Search for the perfect vehicle to hold investments

Falguni Shah / Jayesh SanghviThe perfect vehicle to hold investments in India has always eluded the Indian promoters. With myriad and complex tax laws, an investment vehicle which may seem to be feasible at the outset, may not prove to be so.Historically, it has been observed that promoters of various Indian business groups have largely held their investments through investment companies and a nominal stake has been held through individual holdings - One of the reason was planning for wealth tax. Holding investments through companies comes with a whole set of issues. Prior to the introduction of dividend distribution tax (DDT) and minimum alternate tax (MAT), holding shares through company was not so disadvantageous as compared to direct holding except for trigger of NBFC implications. NBFC implications were overcome by way of maintaining the ratio of non-financial assets and non-financial income below the prescribed threshold. Now, such investment companies are subject to test of scrutiny and compliance of core investment company regulations.After introduction of DDT and MAT, there has been a substantial tax incidence on Indian investment companies. Any dividend declared by domestic company is subject to DDT @ 20.36%. A domestic parent company is eligible to claim set off of dividend received from the subsidiary company against dividend declared by itself provided that such dividend paid by the subsidiary has suffered DDT. However, in case of investment holding company, unless there is a parent subsidiary relationship, there will be a double incidence of DDT on dividend i.e. DDT on dividend paid by the investee company and further DDT incidence on dividend payment by investment holding company to its ultimate shareholders. It is a matter of debate whether DDT should continue as it arguably leads to double taxation. However, it seems that DDT is here to stay for long time to come and hence tax inefficiency will continue to remain in case of Indian investment holding company structure where parent subsidiary relationship does not exist.For all the tax payers, long term capital gains on sale of listed company shares is exempt from tax subject to such sale on stock exchange and payment of securities transaction tax.  In case of an off market transaction, it is taxed at concessional rate of 10%* (without indexation) at the option of the seller compared to normal rate of 20%* (with indexation). However, adding to the anguish of the domestic investment holding companies, long term capital gains on sale of shares of companies is also covered under the purview of MAT @18.5%*. As a result, exemptions /concessions on sale of listed company shares have proved to be redundant for domestic investment holding companies. Similarly in case of long term investments in unlisted companies held by domestic investment holding companies, difference between indexed cost and book cost can lead to difference between book profits under MAT and taxable capital gains on sale of shares and hence could be subject to MAT.  With a huge tax incidence on the profits from investments, domestic promoters are looking at alternatives. To eliminate the incidence of MAT, some of the Indian holding companies chose the option of Limited Liability Partnership (LLP) as its holding vehicle after the introduction of Limited Liability Partnership Act, 2009. One of the ways of achieving LLP structure was conversion of company into an LLP. However, with recent imposition of conditions as to a maximum asset base for a tax neutral conversion, the option of conversion of a company into LLP has also been made less effective. Looking at MAT implications from a different angle, on one hand, domestic companies are subject to MAT, on the other hand foreign companies are now explicitly excluded from the purview of the MAT provisions. With an aim of attracting and retaining foreign investments in the country, such steps soothing the foreign investor community have been taken over. The dichotomy is that if an income in the form of capital gains on sale of shares of a listed company on stock exchange has been expressly exempt, then why there should be discrimination between the foreign companies and domestic companies for applicability of MAT.   With perplexity in the holding company structure for domestic promoters, alternatives could be holding such shares directly in individual hands or through the private family trusts. Private trusts also provides for flexibility in succession planning within the family without losing the control. Eliminating holding companies and holding shares directly or through private family trust can minimise DDT and MAT incidence. With introduction of 10% tax on dividend income in excess of Rs.10 Lakh for individuals, HUFs and Partnership Firms including LLPs, there is an additional tax burden under direct holding route. However, it could be still lesser than the tax incidence under investment holding company route.However, elimination of investment holding companies, transitioning shareholding in individual hands or into private trusts would require careful consideration of tax and other implications and hence one should tread with caution.All in all, the search of domestic promoters for the perfect vehicle to hold investments continues.*excludes applicable surcharge and education cessFalguni Shah is Partner M&A Tax with PwC India Jayesh Sanghvi is Director M&A Tax with PwC India Views expressed are personal