India Union Budget 2012 FII Impact

Date: 26th March, 2012

General Anti Avoidance Rules (GAAR)

A transaction will be an impermissible avoidance arrangement (IAA) when the main purpose or one of the main purpose of Arrangement entered into is to obtain tax benefit
It has been entered into, or carried out, in a manner not normally employed for bona fide business purpose Has created rights & obligations which would not normally be created between persons dealing at arms length Results, directly or indirectly, in the misuse or abuse of the provisions of tax laws Or lacks commercial substance, in whole or in part

Arrangement lacks commercial substance if:

Substance or effect of the arrangement is inconsistent with the form or differ significantly from the form It involves round trip financing, accommodating party, elements that have offseting or cancel each other, a transaction conducted through one or more person and disguises the value, location, source, ownership or control of fund which is the subject matter of the transaction Involves location of asset or a transaction or place of residence of party without any substantial commercial purpose (other than tax treaty benefit)

Treaty override provided Onus on tax payer to prove no tax avoidance

Consequence :
Once the arrangement is held as impermissible then the consequence of the arrangement in relation to the tax or benefit under a treaty can be different for each case. Illustratively, a) the tax office can disregard or combine any step b) ignore the arrangement c) disregard or combine any party d) reallocate expense and income e) relocate place of residence of a party, location of a transaction or situs of an asset f) consider to look through an transaction g) re characterize equity to debt, capital to revenue etc..
2

Vodafone ruling overruled

Law on income taxable in India retrospectively (since 1962) clarified as under :
all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India. Term through as mention above clarified to mean by means of, in consequence of or by reason of Term transfer amended to include and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily by way of an agreement (whether entered in India or outside India) or otherwise nothwithstanding such transfer of rights has been characterized as being effected or dependent upon or flowing from the transfer of a share of company incorporated outside India. Clarified that an asset (share or interest in a company registered/incorporated outside India) shall be deemed to be situated in India if the share or interest derives, directly or indirectly, its value substantially from assets located in India Clarified that property includes & shall be deemed to have always included any rights in or in relation to an Indian company, including rights of management or control or any other rights whatsoever

Impact : In view of the above changes P-notes / Offshore Derivatives Instruments (ODI) structures may have to be re-evaluated for possible tax impact in India (read with the newly introduced GAAR provisions )
P-notes / ODI may be viewed as indirect transfer of shares/ interest & hence may be subject to India tax. Grounds for defending against both indirect transfer & GAAR exists. However, Indian tax assessors may interpret the new provisions to justify taxation on the same The industry is trying to lobby with Indian authorities but timing remains crucial
3

Conclusion
In consequence of GAAR coming into effect from 1st April 2012 most FIIs based in Mauritius will need to reassess their strategy because of the following reasons:
Govt. had been long trying to re-negotiate the treaty with Mauritius with no success Some FIIs may lack of commercial substance in Mauritius

Tax office can pierce the corporate veil & disregard the Mauritius entity as being a Special Purpose Vehicle only

Tax implications on Participatory Notes (P-Notes) / Offshore Derivative Instruments (ODIs) structure needs to be re-evaluated in view of retrospective clarificatory amendments to the terms transfer, asset & property & introduction of GAAR Singapore offers a better alternative to migrate FII business as highlighted in subsequent slide. However, it seems that there may still be the indirect transfer issue for the ODI/ P-notes.

Note : Nomura does not provide any tax advice to its clients and the clients needs to evaluate any impact / change in law with their own tax consultants.

Why Singapore?
Treaty already has a limitation of benefit clause SGD 200,000 p.a. in operating expense for preceding 24 months

Strategic location and time zone (proximity to India)

Infrastructure (Office, employees, traders) Risk management / Senior management on ground Financial centre for South East Asia Competitiveness & Business Environment Economic co-operation & trade agreement with India Regulatory oversight by Monetary Authority of Singapore

Labor regulations most conducive

Transparent, sound & efficient legal system
Note : In view of GAAR & other amendments , the entire structure in Singapore as well needs to be evaluated thoroughly Transition to Singapore still does not resolve the indirect transfer issue for ODI / P-notes and the same needs to be evaluated
5

Appendix

Economic Times Article 24th March 2012