Corporate guarantees given for 2007-08 deals facing high taxes now; industry presses for change in rules.
Three years after the great Indian deals party of 2007-08 got over, the taxman is playing the party pooper. Indian companies that purchased assets abroad are facing an up to 10 per cent increase in deal costs due to transfer pricing adjustments raised by the income tax department.
The department is raising these adjustments on commission or fees chargeable for corporate guarantees given by the acquirers to their subsidiaries abroad.
The financial year 2007-08 was one of the best years in terms of outbound merger and acquisition (M&A) deals in India. According to Bloomberg data, Indian companies acquired assets abroad worth $19.6 billion in 302 deals. According to government rules, transfer pricing officials have a 43-month window to raise adjustments on transfer pricing. The deadline for raising adjustment orders for the tax year ending March 2008 concluded on October 31.
A significant number of companies have already received the orders. In the Mumbai region alone, tax authorities have raised claims of around Rs 30,000 crore, consultants said. This is higher than all transfer pricing orders passed across the country in previous years. Outbound M&A deals contribute a major portion of this sum, said consultants advising the firms. “The size of orders is touching dangerous levels. In some cases, they have fixed commission as high as 10 per cent,” said the tax head of a big accounting firm.
Some of the significant cross-border deals that happened during the period are United Spirits-Whyte and Mckay($1.7 bn), Tata Motors-Jaguar Land Rover ($2.3 bn) and Suzlon-RE Power, showed Bloomberg data. According to the Grant Thornton deal tracker for the year 2007, the largest proportion of outbound acquisitions in terms of value were in Europe (52 per cent of deal value), followed by North America (38 per cent ). In terms of volume, Indian companies acquired more companies in North America (95 deals) than in Europe (84 deals).
Many of these acquisitions were done through a subsidiary domiciled abroad, to enable raising of foreign currency loans. This was necessary as Indian banks are not allowed to fund M&A activities abroad. At the same time, since the foreign vehicles did not have assets on their book to cover the loans, the local companies usually gave guarantees to secure these.
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The tax department has started to view such guarantees as ‘intra-group services’, which require to be charged. The charges payable for such guarantees are calculated and added to the income of the party concerned. While this is a valid concept, the imputation of guarantee charge in the hands of Indian companies needs to be considered differently, given the regulatory environment, say experts.
“Many Indian multinationals have acquired big corporates outside India requiring significant funds, which, for various regulatory and commercial reasons, cannot be borrowed in India. In such cases, a Special Purpose Vehicle is formed which borrows from lenders on the basis of guarantee by the Indian parent. Given this, such a guarantee cannot be considered a service. At the most, it is shareholder services. The passive association of a parent-subsidiary relationship needs to be considered before computing the guarantee charge,” said Samir P Gandhi, partner, Deloitte Haskins & Sells.
The position taken by the tax department for tax year 2007-08 has cast a shadow on outbound deals that happened in subsequent years, too, said experts. According to Bloomberg data, Indian companies have acquired foreign companies worth $60.29 bn in 662 deals since April 2008.
While corporate India is gearing up to challenge these orders within the available framework, industry bodies have called for reforms in the transfer pricing framework. Assocham has called for fundamental reforms in the regulations to allay the risk of tax base erosion. “The sheer magnitude of transfer pricing disputes in India has heralded its place at the forefront of the global dispute resolution roadmap,” its statement said.
Experts said the I-T dispute resolution panel, set up a couple of years before, can play a very efficient role in resolving transfer pricing disputes. “Panel members can be made full-time to ease the process for all stakeholders. Some guidance by CBDT (Central Board of Direct Taxes) on the power to resolve disputes can be of assistance,” said Gandhi of Deloitte.