STRUCTURING M&A TRANSACTIONS IN INDIA...Stamp duty applicable on the business transfer agreement and...

STRUCTURING M&A TRANSACTIONS IN INDIA

RUKSHAD DAVAR

Partner, Head - M&A and Competition Group

8B, Chander Mukhi, 8th floor, Behind The Oberoi

Nariman Point, Mumbai 400 021, INDIA

Tel: +91 22 6123-7272, Fax: +91 22 6123-7252

Other Offices: Bangalore, New York

Integrated Network Offices: Chennai, Hyderabad and New Delhi

E-mail: [email protected]

www.majmudarindia.com

M&A in India: Key Statistics

In the first quarter of the financial year 2018-19, foreign direct investment (“FDI”) into India

was US$12.75 billion. Increase of 23% from the same period in 2017.

Top five (5) states for FDI in India:

Maharashtra;

Delhi;

Karnataka;

Tamil Nadu; and

Gujarat.

Top five (5) sectors for FDI in India:

Services;

Telecommunications;

Computer software and hardware;

Construction development; and

Automobiles.

1

M&A in India

Economy offers long term prospects.

Emerging middle class - the consumer story.

Availability of talent - a vast english speaking population.

Resilient economy which can tackle macro-economic challenges.

Ease of doing business rank improved in the past year.

Reform-minded government.

Inexpensive manufacturing capabilities.

2

M&A in India

Main laws applicable to M&A transactions in India

The Foreign Exchange Management Act, 1999, related regulations issued by the

Reserve Bank of India (“RBI”) and the Circular on Consolidated FDI Policy issued by

the Government of India from time-to-time (“FDI Policy”);

The new Companies Act, 2013 (“Companies Act”) and the Companies Act, 1956;

The Securities and Exchange Board of India’s (“SEBI”) regulations;

The Competition Act, 2002 (“Competition Act”) and the regulations; and

The Income Tax Act, 1961 (“IT Act”) and Double Taxation Avoidance Agreements.

Other legislations include those relating to stamp duty, environment (especially for

manufacturing companies) and anti-corruption (FCPA for US acquirers).

3

Deal Structuring & Tax Issues

In case of investment in a joint venture (“JV”):

Structure of the JV entity:

Can be set up as a company (private or public) or as a LLP.

Strict compliances for a company vis-à-vis LLPs.

Also, FDI in LLPs without the permission of the DIPP is permitted in sectors

where 100% foreign investment is permitted and there are no FDI-linked

performance conditions.

Non-cash contribution in the JV entity:

If contribution to shares of the JV entity is by non-cash consideration then

permission may be required depending on the assets contributed.

For a newly incorporated JV entity, a pre-merger notification may have to be

made to the Competition Commission of India (“CCI”) in case the non-resident

joint venture partner is contributing by way of technology/ machinery.

4


Investment instruments:

Rules for issue of equity shares with differential voting rights also restrict shares with

differential rights from exceeding 26% of equity share capital.

Control of the JV entity:

In sectors such as insurance, print media and multi-brand retail trading where foreign

investment is capped, “control” in the hands of the foreign investor can pose to be an

issue.

Broad definition of “control” can pose issues in structuring investments.

Investment layers:

The Companies Act imposes a prohibition on investment through more than two (2)

layers of “investment companies”.

Exemption from this requirement has been given to existing multi-layered structures

outside India and for multi-layered structures in India and outside India to meet any

legal requirements.

5


Tax Considerations:

A JV registered under the Companies Act is treated as an Indian company and is

subject to income tax at the rate of 25% plus applicable surcharge (if the gross

turnover is up to INR 2.5 billion) or 30% plus applicable surcharge (if the gross

turnover is more than INR 2.5 billion).

Indian companies must also pay a dividend distribution tax at the rate of 20.56%.

From a tax standpoint, LLPs are more beneficial as no dividend distribution tax is

applicable as compared to a company.

Valuation of shares can be as per any internationally accepted pricing methodology,

however fair market valuation required under the IT Act must be complied with.

6


In case of investment through share purchase :

“Control” in the hands of the foreign investor can pose to be an issue. For instance,

the Jet Airways - Etihad deal:

24% acquisition by Etihad;

Extensive scrutiny;

Concerns raised by the foreign investment regulatory, SEBI and the CCI; and

Parties had to amend the investment agreement.

Assess from a competition law perspective if transaction subject to approval of the

CCI.

Successor liability cannot be excluded.

Disclosure and open offer requirements have to be complied with by listed public

companies in India under the SEBI’s takeover regulations.

7


Competition law implications:

Analysis under Section 5 of the Competition Act to be undertaken for assessing if a

pre-merger notification is required to be made.

Procedural requirements may extend timelines.

Considerably high penalties being imposed by the CCI in case of failure to notify a

“combination”.

Tax Considerations:

Changes in India’s tax treaties with Mauritius and Singapore.

Investments made after April 1, 2017 will be subject to capital gains tax at 50% of the

tax rate subject to satisfying the limitation of benefits clause.

Investments made after April 1, 2019 will be subject to the normal rate of tax. All

investments made prior to April 1, 2017 will be grandfathered, subject to fulfillment of

the commercial substance criteria.

8


Alternative tax structuring jurisdictions include Netherlands which allows a tax

exemption on capital gains if sale of shares is to a non-Indian entity;

Deal Nuances:

Enforceability of non-compete obligations in a share purchase transaction is

difficult.

As a result, the transaction may have to be structured as a business transfer and a

sale of goodwill to ensure enforceability of non-compete obligations.

9


In case of business transfer:

If the Indian subsidiary to which the business is transferred is owned and controlled

by its non-resident parent company, then restrictions under the FDI policy in respect

of investment instruments, structure of the Indian subsidiary, sectoral conditionalities

and sectoral caps will be applicable.

Non-compete:

Non-compete obligations in case of a business transfer are enforceable if the

transaction is structured as transfer of goodwill.

Time and scope of non-compete restrictions weigh in - from a CCI perspective

also.

Successor liability can be excluded.

Tax considerations:

Special provision for computation of capital gains tax on slump sale under Section

50B of the IT Act.

The business continuity test should be met.

10


If the undertaking is older than three (3) years, long term capital gains rates apply

even if individual assets are new.

No value added tax on slump sale if transfer of movables under a delivery note.

Stamp duty applicable on the business transfer agreement and the ancillary

agreements.

Deal Nuances:

Non-compete obligations in case of a business transfer are enforceable if the

transaction is structured as transfer of goodwill.

Time and scope of non-compete restrictions weigh in – from a CCI perspective also.

Provisions of the Competition Act also apply because a business transfer is treated

as an acquisition of assets.

11

Recent Reforms

FDI in Limited Liability Partnerships (“LLPs”)

FDI in LLPs has been permitted under the automatic route (i.e., no approval is

required from the Government of India).

This is applicable to LLPs operating in sectors where 100% FDI is allowed under the

automatic route and there are no FDI-linked performance conditions.

Investment by way of swap of shares

Investment by way of swap of shares has been permitted under the automatic route

except for the sectors falling under the government route (i.e., where approval is

required from the Government of India).

FDI in Real Estate

The Government has clarified that real estate broking services do not amount to real

estate business.

FDI up to 100% ownership has been permitted in the business of township

development, housing, built-up infrastructure and real estate broking services.

12

Recent Reforms

Foreign Investment in the Medical Devices Sector

100% FDI is permitted in companies manufacturing medical devices under the

automatic route. The Government has also clarified that the conditions applicable to

FDI in the pharmaceuticals sector would not apply to the medical devices sector.

Reporting on the Foreign Investment and Reporting Management System (“FIRMS”) portal

The Government has introduced the Single Master Form, a consolidated form which

has subsumed the Form FC-GPR, Form FC-TRS, Form LLP-I, Form LLP-II and

Form CN. As a result, entities are now allowed to fulfill reporting requirements online

through the FIRMS portal of the Reserve Bank of India.

FDI in single-brand retail trading

An Indian entity having 100% FDI can now undertake single brand retail trading

business without obtaining government approval.

An Indian entity having FDI beyond 49% and undertaking single-brand retail trading

is required to meet 30% local sourcing norms after the completion of five (5) years of

trading.

13

Recent Reforms

Deferred consideration, escrow accounts and indemnification obligations in case of transfer

of shares from residents to non-residents and vice-versa

In case of transfer of shares between a resident buyer and a non-resident seller or

vice-versa:

Payment of up to 25% of the total consideration can be deferred for a period

up to eighteen (18) months from the date of the transfer agreement without the

approval of the RBI.

In case of deferment of consideration, an escrow arrangement may be made

between the buyer and the seller for an amount up to 25% of the total

consideration and for a period up to eighteen (18) months from the date of the

transfer agreement without the approval of the RBI.

If the total consideration is paid by the buyer to the seller, the seller may furnish an

indemnity for an amount up to 25% of the total consideration and for a period up to

eighteen (18) months from the date of the payment of the full consideration without

the approval of the RBI.

14

Recent Reforms

Changes in pre-merger thresholds

Target-test exemption thresholds have been increased from assets worth INR 2.5

billion and turnover of INR 7.5 billion in India to assets worth INR 3.5 billion and

turnover of INR 10 billion in India.

Enterprises exercising less than 50% of the voting rights in another enterprise have

been exempted from the application of Section 5 of the Competition Act for a further

period of five (5) years from March 4, 2016.

Enhanced the asset and turnover thresholds specified under Section 5 of the

Competition Act, by 100%.

The revised thresholds will reduce the burden of obtaining pre-merger clearance

from the CCI for mid-sized deals and aid M&A activity in India.

15

Recent Reforms

The Insolvency and Bankruptcy Code (Amendment) Ordinance, 2018 (the “IBC

Ordinance”)

The IBC Ordinance has introduced various amendments to the Insolvency and

Bankruptcy Code, 2016 (the “Code”) such as:

Home buyers have been included as financial creditors under the Code and

can initiate insolvency proceedings against defaulting developers and

represent their interests as a part of the Committee of Creditors (“COC”).

Applications for initiating insolvency are now permitted to be withdrawn with

the approval of 90% of the voting share of the COC.

The minimum threshold requirements to approve many important decisions

such as approval of a resolution plan, approval of application for extension of

time, appointment of the resolution professional has been reduced from 75%

to 66% of the vote share of the COC.

Section 29A has been introduced which provides for the disqualification of

resolution applicants including the disqualification of undischarged insolvents,

willful defaulters, persons who are prohibited by SEBI from trading in

securities, etc.

16

Recent Reforms

The Draft Chapter on Cross Border Insolvency, 2018

The Ministry of Corporate Affairs has recently proposed the introduction of provisions

relating to cross-border insolvencies in the Code.

The provisions intend to provide for cooperation with foreign states in order to:

aid Indian creditors to access the overseas assets of a stressed company for

insolvency proceedings;

aid foreign creditors to access the Indian assets of a stressed company for

insolvency proceedings in a foreign jurisdiction based on the UN Model on

Cross-Border Insolvency;

assist with simultaneous insolvency proceedings in respect of the same

corporate debtor in India and in a foreign jurisdiction; and

aid foreign creditors intending to initiate insolvency proceedings under the

Code.

17

Employment law - Key considerations

Employment law of India includes Central laws and State-specific legislations – not

consolidated in one statute. Many State governments have included amendments to the

labour laws passed by the Central Government.

Applicability of employment laws depends on various factors, including, nature of business

of the employer, location of the employer and employee, role, responsibilities and salary of

employee, and number of employees.

Key bifurcation is on the basis of the role of the employee - if in a managerial or

supervisory capacity, then relationship may be governed solely by contract and not any law.

“At will” termination of employees not in a managerial or supervisory capacity is not

possible as law requires a mandatory notice period or payment in lieu of notice as well as a

severance compensation for such employees.

Mandatory contributions by employers and employees to a provident fund. Additionally,

various other contributions by employers in the form of gratuity, bonus, insurance and

labour welfare.

Mandatory requirements on leave, holidays, facilities to be provided by employer, maternity

benefits, policy of prevention of sexual harassment, etc

18

Assignment of Intellectual Property

Under Indian law, any patent created by an employee belongs to the employee.

Likewise any copyright of the work done by an employee belongs to the employee in the

absence of a contract to the contrary.

Any patent or copyright created by an independent contractor belongs to the contractor.

Assignment of copyright and patents created by a service provider or its employees in

course of the services is required.

A deed of assignment must be entered into between the service provider and the service

recipient in this regard.

The deed of assignment in case of patents required to be registered with the patent

registry.

The deed of assignment in case of copyright need not be registered with the Copyright

Board.

19

Data Privacy Issues

India’s data protection laws are at a nascent stage and not as developed as the laws in the

West.

The Information Technology Act, 2000 and the Information Technology (Reasonable

security practices and procedures and sensitive personal data or information) Rules, 2011

regulate data security in India.

The Information Technology Act, 2000 covers only “sensitive personal information” of

individuals and data exchanged in electronic version.

Presently, there is no specific legislation in India regulating protection of data received in a

verbal or written form, or protection of data of juridical persons.

Important to impose stringent data privacy standards in the contracts entered into with

Indian parties.

Comprehensive bill on data protection has been drafted and is proposed to be enacted in

the near future.

20

Anti bribery compliance

The Prevention of Corruption Act, 1988 (“POCA”) is the key legislation on anti corruption.

Some differences between POCA and FCPA:

POCA covers only government officials (public servants) and criminalizes giving and

accepting a bribe;

No requirements on due diligence to mitigate violations under POCA;

No concept of grease money under POCA;

Financial penal implication not very significant - imprisonment between six (6)

months and five (5) years, and a fine.

On a regular basis examine employees’ understanding of anti-bribery issues:

Adopt manuals/ guidance notes on anti-bribery compliances and reporting.

Educate and encourage employees to report any breaches of anti-bribery

policies/laws.

Conduct post training assessment to validate the understanding of the employees,

business partners and associates, agents, distributors related to anti-bribery laws.

21

Enforcement of Contracts

Choice of Law

No statutory restrictions regarding choice of law of the contract, and if one of the

contracting party is a foreign national or entity, then the parties may expressly agree

to any governing law.

Interim reliefs

In case arbitration is the dispute resolution mechanism, courts can grant interim

reliefs during the pendency of arbitration proceedings.

Arbitrations seated outside India can obtain interim relief from Indian courts, if the

final arbitration award will be enforced in India.

Non-compete Clauses

Any agreement which restricts a person from carrying out a lawful profession, trade

or business of any kind, is void to that extent under Indian law.

22

Enforcement of Contracts

Confidentiality Clauses

No specific law in India which protects trade secrets or confidential information, but

Indian courts have granted injunctions to protect confidential information on the

principles of equity and common law.

Non-solicitation Clauses

Enforceable during the term of the contract and generally enforceable even after the

end of the term.

23

Thank You

8B, Chander Mukhi, 8th floor, Behind The Oberoi

Nariman Point, Mumbai 400 021, INDIA

Tel: +91 22 6123-7272, Fax: +91 22 6123-7252

Other Offices: Bangalore, New York

Integrated Network Offices: Chennai, Hyderabad and New Delhi

E-mail: [email protected]

www.majmudarindia.com

STRUCTURING M&A TRANSACTIONS IN INDIA...Stamp duty applicable on the business transfer agreement and...

Documents

Transcript of STRUCTURING M&A TRANSACTIONS IN INDIA...Stamp duty applicable on the business transfer agreement and...