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November 2014
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About NDA
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Contents
ABBREVIATIONS 01
1.
PREFACE 02
I. Legal and Regulatory changes introduced in 2014
02
04
I.
Foreign Direct Investment 04
II.
FVCI Route 07
III.
FPI Route 07
IV.
NRI Route 12
3. LEGAL FRAMEWORK KEY DEVELOPMENTS
14
I.
Shares with Differential Rights 14
II.
Listed Company 14
III.
Inter-Corporate Loans and Guarantee 14
IV.
Deposits 15
V.
Insider Trading 15
VI.
Squeeze out Provisions 15
VII.
Directors 15
VIII. Control and Subsidiary and Associate Company
16
IX. Merger of an Indian company with offshore company.
16
4.
TAXATION FRAMEWORK 17
I.
Overview of Indian Taxation System 17
II. Specific Tax Considerations for PE Investments
18
5.
EXIT OPTIONS / ISSUES 22
I.
Put Options 22
II.
Buy-Back 22
III.
Redemption 23
IV.
Initial Public Offering 23
V.
Third Party Sale 23
VI.
GP Interest Sale 23
VII.
Offshore Listing 24
VIII.
Flips 24
IX.
Domestic REITs 24
6.
DOMESTIC POOLING 28
I.
AIF 28
II.
NBFC 28
7.
THE ROAD FORWARD 29
I.
REITs 29
II.
Partner issues 29
III.
Arbitration / Litigation 29
IV.
Security Enforcement 29
ANNEXURE I
BUDGET 2014: A GAME CHANGER FOR REITS?
31
ANNEXURE II
REITS: TAX ISSUES AND BEYOND
36
ANNEXURE III
OFFSHORE LISTING REGIME: HOW TO RAISE FUNDS AND MONETIZE
INVESTMENTS 38
ANNEXURE IV
REGULATORY REGIME FORCING COS EXTERNALISATION
40
ANNEXURE V
NBFC STRUCTURE FOR DEBT FUNDING 42
ANNEXURE VI
FOREIGN INVESTORS PERMITTED TO PUT: SOME CHEER,
SOME CONFUSION 49
ANNEXURE VII
INDIAN GAAR: RULES NOTIFIED 53
ANNEXURE VIII
FOREIGN INVESTMENT NORMS FOR REAL ESTATE LIBERALIZED
56
ANNEXURE IX
THE CURIOUS CASE OF PRICING GUIDELINES
62
ANNEXURE X
SPECIFIC TAX RISK MITIGATION SAFEGUARDS FOR PRIVATE EQUITY
INVESTMENTS 67
ANNEXURE XI
BILATERAL INVESTMENT TREATIES 69
ANNEXURE XII
FLIPS AND OFFSHORE REITS 71
ANNEXURE XIII
BOMBAY HIGH COURT CLARIFIES THE PROSPECTIVE
APPLICATION OF BALCO 74
ANNEXURE XIV
CHALLENGES IN INVOCATION OF PLEDGE OF SHARES
77
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
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
1. Preface
Year 2014 witnessed interesting changes from a
regulatory, legal and tax perspective. Following
a long dormant phase in the capital markets and
drying up of foreign investment into India, the
reforms proposed to be brought about by the Budget
2014-15 announced by the newly elected Central
Government have attempted to resolve some of
the growth and liquidity issues faced by the Indian
economy over the past few years. A snapshot of some
of those changes, which are detailed later in this
paper is provided below:
1. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Articles/The_Securities_and_Exchange_Board_of_India.pdf
2. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/reits-tax-issues-and-beyond-1.html?no_
cache=1&cHash=a54570354bb5bc1969d720fba3cad33a
E. Control
Definition of control under the FDI Policy has
been amended by FIPB to bring it in line with the
definition of control as provided under CA 20133
and SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011.4 The amendment
has enlarged the scope of the control. Existing
downstream investments by domestic companies
with foreign investment will have to be examined
more closely to ascertain if they are affected by
the new definition of control. In addition, the
amendment may even apply to existing structures
making any further downstream investment subject
to scrutiny.
9. FDI policy refers to FDI as a category of cross border investment made by a resident in one economy (the direct investor) with the objective of
establishing a lasting interest in an enterprise (the direct investment enterprise) that is resident in an economy other than that of the direct investor.
The motivation of the direct investor is a strategic long term relationship with the direct investment enterprise to ensure the significant degree of
influence by the direct investor in the management of the direct investment enterprise. Direct investment allows the direct investor to gain access to
the direct investment enterprise which it might otherwise be unable to do. The objectives of direct investment are different from those of portfolio
investment whereby investors do not generally expect to influence the management of the enterprise. It further mentions that it is the policy of the
Government of India to attract and promote productive FDI from non-residents in activities which significantly contribute to industrialization and
socio-economic development. FDI supplements the domestic capital and technology.
B. Minimum Capitalization
The press release makes no distinction in the
minimum capitalization for wholly owned
subsidiaries and joint ventures with the Indian
partners as provided in the FDI Policy. The minimum
capitalization prescribed is US $ 5 million.
C. Affordable Housing
The projects which will allocate atleast 30% of the
project cost for the low cost affordable housing
will be exempted from the complying with the
minimum land area and the minimum capitalization
requirements as mentioned above.
D. Complete Assets
Press Release clarifies 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 Release 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 Release leaves the question
unanswered whether these companies operating and
managing the assets may own the assets as well.
Please refer to Annexure VIII10 for a detailed analysis
of the press release.
Though the DIPP has not released the press note
amending the FDI Policy, however, it can be expected
that the press note will not be different from the
press release.
10. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/newsid/2638/html/1.html?no_cache=1
Particulars
Equity
Basic Character
Liability to Pay
CCPS
CCD
Dividend on CCPS cannot exceed 300 basis points over and above the
prevailing SBI prime lending rate in the financial year in which CCPS is
issued. No legal restriction on interest on CCD, however in practice it is
benchmarked to CCPS limits.
Tax Efficiency
No tax deduction, dividend payable from post-tax income Dividend taxable @ 15%13 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 permissible
CCPS and CCDs need to be converted to equity before they can be bought
back or extinguished by the Indian company.
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
E. QIB Status
FVCIs registered with SEBI have been accorded
qualified institutional buyer (QIB) status and are
eligible to subscribe to securities at an IPO through
the book building route.
However, the RBI while granting the permission/
certificate mandates that an FVCI can only invest
in the following sectors, viz. infrastructure sector,
biotechnology, IT related to hardware and software
development, nanotechnology, seed research and
development, research and development of new
chemical entities in pharma sector, dairy industry,
poultry industry, production of bio-fuels and hotelcum-convention centers with seating capacity of
more than three thousand.
15. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/rbi-issues-reforms-for-fdi-investments.
html?no_cache=1&cHash=aa112b7416545ec9dccccab2a900687f
16. 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.
A. Categories
Each investor shall register directly as an FPI,
wherein the FPIs have been classified into the
following three categories on the basis of risk-based
approach towards know your customer.
i. Category I FPI
Category I includes Government and governmentrelated investors such as central banks,
Governmental agencies, sovereign wealth funds
or international and multilateral organizations or
agencies.
ii. Category II FPI
Category II includes the following:
i. Appropriately regulated broad based funds;
ii. Appropriately regulated persons;
iii. Broad-based funds that are not appropriately
regulated but their managers are regulated;
iv. University funds and pension funds; and
v. University related endowments already registered
with SEBI as FIIs or sub-accounts
The FPI Regulations provide for the broad-based
criteria. To satisfy the broad-based criteria two
B. Investment Limits
The FPI Regulations states that a single FPI or an
investor group shall purchase below ten percent
of the total issued capital of a company. The
position under the FII Regulations was that such
shareholding was not to exceed ten percent of the
share capital.
Under the FPI Regulations ultimate beneficial
owners investing through the multiple FPI entities
shall be treated as part of the same investor group
subject to the investment limit applicable to a single
FPI.
C. ODIs/P Note
An offshore derivative instrument (ODIs) means
any instrument, by whatever name called, which is
issued overseas by a foreign portfolio investor against
securities held by it that are listed or proposed to be
listed on any recognized stock exchange in India, as
its underlying units. Participatory Notes (P-Notes)
are a form of ODIs.18
P-notes are, by definition a form of ODI including
but not limited to swaps19, contracts for difference20,
options21, forwards22, participatory notes23, equity
Investment
holdings
to hedge
exposures
under the ODI
as issued
24. An Equity-linked Note is a debt instrument whose return is determined by the performance of a single equity security, a basket of equity securities, or
an equity index providing investors fixed income like principal protection together with equity market upside exposure.
25. A Warrant is a derivative security that gives a holder the right to purchase securities from an issuer at a specific price within a certain time frame.
26. 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.
27. 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.
28. Offshore Derivate Instruments: An Investigation into Tax Related Aspects
http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Offshore_Derivative_Instruments.pdf
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
subjected to FDI restrictions.
Since, the number of real estate companies that are
listed on the stock exchange are not high, direct
equity investment under erstwhile FII route was
not very popular. FPI investors are also permitted to
invest in the real estate sector by way of subscription
/ purchase of Non-Convertible Debenture (NCD),
as discussed below.
E. Listed NCDs
Under Schedule V of the amended TISPRO
Regulations, read with the provisions of the FPI
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
10
Particulars
CCD FDI
Equity
Ownership
Initially debt, but equity on conversion Mere lending rights; however, veto rights can ensure certain degree
of control.
ECB
Qualification
Coupon
Payment
Pricing
Security
Interest
NCD - FPI
Investor entitled to equity upside upon NCDs are favorable for the borrower to reduce book profits or tax
conversion.
burden. Additionally, redemption premium can be structured to
provide equity upside which can be favourable for lender since
such premium may be regarded as capital gains which may not be
taxed if the investment comes from Singapore.
NCD listing may cost around INR 10-15 lakh including intermediaries
cost. In case of FPI, additional cost will be incurred for registration
with the DDP and bidding for debt allocation limits, if required.
29. There have been examples where offshore private equity funds have exited from such instruments on the bourses.
30. 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.
11
31. 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
32. 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. at any time, held an Indian Passport or
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).
12
13
33. 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
34. Sections 43 and 47 of CA 2013
35. Chapter IV, Share Capital and Debentures, Rules under CA 2013
36. Section 2(52), CA 2013
14
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.37 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 directors40 such as:
i. Independent Director: Independent Directors
have been formally introduced by CA 2013,
earlier the listing agreements41 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:
i. To act in accordance with the articles of the
company;
ii. To act in good faith in order to promote the
objects of the company for the benefit of its
members as a whole and in the best interests of
the company, its employees, the shareholders,
and the community and for the protection of
environment;
iii. To exercise his duties with due and reasonable
care, skill and diligence and shall exercise
independent judgment;
iv. Not to involve himself in a situation in which
he may have a direct or indirect interest that
conflicts or possibly may conflict, with the
interest of the company;
15
16
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,
the shares of a foreign incorporated company can
17
Taxation Framework
Provided upon request only
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
V to the Finance Act, 1994. Subsequent Finance Acts,
(1996 to 2003) have widened the service tax net by
way of amendments to Finance Act, 1994. Service
tax is levied on specified taxable services at the rate
of 12.3646 percent on the gross amount charged by
the service provider for the taxable services rendered
by him. The Finance Act, 2004 has introduced
construction services as a taxable service and thus
45. Although, substantial has not been defined under ITA, as per draft DTC 2013, substantial is proposed to be 20%
46. Excluding currently applicable education cess of 3 percent on service tax
18
19
Taxation Framework
Provided upon request only
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 X.
20
HEAD OF TAXATION
MAURITIUS
SINGAPORE
NETHERLANDS
Capital gains tax on sale of Mauritius residents not taxed. Singapore residents not
No local tax in Mauritius on
taxed. Exemption subject
Indian securities
capital gains.
to satisfaction of certain
substance criteria and
expenditure test by the
resident in Singapore. No local
tax in Singapore on capital
gains (unless characterized as
business income).
Tax on dividends
Withholding tax on
outbound interest
10%
Withholding tax on
15% (for royalties). FTS 48 may 10%
outbound royalties and fees be potentially exempt in India.
for technical services
10%
Other comments
21
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 arrangements49
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
resolution50 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%51 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
time of issuing of shares. Accordingly, gains that
49. http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8682&Mode=0
50. 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).
51. Exclusive of surcharge and cess.
22
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
of foreign investment into real estate has been
structured through this route. However, not much
23
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 good interest if packaged well and
have the brand of a reputed Indian developer. Hence,
stabilized assets such as educational institutions,
hospitals, hotels, SEZs, industrial parks et al may find
a market offshore.
Please refer to Annexure XII for a detailed note on
exit by rolling assets to offshore REITs.
24
25
6. Domestic Pooling
Domestic pools of capital may be structured
primarily in two ways:
I. AIF
26
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.
Nishith Desai Associates 2014
C. Private Placement 63
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.
58. http://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=8561&Mode=0
59. 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.
60. DNBS (PD) CC.No.376/03.10.001/2013-14
61. 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.
62. 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
63. Ibid
27
Domestic Pooling
Provided upon request only
64. http://www.nishithdesai.com/New_Hotline/Realty/Realty%20Check%20-%20Debt%20Funding%20Realty%20in%20India_Jan2012.pdf
28
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 I for the detailed analysis
of the tax changes introduced in the Budget 2014 in
context of the REITs. Also, please refer to Annexure
II for our article published in Live Mint on the
tax and non-tax issues that make the Indian REIT
unattractive.
65. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/bombay-high-court-clarifies-the-prospective-application-of-balco.html?no_cache=1&cHash=02aa560249d89d9e5e0b18c12f25eddc
66. Court saves promoter pledge, http://www.moneycontrol.com/news/management/court-saves-promoter-pledge_520897.html, last visited on April 8,
2012
29
67. For the first time, a High Court (highest court of law in a state in India) stayed the invocation of a pledge and that too via an ex-parte (without the
defending party being present or heard) injunction handed out on a Sunday.
68. http://www.livemint.com/Companies/l5mzgtPyZRxqtimiq4CsxH/Concerns-among-PE-firms-over-enforcing-realty-share-pledges.html
30
Annexure I
Budget 2014: A Game Changer for Reits?
Budget 2014-15 (Budget) has introduced tax
incentives for the real estate investment trusts
(REITs) regime, and also provided for relaxations in
foreign direct investment (FDI) regime. With the
tax incentives in place, the Securities and Exchange
Board of India (SEBI) is likely to formally announce
the REIT regulations that are currently in draft form.
In this hotline, we discuss some of the key changes
and its Budget 2014 impact on the real estate sector.
For a detailed analysis of the impact of Budget 201415 on other aspects as well, please refer to our hotline
India Budget 2014: New Beginnings and New
Direction.
B. Structure of REIT
Before we move on the tax incentives proposed in
the Budget, we set out below a quick snapshot of
the REIT structure as contemplated under the Draft
31
Investor*
Sponor*
*Mininmum Sponser
Investment: >15% of REIT
Units
REIT
Trustee
Manager
SPV
Analysis
Analysis
Treatment of listed REITs unit akin to listed shares
with respect to rates for LTCG and STCG is a major
relaxation for the unit holders, and will give a major
impetus to the REIT regime. Though the requirement
of holding the units for at least 36 months for
characterization as long term capital gains, unlike
12 months in case of listed shares, is understandable
since REITs are meant to be akin to holding real
estate directly which is any ways subject to 36
months holding period, this may be a disincentive to
invest in REITs.
32
Analysis
To avail the tax pass through on interest income,
the sponsor would have to trade-off by paying tax
on transfer of the SPV / assets. This is so because, (a)
the REIT cannot acquire any debt securities without
a tax incidence for the sponsor (the exemption is
only for shares); and (b) if the monies areraised by
REIT from the public, and infused into a newly
created SPV by way of debt, which acquires the asset
from the sponsor, there is no tax exemption for the
sponsor in such case. To that extent, the benefit of
this relaxation is highly questionable.
iv. Income in the Nature of Dividend
Where dividends are distributed by the SPV to the
REIT, the existing provision dealing with Dividend
Distribution Tax (DDT) under Section 115-O of the
ITA would apply and the SPV would face a 15% tax
on distribution with no further liability on the REIT
as a shareholder. Further, the Bill proposes that any
income distributed by the REIT to its unit holder
that is not in the nature of interest or capital gains is
exempt from income tax. Therefore, distributions of
dividends received from the SPV by the REIT to the
unit holders would be exempt from tax in India.
Analysis
Though distribution of monies received by the REIT
as dividend to the until holders is exempt from tax in
the hands of the unit holders, still the applicability of
both, the corporate tax and dividend distribution tax,
in the hands of SPV makes this route of distribution
tax inefficient. Since, unlike listed developers, REITs
are mandatorily required to distribute 90% of net
distributable income after tax to investors, the
applicability of dividend distribution tax is a major
dampner. To ensure real pass through, it would have
been better if the government had dispensed with
the dividend distribution tax in case of REITs.
Analysis
This would apply in a situation where the REIT is
holding the assets directly or in situations where
they are charging fees to the SPV. There is no
relaxation in such case, as even under the existing
tax regime, tax once paid by a trust would have been
exempt in the hands of the unit holders. To ensure
true pass through to REIT, the gains should have
been tax exempt in the hands of REIT and should
have rather been taxed in the hands of the unit
holders.
vi. Income in the Nature of Capital Gains
Where the REIT earns income by way of capital
gains by sale of shares of the SPV, the REIT would be
taxed as per regular rates for capital gains i.e. 20%
for LTCG and slab rates for STCG. However, further
distribution of such gains by the REIT to the unit
holder is proposed to be exempt from tax liability.
Analysis
Please refer to our analysis in point (v) above.
33
Analysis
Analysis
34
III. Conclusion
REITs are beneficial not only for the sponsors
but also the investors. It provides the sponsor
(usually a developer or a private equity fund) an
exit opportunity thus giving liquidity and enable
them to invest in other projects. At the same time,
it provides the investors with an avenue to invest in
rental income generating properties in which they
would have otherwise not been able to invest, and
which is less risky compared to under-construction
properties.
For a REIT regime to be effectively implemented,
complete tax pass through is essential, as is the case
in most countries having effective REIT regimes.
Though the tax incentives for REITs introduced in
the Budget is definitively a positive move, however,
the tax incentives only result in partial tax pass
through to REIT, at the maximum. It is hoped that
the Finance Minister would address the issues as
mentioned in this piece going forward and possibly
simplify the REIT taxation regime.
Before REITs actually takes off, few other changes
need to be introduced, especially from securities
and exchange control laws perspective. Currently,
units of a REIT may not even qualify as a security.
Since, units of a REIT have to be mandatorily listed,
the first step will be to define units of a REIT as a
security under the SCRA. The next step will be to
amend exchange control regulations to allow foreign
investments in units of a REIT. Capital account
transaction rules will also need to be amended to
exclude REITs from the definition of real estate
business, as any form of foreign investment is
currently not permitted in real estate business.
Under current exchange control laws, investment
Prasad Subramanyan,
Deepak Jodhani and
Ruchir Sinha
35
Annexure II
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.
From a sponsors perspective, capital gains tax
benefit has been given only in cases where shares of
the special purpose vehicle (SPV) holding the real
estate are transferred to a REIT against units of a
REIT, and not when real estate is directly transferred
to a REIT. By doing so, there is an unnecessary
corporate layer imposed between the REIT and the
real estate asset, which could result in a tax leakage
of about 45% (corporate taxes of 30% at the SPV
level and distribution tax of 15% on dividends,
exclusive of surcharge and cess). To the sponsor,
there is no tax benefit (but mere deferral) because
she gets taxed when the REIT units are ultimately
sold on the floor at a much more appreciated value,
even though the units of a REIT would be listed and
exempt from capital gains tax if held by other unit
holders for more than three years.
While capital gains tax incidence may still be
avoided by relying on principles of trust taxation,
there will still be no respite from minimum alternate
tax (MAT), which could become applicable on
transfer of shares to the REIT. Considering that
sponsors would like to transfer the shares at higher
than book value to ensure commensurate fund
raising for the REIT, the issue of MAT seems to be
most critical.
From a REIT taxation perspective, although a passthrough of tax liability to investors for REIT income
was promised, since the SPV is required to pay full
corporate and dividend distribution taxes, where
is the pass-through? What is even worse is that no
foreign tax credit may be available for such taxes
paid in India.
The only way to achieve tax optimization seems to
be by way of infusion of debt into the SPV by a REIT.
In such a situation, interest from the SPV to the
REIT will be a deductible for the SPV, thus allaying
36
37
Annexure III
Offshore Listing Regime: How to Raise Funds
and Monetize Investments
Governments recent initiative to allow unlisted
companies to list on offshore markets through the
depository receipt (DR) mechanism without the
requirement of simultaneous listing in India is likely
to be a major shot in the arm for many sectors, and
also offer exits to private equity players looking to
monetize their investments. Though offshore listing
was permitted later last year by Ministry of Finance,
such listings could not happen as SEBI had not
prescribed the disclosures for such listings.
Government has only recently prescribed that
SEBI shall not mandate any disclosures, unless
the company lists in India. Once the air around
disclosures to SEBI has been cleared, we can expect
offshore listing of DRs to grow on the back of the
reasons set out below.
First, offshore listing will offer the opportunity to a
slew of young Indian companies to tap the overseas
markets, which unlike domestic markets remain
quite vibrant. 2012 saw only 3 mainboard listings as
against 256 in the US.
Second, offshore listing would allow Indian
entrepreneurs the platform to tap investors that
have a much better understanding of the value
proposition of the business. For instance, innovative
tech, biotech, internet services are likely to receive
a better valuation on NYSE / NASDAQ as against
domestic markets.
Today, markets have become associated with
sectors - NYSE / NASDAQ is known for tech, SGX
for real estate and infra, LSE/AIM for infra and
manufacturing. DRs would allow the opportunity
to list on exchanges that are most conducive to the
sector.
Third, foreign investors will find it more amenable
to invest in DRs denominated in foreign currency
as against INR, which has depreciated by more
than 50% since 2007. Hedging cost is likely to be an
important driver for the growth of DRs. Many private
equity players suffered the wrath of their LPs due to
the steep rupee depreciation, despite the company
outperforming the expectations.
Fourth, while the offshore listing regime is meant for
fund-raising (it requires that funds must be brought
back into India within 15 days unless utilized
offshore for operations abroad), with a little bit of
38
39
Annexure IV
Regulatory Regime Forcing Cos
Externalisation
Doing Business away from Indian Tax Oversight and ease of Fund-Raising Among
Reasons for India Incs Tryst with Foreign Shores
With Indian companies rapidly expanding their
presence internationally, there has been an increased
keenness in companies operating in high growth
sectors to migrate their holding company structures
from India to reputed offshore jurisdictions. For
lack of a better word, lets refer this process of
structuring/ restructuring as externalisation as that
term may fit the reference better than globalisation
or internationalisation, both of which have much
wider imports.
There are several drivers for externalisation. First,
it moves the businesses away from Indian tax and
regulatory challenges into jurisdictions that may
be more conducive from an operational standpoint
and also substantially mitigates tax leakage and
regulatory uncertainty. Unwritten prohibition
on put options, retroactive taxation of indirect
transfers, introduction of general anti-avoidance
rules fraught with ambiguities, etc, are a few
examples why Indian companies may want to avoid
direct India exposure.
Second, from a fund raising perspective, it offers
Indian companies to connect with an investor base
that understands their business potential and thus
values them higher than what they would have
otherwise been valued at in domestic markets.
Infosys, Wipro, Rediff, Satyam are classic examples of
companies which preferred to tap the global capital
markets (NYSE and Nasdaq) without going public in
India.
Third, with the Indian currency oscillating to
extremes, one of the biggest concerns for foreign
investors is currency risk. By investing in dollars
in the offshore holding company (OHC), foreign
investors can be immune from the currency risk and
benefit from the value appreciation of the Indian
companies. Many foreign investors that invested in
2007 when the rupee was at around 42 to a dollar
have suffered substantially with the rupee now being
at 62 to a dollar.
Fourth, and this is more of a recent issue, with the
coming of the new Companies Act, 2013, which
provides for class-action suits, enhanced director
liability, statutory minimum pricing norms (beyond
40
41
Annexure V
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
company is treated as an NBFC if its financial assets
Structure diagram
Off-shore Fund
Off-shore
India
Non-Banking Financial Company
Indian Company
1. The Working Group report was published by the RBI in the form of Draft Guidelines on its website 12th December 2012
42
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.),
but since the NBFC will be owned by the foreign
investor itself, the foreign investor is no longer
dependent on the Indian company as would have
been the case if the investment was made directly
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
43
B. Capitalization
The NBFC would be subject to minimum
capitalization requirement which is pegged to the
extent of foreign shareholding in the NBFC as set out
in the FDI Policy.
USD 50 million, with USD 7.5 million to be brought upfront and the balance in 24
months.
44
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.
CCDs clearly standout against CCPS on at least the
following counts. Firstly, while any dividend paid
on CCPS is subject to the same dividend entitlement
restriction (300 basis points over and above the
prevailing State Bank of India Prime Lending Rate at
the time of the issue), dividends can only be declared
out of profits. Hence, no tax deduction in respect of
dividends on CCPS is available. To that extent, the
company must pay 30%7 corporate tax before it can
even declare dividends. Secondly, any dividends can
be paid by the company only after the company has
paid 15%8 dividend distribution tax. In addition,
unlike conversion of CCDs into equity, which is
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
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. Exclusive of surcharge and cess.
8. Exclusive of surcharge and cess.
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)
45
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.
11. The activities permitted under the automatic route are: (i) Merchant Banking, (ii) Under Writing, (iii) Portfolio Management Services, (iv)Investment
Advisory Services, (v) Financial Consultancy, (vi) Stock Broking, (vii) Asset Management, (viii) Venture Capital, (ix) Custodian Services, (x) Factoring,
(xi) Credit Rating Agencies, (xii) Leasing & Finance, (xiii) Housing Finance, (xiv) Forex Broking, (xv) Credit Card Business, (xvi) Money Changing
Business, (xvii) Micro Credit, (xviii) Rural Credit and (xix) Micro Finance Institutions
12. The FDI Policy however under paragraph 6.2.24.2 (1) provides that: (iv) 100% foreign owned NBFCs with a minimum capitalisation of US$ 50
million can set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without
bringing in additional capital.
(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.
46
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
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.
47
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.
18. Exclusive of surcharge and cess
48
Annexure VI
Foreign Investors Permitted to Put: Some
Cheer, Some Confusion
I. Background
1. RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013) available at: http://rbidocs.rbi.org.in/rdocs/Notification/PDFs/
APDIR0901201486EN.pdf
2. SEBI Notification No. LAD-NRO/GN/2013-14/26/6667 (October 03, 2013) available at: http://www.sebi.gov.in/cms/sebi_data/
attachdocs/1380791858733.pdf
49
II. Amendment
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:
III. Analysis
In a market where IPOs are almost non-existent, put
options give tremendous comfort to offshore private
equity funds, should a trade sale not materialize
within their exit horizons. Put options become
even more important for certain asset classes like
real estate or other stabilized yield generating
assets where secondary sales and IPOs are not very
common in the Indian context. The Amendment is a
positive development for such players as commercial
justifications behind inclusion of options into
investment agreements have been recognized, and
Indian companies and their founders can no longer
treat such rights/options as mere paper rights.
50
A. Lock in
While a minimum lock in period of one year has
been specified, it is unclear as to which date it should
apply from. For example, if the date of optionality
agreement and issuance of securities are different,
which would be the relevant date? On a conservative
basis, it may be appropriate to reckon the lock-in
conditions from the later of the two dates.
There are also issues about whether the lock-in
restricts only the exercise of securities or also the
secondary transfer of securities, as well as whether
a secondary transfer would reset the clock in the
hands of the new investor. It appears that the one
year lock would be required only if the option is
being exercised (and not in case of all secondary
transfers), and would apply afresh in the hands of
each subsequent transferee.
D. Determination of Price of
Convertibles Securities
IV. Conclusion
51
52
Annexure VII
Indian Gaar: Rules Notified
Some Relief, But Ambiguities Remain
The Central Board of Direct Taxes has recently
notified Rules that would govern Indias new General
Anti-Avoidance Provisions (GAAR). Although
the Rules introduce some safeguards, the real
concerns surrounding GAAR remain unaddressed.
Ambiguities continue to remain with respect to
concepts such as lack of commercial substance,
substantial commercial purpose, bona fide objects,
abuse and misuse of law. One remains clueless
about the interplay between GAAR and other antiavoidance and anti-treaty abuse provisions, as well as
the fate of Mauritius and other popular investment
routes. The limited grandfathering of specific
investments (prior to August 30, 2010) makes GAAR
more retroactive than prospective.
India like every other country is justified in
defending its tax base, and is in sync with the
global move to curb money laundering and abusive
tax schemes. However, these concerns have to
be balanced with the need for greater taxpayer
certainty, eliminating double taxation on a global
basis and enhanced accountability on behalf of tax
administrations.
The primary concern with GAAR may be
summarized as thus: Is there a real guarantee that
GAAR shall not end up as another weapon to
intimidate taxpayers (borrowing the UK GAAR
Committees words of caution)? This concern has
special relevance in an environment conventionally
known for protracted litigation, retroactive
law making, high pitched tax assessments and
corruption.
The GAAR Rules have been notified as a follow-up
to the Governments announcement in January this
year accepting specific recommendations of the
Shome Committee constituted in 2012 to critically
analyze the GAAR provisions. Earlier, the provisions
were also reviewed by the Parliamentary Standing
Committee on Finance which had also made some
important recommendations. Apart from the
limited grandfathering, the Rules introduce a few
procedural safeguards and some relief for P-note
holders. However, several key recommendations by
the Shome Committee and the Standing Committee
including certain safe harbours, and clarity on the
Mauritius route have been left out.
I. Background to GAAR
GAAR was introduced into Indias tax statute in
2012 and has been criticized widely on account of
the ambiguities in its scope and application, lack
of safeguards and possibility of misuse by the tax
authorities. GAAR empowers the Revenue with
considerable discretion in taxing impermissible
avoidance arrangements, disregarding entities and
recharacterising income and even denying tax treaty
benefits.
The introduction of GAAR led to immense hue
and cry among investors, which prompted the
Government to appoint an Expert Committee under
the renowned economist Dr. Parthasarthy Shome to
consult with stakeholders and review GAAR. (Click
here for our hotline with insights and analysis of the
Shome Committees report.) In its detailed report, the
Expert Committee had recommended a substantial
narrowing down of the scope of GAAR and other
protections in the interest of fairness and certainty.
Following the recommendations of the Shome
Committee, various amendments were introduced
through the Finance Act, 2013 including the
following:
53
A. De Minimis Rule
GAAR shall not be applicable to any arrangement
where the tax benefit arising to all parties to the
arrangement does not exceed a sum of INR 30
million in the relevant financial year.
54
1. The Financial Service Act, 2007 provides certain conditions that the FCS shall consider to determine whether a GBC1 is managed and controlled in
Mauritius
55
Annexure VIII
Foreign Investment Norms for Real Estate
Liberalized
Provisions
I. Changes
The changes sought to be made by the Press Release
are set out below.1
Existing Policy
Minimum area to be developed under each project would
be as under:
i. Development of serviced housing plots: Minimum land
area of 10 hectares;
The funds would have to be brought in within 6 The funds would have to be brought in within 6 months of
months of commencement of the project.
commencement of business of the Company.
Commencement of the project has been
explained to mean date of approval of the
building plan/ lay out plan by the relevant
statutory authority.
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.
56
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 requirement.
Completed
projects
Responsibility
for obtaining
all necessary
approvals
Investee Company.
II. Analysis
Particulars
Existing Policy
Minimum area to be developed under each project would
be as under:
i. Development of serviced housing plots: Minimum land
area of 10 hectares;
57
B. Construction-development Projects
In case of construction-development projects, the
minimum land requirement has been reduced from
Particulars
Minimum
Minimum capitalization of USD 5
Capitalization
million.
Requirements
Particulars
Existing Policy
Timing of
investment
C. Commencement of Business of
Company to Commencement of
Project
58
Particulars
Lock-in
The investor is permitted to exit from the investment The investor is permitted to exit from the investment
at (i) 3 years from the date of final installment,
at expiry of 3 years from the date of completion of
subject to development of trunk infrastructure, or (ii) minimum capitalization.
on the completion of the project.
For investment in tranches: The investor is permitted
Trunk infrastructure has not been defined, but
to exit from the investment at the later of (a) 3 years
is explained to include roads, water supply, street
from the date of receipt of each tranche/ installment
lighting, drainage and sewerage.
of FDI, or (b) at expiry of 3 years from the date of
completion of minimum capitalization.
Repatriation of FDI or transfer of stake by a nonresident investor to another non-resident investor
Prior exit of the investor only with the prior approval
would require prior FIPB 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.
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
Existing Policy
I. Grandfathering
It is unclear whether existing investment, on the
anvil of exit currently would be required to satisfy
the trunk infrastructure requirements. This may be
a major barrier for investors who have completed
the 3 year period from their investment, and are
seeking exit, although trunk infrastructure has not
been developed. It is also unclear whether existing
tranches of investment would be locked in till the
end of 3 period from any future tranches, if any.
Grandfathering of the existing investments from the
requirements to comply with trunk infrastructure
and the lock-in period would be important for
existing investments.
Existing Policy
Requirement of
The requirement of commencement The investor was required to provide the completion
commencement certificate for certificate has been done away with. certificate from the concerned regulatory authority
serviced plots
before disposal of serviced housing plots.
59
Particulars
Minimum
development
Particulars
Existing Policy
Affordable
Housing
Projects which allocate 30% of the project cost for low cost
affordable housing are exempt from the minimum land area,
and minimum capitalization requirements.
No such exemption.
Particulars
Existing Policy
Completed
projects
60
Particulars
III. Conclusion
The changes introduced by way of the Press Release
are along expected lines after the Budget Speech
earlier this year. The minimum land requirement was
an impediment for foreign investment, since it was
difficult to find large tracts of land for development
to satisfy the minimum land requirements in
61
Annexure IX
The Curious Case of Pricing Guidelines
RBI Introduces a new Standards for Pricing Guidelines Amongst other Reforms
B. Pricing Guidelines
I. Background
1. Specifically, relevant circulars are A.P.(DIR Series) Circular No.3 dated July 14, 2014 (Circular No. 3) and A. P. (DIR Series) Circular No. 4 dated July
15, 2014 (Circular No. 4).
2. Para 24, Reserve Bank of India, Dr. Raghuram G. Rajan, Governor, First Bi-monthly Monetary Policy Statement, 2014-15, April 1, 2014 available at
http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30911 (last visited on July 17, 2014)
3. Pricing guidelines are as prescribed by the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements)
Regulations, 2009 (ICDR Regulations) in case of preferential allotment
62
C. Specifically
4. Reserve Bank of India, Foreign Direct Investment- Pricing Guidelines for FDI instruments with optionality clauses, A.P. (DIR Series) Circular No. 86
dated January 9, 2014 (Options Circular). Please note that TISPRO Regulations were also amended in furtherance of the Options Circular.
63
Issue of shares
Transfer price to be not less than fair value of Transfer price to be not less than fair value
shares determined as per DCF method.
worked out as per any internationally accepted
pricing methodology for valuation of shares on
arms length basis.
Transfer of shares from non- For listed securities:
For listed securities:
resident to resident
Transfer price to be not more than price at
No amendment to this provision.
(NR to R)
which a preferential allotment of shares can be
made under the SEBI Guidelines;
Transfer price to not exceed price arrived at on Transfer price to not exceed price arrived at
the basis of RoE as per latest audited balance as per any internationally accepted pricing
sheet.
methodology on arms length basis.
Transfer of convertible
securities having
optionality clause*
64
VII. Understanding
Internationally Accepted
Pricing Methodology At Arms
Length
An important item for consideration is potential
disputes regarding pricing methodologies for
agreements which refer to exits, purchase or sale
at fair market value. If an agreement does not
specifically state which methodology is to be
considered, under the revised pricing guidelines
it would be possible for parties with conflicting
interests to obtain valuations under different pricing
methodologies and arrive at completely different
(and yet completely justifiable) fair market values
for the same asset.
A view can, however, be taken that for existing
agreements entered into till May 2010 (the date
of the 2010 Circular) that CCI based pricing
methodology would be applicable, and for
agreements entered into after 2010 but before July
15, 2014 (i.e. the date of Circular No. 4) that DCF
65
66
VIII. Conclusion
The biggest uncertainty for partly paid shares and
warrants has always been as to when the balance
amount will need to be brought in. By requiring
that the full pricing for the partly paid shares and
warrants be fixed up front and brought in within
12 and18 months, respectively, the RBI has ensured
some comfort is afforded to both the company
issuing the securities and the subscriber. This
flexibility also enables structuring of earn-outs, post
buy-out incentive payments to management and in
structuring re-ups.
This full scale revision of pricing guidelines
continues the RBIs evolution with regards to how
it seeks to regulate transfer / issuance of securities
of Indian companies by / to FDI investors. Where
previously, cross border transactions were heavily
regulated and monitored by the RBI, we are looking
at a shift which provides greater freedom and
respects party autonomy.
By entrusting valuation intermediaries like chartered
accountant and merchant bankers with the right
to guide parties to fair valuation based on facts
and circumstances of each transfer, the RBI also
follows through on the general trend in modern
Indian commercial laws where regulatory bodies
are looking to delegate more and more operational
regulation to intermediaries.
Prasad Subramanyan and
Kishore Joshi
You can direct your queries or comments to the
authors
Annexure X
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.
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.
As a matter of precaution, provision may be
made to ensure that the indemnifying party or
its representatives maintain sufficient financial
solvency to defray all obligations under the
indemnity. In this regard, the shareholder/s
of the indemnifying party may be required to
infuse necessary capital into the indemnifying
party to maintain solvency. Sometimes back-to-
68
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.
Annexure XI
Bilateral Investment Treaties
India has entered into several BITs and other
investment agreements. Relying on the BITs in
structuring investment into India, may be the best
way to protect a foreign investors interest. Indian
BITs are very widely worded and are severally seen
as investor friendly treaties. Indian BITs have a broad
definition of the terms investment and investor.
This makes it possible to seek treaty protection easily
through corporate structuring. BITs can also be used
by the investors to justify the choice of jurisdiction
when questioned for GAAR.
The model clauses for Indian BITs include
individuals and companies under the definition
of an investor. Further, companies are defined to
include corporations, firms and associations. More
importantly, Indian BITs adopt the incorporation test
to determine the nationality of a corporation. This
is a very beneficial provision as a holding company,
which even though is merely a shell company,
would not be excluded from treaty benefits.
Further, the word investment is defined to
include every kind of asset established or acquired
including changes in the form of such investment, in
accordance with the national laws of the contracting
party in whose territory the investment. It
specifically includes the following within the ambit
of investment:-
Incorporation in a
Treaty Jurisdiction
Shareholder
P
Parent Company
Shareholder
I
Intermediary
Incorporation
in USA
S
Subsidiary
Indian
Subsidiary
Fig 1: Operations through an India subsidiary which is held through an intermediary in a treaty jurisdiction.
69
Shareholder
Subsidiary No.1
(Mauritius)
Parent Co.
(USA)
Shareholder
Investee Co.
(India)
Subsidiary No.2
(Netherlands)
er
old
h
e
ar
Sh
Shareholder
Shareholder
er
old
h
e
ar
Sh
Subsidiary No.1
(Cyprus)
Fig 2: Investment in Indian Investee Company through multiple Subsidiaries in different treaty jurisdiction.
70
Annexure XII
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
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.
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.
71
A. FDI Policy
73
Annexure XIII
Bombay High Court Clarifies the Prospective
Application of Balco
The Bombay High Court in Konkola Copper Mines
(PLC) v. Stewarts and Lloyds of India Ltd.1 has
now clarified that it would not be appropriate to
hold that the reasons which are contained in the
ruling in Bharat Aluminium Company and Ors.
v. Kaiser Aluminium Technical Service, Inc. and
Ors.2 (BALCO) would operate with prospective
effect, and thereby to a certain degree have removed
the ambiguity prevailing over the nature of
prospective application of the BALCO judgment.
The court explained that while the ratio of the
BALCO judgment i.e. Part-I of the Arbitration
and Conciliation Act, 1996 (Act) would apply
only to arbitrations seated in India, operates with
prospective effect, the interpretation of Section 2(1)
(e)3 of the Act as provided by the Supreme Court
would not be limited to a prospective application.
I. Facts
The Appellant had entered into certain contracts
with the Respondents for the supply of particular
materials. Dispute arose between the parties which
were then referred to arbitration. The contracts
entered into by the parties provided that the
arbitration shall be conducted in accordance with
the rules of arbitration of the International Chamber
of Commerce and that the venue of arbitration shall
be New Delhi. However, upon invocation of the
arbitration, the Appellant proposed Mumbai as the
place of arbitration. Such proposal was accepted by
the Respondent. The arbitral tribunal constituted,
passed an award in favour of the Appellant and the
Appellant prior to enforcement of the award filed a
petition under Section 9 of the Act, seeking certain
interim reliefs requiring disclosure and freezing of
assets.
The single judge hearing the petition under section
9 of the Act dismissed the same stating that in view
of the agreement between the parties Part I of the
Act stood excluded and the mere fact that parties had
agreed to the venue/place of arbitration as Mumbai,
would not confer jurisdiction on the court in India.
Both parties were aggrieved by the order, filed an
appeal as both parties asserted Part I of the Act
applied however, the dispute was whether the
jurisdiction was vesting with the High Court of
Bombay or with High Court of Kolkata where the
cause of action is said to have arisen.
The Respondent submitted that as the cause of action
for the dispute has arisen in Kolkata, the Calcutta
High Court would have jurisdiction over the dispute.
The Respondents provided that by virtue of the
judgment in Bhatia International v. Bulk Trading
S.A.4 (Bhatia International), Indian courts may have
jurisdiction even though the place of arbitration was
not in India and accordingly various High Courts
had held that place of arbitration was irrelevant for
deciding the question of jurisdiction under Section
2(1)(e) of the Act. It was submitted that the court
which would have territorial jurisdiction over the
place where the cause of action is said to have arisen
in relation to the dispute would be the court for the
purposes of section 2(1)(e) of the Act.
The Appellants on the other hand argued that
Parties had agreed to Mumbai as the place of
arbitration. Further the in the BALCO judgment, the
Supreme Court had clarified that the meaning of
Court as provided under Section 2(1)(e) of the Act
would include the court of the place of arbitration.
Therefore, the Bombay High Court had jurisdiction
to hear the petition under Section 9 of the Act.
Thus, the issue inter alia was whether the
interpretation of Section 2(1)(e) as provided
under the BALCO judgment would apply only
prospectively or would the interpretation be also
applicable to agreements entered into by the parties
prior to September 6, 2012.
1. Appeal (L) No. 199 of 2013 in Arbitration Petitioner No. 160 of 2013 with Notice of Motion (L) No. 915 of 2013; and Appeal (L) No. 223 of 2013 in
Review Petition No. 22 of 2013 in Arbitration Petition No. 160 of 2013
2. (2012) 9 SCC 552
3. Court means the principal Civil Court of original jurisdiction in a district, and includes the High Court in exercise of its ordinary original civil
jurisdiction, having jurisdiction to decide the questions forming the subject-matter of the arbitration if the same had been the subject-matter of a suit,
but does not include any civil court of a grade inferior to such principal Civil Court, or any Court of Small Causes
4. (2002) 4 SCC 105
74
II. Judgment
The court initially taking note of the agreement
reached between the parties provided that Mumbai
is the seat of the arbitration.
The court then analyzed that if Mumbai was the seat
of arbitration does Section 2(1)(e) confer jurisdiction
on courts whose original civil jurisdiction extended
over the place of arbitration, to deal with petitions
under Section 9 of the Act. In this regard, the court
noted that in BALCO, the honble Supreme Court
had held that section 2(1)(e), grants jurisdiction
to both the courts i.e. the court within whose
jurisdiction the seat of arbitration is located and the
court within whose jurisdiction the cause of action
is said to arise or the subject matter of the suit is
situated. Accordingly, by virtue of the interpretation
of Section 2(1)(e) in BALCO judgment, the Bombay
High Court would have jurisdiction over the petition
under section 9 as the place/seat of arbitration was
Mumbai. The court cited the following text from the
BALCO judgment:
III. Analysis
A lot of debate surrounded the prospective
application of the BALCO ruling. The BALCO
judgment completely changed the landscape of
the arbitration law in India and along with it the
approach which was adopted by the courts towards
arbitrations. The judgment discussed at length the
meaning, scope and purport of various provisions of
the Act before coming to the conclusion. However,
the prospective application to the judgment
gave rise to a significant amount of ambiguity
regarding whether such prospective application
would also extend to the reasons as provided or
the interpretation provided under the judgment to
certain provisions while arriving at the decision.
Accordingly, the present judgment of the Bombay
High Court does lend assistance to a certain degree
and is indicative of the fact that not everything
that has been provided under the BALCO judgment
is prospective in nature and the interpretation to
75
76
Annexure XIV
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
invocation; funds are often faced with the dilemma
of whether to invoke the pledge or not, said Sinha.
77
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The following research papers and much more are available on our Knowledge Site: www.nishithdesai.com
Doing Business in
Globalizing India
Corporate Social
India
Inc.
Responsibility &
Social Business
Models in India
May 2014
April 2013
July 2014
Fund Structuring
Joint-Ventures in
Private Equity
and Operations
India
July 2014
September 2014
November 2014
The Indian
Internet of Things:
Employment
Pharmaceutical
Contracts in
Industry
Convergence
India
July 2014
September 2014
August 2014
NDA Insights
TITLE
TYPE
M&A Lab
January 2014
M&A Lab
January 2014
M&A Lab
January 2014
IP Lab
02 April 2013
M&A Lab
01 January 2013
M&A Lab
August 2013
IP Lab
Realty Check
IP Lab
M&A Lab
04 January 2012
M&A Lab
03 January 2012
Yes, Governance
Matters!
Realty Check
28 April 2011
Realty Check
22 March 2011
M&A Lab
15 March 2011
M&A Lab
05 August 2010
M&A Lab
01 April 2010
DATE
September 2013
01 May 2012
21 March 2012
15 September 2011
Research @ NDA
Research is the DNA of NDA. In early 1980s, our firm emerged from an extensive, and then pioneering, research
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