Good packaging but wrong labeling: Offshore Private Equity Funds in Bangladesh – (April 2012, Issue 1)

April 25, 2012, by Junayed Chowdhury

Recently, the National Board of Revenue (NBR) has decided to tax merchant banks at a higher corporate tax rate of 42.5% instead of 37.5%.[1] According to NBR, merchant banks are “financial institutions” (FIs) under the definition provided in the Financial Institutions Act 1993.[2]

 

The Financial Institutions Act 1993 (“the FIs Act”) defines the term financial institutions as non-banking financial institutions, which, amongst others, finance venture capital and includes investment companies.[3]

 

Section 2(l) defines investment companies, amongst others, as a company primarily or wholly engaged in the buying and selling of securities of other companies, and shall include companies which have at any time invested 80% of its paid-up capital in other companies.

 

Does the above definition of investment companies include a private equity firm? A private equity firm invests in other companies’ shares with a view to make profits by maximizing the investee companies’ growth potential. From this stand point, it appears that a private equity firm may be regarded as an investment company as defined in Section 2(l) of the FIs Act.

 

However, what about a private equity firm/fund which is incorporated abroad? The term company is defined in the FIs Act as any company incorporated under the Companies Act 1913 or the Companies Act 1994.[4] Thus, it could be argued that any private equity fund that is incorporated abroad would not be regarded as an investment company under the FIs Act.

 

However, the Companies Act 1994 seems to pose problems for a private equity fund that is incorporated abroad as a company. Under section 379 of the Companies Act 1994, a foreign company establishing a place of business within Bangladesh shall deliver to the Registrar of Joint Stock Companies (RJSC) within 1 month of the establishment of its place of business in Bangladesh certain relevant documents including a certified copy of its memorandum and articles of association, and the full address of its office in Bangladesh which is to be deemed its principal place of business in Bangladesh.

 

The factors for determining whether a particular place is a place of business in Bangladesh for a foreign company depend on the facts of each case, which sometimes becomes a complex fact finding exercise. Generally, to determine the place of business in Bangladesh one has to look for a permanent location from which habitually, or with some degree of regularity, business is carried on by a foreign company. Thus, for a private equity fund incorporated abroad, if it could be shown that it concludes contracts, has office staffs, and does administrative tasks from an office space in Bangladesh, then the offshore private equity fund, being a foreign company under Section 379 of the Companies Act 1994, must register itself with RJSC. However, again, the crucial question to answer is whether the foreign company carries on any business from its office in Bangladesh or whether it is just gathering information for the purpose of its business which is being conducted outside Bangladesh.

 

The consequential effect of registration as a foreign company under the Companies Act 1994 is that the foreign company’s place of business in Bangladesh may be regarded as a “permanent establishment” (PE) under a given Double Taxation Avoidance Agreement (DTAA). Such PE characterization under a DTAA may be unfavourable for an offshore private equity fund that is incorporated in a tax haven jurisdiction. The reason is that under a DTAA, generally, any business profits generated by a PE shall be taxed by the country in which the PE is situated.[5] Thus, in Bangladesh context, if the PE of an offshore private equity fund generates profits, such profits may be taxed at the rate applicable to investment companies as defined in the FIs Act.

 

Therefore, there exist uncertainties with respect to the status of an offshore private equity firm wishing to invest in Bangladesh. The various cross-referencing of different legal regimes makes it harder to come to a definitive conclusion when dealing with an offshore private equity fund. As the market for cross-border investment is slowly opening up in Bangladesh, perhaps this would be a good time for Bangladeshi regulators to issue specific guidelines on the corporate and taxation status of offshore private equity funds.

 

Written by Junayed Chowdhury, Managing Partner  

 

† Disclaimer: The opinions and comments expressed in this Blawg are not to be regarded or construed as legal advice by and from Vertex Chambers or any of its members. It is highly advisable that any person should seek independent legal advice before relying on any of the contents of this Blawg.

[1] See http://www.thefinancialexpressbd.com/more.php?news_id=124322&date=2012-03-22

[2] Ibid.

[3] See Section 2 of the Financial Institutions Act 1993

[4] Section 2(f) of the Financial Institutions Act 1993

[5] See United Nations Model Double Taxation Convention between Developed and Developing Countries