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
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• 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
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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
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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
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• 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
• Demerger of one of the undertakings of I Co A
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
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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
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• 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
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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
Export sales Export sales
Outside
32March 2014
ContractManufacturing
Company AContract manufacturer
Company Z
Transfer ofIP andFunctions
India
Outside
Post restructuring
Part I:….
Company ZEntrepreneur
Owns IP
DistributionCo. X
DistributionCo. Y
Export sales Export sales
Outside
Restructuring carried out to achieve centralized management & control in a regionalheadquarter
33March 2014
Part II: Allocation of Risks
ContractManufacturing
Company AContract manufacturer
TransferofIP andFunctions
Post restructuring
India
Contract
Conduct
Steps
Company ZEntrepreneur
Owns IP
DistributionCo. X
DistributionCo. Y
Export sales Export sales
OutsideComparables
Hypothesise
ControlFinancialCapacity
• Economic significance of Risks
34March 2014
Part III: Post Restructuring
ContractManufacturing
Company AContract manufacturer
TransferofIP andFunctions
Post restructuring
India
• Apply normal TP principles toavoid competitive distortion
• Identify relationship between:
- Compensation forrestructuring and
Company ZEntrepreneur
Owns IP
DistributionCo. X
DistributionCo. Y
Export sales Export sales
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
Company ZEntrepreneur
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