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Indian Tax & Regulatory Aspects May 20, 2015
-- Amithraj AN
Contents
• Typical Fund Structures
• Recent FEMA Developments
• Repatriation Options
Section 1
Taxation of AIF
• DVCF/ specified AIF are regarded as flow through transparent entities, in terms of
Sections 115UB, 10(23FBA) and 10(23FBB)
• AIF Category I and Category II funds are entitled to transparent status
• AIF Category III set-up as Trusts also entitled to similar status, by virtue of being a Trust
• Status of Trust – Specific & Determinate critical to ensure pass through status
• ‘Pass through’ status – nature of income in hands of AIF flows up to the investors
• Except for business profits and business or non-business losses
• Business income to be assessed in hands of AIF
• Taxes to be deducted at source @ 10% (including exempt income?)
• Computation required on an annual basis
• Investors liable to tax on accrual basis and not on actual distribution of proceeds
• Non-resident investors are entitled to claim treaty benefits, with respect their share
of income and categorisation of the same
5 Amithraj AN & Krishna Prasad VC & PE
Taxation of AIF
the holding
• No capital gains tax on investors from
Singapore/ Mauritius
• Possible to claim treaty benefit – Section 90(2)
Business Income
to tax
Investors
SPV
Taxation of FVCI
• No specific exemptions under the IT Act or Section 10(23FB)
• Earlier FVCIs used to contend that their income is business income -- no tax liability
in India, in absence of a PE
• The Finance Act No. 2, 2014 has amended the definition of ‘capital asset’
• Consequently, all incomes arising to FVCIs are liable to tax as capital gains
• Funds qualifying as residents in jurisdictions with favourable tax treaties can avail
capital gains tax exemption
• Challenges in case funds are structured as transparent entities in host countries
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Foreign Investors – MAT Conundrum
• Proposal by Income-tax Department to collect MAT from FIIs, etc.
• Finance Act, 2015 gives MAT relief to foreign investors prospectively
• Prior years – legacy issue
• FM has clarified that MAT will not be collected from treaty jurisdictions having
capital gains exemption
• CBDT circular – no coercive action should be taken, given Justice A.P. Shah
committee has been constituted
• Bombay HC has granted stay in case of Aberdeen Global against MAT levy
8 Amithraj AN & Krishna Prasad VC & PE
Fund Managers – Safe Harbour
• Fund Management in India not to trigger ‘business connection’ for non-resident
funds
• Minimum number of members
• Management fee
• Limit on share of profits
• Other conditions specified
Investment Jurisdictions
(Foreign Sourced Income exemption
Substance in Singapore to be demonstrated
SGD 200k annual expenditure criteria
Cyprus 12.5% Not Taxable Not Taxable Not Taxable as per domestic laws
Treaty renegotiation discussions
resident
Capital Gains taxable in India if sold to Indian Resident
Luxembourg 22.05% Taxable @ 21.63%/ 43.26%
Not Taxable – Participation Exemption
Not Taxable – Participation Exemption
Suitable for debt investments
Not Taxable Not Taxable Not Taxable due to Underlying Tax
Credit Max rate 3%
Cyprus is also under OECD watch list
Section 2
Indian Fund – Entity Form
AIF
Trusts
retirement of investors
as Specific Trusts
• RoC restrictions in setting-up
LLP as investment vehicles
unless it qualifies as AIF Cat I
or II fund
AIF Categories
stage ventures or social
ventures or SMEs or
benefits by Government or
funds
Typical Fund Structures
DVCF – Domestic Investors
Typical Fund Structures
Typical Fund Structures
Typical Fund Structures
DVCF with FVCI
No FIPB Approval
Typical Fund Structures
No FIPB Approval
Key Aspects in Domestic Fund Structure
Constitution of the Fund
Business Income v Capital
Key Aspects in Offshore Fund Structure
Jurisdiction for
Tax efficiency on profit
entities
Issues for Discussion
Investment?
• Payment of interest to DVCF – Whether WHT is applied as payment to Resident or
Non-Resident?
• Income-tax return filing
Funding Instruments
CCPS
Term of the instrument Convertible into equity shares within 20 years – typically 4 to 5 years considered
Nature of Investor DVCF/ FVCI
Coupon Typically nominal coupon (say 0.0001%) required
Companies Act requirement to distinguish against equity shares
FEMA Whether downstream investment?
Allotment pricing Allotment of CCPS at Par or Premium – No significant difference in outcome
Conversion to be at fair value
Security No charge on assets
Possible to have put option with the promoters
CCPS will rank lower than Creditors but higher than equity
Exit Options (a) Transfer of CCPS to Promoters, prior to conversion at a fixed IRR
(b) Conversion of the instrument into equity shares or other instruments at a fixed IRR
(c) Exchange against specific investments held by Investee company/ Promoters
(d) IPO (post conversion into equity) Tax Implications (a) DVCF Perspective
Gains on transfer of CCPS should be taxable as capital gains – short term/ long term
Benefit of DTAA could be claimed by the FVCI in DVCF for capital gains exemption
Conversion of CCPS into equity shares could be liable tax, subject to treaty
Step-up in cost may be possible
(b) FVCI Investor Perspective
(c) Company Perspective
OCRPS
Term of the instrument
Redeemable/ convertible into equity shares within 20 years – typically 4 to 5 years considered
Nature of Investor DVCF
Companies Act requirement to distinguish against equity shares
FEMA Whether downstream investment?
Allotment pricing (a) Allotment of OCRPS at Par
Creation of CRR on redemption of OCRPS – to the extent of par value
Significant increase in authorised share capital required to accommodate issue of OCRPS
Conversion to be at fair value
(b) Allotment of OCRPS at Premium
Appropriate amount of premium to be determined based on conversion ratio
Face value of shares to be allotted on conversion > face value of OCRPS being converted
CRR to be created only to the extent of face value of OCRPS redeemed
Premium on allotment of OCRPS can be utilised to fund the premium on redemption of OCRPS
No Section 56(2)(viib) on allotment of shares at a premium to venture capital funds
Lower increase in authorised share capital required
Security No charge on assets
Possible to have put option with the promoters
OCRPS will rank lower than Creditors but higher than equity
26 Amithraj AN & Krishna Prasad VC & PE
OCRPS
Term of the instrument
Redeemable/ convertible into equity shares within 20 years – typically 4 to 5 years considered
Exit Options (a) Transfer of OCRPS to Promoters, prior to redemption/ conversion at a fixed IRR
(b) Redemption of the instruments at a fixed IRR
(c) Conversion of the instrument into equity shares or other instruments at a fixed IRR
(d) Exchange against specific investments held by Investee company/ Promoters
(e) IPO (post conversion into equity)
Tax Implications (a) DVCF Perspective
Gains on transfer/ redemption of OCRPS should be taxable as capital gains – short term/ long term
Benefit of DTAA could be claimed by the FVCI in DVCF for capital gains exemption
Applying the same ratio, gains on redemption of shares at a premium should be regarded as capital gains
Potential risk of deemed dividend implications on redemption at premium
Conversion of OCRPS into equity shares could be liable tax, subject to treaty
Step-up in cost may be possible
(b) FVCI Investor Perspective
(c) Company Perspective
Potential deemed dividend implications
Withholding tax provisions should not apply on redemption – payment to resident Accounting Coupon payment/ Premium on redemption of OCRPS shall not construed as interest
payment. Hence, no hit in the P&L a/c
Securities premium can be utilised for redemption premium
27 Amithraj AN & Krishna Prasad VC & PE
CCD
Term of the instrument Convertible into equity shares within 10 years – typically 4 to 5 years considered
Nature of Investor DVCF/ FVCI
Coupon Typically nominal coupon (say 0.01%)
FEMA Whether downstream investment?
Possible to undertake repatriation of significant interest
Conversion to be at fair value
Creation of DRR or CRR should not be required for CCD
(b) Allotment of CCD at Premium
Appropriate amount of premium to be determined based on conversion ratio
Face value of shares to be allotted on conversion > face value of CCD being converted
Interest payable only on par value of CCD
No Section 56(2)(viib) on allotment of CCD
Security Can have charge on assets
Possible to have put option with the promoters
Typically CCD will rank lower than Creditors but higher than equity and preference shares
Exit Options (a) Transfer of CCD to Promoters, prior to redemption/ conversion at a fixed IRR
(b) Conversion of the instrument into equity shares or other instruments at a fixed IRR
(c) Exchange against specific investments held by Investee company/ Promoters
(d) IPO (post conversion into equity)
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CCD
Term of the instrument Convertible into equity shares within 10 years – typically 4 to 5 years considered
Tax Implications (a) DVCF Perspective
Gains on transfer of CCDs should be taxable as capital gains – short term/ long term
Benefit of DTAA could be claimed by the FVCI in DVCF for capital gains exemption – language of treaty to be assessed
Conversion of CCD into equity shares not liable to tax
Cost of shares goes back to CCD cost
(b) FVCI Investor Perspective
Capital gains exemption under the treaty can be availed – to be assessed
(c) Company Perspective
Accounting Coupon payment construed as interest payment
Companies Act Maximum tenure – 10 years ?
Deposit if convertible after 5 years, if received from a Trust
Can CCD be converted into Preference Shares
29 Amithraj AN & Krishna Prasad VC & PE
OCD
Term of the instrument
Redeemable/ Convertible into equity shares within 10 years – typically 4 to 5 years considered
Nature of Investor DVCF
FEMA Whether downstream investment?
Possible to undertake repatriation of significant interest
Conversion to be at fair value
Creation of DRR is required
(b) Allotment of OCD at Premium
Appropriate amount of premium to be determined based on conversion ratio
Face value of shares to be allotted on conversion > face value of OCD being converted
Interest payable only on par value of OCD
No Section 56(2)(viib) on allotment of OCD
Security Can have charge on assets
Possible to have put option with the promoters
Typically OCD will rank lower than Creditors but higher than equity and preference shares
Exit Options (a) Transfer of OCD to Promoters, prior to redemption/ conversion at a fixed IRR
(b) Redemption of the instruments at a fixed IRR
(c) Conversion of the instrument into equity shares or other instruments at a fixed IRR
(d) Exchange against specific investments held by Investee company/ Promoters
(e) IPO (post conversion into equity)
30 Amithraj AN & Krishna Prasad VC & PE
OCD
Term of the instrument Convertible into equity shares within 10 years – typically 4 to 5 years considered
Tax Implications (a) DVCF Perspective
Gains on transfer of OCDs should be taxable as capital gains – short term/ long term
Benefit of DTAA could be claimed by the FVCI in DVCF for capital gains exemption – language of treaty to be assessed
Conversion of OCD into equity shares not liable to tax
Cost of shares goes back to CCD cost
Redemption of OCD at premium will be construed as interest payment
Treaty benefit can be claimed with regard to interest income
(b) FVCI Investor Perspective
Capital gains exemption under the treaty can be availed – to be assessed
Interest taxation and treaty benefit
(c) Company Perspective
Withholding tax provisions may apply on redemption – payment to resident Accounting Coupon payment construed as interest payment
Significant impact on P&L on proportionate premium Companies Act Maximum tenure – 10 years ?
Deposit if received from a Trust
Section 5
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• Schedule 5 of FEMA 20 governs foreign investment under NCD route
• SEBI registered FPIs (including FIIs and QFIs) are allowed to invest in listed NCDs or
bonds, government securities/ treasury bills, commercial papers, units of mutual
funds, primary issue of NCDs, etc.
• Primary issue with the condition that NCDs/ Bonds are committed to be listed within 15 days
of investment. Terms of offer to have a clause that if not listed within 15 days, the issuer shall
immediately redeem/ buyback
• SEBI (Foreign Portfolio Investors) Regulations, 2014 govern investment by FPIs
• Three categories of FPI Investors:
• CAT I : includes Government, Govt agencies, sovereign funds, etc.
• CAT II : includes mutual funds, investment trusts, insurance companies, etc.
• CAT III : includes corporate bodies, trusts, foundations, individuals, etc.
• NRIs cannot register as FPIs
• Person seeking FPI registration should engage a Designated Depository Participant
(DDP) for obtaining the registration
• DDP shall also act as a custodian of securities for the FPI
Listed NCD
33 Amithraj AN & Krishna Prasad VC & PE
• Any Indian company (private or public) can issue NCDs on a private placement basis
• NCDs are listed in Wholesale Debt Market (WDM) segment of stock exchange
• Listing not necessary if investment is in ‘infrastructure’ sector
• NCDs subscribed/ purchased by FPIs are not treated as ECB
• No end-use restrictions and also conditions applicable to FDI investors under FDI policy
would not apply
• No restrictions on the interest remittances and also on redemption
• However, NCDs with a maturity of less than one year are regulated by RBI
• NCDs can be secured against mortgage of assets of the issuing company
• NCD issue to comply with SEBI (Issue and Listing of Debt Securities) Regulations
• Compliance with Company Law requirements
• Private placement related provisions
• Does it amount to acceptance of deposit ?
• Stamp duty implications under Indian Stamp Act
• 0.05% per year of the face value of the debenture, subject to a maximum of 0.25% or Rs. 25
lakhs, whichever is lower
NCD Issue Process
Obtaining rating certificate for the NCD issue
Obtain In-principle approval for listing from the stock exchange
Obtain ISIN for the Company from the depository (NSDL/ CDSL)
Filing of listing agreement and other documents with stock exchange and
NCD listing
Subscription and allotment of NCDs
Registration of charge and other RoC filings
Estimated Time Frame : 6 - 8 Weeks (Approx)
Shareholders Approval for allotment of NCD
Board Approval for allotment of NCD and convening of EGM
Section 6
Pricing of FDI Instruments with Optionality
• RBI has recently issued a Circular w.r.t ‘Put & Call options’ in Equity/ CCPS/ CCDs
• RBI was not comfortable with these options in SSA/ SHA – takes color of debt
• Docomo stake sale stuck before RBI on same aspect
• Optionality clause will oblige buy-back of securities from investor at the price
prevailing/ value determined at the time of exercise of option
• RBI has further specified that there shall not be an ‘assured price/ return’ for exit
• Is only buy-back by the Company permitted or purchase by Promoter also possible?
• For Listed Companies – at prevailing market prices
• For Unlisted Companies – As per RBI Pricing Norms
• Minimum lock-in – 1 year (few sectors may require a longer lock-in)
37 Amithraj AN & Krishna Prasad VC & PE
Issue of Partly Paid Shares and Warrants
Partly paid equity shares
• Pricing to be determined upfront
• 25% of consideration to be paid upfront (balance within 12 months)
• Can be received after 12 months, if issue size > 500 cr and appoint monitoring agency
Warrants
• Warrants now FDI compliant
• Pricing of warrants and price/ conversion formula to be determined upfront
• 25% of consideration to be paid upfront (balance within 18 months)
• Price for conversion not to be lower than fair value at the time of issuance of warrants
• Investee company can receive more than pre-determined price
Section 7
Issue of Shares – Companies Act Sections 42, 62, 63, 55 and 54
39 Amithraj AN & Krishna Prasad VC & PE
Types of Share Issue
Rights Issue
otherwise
on Renouncement
OR
Covers Allotment of Equity Shares and Preference Shares
* Can be shorter period, if approved by 90%+ shareholders in a Private Company – Proposed Amendment
41 Amithraj AN & Krishna Prasad VC & PE
Rights Issue – Key Points
• Allotment to persons other than shareholders requires Special Resolution –
Preferential Allotment
• Private Placement guidelines to be complied with for Preferential Allotment
• Not applicable on conversion of loan or convertible debentures
• Special resolution shall have been passed earlier
• Separate compliance prescribed for ESOPs
42 Amithraj AN & Krishna Prasad VC & PE
Preferential Issue/ Private Placement
Invitation sent to select group of
persons
before new issue
cash
within 15 days
43 Amithraj AN & Krishna Prasad VC & PE
Preferential Issue/ Private Placement – Key Points
• Covers allotment of Equity Shares, Convertible Preference Shares and
Convertible Debentures
• These provisions apply to private companies as well
• Applicable to new companies as well (2 year time limit done away)
• QII and employees excluded from 200 limit
• Valuation to be carried out by a CA with 10 years in practice, until Registered Valuer
provisions are notified
• Delay in refund of application money beyond 15 days – 12% interest p.a.
• No public advertisement can be given
• Partly paid-up securities cannot be allotted on preferential basis
• Consideration for non-cash allotment to be valued by Registered Valuer
• List of select group of persons to whom invitation was sent to be filed with RoC
• Return of allotment to be filed with RoC within 30 days
44 Amithraj AN & Krishna Prasad VC & PE
Modes of Allotment of Shares to New Shareholders
Rights Issue and Failure of the same
Rights Issue and Renunciation by Existing Shareholders
Preferential Issue/ Private Placement
Preference Shares
• Payment of dividend
• Repayment of capital, in the case of a winding up
• Possible to have participating preference shares – dividend and/ or capital
• Authorized by Articles and approved through Special Resolution
• Maximum tenure – 20 years
• Infrastructure companies can issue with maximum tenure of 30 years
• Minimum 10% annual redemption after 20 years , at the option of preference shareholders
• Redemption out of free reserves or proceeds of fresh issue
• CRR requirement for redemption out of free reserves
• CRR can be utilized for allotment of bonus shares
• Fresh preference shares can be allotted for redemption of earlier preference shares
• 3/4th shareholders approval
Issue of Debentures
Comply with Acceptance of Deposit Rules
Yes
No
48 Amithraj AN & Krishna Prasad VC & PE
Deposits
• Deposit includes any receipt of money by way of deposit or loan or in any other form,
by a company
• Foreign collaborators, foreign bodies corporate and foreign citizens in compliance
with FEMA
• Inter-corporate loans
• Share application money or advance towards allotment of securities – upto 15 days
after lapse of 60 days
• By a company from a director – declaration
• Bonds/ debentures fully secured with first charge on non-intangible assets
• Debentures convertible within 5 years
• Promoters by way of unsecured loan in pursuance of the stipulation of any lending
financial institution or bank – post repayment of bank loan, loans by promoters
become deposits
Issue of Debentures
Possible to cap liability of the Debenture Trustee
Prior appointment of Debenture Trustees – Invitation to public or members exceeding 500
Debentures to be mandatorily Secured?
Debenture Redemption Reserve to be created
50 Amithraj AN & Krishna Prasad VC & PE
Issue of…