Asia Tax Forum · 2012-05-15 · Asia Tax Forum May 9-10, 2012 –Raffles, Singapore Budget...

Asia Tax ForumMay 9-10, 2012 – Raffles, SingaporeMay 9-10, 2012 – Raffles, Singapore

INDIA – Lessons from a reforming tax

system10 May 2012


Regional developments:

Anti-treaty shopping

China: Circulars issued to limit access to treaty benefitsTax cases on indirect share transfers

Australia: Final determination on application of Australian GAAR to perceived treaty shopping structures and draft determination on availability of treaty relief for certain LLP partnersIndonesia:

Disclosure requirements to obtain treaty benefits. Regulations and law changes to limit treaty benefits

India: Introduction of GAAR measures High profile court cases on indirect disposals and 50 year retroactive “clarification” proposal

Singapore: Increasing difficulty obtaining a COR for investment holding companies

South Korea: Anti-treaty shopping measures and blacklist tax legislation

Japan: Revising tax treaties to include anti-abuse provisions


Key provisions introduced in Budget 2012


Budget – Snapshot of tax proposals

► Union Budget 2012-13 containing tax proposals and policy pronouncements of the Government of India was presented by the Finance Minister on 16 March 2012

Union Budget 2012-13

► FB 2012 will be discussed in the Parliament before it is enacted and is subject to any amendments that may be made pursuant to these discussions

Enactment of Finance Bill 2012 (FB 2012)

► Most direct tax proposals in FB 2012 are effective from the financial year commencing on 1 April 2012, unless otherwise specified

► Most indirect tax proposals are effective immediately

Effective date of amendments


Budget – Snapshot of tax proposals

► APA introduced

► TP on domestic transactions

► Requirement of TRC for treaty benefits

► Government to assign meanings to terms not defined in treaty / Act

u Specific Anti Avoidance Rules

► Increase in withholding tax compliances

► GAAR introduced

u Retrospective amendment:

u Royalty taxation

u Taxation of Indirect transfer


GAAR


GAARAnti abuse provisions

Main purpose* or one of the main

purpose is to obtain

tax benefit

Creates rights and obligations which are not ordinarily created between persons dealing at ALP

Results, directly or indirectly, in the misuse or abuse of the provisions of Act

Lacks commercial substance or is deemed to lack commercial substance in whole or in part

Entered into or carried out by means or in a manner which are not ordinarily employed for bona fide purposes

+OR

OR

OR

Primary condition Tainted element presence

► GAAR to permit declaration of an “impermissible avoidance arrangement”

► Applicable from FY 2012-13 onwards

► An arrangement is an “impermissible avoidance arrangement (IAA)” if:

* Budget provisions does not define the meaning of the term ‘main purpose’


Arrangement lacks commercial substance

An arrangement shall be deemed to lack commercial substance if:

Substance/ effect of arrangement as a whole is inconsistent with or differs significantly from its individual steps or

parts

It involves or includes:

- Round trip financing

- Accommodating party

- Offsetting or self cancelling elements

- Transaction which disguises value, location, source, ownership or control of funds which are subject matter of

transaction

It involves location of an asset /transaction /place of residence of any party which would not have been so located

for any substantial commercial purpose other than obtaining a tax benefit

OR

OR

Onus on taxpayer prove that the main purpose or one of the purpose is not to obtain tax benefit


Tax consequence if GAAR invoked

► GAAR would not apply to transactions concluded prior to 31 March 2012 nor to income accruing prior to A.Y. 2013-14

► However, GAAR most likely to have retroactive application in respect of continuing effect of past transactions and in respect of income pertaining to the period after 1 April 2012

► Applies to residents as well as non-residents including also to court approved schemes

► Consequences including denial of tax benefit or a benefit under tax treaty shall be determined in a manner which is deemed appropriate to the circumstances of case

► Illustrative list of consequences if arrangement is held to be IAA provided for

► To give effect to the tax consequences, the following can be done:

► Treat equity as debt or vice versa

► Treat accrual or receipt of capital nature as revenue and vice versa

► Re-characterize expense/ deduction/ relief, rebate, etc


Case StudyApplicability of GAAR

► Operating Co. has huge past losses; has just started generating profits

► Investor acquires shares of SPV from Holding Co.

► Parties to the share purchase agreement are Investor, Holding Co. and SPV

Questions to be answered?

► Whether there is any tax benefit?

► Whether one of the main purpose is tax benefit?

► Whether it satisfies one of the four tainted element test?

Possible arguments

► Tax benefit is only a subordinate to the acquisition of shares in SPV and its operation at profit

► Commercial considerations need to be considered

Holding Co.

Non resident SPV

Operating Co.

Operating Co. has significant losses due to claim under section 35AD

Investor

Transfer > 51% shares of SPV

As per domestic tax law, if more than 50% of shareholding of a

company is changed, then brought forward

losses is not allowed to be carry forward

(Section 79)


Case Study (cont’d.)Consequence of GAAR

Assuming GAAR provisions are initiated

► Disregard the transaction between Holding Co. and Investor for sale of shares of SPV

► Proposed objective behind transaction is to acquire participation in Operating Co. and to allow carry forward of tax losses of Operating Co.

► Disregard Non-resident SPV as Accommodating Party

Holding Co.

Non resident SPV

Operating Co.

Operating Co. has significant losses due to claim under section 35AD

Investor

Transfer > 51% shares of SPV


GAAR – Global Scenario

► GAAR introduction under debate in UK – though, in past dropped after debate

► However, detailed reporting requirements

► ‘Purpose test’ at the root of the application

► Canada : ‘Primary purpose’

► Singapore : ‘Primary or dominant purpose’

► South Africa : ‘Sole purpose’

► Australia lists ‘8 factor test’ for objective determination of sole and dominant purpose

► Should burden of proof be on the Revenue ► In South Africa, new provisions have reversed the burden of proof from tax authority to

taxpayer


Indirect transferof capital asset


► Transfer of shares of a foreign company outside India in a layer structure will result in capital gains tax levy in the hands of the transferor if:

► by means of;

► in consequence of; or

► by reason of

such transfer thereof, there results transfer of any asset in India, including transfer of control or management rights of an Indian company

► Capital gains tax on such transfer shall be deemed to be taxable in India if the share or interest derives, directly or indirectly, its value substantially from the assets located in India

► Treaty protection can be availed subject to GAAR, and treaty conditions

► Amendment applicable retrospectively w.e.f 1 April 1961

Indirect transfer of capital asset



Clarificatory amendments proposed with retrospective

effect

Source rule: Expression ‘through’ to include ‘by means of’or ‘in consequence of’ or ‘by reason of’ transfer of capital asset in India

Any share or interest in a company or entity outside India deemed to be situated in India if shares or interest derives its value directly or indirectly substantially from assets located in India

‘Property’ to include rights of management or control or any other rights whatsoever

Wide meaning of ‘transfer’

Series of Proposed Amendments



Areas of doubt

The expression “substantial” – cause of concern

► No specific threshold (50% in the DTC)

Issues once asset deemed to be an Indian asset:

► Proportionality taxation vis-à-vis Indian element?

► Threshold for small investor?

► Exemption for listed securities?

Law silent on date on which substantial value criterion is

to be determined to deem an asset to be located in India


Indirect transfer of assetsImpact Assessment

► Does this overturn Supreme Court’s decision in the case of Vodafone?

► Impact on Vodafone

► Impact on other transactions under litigation

► Could the proposals be challenged on ground of constitutional validity?

► Extra territorial operation of law

► Adverse impact on rights and obligations based on prior understanding of law


► Does this overturn Supreme Court’s decision in the case of Vodafone?

► Impact on Vodafone

► Impact on other transactions under litigation

► Could the proposals be challenged on ground of constitutional validity?

► Extra territorial operation of law

► Adverse impact on rights and obligations based on prior understanding of law



Case StudyIndirect transfer of assets

► Foreign Co1 is merged with Foreign Co 2

► Foreign Co1 is tax exempt under the Act as

► 25% of shareholders of Foreign Co1 become shareholders of Foreign Co2

► Transaction is tax protected in Foreign Co1 jurisdiction

► Capital gains tax in the hands of Holding Co due to indirect transfer unless protected by tax treaty

► Current provisions protects Foreign Co1 and not the shareholder

Foreign Co 1

Indian Co.

India

Holding Co.

Outside India

Foreign Co 2

Merger

Issuance of shares by Foreign Co. 2

Proposed


Proposals of Standing CommitteeGAAR & Indirect transfer recommendations

Onus should lie on the Tax Authority invoking GAAROnus to prove

Permit taxpayers to obtain an advance ruling to determine whether the transaction would fall within GAAR

Advance ruling

Provide thresholds to avoid frivolous casesThresholds

Prospective application of GAAR so that it does not apply to existing structures/arrangementsGrandfathering

Remove uncertainty with regard to applicability of treaty provisions so that India’s credibility as a reliable treaty partner is not affected

Tax treaties

► Exemption for transfer of small share-holdings and transfer of listed shares outside India

► Date for computing FMV of assets should be made more specific ► An exception may also be provided to intra-group restructuring outside India

Indirect transfer of

shares of Indian Co.


Revised proposals of FMGAAR “deferred” by one year

Onus shifted on the Tax AuthorityGAAR - Onus to prove

Permitted both for resident & non-resident taxpayersGAAR - Advance ruling

Independent member in GAAR approving panel – officer from Ministry of Law of Joint Secretary & above level

GAAR - Independence

Report to be submitted by May 31, 2012 under the Chairmanship of DGIT (International Tax)GAAR – detailed guidelines

► Clarificatory amendments DO NOT override the provisions of the DTAA’s which India has with 82 countries. It would impact those cases where the transaction has been routed through low tax or no tax countries with whom India does not have a DTAA –still a cause of concern???

Indirect transfer of

shares of Indian Co.

• The retrospective clarificatory amendments now under consideration of parliament will NOT BE used to reopen any past cases where assessment orders have already been finalized. CBDT to issue a policy circular to clearly state this position post passage of the Finance Bill – needs to be evaluated carefully post the policy circular


Revised proposals of FMLong term capital gains on sale of unlisted securities at par with FII’s – 10%

Private Equity & other Investors

Tax exemption on long term capital gains on the sale of unlisted securities in an IPO. STT at the rate of 0.2 per cent on such sale

Capital markets impetus

Subsidiarisation of bank branches to be tax neutralBank branches

The lower rate of withholding tax, of 5%, on external commercial borrowings for the infrastructure sector, has been extended to all businesses, and not only to companies engaged in specified business. This lower rate of tax would also be available for funds raised through long term infrastructure bonds in addition to borrowing under a loan agreement.

Off-shore borrowings

Certain comments of the FM seem to indicate a pragmatic approach of the Government towards addressing the concerns raised on the Budget 2012


Other Provisions


Royalty definition scope widened

Controversy before Budget

► Taxability of software (off the shelf software; shrink wrap software)

► Taxability of services rendered by satellite providers in relation to transmission by satellite

► Taxability of above issues were debatable; various court precedents on these issues; budget proposes to put them to rest.

Amendments proposed

► Right of use or right to use a computer software (including grant of license) irrespective of the medium through which such right is transferred

► Royalty includes consideration for right, property or information, whether or not

► Possession or control of it is with payer;

► It is used directly by the payer

► The location is in India

► Transmission by satellite (including up-linking, amplification, conversion for down-linking of any signal), cable, optic fibre or by any other similar technology

► Process need not be secret process


Tax Residency Certificate (TRC)

► Treaty benefit to be made available to a Non-resident only if a TRC is furnished by the Non-resident from Government of other country including therein particulars as may be prescribed

Unanswered questions

► Acceptability by authorities of other jurisdictions

► Will it be Annual Compliance, regardless of nature and quantum of relief?

► May apply also for continuing transaction where S. 195(2)/ S. 197 certificate may be in place.

► May impact remittance process which is presently supported by CA certificate.

No provision in the current Indian law to issue TRC to Indian companies


Other key provisionsIncreased withholding tax compliances

► Withholding tax obligation to apply to all persons and all cases where income is taxable in India, irrespective of payer having:

► Residence or place of business connection in India;

► Any other presence in any matter whatsoever in India

► Non Resident to deduct tax before making payment to another Non Resident if income of Non Resident is chargeable to tax

Increased compliance burden on Non Resident (‘NR’) payer, where NR is obligated to know and comply with Indian tax laws


New Legislations in India

► Dual-GST – Centre and States to simultaneously levy GST on common base

► Inter-state transactions subject to Inter-state GST (‘IGST’)

► GST credit mechanism

► Central GST (‘CGST’) credit available across CGST/IGST; State GST (‘SGST’) on similar lines

► IGST credit available against both CGST and SGST

► Minimum incentives/exemptions

► Exports to be zero-rated, need to agree on treatment of supplies to/ from SEZs

► Imports subject to Basic Customs Duty, CGST and SGST

► No firm date yet for introduction of the GST

Taxes Subsumed

At the Central level:

Customs, Central Excise

Service Tax

Central Sales Tax (to be removed)

At the State level:

State-VAT (sales tax)

Entry Taxes

Other state levies such as Luxury tax, Entertainment tax, etc

Goods and Service Tax (‘GST’)


New Legislations in IndiaGST and Budget 2012

► No announcement about GST implementation date

► Recommendations awaited from the Parliamentary Standing Committee on the Constitution Amendment Bill

► GST IT Enabled Network (‘GSTN’) proposed to be operational from August 2012

► GSTN will implement common PAN-based registrations, returns, payments processing for all States on a shared platform

Goods and Service Tax (‘GST’) and Budget 2012


Hutchison – Vodafone Transaction

Vodafone PLC

Mauritius

CGP

VEL

CaymanIslands

India

Vodafone NL

UK

HTIL sells shares in CGP to Vodafone NL for USD

11.2 billion

HTIL

Mauritian entity

Netherlands

Hong Kong shareholders


Vodafone: Sequence of Events

September 2007

December 2008

January 2009

May 2010

September 2010

January 2012

u Notice issued to Vodafone NL (buyer entity) for failure to withhold tax as an Assessee in Default

u Vodafone NL challenged the notice and file writ petitions before the Bombay High Court (BHC)

u BHC dismisses writ petition by Vodafone NL and grants 8 weeks to enable appeal before Supreme Court

u Special leave petition filed by Vodafone NL before the Supreme Court also dismissed with a direction to Tax Authority to decide on jurisdiction

u Order passed by Tax Authority asserting jurisdiction to tax the transaction in the hands of Vodafone NL

u BHC dismisses second writ petition by detailed order and jurisdiction of Tax Authority to tax the transaction upheld

u Supreme Court ruled in favor of Vodafone and quashed the demand of Rs. 12000 crores.


Vodafone – Supreme Court RulingKey Take Away► No ‘look through’ provisions under the Income tax law

► “Look at” approach applied first

► Indirect transfer of underlying Indian assets not taxable in India

► Reiterates the judicial position on tax avoidance

► Legitimate tax planning within framework of law permissible; but tax authority can disregard colorable devices/ sham transactions

► Reinforces the view on Mauritius tax treaty

► Circular 789/ TRC cannot be disregarded in the absence of LOB provisions; sham/colorable device an exception

► Acknowledges the use of holding companies/ offshore financial centers in corporate structures

► May provide greater certainty to taxpayers on M&A transactions/ use of Mauritius tax treaty

► Recognizes the importance of stability and certainty in fiscal/ tax policy from a taxpayer/ foreign investor perspective


Vodafone Judgment and Budget 2012

► Provisions taxing indirect transfer – Inserted in Budget 2012

► Insertion of validation clause a challenge for Vodafone; validates all notices, taxes, demands levied by Indian tax authorities overriding any judicial precedents

► Clear intent to overrule some of the guidelines (6 factors test) as laid down in Vodafone case which help in determining whether a transaction is preordained

► However, following factors could still support commercial substance in an arrangement:

► Participation in investment

► Period of business operations in India

► Continuity of business after exit, etc


Cross Border Secondment ArrangementsVerizon Data Services India Private Ltd (AAR) – factual matrix

Verizon US G Co

Verizon India (Applicant)

WOS

1 – MD of the Applicant

2&3 – Liaison with parent & supervise and provide directions for carrying on activities

Business of providing ITES exclusively to the Parent

Affiliate

Parent felt need for secondment to increase efficiency/productivity

US

India


Cross Border Secondment ArrangementsVerizon Data Services India Private Ltd (AAR)* – key findingsIssues under consideration

► Tax withholding on amounts (representing salary payments and other benefits paid to seconded employees) by Verizon India to G Co

AAR observation and ruling

Employer – Employee relationship

► Seconded employees held to be employees of G Co on account of following:

► Agreement provides employees shall remain employees of G Co

► Salary paid to seconded employees by G Co

► Right of termination with G Co

Fee for included services (FIS)

► Managerial services performed by seconded personnel were employees of G Co

► ‘Make available’ criteria’ to be satisfied only in case of technical services and does not apply to managerial or consultancy service; payments made by Verizon India to G Co held to be FIS under India – US Tax Treaty and FTS under the Act and taxes to be withheld at 20% (on gross basis)

Madras High Court has in a Writ petition set aside the finding of the AAR; remanded the relevant question for re-consideration of AAR


Buyback and capital gains exemptionA- AAR ► Co A India, a public limited company proposes to buy

back the shares held by its shareholders – Co A USA, Co A Mauritius, Co A Singapore and General Public

► Resolution for buyback passed on 15 June 2010

► Co A Mauritius accepts the offer

Issue before the AAR:

► Would the buyback be exempt in the hands of Co A Mauritius (Applicant) under the India Mauritius tax treaty?

Additional facts

► Regular dividends declared till 1 April 2003; No dividend declared after 1 April 2003

► Reserves allowed to grow post 1 April 2003

► Earlier buyback scheme effected in year 2008

► Co A USA and Co A Singapore did not accept the offer made via present buyback scheme

Co A USA

Co A(Public Ltd.)

Outside India

India

General Public

Buyback of shares

Co A Mauritius Co A Singapore

48.87%25.06% 27.37%

1.76%


Buyback and capital gains exemptionA- AAR

Co A USA

Co A(Public Ltd.)

Outside India

India

General Public

Buyback of shares


48.87%25.06% 27.37%

1.76%

AAR Ruling

► AAR took cognizance of the following facts:

► Regular dividend declared before 1 April 2003 i.e. before DDT regime

► No dividend declared after 1 April 2003 to avoid DDT

► Reserves allowed to grow from 1 April 2003

► Buyback scheme offered in 2008

► Buyback scheme proposed to be offered now

► Only Co A Mauritius proposing to exercise the option of buyback and not Co A USA and Co A Singapore

► Capital gains exemption available under India-Mauritius tax treaty and not under India-US tax treaty and subject to certain conditions in India-Singapore tax treaty

► Based on the facts it was held that the entire scheme of buyback is a colorable transaction for avoidance of tax


Buyback and capital gains exemptionA- AAR

Co A USA

Co A(Public Ltd.)

Outside India

India

General Public

Buyback of shares


48.87%25.06%

27.37%

1.76%

AAR Ruling (cont’d..)

► Capital Gains exemption claimed by applicant under India Mauritius tax treaty not allowed

► Distribution on buyback re-characterized as dividend and taxable under Article 10 - Dividend of India Mauritius tax treaty

Issue – Lifting of corporate veil – is it justifiable?

Distribution under buyback scheme re-characterized as dividend to be taxed at 5%; seems revenue would also go into appeal?


Buyback and capital gains exemptionZ- AAR

S Ltd

Outside India

India

Co Z Mauritius

V Ltd

Project

Investment in equity shares and CCDs

Subsidiary

► Co Z Mauritius invested in equity share capital and subscribed to CCDs of S Ltd which is engaged in the development of land projects

► S Ltd is a subsidiary of V Ltd which is also into development of land projects in India

► CCDs to be converted into equity shares as per the agreed price after a fixed period of time

► Prior to such conversion of CCDs into equity shares, Co Z was given the put option to sell specific shares and CCDs to V Ltd

► V Ltd exercised the option and purchased the equity shares and CCDs for the agreed purchase price which was dependent on the period of holding and the return on CCDs compounded quarterly

Issue before the AAR:

► Whether such sale of shares and CCDs is exempt in the hands of Co Z Mauritius (Applicant) under the India Mauritius tax treaty?



S Ltd

Outside India

India

Co Z Mauritius

V Ltd

Project


Subsidiary

AAR Ruling

► CCDs creates or recognises existence of debt, which remains, until it is repaid or discharged

► Legal character of CCDs to remain as debt irrespective of the option to redeem or convert into shares

► Purchase price of CCDs is entirely dependent on period of holding the investment and return on CCDs

► Such calculation was akin to calculation of interest on debt

► Definition of interest under the Act and the India Mauritius tax treaty are substantially similar to include any type or form of income from bonds or debentures

► Hence gain on sale of CCDs is in the nature of interest

► Relationship between S Ltd and V Ltd as parent-subsidiary is on paper and they are one and the same entity

► Hence amount paid by V Ltd to Co Z on purchase of CCDs is towards debt taken by S Ltd from Co Z



S Ltd

Outside IndiaIndia

Co Z Mauritius

V Ltd

Project


Subsidiary

AAR Ruling (cont’d..)

► Purchase price has two components, equity shares and CCDs; taxability will be as follows:

► Income on sale of equity shares- would fall under capital gains and thus exempt under India Mauritius tax treaty

► Income on CCDs - CCDs are debt instruments would carry ‘Interest’ and any income on such CCDs is in the nature of interest and taxable under the India Mauritius tax treaty

Issue – Lifting of corporate veil – is it justifiable?

Taxpayers with similar arrangement need to access the impact of the current approach of the tax authorities and AAR along with the proposed GAAR in Budget 2012


Questions

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Asia Tax Forum · 2012-05-15 · Asia Tax Forum May 9-10, 2012 –Raffles, Singapore Budget...

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