M&A and RestructuringsMLI – inbound and outboundChanging landscape

November 10, 2019

Ifs and buts of the Indian Economy…….

Mood in the market……..

Governments’ denial and acceptance – From ‘all is well’ to weekly stimulus

Tackling the new normal – Millennials; new age disruptive business models; paradigm shift in priorities and habits (traditional facing turbulence but Amazon/Flipkart sales are a success)

Coping up with fast changing regulations in a changing business environment – IBC/ stressed assets; Budget/amendment/ordinance; Regulators view (Jet Airways, Bank lending etc)

Geopolitical (e.g., US-China; Brexit; Huawei’s fiasco; thrust on substantive presence, Digital economy etc.) leading to change in the way business is done – e.g., Apple de-risking from China and opening up a facility in India

Uncertainty creates threats and opportunities which requires businesses to structure/restructure, divest/acquire and diversify……….. 2

Deal Trends

A mixed Bag Asset light- Asset heavy, OYO externalisation, shift of residencies, overseas listings

M&As – GSK- HUL, Vodafone Idea- PSU bank mergers, Bharat financial –IndusInd Bank

ESSEL Propack, NIIT

Deleveraging – Café Coffee day, Indiabulls, Deewan Housing, Yes Bank, IBC cases- Ruchi Soya, Jet, Essar, Bhushan

Family splits, internal reorganisation

3

Reduction in tax rate – Impact assessment beyond timing to opt for the new rate

Reversal of MAT Credit/ Deferred Tax reversal – Order of adjustment of losses for determining remainder losses? Impact on Earnings?

Interplay with GAAR if expansion undertaken through WOS?

Splitting-up/ Reconstruction

(Land already acquired, Environmental Clearance obtained, Board announcement to SEs)

4

Tax Arbitrage – LTCG/ STCG

Particulars Direct LLP CompanyCompany

(if under MAT)

Short Term –Listed (111A) 17.94% 17.47% 41.08% 41.30%

Short Term -Other than listed 42.74% 34.94% 46.77% 53.73%

Long Term –Listed (112A) 11.96% 11.65% 37.01% 37.15%

Long Term -Other than listed 28.50% 23.30% 45.14% 45.44%

Bonus stripping. Dividend stripping – fizzle out

Company v/s LLP- What to do?

5

Transition and GAAR

Chaos on Demerger cost splits, sale of shares by promoters in IPO

• Timing

• Tax Rate

• Tax withholding

• Limitations under FDI

Earnouts / Deferred

Consideration

• Period

• Taxability – Business Income vs Capital Gains vs Other Income

• Withholding obligation

• GST implications

Non-Compete• Typical tax indemnities

under Section 281, 170 of the IT Act

• Quantification, capping and period of coverage of Tax liabilities

Indemnities

Deal Dossier….. key matters

Withholding Tax on Sale consideration payable to non-resident – Section 195 Vs 197 Vs Indemnities 6

Amendments impacting IBC process

Opting for Non applicability of

MAT Relief on reversal/ write-back of liability;

Normal provisions –

M&M?

CIRP to be completed

within 330 days including

extended legal proceedings

providing certainty

Comprehensive corporate

restructuring allowed through

merger, amalgamation and demerger

under a resolution plan

Clarification that resolution plan is binding on all

Govt. authorities

7

COC empowered to determine the manner of distribution as per the liquidation waterfall in Section 53 of the Code

Internal reorganization and GAAR on the ground...

Transfer of business – BV

Vs Tax Net worth Vs FV?

Do Gifts work anymore?

Holding Subsidiary

mergers – Has Ajanta Pharma settled down?

8

Contd…..Internal reorganization and GAAR on the ground...

Accelerating utilization of carry

forward losses through

Merger/Demerger?

Non-classical Demerger –

OCRPS/RPS etc

GAAR in Family Settlement?

9

Navigating through a web in transfer of shares……..

FEMA and Companies Act

Pricing / Valuation -Governance

Interplay between multiple Sections –

Section 56(2)(x), 56(2)(viib), 50CA, 43CA,

2(24)(iv), indirect transfers, withholding

obligations

10

Tax overriding commercial rationale……..

No exception under Section 56(2)(x) and

56(2)(viib) to address genuine business

situation (e.g., transactions between

independent parties; real estate transactions etc.)

Section 56(2)(x) applies to Issue of shares? Proportionate Vs

Disproportionate issue? Bonus issue? Buy-back?

Capital reduction?

Timing of testing 56(2)(x) fair value – Agreement date vs Actual date of

transfer/ receipt of shares. Possibility of

increase in fair valuation in future / actual receipt

date

11

Structuring through other instruments like CCD, CCPS, OCRPS etc. – GAAR?

Goodwill on Demerger/ Merger – Tax Depreciation

Common control merger where IND-AS applies to the

merged company –

Goodwill not recognized

Other cases –Purchase

method as per AS 14 –

Goodwill recognized in

books

Significant mismatch in

taxable income and book profits

for MAT –Impact on

decision to opt for lower tax

rate

Practical experience (Schemes &

assessments) -Approval with Tax rider; Tax office denying

claim in assessments

Appointed Date uncertainty now removed by MCA. Such date can be as mentioned in the Scheme and can also be retrospective 12

International trends….

Focus on Substance

•Holding Company jurisdictions gearing up to the changing world –Substance check while issuing TRC’s

SAAR/substance tests being applied

•Canadian ruling disregarding separate existence of Companies for lower Tax regime (Small business tax exemption)

•CJEU has provided guidance on a reference by Denmark Court to it to disregard the intermediary EU Company for not being a beneficial owner

Innovative business models, newer Taxes

•Parliament discussion subject

•Digital Tax

13

Corporates in cross border ….

Multi layer structures,

Roundtripping, overdue

creditors/debtors, capital

regularization

Trading companies, IPR

companies, Financing

companies

SPV/IHC structures – POEM?

14

Individuals in cross border ….

Invisible law on Roundtripping now introduced through an FAQ in May 2019

Individual migrating from India – Tax rate

on disposal as an NRI, non-repatriable

investment, limits on remittance from

India

Migration of Families – Financial

support, Gifting while being a NR

(Trusts?)

15

Family Office ….

Investment instruments – Tax

consequences thereof (e.g.,

NCDs)

Issues concerning holding structures (NBFC/CIC issues in Companies) /

Investment LLPs / Trust / AIF

Investing in securities/ real

estate abroad by Individuals – Fund pooling, LRS/ ODI, compliances; Tax

scrutiny

16Is SEBI approval mandatory for settling Family Trusts for Promoters of Listed Cos?

Key Action Points - India

Following is the progress made so far by India on implementation of the BEPS action plans

•- On 7 June 2017, India along with 67 other countries signed the Multilateral Instrument (MLI) to modify existing tax treaties

•- Ratified instrument submitted with the OECD

Introduction of the interest deduction limitation rule in

2017

Re-negotiation of tax treaties to ensure greater source-based

taxation/ prevention of treaty abuse

•Introduction of Equalization Levy at the rate of 6% on certain digital

advertising transactions in

2016

Introduction of Country by

Country Reporting (CbCR) and Master

File TP documentation in

2016

Committed to minimum

standards for improving

effectiveness on Mutual Agreement Procedures (MAP)

•Introduction of the concept of “significant economic presence” in 2018 to bring certain digital transactions in the tax net

India has been a frontrunner in the global tax transition

MLI Articles - Impacting investments transactions

Article 6 & 7 - Preamble and Prevention of Treaty Abuse

LOB Rule

PPT Rule

Preamble

Article 6 of MLI that mandates inclusion of preamble as a minimum standard

Article 7 of MLI allows to opt for any of the following alternatives:• PPT Only• PPT + LOB (Detailed or

simplified)• Detailed LOB + mutually

negotiated anti-conduit Rule

India has accepted to apply PPT as an interim measure along with Simplified Limitation of Benefit clause

Scope of Principal Purpose Test (‘PPT’) – Article 7(1) of MLI

Para 7(1): Notwithstanding any provisions of a Covered Tax Agreement, a benefit under the Covered Tax Agreement shall not be granted in respect of an item of income or capital if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit,

- Unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the Covered Tax Agreement.”

Benefit’ includes all limitations on taxation imposed on the State of source. Example -Lower rate of WHT, restricted definition of royalty / FTS, Non-applicability of beneficial Permanent Establishment provisions, Capital gain tax exemption, etc.

The terms “arrangement or transaction” should be interpreted broadly and include any agreement, understanding, scheme, transaction or series of transactions, whether or not they are legally enforceable. It includes creation, assignment, acquisition or transfer of the income itself or of property or right in respect of which income accrues

Imperative to demonstrate substance and commercial rationale

Scope of Principal Purpose Test (‘PPT’) – Article 7(1) of MLI

Second limb of PPT Clause –reads as “Unless it is established that granting benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the CTA”

Article 31 of Vienna Convention -A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

SC in case of Azadi Bachao Andolan (supra) observed : similar to deficit financing, treaty shopping, though at first blush might appear to be evil, but is tolerated in a developing economy, in the interest of long-term development.

“…..Despite the sound and fury of the respondents over the so called 'abuse' of 'treaty shopping', perhaps, it may have been intended at the time when Indo-Mauritius DTAC was entered into. Whether it should continue, and, if so, for how long, is a matter which is best left to the discretion of the executive as it is dependent upon several economic and political considerations…...”

• Which Object and Purpose to be analysed? –Original treaty? Protocol? MLI? Impact on protocol to India-Singapore Treaty?

• Whether principles upheld by SC in Azadi Bachao Andolon still hold good?• PPT v/s GAAR?

• PPT V/s Existing LOB clause in tax treaties?

Impact on investment transactions –Principal Purpose Test (‘PPT’) and SLOB

Case Study 1 - PPT

RCo

State X State YState S (Actual

Facility)

State R

Developing Countries

No DTAA with State R

DTAA with State R

Facts:

R Co is a manufacturing entity and has the option of setting up a manufacturing unit in three states i.e. State X, State Y and State S

All three locations were comparable economically and politically, however only State S has a Treaty with State R

R Co decided to set up the facility in State S due to the presence of treaty

BEPS Recommendation:

Given that a general objective of tax conventions is to encourage cross-border investment, obtaining the benefits of the State R-State S convention for the investment in the plant built in State S is in accordance with the object and purpose of the provisions of that convention

Treaty Benefit may not be denied if the commercial action is aligned to treaty objective

Case Study 2 - PPT

Facts:

R Co, a resident of State R, holds 24% in S Co, a resident of State S. There was no treaty between State S and State R

Subsequently R-S Treaty was entered into which provided for 5% WHT rate on dividends subject to shareholding of 25%

R Co increased its holding to 25% to avail concessional rate

BEPS Recommendation:

The facts suggest one of the principal purposes is clearly to obtain the benefit of the lower WHT rate provided by Article 10(2)(a) of a treaty.

However, granting benefit under this Article is permitted to a taxpayer who genuinely increases its participation in a company in order to satisfy the arbitrary threshold of 25%.

No treaty

RCo(State R)

SCo(State S)

24% Holding

Post entering

into treaty

RCo(State R)

SCo(State S)

25% Holding

Any commercial action to comply with treaty conditions should not result in denial of treaty benefit

Case Study 3 - PPT

Facts:

T Co has subsidiaries in different countries, but State T does not have treaty with any of these countries

R Co is established in State R for the purpose of providing managerial services to group companies. State R has treaties with each of the countries where the subsidiaries are located

The decision to invest in State R is driven by the skilled labour force, reliable legal system, business friendly environment, and the comprehensive double taxation treaty network of State R which provide lower WHT rates

BEPS Recommendation:

PPT rule not to apply if R Co undertakes significant FAR for providing services through its own personnel

TCO(PTC & Resident of

State T)

X Y Z

Subsidiaries in different countries

RCO(Resident of

State R)

Management etc. services

Subsidiaries

Commercial substance would prevail to conclude over any alleged treaty abuse measure

Case Study 4 - Holding/financing company structures

Facts:

Foreign parent (‘FP’) intends to make investment in Local Operating Company (‘LOC’)

FP has invested into Regional Holding Company (‘RHC’) through hybrid instruments that is considered as equity in FP jurisdiction and considered as debt in RHC’s jurisdiction.

RHC has in-turn invested into LOC that as per RHC’s jurisdiction is considered as equity and considered as debt as per LOC’s jurisdiction

There is very low or no substance in RHC

Taxability in FP’s jurisdiction

– Dividends from subsidiaries taxable only when dividend is received/declared

– 100% exemption on capital gains, dividend income (subject to conditions)

Taxability in RHCs jurisdiction

– 100% exemption on capital gains, dividend income (subject to conditions)

Taxability in LOCs jurisdiction

– Reduced WHT on dividend, interest payments and capital gains tax protection (subject to DTAA conditions)

Regional holding company (RHC)

ForeignParent (FP)

Asia-PacOperations

Asia-PacOperations

Asia-PacOperations

Local Operating Company (LOC)

Loan/Hybrid instrument

Low to no substance

Loan/Hybrid instrument

Case Study 4 - Holding/financing company structures

Potential Watch out areas post MLI:

FP’s jurisdiction

Can 100% exemption of dividend received from RHC be denied because of a hybrid instrument?

Can CFC Rules be applied for income earned by RHC?

RHC’s jurisdiction

Can deduction for payment to FP be denied because of Hybrid instrument?

Will the interest limitation rule apply?

Can 100% exemption of dividend received from LOC be denied because of a hybrid instrument or lack of substance?

LOC’s jurisdiction

Can tax treaty benefit be denied as per PPT Rule?

Can deduction for payment to RHC be denied because of Hybrid instrument?

Will the interest limitation rule apply?

Regional holding company (RHC)

ForeignParent (FP)

Asia-PacOperations

Asia-PacOperations

Asia-PacOperations

Local Operating Company (LOC)

Loan/Hybrid instrument

Low to no substance

Loan/Hybrid instrument

Need to Re-look legacy structures in light of emerging tax policies

Case Study 5 – Intellectual Property structures

Facts:

Foreign parent (‘FP’) is owning an Intellectual Property (‘IP’) that it want to exploit in various countries

FP forms an IP company in say Country A (tax favoured location) and transfer the ownership of IP to such IP Company

IP Company forms a Regional Holding Company (‘RHC’) in say Country B (low substance) and transfer the right to use the licenses for IP to RHC

RHC forms a Local Operating Company (‘LOC’) in say Country C and sub-license the IP to LOC

LOC would use such IP for commercial purpose (i.e. give it on license to third party) and earn royalty income

Taxability

– LOC would expense out the majority of royalty received for IP licenses to RHC and therefore, there would be very minimum profit taxable in Country C. Further royalty income earned by RHC is taxable at lower rate in Country C as per tax treaty.

– RHC would in turn pay the majority of the license fee received from LOC to IP Company and therefore, there would be very minimum profit taxable in Country B

– Tax rate in Country A on royalty is low

Regional holding company

(Country B)

IP company(Country A)

Foreign Parent

Asia-PacOperations

Asia-PacOperations

Asia-PacOperations

Local Operating Company

(Country C)

IP license

IP license

Low to no substance

Cost-sharing agreement/buy-in of existing IP

No substance

No taxable presence in the tax-favored location

Royalty

Royalty

Case Study 6 – Intellectual Property structures

Potential Watch out areas post MLI :

Will DEMPE (i.e. development, enhancement, maintenance, protection and exploitation of intangibles) rules of BEPS Action Plan 8 apply and maximum profit would be taxable in the jurisdiction where there is economic substance i.e. FP or LOC?

Can the preferential tax regime of low tax rate on royalty in Country A be denied as per BEPS Action Plan 5?

Can tax treaty of Country B and Country C be denied to RHC as per PPT/LOB rules?

Regional holding company

(Country B)

IP company(Country A)

Foreign Parent

Asia-PacOperations

Asia-PacOperations

Asia-PacOperations

Local Operating Company

(Country C)

IP license

IP license

Low to no substance

Cost-sharing agreement/buy-in of existing IP

No substance

No taxable presence in the tax-favored location

Royalty

Royalty

Case Study 7 – Typical outbound investments

Facts:

India Co acquires target through borrowing from banks

SPV set up in a jurisdiction where Underlying tax credit (‘UTC’) benefit is granted under tax treaty

Operating Co is formed through Debt and Equity

Withholding tax in Operating Co jurisdiction is 5% due to favorable domestic withholding provisions

Dividend received by SPV is taxable @15% in SPV’s jurisdiction but relief by way of tax sparing and UTC can be claimed in SPC jurisdiction

Indian Co taxed u/s 115BBD against which UTC is claimed

Indian Co also claims benefit of roll over exemption u/s 115O on distribution of dividend to shareholders

Potential Watch out areas post MLI :

Can PPT be applied to deny UTC or tax sparing credit

Can PPT/GAAR be applied by Indian tax authority questioning the existence of SPV and disallowing UTC

Operating Co

SPV

India Co

Debt + Equity

Dividend withholding - Nil

Headline tax rate – 15%

Business

Bank Borrowing

Equity

Impact on transactions – Others

Case Study 8 – Dual resident entities (Article 4 of MLI)

Facts:

X Co. is dual resident of India (under POEM) and Netherlands (based on incorporation)

Article 10(2) of India-Netherlands tax treaty reads as follow:

“However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed 10 per cent of the gross amount of the dividends”

Tie-breaker residency of X Co. to be decided by way of Mutual Agreement Procedure (‘MAP’) by Competent Authorities of both the Countries

If residency cannot be determined under MAP then treaty benefit would not be available

Potential Watch out areas post MLI :

One of the method for determining tie-break residency is POEM. Can MAP apply the Indian POEM guidelines for the same?

If competent authorities is unable to determine residency by mutual agreement, can Indian shareholder claim the benefit of Article 10(2) of India-Netherlands tax treaty?

X Co. (India &

Netherlands)

Indian shareholder

Dividend

Case Study 9 – Dual resident entities (Article 4 of MLI)

Facts:

X Co. is dual resident of India (under POEM) and Singapore (based on incorporation)

Singapore Shareholder has acquired shares of X Co. before 1st April 2017

Article 13(4A) of India-Singapore tax treaty reads as follow:

“4A. Gains from the alienation of shares acquired before 1 April 2017 in a company which is a resident of a Contracting State shall be taxable only in the Contracting State in which the alienator is a resident”

Tie-breaker residency of X Co. to be decided by way of Mutual Agreement Procedure by Competent Authorities of both the Countries

If residency cannot be determined under MAP then treaty benefit would not be available

Potential Watch out areas post MLI :

If competent authorities is unable to determine residency by mutual agreement, can Singapore shareholder claim the grandfathering provision’s benefit of Article 13(4A) of Singapore tax treaty?

X Co. (India &

Singapore)

Singapore shareholder

Sale of shares

Key Drivers going forward……..

Commercial reason vis-à-vis Tax Reason to drive investment holding structures

Increased documentation imperative to demonstrate substance for investment decisions

Profit allocation would be based on economic substance vis-à-vis legal form of entities

Relook of existing structures to minimize litigation considering the open-ended law of PPT

35

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