B S R and Associates

Investment in Modern Food Distribution and

Cold Chain Infrastructure
– Tax and Regulatory perspective
Jayesh Kariya
December 2010
Contents
1. Backdrop

2. Regulatory Framework

3. Key Considerations for Structuring and

funding Avenues

4. Typical Structures and Exit Mechanisms

5. Tax Incentives and Issues Faced by the

Industry

6. Impact of DTC and GST

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 Backdrop

3
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 Backdrop

Trends

 Strong macroeconomics fundamentals

 Changing tax policy boosting warehousing outsourcing
 Realty players foraying into the market
 Investments from private equity firms

Government Incentives

 Planned shift to GST tax regime

 The Warehousing Act, 2007
 Private investment in logistics parks and Free Trade Warehousing Zones
 Infrastructure developments
 Developments of the dedicated freight corridor

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 Regulatory Framework

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B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Regulatory framework

Foreign Investment Windows

FDI Route FII Route FVCI Route NRI Route

 Investment under  Investment under  Investment under  On repatriation

Schedule 1 to Schedule 2 to Schedule 6 to basis under
FEMA Notification FEMA Notification FEMA Notification Schedule 1 and 3
No. 20 of May No. 20 of May 2000 No. 20 of May 2000 to FEMA
2000  Investment in  Investment in Notification No.
 Investment under accordance with accordance with 20 of May 2000;
Automatic Route SEBI (FII) SEBI (FVCI) or
 Investment on Regulations Regulations  On non-
repatriation basis  Investment on  Investment on repatriation basis
repatriation basis repatriation basis under Schedule 4
to FEMA
Notification N0.
20 of May 2000

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 Regulatory framework
FDI Guidelines
Modern Food Distribution
 Food Distribution operators
(not traders)
– 100% FDI is freely
permissible
B S R and Associates
Foreign Direct Investments (FDI)
Quick Service Restaurants
Cold Chain Industry Warehouse
(‘QSR’)
 Hotel Operators  Operating Cold chain  Operating warehouse
- 100% FDI is freely – 100% FDI is freely – 100% FDI is freely
permissible permissible permissible
- Term hotel includes  Pure Construction of Cold  Pure Construction of
restaurant, beach resorts Chain Storage Warehouse
and other tourism – Whether conditions of P – Whether conditions of P
complexes providing No.2 of 2005 apply? No.2 of 2005 apply?
accommodation and / or
catering food facility to
tourism
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© 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Regulatory framework

In case the Offshore Co contemplates making investment through non-convertible debt instruments, such investment would be considered as foreign debt in nature
and the ECB guidelines would become applicable

Broad overview of ECB Guidelines

 Automatic route – ECB up to USD 500 million (hotel – USD 100 million)
 Permissible end-use – import of capital goods, financing of new projects,
modernization or expansion of existing production units, for investment in
the infrastructure sector in India, obtaining license/permit for 3G
spectrum, specific service sectors viz, hotel, hospital and software
 End-use restrictions – working capital, general corporate purposes and
repayment of existing Indian rupee loan
 Only specified lenders permitted – these include financial institutions and
shareholders holding specified stake in borrower entity
 Minimum maturity – 3 years
 All in cost ceilings prescribed – if borrower wants to pay higher interest over
the all-in cost ceiling, specific RBI approval required

Infrastructure sector is defined as (i) power, (ii) telecommunication,

(iii) railways, (iv) road including bridges, (v) sea port and airport,
(vi) industrial parks, (vii) urban infrastructure (water supply, sanitation
and sewage projects) and (viii) mining, refining and exploration (ix)
cold storage or cold room facility, including for farm level pre-cooling, Eligibility of ECBs to the sectors in discussion??
for preservation or storage of agricultural and allied produce, marine
products and meat.

B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Key Considerations for Structuring
and Funding Avenues

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B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Key Considerations for Structuring and Funding Avenues

Key considerations for structuring

 Payback period and waterfalls  Tax incentives under the Act

 Put and call options including  Impact of DTC and GST
conversion options  Leveraging of debt cost vis-à-vis profitability
 Transfer Pricing
Business Tax
Plan Influence
 Exit Valuation Strategy
 Constraints under Present ECB  Promote Structure in case of
regime Funds
Valuation
 Use of Structured products Vanilla Debt Key points for
consideration
Managing
Cash Trap  Use of Share Premium

Regulatory Overseas
 Cold Chain and warehousing – freely Approvals Entity
permissible Vehicle
 QSR and Modern Food Distribution – freely  Use of FVCI vehicle
permissible  Use of IHC vehicle
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 Key Considerations for Structuring and Funding Avenues

Key funding avenues

Funding avenues

Promoter’s contribution

Bank Loan

Domestic sources
Initial Public Offering

Domestic Venture Capital

Foreign Direct Investment

Foreign Institutional Investors

Foreign sources

Private Equity / Foreign Venture Capital

External Commercial Borrowings

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B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Key Considerations for Structuring and Funding Avenues

Funding Instruments

Equity/ADR/GDR No tax
EQUITY
break on
CCPS dividend
Auto Route CCPs
Capital

CCD
CCDs

MEZZ
Optionally Convertibles Optionally
Tax
Convertibles arbitrage
ECB, may be
Currently, Mezz available on
conditions
Redeemables ECB
FDI is interest
Redeemables and permissible only
restrictions payouts
in form of CCPS
apply and CCD
Debt
DEBT

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 Typical structures and Exit mechanisms

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 Typical structures and Exit mechanisms

Typical Structure Exit Strategies

 Direct Investment
 Enterprise level
 Investment through holding company
 Exit through stake sale to domestic investor / JV partner
 In India
 Exit through an Initial Public Offer listing
 Outside India

 Investment strategy:
 Enterprise level
 Asset Sale
 Project specific SPV (direct)
 Exit through sale to strategic investor
 Project Specific SPV (through a holding company)
 Project Specific SPV (through holding companies)

 SPV level
 Co-ownership structure  Exit through transfer of SPV shares by HC to domestic
investor / JV Partner
 Offshore Fund / FVCI structure
 Exit through transfer of IHC shares overseas / overseas
listing – Vodafone controversy
Other variations in the transaction model could be possible depending Exit rights like put option and tag-along rights could also be considered
on the commercial objectives

B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Tax Incentives and Issues Faced by the Industry

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 Tax Incentives and Issues Faced by the Industry

Tax Incentives under the Income-tax Act, 1961 (‘the Act’)

 Modern Food Distribution / QSR:

− No special incentives under the Act.
− Normal provisions governing taxability of ‘Income from business / profession’ would apply.

 Cold Chain Industry and Warehousing:

− Investment linked incentives to the operator of cold chain facility and warehousing facility for storage of agricultural produce (subject to
certain conditions):
 Accelerated deduction of capital expenditure
 Expenses incurred before commencement of operations – 100% in the 1st year of operation

– Incentives to Developers of Free Trade Warehousing Zones (‘FTWZ’) in the Special Economic Zone (‘SEZ’):
 100% deduction for ten consecutive assessment years out of fifteen years
 Exemption from Minimum Alternate Tax (‘MAT’) and
 Exemption from Dividend Distribution Tax (‘DDT’)

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B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Tax Incentives and Issues Faced by the Industry

Tax Issues Faced by the Industry

 Cold Chain Industry and Warehousing:

– Meaning of Agriculture produce
– MAT liability

– Rent payment to Cold Chain Storage Operator – withholding tax implications

 Taxability of Subsidy from Government – capital vs. revenue receipt

 Characterization of the income
 Tax depreciation – as plant or as building
 Deduction to ICDs / CFCs

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B S R and Associates © 2010 B S R and Associates, a firm of Chartered Accountants, duly registered under the Indian Partnership Act, 1932. All rights reserved.
 Impact of DTC and GST

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 Impact of DTC

Impact of DTC

 Incentives to operator of cold chain facility and warehousing facility for storage of agricultural produce (subject to
certain conditions):
– Investment linked incentives continued

 Incentives to Developer of FTWZ in the SEZ:

– Grandfathering of profit linked incentives – SEZs notified upto 31 March 2012
– Investment linked incentives – SEZs notified on or after 1 April 2012
– No MAT and DDT exemption

 Corporate tax rate – flat tax rate of 30% irrespective of residential status of the assesses
 MAT rate 20% – additional burden
 Additional tax liability for non-resident companies – branch profit tax @ 15%
 Relaxation in DDT credit provisions
 Ordinary Source vs. Special Source
– Rental Income – whether taxed as business income?

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 Impact of DTC

Impact of DTC

 Other aspects:
– GAAR
– CFC regulations
– Place of effective management
– Branch profit tax
– Treaty overrides

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 Impact of GST - Proposed Structure

A  Dual GST for Centre and States

FRAMEWORK  IGST on inter-state transactions incl. stock

transfers
 1 April 2011?
 Separate legislation, levy and administration
 Place of supply rules for determining “situs” of
services

D B
TIMELINE GST COVERAGE

C  Excise duties/ Service tax/ CVD/ SAD/

 Peak rate of 20 percent (with gradual Surcharges/ Cesses
reduction) LIKELY RATE and  VAT/ Entertainment tax/ Luxury tax/ Entry tax
CREDITS (except in lieu of Octroi)
 Concessional rate for select goods (not for
 Cesses and surcharges on goods and services
services) at 12 percent
supply
 Tax on services at 16 percent  Certain petroleum/other products likely to be
outside the purview of GST

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Impact of GST

The impact of GST on the subject business needs to be established from the following two perspectives:

 Impact on revenue, Tax cost on sourcing/ distribution/ logistics, cash flows, pricing,
Internal impact
Invoicing, returns etc

 Impact on the business decisions and operations of 3PL service provider, arising out of the
External Impact
supply chain decisions taken by their customers in the proposed GST regime

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 Impact of GST - Supply Chain

Existing scenario Points for consideration – supply chain

 Interstate sale attracts CST – non  Shift of trend in movement of goods:

creditable – interstate freight likely to increase
 Stock transfers not liable to CST/ VAT – reduction in number of depots
 Need for depots to stock transfer and make – reduction in stock transfers
onward sales – more stocking at mother warehouses

 Identifying the correct number and appropriate location of depots

GST scenario
 Developing efficient distribution plans – movement points, quantity
 Interstate sale to attract IGST – creditable for distribution
 Stock transfers to attract IGST –  Optimize the tax implications
creditable. However, such IGST to result in  Cost for opening and operating of depot
blockage of working capital till inventory
disposed

GST to force industry to re-visit existing logistics and warehousing set up

– Opportunity for 3 PL service providers

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 Jayesh Kariya
Partner
Tax and Regulatory Services
Thank you B S R and Associates

Phone: +91 (22) 30902080

Email: jayesh@kpmg.com

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