Taxation of Foreign Investors in Asia

1. Taxation of Foreign Investors in Asia Michael G. Velten (Velten Partners LLP) and Lian Chuan Yeoh (Rajah & Tann LLP) October 22, 2009 International Fiscal Association SINGAPORE

2. Tax planning for investments in Asia • Tax planning for investments in Asia must take account of the possible trends in taxation. It is simply not possible to plan an investment based solely on the tax position as it might stand today • The past 5 years in Asia taxation provides examples of tax authority challenges to what had been accepted investment structures: • South Korea : Labuan and Belgium holding companies (e.g. Lone Star) • India: The “Mauritius route” (e.g. E Trade case); Sale of an upper tier holding company (e.g. Vodafone case) • Indonesia: Conduit financing • China: Barbados and Singapore holding companies (Chongqing Case and Xinjiang Case) There is an understandable tendency to look to the law as it is when planning an investment in Asia as opposed to how it may be. Experience tells us that what is thought to be accepted tax planning today may subsequently be viewed very differently

3. A new approach to tax planning for investments • Investment planning in Asia needs to reflect as best it can how the law may evolve. This is particularly true in the case of tax treaty planning and the use of holding company structures. • This can be difficult: • There may well be a historic acceptance of tax treaty “shopping” in the jurisdiction concerned (e.g. in the case of India, Union of India v. AzadiBachao Andolan) • We know though that circumstances may change: • In South Korea private equity making large tax free gains on investments made during the Asia economic crisis rankled the public and led to the investments being audited (and taxes and penalties assessed) and changes in Korean tax law • This is not to say that a currently accepted approach to investment planning in Asia should not be used: • For instance, the “Mauritius route” should still be considered with respect to investments in India • The possible challenges to that investment structure need however to be weighed as should the alternatives: • In the case of India the possible challenges to the “Mauritius” route include a tax treaty override and GAAR in the Direct Tax Code and/or the introduction of a Limitations of Benefits - or "LOB" article in the Mauritius – India tax treaty • An alternative to the “Mauritius route” would be Singapore. It too would be impacted by a tax treaty override and GAAR in the Direct Tax Code and in the near term arguably lacks the certainty that Circular 789 brings to Mauritius The result is the need for a shift in approach to Asia tax planning

4. Trends in the taxation of foreign investors in Asia • Trends in both international and Asia tax must be identified: • Internationally there is a focus on AML, tax havens and EOI • OECD: • See “Overview of the OECD’s Work on Countering International Tax Evasion” (10 September, 2009) • FTA: • International non-compliance and tax evasion (e.g. “structures involving the misuse of tax treaties”: Seoul Declaration,2006) • “Role of tax intermediaries in aggressive tax planning”: Cape Town Communiqué, 2008 • Global Forum on Transparency and Exchange of Information • 12 EOIs • G20: Uncooperative tax havens (2009) • G20 to use countermeasures against tax havens from March 2010 • Financial Action Task force (FATF): 40 + 9 Recommendations • Regionally there is a trend towards substance: E.g. South Korea, China and Indonesia Tax planning for investments in Asia must take account of relevant developments, and trends, in the taxation of foreign investors

5. An overview of our presentation • Our presentation will first address some of the current developments in the taxation of foreign investors in Asia: • This cannot be a complete discussion and for that we refer to “Taxation of Foreign Equity Investors in Asia” which appears in TaxViews Asia Issue No. 2 (September, 2009) • There will then be a discussion of the Prevost case • We will then set out some of the trends that may be distilled in the area of the taxation of foreign investors in Asia and what that means for investment planning and in particular the future of holding company planning for investments in Asia • Finally, the possible use of Singapore Fund structures in Asia private equity will be discussed. Some observations on investment planning by private equity in Asia will also be made

6. Current developments in the taxation of foreign investors in Asia • There are a number of important developments in the taxation of foreign investors in Asia • China: • DWT must be withheld on dividends paid to “A”, “B” and “H” shareholders. The procedure for claiming a reduced rate of DWT under an applicable tax treaty has also been prescribed • The taxation of “A” share gains earned by a QFII is yet to be addressed by the SAT. These gains (as well as those arising on a sale of “B” and “H” shares) may be taxed under the new EIT Law. At the same time the 1993 capital gains tax exemption for “B” share gains has been removed. How China proceeds to deal with the taxation of listed share sale gains is a key open issue. Pending guidance from the SAT there remains uncertainty for investors in PRC listed company shares

7. China • The notions of economic substance and business purpose are embedded in the general anti-avoidance rules in Article 47 of the new EIT Law and are now a part of administrative practice in China • Circular No. 2 clarifiesthe general anti-abuse clause. Among other things, it provides that the tax authorities may initiate a general anti-avoidance investigation to enterprises with the following tax avoidance arrangements: (i) abuse of tax incentives; (ii) abuse of tax treaties; (iii) abuse of a company’s legal form; (iv) tax avoidance through a tax haven; and (v) other arrangements without bona fide business purpose: • In two recent tax cases - Chongqing Case and Xinjiang Case, China’s tax authorities either disregarded or denied treaty benefits to an offshore special purpose vehicle - which were found to lack substance. Although not specifically stated in the cases, tax practitioners generally believe that the general anti-abuse clause in the new EIT law was the underlying rationale and legal basis in deciding these two cases • Notice No. 81 (2009) empowers the tax bureaus in China to investigate and to deny treaty benefits where the main purpose of a transaction or an arrangement is to obtain more favourable treatment of dividends under a tax treaty

8. India • India: • The Indian tax authorities have been giving greater scrutiny to cross border transactions. The ongoing E*Trade casebears this out • Generally, the use of the “Mauritius route” should mean that the possible application of India domestic tax law to a share sale gain does not need to be considered.This, however, may not be the case if shares in a Mauritius company, which in turn has invested in an Indian company, are sold at a gain • The question is whether that share sale gain has a “business connection” with India and therefore taxable under section 9(1) of the IndiaIncome Tax Act, 1961. If so, a requirement on the purchaser of the shares to withhold tax for remittance to the India tax authority arises under section 195 of the India Income Tax Act, 1961 • This issue arose in the Vodafonecase

9. India • On 12 August 2009 the Finance Minister released a draft of the Direct Tax Code and a Discussion Paper for public comment. The new Code aims to replace current India Income-tax Act, 1961 and Wealth Tax Act, 1957 • The new Direct Tax Code is to introduce provisions to prevent the misuse of tax treaties. A general anti-avoidance rule (GAAR) is to be introduced.Importantly, the Direct Tax Code will override tax treaties which India has entered: • The Direct Tax Code provides that: “For the purposes of determining the relationship between a provision of a treaty and this code neither the treaty nor the code shall have a preferential status by reason of its being a treaty or law; and the provision which is later in time shall prevail” • This provision is of particular interest to FII investors in India’s stock exchanges • The proposed Direct Tax Code is expected to become law in 2011

10. Indonesia • Indonesia: • A new definition of “beneficial owner” has been introduced into Article 26 paragraph (1a) of the Income Tax law: Law No. 36 of 2008. The new law took effect on January 1, 2009: • "The country of domicile of a foreign taxpayer, other than those carrying on business or conducting business activity through a permanent establishment in Indonesia that receives income from Indonesia, shall be determined based on the residence or domicile of the taxpayer that actually receives the benefit of the income (beneficial owner). Accordingly, the country of domicile shall not only be determined based on the Certificate of Domicile, but also the residence or domicile of the beneficial owner of the said income. In the event that the beneficial owner is an individual, his/her country of domicile shall be the country where the individual resides or lives, whereas if the beneficial owner is a corporate entity, the country of domicile shall be the country where the owner of more than fifty percent (50%) shares both individually or jointly domiciled or where the effective management is located“. • Other relevant developments in Indonesia related to the meaning of “beneficial ownership” include: Circular Letter No. SE-03/PJ.03/2008 (and the revocation of Circular Letters No. SE-04/PJ.34/2005 and No. SE-02/PJ.3/2006) and the recent decision of the Indonesia Tax Court on beneficial ownership.(Interestingly, the Tax Court held that the term ‘‘beneficial owner’’ is based on a substance-over-form doctrine and an economic approach)

11. South Korea • South Korea: • An international substance over form principle has been introduced into Korean tax law, together with a special withholding tax regime and procedures for asserting tax treaty claims • South Korea is also working to re-negotiate several of its tax treaties to include a LOB article • The Seoul Administrative Court recently issued judgments in two cases in which private equity funds had established an investment holding company in Labuan and claimed the benefit of the Korea–Malaysia tax treaty with respect to the gain that arose on the sale of shares in a Korean company: • The National Taxation Service (NTS) had denied the application of the tax treaty and assessed capital gains tax to the foreign private equity funds arguing that the investment holding company should not be respected as beneficial owner of the gain. Rather, the NTS said that the foreign investors in each investment holding company should be viewed as the beneficial owner in substance of the capital gains through an application of the substance over form principle under Korean domestic law • The Seoul Administrative Court held that the Korean substance over form principle could apply in the context of a tax treaty (even in the absence of an express beneficial ownership requirement in that tax treaty with respect to capital gains). The share sale gains in question could thus be taxed in Korea on the basis that the CGT exemption in the Korea–Malaysia tax treaty was not applicable in these cases

12. Australia and Japan • Australia: • Australia has introduced a broad based exemption from domestic capital gains tax on most share sale gains. In very broad terms only gains arising on the sale of real property companies are taxed • Japan: • Japan has recently relaxed the application of its capital gains tax to certain Funds. Essentially the 25% tax exemption threshold is now tested at the Limited Partner level and not that of the Partnership. The domestic Japan capital gains tax is subject to an applicable tax treaty capital gains tax exemption available to the Limited Partner (subject to an assertion of that tax treaty exemption claim by the Limited Partner)

13. Recent case law: Prevost • Facts: • Prevost Car Inc. was a corporation resident in Canada and active in bus manufacturing. It was a wholly-owned subsidiary of Prevost Holding BV, a Dutch resident holding company. The BV was in its turn owned for 51% by Swedish resident Volvo Bus Corp., and for the other 49% by UK resident Henly's Group PLC • Volvo Bus Corp. and Henly's Group PLC wanted to expand their business into Canada and the US and considered doing so through a holding company, preferably -- for logistical reasons – in Europe. For various reasons, it was decided to set up the holding company in NL • Volvo Bus Corp. and Henly's Group PLC entered into a Shareholders' Agreement, to which the company (Prevost Holding BV) was not a party, and in which they agreed that not less than 80% of the original (Canadian) Prevost Car Inc. profits that were received by the BV, were to be distributed to them • Prevost Holding BV had no employees and no other investments than the shares of Prevost Car Inc. • When Prevost Car Inc. paid dividends to Prevost Holding BV, it applied the NL-Canada treaty and withheld only 5% tax. Canada Revenue Agency (CRA) took the position that the BV did not exist, or that it was an agent or conduit for its shareholders – and that, instead, 15% withholding tax under the Canada-Sweden treaty was due in respect of 51% of the dividends (for Volvo) and 10% withholding tax rate under the Canada-UK treaty for 49% of the dividends paid to the BV • The taxpayer appealed to the Tax Court of Canada, where the taxpayer won. CRA appealed to the FCA

14. Prevost • FCA (Observations): • FCA reached the conclusion that “for the purposes of interpreting the Tax Treaty, the OECD Conduit Companies Report (in 1986) as well as the OECD 2003 Amendments to the 1977 Commentary are a helpful complement to the earlier Commentaries, insofar as they are eliciting, rather than contradicting, views previously expressed” • The "beneficial owner" of dividends is: the person who receives the dividends for his or her own use and enjoyment and assumes the risk and control of the dividend he or she received. Where an agency or mandate exists or the property is in the name of a nominee, one looks to find on whose behalf the agent or mandatory is acting or for whom the nominee has lent his or her name • When corporate entities are concerned, one does not pierce the corporate veil unless: the corporation is a conduit for another person and has absolutely no discretion as to the use or application of funds put through it as conduit OR has agreed to act on someone else's behalf pursuant to that person's instructions without any right to do other than what that person instructs it, for example, a stockbroker who is the registered owner of the shares it holds for clients • FCA (Findings): • Prevost Holding BV was not an agent/mandatory or nominee • Prevost Holding BV was not a conduit with “absolutely no discretion”, nor agreed to act upon another person’s instructions • Prevost Holding BV was: not a party to the Shareholders Agreement, was not obliged to pay dividends to its shareholders, was the registered owner of the shares, and the dividends it received were its property and are available to its creditors until it declared itself a dividend

15. Trends in the area of the taxation of foreign investors in Asia • Certain jurisdictions (e.g. Australia and Japan) have broadened the scope of the exemption from capital gains tax for non resident investors • There is an emerging anti-avoidance principle in China that poses challenges to the use of a holding company structures that seek to achieve a reduced rate of DWT or a capital gains tax exemption. • The trend towards substance is seen in South Korea and Indonesia • The Vodafone case in India has highlighted the possible application of domestic tax rules to tax an “offshore” gain on the sale of shares where that the share sale gain has a “business connection” with India. Challenges to the “Mauritius” route are also evident; most recently the Direct Tax Code and its inclusion of a tax treaty override and GAAR • The concept of “beneficial ownership” has been tested in the courts in Indonesia and outside the region with implications for structuring investments into Asia

16. The future of holding company structures in Asia tax planning • Tax treaty based planning for South Korea investments is not to be undertaken lightly in view of recent developments: • To the extent that tax treaty based planning has continued to be undertaken post 2005 for  Korean investments Ireland and  the Netherlands have been used.  These structures can be expected to be challenged • In a Fund context certainty of tax outcome is desirable in order to mitigate the risk of a claw back  post investment exit/distribution to investors, and penalties/interest. Query whether this suggests that a holding company other than in a jurisdiction where the investor is located should be used. (It is noted that there is a domestic exemption from capital gains tax for certain listed share sales). In a Fund context seeking a “look through” to tax treaty based investors should be explored • The recently released draft Direct Tax Code that is due to take effect in 2011 and which is currently subject to a consultation process has the potential to reshape investment planning for India. At first blush each of the popular investment routes will be impacted. It is important to focus on these changes and the current consultation process to ascertain what each might mean to India investment planning in the longer term. In the near term developments in the E-Trade and Vodafone cases will need to be  followed as well as any steps taken by India to negotiate with  Mauritius for a LOB Clause in the  India - Mauritius tax treaty • The fact that a jurisdiction has not focused on tax treaty abuse does not mean that is not possible: • For instance, in Thailand the focus on the legal registered owner of securities when applying a tax treaty capital gains tax exemption. It is not inconceivable that this position may be revisited in due course • Given the possibility of penalties and interest being imposed following a change in law and/or practice, obtaining a ruling is something that might be considered

17. Enhanced Tier Fund Management Incentive Open to fund vehicles in the form of companies, trusts and limited partnerships Minimum fund size: SGD$50m No restrictions on residency status of the fund vehicle or the investors Effective: 1 April, 2009 – 31 March, 2014 Tax treaty entitlements and Singapore funds Singapore Funds – an alternative

18. Some observations for private equity • If an investment focus of a Fund is or is to be China the impact of recent regulatory developments may dictate consideration of the establishment of a RMB Fund as an Alternative Investment Vehicle. The FVCIE has limitations, but permits the Fund access to deals that will not otherwise be open to it • The FVCIE would be constituted as a non legal person CJV. (When foreign investment in partnerships is permitted, FVCIE’s will convert to that legal form). Pass through tax treatment for the FVCIE is typically confirmed by the Local Tax Bureau that has jurisdiction over the FVCIE. This means that there is no EIT at the FVCIE “level”. The FVCIE Investors will for PRC tax purposes be treated as deriving the gain from the sale of an investment in China. This gain is subject to a 10% tax in China, although is subject to an applicable tax treaty exemption • To date most FVCIE investors have been set up as Hong Kong companies. To the extent that the private equity investment is less than 25% of the investee, the capital gains tax exemption in the Hong Kong - China tax treaty may be asserted • The tax treatment of Hong Kong investors in FVCIEs is a nuanced issue. The end result should  be that distributions by the FVCIE to the Hong Kong investor are not subject to Hong Kong Profits Tax

19. Some observations for private equity (cont) • “H” shares sale gains may be subject to 10% PRC EIT under the new EIT Law: • Whether and if so how a tax on “H” share gains would be imposed is open to question • To the extent that the possibility of tax exists consideration may be given to a Luxembourg holding company to make this investment: • The Luxembourg vehicle that would be used is a SOPARFI • This is not to say that other jurisdictions (save for Hong Kong) may not be used