital gains tax in

India and Netherlands if the shares are sold to

non residents

Subject to capital gains tax in India

Royalties Withholding is required to be @

10%

Withholding is required to be @ 15%

(rate under Indian Domestic tax law is

lower)

Withholding is required to be @

15%


lower)


20%


lower)


10%


lower)

Fees for technical services


10%

No withholding is required


10%


20%


10%


Relief under the tax treaties

Criteria Singapore Mauritius Cyprus Netherlands Luxembourg

Tax Credit Provisions in tax Treaty

Tax Sparing and Underlying tax credit available

Tax Sparing and Underlying tax credit

available

Tax Sparing credit available

Tax Sparing and Underlying tax credit available

Exemption method

Limitation of benefits Clause

Exists No limitationon benefits

Tax Residency Certificate is required and a judgment of the Supreme Court also is

in the form of an insulation

No limitationon benefits

Exists Exists

Nature of the Limitation of Benefits Clause

To qualify for benefits, total

annual expenditure on Singapore

operations should be at least

$200,000 in the immediately preceding 24

months from the date of gain

NA NA NA To qualify for benefits, it is to be

proved that the main purpose or one of the main

purposes of creation of the

enterprise is not to obtain benefits under the DTAA

which would otherwise not be

available


Draft Direct Tax Code


Finance bill 2010-11

• The Finance Minister while presenting the Finance Bill 2010-11, has commented about the reforms in the form of Direct Tax Code (DTC)

• The Finance Minister has indicated that the DTC is likely to be implemented with effect from 1st April 2011

• Certain important provisions proposed in the DTC relevant to international taxation have been discussed in the ensuing slides



Concept of “domestic tax law or treaty, whichever is more beneficial” done away with. After the introduction of the code, the domestic tax law or treaty, whichever is later in time, shall prevail.

Treaty benefits claimed hitherto, will not be available post introduction of the

DTC – E.g.

• Exemption from Capital Gains, Interest etc

• Benefit of restricted scope of definition of royalty and FTS

• Narrow scope for business presence - permanent establishment

• Lower rates for Royalty and FTS



Issues Existing provisions Direct Tax Code Remarks

1. Exit for investors:a. Beneficial treatment

available for Capital Gains under certain treaties like Mauritius, Cyprus, Singapore, Netherlands etc.

Assessee eligible to claim the benefit of the treaty if the same is more beneficial as compared to the domestic tax law

Provisions of the Code, or the treaty whichever is later in time shall prevail.

Investors were able to claim treaty benefits at the time of exit in respect of investments structured through treaty favoured jurisdictions. However, post introduction of the DTC, the such exits will be governed by the DTC, as the same would be later in time.

b. Business Income Business Income of non residents taxable in India only if the nonresident has a permanent establishment in India in terms of the treaty provisions

Definition of business connection under the proposed Code is wider than the definition of permanent establishment under the treaty. Provisions of the Code, or the treaty whichever is later in time shall prevail.

Taxation of non-residents, hitherto covered by treaty law will now be governed by DTC, as the same would be later in time.


Definition of “Resident” changed

Residence concept for companies changed:

Impact

• The proposal may impact the Indian MNCs who have subsidiaries abroad or Global organisations having corporate head quarters in India or MNCs having regional hub in India

• Global income of such companies likely to be brought within the tax net • Even a single director (participating in decision making) resident in India could

result in part management of the foreign company to be construed in India

Definition of resident as per DTC

• Indian company to be treated as resident in India• Foreign company and every other person to be treated as resident in

India, if the control and management of its affairs are situated wholly or partly in India at any time in the financial year

• Global income of a resident shall be taxable in India


Direct and indirect transfer of Indian assets

Proposed provision

Indian Assets• Any transfer of Indian assets, whether directly or indirectly, shall be taxable in

India

Impact• Global reorganisation leading to transfer of ownership of Indian assets even

indirectly is brought into the tax net

• Post 1 April 2011, irrespective of the jurisdiction of the holding company, any buyback would result in capital gains taxable in India

• Capital gains are taxable @ 30% in case of non-residents


General Anti-Avoidance Rule (GAAR)

Introduction of Anti-Avoidance Rules• GAAR introduced to curtail tax avoidance and to be invoked on satisfaction of

prescribed conditions• Commissioner of Income-tax (CIT) empowered to declare a transaction as

impermissible if the same has been entered into − with the objective of obtaining tax benefit; or− without any commercial substance; or − creates any rights or obligations not normally created in the arm’s length

transactions; or − results into direct or indirect misuse of the provisions of the Code

• GAAR empowers CIT to alter, nullify or re-characterise the transaction• GAAR to override the tax treaty• GAAR to be further supported by specific anti-abuse rules in circumstances such

as − payment to associated persons in respect of expenditure, − international transaction not at arm’s length, − transactions resulting in transfer of income to non-residents and avoidance of

tax in certain transactions in securities• Provisions aimed to prevent misuse of tax status of investor or financier


General Anti-Avoidance Rule (GAAR)

Commercial substance• Lacking commercial substance defined to

include situations where there is a − significant tax benefits without a significant effect

upon business risk or net cash flows− legal substance or effect differs from legal form− it involves or includes • round trip financing• an accommodating or tax indifferent party• any element that has the effect of offsetting or cancelling each

other

− a transaction which is conducted through one or more persons and disguises the nature, location, source, ownership or control of funds

• Onus on the tax payer to prove that the transaction is not an impermissible transaction


FDI policy and recent amendments


Foreign Direct Investment (FDI) regulatory framework

• Certain specific sectors have now been explicitly indentified e.g. − Headend-In-The-Sky (HITS) Broadcasting Service, business services, health

and medical services, securities agencies in private sector, etc.

• For the first time the term wholesale cash and carry trading has been explained. It is also now provided that − Wholesale trading among group companies would be permitted only up to 25%

of the total turnover of the wholesale venture and − The wholesale made to the group companies should be for their internal use

only.


Liberalisation of limits on royalty remittances

• FEMA regulations had certain restrictions as given below on remittance of royalty payments to non residents− If the technology transfer fee exceeds USD 2 million, it has to be approved by

the RBI− For royalty, the limit is 5% of domestic sales and 8% of exports − If there is no transfer of technology, royalty (for brand name) limit is 1% of

domestic sales and 2% of exports

• It is now proposed to allow all payments for royalty, know-how fee for transfer of technology, payments for use of trademark or brand name through the “automatic route” without any restrictions


Part 2: Opportunities for Investment funds


Opportunities for investment funds


How UCITS currently invest in India

Regulatory requirements

Corporate governance

requirements

Fully owned subsidiary

Fund

Mauritius subsidiary

Indian assets

Model of UCITS investing in Indian assets


• Tax efficient structure

• Access to the Indian market

• Luxembourg has build a specific knowledge in setting up such structure

• Quite unique in the UCITS universe

• No easy to implement

• Cumbersome from administrative and organisation point of view

• High set-up and running costs

• Can cause uncertainties in the cross-border distribution

Pros

+

Cons

-

… not an ideal situation


New opportunities exist to set-up UCITS investment vehicle in Luxembourg

- to gain exposure to the Indian Market from an Asset Management perspective

- for fund promoter to propose investment products investing in India

• Vehicle Remain tax efficient

• Direct investment will result in a less costly structure

• Easy to implement from an administration perspective

• Reduced uncertainties from a cross-border perspective.

• Custody knowledge in Luxembourg to deal with foreign markets

Many opportunities arising from a new potential tax regime

Potential advantages of the new Luxembourg regime


Part 2: Cash Tax Savings ideas and opportunities generated by the recent Double Tax Treaty

Opportunities for Indian inbound investments 1

Opportunities for Indian outbound investments 2

Overview aIdeas for financing structures

b

c Ideas for Intellectual Property structures


Opportunities for Indian inbound investments


A - Opportunities for Indian inbound investments Overview

ParentCo

LuxCo

NewLuxCo

Indian branch

IndianCo

Advantage:• A larger scope of activities is

permittedDisadvantage:• Dividend distribution subject

to 16,61% taxation

Advantage:• No WHT on remittance of

profits to Lux head-officeDisadvantage:• Limited scope of activities

permitted

Overview

• A group is operating and has investments in India

• The investment in India may be done though Luxembourg via Indian subsidiary or Indian branch office

• Funding of the Indian operations can be done with Foreign Direct Investment and/or External Commercial Borrowing


Investing in India – FDI ECB overview

Foreign Direct Investment (FDI) External commercial borrowing (ECB)

Applicable to:

• Equity• Convertible debentures• GDR (Global Depository Receipts)• American Depository receipts (ARD)

• Loans: - Corporate loans/borrowings- Partially/optionally/non convertible debentures- Partially/optionally/non convertible preference shares

Main characteristics

• Prohibited for following activities:- Gambling/betting- Lottery business- Atomic energy- Etc (see slides)

• Limits as regards the eligible lenders and borrowers• Limits as regards the amounts at stake and maturity• Limits as regards the permitted end-use of the loans • See slides for more information

• Most of the areas of activity are placed under automatic route:- 100% FDI for sectors such as investment in power, construction,

development projects, non banking finance companies, manufacturing, venture capital funds

- Where 100% FDI is not allowed, the Government permits FDI up to a certain percentage (sectoral cap)

- 100% FDI is permitted from Special Economic Zone and Export Oriented unit

- 100% is permitted for setting up of Industrial Parks/Industrial Model Towns

Advantages • Less restrictions contained in the FDI guidelines• Scope of permitted activities is larger under FDI

• The WHT on interest is reduced to 10% du to the DTT between Lux and India

• The interest is fully deductible

Disadvantages • As treated as equity repatriation of dividends is subject to 17% of WHT in India

• More restrictions as regards the activities /amounts/rates for the financing under ECB

CONVERTIBLE DEBENTURES combine the advantages of both FDI and ECB• Treated as equity for FDI purposes• Debt for tax purposes in India deductibility of the interest payment + reduced WHT


Benefits

From Indian perspective:

• The interest paid on the loan is fully deductible at India Co level

• WHT tax of 10% on interest paid is due to the Lux-India Double Tax Treaty (instead of 20% plus surcharge and fees)

• ECB guidelines to be complied with

From Luxembourg perspective:

• The interest income received by the Finance branch will be fully exempt in Luxembourg as the finance branch qualifies as a permanent establishment under DTT provisions (can be Switzerland /US/ Ireland/ Hong Kong)

ParentCo

Mauritius / Singapore/ Cyprus

Co

LuxCo

Finance branch

IndianCo

Loan

Interest

B - Opportunities for Indian inbound investments Ideas for financing structures


Benefits

From India perspective:

• The royalties paid on IP licenses are fully deductible at the level of the Indian Branch/IndianCo

• WHT tax of 10% on royalties paid due to the Lux-India Double Tax Treaty (instead of 20% plus surcharge and fees)

From Luxembourg perspective:

• The IP licensing activity can benefit from the IP box regime available in Luxembourg (exemption of 80%)

• Other alternative IP tax plannings may be implemented at the level of IPCo

C - Opportunities for Indian inbound investments Ideas for IP structures

ParentCo

Mauritius / Singapore/ Cyprus

Co

LuxCo IndianCo

Royalties


Purpose• Offset the Luxembourg Corporate Income Tax using the Indian

withholding tax paid

Benefits• Royalties deduction in India Reduction of IndianCo’s taxable

basis• Low global royalties taxation

Luxembourg Foreign Tax Credit System• Royalties received in Luxembourg from India: 90• Luxembourg operating expenses: 10• Net royalties income: 90 – 10 = 80• Application of the IP Box regime 80% royalties exemption• Taxable Indian royalties in Luxembourg: 16• Tax due in Luxembourg (prior to the use of tax credits):

− Corporate Income Tax (21,84%): 3,49− Municipal Business Tax (6,75% in Lux city): 1,08

Luxembourg IPCo

IndianCo

IP

Royalties(90)

10% Indian WHTon roaylties

NewLuxCo

Indian branch

Royalties(90)



Luxembourg Foreign Tax Credit System (ct’d)• Withholding tax paid in India: 10 Indian WHT is creditable against Luxembourg CIT using the following formula:

− Gross profit arising from India: 100− Net profit arising from India: 100 – 10 = 90− Maximum theoretical amount of WHT creditable against

Lux CIT: (90 * 0,2184) / (1 – 0,2184) = 25,19 All of Indian WHT (10) is creditable against Luxembourg CIT

Final Tax Liability• In Luxembourg (after use of tax credit)

− Corporate Income Tax: 3,49 – 10 = 0 Indian WHT can only be used up to the Lux CIT tax liability

− Municipal Business Tax (6,75% in Lux city): 1,08Indian WHT cannot be credited against Lux MBT

• In India− 10 % Withholding Tax: 10

Global ETR: (1,08 + 10) / 100 = 11,08%(Mainly composed of Indian WHT, not subject to reduction)

Luxembourg IPCo

IndianCo

IP

Royalties(90)

10% Indian WHTon roaylties

NewLuxCo

Indian branch

Royalties(90)





Benefits

• Deductions in source countries • Income pick up reduced in Luxembourg based on

exemptions and plannings• Repatriation is also possible in the following ways:

− Royalty payments− Fees for technical services− Interest payments (lending by IndianCo to

LuxHoldCo)

Considerations

• Repatriation of profits and/or reengineering• India Luxembourg tax treaty has a “Limitation of

Benefits” clause which need to be complied

LuxHoldCo

Indian Co

Subs

Low ETR in Luxembourg:

• Dividend, capital gains, liquidation proceeds exempt if conditions met

• Planning for financing, IP, entrepreneur activities

No or reduced WHT based on EU Directives

or DTTs



Appendices

Documents

Leveraging Tax Opportunities with India: W hat you need to know !