We have seen in the blog dated September 14, titled ‘Using SPAC Vehicles as a Means of Listing Outside India’, that special purpose acquisition companies (“SPAC”) are making a comeback for the purposes of listing of companies outside India.
As a follow up to the earlier blog, we will examine some feasible structures for offshore listing and their Indian tax considerations. This examination is intended to identify the relevant tax considerations and ensure that such a listing takes place with due regard to them.
Shares of Indian companies and of foreign companies, deriving substantial value from Indian assets, are regarded as capital assets situated in India. Any gains derived by any person, including a non-resident, from transfer of an Indian capital asset is regarded as income taxable in India. The term ‘transfer’ in this context is given a very wide meaning and it includes within its purview sale, exchange, relinquishment of the asset, extinguishment of any right in the capital asset, conversion of the capital asset into stock in trade, maturity or redemption of zero coupon bond, etc. We will limit ourselves here to the meaning of transfer in relation to shares and securities. The law also provides how the gains are to be computed when there is a transfer of shares. It is a settled law that where the mechanism to compute gains is not available, it is presumed that the legislature did not intend such a transfer to be subjected to tax.
The income tax law also lists a host of transfers which are exempt from the levy of tax in India. A significant number of these exemptions relate to business reorganization, such as transfer of assets between a holding company and a subsidiary, transfer of business by merging company to merged company, transfer of shares by shareholders of merging company when they receive shares of merged company, also in case of demerger (understood to be hive-off).
There are some other anti-abuse provisions such as the requirement that the securities must be transferred or acquired at a price which is fair market value (“FMV”). If the acquirer pays less than FMV, then the difference is taxable in the hands of the acquirer as income other than business income or capital gains. If the seller of unlisted shares receives a consideration lower than the FMV of such shares, it is deemed that he has received the FMV and is taxed on his gains from such a sale accordingly.
Tax Considerations in offshore listing
Against this backdrop, it is opportune to evaluate the tax considerations in offshore listing of Indian companies, in the context of various aspects discussed in the above referred blog.
The first step having identified the relevant Indian company (“Indian Target”) would be that the SPAC would acquire its shares and thereby make the Indian Target its wholly-owned subsidiary. This could be achieved by either (i) the SPAC purchasing shares of Indian company from its shareholders for cash consideration; or (ii) the SPAC purchasing shares of Indian company from its shareholders in exchange for its own shares being issued to them; or (iii) a combination of (i) and (ii).
Under (i), the Indian shareholders shall be liable to capital gains tax in India, on the difference between the consideration received from SPAC and their own cost of acquisition of the shares of the Indian Target. In view of the anti-abuse provision under the Income-Tax Act, 1961 (“IT Act”), SPAC would need to acquire the shares of the Indian Target at least at the FMV of such shares. This would mitigate any adverse Indian tax implications on the SPAC and the shareholders of the Indian Target under such deeming provisions.
In case of the swap under (ii) also, the Indian shareholders would likely realise capital gains as the FMV of SPAC shares is expected to be higher than their cost basis of the shares in the Indian Target. Both of them need to be valued to arrive at their FMV under the IT Act.
Alternative 1 – Listing of SPAC and holding Indian company as a subsidiary of the SPAC
The listing of an Indian Target can be achieved indirectly by listing of the SPAC on overseas exchange. This may be done by SPAC offering its existing shares in an offer for sale or issuing new shares or a combination of the two. When the shares of SPAC are offered in public offering, assuming that either the Indian Target is the only asset of SPAC or that SPAC derives its value substantially from the Indian asset, the SPAC share would be deemed to be situated in India. Hence, if the transfer of the shares of SPAC results in gains to the transferor shareholder of the SPAC, then the same could be taxable in India, unless a specific exemption is provided in Indian law to the effect that the sale of shares of SPAC on overseas stock exchange would not attract Indian capital gains tax. Even if there is no specific exemption provided:
i. such seller would still be exempt if it is a small shareholder (holding less than 5% directly or indirectly in the Indian company) and has no management control rights directly or indirectly in the Indian Target; or
ii. the selling shareholder is not liable to tax in India based on the Double Taxation Avoidance Agreement (“DTAA”) entered into between India and the country of residence of such shareholder.
In addition to tax as discussed above, it will also need to be ensured that the shares of SPAC are transferred at FMV under the IT Act, to avoid the implications under the anti-abuse provision.
In the event that such transfer becomes taxable in India, there should be either exemption from capital gains tax on such transfer in the home jurisdiction of the investor or if there is tax, then, credit for the Indian taxes should be available under the applicable DTAA between India and the country of residence of the seller of SPAC shares.
Alternative 2 – Merger of Indian Target into the SPAC
Once the Indian Target is acquired by the SPAC, it can be merged with SPAC (cross border merger) pursuant to which it becomes resident of the jurisdiction of SPAC.
If the merged company were to be an Indian company:
i. transfer of assets by Indian Target to the merged company would be tax neutral in India if the merger satisfied certain conditions; and
ii. The shareholders of the Indian Target would not have any tax incidence.
However, since the SPAC would not be an Indian company, this merger is likely to be taxable both for the Indian Target as well as its shareholders.
In view of the above, a specific provision to make this merger tax neutral would be required and the Indian shareholders should also be made exempt from such tax in India.
In addition to the tax neutrality of the merger, the value of the shares of the Indian Target that the Indian shareholders give up for getting shares in SPAC should be equal to or more than the FMV of the shares of SPAC. This will ensure that they are not subject to tax under the anti-abuse provision under the IT Act. If a new provision for making this merger tax neutral is included in the Indian law, then exemption from this provision can also be sought.
Tax implications post listing of SPAC
Upon merger of the Indian Target into SPAC, the Indian office of the Indian company will be treated as a foreign company/ branch office of the merged foreign entity.
The branch office in India would be regarded as Permanent Establishment (“PE”) of the SPAC in India for tax purposes. A PE of a foreign company shall be taxed in India at 40% on its net income. In case there is a change in the business model such that SPAC also earns revenue in its home jurisdiction, then it needs to be ensured that no part of that revenue is attributable to the activities of the Indian PE. This would protect the revenue earned outside India from taxation at 40% in India. The repatriation of income outside India of the PE will not attract further tax in India. The home jurisdiction of SPAC should give credit for the 40% tax paid in India.
In addition to the taxability of Indian branch as a PE of SPAC in India, it would be relevant to examine and ensure that the ‘place of effective management’ (“POEM”) of SPAC is not found to be in India. This could happen if the key management personnel of SPAC are located in India or during a financial year, key management decisions with regard to the business of SPAC are taken by directors or officers of SPAC, while they are situated in India. In case the POEM of SPAC is determined to be in India, then SPAC would be considered to be a tax resident of India and will be subject to Indian taxes on its global income. This aspect would need to be factually verified and appropriate safeguards would need to be built in, to mitigate any adverse implications.
If the Indian Target were otherwise liable to tax in India at lower tax rate, say 22% or 15% (applicable to a newly set up manufacturing company post October 2019, satisfying certain conditions), it should be carefully considered whether the merger is necessary for other reasons in spite of the significant additional burden being imposed upon SPAC on account of taxation.
Any transaction between the SPAC and the Indian PE would need to be carried out on arm’s length basis under the applicable transfer pricing regulations in India. This would also be the case where SPAC and the Indian Target have a parent-subsidiary relationship, i.e. if the Indian Target is not merged with SPAC.
Indian shareholders of SPAC may be taxed in the country of SPAC on the dividend paid by SPAC to the shareholders, by way of dividend withholding tax. This rate would be as per the rate in the DTAA between India and the country where SPAC is located. They would also be taxed in India on these dividends at the same rate as they would have been taxed when receiving dividend from the Indian Target. They should however get credit for the taxes withheld in the home country of SPAC and double taxation should be avoided. Indian shareholders would also be taxed on capital gains realised when they sell the shares of SPAC on the overseas stock exchange. Such gains may also be taxed in the country of SPAC as per the domestic law and they should get credit for such taxes in India. Foreign tax credit in India is a complex issue and has to be considered very carefully to avoid any double taxation. Most jurisdictions may not levy tax on these capital gains realised by Indian shareholders.
Well-articulated tax related provisions along with other legal and regulatory provisions for listing of an Indian company would ensure that the complex tax considerations discussed here and some others are simplified and this option is made more attractive for both domestic shareholders and overseas investors, paving the way for much required equity capital from international investors.