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Regulatory and Tax Aspects of Fo

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                         Regulatory and Tax Aspects of
                         Foreign Direct Investment in
                         India
                         DUBLIN




                                                 Nitin Karve
                                                     Partner
                                                         Tax
                                               Mumbai, India
AUDIT
AUDIT   TAX
        TAX   ADVISORY
              ADVISORY
                                             24 October 2007
 Overview


            Foreign Direct Investment Regime
            Foreign Direct Investment Regime


                   Regulatory Issues
                   Regulatory Issues



                 India – Entry Strategy
                 India – Entry Strategy


                Funds Repatriation // Exit
                Funds Repatriation Exit
                      Strategies
                      Strategies


                Overview of Tax Regime
                Overview of Tax Regime


kpmg                                           2
Vehicles for Foreign Investment in India

                                        Foreign Venture                   Foreign
        Foreign Direct
                                        Capital Investor                Institutional
       Investment (FDI)
                                             (FVCI)                    Investor (FII)




                                     Investments in India


                                                            Appropriate vehicle for
             Type of investment
                                                             investment in India

 Investments in listed companies through the Stock
                                                                      FII
 Exchanges of India


 Other investments in shares                                          FDI

 Investments in units of a Venture Capital Fund
 .
                                                                     FVCI



kpmg                                                                                    3
 India’s FDI policy - “Open Door”

         Sectors – No Approval             Sectors – Prior Approval       Sectors – Negative List
              (Illustrative)                     (Illustrative)                (Illustrative)

        NBFC (minimum                      Existing Airports beyond 74%   Agriculture
        capitalisation norms)                                             Atomic energy
                                           Asset Reconstruction
        IT / ITes                          Companies 49%                  Retail trading (except single
        Financial   services(a)            Atomic Minerals 74%            brand up to 51%)
        Insurance (26 per cent cap)(a)                                    Lottery, betting and
                                           Broadcasting (a)
        Select Real Estate(a)                                             gambling
                                           Cigars & Cigarettes 100%
        Special Economic Zones
                                           Courier 100%
        Infrastructure
                                           Print Media
        Shipping
        Manufacturing sector               Single brand retailing 51%
        Hotels and tourism
        Pharmaceuticals

Note:     (a) Sector-specific guidelines


 kpmg                                                                                                4
 Entry / Exit Pricing

  Transactions involving residents have to comply with pricing
  guidelines


  Separate pricing guidelines prescribed for listed and unlisted
  shares
       Listed Shares – generally linked to price on the stock
       exchange
       Unlisted Shares – complex formulae




kpmg                                                               5
 Overview


            Foreign Direct Investment Regime
            Foreign Direct Investment Regime


                   Regulatory Issues
                   Regulatory Issues


                 India – Entry Strategy
                 India – Entry Strategy


                Funds Repatriation // Exit
                Funds Repatriation Exit
                      Strategies
                      Strategies


                Overview of Tax Regime
                Overview of Tax Regime


kpmg                                           6
 Technical collaboration payments

 Technical Royalties            Brand Royalties            Consultancy fee
       Lump sum not to              Up to 1 per cent on         Remittance up to USD
       exceed USD 2                 domestic sales and 2        1 million per project
       million and                  per cent on export          permitted (USD 10
       Recurring payments           sales, where no             million for infrastructure
       up to 5 per cent on          technical royalties         projects)
       domestic sales and 8
                                    Payment over                Payment over
       per cent on export
                                    prescribed ceiling          prescribed ceiling
       sales
                                    requires prior              requires prior approval
       Payments over                approval                    of the RBI
       ceiling requires prior
                                                                No limit on remittances
       approval –
                                                                out of Exporters’
       discretionary
                                                                Foreign Currency
       Separate ceilings for                                    Account
       hotel sector
                                                           Payments for purchase / use
                                                           of trademark and franchise in
                                                           India permissible




kpmg                                                                                         7
 FII – Portfolio investments in listed securities

  Registration with SEBI as a FII / sub-account


  Appointment of a local custodian banker and a broker


  Investment in a company by an FII on its own account / on behalf of his sub-
  accounts, cannot exceed 10% of the total issued capital of that company


  In case of foreign companies or individuals, each of such sub-account shall not
  invest more than 5% of the total issued capital of that company


  All FIIs and their sub-accounts put together, can invest only up to 24% of the
  total issued capital of an Indian company


  The investment can be increased upto the sectoral cap, as applicable to the
  said company, where the investee company passes such a resolution



kpmg                                                                                8
 Overview


            Foreign Direct Investment Regime
            Foreign Direct Investment Regime


                   Regulatory Issues
                   Regulatory Issues


                 India – Entry Strategy
                 India – Entry Strategy


                Funds Repatriation // Exit
                Funds Repatriation Exit
                      Strategies
                      Strategies


                Overview of Tax Regime
                Overview of Tax Regime


kpmg                                           9
 Entry Strategy


          Direct investment                        May not be tax-efficient!
             from Ireland

                Effective Tax Cost
                                                         Choice of
                                                         appropriate structure

       De                                                 Domestic tax
         sir                                              incentives
               ed
                  E   ffe
                          cti                             Mode of funding
                             ve
                                  Ta
                                     x   Co               Jurisdiction planning
                                              st


kpmg                                                                              10
Investment Vehicles

                    Liaison office                    Project office                    Branch office                      JV / Subsidiary

Suitability      Representation /              Turnkey projects for                 Import / Export                   Limited liability for Indian
                 communication only            limited duration e.g.                Other permissible                 operations
                 Pilot vehicle for             Power, Infrastructure etc            activities                        Pan - India presence
                 future entity set up                                               Limited geographical
                 Ideal for market                                                   presence
                 study and research

Regulatory       Prior approval of RBI         Generally no prior                   RBI approval                      Investment approvals
Authorities      Granted initially for         approval necessary                   necessary                         where required
                 three years and                                                                                      RBI guidelines for pricing /
                 thereafter to be                                                                                     issue of shares
                 renewed

Set-up time &    6 – 8 weeks                   Quickest to set up, as no            6 – 8 weeks                       6 – 10 weeks and if
Cost             Cost of set up /              approvals necessary                  Cost of set up /                  Government approval is
                 operation lower than          Cost of set up / operation           operation lower than              required then about 16 to
                 company                       lower than company                   company                           20 months
                                                                                                                      Higher costs of set up and
                                                                                                                      higher operational costs

Taxation                     non-
                 Generally a non-              Taxable presence                     Taxable presence                  Taxable presence
                 taxable presence              Tax rate – 42.23%*                   Tax rate – 42.23%*                Tax rate – 33.99%* plus
                                                                                                                               distribution–
                                                                                                                      taxes on distribution–
                                                                                                                      16.995%
kpmg Note:      Basic rate plus applicable surcharge and education cess for financial year (April to March) 2007-08                                  11
Broad comparisons between Private and Public
Company – Subsidiary

                   Particulars                          Private Company                    Public Company
 Minimum / maximum number of shareholders                   Two / Fifty                     Seven / No limit
 Minimum Directors                                             Two                               Three
 Minimum paid up capital                                  INR 0.1 million                   INR 0.5 million
 Suitability                                       Suitable for close and private     Suitable for listing purposes
                                                              holding
 Conditions under company law                      No public subscription / listing   No such restrictions, subject
                                                   of shares;                            to other compliances
                                                   Shares not freely transferable;
                                                   Cannot accept deposits from
                                                   public, except members,
                                                   directors and their relatives
 Conditions with respect to further issue of              Not Applicable                       Applicable
 capital
 Provision of disproportionate voting rights                 Allowed                          Not Allowed
 and other relaxations
 Incorporation levies (stamp duty / filing fees)               Typically, up to 1 per cent of capital




kpmg                                                                                                                  12
 Debt Structuring

                        • Internationally recognised sources (international banks, capital markets, multilateral financial
                          institutions, equipment suppliers, foreign collaborators)
      Lenders
                        • In case of foreign equity holder owning 25% or more and in case of overseas loans above
                          USD 5mn, debt equity ratio not to exceed 4:1


                       • Maximum amount of overseas loans that can be raised is USD 500mn during a financial year
  Amount / Maturity    • Up to USD 20mn – Minimum average maturity of 3 years, can have call / put option
                       • Over USD 20mn to USD 500mn – Minimum average maturity of 5 years



                                                                                  modernisation
                       • Investment in real sector (capital goods, new projects, modernisation / expansion of units)
       End use         • Not to be utilised for working capital, loans and investments, real estate, etc.
                                                                                        real



                        • If end use is for rupee expenditure
  Approvals required
                        • If end use is for foreign expenditure and loan exceeds USD 20mn



                                                                         3-
                       • Overseas Loans with minimum average maturity of 3-5 years: 150 bps above 6 month LIBOR
  Total cost of debt                                                                  years:
                       • Overseas Loans with minimum average maturity of more than 5 years: 250 bps above 6
                         month LIBOR


                                                                   pre-
                           Overseas Loans up to USD 400mn can be pre-paid without prior approval subject to
     Prepayment
                           compliance with minimum average maturity period


kpmg                                                                                                                         13
 FDI - Possible Entry Strategies

         Direct Investment   Step down investment I   Step down investment II

            Irish Parent          Irish Parent             Irish Parent




                                 Other Overseas           Intermediate Tax
                                    Company                  Jurisdiction


 Overseas

 India

            Subsidiary            Subsidiary                 Subsidiary


kpmg                                                                            14
 Treaty comparison

                        Ireland                          Mauritius                 Netherlands       Singapore

 Capital
                        As per Indian tax laws               Nil                      Nil***            Nil
 Gains

 Interest*              10%                                 Nil / 21.12%              10%            10% / 15%


 Royalty*               Nil / 10%                            10.56%                   10%               10%


 Dividend**              Tax-
                         Tax-free in the hands of the recipient under the Indian domestic tax laws

 * Rates - Lower of Indian domestic tax laws / tax treaty
 ** Dividend distribution tax (DDT) to be paid by the company at 16.995 per cent
 ***Subject to certain conditions


Singapore tax treaty – Limitation of benefits rule
•                                                          favourable
    A shell / conduit company will not be eligible for the favourable capital gains tax treatment
•                                                               capital
    Affairs arranged for tax avoidance will not be entitled for capital gains tax treatment
•                                          India-
    Capital gains tax exemption linked to India-Mauritius tax treaty




kpmg                                                                                                             15
FII – Illustrative Structure and Mechanics

                            Investors



                                     Equity                          The FII (Investment
                                                                     company) will be
                              Fund
                                                                     located in a tax-friendly
                     Loan            Equity
                                              Preferred Locations:   jurisdiction
                                              •Singapore
 Overseas                                     •Mauritius
                               FII
 Advisor    Advice                            •Netherlands
                     Loan            Equity
                                              Overseas               Indian advisor should
  Advice                                          India
                                                                     not control investment
  Indian
                             Indian                                  company
                             Target
  Advisor
                            Company




kpmg                                                                                             16
 Overview


            Foreign Direct Investment Regime
            Foreign Direct Investment Regime


                   Regulatory Issues
                   Regulatory Issues



                 India – Entry Strategy
                 India – Entry Strategy


                Funds Repatriation // Exit
                Funds Repatriation Exit
                      Strategies
                      Strategies


                Overview of Tax Regime
                Overview of Tax Regime


kpmg                                           17
Funds Repatriation / Exit Strategies…
                          Strategies…

                      Dividend                                          Buy-back of shares
Suitability                                           Suitability
   Preferred by profit-making companies                  Preferred by profit-making companies
   Repatriation is easy                                  ‘Capital gains’ v ‘dividend’ – possible treaty benefits



Tax Aspects                                           Tax Aspects
   Dividend exempt in the hands of the shareholders      Gains on sale of buy-back of shares would be liable to
   Company to pay DDT                                    capital gains tax in the hands of the shareholder
   In a holding company structure there would be a
   dual / multiple layer of DDT
   Availability of credit of DDT in the hands of
   Investment company needs to be examined as per
   the domestic tax laws of the Investee country




kpmg                                                                                                               18
…Funds Repatriation / Exit Strategies
…Funds


                Capital reduction                                       Sale of Shares


Suitability                                           Suitability
   Cash rich company with low reserves                   ‘Capital gains’ v ‘dividend’ – possible treaty
   Loss making company with cash reserves                benefits


Tax Aspects                                           Tax Aspects
   To the extent of reserves, distribution would         Gains on sale of shares would be liable to
   attract DDT                                           capital gains tax in the hands of the shareholder
   The excess (consideration reduced by the cost
   plus deemed dividend) would be liable to capital
   gains tax in the hands of the shareholders




kpmg                                                                                                         19
 Overview


            Foreign Direct Investment Regime
            Foreign Direct Investment Regime


                   Regulatory Issues
                   Regulatory Issues



                 India – Entry Strategy
                 India – Entry Strategy


                Funds Repatriation // Exit
                Funds Repatriation Exit
                      Strategies
                      Strategies


                Overview of Tax Regime
                Overview of Tax Regime


kpmg                                           20
Direct Tax
- Substantive provisions

 •   Uniform financial year for tax : 1 April - 31 March

 •   Profits generally computed on business principles

 •   Depreciation allowed typically at commercial rates on tangible and intangible assets

 •   Carry forward of business losses permissible up to eight years and unabsorbed depreciation
     indefinitely

 •   Restriction on carry forward of losses after change of control

 •   Losses from speculative transactions / share transactions by companies treated separately for
     set-off

 •   No provision for consolidation of tax profits / losses of entities within same group

 •   Applicability of minimum alternative tax in certain cases

 •   Tonnage Tax Regime for shipping industry

kpmg                                                                                                 21
Direct Tax
- Procedural provisions

 • Extensive withholding tax obligations on various payments at applicable rates

 • Mandatory filing of tax returns

 • Tax registration numbers mandatory

 • Maintenance of books of accounts

 • Tax audit report required




kpmg                                                                               22
Direct Tax
- Anti avoidance provisions


 • Transfer pricing provisions in line with International Practices

 • No thin capitalisation rules

 • No rules for Controlled Foreign Corporations




kpmg                                                                  23
Direct Tax
- International aspects

 • Large tax treaty network – close to 70 countries

 • Tax treaty applies if more beneficial

 • Credit available for taxes paid outside India

 • Binding rulings available for non-residents

 • Presumptive basis taxation for non-residents engaged in select activities




kpmg                                                                           24
 Direct Tax
 - Tax Holidays and Incentives


       Particulars                    Deduction

   Export-oriented   Special Economic Zones –
                     100 per cent for five years and 50% for next
                     10 years
   Infrastructure    Road, Highway project, Power, etc –
                     100 per cent for 10 years
   Location          Select states –
                     100 per cent or varying up to 10 years




kpmg                                                                25
 Taxation of Foreign Nationals

    Taxation of a foreign national in India depends upon his residential status for the
    relevant financial year


                         Resident                    Liable to tax on his worldwide income



                                             Liable to tax in respect of income earned or received
 Individual            Non-resident
                                                                     in India


                     Resident but not                     Liable to tax in respect of
                     ordinarily resident   income earned or received in India but slightly wider scope



    Tax status to be decided on the number of days stay in India
    Maximum marginal rate is 33.99 per cent
    Short-stay exemption for non-residents
    Treaty benefits available


kpmg                                                                                                     26
 Indirect taxes in India

  Customs Duty
  - Applicable on import of goods and on export of selected goods
   - Effective customs duty consists of various duties like basic duty, additional duty, etc.
   - Countervailing duty and Additional customs duty allowed as input tax credit to manufacturers and
  service providers and manufacturers respectively

   Excise Duty
   - Applicable on ‘manufacture’ of goods
  - Corresponding duty on import of goods
   - Standard effective rate -16.48 percent
   - Input tax credit available to manufacturers and service providers
   - Exports free from CENVAT

  Service Tax
  - On the provision of services (100 classes of services are currently covered)
  - Current effective rate - 12.36 per cent
  - Input tax credit available to manufacturers and service providers
  - “Reverse charge” mechanism for services provided by non-residents
  - Exports free from service tax


kpmg                                                                                                    27
 Indirect taxes in India

   Research and Development Cess
   - 5 per cent cess on import of technology
   - Set off available against specific category of service tax

   Sales Tax on out-of-State purchases / sales
   - Levied on sale transactions that occasion movement of goods from one State to another State
   within India (i.e. inter state sales)
   - Also includes “deemed” sale transactions i.e. “works contracts” and “lease”
   - Sales tax rates applicable as per the corresponding State VAT/ Sales Tax rates of the selling State
   - No input tax credits available
   - Sales tax on business to business transactions - 3 per cent, subject to certain conditions (to be
   phased out by 2010)
   - Exports and imports free from Sales tax

   Sales Tax on sales / purchases within State
   - State VAT / Sales Tax - on local (intra-state) sales (including ‘deemed sales’) of goods
   - State VAT rates (%) - 0, 1, 4, 12.5 (Standard Rate),
   - Input tax credit available for State VAT
   - Imports and Exports exempt from State VAT


kpmg                                                                                                       28
 Indirect taxes in India

   Leasing transactions
    - Leasing transactions taxable as ‘deemed sales’
    - Applicable rates – Same as sales tax / State VAT
    - No input tax credits available for CST
    - Input tax credit available for State VAT
    - Imports and Exports free from CST / State VAT or Sales tax

   Octroi and Entry Tax
    - Levy on entry of goods into State or into local government area
    - Not levied by all States
    - Input credit available in certain circumstances
    - Rate up to 12.5 per cent

   Stamp Duty
    - Certain duties covered by state laws
    - These vary from State to State and type of instrument
    - Certain duties under Central laws




kpmg                                                                    29
Thank You!




             30
                                    Presenters’ contact details



                                             Nitin Karve
                                             +91 (22) 3983 5706
                                             nkarve@kpmg.com
                                             www.in.kpmg.com




The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we
endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will
continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular
situation.


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