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SILICON VALLEY
BANGA LORE
SINGA P ORE
MUMBA I BK C
NE W DE L HI
MUNICH
February 2015
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About NDA
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Contents
ABBREVIATIONS 01
1. PRIVATE EQUITY IN 2014: LESSONS LEARNT AND EXPECTATIONS IN 2015!
03
I.
Withholding Taxes 03
II.
General Anti-Avoidance Rules (GAAR) 03
III.
Companies Act, 2013 03
IV. Representation and Warranties Insurance (R&W Insurance)
04
V.
Structured Debt Transactions 04
VI.
RBIs Timeline for Regulatory Approval 05
VII.
Shareholder Activism 05
VIII.
Diligence 05
IX.
Entry and Exit Facilitation 05
X.
Externalisation 05
XI.
Depository Receipts (DRs) 05
XII.
Conclusion 07
2. REGULATORY FRAMEWORK FOR FOREIGN INVESTMENT
07
I.
Foreign Direct Investment 07
II.
FVCI Route 10
III.
FPI Route 11
IV.
NRI Route 16
3. LEGAL FRAMEWORK KEY DEVELOPMENTS
18
I.
Shares with Differential Rights 18
II.
Listed Company 18
III.
Inter-Corporate Loans and Guarantee 18
IV.
Deposits 19
V.
Insider Trading 19
VI.
Squeeze out Provisions 19
VII.
Directors 19
VIII. Control and Subsidiary and Associate Company
20
20
4.
TAXATION FRAMEWORK 21
I.
Overview of Indian Taxation System 21
II. Specific Tax Considerations for PE Investments
23
5.
EXIT OPTIONS / ISSUES 26
I.
Put Options 26
II.
Buy-Back 26
III.
Redemption 27
IV.
Initial Public Offering 27
V.
Third Party Sale 27
VI.
GP Interest Sale 28
VII.
Offshore Listing 28
VIII.
Flips 28
IX.
Domestic REITs 29
6.
DOMESTIC POOLING 30
I.
AIF 30
II.
NBFC 31
7.
THE ROAD FORWARD 33
I.
REITs 33
II.
Partner issues 33
III.
Arbitration / Litigation 33
IV.
Security Enforcement 33
V. Offshore listing allowed for unlisted Indian companies
34
ANNEXURE I
Foreign Investment Norms for Real Estate Liberalized 35
ANNEXURE II
Foreign Investment Norms in Real Estate Changed
42
ANNEXURE III
Specific Tax Risk Mitigation Safeguards for Private Equity Investments
44
ANNEXURE IV
Flips and Offshore REITs 46
ANNEXURE V
Reits: Tax Issues and Beyond 49
ANNEXURE VI
NBFC Structure for Debt Funding 51
ANNEXURE VII
Challenges in Invocation of Pledge of Shares
59
Abbreviations
Abbreviation
AAR
AIF
AIF Regulations
CBDT
CCDs
CCPS
DCF
DDT
DIPP
DTAA
ECB
FATF
FDI
FDI Policy
FEMA
FIPB
FII
FPI
FVCI
GAAR
GP
General Partner
HNI
InvIT
InvIT Regulations
IPO
ITA
LP
Limited Partner
LRS
NBFC
NCD
Non-Convertible Debenture
NRI
Non-Residential Indian
PE
Permanent Establishment
PIO
PIS
PN2
Press Note 10
Press note 10 of 2014 issued by the Ministry of Commerce and Industry dated December 03, 2014
Press Release
Press release issued by the Ministry of Commerce and Industry dated October 29, 2014
Abbreviations
Provided upon request only
QFI
RBI
REITs
REIT Regulations
Securities And Exchange Board of India (Real Estate Investment Trusts) Regulations
REMF
Rs./INR
Rupees
SEZ Act
SBT
SEBI
SPV
TISPRO Regulations
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India)
Regulations, 2000
I. Withholding Taxes
Notwithstanding the fact that the seller was an
eligible tax resident of Mauritius or Singapore
or other treaty jurisdiction, buyers in almost all
secondary transactions insisted on withholding
full capital gains taxes, and typically negotiated
for a host of alternatives such as NIL withholding
certificate, tax escrow, tax insurance, tax opinions
and specific tax indemnities. With tax insurance not
being available in all cases, deals were seen being
done typically on the back of tax opinion and tax
indemnity. Please see our article on such safeguards.
With Cyprus notified as a non-cooperative
jurisdiction under Section 94A of the Income Tax
Act, we saw increased applications being made to
tax authorities under Section 197 of the IT Act for nil
withholding.
A. Directors liability
For the first time ever, the duties of the directors
have been codified and a monetary punishment
has been prescribed in case the directors act in
contravention of their prescribed duties. Further,
under the 2013 Act, any director who becomes
aware of any contravention of the provisions of
the 2013 Act by way of his participation in the
board meeting or receipt of information under
any proceedings etc. but does not object to such
contravention is termed as an officer in default and
the concerned director is subject to the punishment
prescribed under the 2013 Act. Such liability also
1. http://myiris.com/news/economy/private-equity-investments-is-positive-in-2015-pwc-india/20141223140914199
2. http://www.vccircle.com/news/general/2014/12/31/top-pe-deals
3. http://www.vccircle.com/news/general/2014/12/31/top-pe-exits
4. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/taxing-times-copyright-or-copyrightedarticle-the-debate-continues.html
5. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/companies-act-series.html
B. Insider trading
Insider trading provisions do exist for listed
companies and very recently the Securities
Exchange Board of India (SEBI) has notified the
new regulations (please click here 6 to read our
analysis on the same). However, the 2013 Act has
also introduced an insider trading provision, which
in addition to public listed companies, also applies
to unlisted companies (whether public or private).
Please click here7 for our article on the new insider
trading regulations.
C. Voting arrangements
Under 1956 Act, concept of different classes of shares
i.e. equity shares and preference shares was not
applicable to private companies, and hence such
companies were allowed to issue shares (whether
equity or preference) with differential rights. For
instance, preference shares with voting rights on
as if converted basis, etc. However under the 2013
Act, (i) the provision relating to different classes
of shares has been made applicable to both private
and public companies; (ii) no separate exemption
has been provided to private companies for the
issuance of shares (whether equity or preference)
with differential rights; and (iii) it has been
specifically provided that preference shares cannot
have voting rights; therefore, private companies
now cannot issue preference shares with voting
rights. Since, preference shares continue to be the
preferred instrument of investment because of
certain other benefits such as better enforcement of
anti-dilution and liquidation preference, we have
seen more voting rights arrangements being entered
into between the shareholders, to give effect to the
commercials.
6. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Articles/India_s_SEBI_Approves_New_Regulations_on_Insider_Trading.
pdf
7. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/sebi-finally-introduces-stricter-insidertrading-regulations.html?no_cache=1&cHash=42ba49fb253107995ceb11da2af4163a
8. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Private_Equity_and_Private_Debt_Investments_in_India.pdf
VIII. Diligence
2014 witnessed investors conducting more stringent
background checks on the promoters and key
managerial personnel. Forensic audits and anticorruption / anti-bribery compliances gained
increased importance.11
X. Externalisation
Externalization, or setting up of offshore holding
companies for Indian assets, continued to attract
both private equity players and their portfolio
companies, especially in the tech space. Some of the
major reasons for doing so include tax benefits at
the time of exit, avoiding Indian exchange control
issues, mitigating currency fluctuation risk, better
enforceability of rights, etc. For a more detailed
analysis on externalisation, please click here.13
9. http://www.ft.com/cms/s/0/3f0aa396-7ba7-11e4-b6ab-00144feabdc0.html#axzz3OaSRBnji
10. http://www.business-standard.com/article/markets/shareholder-activism-in-india-highest-in-asia-says-report-114092300620_1.html
11. http://articles.economictimes.indiatimes.com/2015-01-07/news/57791855_1_india-fraud-survey-j-sagar-associates-uk-bribery-act
12. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/cheers-for-offshore-funds-put-optionspermitted.html?no_cache=1&cHash=02e2afb88f85c0c69750945d7ac21f59
13. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/regulatory-regime-forcing-cosexternalisation-1.html?no_cache=1&cHash=a66f640217af2550c22a0751446e2945
14. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/access-to-global-capital-markets-madeeasier.html?no_cache=1&cHash=76d2a124a22b9184d0eda9cc21e00569
Conclusion
A. MAT
F. Transfer Taxes
E. FVCI Investment
FVCIs should be permitted to invest in all sectors
(except the current negative list), rather than the
current nine sectors that FVCIs are eligible to invest
in.
15. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/access-to-global-capital-markets-madeeasier.html?no_cache=1&cHash=76d2a124a22b9184d0eda9cc21e00569
16. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Articles/How_to_raise_funds_and_monetize_investments.pdf
B. Minimum Capitalization
The minimum capitalization has been reduced
to US $5 million. Further, different minimum
capitalization prescribed for wholly owned
subsidiaries and joint ventures with the Indian
partners has been done away with.
C. Affordable Housing
An exemption is provided to the real estate projects
which allocate 30% of the total project cost towards
the affordable housing projects from complying with
the minimum land area and minimum capitalization
requirements.
Press Note defines affordable housing projects as
projects where at least 40% of the FAR / FSI is for
dwelling unit of floor area of not more than 140 sq.
meters, and out of the total FAR / FSI reserved for
affordable housing, at least 1/4th (one-fourth) should
D. Complete Assets
Press Note 10 has clarified that 100 percent FDI
under the automatic route is permitted in completed
projects for operation and management of townships,
malls/ shopping complexes and business centres.
It has been long debated whether FDI should be
permitted in commercial completed real estate.
By their very nature, commercial real estate
assets are stable yield generating assets as against
residential real estate assets, which are also seen as
an investment product on the back of the robust
capital appreciation that Indian real estate offers.
To that extent, if a company engages in operating
and managing completed real estate assets like a
shopping mall, the intent of the investment should
be seen to generate revenues from the successful
operation and management of the asset (just like a
hotel or a warehouse) as against holding it as a mere
investment product (as is the case in residential
real estate). The apprehension of creation of a
real estate bubble on the back of speculative land
trading is to that naturally accentuated in context of
residential real estate. To that extent, operation and
management of a completed yield generating asset
is investing in the risk of the business and should be
in the same light as investment in hotels, hospitals
or any asset heavy asset class which is seen as
investment in the business and not in the underlying
real estate. Even for REITs, the government was
favorable to carve out an exception for units of a
REIT from the definition of real estate business on
the back of such understanding, since REITs would
invest in completed yield general real estate assets.
The Press Note 10 probably aims to follow the
direction and open the door for foreign investment
in completed real assets, however the language is not
entirely the way it should have been and does seem
to indicate that foreign investment is allowed only in
entities that are operating an managing completed
assets as mere service providers and not necessarily
real estate. While it may seem that FDI has now
been permitted into completed commercial real
estate sector, the Press Note 10 leaves the question
unanswered whether these companies operating and
managing the assets may own the assets as well.
Please refer to Annexure I17 for our analysis on the
Press Release.
17. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/fdi-in-real-estate-liberalized.html?no_
cache=1&cHash=aab4287c1bb5517a914df41d068bd6fc
i. Lock-in restriction
The Press Release proposed that a foreign
investor could exit its investment either on
completion of the project or completion of three
years from the date of final investment, subject
to the development of the trunk infrastructure.18
The Press Note 10 has done away with such
restrictions, now a foreign investor can exit
its investment only on the completion of the
project or after the development of the trunk
infrastructure. This will entail both positive
and negative consequences. As this will provide
stimulus for small projects wherein the project
can be completed before three years. But, it
will pose practical issues to the projects which
are developed in phases, because it is unclear
whether a foreign investor can now exit upon
completion of any phase of project, when the
trunk infrastructure for other phases is not
developed.
Particulars
Equity
CCPS
CCD
Basic Character
Participation in governance
and risk based returns
Assured Dividend
Convertible into Equity
Assured Coupon
Convertible into Equity
Liability to Pay
Limits to Payment
No cap on dividend
Tax Efficiency
No tax deduction, dividend payable from post-tax income Dividend taxable @ 15% 21 in the hands of the company
Liquidation Preference
CCD ranks higher than CCPS in terms of liquidation preference. Equity gets the last
preference.
Others
Buy-back or capital reduction CCPS and CCDs need to be converted to equity before they
permissible
can be bought back or extinguished by the Indian company.
21. All tax rates mentioned herein are exclusive of surcharge and education cess.
22. RBI clarified in its A.P. (DIR Series) Circular No. 36 dated September 26, 2012, that shares can be issued to subscribers (both non-residents and NRIs)
to the memorandum of association at face value of shares subject to their eligibility to invest under the FDI scheme. The DIPP inserted this provision
in the FDI Policy, providing that where non-residents (including NRIs) are making investments in an Indian company in compliance with the provisions of CA 1956, by way of subscription to its Memorandum of Association, such investments may be made at face value subject to their eligibility
to invest under the FDI scheme. This addition in the FDI Policy is a great relief to non-resident investors (including NRIs) in allowing them to set up
new entities at face value of the shares and in turn reduce the cost and time involved in obtaining a DCF valuation certificate for such newly set up
companies.
23. Venture capital undertaking means a domestic company:- (i) whose shares are not listed in a recognised stock exchange in India; (ii) which is engaged in the business of providing services, production or manufacture of articles or things, but does not include such activities or sectors which are
specified in the negative list by the Board, with approval of Central Government, by notification in the Official Gazette in this behalf.
10
A. Free Pricing
The entry and exit pricing applicable to FDI regime
do not apply to FVCIs. To that extent, FVCIs can
subscribe, purchase or sell securities at any price.
B. Instruments
Unlike FDI regime where investors can only
subscribe to only equity shares, CCDs and CCPS,
FVCIs can also invest into Optionally Convertible
Redeemable Preference Shares (OCRPS),
Optionally Convertible Debentures (OCDs) and
even Non-Convertible Debenture (NCDs).
C. Lock-in
Under the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 (ICDR
Regulations) the entire pre-issue share capital
(other than certain promoter contributions which
are locked in for a longer period) of a company
conducting an initial public offering (IPO)
is locked for a period of 1 year from the date
of allotment in the public issue. However, an
exemption from this requirement has been granted
to registered FVCIs, provided, the shares have been
held by them for a period of at least 1 year as on the
date of filing the draft prospectus with the SEBI. This
exemption permits FVCIs to exit from investments
immediately post-listing.
A. Categories
E. QIB Status
i. Category I FPI
11
B. Investment Limits
C. ODIs/P Note
12
Eligible FPIs
Investment
holdings
to hedge
exposures
under the ODI
as issued
Distributions including
dividends and capital gains
33. CSX Corporation v. Childrens Investment Fund Management (UK) LLP. The case examined the total return swap structure from a securities law
perspective, which requires a disclosure of a beneficial owner from a reporting perspective.
34. Reference may be made to Explanation 1 to Regulation 5 of the FPI Regulations where it is provided that an applicant (seeking FPI registration) shall
be considered to be appropriately regulated if it is regulated by the securities market regulator or the banking regulator of the concerned jurisdiction in the same capacity in which it proposes to make investments in India.
13
D. Listed Equity
The RBI has by way of Notification No. FEMA.
297/2014-RB dated March 13, 2014 amended the
TISPRO Regulations to provide for investment by
FPIs. Under the amended TISPRO Regulations, the
RBI has permitted Registered Foreign Portfolio
Investors (RFPI) to invest on the same footing as
FIIs.
A new Schedule 2A has been inserted after Schedule
2 of the TISPRO Regulations to provide for the
purchase / sale of shares / convertible debentures of
an Indian company by an RFPI under the Foreign
Portfolio Investment Scheme (FPI Scheme).
The newly introduced Schedule 2A largely
mirrors Schedule 2 of TISPRO which provides for
investments in shares / convertible debentures by
FIIs under the portfolio investment scheme (PIS).
Accordingly, an FPI can buy and sell listed securities
on the floor of a stock exchange without being
E. Listed NCDs
Under Schedule V of the amended TISPRO
Regulations, read with the provisions of the FPI
Regulations, FPIs are permitted to invest in, inter
alia, listed or to be listed NCDs issued by an Indian
company. FPIs are permitted to hold securities only
in the dematerialized form.
Currently, there is an overall limit of USD 51 Billion
on investment by FPIs in corporate debt, of which
90% is available on tap basis. Further, FPIs can also
invest up to USD 30 Billion in government securities.
Listing of non-convertible debentures on the
wholesale debt market of the Bombay Stock
Exchange is a fairly simple and straightforward
process which involves the following intermediaries:
i. Debenture trustee, for protecting the interests of
the debenture holders and enforcing the security,
if any;
ii. Rating agency for rating the non-convertible
debentures (there is no minimum rating required
for listing of debentures); and
iii. Registrar and transfer agent (R&T Agent), and
the depositories for dematerialization of the
NCDs.
The entire process of listing, including the
appointment of the intermediaries can be
completed in about three weeks. The typical cost of
intermediaries and listing for an issue size of INR
One Billion is approximately INR One Million.
Herein below is a structure chart detailing the steps
involved in the NCD route:
35. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/sebi-rewrites-rules-on-offshore-derivative-instruments-odi.html?no_cache=1&cHash=60c81c4a0fcc1c1ffbbe8d2aae5e2e5bzz
36. Offshore Derivate Instruments: An Investigation into Tax Related Aspects
http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Offshore_Derivative_Instruments.pdf
14
FPI
Offshore
Buy
India
Step 3: Trading of
NCDs on the floor
of stock exchange
Step 2
Listing of NCDs
NCDs
Issuing Company
Warehousing Entity
Cash
Step 1: Issuance of NCDs
Fig 2: Investment through NCDs
37. There have been examples where offshore private equity funds have exited from such instruments on the bourses.
38. Security interest is created in favour of the debenture trustee that acts for and on behalf of the NCD Holders. Security interest cannot be created
directly in favour of non-resident NCD holders.
15
Particulars
CCD FDI
NCD - FPI
Equity Ownership
ECB Qualification
Coupon Payment
Pricing
Security Interest
Sectoral
conditionalities
Equity Upside
Administrative
expenses
No intermediaries required
39. Prohibited companies means - company which is a chit fund or a nidhi company or is engaged in agricultural/plantation activities or real estate
business or construction of farm houses or dealing in transfer of development rights
40. A PIO means an individual (not being a citizen of Pakistan or Bangladesh or Sri Lanka or Afghanistan or China or Iran or Nepal or Bhutan) who
1.
2.
who or either of whose father or mother or whose grandfather or grandmother was a citizen of India by virtue of the Constitution of India or the
Citizenship Act, 1955 (57 of 1955).
17
41. Section 90(2) of CA 1956 exempts applicability of Sections 85 to 89 to a private company unless it is a subsidiary of a public company
42. Sections 43 and 47 of CA 2013
43. Chapter IV, Share Capital and Debentures, Rules under CA 2013
44. Section 2(52), CA 2013
18
IV. Deposits
Under CA 2013, acceptance of deposits by an Indian
company is governed by stricter rules. Securities
application money that is retained for more than
60 days without issuance of securities shall be
deemed as a deposit. CA 2013 lays down stringent
conditions for issuance of bonds and debentures
unsecured optionally convertible debentures are
treated as deposits. CA 2013 also specifies additional
compliances for deposits accepted prior to the
commencement of CA 2013.
V. Insider Trading
CA 2013 now has an express provision for insider
trading wherein insider trading of securities of
a company by its directors or key managerial
personnel is prohibited.45 SEBI had notified the SEBI
(Prohibition of Insider Trading) Regulations, 1992
to govern public companies. The provision governs
both public and private companies. Hence, nominee
director appointed by a private equity investor
may also be subjected to insider trading provisions.
However, the practical application of section 195 of
CA 2013, with respect to a private company remains
to be ambiguous.
VII. Directors
CA 2013 introduces certain new requirements with
respect to directors48 such as:
i. Independent Director: Independent Directors
have been formally introduced by CA 2013,
earlier the listing agreements49 provided for
appointment of independent directors. CA 2013
provides that Every listed public company
shall have at least one-third director of the total
number of directors as independent directors.
The term every listed public company is
ambiguous as it is the only instance in CA 2013
which applies to the listed public company and
not just listed company. This is relevant because
under CA 2013, a listed company also includes
a private company which has its NCDs listed on
the stock exchange.
ii. Resident Director: Every company to have a
director who was resident in India for a total
period of not less than 182 days in the previous
calendar year.
iii. Women Director: Prescribed class of companies
shall have atleast one woman director.
CA 2013 has for the first time, laid down specific
duties of directors, as follows:
19
20
4. Taxation Framework
I. Overview of Indian Taxation
System
Income tax law in India is governed by the Income
Tax Act, 1961 (ITA). Under the ITA, individuals and
entities, whether incorporated or unincorporated,
if resident for tax purposes in India, shall be taxed
on their worldwide income in India. Companies are
held to be resident in India for tax purposes a) if they
are incorporated in India; or b) if they are controlled
and managed entirely in India. Therefore, it is
possible for companies incorporated outside India
to be considered to be resident in India if they are
wholly controlled in India. Non-residents are taxed
only on income arising from sources in India.
India has entered into more than 80 Double Taxation
Avoidance Agreements (DTAAs or tax treaties).
A taxpayer may be taxed either under domestic law
provisions or the DTAA to the extent that it is more
beneficial. In order to avail benefits under the DTAA,
a non-resident is required furnish a tax residency
certificate (TRC) from the government of which it
is a resident in addition to satisfying the conditions
prescribed under the DTAA for applicability of the
DTAA. Further, the non-resident should also file
tax returns in India and furnish certain prescribed
particulars to the extent they are not contained
in the TRC. For the purpose of filing tax returns
in India, the non-resident should obtain a tax ID
in India (called the permanent account number
PAN). PAN is also required to be obtained to claim
the benefit of lower withholding tax rates, whether
under domestic law or under the DTAA. If the nonresident fails to obtain a PAN, payments made to
the non-resident may be subject to withholding
tax at the rates prescribed under the ITA or 20%,
whichever is higher.
A. Corporate Tax
Resident companies are taxed at 30%. A company
is said to be resident in India if it is incorporated in
India or is wholly controlled and managed in India.
A minimum alternate tax (MAT) is payable by
companies at the rate of around 18.5%. Non-resident
companies are taxed at the rate of 40% on income
derived from India, including in situations where
profits of the non-resident entity are attributable to a
permanent establishment in India.
C. Capital Gains
Tax on capital gains depends upon the holding
period of a capital asset. Short term capital gains
(STCG) may arise if the asset has been held for less
than three years (or in the case of listed securities,
less than one year) before being transferred; and
gains arising from the transfer of assets having
a longer holding period than the above are
characterized as long term capital gains (LTCG).
The 2014 Finance Budget proposes a minimum
holding period of 3 years for LTCG with respect to
unlisted securities.
LTCG earned by a non-resident on sale of unlisted
securities may be taxed at the rate of 10% or 20%
depending on certain considerations. LTCG on sale of
listed securities on a stock exchange are exempt and
only subject to a securities transaction tax (STT).
STCG earned by a non-resident on sale of listed
securities (subject to STT) are taxable at the rate of
15%, or at ordinary corporate tax rate with respect
to other securities. Foreign institutional investors
or foreign portfolio investors are also subject to
tax at 15% on STCG and are exempt from LTCG
(on the sale of listed securities). The 2014 Budget
also proposes to treat all income earned by Foreign
Institutional Investors or Foreign Portfolio Investors
as capital gains income. In the case of earn-outs or
deferred consideration, Courts have held that capital
gains tax is required to be withheld from the total
sale consideration (including earn out) on the date of
transfer of the securities / assets.
India has also introduced a rule to tax non-residents
on the transfer of foreign securities the value of
which may be substantially (directly or indirectly)
derived from assets situated in India. Therefore,
21
D. Interest
Interest earned by a non-resident may be taxed at a
rate between 5% to around 40% depending on the
nature of the debt instrument. While a concessional
withholding tax rate of 5% for interest on long
term foreign currency denominated bonds is
available until July 1, 2017, the eligibility of rupeedenominated non-convertible debentures for the
same benefit expires on June 1, 2015.
G. Wealth Tax
Buildings, residential and commercial premises held
by the investee company will be regarded as assets as
defined under Section 2(ea) of the Wealth Tax Act,
1957 and thus be eligible to wealth tax in the hands
of the investee company at the rate of 1 percent on
its net wealth in excess of the base exemption of INR
30,00,000. However, commercial and business assets
are exempt from wealth tax.
H. Service Tax
The service tax regime was introduced vide Chapter
53. Although, substantial has not been defined under ITA, as per draft DTC 2013, substantial is proposed to be 20%
22
23
F. Withholding Obligations
Tax would have to be withheld at the applicable
rate on all payments made to a non-resident, which
are taxable in India. The obligation to withhold
tax applies to both residents and non-residents.
Withholding tax obligations also arise with respect
to specific payments made to residents. Failure to
withhold tax could result in tax, interest and penal
consequences. Therefore, often in a cross-border the
purchasers structure their exits cautiously and rely
on different kinds of safeguards such as contractual
representations, tax indemnities, tax escrow, nil
withholding certificates, advance rulings, tax
insurance and legal opinions. Such safeguards have
been described in further detail under Annexure V.
MAURITIUS
SINGAPORE
NETHERLANDS
Tax on dividends
Withholding tax on
outbound interest
10%
Withholding tax on
15% (for royalties). FTS 56
outbound royalties and fees may be potentially exempt in
for technical services
India.
10%
10%
Other comments
Mauritius treaty in
the process of being
renegotiated. Possible
addition of substance rules.
25
I. Put Options
Put options in favour of a non-resident requiring an
Indian resident to purchase the shares held by the
non-resident under the FDI regime were hitherto
considered non-compliant with the FDI Policy by
the RBI. RBI has legitimized option arrangements57
through an amendment in the TISPRO Regulations.
The TISPRO Regulations now permit equity shares,
CCPS and CCDs containing an optionality clause to
be issued as eligible instruments to foreign investors.
However, the amendment specifies that such an
instrument cannot contain an option / right to exit at
an assured price.
The amendment, for the first time, provides for a
written policy on put options, and in doing that sets
out the following conditions for exercise of options
by a non-resident:
i. Shares/debentures with an optionality clause
can be issued to foreign investors, provided that
they do not contain an option/right to exit at an
assured price;
ii. Such instruments shall be subject to a minimum
lock-in period of one year;
iii. The exit price should be as follows:
a. In case of listed company, at the market price
determined on the floor of the recognized stock
exchanges;
b. In case of unlisted equity shares, at a price
not exceeding that arrived on the basis of
internationally accepted pricing methodologies
c. In case of preference shares or debentures, at a
price determined by a Chartered Accountant
or a SEBI registered merchant banker per any
internationally accepted methodology.
II. Buy-Back
In this exit option, shares held by the foreign
investor, are bought back by the investee company.
Buy-back of securities is subject to certain
conditionalities as stipulated under Section 68 of
CA 2013. A company can only utilize the following
funds for undertaking the buy-back (a) free reserves
(b) securities premium account, or (c) proceeds of
any shares or other specified securities. However,
buy-back of any kind of shares or other specified
securities is not allowed to be made out of the
proceeds of an earlier issue of the same kind of shares
or same kind of other securities.
Further, a buy back normally requires a special
resolution58 passed by the shareholders of the
company unless the buyback is for 10% or less of
the total paid-up equity capital and free reserves
of the company. Additionally, a buy back cannot
exceed 25% of the total paid up capital and free
reserves of the company in one financial year, and
post buy-back, the debt equity ratio of the company
should not be more than 2:1. Under CA 1956, it was
possible to conduct two buy-backs in a calendar year,
i.e., one in the financial year ending March 31 and a
subsequent offer in the financial year commencing
on April 1. However, in order to counter this
practice, the CA 2013 now requires a cooling off
period of one year between two successive offers for
buy-back of securities by a company.
From a tax perspective, traditionally, the income
from buyback of shares has been considered as
capital gains in the hands of the recipient and
accordingly the investor, if from a favourable treaty
jurisdiction, could avail the treaty benefits. However,
in a calculated move by the Government to undo this
current practice of companies resorting to buying
back of shares instead of making dividend payments,
the government, vide Budget 2013-2014 levied a tax
of 20%59 on domestic unlisted companies, when
such companies make distributions pursuant to a
share repurchase or buy back.
The said tax at the rate of 20% is imposed on a
domestic company on consideration paid by it which
is above the amount received by the company at the
57. http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8682&Mode=0
58. Under CA 2013, a Special Resolution is one where the votes cast in favor of the resolution (by members who, being entitled to do so, vote in person
or by proxy, or by postal ballot) is not less than three times the number of the votes cast against the resolution by members so entitled and voting.
(The position was the same under CA 1956).
59. Exclusive of surcharge and cess.
26
III. Redemption
In recent times, NCDs have dominated the market.
NCDs can be structured as pure debt or instruments
delivering equity upside. The returns on the NCDs
can be structured either as redemption premium or
as coupon, the tax consequences of the same is set
out earlier in this paper. The redemption premium
in certain structured equity deals can be pegged to
the cash flows or any commercially agreed variable,
enabling such debentures to assume the character
of payable when able kind of bonds. A large amount
27
VIII. Flips
Another mode of exit could be by way of rolling
the real estate assets into an offshore REIT by
flipping the ownership of the real estate company
to an offshore company that could then be listed.
Examples of such offshore listings were seen around
2008, when the Hiranandani Group set up its
offshore arm Hirco PLC building on the legacy of
the Hiranandani Groups mixed use township model.
Hirco was listed on the London Stock Exchanges
AIM sub-market. At the time of its admission
to trading, Hirco was the largest ever real estate
investment company IPO on AIM and the largest
AIM IPO in 2006. Another example is Indiabulls
Real Estate that flipped some of its stabilized and
developing assets into the fold of a Singapore
Business Trust (SBT) that got listed on the
Singapore Exchange (SGX). However, both Hirco
and Indiabulls have not been particularly inspiring
stories and to some extent disappointed investor
sentiment. Based on analysis of the listings, it is clear
that there may not be a market for developing assets
on offshore bourses, but stabilized assets may receive
62. Reaping the Returns: Decoding Private Equity Real Estate Exits in India, available at http://www.joneslanglasalle.co.in/ResearchLevel1/Reaping_
the_Returns_Decoding_Private_Equity_Real_Estate_Exits_in_India.pdf
63. The Press Release is available on:http://finmin.nic.in/press_room/2013/lisitIndianComp_abroad27092013.pdf
64. Notification no. GSR 684(E) [F.NO.4/13/2012-ECB], dated 11-10-2013
65. RBI A.P. (Dir Series) Circular No. 69 of November 8, 2013
28
29
6. Domestic Pooling
Domestic pools of capital may be structured
primarily in two ways:
I. AIF
In 2012, SEBI notified the (Alternative Investment
Funds) Regulations, 2012 (AIF Regulations) to
regulate the setting up and operations of alternate
investment funds in India. As provided in the AIF
Regulations, it replaces and succeeds the erstwhile
SEBI (Venture Capital Funds) Regulations, 1996.
The AIF Regulations further provide that from
commencement of such regulations, no entity or
Person shall act as an AIF unless it has obtained a
certificate of registration from the SEBI. The AIF
Regulations define Alternative Investment Funds
as any fund established or incorporated in India
in the form of trust, company, a limited liability
partnership or a body corporate which is a privately
pooled investment vehicle which collects funds from
investors, whether Indian or foreign, for investing
in accordance with a defined investment policy for
the benefit of investors, and is not covered under the
SEBI regulations to regulate fund management.
The real estate funds shall be registered with SEBI as
a Category II Alternate Investment Fund and shall be
governed by the provisions of the AIF Regulations.
The AIF Regulations prescribe that the raising of
commitments should be done strictly on a private
placement basis and the minimum investment
that can be accepted by a fund from an investor
is INR 1,00,00,000 (Rupees One Crore Only). The
AIF Regulations also prescribe that a placement
memorandum detailing the strategy for investments,
fees and expenses proposed to be charged, conditions
and limits on redemption, risk management tools
and parameters employed, duration of the life cycle
of the AIF should also be issued prior to raising
commitments and be filed with the SEBI prior to
launching of a fund. Further, the AIF Regulations
also prescribe that the manager or a sponsor of an
AIF shall have a continuing interest in the AIF of
not less than 2.5% of the corpus or INR 5,00,00,000
(Rupees Five Crore Only), whichever is lower, in the
form of investment in the AIF and such interest shall
not be through the waiver of management fees.
The AIF Regulations provide that a close ended
AIF may be listed only after the final closing of the
fund or scheme on a stock exchange subject to a
30
II. NBFC
In light of the challenges that the FDI and the FPI
route are subjected to, there has been a keen interest
in offshore realty funds to explore the idea of setting
up their own NBFC to lend or invest to real estate.
An NBFC is defined in terms of Section 45I(c) of the
RBI Act, 1934, as a company engaged in granting
loans/advances or in the acquisition of shares/
securities, etc. or hire purchase finance or insurance
business or chit fund activities or lending in any
manner provided the principal business of such
a company does not constitute any non-financial
activities such as (a) agricultural operations (b)
industrial activity (c) trading in goods (other than
securities) (d) providing services (e) purchase,
construction or sale of immovable property. Every
NBFC is required to be registered with the RBI, unless
specifically exempted.
Following are some of the latest changes with
respect to NBFC:
66. http://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=8561&Mode=0
67. The public notice had be published in one English and one vernacular language newspaper, copies of which were required to be submitted to the
RBI.
68. DNBS (PD) CC.No.376/03.10.001/2013-14
69. Under the Master Circular on Corporate Governance dated July 1, 2013, RBI had emphasized the importance of persons in management who fulfil
the fit and proper criteria. The Master Circular provides as follows:
it is necessary to ensure that the general character of the management or the proposed management of the non-banking financial company shall not
be prejudicial to the interest of its present and future depositors. In view of the interest evinced by various entities in this segment, it would be desirable that NBFC-D with deposit size of Rs 20 crore and above and NBFC-ND-SI may form a Nomination Committee to ensure fit and proper status of
proposed/existing Directors.
70. RBI/2012-13/560 DNBD(PD) CC No. 330/03.10.001/2012-13 and RBI/2013-14/115 DNBS(PD) CC No.349/03.10.001/2013-14
31
Domestic Pooling
Provided upon request only
C. Private Placement 71
As per Section 67(2) of CA 1956, private placement
means invitation to subscribe shares or debenture
from any section of public whether selected as
members or debenture holders of the company
concerned or in any other manner. Section 67(3)
prescribes that shares or debenture under such
offer can be offered to maximum of fifty persons.
However, NBFCs where excluded from Section
67(3). But RBI has now restricted private placement
to not more than 49 investors, in line of the private
companies which are to be identified upfront by the
NBFC.
71. Ibid
72. http://www.nishithdesai.com/New_Hotline/Realty/Realty%20Check%20-%20Debt%20Funding%20Realty%20in%20India_Jan2012.pdf
32
I. REITs
The Budget 2014-2015 has put REITs back on the
fast track by proposing to take steps to bring clarity
in tax treatment of REITs, including a partial tax
pass-through regime for REITs. This will result in
the REIT not being subject to any tax in respect of
such interest income, whereas the investors will be
subject to tax on the same.
The much awaited framework for REITs has also
been announced and thanks to the present clarity in
tax treatment, global investors can soon participate
in core real estate assets in India. Long term capital
gains on sale of units as well as dividends received
by the REIT and distributed to the investor shall be
tax exempt. Interest income received by the REIT is
tax exempt and foreign investors shall be subject to a
low withholding tax of 5% on interest payouts.
In spite of the positive proposals brought forward by
the government to establish an investment-friendly
regime, there still remain certain issues with respect
of taxation of REITs. It should be noted that almost
all countries provide for a complete pass through
regime for REITs if the prescribed regulatory criteria
is met and a move towards that will further increase
interest in this space. It is hoped that the Finance
Ministry would address the above issues going
forward and possibly simplify the REIT taxation
regime.
Please refer to Annexure V for our article published
in Live Mint on the tax and non-tax issues that make
the Indian REIT unattractive.
33
75. http://www.livemint.com/Companies/l5mzgtPyZRxqtimiq4CsxH/Concerns-among-PE-firms-over-enforcing-realty-share-pledges.html
34
Annexure I
Foreign Investment Norms for Real Estate
Liberalized
Minimum area threshold reduced from 50,000 sq
ft. to 20,000 sq ft.
No minimum area threshold, if 30% project cost
is contributed towards development of affordable
housing.
Are investments in completed yield generating
real estate assets allowed?
I. Changes
The changes sought to be made by the Press Release
are set out below.1
Provisions
Existing Policy
Minimum Land
Requirements
i. Development of serviced plots: No minimum i. Development of serviced housing plots: Minimum land
land requirement;
area of 10 hectares;
ii. Construction-development projects:
ii. Construction-development projects: Minimum builtup area of 50,000 sq. meters;
Minimum floor area of 20,000 sq. meters;
iii. Combination project: Any of the above two
conditions need to be complied with
Minimum
Capitalization
Requirements
Timing of
investment
1.
The changes brought in by the Amendment are expected to be formalized in the form of a Press Note or by way of inclusion in the FDI Policy, and till
such time the changes do not have the binding force of law.
35
Lock-in
The requirement of completion certificate has The investor was required to provide the completion
been done away with
certificate from the concerned regulatory authority
before disposal of serviced housing plots.
Minimum
development
Exemption
Affordable
Housing
No such exemption.
Certificate from
architect
No such requirement.
Completed
projects
Responsibility
for obtaining
all necessary
approvals
Investee Company.
36
II. Analysis
Provisions
Existing Policy
Minimum Land
Requirements
Provisions
Existing Policy
Minimum
Capitalization
Requirements
37
Provisions
Existing Policy
Timing of
investment
C. Commencement of business of
company to commencement of
project
Provisions
Existing Policy
Lock-in
38
Prior exit of the investor only with the prior approval of FIPB.
E. Exit on completion
A welcome change is permitting investors to exit on
the completion of the project. Hitherto, each tranche
of investments were locked-in for a period of 3 years,
even if the project was completed. This posed a major
challenge for last-mile funding for projects, since the
investment was stuck even on the completion of the
project.
I. Grandfathering
F. Lock-in of 3 years from final
instalment
The lock-in for ongoing or non-completed projects
for 3 years from the final tranche may need to be
examined. The earlier regulations required any
tranche to be locked in for a period of 3 years from
the date of receipt of such tranche only.
G. 50% in 5 years
Another positive move is the removal of the
minimum development of 50% in 5 years from the
date of obtaining all statutory clearances. Earlier,
there some ambiguity in relation to when the 50%
development requirement would trigger, since it
was unclear what all statutory approvals meant.
To remove this ambiguity, the requirement for the
minimum development of 50% in 5 years has been
removed. However, in spirit, the same has been
introduced by requiring trunk infrastructure to be
developed before any exit.
H. Trunk infrastructure
To be eligible to exit at the end of 3 years from the
Provisions
Requirement of
commencement
certificate for
serviced plots
39
Provisions
Existing Policy
Minimum
development
Provisions
Affordable
Housing
No such exemption.
Existing Policy
Completed
projects
Provisions
Existing Policy
Responsibility for
obtaining all necessary
approvals
Investee Company.
K. Analysis
The obligation to obtain all necessary approvals,
including the business plans has now been clarified
to be that of the investee company in India, doing
away with the unnecessary hassles around this for
investor
III. Conclusion
41
Annexure II
Foreign Investment Norms in Real Estate
Changed
i. Analysis
3 year lock-in restriction removed
Criteria for affordable housing projects relaxed
Whether investments are now possible in
brownfield real estate projects?
I. Changes
i. Analysis
This relaxation is a welcome move, since projects
which qualify for affordable housing will not be
required to comply with certain conditionalities
like minimum area requirements and minimum
investment requirements. Having said the above,
since the area requirements is relaxed to as high as
140 sq. meters (approx. 1510 sq. feet), and only 1/4th
of the affordable housing portion needs to be 60 sq.
meters (approx. 645 sq. feet), whether the purpose
for which this relaxation is introduced will be met or
not is not clear.
C. Combination project
The Press Release retained the provision that in case
of combination projects (mix of serviced plots and
construction development), either of the condition
for minimum area requirement can be satisfied.
However, since now the minimum area restriction
(being 25 acres) for serviced plots has been removed,
to avoid any misuse, the concept of combination
projects has been removed in the Press Note.
D. Grandfathering
The Foreign Exchange Management (Transfer or
Issue of Security by a Person Resident outside India)
(Sixteenth Amendment) Regulations, 2014, dated
December 8, 2014 (Amendment Regulations)
which amends the Foreign Exchange Management
(Transfer or Issue of Security by a Person Resident
outside India) Regulations, 2000 to include the
changes introduced by the Press Note, provides that
(i) the Amendment Regulations shall be deemed to
have come into force from December 3, 2014, and (ii)
no person will be adversely affected as a result of the
retrospective effect being given to the Amendment
Regulations.
II. Conclusion
43
Annexure III
Specific Tax Risk Mitigation Safeguards for
Private Equity Investments
In order to mitigate tax risks associated with
provisions such as those taxing an indirect transfer
of securities in India, buy-back of shares, etc., parties
to M&A transactions may consider or more of the
following safeguards. These safeguards assume
increasing importance, especially with the GAAR
coming into force from April 1, 2015 which could
potentially override treaty relief with respect to tax
structures put in place post August 30, 2010, which
may be considered to be impermissible avoidance
arrangements or lacking in commercial substance.
44
IV. Escrow
Parties may withhold the disputed amount of tax
and potential interest and penalties and credit such
amount to an escrow instead of depositing the same
with the tax authorities. However, while considering
this approach, parties should be mindful of the
opportunity costs that may arise because of the funds
getting blocked in the escrow account.
V Tax insurance
A number of insurers offer coverage against tax
liabilities arising from private equity investments.
The premium charged by such investors may vary
depending on the insurers comfort regarding the
degree of risk of potential tax liability. The tax
insurance obtained can also address solvency issues.
It is a superior alternative to the use of an escrow
account.
A. Scope
The indemnity clause typically covers potential
capital gains tax on the transaction, interest and
penalty costs as well as costs of legal advice and
representation for addressing any future tax claim.
B. Period
Indemnity clauses may be applicable for very long
periods. Although a limitation period of seven years
has been prescribed for reopening earlier tax cases,
the ITA does not expressly impose any limitation
period on proceedings relating to withholding tax
liability. An indemnity may also be linked to an
advance ruling.
C. Ability to indemnify
The continued ability and existence of the party
providing the indemnity cover is a consideration
to be mindful of while structuring any indemnity.
D. Conduct of proceedings
The indemnity clauses often contain detailed
provisions on the manner in which the tax
proceedings associated with any claim arising under
the indemnity clause may be conducted.
45
Annexure IV
Flips and Offshore REITs
One of the means of exit for shareholders of a real
estate company and also a way of accessing global
public capital is by way of flipping the assets of the
real estate company into the fold of an offshore REIT
vehicle.
Investors
Offshore
Units in the
trust
SBT
Investors
Trust Management
Company
Singapore SPV
Singapore
100% owner
India
Promoter
Real Estate
Company
100% Equity /
Listed NCDs
Indian SPV
I. In this Structure
i. The individual shareholders of the Promoter
entity acquires an interest in the management
company in Singapore under the liberalized
remittance scheme (LRS) which sets up the
Singapore business trust (SBT). LRS permits
an Indian resident individual to remit upto USD
125,000 in any financial year for most capital /
current account transactions.
46
iv. The Indian SPV can then either purchase the real
estate project on a slump sale basis on deferred
consideration.
v. SBT can then raise monies by way of private
placement or through listing of its units on the
Singapore stock exchange. These monies can
then be utilized to settle the deferred purchase
consideration or purchase the real estate project.
vi. The proceeds from the sale of the real estate
Nishith Desai Associates 2015
47
48
Annexure V
REITs: Tax Issues and Beyond
APART FROM THE TAX CHALLENGES, THERE ARE NON-TAX ISSUES ALSO THAT MAKE
THE INDIAN REIT UNATTRACTIVE
The Securities and Exchange Board of India (Sebi)
recently introduced the final regulations for real
estate investment trusts (REITs) and infrastructure
investment trusts (InvITs). These regulations come
on the back of recent tax initiatives introduced in
the budget this year. While the initiative is indeed a
positive step, the tax measures governing REITs or
business trusts (as they are referred to in the Incometax Act) do not offer much encouragement, neither
to the sponsor nor the unit holders.
Apart from the tax challenges set out above, there are
also several non-tax issues that make the Indian REIT
story unattractive. The requirement for a sponsor to
have a real estate track record is likely to rule out a
substantial portion of yield generating assets. This
eliminates the possibility of non-real estate players
such as hotels, hospitals, banks and others (such as
Air India) becoming sponsors of REITs.
Most importantly, the marketability of Indian REITs
compared with other fixed-income products remains
weak since the expected yield on REITs may not
exceed 5-6% compared with an around-8% yield
offered by government securities. Though REITs
may offer a higher return considering the capital
appreciation, offshore investors seem reluctant to
buy the cap rate story attached to a REIT.
Having said that, REITs are likely to offer
monetization opportunities to private equity funds
and developers, which have till now been unable to
find institutional buyers for completed real estate
assets. As the appetite for developmental projects
has reduced, REITs will offer opportunities to foreign
investors to invest in rent generating assets, an asset
49
50
http://www.nishithdesai.com/information/researchand-articles/nda-hotline/nda-hotline-single-view/
article/reits-tax-issues-and-beyond-1.html?no_cache=
1&cHash=a54570354bb5bc1969d720fba3cad33a
Sriram Govind &
Ruchir Sinha
You can direct your queries or comments to the
authors
Annexure VI
NBFC Structure for Debt Funding
In light of the challenges that the FDI and the FPI
route are subjected to, there has been a keen interest
in offshore funds to explore the idea of setting
up their own NBFC to lend or invest in Indian
companies.
An NBFC is defined in terms of Section 45I(c) of the
RBI Act, 1934 (RBI Act) as a company engaged
in granting loans/advances or in the acquisition
of shares/securities, etc. or hire purchase finance
or insurance business or chit fund activities or
lending in any manner provided the principal
business of such a company does not constitute
any non-financial activities such as (a) agricultural
operations, (b) industrial activity, (c) trading in
goods (other than securities), (d) providing services,
(e) purchase, construction or sale of immovable
property. Every NBFC is required to be registered
with the RBI, unless specifically exempted.
The Act has however remained silent on the
definition of principal business and has thereby
conferred on the regulator, the discretion to
determine what is the principal business of
a company for the purposes of regulation.
Accordingly, the test applied by RBI to determine
what is the principal business of a company was
articulated in the Press Release 99/1269 dated April
8, 1999 issued by RBI. As per the said press release, a
Structure diagram
Off-shore Fund
Off-shore
India
Indian Company
1.
The Working Group report was published by the RBI in the form of Draft Guidelines on its website 12th December 2012
51
B. Regulatory Uncertainty
The greatest apprehension for funds has been
the fluid regulatory approach towards foreign
investment, for instance put options. The NBFC
being a domestic lending entity is relatively immune
from such regulatory uncertainty
C. Security Creation
Creation of security interest in favour of nonresidents on shares and immoveable property is
not permitted without prior regulatory approval.
However, since the NBFC is a domestic entity,
security interest could be created in favour of
the NBFC. Enforceability of security interests,
however, remains a challenge in the Indian context.
Enforcement of security interests over immovable
property, in the Indian context, is usually a time
consuming and court driven process. Unlike banks,
NBFCs are not entitled to their security interests
under the provisions of the Securitization and
Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act.
D. Repatriation Comfort
Even though repatriation of returns by the NBFC to
its offshore shareholders will still be subject to the
restrictions imposed by the FDI Policy (such as the
pricing restrictions, limits on interest payments etc.),
52
B. Capitalization
2.
The public notice had be published in one English and one vernacular language newspaper, copies of which were required to be submitted to the
RBI
3.
4.
Under the Master Circular on Corporate Governance dated July 1, 2013, RBI had emphasized the importance of persons in management who fulfil
the fit and proper criteria. The Master Circular provides as follows:
it is necessary to ensure that the general character of the management or the proposed management of the non-banking financial company shall
not be prejudicial to the interest of its present and future depositors. In view of the interest evinced by various entities in this segment, it would be
desirable that NBFC-D with deposit size of Rs 20 crore and above and NBFC-ND-SI may form a Nomination Committee to ensure fit and proper
status of proposed/existing Directors.
5.
Net Owned Funds has been defined in the RBI Act 1934 as (a) the aggregate of paid up equity capital and free reserves as disclosed in the latest
balance sheet of the company, after deducting there from (i) accumulated balance of loss, (ii) deferred revenue expenditure and (iii) other intangible
asset; and (b) further reduced by the amounts representing (1) investment of such company in shares of (i) its subsidiaries; (ii) companies in the same
group; (iii) all other NBFCs and (2) the book value of debentures, bonds, outstanding loans and advances (including hire-purchase and lease finance)
made to and deposits with (i) subsidiaries of such company and (ii) companies in the same group, to the extent such amounts exceed ten percent of
(a) above
53
C. The Instrument
Before we discuss the choice of an instrument for the
NBFC, lets discuss the instruments that are usually
opted for investment under the FDI route
CCDs essentially offer three important benefits.
Firstly, any coupon paid on CCDs is a deductible
expense for the purpose of income tax. Secondly,
though there is a 40% withholding tax that the nonresident recipient of the coupon may be subject to,
the rate of withholding can be brought to as low as
10% if the CCDs are subscribed to by an entity that
is resident of a favorable treaty jurisdiction. Thirdly,
coupon can be paid by the company, irrespective
of whether there are profits or not in the company.
Lastly, being a loan stock (until it is converted), CCDs
have a liquidation preference over shares. And just
for clarity, investment in CCDs is counted towards
the minimum capitalization.
USD 50 million, with USD 7.5 million to be brought upfront and the balance in 24 months.
6.
Although the requirement of net owned funds presently stands at INR 20 million, companies that were already in existence before April 21, 1999
are allowed to maintain net owned funds of INR 2.5 million and above. With effect from April 1999, the RBI has not been registering any new NBFC
with net owned funds below INR 20 million.
7.
8.
9.
Note that an NBFC becomes a systemically important NBFC from the moment its total assets exceed INR 100 crores. The threshold of INR 1 billion
need not be reckoned from the date of last audited balance sheet as mentioned in the Prudential Norms.
10. Owned Fund means Equity Capital + CCPS + Free Reserves +Share Premium + Capital Reserves (Accumulated losses + BV of intangible assets +
Deferred Revenue Expenditure)
54
(v) Joint Venture operating NBFCs that have 75% or less than 75% foreign investment can also set up subsidiaries for undertaking other NBFC
activities, subject to the subsidiaries also complying with the applicable minimum capitalisation norms.
55
E. Deployment of Funds
NBFCs can issue debentures only for deployment
of the funds on its own balance sheet and not to
facilitate requests of group entities/ parent company/
associates. Core Investment Companies have been
carved out from the applicability of this restriction.
13. The term group has not been defined in the Prudential Norms
14. Public funds includes funds raised either directly or indirectly through public deposits, Commercial Papers, debentures, inter-corporate deposits
and bank finance.
56
I. Exit
Exit for the foreign investor in an NBFC is the most
crucial aspect of any structuring and needs to be
planned upfront. The exits could either be by way of
liquidation of the NBFC, or buy-back of the shares
of the foreign investor by the NBFC, or a scheme
of capital reduction (where the foreign investor is
selectively bought-back), or the sale of its shares in
the NBFC to another resident or non-resident, or
lastly, by way of listing of the NBFC.15
Unlike most countries, liquidation in the Indian
context is a time consuming and elaborate process in
India, sometimes taking in excess of 10 years.
Buyback of securities is another alternative,
however, CCDs cannot be bought back. CCDs
must be converted into the underlying equity
shares to be bought back. Buy-back of securities is
subjected to certain conditionalities as stipulated
under Section 68 of the Companies Act, 2013. A
buyback of equity shares can happen only out of
free reserves, or proceeds of an earlier issue or out of
share premium.16 In addition to the limited sources
that can be used for buy-back, there are certain other
restrictions as well that restrict the ability to draw
out the capital from the company. For instance, only
up to a maximum of 25% of the total paid up capital
and free reserves of the company can be bought in
one financial year, the debt equity ratio post buyback should not be more than 2:1 etc. Buy-back
being a transfer of securities from a non-resident
to a resident cannot be effected at a price higher
than the price of the shares as determined by the
discounted cash flows method. Although, buy back
from the existing shareholders is supposed to be on
15. The forms of exit discussed here are in addition to the ability of the foreign investor to draw out interest / dividends from the NBFC up to 300 basis
points over and above the State Bank of India prime lending rate.
16. As a structuring consideration, the CCDs are converted into a nominal number of equity shares at a very heavy premium so that the share premium
can then be used for buy-back of the shares.
17. Exclusive of surcharge and cess.
57
58
Annexure VII
Challenges in Invocation of Pledge of Shares
Promoters of Unitech obtained the injunction due
to the unreasonable notice period given to them, the
company said in an email release. Outstanding loan
amount was repaid in full by the promoters within
a few days of obtaining the injunction and ahead of
the schedule. The pledged shares got released nearly
three months ago.
The pledging of shares is a mechanism through
which an investor or a lender can ensure a company
or a borrower delivers a promised return or repays
a loan within the stipulated period. When the
company defaults on the pledge, the shares are sold.
PE funds that focus on real estate have got such
pledged shares from their portfolio companies.
The Unitech case has raised concerns among PE
investors about the enforceability of the pledge,
said Ruchir Sinha, co-head, real estate investments
practice, at law firm Nishith Desai Associates. Many
funds are looking to enforce the pledge today, but
are concerned if the company can take them to court
and obtain a stay order.
Realty valuations have been declining as some
companies have been facing allegations of
wrongdoing relating to bribes given for loans and the
allocation of telecom spectrum, besides falling home
sales and rising interest rates.
On 30 January, Unitechs promoters approached the
Delhi high court and secured an injunction against a
move by debenture trustee Axis Trustee Services Ltd
to sell pledged shares. The promoters of Unitech had
raised Rs 250 crore from high networth individuals
(HNIs) in 2010 through the issue of non-convertible
debentures and had pledged their shares in the firm
as security to raise these funds.
However, on 28 January, Unitechs stock price
dropped to Rs 51 per share, marking a 38% decline
since November 2009 and triggering the default.
The same day Axis Trustee Services informed the
promoters that it would sell the pledged shares
on the next working day, as per their agreement.
Unitech moved the high court, which said that if
the stay was not granted, the company would suffer
irreparable loss.
Invoking a pledge can be challenging even in a
publicly traded company, since the law requires
that a fund must immediately sell the shares upon
Nishith Desai Associates 2015
59
60
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Research @ NDA
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