Update on India - July 2013

• The Finance Bill 2013 (“Bill”) was presented to the Indian Parliament in February and passed by the Lower House with certain amendments. It was subsequently cleared by the Upper House of the Parliament and received assent in May to be passed as law.
• The Securities Exchange Board of India has released a circular on Infrastructure Debt Funds to clarify and implement the amendments brought about by regulations in this sector.
• The Indian Government has also passed new legislation with detailed provisions relating to the pricing and supply of drugs.
• In two recent cases, a challenge to the Indian Government’s decision to allow foreign direct investment in Multi-Brand Retail Trading has been dismissed, and income arising from procurement activities carried out by Nike’s liaison office in India for onward export was held not to be taxable in India.
• From a competition perspective, the Competition Commission of India has amended regulations in relation to acquisitions and joint control of a company.

The main features of these developments are discussed below.

The key features of the 2013-14 Budget

The Indian Finance Minister (“Minister”) presented the much awaited 2013-14 Budget and Bill with the objective of promoting higher growth leading to inclusive and sustainable development, recognising that India has no alternative but to welcome foreign investment. Certain amendments were subsequently made to the Bill by the Lok Sabha (the Lower House of the Parliament). The Bill was then cleared by the Rajya Sabha (the Upper House of the Parliament) and received Presidential assent on 10 May 2013 to be passed as law.

Key amendments in the Income-tax Act, 1961 (“IT Act”) are as follows:

• An exemption from tax for securitization trusts and investors in trusts such as mutual funds (the Budget has however introduced 25%/ 30% tax to be paid by such trusts at the time of distribution of income to their unit holders). Alternative Investment Funds (“AIFs”) comprising Venture Capital Funds are also granted an exemption from tax. Other categories of AIFs have not been granted this status.
• A 20% tax has been introduced on income distributed by an unlisted company to its shareholders by way of a share buy-back.
• The extension for a further year of the lower 15% tax rate on dividends received from foreign companies by Indian companies holding at least 26% equity.
• The incorporation of a number of changes to the General Anti-Avoidance (“GAAR”) regime (introduced by the Finance Act 2012), as proposed by the Shome Committee, which was set up to review and comment on the GAAR provisions following severe criticism on account of their far reaching impact and the discretionary powers conferred upon the Tax Authorities. The Committee’s proposed changes have been incorporated into the IT Act with certain exceptions, one of them being a ‘grandfathering’ provision.
• Commodities Transaction Tax has been introduced at the rate of 0.01% on transactions involving the sale of commodity derivatives (other than agricultural commodities) traded on a recognised association.
• The IT Act, as amended by the Finance Act 2012, provided that a Tax Residence Certificate (“TRC”) containing the ‘prescribed particulars’ is required by a non-resident to qualify for the benefits under the relevant Double Taxation Avoidance Agreement (“DTAA”). The IT Act has been amended to remove the requirement to obtain a TRC containing the prescribed particulars. Therefore a non-resident would now only need to obtain a TRC in whichever format the government of its country of residence issues the TRC, and to submit the same to the Indian Tax Authorities.
• The Bill initially proposed to further amend these provisions to expressly provide that submission of a TRC containing the prescribed particulars is a ’necessary’ but not a ‘sufficient’ condition for the purpose of qualifying for the DTAA benefits. Following dissent amongst foreign investors, this provision was deleted. However a new provision has been added to the effect that the non-resident tax payer shall also be required to provide such other documents and information as may be required in order to qualify for the benefits under the relevant DTAAs. It remains to be seen what nature of documents or information would be required under this provision.
• The Bill initially proposed to extend the benefit of a lower withholding tax rate of 5% on interest paid to non-residents who subscribe to rupee denominated long term infrastructure bonds issued by Indian companies. This proposal has now been deleted from the Bill. However, a new amendment has been introduced extending the benefit of the lower rate of 5% tax to Foreign Institutional Investors and Qualified Foreign Investors investing in all rupee denominated bonds of an Indian company (irrespective of the sector) or in Government securities. The benefit will be available for interest paid between 1 June 2013 and 1 June 2015, subject to the interest being within limits to be specified by the Government.
• Under the IT Act, in the absence of a Permanent Account Number (“PAN”) of the payee, a payer is required to withhold tax at a minimum rate of 20%, even where a lower tax rate is available. It has now been proposed that this provision relating to a compulsory requirement of PAN would not be applicable in the case of interest paid on long term infrastructure bonds which is eligible for the concessional rate of 5%. Therefore, in these cases the applicable rate of withholding tax under the IT Act would be 5% even if the holder of such long term infrastructure bonds does not provide its PAN.
• The provisions relating to computing time limits for completion of assessments and reassessments involving transfer pricing so that they are no longer dependent on the date of reference or order of the Transfer Pricing Officer have been amended.

The Finance Act 2012 had introduced a 10% tax for long term capital gains on unlisted securities. Though the intention was to introduce the 10% tax for unlisted shares, the law restricted the reduced rate to shares of unlisted public companies, and private companies were not covered by this. The anomaly has not been corrected.

It was expected that multi-level shareholding structures would be exempted from multi-levels of Dividend Distribution Tax (“DDT”) of 15%. Unfortunately the current law, under which only one level in a multi-level shareholding structure is spared from DDT and not the subsequent layers, continues to stand.

There is still uncertainty as to what documents or information will be required in order to qualify for DTAA benefits and whether the above-mentioned amendment will prove to be more onerous than the existing provisions under the IT Act.

Certain issues in relation to General Anti-Avoidance Rules (“GAAR”) such as whether past investments or transactions would be grandfathered and whether GAAR or ‘special anti avoidance provisions’ would prevail over the other, have still not been addressed..

SEBI Circular on Infrastructure Debt Funds

The Securities Exchange Board of India (“SEBI”) has released a circular dated 23 April 2013 on Infrastructure Debt Funds (the “Circular”) to further clarify and implement the amendments brought about by the SEBI Mutual Funds (Amendment) Regulations 2013. Key features of the circular are as follows:

• In the case of Infrastructure Debt Funds (“IDF”), private placements to less than 50 investors are permitted as an alternative to a new fund offer (“NFO”) to the public. All other conditions applicable to IDF making offers through the NFO route, such as investment restrictions, will also be applicable to IDF making offers through a private placement.
• For private placements, mutual funds are required to file a placement memorandum (in a prescribed format annexed to the Circular) (“Placement Memorandum”) with SEBI instead of a scheme information document and a key information memorandum.
• Asset Management Companies (“AMC”) must ensure that the Placement Memorandum is uploaded on their websites after the allotment of shares. The Placement Memorandum also must be uploaded on the website of a recognised Stock Exchange where an AMC is proposing to be listed at the time of listing.
• The format of the Placement Memorandum in the Circular must include (i) risk factors; (ii) the minimum number of investors that should be involved in the scheme; (iii) (in the case of AMCs) a due diligence certificate signed by the compliance officer/chief executive officer/managing director/whole time director/executive director of the AMC and countersigned by a director of the trustee company/trustee from the board of trustees (which must be submitted to the SEBI); and (iv) information about the scheme.
• The scope of investors in IDF has been expanded to include Foreign Institutional Investors registered with SEBI (“FIIs”), which are long term investors subject to investment limits. For IDF only, the following categories of FIIs are classed as long term investors: Foreign Central Banks, Governmental Agencies, Sovereign Wealth Funds, International/Multilateral Organisations and Agencies, Insurance Funds and Pension Funds.
• The investments by IDF in bank loans can only be made through a securitization.

India implements a new regime for the regulation and production of drugs

The Indian Government passed the Drugs Prices (Control) Order 2013 (“DPCO 2013”) on 15 May 2013, superseding the Drugs Prices (Control) Order 1995 (“DPCO 1995”). The DPCO 2013 contains provisions relating to the pricing and supply of drugs, and applies to 348 drugs mentioned in the National List of Essential Medicines 2011 (“Scheduled Formulations”) and to other drugs as well (“Other Drugs”).

For Scheduled Formulations, the key provisions are as follows:

• The pricing will be ‘market-based pricing’, an average of the prices at which different versions having a market share of more than or equal to 1% are selling drugs. The DPCO 2013 makes separate provisions for the pricing of new drugs and also of drugs where there is no competition.
• The maximum retail price of drugs will be the ceiling price plus local taxes.
• The prices fixed under the DPCO 1995 prior to 31 May 2012 were valid until 31 May 2013, and those fixed after 31 May 2012, will be valid for a period of 1 year. Thereafter, the manufacturers may revise the price upwards based on the wholesale price index. From the first day of April of the following financial year (most likely, 1 April 2014), the pricing fixed under the DPCO 2013 is expected to be put in place.
• Pricing will be based on data collected by IMS Health (“IMS”). The IMS data provides stockists prices, and therefore a further 16% will be added to account for retailer margin. Where IMS data is unavailable, the National Pharmaceutical Pricing Authority will collect data separately.
• Ceiling prices will apply to imported scheduled formulations.
• Manufacturers should ensure compliance with a ceiling price within forty five days of its notification by the government.

For Other Drugs, the key provisions are as follows:

• The government will monitor prices, and manufacturers are not permitted to increase the maximum retail price by more than 10% of the price during the preceding twelve months.
• The prices fixed under the DPCO 1995 prior to 31 May 2012 were valid until 31 May 2013, and those fixed after 31 May 2012 will be valid for a period of 1 year. Thereafter, prices will be governed by the method mentioned above.

Manufacturers of Scheduled Formulations are required to furnish production information to the government on a quarterly basis. Where a manufacturer wishes to discontinue the manufacture of a Scheduled Formulation, it must issue a public notice and notify the government 6 months before the discontinuation.

Additionally, the government has broad powers in the case of public interest or extraordinary circumstances to fix ceiling prices of any drug, and to require a manufacturer to increase production of certain active pharmaceutical ingredients, bulk drugs and formulations, and to sell them to government specified agencies and hospitals. The DPCO 2013 makes concessions for innovation and provides bound concessions within a time-frame to new drugs developed based on innovative research and development.

Supreme Court dismisses challenge to FDI in Multi-Brand Retail

The Supreme Court of India (“Supreme Court”) dismissed a public interest litigation claim (“PIL”) challenging the Indian Government’s decision to allow foreign direct investment (“FDI”) in Multi-Brand Retail Trading (“Multi Brand Retail”).

In September 2012, the Indian Government announced that it would permit FDI in Multi Brand Retail up to 51% subject to prior approval being obtained from the Foreign Investment Promotion Board (“FIPB”). Various other conditions were also imposed, and the implementation of the policy was eventually left to the discretion of each state.

An individual (“Petitioner”) filed a PIL challenging the policy as unconstitutional. Among other claims, the Petitioner contended that the Indian Government was not competent to pass such a policy on FDI in Multi Brand Retail and also contended that the Indian Government did not have any statutory authority to take this decision. The Supreme Court dismissed the PIL. It held that the introduction of such a policy by the Indian Government was well within its legislative and constitutional powers and that it was eventually the states’ decision whether they would implement the policy. The Supreme Court also noted how this policy would eventually benefit consumers and producers, by removing middlemen who were retaining a sizeable chunk of profits associated with such retailing activities.

This decision of the Supreme Court should reinforce the confidence that the Indian Government and the Commerce Minister have been trying to instil in global Multi Brand Retail giants.

Nike’s liaison office in India not to be liable for income tax

The High Court of Karnataka (“High Court”), in the case of Nike Inc (“Nike”), has ruled that income generated from procurement activities carried out by Nike’s liaison office (“LO”) in India for onward export, including assisting third party manufacturers in India to manufacture goods according to the specification of foreign buyers, is not taxable in India as the LO does not constitute a ‘business connection’ in India.

Background

In order to procure goods manufactured in India for its various subsidiaries around the world, Nike established a LO in India with the approval of the Reserve Bank of India (“RBI”).

RBI granted the approval subject to the following conditions:

• The LO would not undertake any trading, commercial or industrial activities or enter into any business contracts in its own name without RBI’s consent.
• The LO would not be able to charge commission, fees or remuneration in regard to any of the services rendered by it in India.
• The entire expenditure of the LO would be borne by Nike.
• The LO would not borrow or lend without RBI’s consent.

Facts

• The LO liaised between local manufacturers in India and Nike’s head office in the USA, whilst monitoring the progress of the manufacturing and the quality of the goods being produced by the local Indian manufacturers. The LO rendered such assistance as was required in the dispatch of the goods to the foreign buyer.
• The Tax Authorities held that such activities went beyond the LO’s permitted activities, as by procuring the manufacturing of its apparel in India and exporting the goods thereafter, a part of the business was carried out in India. As such, Nike was taxed on the income generated from such activities carried out in India.
• On appeal, the Tax Authorities’ order was upheld based on the fact that Nike was not involved in the purchase of manufactured goods for the purpose of export. As such, Nike would not be exempt under the IT Act, which prevents income of a non-resident being taxable in India if its operations are confined to the purchase of goods in India for the purposes of export.
• On further appeal, the Income Tax Appellate Tribunal (“Tribunal”) overturned the previous rulings on the basis that as Nike’s activities were confined to the purchase of goods in India for the purpose of export, none of Nike’s income actually accrued in India and as such, no income tax was payable.

Ruling of the High Court

The High Court upheld the Tribunal’s finding and held that the LO’s activities in India only amounted to the purchase of goods in India for the purpose of export and therefore no income tax should be payable.

The High Court made the following observations in its judgment:

• The LO’s activities did not constitute a ‘business connection’ (defined to include any business activities carried out by a person who acts on behalf of a non-resident and regularly exercises in India an authority to conclude contracts on behalf of the non- resident unless his activities are limited to the purchase of the goods/merchandise for the non-resident).
• Nike, through its LO, enabled the manufacturers to manufacture goods to a particular specification required by the foreign buyer. Therefore the objective of the transaction was to purchase goods for the purpose of export. As such, any income earned would not accrue or arise in India.
• The objective of the income tax exemption under the IT Act is to encourage exports, ensuring that India can earn foreign exchange.
• If the foreign buyer pays Nike consideration outside India for the procurement of the manufactured goods, the contract between Nike and such foreign buyer would be entered into outside of India and so any income that arose or was accrued thereby would be outside India and therefore would not attract taxation in India.

It appears that in order to constitute a ‘business connection’, the connection must be real and one through which income must arise whether directly or indirectly to the non-resident in India. There must be continuity of activity or operation of the non-resident and the activities carried out in India by the Indian party. An isolated transaction is not enough to establish a ‘business connection’. This ruling reinforces the principle that if a LO of a foreign company is engaged only in activities ancillary to the activities of its head office or is merely a vehicle for communication between the head office and parties in India or is involved only with the purchase of goods for export, then it does not constitute a ‘business connection’.

Competition Law: combinations (Merger) Regulations amendments

The Competition Commission of India (“CCI”) has amended the CCI (Procedure in Regard to the Transaction of Business Relating to Combinations) Regulations, 2011. The amendments include the following:

• Where a buyer or its group holds more than 25% and less than 50% of the shares or voting rights in a target company, then such buyer or its group can acquire up to 5% additional shares or voting rights in the same financial year without seeking CCI consent. This is unless the transaction results in the acquisition of sole or joint control of the target by the buyer or its group. This 5% acquisition must be gross, and not the net acquisition of equity over a financial year.
• The acquisition of trade receivables and other current assets in the ordinary course of business would also not require CCI consent.
• Where a buyer acquires control of another entity within the same group of companies as the buyer and such target company is jointly controlled by entities outside the buyer’s group of companies, CCI consent will be required.
• A merger between two companies in which one company holds more than 50% would not require filing with the CCI. Also, a merger between companies in which more than 50% of the equity in each company is held by the same group need not seek the approval of the CCI. These transactions, however, should not lead a transfer from joint control to sole control.

We are very grateful to Khaitan & Co, the leading Indian law firm with offices in Mumbai, New Delhi, Kolkata and Bangalore, for allowing us to use their newsletters to prepare this briefing note.

You can contact Khaitan & Co at editors@khaitanco.com for further information or specific advice on the issues covered by this briefing note.

For further information, please contact: