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INSTITUTE OF COMPANIES SECRETARIES OF INDIA
TAXATION ASPECTS OF DIRECT TAX DUE DILIGENCE
September 26, 2009
Rajiv AnandExecutive Director PricewaterhouseCoopers
Slide 2 PricewaterhouseCoopers
September 26, 2009
Why Tax Due Diligence
Methodology of Doing a Tax Due Diligence
Impact of Tax Due Diligence on Deal
CONTENTS
Slide 3 PricewaterhouseCoopers
September 26, 2009
To avoid any uncertain tax claims from the tax authorities in future
Review whether enterprise value needs adjustment from tax perspective
Review whether there is any un-provided tax liability in the financials
Review of brought forward losses / unabsorbed allowances
Review of tax holiday claims
WHY TAX DUE DILIGENCE ?
Slide 4 PricewaterhouseCoopers
September 26, 2009
Corporate Income Tax review
Withholding Tax review (TDS)
METHODOLOGY OF TAX DUE DILIGENCE
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September 26, 2009
Understanding the nature of business
Conduct detailed review of financials for the review period
Conduct detailed review of tax documents like the income tax returns, assessment / appeal orders, pending litigations / appeals, demands, etc.
CORPORATE INCOME TAX REVIEW – HOW UNDERTAKEN
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September 26, 2009
CORPORATE TAX REVIEW INTER-ALIA FOCUSES ON….
ISSUES REMARKS
Carry forward of losses
Analyze continuity of brought forward losses –
- To analyze implications under Section 79 of the Act
- To analyze the conditions pertaining to transfer of Unit if the Unit is enjoying tax holiday
Transaction between Group Companies
Deemed Dividend Implications
– Inter group-company transactions need to be reviewed
– Loans / advances given to group companies could qualify as deemed dividend under certain circumstances
Benefit Test
– To analyze whether or not the Target obtained any benefit in respect of payments made to group companies
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ISSUES REMARKS
Tax Holiday Claims If a new unit has commenced manufacturing during the due diligence review period and which is otherwise eligible for tax holiday, the following to be analyzed –
– Whether the unit has been formed as a result of splitting up / reconstruction of an already existing business
– Other conditions are fulfilled
Capital / Revenue expenditure
– To analyze whether any item of capital nature has been claimed as revenue
CORPORATE TAX REVIEW INTER-ALIA FOCUSES ON…. ..Contd.
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ISSUES REMARKS
Deductions / Exemptions
– Analyze the conditions required for claiming deductions and exemptions
– Applicability of Section 14A of the Income-tax Act
– Inter-se setting off of profits and losses between eligible and non-eligible units
Provisions – To review the movement of various provisions in the books of account to examine whether they are contingent in nature
Litigations – To review the stand taken by the company in ongoing litigations
CORPORATE TAX REVIEW INTER-ALIA FOCUSES ON…. ..Contd.
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September 26, 2009
Understanding nature of expenses / payments
Review of standard agreements pertaining to expenditures which get covered under various tax withholding provisions like sections 195, 192, 194H, 194I, 194J
Reconciliation of taxes withheld as per Profit & Loss Account and as per TDS returns
WITHHOLDING TAX (TDS) – HOW UNDERTAKEN
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September 26, 2009
Applies when following conditions are fulfilled:
• Payment is in nature of income in the hands of non-resident;
• Such income is taxable in India; and
• At the time of credit or payment
Payment must be in the nature of “Income”
• Ericsson Communications Ltd. (Delhi ITAT)
Payment must be “Taxable in India”
• Option to choose between DTA and ITA, 1961
• Case Study
WITHHOLDING TAX (TDS) – SECTION 195
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September 26, 2009
Assessee deemed to be in default - Penal Provisions:
- 201(1) – Recovery of tax from defaulting payer
- 201(1A) – Interest levy is mandatory
– Reasonable cause not relevant
- 271C – Penalty for failure to deduct, unless reasonable cause proved
WITHHOLDING TAX (TDS) – SECTION 195 …Contd.
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• ISP contracts with SAT for availing connectivity/ access to the Internet cloud
• ISP has its own gateway in India for availing connectivity/access
• Satellite/ other network facilities of SAT operated by SAT
• ISP has no possession/ control over the satellite/ other SAT facilities
• Transaction merely affords connectivity
ISP in India SAT Overseas
Satellite Connectivity Payments
CASE STUDY – TDS UNDER SECTION 195
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September 26, 2009
Internet Cloud
Satellite receives and forwards the signals through transponders
SATELLITE
SAT Earth Station/Facilities (located outside India)
ISP Gateway
Subscriber
Payments
INDIA
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September 26, 2009
Connectivity Payments
WHETHERROYALTY?
WHETHER TECHNICAL SERVICE FEE?
Issue CASE STUDY – TDS UNDER SECTION 195
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September 26, 2009
Definition of Royalty
• Payments for ‘Right to use’
- equipment
- secret formula or process
What is ‘Right to use’
• Royalty in respect of licenses ‘to use’ ….are income to the recipient from letting [OECD Commentary]
• Phrase interpreted to mean a “leasing transaction” [Memorandum explaining Finance Act 2001]
• Letting/leasing would envisage separation of ownership of an asset and its possession
CASE STUDY – TDS UNDER SECTION 195
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…..what is ‘Right to use’
• Klaus Vogel:
- Clean distinction between letting the asset to the payer and the use of it by the payee himself
- Payee using the asset himself to provide services to payer while not letting the same to him does not qualify as ‘right to use’
Right to use Equipment - Criteria for determination
• Customer has physical possession/ control over the equipment
• Has significant economic or possessory interest in the equipment
• Provider does not bear any risk of substantially diminished receipts or substantially increased expenditures
• Provider does not use the property concurrently to provide services to others [OECD Report]
CASE STUDY – TDS UNDER SECTION 195
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Whether Right to use secret formula/process – Criteria
• Imparting information about ideas and principles underlying the program viz. logic, algorithms or programming language or techniques may be characterized as right to ‘use secret formula’ [OECD Commentary]
None of the conditions fulfilled in present case – No leasing of any
asset whether tangible or otherwise
CASE STUDY – TDS UNDER SECTION 195
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September 26, 2009
What is a “technical service”
• One party undertakes to use customary skills of his calling to execute work himself for another person
• When special skills or knowledge related to a technical field are required for provision of a service
• Point of time when the special skill or knowledge is used – a relevant criteria
• Technology/medium used in providing a service - not a relevant criteria
• Provision of online advice through communication with technicians – a technical service
• Mere provision of access to a trouble-shooting database - not a technical service
SAT not providing any technical service to ISP
CASE STUDY – TDS UNDER SECTION 195
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September 26, 2009
• Since SAT not having taxable presence in India, no TDS required under law
• Issues to be managed
- Many judgments take contrary view
- Recent Karnataka High Court decision
CASE STUDY – TDS UNDER SECTION 195
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Estimating the tax, interest and penalty exposure that the Target may have on account of defaults and/or aggressive and/or unacceptable stands taken by it
Depending on the risk profile of the issues unearthed in the review exercise, appropriate representations and warranties to be secured from Vendor. In cases where high risk exposure is involved, appropriate adjustments in enterprise valuation to be considered
IMPACT OF DUE DILIGENCE ON THE DEAL
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Thank You
Rajiv Anand Executive Director / Partner Tel : +91 11 4115 0201
Mobile : +91-9810223812
Email : rajiv.anand@in.pwc.com