business reorganisation and issues - the chamber of tax ... · transfer and therefore the charging...

Business Reorganisationand Issues

1 March 2014

Sanjay Tolia

Presentation Outline• Introduction and Relevance

• Expanded definition of international transactions

• Rationale for restructuring and concerns

• Subscription of shares

• Applicability of Transfer Pricing in non taxable event• Applicability of Transfer Pricing in non taxable event

• M&A and Transfer Pricing

• Case Studies on Transfer Pricing issues post Business Reorganisation

• Business Restructuring – OECD Guidelines

• General Anti Avoidance Rule

• Way forward

2March 2014

Introduction and Relevance

3March 2014

Introduction and Relevance

4March 2014

Expanded definition of internationaltransaction

5March 2014

Explanation (i)(e) to 92B(1)…

“(e) a transaction of business restructuring or reorganisation, entered into by anenterprise with an associated enterprise, irrespective of the fact that it has bearingon the profit, income, losses or assets of such enterprises at the time of thetransaction or at any future date”

Impact

• Advance rulings in case of Vanenburg, Dana Corporation, Amiantit, etc overruled - ‘No tax, no• Advance rulings in case of Vanenburg, Dana Corporation, Amiantit, etc overruled - ‘No tax, notransfer pricing’ does hold good?

• Disclosure requirements in Form 3CEB irrespective of the fact that it has bearing on the profit,income, losses or assets - at the time of the transaction or at any future date

Issue

• Identification of transactions in the nature of business restructuring or reorganisation?

March 20146

Rationale for restructuring andconcerns

7March 2014

Rationale for restructuring

DriversActions Benefits

Business Drivers

Profitable growth Globalization Customer demands

planning& mgmt

Centralization of

Shared services

Risk centralization

Optimizedsupplychains

Customer demands

Lower costs

Shareholder value

Financial Drivers High domestic tax rates Complex transfer pricing Tax incentives More aggressivetax authorities Trapped tax losses

Integrated supplychain management

Global/regionalbusiness units

Improved cash flow

Lower effective

Facilitate global/ regionalcustomer demands

tax rate

Aligned tax andbusiness structure

Less transferpricing risk

March 20148

Business restructuring common concerns

• Exit tax

- Goodwill disposition

- Local IP

- Agreement termination

• Substance requirements

• Commercial rationale ofrestructuring

• Arm’s length nature of new TP

policy

• Treatment of issues by OECD

Vs Non- OECD Countries

• PE risk

• Implication from a Indirecttax perspective

• Specific local requirements

The risk assessment and risk mitigation strategy will enable to anticipatethe most likely queries that could be raised by the Tax Authorities.

Being prepared and having the correct documentation available helps withthe discussions with the Tax Authorities.

March 20149

Subscription of shares

10March 2014

Subscription of shares

Taxable Transaction (Revenues contention) :

• Foreign entity subscribed to shares of its Indian arm at prices much lower

than the market price or fair price;

• Market price of unlisted shares that the Revenue is taking recourse to

Discounted Cash Flow (‘DCF’) Methodology ;

• DCF method is very subjective on growth projections and various• DCF method is very subjective on growth projections and various

assumptions providing an opportunity to the Revenue to challenge the

valuation done by the tax payer

11March 2014

M/s Vijai Electricals .The Hyderbad Tribunal held that for such transactions transactions are not in thenature of transactions referred to section 92-B of the IT Act and the transfer

pricing provisions are not applicable as there is no income.

Applicability of Transfer Pricing innon taxable event

12March 2014

Transfer of Shares - Dana Corporation (A.A.R. No.788 of 2008)

AAR Ruling:

• Section 45 must be read with section48 and if computation provisioncannot be given effect to for anyreason, the charge under section 45 ofthe Act fails.

• There was no consideration for the

13

• There was no consideration for thetransfer and therefore the chargingprovisions under section 45 of the Actbecame inapplicable

• Section 92 is not intended to bring ina new head of income or to charge thetax on income which is not otherwisechargeable under the Act.

March 2014

Transfer of Shares - Amiantit InternationalHolding Ltd. (A.A.R. No. 817 of 2009)

Contribution / Gift ofshares of Indian

Company withoutconsideration

AAR Ruling:

• When the computational provisions(section 48) cannot be applied at all, thecase is not intended to fall within thecharging section (section 45)

• If the consideration is such that it isincapable of being valued in definite

14

Foreign Company(Bahrain)

IndianCompany

ForeignCompany(Cyprus)

100%70%

consideration incapable of being valued in definiteterms or is unascertainable on the date oftransfer, section 45 read with section 48of the Act cannot be applied

• As regards the applicability of section 92of the Act to this transaction, relyingupon its view in the case of DanaCorporation, the AAR held that in a casewhere income was not chargeable to taxat all, the provisions of Chapter X (TPprovisions) are not attracted

March 2014

Section 92 in case of non-taxable event

Section 92 is a machinery provision and not thecharging section. Accordingly, in case the

transaction is not taxable , the Transfer Pricingprovisions would not apply.

Vanenburg Group B.V. (A.A.R. No. 727 of2006)VNU International B.V. (A.A.R. No. 871 of2010)

15

2010)

March 2014

Transfer of Shares – Castleton Investment Ltd (TS-607-AAR -2012)

AAR Ruling:

• AAR emphasized that TP provisions do not automatically become inapplicable if thereis no liability to pay tax.

M&A and Transfer Pricing

16March 2014

Modes of M & A

Restructuring

AcquisitionsCapital

Re-organisationScheme of

Arrangement

17

AssetPurchase

StockPurchase

SlumpSale

ItemizedSale

Re-organisation

Merger

Demerger

Buy-back

CapitalReduction

Arrangement

Inbound

Outbound

March 2014

Merger

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,

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

Merger of F Co A and F Co B

Shareholders F C0 A Shareholders F Co B

18

shares of an I Co pursuant to the said merger,

TP will not apply if atleast 25% of of

shareholders of the F Co A continue to remain

shareholders of F Co B. The merger needs to

be tax neutral in other country.

• Merger of I Co A with I Co B – TP will not

apply

• Merger of F Co with I Co (WOS of I Co) – Tax

neutral, accordingly TP will not apply

I Co

Shareholders F C0 A Shareholders F Co B

Co A Co B

100%

March 2014

Demerger

Applicability of Transfer Pricing

• Demerger of one of the undertakings of I Co A

Demerger involves transfer of identified business from onecompany to another and in consideration, the company whichacquires the business issues shares to shareholders of theselling company

Demerger of Business B

19


(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


into I Co B – TP will not applyI Co A

Business A

Business A Business B

DemergedBusiness B

F Co

I Co B

100%

100%

March 2014

Acquisitions

Acquisitions

AssetPurchase

StockPurchase

20

SlumpSale

ItemizedSale

Sale of business on agoing concern basis for alump sum or ‘slump’consideration

Sale of assets & liabilitieswith values assignedseparately for each item ofassets & liabilities

F Co needs to interpose I Co to carry out slump sale / itemised sale andaccordingly, Transfer Pricing provisions will not apply

March 2014

Buy-back

On Buyback/ Sale of shares the shareholder is liable to tax based on the following criteria:• Shares held for 12 months or less = Short Term• Shares held for more than 12 months = Long Term

• No Deemed Dividend Tax implication in the hands of Company

Buyback is acquiring its own shares from the existing shareholdersby the company to reduce its paid-up capital

• No Deemed Dividend Tax implication in the hands of Company

• Transfer Pricing regulations, applies, unless the transaction is nottaxable in India

• Under Income-tax Act, 1961 - Section 47(iv) exempts capital gainson ‘transfer’ of capital assets by a Holding company to its WOS

- Holding – WOS relationship to be retained for eight years

TaxImplications

21March 2014

Buy-back – Exchange Control provisions

• Pricing norms specified by regulatory authorities to be complied with - Maximumconsideration payable as per RBI pricing guidelines

- Listed shares: Price to be average quotations (average of daily high & low) for oneweek preceding the date of application with 5% variation

- Unlisted shares :

Old provisions New provisions

• The fair valuation done by a Chartered • The fair valuation of shares would be

22

• The fair valuation done by a Chartered

Accountant as per the erstwhile

Controller of Capital Issues (CCI)

guidelines

• The fair valuation of shares would beundertaken by a SEBI registeredMerchant banker or a CharteredAccountant as per the DiscountedFree Cash Flow (DCF) method1.

1 Reserve Bank of India (RBI) has, by a notification dated 7 April 2010 amended the FDI Regulation with regardto pricing guidelines. The amendments are made effective from 21 April 2010.

March 2014

Capital ReductionReduction 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

– Utilisation of securities premium for purpose other than provided u/s 78

In the hands ofthe Company

In the handsof shareholder

• Sec 2(22)(d) of Income-tax Act, 1961 provides that distribution on account ofreduction of capital will be regarded as ‘deemed dividend’ to the extent ofaccumulated profits.

• DDT payable by the company on such dividends

• Transfer Pricing provisions will apply

• To the extent of accumulated profits, dividend is exempt in the hands ofshareholders (since DDT paid by company on the deemed dividend)

• Excess over accumulated profits - chargeable as capital gains

• Transfer Pricing provisions will apply

23March 2014

Transaction, Benchmarking and Documentation

Taxable Transaction:

• Capital Gain on Buy back / Capital Reduction of Shares

• Issue of Equity/Preference shares (CCPs, NCCPs) – Whether a transaction?

Benchmarking:

• Whether one needs to carryout a functional analysis and characterise the• Whether one needs to carryout a functional analysis and characterise the

entities involved?

• Which method can be used?

Documentation:

• Business objective of re-organisation / restructuring

• Documents supporting the transfer price

• Negotiation between the parties

24March 2014

Valuation

• Independent valuer’s certificate – Generally considered for benchmarkingthe transaction of purchase / sale of shares / assets

• Assumptions taken while valuing the shares / assets should be reasonablein the given circumstances

Intel Asia Electronics Inc.The Bangalore Tribunal held that for assets sold to associated enterprises, third party

25

The Bangalore Tribunal held that for assets sold to associated enterprises, third partyvaluation could be the most appropriate means under the Comparable Uncontrollable

Price Method.

March 2014

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.

Case studies on Transfer Pricing postmerger

26March 2014

Case 1

• R. Co and T. Co are independent MNCs having operations in India thrutheir respective subsidiaries

• Both have outsourced ITES to their respective Indian subsidiaries. R. Co isremunerated @ 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, ITESactivity of R. Co is transferred to T.Co by way of a slump sale

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

27March 2014

Case 1

R. CoUK

T. CoCanada

Outside India

India

Worldwide acquisition

100 % Shareholding 100 % Shareholding

T. CoIndia

R. CoIndia

India

ITES activities

(cost+15%)

ITES activities

(cost+10%)

IT Others

Slump Sale

DistributionBusiness

28March 2014

Business Structuring – OECDGuidelines

29March 2014

OECD Guidance - TP aspects of BusinessRestructuring

• Final Report – Released on 22 July 2010 (Ch.IX of TP Guidelines with 4Parts)

Guidance

Arm’s lengthcompensation for

restructuringitself

Remuneration ofpost –

restructuringcontrolled

transactions

Recognition ofthe actual

transactionsundertaken

Specialconsiderations

for risks

30March 2014

Business restructurings – Case studies

Conversion of full-risk manufacturer into Contract Manufacturer

Company AEntrepreneur manufacturer

- Owns IP

Pre restructuring

DistributionCo. X

DistributionCo. Y

Export sales Export sales

Outside

India

31March 2014

Part I: Compensation for restructuring…

Profit Potential

• Compensation required whentransfer of rights and / or assets

• No compensation for merereduction in profit

ContractManufacturing

Company AContract manufacturer Transfer

ofIP andFunctions

Post restructuring

India

To determine compensation

• Review of FAR before and afterrestructuring

• Evaluate Business reasons

• Consider options realisticallyavailable

Company ZEntrepreneur

Owns IP

DistributionCo. X

DistributionCo. Y


Outside

32March 2014


Company AContract manufacturer

Company Z

Transfer ofIP andFunctions

India

Outside

Post restructuring

Part I:….


Owns IP

DistributionCo. X

DistributionCo. Y


Outside

Restructuring carried out to achieve centralized management & control in a regionalheadquarter

33March 2014

Part II: Allocation of Risks



TransferofIP andFunctions

Post restructuring

India

Contract

Conduct

Steps


Owns IP

DistributionCo. X

DistributionCo. Y


OutsideComparables

Hypothesise

ControlFinancialCapacity

• Economic significance of Risks

34March 2014

Part III: Post Restructuring



TransferofIP andFunctions

Post restructuring

India

• Apply normal TP principles toavoid competitive distortion

• Identify relationship between:

- Compensation forrestructuring and


Owns IP

DistributionCo. X

DistributionCo. Y


Outsiderestructuring and

- Compensation for post-restructuring

35March 2014

Part IV: Recognition

Company BContract manufacturer

Transfer of functions/IP to a shell company

Pre restructuring

Contract manufacturer

Company CDistributors

Company AEntrepreneur Mfg

Physical flow ofgoods

36March 2014

Part IV: Recognition

Company B

Transfer of functions/IP to a shell company

Transfer of Brand name,Technology AND `KEY EMPLOYEES`

Post restructuring

Company BContract manufacturer

Company CDistributors

Company AService Provider

Physical flowof goods


ALP for central services

37March 2014

Good and Worrisome

• Impact of OECD’s Guidance

- Tax authority to respect commercially rational restructuringtransactions that have economic substance

- Restructuring may be disregarded in exceptional situation

- Non-arm’s length behaviour to be addressed through priceadjustment

- Restructuring to be evaluated not from group’s perspective buteach entity’s perspective

38March 2014

Good and Worrisome

• Impact of OECD’s Guidance (contd..)

- Post restructuring to be addressed under normal TP rules

- Tax authorities may want to look at entirety of arrangements

- Presence of Tax motive is not sufficient for non-recognition

- Documentation requirements are stringent

39March 2014

General Anti Avoidance Rule (‘GAAR’)under Chapter X-A of the Act

40March 2014

GAAR

• Deferred by two years

• “Main purpose” to obtain tax benefit

• Onus on tax-payer!

• Treaty override

• Independent Approving Panel

Impermissible avoidance arrangement

Anarrangement

Not at arm’s-length

Lacks commercialsubstance

Disregard, combine recharacteriseany step

Treats arrangement as void, ortreat in any other manner

arrangementwhose“main”

purpose is to“obtain a tax

benefit”

substance

Misuse /Abuse of the Act

Not for bona fidepurposes

Disregard accommodating party

Treat connected persons and otherparty as one and the same

Reallocation amongst parties to anarrangement

Re-characterize Equity -Debt,Income, expenses, relief, etc

42March 2014

Way Forward

March 201443

Way Forward

DisputeResolution

Pricing Policy and

Public Documents

• Website

People

• ManagementResolutionStrategies

Pricing Policy andDocumentation

• Website

• Annual Reports

• Other publications

• Managementand Taxteam – closerinteraction

44March 2014

Questions

45March 2014

Thank You