The Hindu Business Line : When foreign targets blip on your deal radar

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When foreign targets blip on your deal radar

Achieving global effective tax rate (GETR) reductions will improve post-tax cash flows and enhance shareholder value. However, tax planning should not be conducted in isolation but must be integrated into business initiatives.

MR GAURAV TANEJA, NATIONAL TAX DIRECTOR AND PARTNER, ERNST & YOUNG, INDIA.

Raj Kapoor's Sangam of the early 1960s got filmmakers thinking of heading Westwards, rather than stick to Ooty, Kashmir, Mahabaleshwar, Lonavala, Mussoorie, and so on. Thus recounts Komal Nahta in an article Shooting Indian films abroad, posted on http://sify.com. "Among the other old films which brought plenty of foreign locales alive on the silver screen were Pachhi's International Crook, Shakti Samanta's An Evening In Paris and Great Gambler, Manoj Kumar's Purab Aur Pachhim, Brij Sadanah's Night In London, the Sameer-Simi starrer Pasand Apni Apni and the Rajesh Khanna starrer, Aashiq Hoon Baharon Ka. Much later, in the mid-1990s, Rishi Kapoor debuted into direction with Aa Ab Laut Chalen which was shot about 70 per cent abroad."

Well, this story is not about Indian films but Indian firms that are shooting abroad, shooting not movies but targets that get snapped shut in their deal camera. In the first two months of this calendar year, the number of outbound cross-border deals was 40 valued at $21 billion, according to Grant Thornton. "We are seeing outbound deals much larger in number and value compared to inbound deals," states the firm's Dealtracker. "The key rationale for outbound deals have been to make significant strides in the international market by making high value acquisitions." Aggressive, you may say, because in most of the large deals, `the acquirer has bought companies with values larger their own revenues,' as in the case of Tata-Corus and Hindalco-Novelis.

"While large deals have hit the headlines, mid-size companies are also in the fray to optimise growth through outbound acquisitions. Action is visible in various sectors such as manufacturing, commodities (metals), pharma, IT, oil and gas, auto, telecom and so on," says Gaurav Taneja, national tax director and partner, Ernst & Young, India, in a recent interaction with Business Line.

"Indian enterprises are contributing significantly to the global economy. They are no longer low-cost outsourcing partners but are establishing themselves as global business partners," he says. "By acquiring companies overseas and, in fact, turning around these companies and putting them back on the profitable path, several Indian enterprises have created a brand name for themselves and boosted India's image."

Gaurav has over 18 years of experience in tax and regulatory consulting. He has advised Indian and multinational companies on tax and investment structuring, double tax treaties, M&A (mergers and acquisitions) and establishment of business in India. A commerce graduate from Delhi University, and a chartered accountant, Gaurav was earlier a partner with another Big 4 accounting firm and CFO of Bacardi Martini India. He is Co-Chairman on the Taxation Committee of the Federation of Indian Chambers of Commerce and Industry (FICCI), and Chairman of the Tax and Tariff Committee of the American Chamber of Commerce (AMCHAM).

Here is Gaurav's take on a few questions about outbound investments.

Is tax a major consideration in acquisition?

Integration with the target is important, including on a cultural platform. However, on the tax front, enterprises must achieve global effective tax rate (GETR) reductions which, in turn, will improve post-tax cash flows and enhance shareholder value. However, tax planning should not be conducted in isolation but must be integrated into business initiatives. Designing a tax effective supply chain structure, for instance, will help achieve this objective.

How to reduce GETR?

Achieving a GETR reduction entails looking at the following aspects:

Review of the international holding company structure, which could consider issues such as tax efficiency in profit repatriation and cash extraction from operating entities and tax deferral benefits for ultimate shareholder/promoter groups.

Evaluation of the need for using intermediary holding companies for the operating entities, keeping in mind specific local country tax issues.

Review of the withholding tax on cross-border transactions among the various group entities as well as with third party customers and evaluation of opportunities for minimising the same, this would include considering foreign tax credit eligibility.

Designing a tax effective supply chain system and transfer pricing model which would enable the group to optimise allocation of revenues and costs among group entities.

Business exigencies and transfer pricing principles dictate that allocation of revenue between related parties should be commensurate with the functions performed, risks assumed and assets owned by the respective entities.

On forming a `principal company' in a favourable location.

When feasible, from a commercial perspective, the Indian group could consider consolidating its significant value adding functions, associated risks and ownership of intangible property in a `principal company' located in a jurisdiction such as Singapore or Switzerland which, in addition to being an attractive place for doing business, also offers customised tax incentives and rulings based on the scale of operations.

In such a scenario, transfer pricing principles could permit allocating significant revenue from the supply chain to this entity (which would be taxed at a low effective tax rate). Other operating entities in the group could be risk mitigated resulting in lower profits. However, in any such exercise the global business model of the enterprise must be examined and realignment must be backed by substance.

From a tax angle, do Indian enterprises face any hurdles when repatriating funds back to India?

Tax policies must not only aid foreign investments but also repatriation of foreign profits back into the country. Dividends are the simplest way of repatriating funds back into India from overseas investments, be it from JV investments or wholly-owned subsidiaries. However, this entails a substantial tax cost. When overseas dividends are received from a foreign subsidiary, tax is levied under the Indian Income-Tax Act, 1961 at 33.99 per cent (rate as proposed in the Finance Bill, 2007 — for SMEs the proposed rate is 30.09 per cent). Repatriation of capital gains suffers from the same tax incidence, with the tax incidence being as high as 33.99 per cent (as explained above) for short term capital gains.

In addition to this tax incidence on overseas dividend income, Indian business entities face a double whammy because of absence of underlying tax credit. Underlying tax credit (credit for the taxes borne by the subsidiary on the income from which dividend is paid) is allowed only under provisions of tax treaties entered into with Singapore and Mauritius.

What then are the options for companies?

Indian enterprises are forced to look for low-tax intermediary jurisdictions to set up holding companies and outbound investments are routed through such jurisdictions. As long as the income, be it dividends or capital gains, is held at the holding company level, no tax is payable by the Indian shareholder (Indian investor company) in India.

Tailpiece

"I knew that the English teacher was earlier in finance, when... "

"He started talking mumbo-jumbo?"

"No, he wrote on the board `Prometheus outbound'!"

Do other countries have in place a mechanism to mitigate tax costs arising on repatriation of overseas profits back to the home country?

Yes, several countries have in place mechanisms to help mitigate this tax cost. One of the popular mechanisms is the `participation exemption regime'. Countries which provide for this regime include the Netherlands, Luxembourg, Ireland, Spain, Cyprus and Austria. Under their domestic tax regime, foreign dividends and capital gains are exempt when repatriated back into the home country, subject to certain shareholding norms in the overseas entities. Further, the shareholding norms are not high and range upward of 5 per cent.

It is also important to note that not all these countries are tax havens. However, owing to a liberal tax regime, these countries have become popular for setting up of holding companies. In fact, the Netherlands is a popular jurisdiction for Indian investors to set up holding companies.

Indian companies targeting outbound acquisitions or even setting up operations overseas should look at the global tax impact and take appropriate measures prior to actual investments. They could look at an appropriate jurisdiction to set up a holding company — one that provides for a good treaty network, relaxations from withholding tax in the source country, ease of formation and operations. Luxembourg, Belgium, the Netherlands, Cyprus, Switzerland, Mauritius, Singapore and Hong Kong are popular choices with Indian enterprises.

If an Indian enterprise sets up a holding company in any one of the above-mentioned jurisdictions, then the dividends and capital gains earned by the holding company from the overseas operations would not generally be taxed at the holding company level.

On the law in the EU that should be relevant to outbound investments.

If both the holding company and the overseas operations are in the European Union (EU), then no withholding taxes would be applicable at the operating company level as per the EU parent-subsidiary directive. In general, this Directive provides that dividends received from other companies in the EU countries shall be tax exempt if the holding company holds more than 5-10 per cent of the equity stake in the investee company.

What measures would you suggest to encourage outbound acquisitions?

New generation tax reforms are much needed. Overall tax policies must be contemporary and assist in mitigating litigation. Today, we do not even have specific rules for claiming foreign tax credits, that is, credit for taxes paid abroad against the domestic taxes payable, this results in litigation. The Government should also consider eliminating some of the distortions in the current dividend taxation system. For example, even if the Government introduces a participating exemption or provides for underlying tax credit for foreign dividends, the dividends when further distributed by the Indian company to its shareholders would be subject to a dividend distribution tax (DDT).

Further, if the Indian group has a multi-tier structure (which is quite common among Indian groups) there would be a cascading effect of DDT. Therefore, if we look at the issue of dividend taxation in totality, it would appear that whatever benefits a participation exemption or an underlying tax credit may offer can be taken away (at least partially) by DDT applying when the Indian company distributes dividends.

The Government is contemplating ushering in a new comprehensive simple Act. The revised Act must take into consideration the need of Indian entities that are now playing in an international arena. While the Government may not want to offer any tax incentives for promoting outbound investment, it should ensure that tax is not a disincentive or barrier for such investment.

Do you think the government should join hands and be an effective business partner?

The norms for inbound investments have been liberalised over the years. Today, 100 per cent foreign direct investment is permitted in most sectors. Now, the Government needs to join hands and help build the global dreams of Indian enterprises. This can be achieved by ushering in friendly investment policies including contemporary tax policies, which boost outbound investments and growth.

http://Detaxification.blogspot.com

D. Murali

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