Thursday, February 3, 2011

Corporate Structure for Foreign Banks in India

Historically, the RBI appears to have had a preference for allowing foreign banks to operate in India as branches rather than separately incorporated subsidiaries. Consequently, most (if not all) foreign banks have been established as branches for the purposes of banking law as well as company law. Apart from the fact that a branch enjoys the support, creditworthiness, and solvency of the main entity (as the branch is merely a part thereof), it was always an intriguing question as to why there was a preference for this form.

In the last 5 years, however, RBI has revisited this position and has now expressed (in a roadmap issued in 2005) a preference for the subsidiary structure rather than the branch structure for foreign banks to operate in India. RBI has not only looked at the experience of other countries, but has also closely monitored lessons from the financial crisis.

A few weeks ago, the RBI issued a Discussion Paper on the “Presence of Foreign Banks in India”, which discusses the advantages of the subsidiary structure. These include clear delineation of assets and liabilities (from that of the parent), easier identification of laws that apply to the subsidiary, more effective control and regulation, greater clarity with corporate governance norms applicable to the subsidiary as well as treatment of assets and liability during insolvency. The discussion paper also encourages foreign banks with existing branches to convert them into subsidiaries.

An editorial in the Hindu Business Line sets out the gist of the discussion paper and also points to some open issues:
The paper considers two vehicles for foreign bank expansion — branches and ‘wholly-owned subsidiaries' (WOS) — and, guided by experience, roots for the latter. Wholly-owned subsidiaries, unlike branches, can be treated as separate legal entities; locally incorporated, they have their own capital base and their own local board of directors. In the case of branches, parent banks are, in principle, responsible for their liabilities but assets can easily be transferred to head offices and, should the branch fail, it would be difficult to determine the assets available to satisfy the claims of local creditors. Managements of the subsidiaries, in short, have fiduciary responsibility to their local clients, branches do not. Of course, subsidiaries in trouble can be abandoned by their parents, as some were in the Argentine crisis, or in good times dominate the domestic system, but with sufficient “prudential measures” the RBI feels confident of maintaining a level field. But a problem arises: since the RBI would like to “mandate” new entrants as wholly-owned subsidiaries what happens to existing bank branches? Here, ambiguity steps in for the paper leaves it to the existing foreign banks voluntarily to convert their branches into subsidiaries even as regulation would mandate local incorporation for new entrants.

1 comment:

vswami said...

I. On a quick reading of the subject post, as also the Editorial in Business Line referred to, they seem to suggest the foreign banks' possible preference should be / may be the route of - 'subsidiary', instead of 'branch'. I wonder whether in doing so, a very crucial / important aspect namely, - the Indian tax law and the treaty implications, have or not been kept in view . For, after at all no foreign bank, would or could prudently venture and decide upon the preferable route, without having regard to/ taking into account the taxation aspects - even in the normal course and as part of a routine preliminary exercise.

Further, even going by common commercial or economic sense, any decision on the preferred route, if it were to be taken, without giving an in-depth consideration not only to the tax implications as per the extant law but also to the possible or most likely impact of the proposed changes as per the DTC Bill (e.g. in the 'deeming provisions', as also in the 'transfer pricing' provisions), as I visualise, might prove suicidal for the foreign banks.

II. As regards the changes in the deeming provisions referreed above, one may wish to go through the article published in Business Line Issue of 29th January.


My following feedback comments sent to BL wrt that article will enable one to at least realise that the deeming provisions as discussed, if enacted in the present form, have every potential to lead to a fresh series of litigation:



1.The referred provisions as proposed in the last revised DTC Bill, if and when enacted, would come into effect from 1st April 2012. As such, they could not be relied on by the Revenue, much less influence the final verdict in the pending dispute of Vodafone.


For, it has been the long established and well settled proposition (read case law on the subject of 'interpretation'), a subsequent enactment , especially an enactment which seeks to radically change/has the effect of so changing the erstwhile legal position - that is, as per the present law, cannot be a guide to decide any issue under the present law.


Besides, for obvious reasons (rather, easily inferable logic), any reliance or even a reference by the Revenue to the subsequent change in law could only prove suicidal / go against its own case.


2. One is not at clear as to why the new provision - section 5(4)(g) should , in terms, be so construed as to have brought about any change in the present law; or enable the revenue to validly tax, as intended, an entity simply on the ground of its more than 50% shareholding in the operating company in India. For an appreciation of the grave doubt raised, one has to keep in mind that , as has been the traditionally established and conventionally accepted proposition - the assets of a company could not, except in extremely odd situations, be rightly regarded to be 'owned' by any of its shareholders, including one having a majority/ ‘controlling interest’.


3. Even if one were to accept or proceed on the premise that the new provision (section 5 (4) (g)), on its enactment, would enable the Revenue to try and tax a foreign entity, that is possible provided the related tax treaty provisions do not come in the way of such taxation.


4. The discussion / views as per the write-up on the- ‘doctrine of apportionment’ and ‘new formula’ (section 5 (6)) do not, seem to hold water.


The reason is – if at all, they are of relevance or application only to such types of income as are sought to be taxed on the ground of ‘source’, etc., not to any income arising on ‘transfer’ of a ‘capital asset’.



In the nature of things, it is only the whole of ‘capital gains’, that would become taxable; an apportionment as proposed verges on a fiction / is prima facie illogical. In other words, the provision (section 5(6)) is, in my view, basically irrational and ill founded.


vswaminathan