It is no secret that in the last two decades the Indian economy and
its financial markets have undergone a radical revamping, due in large
part to the economic crisis of the 1980s and the consequent depletion of
India's foreign currency reserves. The resulting unprecedented growth
of the Indian economy in the 2000s led to a significant increase in
capital market activity. As raising capital became a priority, the need
for capital market reforms, and a legal framework that balanced investor
protection with policies conducive to investment and growth, was keenly
felt by the Indian government.
A key element of India's reform strategy was the introduction of a
strong, independent capital market regulator. Under the Securities and
Exchange Board of India Act, 1992, the Securities and Exchange Board of
India (SEBI) was formed as an autonomous body empowered to regulate the
stock exchanges, brokers, merchant bankers, mutual funds, underwriters
and various other financial advisors and market intermediaries. The two
pronged fundamental objectives of SEBI became investor protection and
the orderly growth of the Indian capital market.
One of the main tenements of SEBI's regulatory regime has been the
introduction of the Substantial Acquisition of Shares and Takeover
Regulations, 1997 – the primary objectives of which was the regulation
of actions taken by promoters and significant stake holders of Indian
listed companies, and the promotion of greater transparency in the
corporate takeover process. In September, 2011, SEBI announced the
advent of the new Substantial Acquisitions of Shares and Takeover
Regulations, 2011 (the new Takeover Regulations) – a much-awaited update
to the earlier laws bringing with them the following key changes to the
Indian M&A landscape:
- An increase in the threshold limits of the statutory open offer size
from 15% to 25% of the shares or voting rights of the target company.
Thus, where earlier acquiring 15% of an Indian listed company would have
required the acquirer to make an open offer, an acquirer can now
acquire up to 25% (i.e. 24.99%) of the company and not trigger such
obligations. In today's high interest era, the impact of increasing this
threshold enhances the ability of Indian listed companies to raise
equity capital from financial investors/private equity players without
triggering any open offer requirements, thus increasing their capital
generations avenues.
- However, the new Takeover Regulations balances out its generosity of
spirit towards the open offer triggers by increasing the size of the
statutory open offer from 20% to 26%. Therefore, for example, any
acquirer who intends to acquire 25% or more of the shares or voting
rights of an Indian listed company will now also have to make an offer
to buy a further 26% stake in that company from the other public
shareholders. This amendment forces investors acquiring significant
stakes in a company to provide transparent exit routes to the minority
shareholders and as such is a form of potent protection for the voice of
the minority shareholders.
- In a welcome step towards certainty the new Takeover Regulations lay
out objective criteria that specify that if a company derives more than
80% of its net worth, turnover or market capitalisation from
investments in an Indian listed company, then the acquisition of such
company, beyond the prescribed thresholds, automatically becomes a
direct acquisition and the provisions of the new takeover regulations
(including the statutory open offer requirements) would then apply.
The new Takeover Regulations did also provide for certain key
exemptions from the open offer requirements aimed at facilitating
smoother corporate actions:
- Inter se transfers of shares in listed companies among them,
their subsidiaries, their holding companies and their fellow
subsidiaries are exempt from the open offer requirements, subject to
compliance with specific pricing restrictions and timely intimation to
the stock exchange.
- Inter se transfers among promoters, Persons Acting in Concert
(PAC) with the promoters (promoters and PACs should be disclosed as
such for a minimum of three years preceding the transfer) and companies
owned by such persons are also exempt from the open offer requirement,
subject to the same conditions as inter-group inter se transfers.
- Acquisitions of shares in listed companies pursuant to a scheme of
arrangement or reconstruction, involving the target company such as a
merger, demerger etc., approved by a court order or order passed by any
such other competent authority, are also exempt from the statutory open
offer obligations under the new Takeover Regulations.
- Acquisitions pursuant to a scheme of arrangement or reconstruction,
not directly involving the target company are also exempt but are
subject to further conditions that require, inter alia, that the
cash and equivalent consideration should be less than 25% of the total
consideration due under the scheme, and that persons holding at least
33% of the voting rights in the combined entity post the transaction
should be the same as those before the transaction.
A fine balance
On the whole, the changes brought about by the new Takeover
Regulations reflect a fine balance of consideration towards all the
stakeholders – the acquirer, the target company and the minority
shareholders.
Another critical cornerstone of SEBI's regulation regime was
formalised in the form of the SEBI (delisting of equity shares)
Regulations, 2009 (the 2009 regulations), which replaced the erstwhile
delisting regulations of 2003 (the 2003 regulations). The 2009
regulations brought with them the following critical developments:
- A delisting offer is successful only if shareholding of the promoter
reaches the higher of: 90% of the total equity of the target; or the
sum of the promoter's pre-offer shareholding and 50% of the offer size.
- The delisting of a company's shares is no longer allowed to be
funded via a preferential allotment of shares or by the use of company
funds by a promoter to finance the exit option offered to the public
shareholders.
- Approval from the board of directors of the target company is now required for delisting.
- Any motion by the board of directors of a company to voluntarily
delist the company's shares has to be ratified via a resolution passed
by the non-promoter shareholders at a shareholders' meeting, conducted
by postal ballot. Further, the number of shareholders approving the
resolution have to be twice in number as those against.
Competition Commission
2011 also saw the introduction of a new regime of competition
regulations in the form of the Competition Commission of India
(procedure in regard to the transaction of business relating to
combinations) Regulations, 2011 – the Competition Regulations, to be
enforced under the extant provisions of the Competition Act, 2002. Under
this new regime all transactions, approved or executed on or after June
1 2011, as a consequence of which the resulting asset base/turnover of a
company would trigger the prescribed threshold limits given in the
Competition Act, are required to be notified to the Competition
Commission of India and seek the approval of the Commission to go ahead
with the transaction. The Commission's main objective is to curtail the
development of significant monopolies within the Indian economy which
would have the power to subjectively manipulate a specific industry or
economic sector, including the relevant consumer base, as a result of
such monopolistic strength.
Beginning 2012 on a welcoming note, on January 1 2012, the Government
of India announced its decision to allow Qualified Foreign Investors
(QFIs) to invest directly in the Indian equity markets. This move was
especially welcome in the current economic environment, which has seen
significant volatility in Foreign Institutional Investors (FII)
investments in the Indian capital markets. The government's decision
(ratified by the Reserve Bank of India (RBI), and SEBI) was a logical
follow-on step from its decision in August 2011 to allow QFIs to invest
indirectly in the Indian capital market by investing directly in the
equity and debt schemes of domestic mutual funds. Up until now, other
than the mutual fund route, only FIIs and non-resident Indians (NRIs)
were able to invest directly in the Indian equity markets via the
previously notified Portfolio Investment Scheme (PIS). Under the new
provisions, general permission has been granted by the RBI for
investment by QFIs via the existing PIS route – similar to the
provisions for existing FIIs. As per the provisions, a QFI is defined to
mean a person, who is not an existing SEBI registered FII, who is
resident in a country that is compliant with the Financial Action Task
Force (FATF) standards and is a signatory to the Internal Organization
of Securities Commission's (IOSCOs) Multilateral Memorandum of
Understanding – a broad enough definition given that most countries
comply with the FATF standards and are signatories with the IOSCO. By
providing direct access to the Indian equity markets, these provisions
aim to widen the existing class of foreign investors able to invest in
India, attract more foreign funds and thereby reduce market volatility
and deepen the Indian capital market.
Under the SEBI (Foreign Institutional Investors) Regulations, 1995,
(FII Regulations), FIIs must comply with stringent conditions applicable
to the registration of FIIs focusing in particular on their intention
to make investments only on behalf of broad based funds. Individuals
desiring to register a sub-account under an FII can only do so if they
have a minimum networth of $50 million. In comparison, the provisions
for investments by QFIs do not contain any registration or eligibility
requirements making the QFI route appear far more attractive. Amid the
significant FII capital outflows and the state of global capital
markets, the introduction of a route that provides more straight forward
access to the Indian markets augurs well for the Indian capital market
as it brings with it the potential to stimulate investment activity and
increase the attractiveness of the Indian markets in general.
The Indian capital market has come a long way in the last two
decades, where the coordinated efforts by the Indian government and the
various capital market regulators have resulted in the development of a
sophisticated and competitive regulatory regime.
Judicial decisions
In addition to the legislative regulatory regime, key decisions of
the judicial system also have the potential to significantly impact the
development of the Indian capital market. A true testament of the role
of the Indian judiciary system in the functioning of the country's
capital market was seen in the saga that was the Vodafone case
which raised the critical question of whether or not a transaction
involving the transfer of shares in a foreign company from one
non-resident to another non-resident entity, where the foreign company's
underlying assets were shares and rights in an Indian company, gives
rise to taxable income in India. One of the primary messages of the
Supreme Court's (SC) decision was the fact that under the existing
provisions of the law, the Indian tax authorities had no locus standi
to tax a transfer of shares of a foreign company, from one non-resident
to another, regardless of the underlying assets of the foreign company.
The SC stated that the inclusion of anti-abuse provisions dealing with
tax avoidance under the statute was a matter of nation economic policy,
in the absence of which it was not the court's role to create
legislative policy or legislate by interpretation – this was an area for
intervention by the legislative authorities
The result of the court's decision was seen in the following
controversial retrospective amendments, made via the Indian Finance Act
2012 bringing with them the potential to significantly impact the
sentiments of foreign investors:
- Until now, the term capital asset had been defined under the Income
Tax Act, 1961 (IT Act), to mean property of any kind, excluding
stock-in-trade, personal effects, etc. Under the Finance Act, it has
been clarified that property in terms of the type referred to when
defining a capital asset, includes any rights in or in relation to an
Indian company, including rights of management or control or any other
such right. This amendment is clearly in response to the SC's view that
the influence of a parent company over its subsidiary cannot be
construed as a capital asset because to be a capital asset the right has
to be legally enforceable as the property of the parent company.
- The definition of what constitutes a transfer under the IT Act was
also amended by the Finance Act to include the disposal of/parting with
an asset or any interest in that asset, the creation of any interest in
an asset, in any manner whatsoever, directly or indirectly, absolutely
or conditionally, voluntarily or involuntarily, via an agreement,
entered into in India or outside India, regardless of whether or not the
transfer of such rights is a result of the transfer of shares of a
foreign company. Thus, even an indirect transfer/acquisition of
underlying Indian assets will constitute a transfer such as a taxable
event under Indian tax laws. What has been left unclear is whether
corporate actions taken by global conglomerates that are in fact
internal group restructuring exercises will or will not be considered as
taxable transfers.
- To ensure that both indirect and direct transactions were explicitly
covered under the provisions of the IT Act, the Finance Act clarified
that any income arising "by means of", "in consequence of" or "by reason
of" the transfer of a capital asset will be deemed to accrue or arise
in India. This amendment thus broadens the scope of the type of income
that falls within the jurisdiction of the Indian tax authorities to
include income generated by both direct and indirect holdings. The
Finance Act also clarified that shares or interest in a foreign company
or entity will be deemed to have situs in India if such shares or
interest derive their value, directly or indirectly, substantially from
assets located in India – however what constitutes substantial value has
been left unsaid.
- Previously, any person (resident or non-resident) making a payment,
that was chargeable to tax in India, to a non-resident was obligated to
withhold applicable taxes under the provisions of the Indian tax laws.
The Vodafone case highlighted the uncertainty surrounding this provision
by raising the question as to whether the term "any person" in this
context should be construed to mean a person having an existing presence
in India or not. Putting an end to this debate and clarifying the
mandate of the withholding obligation, the Finance Act makes the
obligation to withhold applicable taxes on payments made to a
non-resident mandatory on both residents and non-residents, irrespective
of whether the non-resident payer has a place of business, a business
connection, residence or any other presence, in any other manner, in
India.
Retrospective amendments
All the above amendments are intended to take retrospective effect
from April 1 1962. Certainty in a country's tax regime is crucial to the
development of its capital market as it allows investors to quantify
and plan for their investment risks. Such retrospective amendments have
the potential to increase the uncertainty levels of foreign investors
with regards to the stability of the Indian regulatory regime.
Attempting to provide some measure of comfort the Finance Minister of
India, in his speech before the Lower House of the Indian Parliament,
has clarified that these retrospective amendments will not be used to
reopen any cases where assessment orders have been given and finalised
by the Indian authorities. However, neither the term "reopen" nor
"finalised" have been explicitly defined, leaving open the number and
the type of transactions that could fall with the mandate of the
retrospective amendments.
A key point on the future agenda of the Indian corporate and capital
market landscape is the much awaited updating of India's corporate laws.
Consolidating more than 50 years of practical and legislative history
is no easy task, making the responsibility lying on the shoulders of the
new Companies Bill 2011(the new Bill) a heavy one as the proposed bill
stands to replace legislation that was put in place more than half a
century ago. The 382 pages of the new Bill contain the following key
provisions:
- The new Bill provides for the opening up of the Indian M&A
sector by finally allowing cross-border M&A transactions involving
Indian companies merging into certain foreign companies. Under the
provisions of the new Bill, the merger of an Indian company into a
foreign company – including any company or body corporate incorporated
outside India, whether or not it has a place of business in India – and
vice versa will now be given the green light for companies from certain
jurisdictions that will be specified by the Central Government.
- Providing clarity on what constitutes a foreign company as per
India's corporate laws, the new Bill defines a foreign company as a
company or body corporate incorporated outside India which has a place
of business in India and which conducts some business activity in India.
- In case of any amalgamation, reconstruction, demerger or any other
compromise or arrangement, the National Company Law Tribunal (NCLT) has
the power to require that an exit opportunity be provided to those
shareholders that did not give their approval to such a compromise or
arrangement.
- Where a scheme or contract for a transfer of shares has been
approved by shareholders holding nine-tenths in value of the shares
being transferred, the transferee has the right to give notice to any
dissenting shareholder stating its intention to acquire their respective
shares. In the absence of the dissenting shareholder submitting any
application or an order by the NCLT stating otherwise, the transferee
company becomes legally entitled to acquire the minority shares via a
purely procedural route of share transfer.
In addition to the provisions of a new Companies Bill, Indian Inc is
looking forward to a slew of anticipated legislation that has the
potential to substantially change the Indian corporate landscape,
including a comprehensive Direct Taxes Code. The new regime of
regulations will be welcomed by investors, if they signal a continuation
of the past growth-focused policies and legislative security for direct
and indirect tax structures that are essential to assess and qualify
investment risk.
Views expressed are personal.
| Biography |
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Amit Maru
Ernst & Young
Tel: +91 22 619 20660
Email: amit.maru@in.ey.com
Amit Maru is based in Mumbai and has more than 14 years experience in
mergers and acquisitions, inbound and outbound. He is qualified
chartered accountant from the Institute of Chartered Accountants of
India and a company secretary from the Institute of the Company
Secretary of India. Amit's area of specialisation includes acquisitions,
business reorganisations, group restructurings, joint ventures, family
wealth management and succession planning etc.
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