private equity handbook tax & regulatory reckoner
TRANSCRIPT
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Private equity
handbookTax and regulatory reckonerJanuary 2013
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A. Foreign investment in India 04
B. Types of instruments 12
C. Repatriation and exit 18
D. Tax rates 20
E. Domestic fund structuring 26
Contents
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Private equity handbook Tax and regulatory reckoner4
Alternative routes forinvesting in India
Foreign investment in India is permitted
under the direct investment and portfolio
investment routes.
Direct investment route
Any person resident outside India (subjectto a few limitations) can invest in India
under the direct investment route (FDI
route). Persons resident outside India
registered as Foreign Venture Capital
Investors (FVCI) with the Securities and
Exchange Board of India (SEBI) are also
allowed to make direct investments in
India with some concessions (FVCI route).
Portfolio investment route
This route is available to persons resident
outside India registered with SEBI as
Foreign Institutional Investors (FII)/
sub-accounts, and to Qualied Foreign
Investors (QFI) and non-resident Indians
(NRIs).
Foreign investmentframework
The Foreign Direct Investment (FDI)
regime has been progressively liberalized
in India over the last two decades, with
most restrictions on foreign investment
being removed and procedures being
simplied. With limited exceptions,foreigners can invest directly in India
either on their own or as part of a joint
venture.
The FDI policy in India is formulated
by the Department of Industrial Policy
and Promotion within the Ministry of
Commerce and Industry, Government of
India. The consolidated FDI policy is issuedannually and is updated for press releases
and clarications issued during the year.
The FDI policy framework is notied by
the Reserve Bank of India (RBI) under the
Foreign Exchange Management (Transfer
or Issue of a Security by a Person Resident
Outside India) Regulations, 2000 and is
amended from time to time.
Foreign investmentsin India
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Private equity handbook Tax and regulatory reckoner 5
Entities into which
foreign investment can be
made
Foreign investment in Indian companies is
typically permitted subject to conditions(where applicable). Foreign investment
in partnerships and proprietary concerns
is restricted only to NRIs and persons of
Indian origin1. Further, foreign investment
in trusts is prohibited unless the trust is
a SEBI registered venture capital fund
(VCF)2. Investment in VCF (other than
by FVCIs) requires prior approval of the
Foreign Investment Promotion Board
(FIPB)3. Foreign investment in limited
liability partnership (LLP) is allowed only
under the FDI route and only in sectors
where FDI is allowed under the automatic
route and where there are no FDI-linked
performance conditions (such as minimum
capitalization, lock-in conditions, etc.)
under the approval route.
1 Investments by NRIs/PIOs in partnerships and
proprietory concerns on a non-repatriation
basis are under the automatic route. However,
investments by NRIs/PIOs in partnerships and
proprietory concerns require prior approval of the
RBI.
2 VCF is a domestic venture capital fund set up
as a company or trust that primarily invests
in domestic unlisted companies in accordance
with SEBI (Venture Capital Funds) Regulations,
1996. The said regulations were repealed in May,
2012 and SEBI (Alternative Investment Funds)
Regulations, 2012(SEBI AIF Regulations) were
notied in May 2012.
3 FIPB considers proposals for foreign investment
that do not qualify for automatic approval. The
FIPB is empowered and chaired by the Secretary
of the Ministry of Finance and has been set up
specically to expedite the approval process for
foreign investment proposals.
FDI routeForeign investments under the FDI
route can be made either under the
automatic route or under the approval
route depending on the sector/activities
in which the Indian company is engaged.
Foreign investment in most sectors is
permitted under the automatic route
without any ownership restrictions or
conditions. Foreign investment caps,
minimum capitalization norms and lock-in
requirements are specied for certain
sectors/activities. Further, certain sectors
are prohibited4from FDI.
4 Prohibited sectors include lottery business,
gambling and betting, chit funds, nidhi company,
trading in transferable development rights
(TDRs), real estate business or construction
of farm house, activities/sectors not open for
private sector investments ( e.g., atomic energy,
railway transport)
Foreign investments in India
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Private equity handbook Tax and regulatory reckoner6
Sectors Sectoral
caps
Caps
applicable to
Entry route Additional
conditions*
Broadcasting 26% to
74%
FDI, NRI, PIO,
FII#
Approval Yes
Banking-Public sector 20% FDI and FII Approval Yes
Banking-Private sector 74% FDI and FII Automatic upto49%
Yes
Cash and carry
wholesale
100% FDI Automatic Yes
Courier 100% FDI Approval
Construction
development of
townships, built-up
infrastructure
townships, etc.
100% FDI Automatic Yes
Defence 26% FDI Approval Yes
E-commerce activities 100% FDI Automatic Yes
Education 100% FDI Automatic
Hospital 100% FDI Automatic
Hotel & Tourism 100% FDI Automatic
Industrial parks 100% FDI Automatic Yes
Infrastructure 100% FDI Automatic
Insurance 26% FDI Automatic Yes
FDI norms for select sectors:
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Private equity handbook Tax and regulatory reckoner 7
Sectors Sectoral
caps
Caps
applicable to
Entry route Additional
conditions*
Multi-brand retail 51% FDI Approval Yes
Non-banking nancial
services companies
100% FDI Automatic Yes
Pharmaceuticals 100% FDI Automatic
(Green-eld)
/ Approval
(Browneld)
Print media 26% FDI, FIIs, NRIs,
PIOs
Approval Yes
Single brand retail 100% FDI Approval Yes
Special economic zone 100% FDI AutomaticTest marketing 100% FDI Approval Yes
Telecommunications
(Other than
manufacturing of
equipments)
74% FDI Automatic up
to 49%
Yes
* For detail conditions applicable on each sector, please refer to The Consolidated FDI Circular dated
April, 2012 and subsequent Press Notes issued by Department of Industrial Policy and Promotion till date.
# NRI and PIO investments are allowed only in certain activities under the broadcasting sector
Foreign investments in India
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Private equity handbook Tax and regulatory reckoner8
Pricing norms
Pricing guidelines for investment under
the FDI route for issue/transfer of
capital:
Issue ortransfer ofcapital listed ona recognizedstock exchangein India
Price is worked outin accordance withSEBI guidelines, asapplicable
Issue ortransfer ofcapital not
listed on anyrecognizedstock exchangein India
The fair valuation ofshares is undertakenby a SEBI registered
Category I MerchantBanker or a CharteredAccountant as per thediscounted free cashow method
The price of shares issued/transferred to
persons resident outside India under the
FDI policy cannot be less than the value
determined as per the above guidelines.
Further, in the case of the issue of CCPS
and CCDs, the price/conversion formula
is to be determined upfront at the time of
the issue of instruments. In such cases,
Eligible instruments
Investments under the FDI route
can be made only by way of equity
shares, compulsorily and mandatorily
convertible preference shares (CCPS), and
compulsorily and mandatorily convertibledebentures (CCD). Investments by way
of warrants and partly paid shares of an
Indian company are allowed subject to
prior approval of the FIPB. Further, listed
Indian companies can also issue American
depository receipts/global depository
receipts as per the prescribed5guidelines.
Other types of preference shares/debentures, i.e., non-convertible, optionally
convertible, or partially convertible, are
considered as debt and need to comply
with external commercial borrowing (ECB)
norms pertaining to eligible borrowers,
recognized lenders, amount and maturity,
end-use stipulations, etc. Instruments such
as foreign currency convertible bonds and
foreign currency exchangeable bonds are
also considered as ECBs and are required
to comply with ECB norms.
5 Issue of Foreign Currency Convertible Bonds and
Ordinary Shares (Through Depository Receipt
Mechanism Scheme), 1993 and guidelines issued
by the Government of India
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Private equity handbook Tax and regulatory reckoner 9
the price at the time of conversion should
not be lower than the valuation worked
out at the time of the issuance of such
CCPS/CCD.
The transfer of shares of an Indian
company by a person resident outsideIndia to a person resident in India cannot
be undertaken at a price that is higher
than the value determined as per the
pricing guidelines. Pricing guidelines do
not apply to the transfer of shares of
an Indian company between two non-
residents.
Downstream investment6
Downstream investments by an Indian
company owned7or controlled8by non-
resident entities are required to comply
with sectoral caps, entry conditions,
pricing norms, etc, as specied under the
FDI route. LLPs with FDI are not allowed
6 Downstream investment means indirect foreign
investment by one Indian company into another
Indian company by way of subscription or
acquisition
7 A company is considered as owned by non-
resident entities if more than 50% of the capital
in it is benecially owned by non-resident citizens
and/or entities, which are ultimately owned and
controlled by non-residents.
8 Control has been dened to mean power to
appoint the majority of directors
to make any downstream investments.
A methodology has been prescribed to
determine the level of foreign investment
in a multi layered investment structure.
FVCI route
FVCIs are persons resident outside India
and registered with the SEBI as FVCIs.
They make investments in India under the
applicable SEBI regulations.
SEBI has been granting approvals to FVCI
only for investments in certain specied
sectors9and in SEBI-registered VCFs.
Further, SEBI regulations have beenrecently amended to permit FVCIs to
invest in Category I Alternative Investment
Funds (AIF)10.
FVCIs can invest in units of VCFs
and Category I AIFs or investment in
equity or equity-linked instruments,
debt instruments of Venture Capital
Undertakings (VCUs)11/ Non-VCUs subject
9 Specied sectors include (i) infrastructure sector
(as dened under ECB norms), (ii) biotechnology,
(iii) information technology relating to hardware
and software development, (iv) nanotechnology,
(v) seed research & development, (vi) research
and development of new chemical entities in
pharmaceutical sector, (vii) dairy industry, (viii)poultry industry, (ix) production of bio-fuels and
(x) hotel-cum-convention centers with seating
capacity of more than 3,000.
10 AIFs are domestic pooling vehicles that are
governed by SEBI (Alternative Investment Funds)
Regulations, 2012 (SEBI AIF Regulations). They
are discussed in detail in a subsequent chapter.
11 VCU means a company incorporated in India
whose shares are not listed on a recognized stock
exchange in India and which is not engaged in an
activity specied under the negative list specied
by the SEBI.
Foreign investments in India
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Private equity handbook Tax and regulatory reckoner10
Portfolio investment route
FII route
FII investments are governed by SEBI
regulations. FIIs are institutions established
or incorporated outside India that proposeto make investments in India. Sub-accounts
are persons resident outside India on whose
behalf investments are proposed to be made
in India by the FII. Qualifying conditions
have been specied for FII registration.
Apart from entities that can register as
FIIs, other foreign investors could choose
to register as sub-accounts. These may be
collective investment funds and institutions,proprietary funds, or foreign corporations
and nationals meeting certain conditions.
No sector restrictions are typically
applicable to investments under the FII
route, unless specically provided for
within sectoral caps prescribed under the
FDI route12. FIIs are allowed to invest in
recognized stock exchange only through aregistered broker. FIIs are also permitted
to invest through private placement/initial
public offers.
FIIs are allowed to invest in shares or
debentures of an unlisted company or a
company that is listed on a recognized stock
exchange in India, as well as government
securities/treasury bills, listed non-convertible bonds/debentures, listed/
unlisted non-convertible infrastructure
bonds, commercial papers, units of domestic
mutual funds, security receipts (only for
FIIs) and perpetual debt instruments.
12 Please refer to the table on page 6-7 relating to FDI
norms on select sectors
to specied conditions by way of private
placement/purchase from third party.
FVCIs are not subject to pricing guidelines
or ceiling on dividends. The valuation on
purchase/transfer can be mutually decided
between the buyer and seller.
FVCIs enjoy certain additional regulatory
advantages:
The transfer of shares from FVCIs to
promoters is exempted from public
offer provisions under SEBI takeover
regulations.
FVCIs are granted the status of aqualied institutional buyer and enjoy
certain relaxations on pricing norms
and longer conversion period for
securities under SEBI regulations.
FVCIs are not subject to lock-in
requirements post the initial public
offering of an Indian company under
SEBI regulations subject to certain
conditions.
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Private equity handbook Tax and regulatory reckoner 11
Specic overall monetary limits are
prescribed for investments in listed
corporate debt, unlisted long-term
infrastructure bonds and government
securities (including treasury bills).
QFI route
QFIs are persons resident in a country
that is compliant with Financial Action
Task Force (FATF) standards (including
residents of countries that are part of agroup that is a member of FATF) and that
is a signatory to the IOSCO13multilateral
memorandum of understanding, European
Union (EU) or Gulf Cooperation Council
(GCC) or a signatory of a bilateral MOU
with SEBI. Further, such person should not
be registered as FII/sub-account or as FVCI
with SEBI.
Unlike FIIs, QFIs are not required to be
registered with SEBI. However, they are
required to open a demat account with a
qualied depository participant14and are
13 International Organization of Securities
Commission
14 Qualied depository participants are thosedepository participants registered with SEBI who
also required to obtain permanent account
number from Indian tax authorities.
QFIs are permitted to invest in the equity
shares of listed companies on a recognized
stock exchange, listed corporate debt, as
well as in the units of equity and debt-
oriented mutual funds.
QFIs are permitted to invest in listed
equity shares up to an individual limit of
5% of the paid-up capital of the company(overall limit of 10% of the paid-up capital
of the company). Further, separate overall
monetary limits have been prescribed for
investments by QFIs in listed corporate
debt, equity-oriented mutual fund
schemes and debt mutual fund schemes
(including infrastructure debt funds).
fulll the eligibility criteria specied by SEBI to act
as a depository participants for QFIs
Total holding by each
FII / sub-account
10% of the paid-up equity capital or paid-up value of each
series of debentures
Total holding by all FII /sub-account
24% of the paid-up equity capital or paid-up value of each
series of debentures (the limit can be increased to the FDIsectoral cap by a special resolution at the general body
meeting of the investee company)
Foreign corporate and
individuals registered as
sub-accounts
5% of the total paid-up equity capital or 5% of the paid-up
value of each series of convertible debentures subject to
the overall ceiling of 24%
Foreign investments in India
Investment limits for FIIs in shares and convertible debentures:
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Private equity handbook Tax and regulatory reckoner12
Debt securities that are issued bycompanies are called debentures or
bonds. Debenture is an instrument of debt
executed by a company acknowledging
its obligation to pay interest on the
debt at a xed rate at regular intervals.
Debentures do not carry any voting
rights and are generally secured against
property. Additionally, debentures can
be redeemed or converted into equity
or a combination of both. Debt funding
from non-resident lenders [excluding
compulsorily convertible instruments and
listed non-convertible debentures (NCDs)]
is generally referred to as ECB and is
closely regulated specically with respect
to end use, party from whom lending
is sought, interest payment, amount offunding, maturity period, etc.
Either of the above mentioned instruments
or their combination could be used for
investing in an Indian company.
From a regulatory perspective, a resident
can invest in an Indian company using
any of the instruments mentioned above
Types of instruments
An Indian company can raise fundsby way of shares or debt. Shares of a
company are categorized as equity or
preference shares. Equity shares have the
fundamental characteristic of representing
ownership interest in a company and
carrying voting rights. While a public
company may create classes of shares
having differential rights as to voting,
dividend, etc., subject to applicable
restrictions, a private company can issue
shares with differential rights without any
restriction. Preference shares are entitled
to a xed rate of dividend, do not typically
carry any voting rights and get a priority
over equity shares in the distribution of
assets in event of liquidation. Preference
shares can be converted into equity(either optional or mandatory) and/or
can be redeemed (period not exceeding
20 years). Redemption can only be out
of accumulated prots, which would
otherwise be available for dividend or
out of fresh issue of shares made for
redemption.
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Private equity handbook Tax and regulatory reckoner 13
without any restrictions. However, a non-
resident is subject to several restrictions,
depending on the type of instrument.
For example, funds brought in as equity
(including instruments mandatorily
convertible into equity) are generally
permitted automatically under the
FDI policy, subject to sector-specic
restrictions. All other instruments would
be considered as debt and would require
compliance with ECB guidelines.
Equity sharesEquity
shares
Hybrid
instruments
Debt
Compulsorily
convertible
debentures
Compulsorily
convertible
preference shares
Optionally
convertible
preference shares
Non-convertible
preference shares
Non-convertible
debentures
Optionallyconvertible
debentures
Shareholders
loan
FDI - No
end use
restriction
ECB -
Specifiedend use
restrictions
Future profit
repatriation
possible Tax
efficient
interest
payout
possible
Tax
arbitrage
may be
available
on
interest
payouts
Tax
efficient
profit
repatriation
could be
factored
Types of instruments
Pictographic representation of the types of instruments for foreign investment
in India:
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Private equity handbook Tax and regulatory reckoner14
Criteria Equity
shares
CCPS CCDs Optionally
convertible/
redeemable
preference shares
Shareholder
loans/other
debentures15
Treated as FDI ECB
Restriction
on amount
NA Automatic route up to USD 750
million16Approval route USD 750 million16
End Use
restrictions
NA17 NA17 NA17 Cannot be usedfor specied
purposes18
Cannot beused for
specied
purposes18
All in cost Not
specied
Maximum
dividendthat can be
paid is SBIPLR + 300
bps
Not
specied(possible
view);interest
rate cannotexceed rate
prescribedfor CCPS)
For maturity of 35 years 6 month
LIBOR + 350 bps
For maturity > 5 years 6 monthLIBOR + 500 bps
Pricing
guidelines
Pricing
guidelines
prescribedby theRBI to be
compliedwith at the
time of issueof shares or
acquisitionof shares
from aresident
Price/
Conversion
formulato bedetermined
upfront atthe time of
issue basedon pricing
guidelinesprescribed
by the RBI;price at
the time of
conversioncannot
Price/
Conversion
formulato bedetermined
upfront atthe time of
issue basedon pricing
guidelinesprescribed
by the RBI;price at
the time of
conversioncannot
Optionally
Convertible
PreferenceShares (OCPS) pricing guidelines
prescribed by theRBI to be complied
with at the time ofconversion
Optionally
Convertible
Debentures(OCDs) pricing
guidelinesprescribed by
the RBI to becomplied with
at the time ofconversion
15 Excluding listed NCDs
16 To be read as USD 200 million for corporates in
services sector viz. hotel, hospital and software.
17 Downstream investment into Indian companies
is permissible if compliant with the regulatory
framework
18 Specied purposes:
- On-lending, investment in capital market,
acquiring a company in India or a part thereof
(except for specied companies)
- In real estate
- For working capital, general corporate purpose
and repayment of existing rupee loans (except forspecied companies subject to specied conditions)
Key tax and regulatory features pertaining to each type of instruments:
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Private equity handbook Tax and regulatory reckoner 15
Criteria Equity
shares
CCPS CCDs Optionally
convertible/
redeemable
preference shares
Shareholder
loans/other
debentures15
Pricing
guidelines
(contd.)
be lower
than the
minimumpricedetermined
upfront atthe time of
issue
be lower
than the
minimumpricedetermined
upfront atthe time of
issue
Non Convertible
Preference Shares
(NCPS) pricingguidelines notapplicable
NCDs pricing
guidelines not
applicable
Shareholder
loans pricingguidelines not
applicable
Right of
dividend/
interest
Can be
paid onlyfrom prot
after tax
(PAT) andafter thepayment of
preferencedividend
Right to
receivedividend
over equity
shares andcan be paidout of PAT
Interest
can be paidirrespective
of the
availabilityof prots
Right to receive
dividend overequity shares and
can be paid out of
PAT
Interest
can be paidirrespective of
the availability
of prots
Voting rights Available
Further,exibility for
differentialvoting rights
available,subject to
conditions
Available if
dividend isnot paid for
two yearsor post
conversioninto equity
shares
Available
postconversion
into equityshares
Available if
dividend is not paidfor two years and
in respect of partconverted into
equity shares
Not available
except inrespect of part
converted intoequity shares
Prepayment /
Repatriation
Equity share
capital canbe cancelled
by way ofa buyback/
capitalreduction
Possible
view:Buyback/
Capitalreduction
of CCPSnot possible
before theconversion
of CCPSinto equity
shares
Possible
postconversion
into equityshares
throughcancellation
by way ofbuyback/
capitalreduction
ECB up to USD 20
million = minimumaverage maturity
3 years
ECB > USD 20million and up to
USD 750 million =minimum average
maturity 5 years
Preference shares maximum time
20 years from thedate of its issue
ECB up to USD
20 million= minimum
averagematurity 3
years
ECB > USD20 million and
up to USD500 million
= minimumaverage
maturity 5years
Minimum
time
period for
redemption
NotApplicable
Preferenceshares -
Maximumtime - 20
years from
the date ofits issue
No timelimit for CCD
Types of instruments
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Private equity handbook Tax and regulatory reckoner16
Criteria Equity
shares
CCPS CCDs Optionally
convertible/
redeemable
preference shares
Shareholder
loans/other
debentures15
Withholding
on dividend /
interest
Not required
An Indian
companyis requiredto pay DDT
at 15%19onthe amount
of dividenddistributed
Not required
An Indian
companyis requiredto pay DDT
at 15%19onthe amount
of dividenddistributed
Tax
required to
be withheldon interestat lower of
the rates, asspecied in
tax treatyor the
domestictax law
Not required An
Indian company
is required topay DDT at 15%19on the amount
of dividenddistributed
Tax required
to be withheld
on interestat lower ofthe rates, as
specied in
tax treaty or
the domestictax law
Tax
deductibilityof dividends/
interest
Equity
dividend notdeductiblefor tax
purposes
Preference
dividend notdeductiblefor tax
purposes
Interest
is taxdeductiblesubject to
appropriatewithholding
of tax
Preference
dividend notdeductible for taxpurposes
Interest is tax
deductiblesubject toappropriate
withholdingof tax
Applicability
of Indian
transfer
pricing
regulations
Notapplicable
Notapplicable
Applicable Not applicable Applicable
Taxation on
conversion
Notapplicable
No clearprovisions
arguablymay be
exempt
Exempt No clear provisions arguably may be
exempt
NA/Exempt
19 Tax rates are excluding the applicable surchargeand education cess
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Private equity handbook Tax and regulatory reckoner 17
Warrant:A warrant is a security that
entitles the holder to buy the underlying
stock of the issuing company at a
xed exercise price until the expiry
date. Warrants can be issued to non-
residents under the approval route. The
government, at the time of granting
approval, may prescribe the minimum
amount to be brought upfront and the
period within which the warrants holder
needs to exercise his right. The upfront
payment for the issue of warrants is
forfeited if the warrants are not converted
into equity shares.
Furthermore, the following instruments
could also be considered:
ADRs/GDRs: Depository receipts are
securities issued by a bank or depository
outside India against underlying Rupee
shares of a company incorporated in India.These are treated as foreign securities
issued by an Indian company and are
usually denominated in USD. Holders
of ADR/GDR have the right to sell these
instruments outside India or convert them
into equity shares at any point of time.
Listed NCDs: Under this route, any
private or public company could list NCDson the wholesale debt market segment of
any recognized stock exchange. Any FII
or any sub-account of an FII entity could
purchase these NCDs subject to prescribed
allocation methodology. For an exit, these
debentures may either be sold on the oor
of the stock exchange or redeemed by the
issuing company. The terms of listed NCDs
are not subject to ECB or FDI guidelines.
Types of instruments
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Private equity handbook Tax and regulatory reckoner18
Alternative options for
repatriation of capital andreturns
Dividend
Dividend distribution is the typical
route for the repatriation of prots
by a company. Dividend payments
are considered as an appropriation of
prots rather than as an expense for taxpurposes. Dividend payment is required
to be made to all shareholders of a
company. In case the companys capital is
divided into different classes of share, the
company may distribute dividend only to a
specic class of shareholders.
Buyback
Buyback of shares is a scheme whereinan Indian company re-purchases its own
shares from its shareholders. Under the
Indian tax laws, buy back is treated as the
sale of shares by the shareholder. Offer
for buy back is required to be made to
all shareholders (holding shares of the
same class) and is at the discretion of
the shareholder to accept or reject. For
listed companies, in certain situations, aspecied class of shareholders may not be
eligible to tender their shares in the offer
for buyback.
Capital reduction
Capital reduction is a court regulated
process of cancellation of subscribed
capital of an Indian company or reduction
of the face value of shares. From a tax
perspective, capital reduction typically
involves distribution of capital and
accumulated prots.
Repatriation and exit
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Private equity handbook Tax and regulatory reckoner 19
20 - In light of a recent judicial precedent, there is a
risk that the ITA may consider the buy-back as
payment of dividend.
- Availability of treaty benets subject to
applicability of GAAR to the transaction.
21 Tax rates are excluding the applicable surcharge
and education cess
22 Unless dispensed by the Court.
Criteria Dividend Buyback undersection 77A of the
Companies Act, 1956
Capital Reduction undersection 100 of the
Companies Act, 1956
Taxation in the hands
of shareholder
No Subject to capital gain
tax, shareholders can
claim tax exemption
under an applicable tax
treaty20
Subject to capital gain tax
on distribution in excess
of accumulated prots;
shareholders can claim
tax exemption under the
applicable tax treaty20
Taxation in the handsof the company
At the rateof 15%21on
dividend
distributed
No At the rate of 15%
21
to theextent of accumulated prots
distributed
Court process No No Yes
Approval of creditors No No Yes22
Selective distribution No Depends on response
to buyback offer20Yes
Applicability of RBI
pricing guidelines
NA Yes Yes
Requirement of
regulatory approval
No No No
Key aspects relating to each of the above repatriation options:
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Private equity handbook Tax and regulatory reckoner20
rates mentioned are base rates, to beincreased by applicable surcharges. For
Indian residents, rates are provided in the
context of a corporate tax payer.
The table below enumerates the applicabletax rates under the domestic tax law on
income derived from investments in Indian
securities (shares and debentures). The
Tax rates
Income Foreign
investors
QFI/ FVCI FII Indian
residents
Interest on foreign
currency borrowing by
Indian concerns
20% Not
applicable
20% Not
applicable
Interest on approved
long-term infrastructure
bonds/loan agreements
5% 5% 5% Not
applicable
Dividends on equity
shares
Exempt;
however,
subject to
dividend
distribution
tax at 15%
Exempt;
however,
subject to
dividend
distribution
tax at 15%
Exempt;
however,
subject to
dividend
distribution
tax at 15%
Exempt;
however,
subject to
dividend
distribution
tax at 15%
Interest on Rupee-
denominated debt
40% 40% 20% 30%
Tax rates on interest and dividend income under various routes23
23 Tax rates are excluding the applicable surcharge
and education cess
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Private equity handbook Tax and regulatory reckoner 21
Other key aspects
Direct sale
On sale of shares of an Indian company,
the difference between the cost of
acquisition and the value of considerationreceived would be deemed to be capital
gains. Capital gains on the sale of shares
affected on stock or through an offer for
sale in an IPO are either exempt or taxable
@15% depending on whether there is
LTCG or STCG, respectively. Capital gains
tax can be mitigated if investment is made
through a tax-efcient jurisdiction. Key
jurisdictions considered while investing
in India are Mauritius, Singapore, Cyprus
and the Netherlands. Subject to thefulllment of certain conditions, rights to
tax capital gains on the transfer of shares
of Indian companies by tax residents of the
mentioned countries have been granted
only to the mentioned countries. Refer to
the table provided in the next chapter for
tax rates under select tax treaties.
However, recently, the tax department
has been questioning tax exemption on
the exit of investments made through
the mentioned jurisdictions. The lack of
commercial substance has been the main
concern of tax authorities.
Indirect sale
As per the recent amendments in tax laws,
any indirect transfers, i.e., situations
where shares of a foreign company are
transferred with substantial underlying
assets in India, would be taxable in
India, subject to the availability of treaty
benets.
However, there is lack of clarity on several
parameters related to the taxation ofindirect transfers. For example, what
would constitute as substantial is not
mentioned; date as on which substantial
value criteria needs to be determined is
not claried; whether the entire gains on a
transaction would be taxable or only gains
proportional to the Indian element will be
taxable is not clear, and so on.
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Private equity handbook Tax and regulatory reckoner22
General Anti Avoidance Rules
(GAAR)
GAAR provisions were introduced in
the Income-tax Act, 1961 by Finance
Act 2012 to deal with aggressive tax
planning. Consistent with international
practice, GAAR provisions seek to codify
the substance over form doctrine.
These provisions would empower tax
authorities to declare an arrangement
to be an impermissible avoidance
arrangement if the main purpose or one
of the main purposes of an arrangement
(or step or part thereof) is to obtaina tax benet. These provisions are
applicable to all tax payers and are
equally applicable to domestic, as well
as international transactions. Once an
international transaction is declared to be
an impermissible avoidance arrangement,
the provisions of GAAR would override
the benecial provisions of the relevant
tax treaty.
Expert Committee (EC) appointed
by Prime Minister of India to review
GAAR provisions has given its nal
recommendations, which have mostly
been accepted by the Finance Ministry.
Some of the major changes include
clauses pertaining to GAAR provisions
coming in effect from nancial year201516 instead of 201314 and an
arrangement would be impermissible
if the main purpose of the same is to
obtain a tax benet; however, it would
not merely be one of the main purposes.
Further, investments made prior to 30
August 2010 would be grandfathered.
However, the consequential changes in
law are still to be effected.
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Private equity handbook Tax and regulatory reckoner 23
Capital gains tax rate24
Particulars Resident company Non-resident company
LTCG25 STCG26 LTCG25 STCG26
Sale of listed shares SE
transaction27
Exempt 15% Exempt 15%
Sale of listed shares
off-market transaction
(i.e., sale of listed shares
through private deal)
10%28/20%29 30% 10%30/20% 40%31
Sale of unlisted shares offer
for sale to public under IPO27Exempt 15% Exempt 15%
Sale of unlisted shares 20%29 30% 10%32/20% 40%31
Sale of listed debentures 10%28/20%29 30% 10%30/20% 40%31
Sale of unlisted debentures 20%29 30% 10%32/20% 40%31
24 Tax rates are excluding the applicable surcharge
and education cess
25 Period of holding more than 12 months for shares
and specied securities
26 Period of holding less than or equal to 12 months
for shares and specied securities
27 STT payable on the value of transaction
28 Without indexation benet
29 With indexation benet
30 Foreign exchange adjustment possible along with
10% rate. However, there are conicting judicial
precedents on the availability of lower rate of 10%.
31 30% for FIIs
32 Without foreign exchange rate adjustment.
Further, it is unlikely that the concessional rate
of 10% would be available on sale of shares of a
private limited company
Tax rates
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Private equity handbook Tax and regulatory reckoner24
Tax rates under select tax treaties:
Particulars Treaty in force Capital gain on
sale of shares
Capital gains
on sale of
debentures
Interest
Mauritius Yes Not taxable Not taxable Taxable at
20%33/40%34
Singapore Yes Not taxable
subject to the
limitation of
benet clause
(LOB clause35)
Not taxable
subject to LOB
clause35
Taxable at 15%
Cyprus Yes Not taxable Not taxable Taxable at 10%
The
Netherlands
Yes Not taxable
subject to
conditions36
Not taxable Taxable at 10%
Luxembourg Yes Taxable Not taxable Taxable at 10%
The United
States of
America
Yes Taxable Taxable Taxable at 15%
The United
Kingdom
Yes Taxable Taxable Taxable at 15%
Cayman Islands No Taxable Taxable Taxable
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Private equity handbook Tax and regulatory reckoner 25
33 On borrowings in foreign currency. Tax rates are
excluding the applicable surcharge and education
cess
34 On borrowings in Indian currency. Tax rates are
excluding the applicable surcharge and education
cess
35 A Singapore resident availing the capital gain
exemption under the India-Singapore tax treatymust satisfy the following conditions:
i. Its affairs are not arranged with the primary
purpose to take advantage of the benets of
the LOB clause under the treaty; and
ii. It should not be a shell/ conduit company
i.e. its annual expenditure on operations
in Singapore is equal to or more than SG$
200,000 in the immediately preceding
24 months from the date on which capital
gain arise from the transfer of shares/
debentures;or
iii. It is listed on a recognized stock exchange inSingapore.
36 Capital gains from the sale of shares in an Indian
company would not be taxable in India under
the India-Netherlands tax treaty, if the following
conditions are satised:
i. In case of shares of an unlisted real estate
company in India, the shares form part of less
than 25% interest in the capital stock in the
company
ii. In case of shares of any other company in India;
a. The shares are sold to a non-resident;
b. The shares are sold to a resident and the
shares form part of less than 10% interest
in the capital stock in the company; or
c. The shares are sold pursuant to a
corporate organization, re-organization,
amalgamation, division or similar
transaction.
Tax rates
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Private equity handbook Tax and regulatory reckoner26
India has a regulatory framework for
raising an alternative investment fund.
The framework is contained in the AIF
Regulations, which were notied in May
2012 and repealed the erstwhile SEBI
(Venture Capital Funds) Regulations, 1996
(VCF Regulations). Funds registered under
the VCF Regulations are grandfathered
until they are wound up and are prohibited
to launch any new scheme or increase the
targeted corpus.
Under AIF Regulations, funds are
mandatorily required to obtain registration
and comply with the investment and other
conditions.
An AIF has been dened as a privately
pooled investment vehicle that collects
funds from investors, whether Indian
or foreign37, in accordance with a
dened investment policy. An AIF can be
established as a company, a trust or a
LLP, or any other body corporate. AIFs are
segregated into the following categories
for the purpose of registration:
Domestic fundstructuring
37 Guidelines for foreign investments in AIFs
(excluding FVCI investment into Category I AIF)
are yet to be notied by the Government.
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Private equity handbook Tax and regulatory reckoner 27
All AIFs are required to mandatorily seek
registration in one of the categoriesmentioned in the table above. In case of
Category I AIF, they also need to register
under one of the sub-categories as
prescribed. An AIF can launch schemes
without seeking prior SEBI approval.
Various eligibility criteria such as minimum
commitment, minimum investmentper investor, sponsor commitment,
minimum maturity, track record for key
investment team manager, term of the
funds and conditions as to open ended
and close ended have been prescribed for
registration.
Category I AIF Category II AIF Category III AIF
Funds that invest in startup or
early-stage ventures or social
ventures or Small and Medium
Enterprises (SMEs) or infrastructure
or other sectors or areas that the
government or regulators consideras socially or economically desirable
Include venture capital funds,
SME funds, social venture funds,
infrastructure funds and such other
AIFs, as may be specied
Funds that do not fall
in Category I and III
AIF and that do not
undertake leverage or
borrowing other than
to meet the permitteddaily operational
requirement
Include private equity
funds and debt funds
Funds that employ
diverse or complex
trading strategies and
may employ leverage
including through
investment in listed orunlisted derivatives
Include hedge funds
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Private equity handbook Tax and regulatory reckoner28
Investment conditions and restrictions
AIF Regulations prescribe detailed conditions/restrictions for each category/
sub-category of AIF:
Category I AIF
Venture Capital
Fund
Minimum 66.67% of its corpus in equity and equity-linked
instruments of VCUs and SMEs and balance 33.33% in debt
instruments, public offer/preferential allotment of listed
companies (subject to conditions)
Infrastructure Fund At least 75% of its corpus in VCUs or investee companies
engaged in infrastructure and balance also in listed securitized
debt instruments, as well as listed debt instruments
Social Venture Fund At least 75% of its corpus in social venture funds
Small and Medium
Enterprise Fund
At least 75% of its corpus in VCU and/or investee companies38
that are SMEs
Category II AIF
Private Equity Fund Primary investment in equity and equity-linked instruments of
unlisted companies
Debt Fund Primary investment in debt or debt securities of unlisted
securities
Category III AIF
Hedge Funds etc. Permitted to invest in securities of listed or unlisted investee
companies or derivatives or complex or structured products
38 Company, SPV, LLP, or other body corporate
Furthermore, Category I AIFs are
permitted to invest in units of Category I
AIFs of the same sub-category. Category
II and Category III AIFs are permitted toinvest in units of Category I and Category
II AIFs. AIFs are not permitted to invest in
fund-of-funds.
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Private equity handbook Tax and regulatory reckoner 29
Other key aspects
AIF Regulations prescribed conditions
for investment in associate companies,
borrowing, leveraging/hedging, listing of
AIFs, and valuation of units of AIFs. They
also prescribed certain governance normspertaining to conict of interest, duciary
responsibility of the investment manager,
transparency, etc.
Taxation
Category I AIFs have been granted pass-
through status. Specied income received
by such funds is taxed directly in the hands
of beneciaries. However, Category I (for
non-specied income), Category II and
Category III AIFs are not accorded a pass-
through status. Tax implications for such
funds would be based on the legal status
of such funds, i.e., whether such funds are
set up as companies, LLPs or trust.
Domestic fund structuring
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ContactsIf you would like to discuss any of the insights in this report or opportunities in India,please contact your Ernst & Young advisor or any of the contacts below.
Sudhir Kapadia
National Tax Leader
Email: [email protected]
Avinash Narvekar
Private Equity Tax Leader
Email: [email protected]
For any private equity related enquires, please contact:
Mayank Rastogi
Email: [email protected]
Amrish Shah
National Leader - Transaction Tax
Email : [email protected]
Subramaniam Krishnan
Partner, Tax and Regulatory Services
Email : [email protected]
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Our ofces
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