LIAISON OFFICE NOT TO BE TAXED

As per the current regulations, a foreign company can open a liaison office (LO) in India by seeking approval from the RBI. An LO can only engage in activities specifically allowed by the regulations and that too with RBI’s permission. An LO has the limited role/authority to act as a bridge between the parent company and the vendors in India. No commercial activities are permitted. Income Tax law says that liaison offices, which merely assist the export of goods on behalf of the foreign parent, are exempt from tax liability. Tax authorities, however, in their over enthusiasm to collect more tax, have of late been arguing that LOs of foreign companies carry out commercial activity in the country, which results in business connection for the parent multi-national in India.

CAPITAL GAINS

According to the Mumbai Income Tax Appellate Tribunal (ITAT) the difference between the cost price and the prevailing market price cannot be construed as capital gains, if the shares were transferred at the cost price.

The appellant, an investment company, under an MOU between the group companies, transferred shares of a group company to another group company at a cost price, which was less than the market price. The Income Tax department disregarded the transfer price and levied capital gains tax on the difference between market price and the cost price of shares.

Overturning the order of the IT department, the ITAT held that capital gains which had never actually accrued to a tax payer, cannot be brought under capital gains tax. For computing capital gains, the transfer price of the capital asset is that which the transferor actually receives for the assets that he transfers. It cannot include prevailing market price of asset which was never received by the taxpayer. Hence, Capital gain is to be computed as the difference between full value of consideration received or accruing as the result of the transfer of capital asset and not the fair value of capital asset so transferred.

YOU CAN’T CHANGE THE TUNE HALF-WAY THROUGH…

No unilateral alteration of contract says Supreme Court.

The Supreme Court in a case involving the Delhi Development Authority, a statutory body, stated that a party to the contract cannot at a later stage, while the contract was being performed, impose terms and conditions which were not part of the offer and which were based upon unilateral issuance of office orders, but not communicated to the other party to the contract. Elaborating on its reasoning the Court said that the terms and conditions of the contract can indisputably be altered or modified by the parties. They cannot, however, be done unilaterally, unless there exists any provision either in contract itself or in law. Novation of contract in terms of Section 60 of the Contract Act must precede the contract making process i.e. the offer and acceptance. The parties thereto must be ‘ad idem’ so far as the terms and conditions are concerned.

SMART ALECS GET OUT-SMARTED…AT LONG LAST!

The Supreme Court of India in a recent judgment held that if the consideration clause in a ‘Technical Assistance and Trade Mark Agreement’ indicates that the importer/ buyer had adjusted the price of the imported goods in the guise of enhanced royalty or where the department finds that the buyer had misled the department by such pricing adjustments then the adjudicating authority would be justified in adding the royalty/ licence fees payment to the price of the imported goods for Customs Valuation.

This is an exception to the views expressed by the Court in earlier cases where it was held that royalty and technology transfer fees relating to manufacture cannot be added to the value of imported goods and unless the fees relate to the imported goods in question, the loading would be unjustified.

Now, as per the new judgment two concepts operate simultaneously, namely, the price for the imported goods and the royalty/ licence fees paid to the foreign supplier. The department is required to look not only at technical assistance and trade mark agreement but also the pricing arrangement/ agreement between the Indian buyer and the foreign collaborator.

Definitely a case of ‘Better late than Never!’

THE MONITOR JUST GOT MORE LIBERAL!

Trusts’/ Societies’ overseas ambitions…

Continuing with its avowed liberalisation objectives, to steer the economy forward, the RBI has come up with yet another enabling provision which permits overseas investments by Registered Trusts and Societies. Unlike before, any Trust/Society, engaged in manufacturing/educational sector) can now investment in ‘the same sector(s)’ whether by entering into a JV or through a ‘Wholly Owned Subsidiary’ outside India, by taking prior approval from RBI. The eligibility criteria have been prescribed and applications in the prescribed form/manner are to be submitted to the RBI by the intending trusts/societies.

SEBI - SENSE AND SIMPLICITY

Wanting to create a viable market for corporate bonds, the Securities and Exchange Board of India (SEBI) has promulgated Regulations for Issue and Listing of Debt Securities, resulting in a much-simplified regulatory framework for issuance and listing of non-convertible debt securities (excluding bonds issued by Governments) issued by any company, public sector undertaking or statutory corporations.

Whereas the time-consuming requirements of filing of draft offer documents with SEBI have been dispensed with, more vigilant obligations like due diligence, adequate disclosures, and credit ratings are being put in place for ensuring transparency. The Regulations also emphasize on the role and obligations of the debenture trustees, execution of trust deed, creation of security and creation of debenture redemption reserve in accordance with the stipulations of the Companies Act.

The Regulations provide for rationalized disclosure requirements for public issues and flexibility to issuers to structure their instruments and decide on the mode of offering, without diluting the areas of regulatory concern. In case of public issues, while the disclosures specified under Schedule II of the Companies Act, 1956 shall be made, the Regulations require additional disclosures about the issuer and the instrument viz. nature of instruments, rating rationale, face value, issue size, etc.

Going a big step forward, electronic disclosures have been allowed. Additionally option has been given to the issuers to list their debt securities on private placement basis subject to compliance. For a better enforcement of these regulations a rationalized listing agreement for debt securities is also under preparation.

Clearly, “Corporate Governance” has come a long way from the times when it was little more than a fashionable new mantra in corporate conclaves!

RUNNING AMOK…ITS FURY UNABATED!

Irascible Inflation

Comparing runaway inflation to a raging bull gone mad, is obviously old hat. Except that never before has the sense of high drama been so chillingly close to our every-day lives… literally leaving us gasping for breath. Laden as it is with the unenviable task of somehow containing this mad monster, the Indian Reserve Bank (RBI) is taking all possible steps to tackle Inflation; currently at a 13 year high of 11.91%. Among other steps are the raising of the Repo rate and Cash Reserve Ratio (CRR) to 50 basis point (100 basis point equals to 1%). (Please refer our Newsletter Editions of May & June 08)

CRR is the rate of amount that is to be maintained by all the commercial banks with the RBI. The CRR has been increased from 8.25% to 8.75% in two stages. From July 5, CRR will be set at 8.50%, and from July 19, at 8.75%.

Repo rate, the rate at which the commercial banks borrow from the RBI, has also been increased to 8.5% from 8% with immediate effect. A rise in repo rate will make it more expensive for banks to get money from RBI, which is likely to force them to charge customers a higher interest rate.

These measures aim at reducing the liquidity in the economy and thereby reigning in inflation. Commercial banks will also raise prime lending rates (PLR). The interest on the consumer loans, home loans, and personal loans from commercial banks is expected to go up and some banks have already taken steps in this direction. Whereas these steps are conventionally applied (with predictable results of containing inflationary trends) they clearly have a downside; adverse impact on overall economic growth. It comes as no surprise therefore that the RBI’s actions have made Indian Industry jittery.

Obviously the general public is severely hit since the family budgets have gone for a toss, with the prices of every single commodity having touched an all-time-high. The long-term scenario is indeed grim because the Great Indian Growth story seems to be in a “pause” mode…for now.

EXPORTERS BREATHE EASIER AS RBI LOOSENS THE REINS…JUST A LITTLE!

Gone are the days when Indian exports were ‘Neighbours envy; owner’s pride!’ With the gradual appreciation of the Indian Rupee in relation to the USD/Euro etc., over the years the export sector has been hit hard. To mitigate the hardships faced by Indian exporters, to some extent, the Reserve Bank of India (RBI) has decided to increase the time limit for realization/repatriation of export proceeds to India from six months to twelve months from the date of export. This is subject to review after one year. However for units situated in Special Economic Zone (SEZ) and cases where exports are made to warehouses established outside India, the position remains as before.
Some respite, that….howsoever modest!

POLICY PUZZLE - THE PIECES JUST DON’T FIT!

No tax holiday if it is Natural Gas….says the Finance Ministry!

Clearly the move defies comprehension! In an economic scenario characterised by skyrocketing petroleum prices, anyone would have thought that the government would leave no stone unturned to accelerate in-house oil exploration in terms of the New Exploration Licensing Policy (NELP-VII).

In fact the Ministry of Petroleum & Natural Gas (MOPNG), in the last few months, had postponed NELP-VII bid dates three times, in its efforts to convince the Finance Ministry to offer same tax breaks to natural gas production that were available to crude oil production.

Obviously it came as a rude shock to prospective bidders when they were advised through the ministry’s official website that no Income Tax rebates were available for commercial production of Natural Gas, as against “Crude Oil” which would enjoy a 7 year Income tax rebate from the date of Commercial production.
No wonder this last minute communiqué (issued just three days before the closing of bid submission!) acted as a definite dampener to the seventh round NELP bids…….and the consequences are plain as daylight!

By the Government’s own admission, it has received just 181 bids for 45 blocks by the bid closing date i.e. June 30, 2008. What is more is that of the 57 blocks offered there was not a single bid for 12 blocks (viz. 7 deep water blocks, 2 shallow water blocks and 3 on-land blocks).Out of the remaining blocks,19 blocks received single bids only.

A total of 96 companies (21 foreign and 75 Indian) have bid either on their own or as a consortium. 42 new players have bid for the nine S-type blocks, either singly or as parts of a consortium. Similarly, in the deep water blocks 2 ‘Super majors’ viz. BP and BHP Billiton have bid in consortium with Indian companies, namely, RIL and GVK, respectively. Other bidders in deepwater include ONGC, Cairn and GSPC. It is not yet clear if global giants like Exxon, Mobil and Chevron have evinced any interest in the seventh round of NELP.

Evaluation of the bids will be undertaken by the Government and the blocks are expected to be awarded by August 31, 2008 culminating in the contracts being signed by September 30, 2008.

Recapping the preceding six rounds of NELP, there is cause for satisfaction that the awarded contracts for 162 blocks have yielded 49 oil and gas discoveries in Cambay on-land, North East Coast and Krishna Godavari deepwater areas, accreting over 600 million tonnes of reserves. Obviously the process needs to go on.

CALIBRATION AND CONSOLIDATION

FDI Policy revisited

In an ongoing effort towards streamlining the Government of India’s stance on Foreign Direct Investment, the Ministry of Commerce & Industry, in Press Note No. 7 dated June 16, 2008 has reviewed/consolidated the FDI policy, making it more comprehensive and self-contained than the earlier Press Note 4 of 2006. A corrigendum pertaining to “non-banking finance companies (NBFCs)” was also issued on June 27, 2008. Apart from listing out the sector-specific policy for FDI, the new Press Note also lists sectors, which are prohibited for FDI. These prohibited sectors cover retail (except single brand retailing), atomic energy, lottery, gambling & betting, chit funds business and trading in transferable development rights.

With the exit of the left parties from the ruling coalition, it is expected that the economic reforms will now get a big push forward. Some of the areas which need immediate attention are permitting foreign equity in multi-brand retailing, higher equity for foreign companies in single-brand retailing, higher foreign equity for foreign companies in insurance sector, development of a vibrant corporate bond market, easier norms for foreign banks to set up operations in India, divestment of government equity in public sector undertakings, privatisation of state-run companies, liberal labour policies for corporate sector etc. Subject to the government proving its majority in Parliament, these and other areas may get a fresh look soon - hopefully !! Clouds do have silver linings!

INTERNATIONAL COMMERCIAL ARBITRATION

A recent decision of the Supreme Court of India in Venture Global Engineering (which reiterated its earlier decision in Bhatia International) has resulted in wide discussions on whether it is advantageous for a party to an international contract, to specifically exclude application of Part-1 of the Arbitration & Conciliation Act, 1996.
Part-I of the Act contains provisions including issues like what constitutes an arbitration agreement; the composition of the arbitral tribunal; jurisdiction; arbitral proceedings; making of an arbitral award; termination of proceedings; ground for challenging an award etc.
Part-11 deals with the enforcement of foreign awards made in countries which are parties to the New York Convention and/or Geneva Convention.
Till the Bhatia case, the view expressed by many Indian High Courts was that Part-I of the Act will apply only to domestic awards and international commercial arbitration held in India. This perception now stands changed due to the SC ruling.
Since both the above named cases were initiated by foreign parties who had argued in favour of the application of Part-I and since the SC’s ruling has gone in their favour.
Considering the facts involved in the above mentioned cases, it may not be always advantageous to exclude the application of Part-I of the Act. The advantage or disadvantage will depend on which side of the fence you are at the relevant time.

YOU CANNOT RUNAWAY FROM JURISDICTION!

Can two companies incorporated in India subject themselves to the law and jurisdiction of another country if disputes arise between them?

According to the petitioner before the Supreme Court of India, when the central management and control of a company is exercised in Malaysia, despite the fact that the company is incorporated and registered in India, it will become resident of Malaysia. NO - said the Supreme Court of India...... Very well said.

The nationality of a company, which is a legal person, is determined by the law of the country in which it is incorporated and from which it derives its personality.
Thus, when both companies are incorporated in India, neither can claim ‘international commercial arbitration’ on the averment that the management and control of either or both is situated outside India.

According to the Arbitration and Conciliation Act, 1996, in arbitration other than an international commercial arbitration, the arbitral tribunal shall decide the dispute submitted to arbitration in accordance with the substantive law for the time being in force in India. As part of public policy of the country, the intention of the legislature appears to be that Indian nationals should not be permitted to avoid Indian law.

The Court, however clarified that , for the purpose of taxation, test of residence may not be the registration but where the company does its real business and where the central management and control exists.

ALL ROADS LEAD THROUGH … (NO IT’S NOT ROME...CONTINUES TO BE MAURITIUS!!)

Courtesy DTAA - Mauritius continues being the favoured route for Investors :

India and Mauritius signed a Double Taxation Avoidance Agreement (DTAA) 26 years ago. That Mauritius currently accounts for nearly half of all foreign direct investment (FDI) inflows into India. DTAA provides/allows tax benefits for investments flowing from/through Mauritius .This special status accorded to investments from/through Mauritius came up for judicial review few years back. However the Supreme Court of India had refused to interfere and so the status quo continues.
On the flip side however, the said agreement with Mauritius is costing the Indian exchequer over INR 40 billion annually on account of the capital gains exemption for investors who route their funds through Mauritius to avail this benefit. To address the issue, the Indian government tried negotiating for an amendment in the DTAA. The idea was to move from a 'residence-based system of taxation' to a 'source-based' system. Under the proposed ‘source-based’ system, investors from Mauritius would need more than a ‘postbox’ registered office in Mauritius to qualify for the tax benefit.
However, it is reported that Mauritius has rejected India’s proposal for modifying the DTAA, despite India’s offer to compensate Mauritius for any loss of revenue resulting from changes in the existing agreement.
Therefore, as of now, Mauritius continues to be a favored route for FDI to India.