Challenge Us

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Cross border transactions

Mukesh Butani
November 17, 2005

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Agenda
Transaction imperatives
Key tax and financial considerations

Income stream

Entry strategy

Financing options

Debt structuring

Cash repatriation

Exit considerations
Case Study

Business reorganisations

Leasing transactions

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Cross border transaction imperatives

Business
Environment

Cultural Issues

Business
Dynamics

Accounting
treatment

CrossBorder
Border
Cross
Transactions
Transactions
Legal & regulatory
framework

Tax regimes &

treaties

Identifying and
delivering synergies

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Key tax and

financial
considerations

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Key tax and financial considerations

2

Entry Strategy

Income flows and

their taxability

Financing
options

Crossborder
border
Cross
transactions
transactions
Exit considerations

4
Debt Structuring

Cash repatriation

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1 Income stream and their taxability

Income streams

Dividends

Capital gains

Principles for evaluation

Interest, TS and royalty can flow independent

of ownership pattern
TS and royalty would typically flow to an
operating entity, which possess technical
capabilities

Interest

Principal drivers are tax costs associated with

dividend flows and gains on disposal of

Others: royalty / brand fees / technical

services / management services

shares
Brand fee would flow to the IPR company

Key elements arms length principle, documentation, overall tax costs and foreign tax credits

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1 Comparison between various tax regimes

Jurisdiction
Mauritius

Cyprus

Netherlands

Singapore

USA

Nature of
Income
Dividends

Nil*

Nil*

Nil*

Nil*

Nil*

Capital gains on
disposal of shares

Nil

Nil

Note

Nil

As per Indian
tax Laws

Interest

0 / 20.91%

10%

10%

10%

0/10/15%

Royalty

10.46%

10.46%

10.46%

10%

10/15/20%

*DDT @ 14.025%
Note Nil in case of transfer of shares by one non-resident to another non-resident

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2 Entry strategy
Direct investment
US Parent

Step down investment

US Parent

Double step down investment

US Parent

European /
Netherlands sub
European /
Netherlands sub
Overseas

Singapore /
Mauritius sub

India

WOS/ Branch

WOS/ Branch

WOS/ Branch

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3 Financing options
Parameters

Equity

Debt (related & third party)

Quasi Debt (Preference stock

mezzanine instrument )

Term

Long Tem

Medium to long term

Medium to long term

Pay outs

Dividend

Interest

Dividend

Tax rate

DDT payable @ 14.025%

Withholding tax @ 0 / 10 / 15 /
20%

DDT would be payable @

14.025%

Tax credit

Not available under most Treaties

(check domestic laws of home
country)

Tax withholding on interest

available

Not available under most

Treaties (check domestic laws
of home country)

Usage

No restrictions

Restriction on usage as per ECB

guidelines (see next slide)

No restrictions

Deductibility

Dividends and DDT not

deductible

Interest allowed as deduction

(arms length principle)

Dividends and DDT not

deductible; consider double dip
deduction

No thin capitalisation norms and hence an Indian company can be highly leveraged if it meets
commercial requirements
Leveraging Indian company using overseas debt subject to restrictions in ECB Guidelines (see next
slide)

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4 Debt structuring
Internationally recognized sources (international banks, capital markets, multilateral financial

Lenders

Amount/
maturity

Institutions, equipment suppliers, foreign collaborators)

Foreign equity holder if:
ECB up to 5 MUSD minimum equity of 25%
ECB above 5 MUSD minimum equity of 25% and debt-equity ratio not exceeding 4:1
Upto 20 MUSD Minimum average maturity of 3 years, can have call / put option
Over 20 MUSD to 500 MUSD Minimum average maturity of 5 years
ECBs outside the above limits/ maturity period need specific approval
Investment in real sector (capital goods, new projects, modernization/ expansion of units)

End use

Investment in Infrastructure sector (power ,telecommunication, railways, roads, ports etc)

Not to be utilized in capital market transactions, real estate, acquisition, working capital,
repayment of Rupee loans

Total cost
of debt
Prepayment

ECBs with minimum average maturity of 3-5 yrs: 200 bps above six month LIBOR
ECBs with minimum average maturity of more than 5 yrs: 350 bps above six month LIBOR
ECBs upto 200 MUSD can be pre-paid without approval subject to compliance with minimum
average maturity period
MUSD means million United States Dollars

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5 Cash repatriation
Suitability

Dividend distribution
Simplest and most common

Capital reduction
Court regulated process, involving repayment of share capital
comparatively complex and time consuming amount paid to
the extent of accumulated profits of the company would be
taxable as dividend in India
Share buyback
Repurchase of shares restricted amount of repatriation
income taxable as capital gains in hands of the shareholder
Broad mechanics of each of the above options have been
discussed in detail in Annexure 1

Profit making
company
Ease of repatriation

Cash rich company with

low reserves
Loss making company
with cash reserves
Maximum amount of
repatriation desired
Profit making company
Foreign Co desires to
classify the income as
capital gains instead of
dividend possible
treaty benefits

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6 Exit considerations
Capital gains
No Objection Certificate requirement for setting up new venture Press note
1 of 2005 (refer Annexure 2 for process)
Shareholders agreement and implications thereof
Right of First Refusal; Tag Along rights; Drag Along rights
Liquidation process long drawn and Court approval process

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Case study
business
reorganization

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Case Study acquisition of business

US Corp

Global
conglomerate
engaged in
diversified
businesses
Aggressively
targeting Asian
foods markets
Has significant
experience in
the foods
business and
commands a
powerful brand
name

Target Co
Indian
Controls
significant
share of the
Indian foods
market
Leading
exporter to
Asia
Strong track
record and
substantial
reserves

Mauritian Co

US Corps
strategic holding
company for
Asian
investments
Has a wholly
owned Indian
subsidiary, F&P,
engaged in two
businesses foods and
packaging
F&P has
accumulated tax
losses

Indian Partner

Leading Indian
company (not
part of US Corp
group)
Holds majority
equity in Target
Co

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Overview of the structure

Case Study to suggest mechanism to achieve business objectives of
US Corp & Indian Partner

USA

Business strategy
US Corp

US Corp
(conglomerate)

100%

Mauritian
Co*

100%

Mauritius
43%

Target Co
(Foods)

India

Phase II
Target Co sells trademark
to US Corp
US Corp licenses
trademark to Target Co
US Corp receives royalty
Indian Partner

57%

*Consider Singapore
jurisdiction

Phase I
Asian strategy - acquire
control of Target Co
Foods business of F&P to
be consolidated with
Target Co

Indian Partner
Auto ancillary

Foods &
Packaging

Redefining strategy
Focus on core business
- auto ancillary
Exit non-core business
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Case study - modes of acquisition

Increase in
stake

Direct
increase
Acquisition of
shares

Passive
increase
Preferential
allotment of
shares
Capital reduction
of identified
shares
Share buyback

Business
restructuring
Merger
Demerger
Sale of business
undertaking/
sale of assets

The case study however discusses the implications arising under the
merger option, in detail in following slides

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Phase I - Mechanics of merger

100%

Mauritius
Co

51%
43%

Target Co
Indian
Partner

Merger

Foods &
Packaging

57%
49%

Present scenario

Issue of shares to Mauritius Co. as consideration of food business

Post Merger

Fiscal and regulatory implications of merger

Company Law Implications
Special resolution
Court approved process
Dissolution of F&P under
Court order without
winding up

Tax Implications
Broadly tax neutral on
satisfying conditions
Transfer of tax losses and
tax benefits of F&P
Tax losses available for
fresh lease of 8 years
Stamp duty costs
significant

Other Implications
Valuation of companies
No foreign investment
approvals, subject to
conditions
No cash outflow for
Mauritian Co
No consideration to Indian
Partner on indirect
dilution of its stake
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Phase II Sale and license back of trademark

Mechanics

Mauritius
India

51%

Sale of trademark
capital gains

Target Co transfers
its Trademark (TM)
to Mauritian Co.
Subsequently
Mauritian Co
licenses TM back to
Target Co

License of trademark
royalty income

Mauritian
Co

Target Co

Arms length nature of sales and licensing of trademark

May entail service tax and Value Added Tax
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Leasing
transactions

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Salient features of leasing transactions

Wet lease
Lease of equipment with resources to operate the equipment
Lessor continues to control the operation of the equipment and its maintenance
Example Lease of an aircraft along with flight crew; lessor responsible for selection/
hiring of flight crew, operation and maintenance of aircraft, etc
Dry lease
Lessor merely provides the equipment at a particular location
Lessee operates the equipment using his own resources
Example Lease of aircraft without crew
Forms of dry lease:

Operating lease
Finance lease (for detailed discussion, refer next slide)

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Operating Lease vs. Finance Lease

Operating lease
Lessor is the legal and the
economic owner

Risks and rewards associated

with the asset not substantially
transferred

Finance lease
Lessor is the legal owner
Lessee is the economic owner

Risks and rewards associated

with the asset are substantially
transferred

Risks include losses due to idle capacity, technological obsolescence & changing
economic conditions. Rewards include expectation of profitable operation over economic
life of asset and gain from appreciation in value or realisation of residual value

Source: Accounting Standard 19 issued by the Institute of Chartered Accountants of India

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Taxation of leases domestic law

Wet lease

Dry lease

Lessor
Royalties - Section 9(1)(vi)
Or
Section 44BBA - 5% of deemed profits

Lessor
Royalties - Section 9(1)(vi)
Or
Section 44BBA 5% of deemed profits

Lessee
Lease rentals allowed as deduction
Depreciation allowed to lessor

Lessee
Resident - Lease rentals would be
allowed to the lessee
Depreciation would be allowed to the
lessor
Section 10(15A) exemption from tax
withholding extended

May entail service tax and Value Added Tax

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Taxation of leases treaty law

Wet lease
Article 8 (1) - Profits from operation of ships or aircraft in international traffic taxable
only in state of residence
OECD Commentary of Article 8 of model tax treaty - Profits obtained by leasing a ship
or aircraft on charter fully equipped, manned and supplied must be treated like the
profits from the carriage of passengers or cargo
Dry lease
Article 12 Royalties includes consideration for use of equipment
Article 7 Business Profits applies where Article 12 does not cover payments for use
of equipment
Klaus Vogels commentary - If enterprise lets or leases facilities, equipment, buildings
or intangibles to enterprise of other state without maintaining a fixed place of business
for such letting or leasing activity in the other state, the lessees facilities, equipment,
buildings or intangible property, as such, will not constitute PE of lessor, if contract
limited to leasing of equipment
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Thank you

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Annexure 1

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Cash repatriation strategies

Criteria/ Option
Distribution of
dividend

Limitations
Amount
restricted to
positive
distributable
reserves

Key fiscal costs

Other issues

14.025 % Dividend Distribution

Tax (DDT)

Can be paid from

current year profits
subject to transfer to
reserves

Income exempt in recipients

hands
Tax treaties with some countries
provide for Underlying Tax Credit
(UTC) on DDT

Dividend can also be

paid out of past
accumulated profits
subject to a maximum
limit of 10% of paid up
share capital
Board/ shareholder
approvals required
Generally no
regulatory approvals
required

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Cash repatriation strategies (contd)

Criteria/ Option
Capital
repayment or
capital
reduction

Limitations

Key fiscal costs

Other issues

Positive
distributable
reserves are not a
pre-requisite

Funds paid to the extent of

accumulated profits (including
capitalized profits) taxable as
dividend (dividend tax @ 14.025 %

Board/ shareholder
approvals required

Capital repayment
not possible at
amount higher
than par value of
shares

For public listed companies if

Securities Transaction Tax applies,

Allowed without
regulatory approvals
from an exchange
control perspective
subject to certain
conditions

Possible to
increase cash pay
out by capitalizing
reserve

Long term - NIL

Short term @11.22%
Tax rate for private companies

Long term - 22.44% (in case

Court/ creditor
approval required

of foreign company 20.91%)

Short term - 33.66% (in case

of foreign company 41.82%)
Tax withholding
Treaty consideration
Possible Stamp duty exposure @
0.25%
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Cash repatriation strategies (contd)

Criteria/ Option
Capital repurchase or
buyback
through tender
offer

Limitations

Key fiscal costs

Amount restricted
to 25 per cent of
(share capital+free
reserves)

Capital gains tax for shareholder on

consideration less acquisition cost
(after adjusting for exchange
fluctuations)

Max 25 per cent of

equity share capital
permitted to be
repurchased in an
year

For public listed companies if

Securities Transaction Tax applies,

Post buyback Debtequity ratio not to

exceed 2:1
Minimum 12
months gap
between two
consecutive
buyback

Long term NIL

Short term @11.22%
Tax rate for private companies

Long term - 22.44% (in case of

foreign company 20.91%)

Short term - 33.66% (in case of

foreign company 41.82%)
Possible stamp duty exposure @
0.25%.
Appropriate tax to be withheld by
Indian Co
Provisions of applicable treaty to be
considered

Other issues
Board approval if
buyback is less
than10% of total
paid-up equity
capital and free
reserves/
shareholder
approval required
if buy-back more
than 10%
Buy back price
would need to be
in consonance
with fair
valuation
principles
enunciated in
transfer pricing
legislations
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Cash repatriation strategies (contd)

Criteria/
Option
Capital repurchase ie
buyback
through
tender offer

Limitations

Broad time
frame

Key fiscal costs

Other issues
Under exchange control
Under exchange
regulations,
on per
controlcap
regulations,
on per
share on
sharecap
amount
payable
amount
on
buyback
is thepayable
higher of
buyback is the higher
the price based on the
of the price based `on
NAV per
linked
with
the share
NAV per
share
stock linked
exchange
as per
with or
stock
exchange
or as per
valuation
of statutory
valuation
of statutory
auditor/
merchant
banker
auditor/ merchant
Disclosure
in offer
banker
document,
if the in offer
Disclosure
promoters
to tender
document,
if the
promoters
tender
shares,
for publictolisted
shares, for public
companies
listed companies

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Annexure 2

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Regulatory compliances
No Objection Certificate from Indian partner has been a key negotiation point for foreign company having existing
JV relationship in India In certain cases MNC have to sacrifice by accepting low JV exit price

What do the prevailing Foreign

investment regulations provide?

Does the Foreign company have an existing venture?

Is the existing venture in same field?
(this includes equity holdings, technical collaboration,
brand collaboration, etc)
Yes

Prior approval from FIPB

required for financial/ technical
investment in India

NOC from Indian partner required

No
No prior approval required
investment can be made by
foreign company

FDI restrictions for the particular

sector to apply

NOC has been made inapplicable to past ventures as also relaxing the allied field condition

Ventures existing on January 12, 2005 would be treated as existing ventures

For ventures after January 12, 2005, parties are free to contractually agree a conflict of interest clause
accordingly, it is advisable to incorporate easy exit clause for future independence, while entering into a JV
relationship
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