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Inbound Investment into India

Tax and regulatory aspects

August 20, 2011 Arvind Singal

Foreign Direct Investment in India - An Overview

Foreign Investment in India - An Overview


 Indias foreign investment framework has evolved over several years.  In 1991, the Government liberalized the foreign investment policy
significantly.

 Since then, the Government has been steadily liberalizing various aspects
of the policy to attract increased foreign investment.

 Globally, since 2007, Foreign Direct Investments (FDI) Inflow pattern


shows movement of inflows away from USA, UK, France and other OECD countries*.

 Despite challenges on account of inflation and corruption being faced by


the country, India continues to be an attractive investment destination amongst various emerging markets.

 Following other factors are also driving investments into India:  European countries debt problems  Political unrest in Middle East and North Africa  Nuclear disaster in Japan  Downgrading of US economy
*OECD International direct investment database, Eurostat, IMF.
2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved

Foreign Direct Investment in India - An Overview


 There is a big increase in flows to BRIC countries (namely, Brazil, Russia,
India and China).* They are currently worth USD 11-12 trillion while US economy is worth USD 15 trillion.

 BRIC countries expected to be bigger than the US by 2018.  FDI into India went up from USD 4,029 million in 2000-2001 to USD
27,024 million in 2010-2011 and is USD 3,121 million for the month of April 2011.**

 India continues to attract maximum FDI from Mauritius followed by


Singapore. However, during April 2011, Singapore was the biggest investor.

 Percentage share of top three investing countries (for Equity inflow only)
in India.** Country Mauritius Singapore USA
*OECD International direct investment database, Eurostat, IMF. ** Department of Industrial Policy & Promotion, Ministry of Commerce and Industry (India FDI Fact Sheet , April 2011)
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Percentage 42 10 7

Foreign Investments in India - The Roadmap

Sectoral caps raised; Conditions relaxed


Up to 100% under Automatic Route in all sectors except a small negative list Up to 74/51/50% in 111 Sectors under Automatic Route 100%in some sectors
Up to 51% under Automatic Route for 35 Priority Sectors Allowed selectively up to 40%

Pre 1991

1991

1997

2000

Post 2000
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Foreign Investor Key Concerns


While making foreign investment into a country, an investor needs to take into account certain vital factors, such as: Political stability; Economic indicators; Competitive advantages; Business plan and objective; Compliance obligations; Tax and regulatory environment of the country; Exit options, etc.

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Regulatory Overview in India

Consolidated FDI Policy  FDI policy in India is formulated by Department of Industrial


Policy and Promotion (DIPP), Ministry of Commerce & Industry

 DIPP earlier regulated FDI through Press Notes  Consolidated FDI policy a recent publication  Consolidation
clarifications of all press notes/ press releases/

 Sunset date of six months (Effective from 1 April and 1


October)

 First Consolidated FDI Policy was effective 1 April 2010 vide


Circular 1 of 2010

 Current Consolidated FDI policy is effective 1 April 2011 vide


Circular 1 of 2011

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FDI - Regulatory snap shot


Automatic Route  100% FDI permitted in most sectors  No prior approval necessary; only post-facto filings  FDI should be brought through normal banking channels  Investment represented by fresh issue of shares

Prior Approval  Generally, applicable in following cases: - Certain cases where FDI is regulated - E.g. Single Brand Retailing Sector with FDI permissible upto 51%, Defence sector with FDI permissible upto 26% subject to licensing etc.  Applications processed by FIPB

Negative List  FDI not allowed in certain sensitive sectors e.g.: Retail trading (except Single Brand Product retailing) Atomic energy Lottery business Gambling and betting sector

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Foreign investment Possible entities

Liaison office Prior Approval of RBI required. No commercial or business activities permitted. Only liaison, representation, communication role is permitted.

Branch office Prior Approval of RBI required. Activities listed/ permitted by RBI can only be undertaken.

Project Office Prior Approval of RBI not required if certain conditions are fulfilled. Permitted if a foreign company has a secured contract from an Indian company to execute a project in India.

Company Automatic Approval in certain sectors/ activities. Approval required from Government/ FIPB for other sectors. All activities mentioned in Memorandum of Association permitted subject to FDI guidelines.

Limited Liability Partnership FDI in Limited Liability Partnership permitted by amendment in FDI Policy on 20 May 2011 Prior approval of FIPB required.

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Exchange control regulations Permissible transactions

CAPITAL ACCOUNT TRANSACTIONS Prohibited unless specifically permitted

CURRENT ACCOUNT TRANSACTIONS Freely permitted Subject to ceilings


Where ceilings breached approvals required

Remittance

Approving authority

RBI

Central Government/ RBI

Illustrations

      

Investment in regulated sectors Investment into a partnership firm, proprietorship concern or trust Investment in immovable property Remittance outside India of capital assets in India Taking overseas loans/ overdrafts Issuing guarantees Maintaining deposits/ foreign currency account

     

Dividend payments Payments of royalty & technical collaboration fee Payment of management fee/ technical services fee/ consultancy services upto prescribed limits Payment of pre-incorporation expenses subject to prescribed limits Remittance towards purchase of trademark/ franchise Reimbursement of expenses/ head office allocations
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Direct Investment vs Intermediate Holding Company (IHC) Route

Choice of holding structure

Direct inbound structure

Inbound structure through IHC

Foreign Investor
Abroad Abroad

Foreign Investor

Singapore Intermediate Holding Company

India

Mauritius
India

Indian Company

Indian Company

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IHC Structure vs Direct Investment - Key considerations


Potential benefits of IHC structure vis--vis a direct investment: Possibility of reducing tax withholding on paybacks; Reduced tax incidence on exit; Enhanced ability to leverage on group strength; Reduced overall group tax cost; and Effective management of credit and currency risk. Selection criteria for IHC: Treaty network with countries; Minimal exchange control norms; Existence of substance; Lower tax rates; and Flexibility in funding. Pitfalls / Challenges of IHC structure: Substance test criteria Demonstrating adequate substance at IHC level is critical; Recent controversy in India on disposal / exit at IHC level resulting in taxable situation in India from transfer of underlying asset
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Case Study: Direct Investment vs. IHC Return on Investment


Direct investment
Foreign Investor

Investment through an offshore IHC


Foreign Investor Abroad Equity Capital Gains Abroad

Capital Gains Equity

IHC

Mauritius/ Singapore

India India Indian Company


INDIA Sale Consideration Less: Cost of acquisition Capital Gains Less: Income Tax @ 21.012% (Assuming long term capital gains) Gains after tax Tax Outflow 79 21
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Equity Indian Company


INDIA

Capital Gains

150 (50) 100 (21)

Sale Consideration Less: Cost of acquisition Capital Gains Less: Income Tax Gains after tax Tax Outflow

150 (50) 100 0 100 0

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Comparative Analysis - Singapore vis--vis Mauritius

Particulars`

Singapore

Mauritius

Indian tax antiavoidance considerations and substance requirements

Not regarded as a tax haven Benefits under the treaty are available subject to satisfaction of certain conditions which include - carrying of business operations; and total annual expenditure to be SGD 200,000 (in a period of 24 months preceding the date of sale of shares) Taxable only in Singapore provided substance requirements are met (available only till capital gains exemption benefit is available under India-Mauritius Tax treaty). No withholding tax on dividends and capital gains. Withholding tax on interest @ 15%

Recent denial of India-Mauritius treaty benefits over lacking substance despite residency certificate India-Mauritius Treaty under scrutiny Possibility of re-negotiation for preventing tax evasion

Favorable treaty provisions on capital gain

Exemption from capital gains tax, subject to fulfillment of substance test

Withholding tax on payments from India

No withholding tax on dividends and capital gains. Withholding tax on interest @ 21.01% (for foreign currency denominated debt) / 42.02% (for non-foreign currency debt, Indian rupee)
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Mauritius vis--vis Singapore - Overall Evaluation


 Well respected as a business and economic hub - Singapore is known for its sound financial and governance base.  Vis--vis other tax havens, Singapore is viewed as a preferred jurisdiction both commercially and optically.  Capital gains tax benefit is available under the India-Singapore treaty until the same is available under the India-Mauritius treaty.  Limitation of Benefit (LOB) clause (i.e. pre-conditions to be able to claim the capital gains tax benefit) under the India-Singapore treaty are specifically defined.  Availability of treaty benefits vis--vis tax havens (specially Mauritius) continue to be a bone of contention Central Board of Direct Tax (the apex Tax Administrative body in India) has set up a task force to advice on prevention of treaty shopping involving Mauritius treaty.

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Funding Options

Alternative modes of funding


Alternative modes of funding for Indian Company which may be considered are:  Share Capital  Equity share capital; and  Preference share capital*.  Debt  Debentures*  Overseas Debt / External Commercial Borrowings (ECB)
* Compulsorily Convertible Preference Shares (CCPS) and Compulsorily Convertible Debentures (CCD) are treated as Foreign Direct Investment and included in computing the foreign equity. Other variants of such instruments, for e.g. non-convertible preference shares (NCPS), optionally convertible preference shares (OCPS), partially convertible preference shares (PCPS), non convertible debentures (NCD), optionally convertible debentures (OCD), partially convertible debentures (PCD), etc. are considered as debt and shall require conforming to ECB guidelines.

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Few Key Aspects of Possible Funding Options


Particulars Equity Capital Compulsorily Fully Convertible Preference Shares Compulsorily Fully Convertible Debentures Overseas Debt/ ECB*

Regulatory approvals

Under automatic route

Treated as FDI, hence under automatic route

Automatic route available subject to guidelines prescribed for ECB Eligible borrowers Corporates; SEZ Units; etc. Recognized lenders International Capital Markets; certain FIs; Export credit agencies; Suppliers of equipment; Foreign collaborators; Foreign equity holders etc (Foreign equity holder can provide ECB if minimum paid up equity of 25% is held directly in the Indian company) End use restrictions are there. Permitted:- Investment in real sectors - Industrial sector, Infrastructure sector and specified service sectors namely, hotels, hospitals and software. Not permitted:- Real Estate sector; working capital; general corporate purpose; repayment of existing loans, etc.

End use restrictions

No specified end use restrictions

Restrictions on quantum Valuation

No cap

USD 500 million in a financial year under the automatic route. Additional ECB upto 250 million under approval route N.A

Fair valuation by SEBI registered Category-I Merchant Banker or Chartered Accountant as per Discounted Cash Flow (DCF) method. No deduction of dividend for tax purposes

Expense Deduction

Deduction of interest available for tax purposes

* includes NCPS, OCPS, PCPS, NCD, OCD and PCD


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Repatriation options

Repatriation options
 Alternative options for repatriation of profits/ capital include:  Dividend;  Buy back of shares;  Royalty; and  Consulting fee, etc.

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Key Aspects of Possible Repatriation Options


Criterion/ Option Buy back of shares Implications

Amount payable to shareholders restricted to 25% of (paid-up share capital + free reserves) 25% of equity share capital permitted to be repurchased in a financial year Buyback- Only possible from free reserves, share premium and funds received from fresh issue of shares Post repurchase, debt equity ratio not to exceed 2:1 Lock in period of 6 months for fresh issue of same class of shares Transfer from Resident to Non-Resident subject to RBI pricing guidelines like in case of Non-listed shares, transfer shall be at a price not less than the fair value arrived as per DCF Method (valuation to be carried our by Category I Merchant Banker or a Chartered Accountant)

Transfer from Non-Resident to Resident also subject to RBI pricing guidelines wherein transfer shall be at a price not more than the fair value arrived as per DCF Method (valuation to be carried our by Category I Merchant Banker or a Chartered Accountant)

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Key Aspects of Possible Repatriation Options


Criterion/ Option Dividend Implications

No prescribed fixed rate of dividends on equity shares - Flexibility to issue equity shares with differential dividends and voting rights, in case of a private limited company

Dividend income is exempt in the hands of shareholders - Company is required to pay DDT @ 16.2225% Dividend on shares not deductible as business expenditure for tax purposes. Only post tax profit can be repatriated by way of dividends. Mandatory transfer of profits to Reserves in case of dividends on equity shares (not required in case of dividend on preference shares)

Royalty

Royalty payments were earlier subject to certain regulatory restrictions. Liberalized policy now permits all payments for royalty, lump-sum fee for transfer of technology and payments for use of trademark/brand name under the automatic route without any regulatory restrictions

Consulting Fee

Transactions should conform with arms length principle from a Transfer Pricing perspective Payments shall be subject to tax in India at prescribed tax rate. Consulting fee is subject to an upper limit of USD 1 million per project. Accordingly, repatriation, subject to a limit of USD 1 million per project, can be made.

Transactions should conform with arms length principle from a Transfer Pricing perspective Payments shall be subject to tax in India at prescribed tax rate.
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2011 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved

THANK YOU ALL FOR YOUR ATTENTION !


Presenters contact details Name: Arvind Singal Email: asingal@kpmg.com
The views in this presentation are personal views of the Presenter. Further, the information contained is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although, the endeavor is 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 / this information without appropriate professional advice which is possible only after a thorough examination of facts / particular situation.
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