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Financial turmoil and its tax implications
October, 24th 2008

What has been described as once in-a-generation global crisis is likely to leave its mark across sectors, though more prominently on the banking and financial services sector. India, being a relatively shielded economy, has been spared much of the more direct brunt of this turmoil.

The swift response of the policymakers and their ability to leverage this global crisis and turn the tides of global wealth in favour of India could re-define the growth story of India for the next decade.

While the financial sector the world over is in a restructuring mode, counter intuitive propositions are being formulated by different sets of players as they consider the battle scarred landscape for opportunities to mine. Headhunters may witness a short term surge in activities as individuals displaced by the ongoing crisis are placed into new homes.

Bankruptcy lawyers are stretched as they represent various creditor groups as well as failing institutions. Financial market players, who have been less afflicted by the ongoing developments are looking at opportunities to acquire teams and businesses at fire sale prices.

Tax will undoubtedly follow suit. While tax advisors around the world apply their minds to optimising client tax positions in the aftermath of the crisis, revenue authorities will be preparing to review the tax positions that companies will adoptwhether such companies represent failed enterprises , or those that have survived and grown from the crisis through strategic acquisitions.

The foremost issue would be the tax deductibility of the write-offs on account of bad loans. The period of accrual of the losses, whether the losses have actually been crystallised or merely represent accounting provisions could potentially increase the gap between accounting profits and tax profits.

Another issue that could arise in the Indian context would be that pertaining to tax holidays. A number of banks and financial institutions have set up offshore units in India either as software technology park units or as special economic zone units. It is likely that some or more of these units may now find new owners.

The continuity of the associated tax holiday is clear when these units are transferred under a scheme of merger or demerger. However, given that both mergers and demergers require court approvals and involve a fairly length process, an acquisition of assets either on a standalone or a going concern basis appears more practical and attractive .

While the intent in law has been for the tax holiday benefits to pass on with the undertakings, the law is not entirely clear and could give rise to some uncertainty or litigation. Lastly, the ghost of the Vodafone issue would pose a potential threat.

In some instances, where the ownership of financial institutions changes hands at the global level, the question would remain as to whether the value assigned to the Indian business should be liable to Indian capital gains tax.

This could have an adverse impact as in all probability, the overall business may be sold at a loss although the Indian business, which may not be affected by the global crisis, may be more valuable. Shelling out tax on notional gains in such a situation could aggravate the pains that institutions are already experiencing.

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