International Holding Companies

NASSCOM decided to hold a series of lectures for its members. For some reason, they chose to talk to a group of decidedly SME firms on International Holding Companies. By the end of the discussion, when someone spoke out on the obvious expenses involved in setting up such a holding company, the speaker mentioned that it certainly does not make sense for a small enterprise to look at this option. The costs, he confirmed will be prohibitive and more importantly unnecessary when they will only be acquiring one or maybe two companies abroad.

Having said this, I still enjoyed myself learning about the various new concepts that exist in the business world. Just for that evening, I wanted to be an MD who creates wealth and uses innovative but legal ways to protect that wealth for the company’s shareholders.
As a typical middle class service oriented individual, I have always been averse to the risk involved in going into business. However, the thought processes behind the ideas that people have come up with for creation of wealth and the more baser urge that people at all levels seem to have to avoid or at least minimise taxation of the wealth created is very educative. Also amazing are the laws that have come into effect to effectively curb as many of such ideas as possible. The certainty of death and taxes is true even more today than it was before. The cat and mouse game between the Governments of the world and the increasingly global corporate houses continues and there are as many brainy ideas to ensure maximising tax collections as there are to evade taxes.

Most of the discussion was based on US corporate law with specific reference to Indian corporate houses. Specifically in relation to setting up an IHC in those countries that have a favourable tax system themselves as well as a favourable treaty with the US. They are called Tax havens.

Some surprising names that I remember are the Netherlands, UK and Ireland. Do you know that the corporate tax in Ireland is just 12.5%? When comparing this with the 35% payable here in India, it sounds like a no-tax regime. How do they possibly manage?
It seems places like the Cayman Islands and Malta are no longer considered the best option and it would not make sense to set up the IHC and not be in a position to prove “Substance over Form”. This caption basically means that the Holding Company is not really a paper company and must have a reason to exist in the chosen location.

The four main areas for tax impact while deciding on an IHC are:
Dividend
Interest
Royalty
Sale of shares.

Let us now see if I understood some of the concepts that stayed with me since that day.

The LSE’s Alternative Investment Market - AIM is the London Stock Exchange's international market for young and growing companies. Launched in 1995, AIM gives companies from all countries and sectors access to a market at an earlier stage of their development, by combining the benefits of a public quotation with a more flexible and less stringent regulatory approach.

The Delaware Company Concept – The Delaware General Corporate Law is one of the most advanced and flexible corporation statutes in the nation. Secondly, Delaware courts and, in particular, the Court of Chancery, have over 200 years of legal precedent as a maker of corporation law. Thirdly, the state legislature seriously takes its role in keeping the corporation statute and other business laws current. Lastly, the office of the Secretary of State operates much like a business rather than a government bureaucracy with its modern imaging system and customer service oriented staff. Delaware is also know as the First State because it was the first state to ratify the Constitution of the United States; Delaware's business laws, its Chancery Court with nationally recognized expertise and governmental services make Delaware a corporate haven.

Thin capitalization law - A Corporation that gets its capital primarily as loans from shareholders rather than stock investment. The main tax advantage attempted here is the distribution of interest that is tax deductible, whereas distribution on stock is non-deductible Dividends. If the debt-to-stock ratio becomes excessive, the IRS may contend that the capital structure is unrealistic and the debt is not Bona Fide. The acceptable debt-to-stock ratio varies according to industry norms. If the corporation's debt is recast as stock, the corporation loses its deductible interest expense.

Limitation of benefits clause – A US law, the Limitations on benefits provisions generally prohibit third country residents from obtaining tax treaty benefits. For example, a foreign corporation may not be entitled to a reduced rate of withholding unless a minimum percentage of its owners are citizens or residents of the United States or the treaty country.

CFC regulations - CFC (controlled foreign company) regulations have been implemented by most western high-tax countries to prevent residents setting up and keeping profit in companies in low tax jurisdictions. Usually, the CFC regulations stipulate that resident shareholders shall be taxed directly for the profit of a CFC – regardless of whether any dividend has been paid. This effectively prevents a CFC from building up any capital. In addition the tax imposed on the shareholders will often exceed the domestic rate for company and dividend tax. CFC regulations are based on Jurisdiction and what may work in one jurisdiction may be a legal disaster in another.

Anti-inversion statute - The American Jobs Creation Act of 2004 (2) added Code Sec. 7874 to the Internal Revenue Code to combat the perceived abuse of inversions of U.S. corporations into foreign corporations.

I shall end here since the last one seems too difficult to understand.