Taxing Implications On A Joint Venture

Taxing implications on a Joint Venture Manish Madhukar

Kaushambi Ghosh

Mohit Almal

Mirza Sakhawat Ullah

Manoj Mani Iyer

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Agenda • Joint Venture – Definition – Classification – Objectives – Factors involved

• Deal Structuring • Case Citation

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Joint Ventures • Joint venture is a strategic alliance in which two or more firms create a legally independent company to share some of their resources and capabilities to develop a competitive advantage. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise.

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Classification • A typical Indian Joint Venture is where: – Two parties (individuals or companies), incorporate a company in India. Business of one party is transferred to the company and as consideration for such transfer, shares are issued by the company and subscribed by that party. The other party subscribes for the shares in cash – The above two parties subscribe to the shares of the joint venture company in agreed proportion, in cash, and start a new business – Promoter shareholder of an existing Indian company and a third party, who/which may be individual/company, one of them non-resident or both residents, collaborate to jointly carry on the business of that company and its shares are taken by the said third party through payment in cash 4

Invest in a U.S company with a services fulfillment subsidiary in India

Financial Investor (FII or FVCI)

Direct investment in Indian company from destination like Mauritius & Cyprus Direct Investment in Indian company through a venture Capital fund which is registered under SEBI

Investing in India

Branch office Operate as a Foreign Company

Liaison office

Project office

Strategic Investor

Joint venture Operate as an Indian Company

Public

Wholly owned Subsidiary Private

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Primary Goal to start a JV • Extend the Market reach • Get access to needed information and resources • Build credibility with a particular target market • Access new market which is inaccessible without the partner 6

Types of JV • Corporate Joint Ventures • Contractual Joint Ventures

• Partnerships • Trusts 7

Key factors involved in JV • • • • • • • • • •

Early considerations Understanding FDI rules Conducting appropriate due diligence Structuring the joint venture vehicle Company formation Obtaining regulatory licences and approvals Employee issues Taxation and duties Protecting intellectual property rights (IPR) Joint venture documents 8

Government Approvals • All the joint ventures in India require governmental approvals, if a foreign partner or an NRI or PIO* partner is involved • The approval can be obtained from either from RBI or FIPB (Foreign Investment Promotion Board). In case, a joint venture is covered under automatic route, then the approval of Reserve bank of India is required • In other special cases, not covered under the automatic route, a special approval of FIPB is required Investment limits.xlsx *Person of Indian Origin: For investments in immovable properties A foreign citizen (other than a citizen of Pakistan, Bangladesh, Afghanistan, China, Iran, Bhutan, Sri Lanka, or Nepal) is deemed to be of Indian origin if, (i) he held an Indian passport at any time, or (ii) he or his father or paternal grand-father was a citizen of India by virtue of the Constitution of India or the Citizenship Act, 1955 (57 of 1955)

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Deal Structuring-Key Consideration Choice of Jurisdiction (Taxability of)

Investment Vehicles

Funding options

Operational Synergies

Equity Dividends

Regulations

Preference Capital Gains

Interest on Debt Funding

Tax considerations

Convertible Debt Differential Rights 10

Choice of Jurisdiction • Taxability of – Distribution of Dividends • In Indian context, any Jurisdiction is tax neutral due to the fact that DDT @ 16.995% is levied upon the distributing company

– Capital Gains • Capital Gains would arise upon the sale of the investment in India. Thus, this aspect concerns the exit option for the investor. • In the Indian context, gains made on the sale of investment attracts a capital gain tax of 20% if the holding period of the asset is less than 3 years and 10% if the holding period exceeds 3 years. In view of the same, the investment can then be structured through a holding company set up at a location where such gains are exempt. 11

Choice of Jurisdiction • Taxability of – Interest on Debt funding • Interest on debt funding is a very critical part of the entire transaction • The tax deductibility of these expenses is critical, since this would result in a considerable amount of savings

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Choice of Jurisdiction Income Stream

Israel

Mauritius

Singapore

Netherlands

Cyprus

Dividends

Nil*

Nil*

Nil*

Nil*

Nil*

Capital Gains

Taxable in India@ 21.12%(long term &42.23%(Sho rt term

Exempt in India

Exempt in India subject to limitations on amount

Exempt in India if holding is less than 25%

Exempt in India

Interest

Withholding Withholding Withholding Withholding Tax tax @ 10% tax @ 15% tax @ 10% @21.15%

Withholding tax @ 10%

*Dividend Distribution Tax is payable by the Indian company @ 16.995%

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Investment Vehicle • The choice of investment vehicle is largely based on the regulations and the tax considerations existing in the country where the target company is situated • The overall guiding principle would be that the investment vehicle qualifies to claim treaty benefit under the tax treaty between India and the relevant jurisdiction • The choice of investment vehicle would be considered at 2 levels : – Jurisdiction Level – Indian Level(Country of the target Company) 14

Investment Vehicle • Jurisdiction level Parameters – Ease of formation and administration – Ease of Exit – Local Regulatory(non-tax considerations) – Tax treatment in the country of residence – Tax differentiators vis-à-vis tax treaties with India. This becomes critical due to the fact that the same income not be taxed twice under two different jurisdictions 15

Investment Vehicle • Indian level Parameters – FDI restrictions in India based on the sectoral caps in place – Regulatory registrations and administration

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Taxation and duties • The impact of tax treaties and agreement between various countries and the optimum use of offshore finance centers and tax havens is critical for structuring a transaction

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Funding Options • The funding options available for the structuring would vary depending upon the present structure of the company and the availability of debt. The normal options available would be Equity, Preference, Convertible Debt and Differential Rights apart from the structured funding options. These would vary based on : – The investor's preference for dividend or liquidation or both – Prevailing Indian exchange control laws, which do not permit foreign equity investment beyond a certain level in certain sectors – The investor may wish to get disproportionate voting rights on its investment in return for the strategic value such investor may bring to the table – Restrictions placed by the Indian corporate and securities laws with respect to equity shares which may not suit the commercial understanding between the parties

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Equity • Most sectors have been opened up for foreign investment and, hence, no approvals from the government of India are required for issue of fresh shares with respect to these sectors • The tax implications are as under : – Dividends • Dividends can be freely repatriated under exchange regulations • Transfer to reserves before declaring dividends • Dividends not taxable in hands of shareholders • The domestic company must pay dividend distribution tax (DDT) at the rate of 16.995% (15% plus surcharge of 10% and education cess of 3%) – Capital • Repatriation of funds not possible, as equity capital cannot be withdrawn during the life-span of the company, except in the case of a buy-back of shares 19

Preference Capital • Preference shares (except foreign through fully convertible) are considered as debt and has to be issued in conformity with ECB guidelines/caps • Tax Implications – Dividends • On fully convertible, can be repatriated but the maximum rate is capped • On any other type needs to confirm to the all-in-cost ceiling prescribed in the ECB guidelines • Tax Implications same as Equity shares – Capital • No company can issue preference shares that are either non-redeemable, or are redeemable after 20 years from the date of their issue 20

Example • Following is an example of a possible capital structure that can be arrived at a deal by a foreign investor who is taking into account exit options and is investing 20 billion INR in a wholly owned subsidiary

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Example • Parameters to be considered for Capital Structure – Different classes of shares in smaller amounts facilitate exit through buy back of an entire class of shares as against pro-rata buy back from all investors in the same class – Share premium can be utilized for buy back of shares under the Indian corporate laws in the absence of profits – 100% of the CCPS can be bought back in a single year unlike equity shares where there is a limit of 25% per year – CCD's facilitate exit and also improve IRRs through regular flow of interest

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Hutch-Vodafone Deal • On February 12 2007, HTIL sold its 67% interest in Hutchison Essar to a subsidiary of Vodafone for a total consideration of US$10.7 billion, to be satisfied in cash • Vodafone will assume net debt of approximately US$2.0 billion, estimated as at 31 January 2007 • The consideration represents a premium to HTIL's telecom assets in India and unlocks substantial value of its investment in the country

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Hutch Vodafone Deal • Hutchison International, a non-resident seller and parent company based in Hong Kong sold its stake in the foreign investment company CGP investments Holdings Ltd, registered in the Cayman Islands, which in turn held shares of Hutchison Essar (the Indian company) to Vodafone, a Dutch non-resident buyer. The deal consummated for a total value of $11.2 billion, which comprised a majority stake in Hutchison Essar India • In the light of this, the Revenue issued show-cause to Vodafone asking for an explanation as to why Vodafone Essar (which was formerly Hutchison Essar) should not be treated as an agent (representative assessee) of Hutchison International and asked Vodafone Essar to pay $1.7 billion as capital gains tax. 24

Hutch Vodafone Deal • Controversy – The whole controversy in the case of Vodafone is about the taxability of transfer of share capital of the Indian entity – Generally the transfer of shares of a non-resident company to another non- resident is not subject to tax in India – But the revenue department is of the view that this transfer represents transfer of beneficial interest of the shares of the Indian company and, hence, it will be subject to tax

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Hutch Vodafone Deal • Vodafone’s argument – Vodafone's argument is that there is no sale of shares of the Indian company and what it had acquired is a company incorporated in Cayman Islands which in turn holds the Indian entity. Hence the transaction is not subject to tax in India

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Hutch Vodafone Deal • Ruling favoring Vodafone – Revenue would be left with little choice but to propose an amendment of the tax legislation to include the concept of beneficial ownership in the definition of 'transfer‘ – Given the volume of crossborder deals involving Indian companies, the Revenue taking this step is not farfetched

• Ruling favoring Revenue – Revenue authorities can go ahead and assess the agent for recovery of various tax liabilities on transactions of the non- resident entity, including the capital gains tax liability on the transfer of beneficial ownership of the Indian entity – This would mean any transaction happening anywhere in the world would be subject to tax in India, if nexus with India is proved 27

Thank You

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