bbsr & co. llp...2015/11/04 · 7 explanation (i)(e) to 92b(1)… “(e) a transaction of...

BBSR & Co. LLP

Business Restructuring

Munjal Almoula

Nikhil Dhariwal

11 April 2015

1

1 Introduction and Relevance

Contents

2 Rationale for restructuring

3 Types of Restructuring

4 Transaction, Benchmarking and Documentation

© 2015 BBSR & Co. 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.

2

Introduction and

Relevance

3

Introduction and Relevance


4

Rationale for

Restructuring

5

Rationale for Restructuring

Business Drivers

• Profitable growth

• Globalization

• Customer demands

• Lower costs

• Shareholder value

Financial Drivers

• High domestic tax rates

• Complex transfer pricing

• Tax incentives

• More aggressive tax

authorities

• Trapped tax losses

Centralization of Planning and Management

SharedServices

Integrated Supply Chain Management

Global/regionalbusiness units

Aligned tax andbusiness structure

RiskManagement

Optimized SupplyChains

Improved Cash Flow

Lower effective tax rate

Facilitate global/regional customer demands

Less transfer pricing risk

Drivers Actions Benefits


6

Expanded definition

of international

transaction

7

Explanation (i)(e) to 92B(1)…

“(e) a transaction of business restructuring or reorganisation, entered into by an

enterprise with an associated enterprise, irrespective of the fact that it has bearing on the

profit, income, losses or assets of such enterprises at the time of the transaction or at

any future date”

Section 44DB on computing deductions in the case of business reorganization of co-

operative banks…

“business reorganisation” means the reorganisation of business involving the

amalgamation or demerger of a co-operative bank”


8

Types of

Restructuring

9

Types of Restructuring

Restructuring

Acquisitions

Asset

PurchaseStock

Purchase

Slump

Sale

Itemized

Sale

Capital

Re-organization

Merger

Demerger

Buy-back

Scheme of

Arrangement

Inbound

Outbound

Internal* External

Conversion of full-

fledged manufacturer

to limited risk

manufacturer

Conversion of full-

fledged distributor to

limited risk distributor

Transfer of Intangible

property rights to a

central entity

Issue of

shares

Capital

Reduction

* Internal restructuring primarily consist of internal re-allocation of functions, assets and risks within a multinational enterprise


10

External

Restructuring

11

Issue before Bombay High Court

Whether alleged shortfall in share premium arising out of shares issued by Vodafone India to its AE

constitutes chargeable income in hand of Vodafone India and thereby result in application of transfer

pricing provision?

Ruling of Bombay High Court

• A precondition for application of Transfer Pricing provision (i.e. Chapter X of the Act) is that there

should be income arising from “International Transactions”.

• The amount received on account of issue of shares to AE was a capital account transaction not

separately brought within the definition of “Income” under the Act. Therefore, in absence of express

legislation, the amount received, accrued or arising on account of capital account transaction could

be subjected to tax as “Income”.

• Thus, nether the capital receipt received by Vodafone India on issue of equity share to its AE nor

the alleged shortfall between so called fair market value of equity share vis-à-vis its issue price

could be considered as “Income” under the Act.

• Chapter X of the Act is machinery (i.e. computational) provision to arrive at ALP of transactions

External Restructuring

Issue of shares [Post Vodafone – Bombay High Court Ruling]


12

with AE and it is not a charging section (such as section 15 – Salaries, section 22 – Income from

House Property, etc.).

• In absence of charging section in Chapter X of the Act, it was not possible to read charging

provision into Chapter X of the Act.

• Based on above Bombay High Court concluded that there is no need to invoke transfer pricing

provisions (i.e. Chapter X of the Act) in case of issue of shares


Issue of shares

Based on the above principles and rulings, Bombay High Court in the

following rulings deleted adjustment on account on Issue of Shares:

Shell India Markets Pvt. Ltd (TS-380-HC-2014(BOM)-TP);

Essar Projects (India) Ltd. (TS-399-HC-2014(BOM)-TP);

S.G. Asia Holdings (India) Pvt. Ltd (TS-401-HC-2014(BOM)-TP)

Essar Power Ltd. (TS-402-HC-2014(BOM)-TP)


13


Merger

A merger involves the union of 2 or more legal entities into 1 legal entity accompanied by pooling of all

financial and other resources of the entities.

I Co

Merger of F Co A and F Co B

Shareholders F C0 A Shareholders F Co B

Co A Co B

100%

Applicability of transfer pricing

• Merger of F Co A with F Co B - Transfer of shares of

an I Co pursuant to the said merger, TP will not apply if:

atleast 25% of the shareholders of F Co A continue

to remain shareholders of F Co B; and

the merger needs to be tax neutral in other country.

In case above conditions are not fulfilled - TP would

apply

• Merger of I Co A with I Co B - TP will not apply,

transaction entered into between two domestic

companies

• Merger of F Co (WOS of I Co), with I Co - Tax neutral,

accordingly, TP will not apply


14


Demerger

Demerger involves transfer of identified business from one company to another and, in consideration,,

the company which acquires the business issues shares to shareholders of the selling company

I Co A

Demerger of Business B

Business A

Business A Business B

Demerged Business B

F Co

I Co B

100%100%

Applicability of transfer pricing

• Demerger of one of the undertakings of I Co A

(WOS of F Co) into I Co B (WOS of F Co) - Issue

of shares by I Co B to F Co . Tax neutral scenario,

accordingly TP will not apply


15


Acquisitions

Acquisitions

Asset

Purchase

Stock

Purchase

Slump

Sale

Itemized

Sale

Sale of business on a

going concern basis for a

lump sum or „slump‟

consideration

Sale of assets & liabilities

with values assigned

separately for each item of

assets & liabilities

F Co needs to interpose I Co to carry out slump sale / itemised sale and accordingly,

Transfer Pricing provisions will not apply


16

External Restructuring – Buyback of shares

• I Co is an unlisted company, which is 100% subsidiary of

F Co.

• I Co. buy-backs its shares from F Co.

• On the buy back transaction, I Co. will be liable to pay an

additional tax @ 20% on „distributed income‟ on buy-

back of shares as per Section 115QA of the Act

• The income would be exempt in the hands of the

shareholders under Section 10(34A) of the Act

• There is no income generated in the hands of Indian

company, therefore, no transfer pricing would apply

I Co A

F Co

100%Buyback of shares

In case of an unlisted company

• I Co is a listed company, of which 50% shares are held by

F Co. and 50% by other investors

• I Co. buy-backs its shares

• On the buy back transaction, the shareholders would be

liable to pay tax under Section 46A of the Act (Short term

rate – at applicable tax rates and long term – 20% with

indexation and 10% without indexation)

• I Co do not have to pay tax on the buy-back

• There would be transfer pricing implications in the

hands of shareholders

I Co A

F Co

50%Buyback of shares

In case of a listed company

Investors

50%


Buyback is acquiring its own shares from the existing shareholders by the company to reduce

its paid-up capital

17


Capital Reduction

Reduction of capital may be achieved in the following manner:

• Reduce liability on shares in respect of unpaid capital

• Extinguish liability on shares in respect of unpaid capital

• Pay paid-up capital in excess of wants of the company

• Cancel paid up capital which is lost or is not represented by available assets of the company

• Utilization of securities premium for purpose other than provided u/s 78 of the Company‟s Act

In the hands of

the Company

In the hands of

shareholder

• Sec 2(22)(d) of Income-tax Act, 1961 provides that distribution on account of

reduction of capital will be regarded as „deemed dividend‟ to the extent of

accumulated profits

• DDT payable by the company on such dividends

• To the extent of accumulated profits, dividend is exempt in the hands of

shareholders (since DDT paid by company on the deemed dividend)

• Excess over accumulated profits - chargeable as capital gains

• Transfer Pricing provisions will apply


18

Transaction,

Benchmarking and

Documentation

19

Transaction, Benchmarking and Documentation

Taxable Transaction:

• Capital Gain on Buy back / Capital Reduction of Shares

• Issue of Equity/Preference shares (CCPs, NCCPs) - Whether international transaction?

Benchmarking:

• Whether one needs to carry-out a functional analysis and characterize the entities involved?

• Which method can be used?

Documentation:

• Business objective of re-organisation / restructuring

• Documents supporting the transfer price i.e. DCF valuation

• Negotiation between the parties


20

Valuation

• Independent valuer‟s certificate – Generally considered for benchmarking the transaction of

purchase / sale of shares / assets

• Assumptions taken while valuing the shares / assets should be reasonable in the given

circumstances

Intel Asia Electronics Inc

The Bangalore Tribunal held that for assets sold to associated enterprises, third party valuation

could be the most appropriate means under the Comparable Uncontrollable Price Method

Tally Solution Private Limited

The Bangalore Tribunal upheld use of „Excess Earning Method‟ (subject to adjustments) while

determining ALP for sale of IPR

Ascendas (India) Private Limited

The Chennai Tribunal upheld the use of upheld use of DCF method to compute ALP for sale of

shares to AE

VIHI, LLC

The Chennai Tribunal held DCF method for determining ALP for issue price of share


21

Case studies on

Transfer Pricing

post merger

22

Case 1

R. Co

UKT. Co

Canada

T. Co

India

R. Co

India

Outside India

India

Worldwide acquisition

100 % Shareholding100 % Shareholding

ITES activities

(cost+15%)

ITES activities

(cost+10%)

IT Others

Slump Sale

Distribution

Business


23

Case 1

• R. Co and T. Co are independent MNCs having operations in India through their respective

subsidiaries

• Both have outsourced ITES to their respective Indian subsidiaries. R. Co is remunerated @

cost +15% and T. Co @ cost + 10%.

• R. Co gets acquired by T.Co overseas

• As a result of the global acquisition, to consolidate operations, ITES activity of R. Co is

transferred to T.Co by way of a slump sale

• Aligning TP policies post acquisition – to integrate with business changes

© 2015 BBSR & Co. 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.``

24

Case 2

• Whether a revised Transfer Pricing Study Report needs to be prepared and a revised

Accountants‟ Report is required to be filed?

B Co

IndiaA Co

India

AE of A Co

UK

AE of B Co

UK

Merger (say w.e.f April 2014)


25

Internal

Restructuring

26

Internal restructurings

Conversion of full-risk manufacturer into Contract Manufacturer

Distribution

Co. X

Distribution

Co. Y

Export sales

Company AEntrepreneur manufacturer

- Owns IP

Export sales

Pre restructuring

Outside

India

Pre-Restructuring Scenario

• Company A, Indian company, is an

entrepreneur manufacturer, owning all the

IPRs i.e. technical know-how, brand name,

etc.

• It has appointed Company X and Company Y

as its distributors in different markets

• Under the present arrangement, Company X

and Company Y would retain return on sales

undertaken by them

• The balance is remitted back to the Company

A as a return for its manufacturing activities,

owning technical know-how, brandname, etc.


27


Functional Analysis of Company A - Pre restructuring

Particulars Functions

Owns technology & conducts R&D √

Owns Raw Materials & Finished Goods √

Manufactures for himself (right to sell) √

Marketing Activities √

Particulars Assets

Tangible assets: manufacturing facility, work force, office premises, etc √

Intangibles: technical know-how, brandname √

Particulars Risks

Market Risk √

Inventory Risk √

Capacity Utilisation Risk √

Product Liability / Warranty Risk √

Technology / R&D Risk √


28

Contract

Manufacturing

Company A Contract manufacturer

Company ZEntrepreneur

Owns IP

Transfer of

IP and

Functions

Distribution

Co. X

Distribution

Co. Y

Export salesExport

sales

India

Outside

Restructuring carried out to achieve centralized management & control in a regional headquarter


Conversion of full-risk manufacturer into Contract Manufacturer

Post-Restructuring Scenario

• Post restructuring, Company A became a

contract manufacturer

• Company A transfers its technical know-how,

brandname/ tradename, etc to Company Z,

central management entity

• Company A would be manufacturing products

for Company Z using technical know-how and

brandname of Company Z

• For its activities, Company A would be

remunerated on a Cost Plus Basis

• Company Z would earn return for owning

brandname, technical know-how, etc


29


Functional Analysis – Post restructuring

Particulars Functions

Owns technology & conducts R&D X

Owns raw materials √

Manufactures for himself (right to sell) X

Marketing activities X

Particulars Assets

Tangible assets: manufacturing facility, work force, office premises, etc √

Intangibles: technical know-how, brandname X

Particulars Risks

Market Risk X

Inventory Risk X

Capacity Utilisation Risk X

Product Liability / Warranty Risk √

Technology / R&D Risk X


30

Part I: Allocation of Risks

Company A

Contract manufacturer

Company ZEntrepreneur Owns IP

Distribution

Co. X

Distribution

Co. Y

Export sales Export sales

Post restructuring

Contract

Conduct

Comparables

Hypothesise

ControlFinancial

Capacity

• Economic significance of Risks

Internal Restructurings

Transfer of

IP and

FunctionsContract

Manufacturing

India

Outside

Steps


31


Profit Potential

• Compensation required when transfer of rights

and / or assets

• No compensation for mere reduction in profit

To determine compensation

• Review of FAR before and after restructuring

• Evaluate Business reasons

• Consider options realistically available

Part II: Compensation for restructuring

Company A



Distribution

Co. X

Distribution

Co. Y


Post restructuring

Transfer of

IP and

FunctionsContract

Manufacturing

India

Outside


32


• Apply normal TP principles to avoid

competitive distortion

• Identify relationship between:

- Compensation for restructuring and

- Compensation for post-restructuring

• Compare pre and post restructuring

scenario

Part III: Remuneration of post

restructuring controlled transaction

Company A



Distribution

Co. X

Distribution

Co. Y


Post restructuring

Transfer of

IP and

FunctionsContract

Manufacturing

India

Outside


33

Internal Restructuring

Part IV: Recognition of the actual transactions undertaken

Pre restructuring Pre-Restructuring Scenario

• Company A, Indian company, is an entrepreneur

manufacturer, owning all the IPRs i.e. technical know-

how, brand name, etc.

• It has appointed Co. X as Limited Risk Distributor and

Co. Y as contract manufacturer in respectively.

• Co. X and Co. Y return the realized amount on sale of

group products after retaining their respective

margins.

• The difference between realized amount and cost of

product is the margin of Company A taxable in India.

• This return consists of two factors –return for supply

of services and return for the IPRs

Company AEntrepreneur Owns IP

Distribution

Co. X

Contract

manufacturer

Co. Y

Supply of

goods

India

Outside


34


Post restructuringPost-Restructuring Scenario

• Company A transfers the technical know-how,

brandname, etc to Company B under the

process of restructuring

• Company B would be dealing with Contract

manufacturer and limited risk distributors for

manufacturing and selling of goods respectively

• Post transfer, Company A becomes a routine

service provider and Company B becomes an

entrepreneur manufacturer

• Company A would now receive return for

rendering services and balance would be

passed on to Company B

India

Outside

Company A

Service Provider

Company BEntrepreneur Owns IPs

Distribution

Co. X

Contract

Manufacturing

Co. Y

Transfer of

IP

Return for

services

Supply of

goods


Transfer of functions/ IP to Company B


35


Post restructuringPost-Restructuring Analysis

• Company B does not have people who have the

authority and capabilities to perform functions in

relation to the risks associated with the strategic

development of the brandnames

• Company B does not have financial capacity to assume

these risks

• Key/ Strategic decisions are prepared in Company

A’s office by employees of Company A and validated in

Company B‟s office by employees of Company A

• Development, maintenance and execution of the

worldwide marketing strategy are still performed by

Company A

• Therefore, Company B does not have the real

capabilities to take the risks

Company A

Service Provider

Company BEntrepreneur Owns IPs

Distribution

Co. X

Contract

Manufacturing

Co. Y

Transfer

of IP

Return for

services

India

Outside

Supply of

goods


Transfer of functions/ IP to a Shell Company

Based on the above facts, the tax authorities could reject the re-structuring due to lack of

economic substance and business reasons for such structuring


36

Key Takeaway

37

Key Takeaway

The business team and tax team should work more closely to align business and tax structures

The taxpayer should maintain robust documentation to capture the commercial reasons of re-

structuring

The taxpayers should undertake valuations (wherever required) of assets/ shares, etc based on

acceptable valuation methods

Set up appropriate transfer pricing policies with respect to international transactions post re-

structuring

Prepare and document appropriate dispute resolution strategies with respect to the international

transactions to be undertaken post restructuring


Thank you

Munjal Almoula

Partner

Global Transfer Pricing Services

T: + 91 22 3090 1760

E: [email protected]

Nikhil Dhariwal

Senior Manager

Global Transfer Pricing Services

T: + 91 22 3090 1519

E: [email protected]

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