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Development on Investments in India
Pepper Hamilton | Philadelphia | 10 September 2012
Why India
The Law
Entry Options
Key Drivers
Define Strategy
Primary Risk Assessment
Secondary Risk – Dealing with
imponderables
Foreign Direct Investment
Investment Route
Funding Options
Computation of Foreign
Investment
Other Investors
FIIs
Mergers & Acquisitions
Comparative Overview
Competition Act
Takeover Code
Watch-Out Issues
Sign Off Note
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Why India
World’s largest democracy
Parliamentary system of Government
Federal structure with elected Government in
28 States and 7 Union Territories
Powers of executive, legislature and judiciary separate
Trillion Dollar economy
Stable growth rate and comfortable foreign exchange reserves
Huge domestic demand
Skilled manpower
Laws modeled on English laws
Indian Economy in the integration stage with the world market
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The Law
Key Regulations
Foreign Exchange Management Act
Foreign Direct Investment (“FDI”) policy framed by the Government of India
Indian Companies Act
The Competition Act
The Securities and Exchange Board of India (Substantial Acquisition of Shares and
Takeovers) Regulations (“Takeover Code”)
The Indian Income Tax Act
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Entry Options
Wholly owned subsidiary
Joint venture with an Indian partner
Limited liability partnership
Liaison office
Project office
Branch office
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Key Drivers
Entry into New Markets and Profit Pools
Establishment of Leadership Positions
Acquisition of Technology Knowhow
Inorganic Growth
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Define Strategy
Target – market technology, skills
Funding requirements
Enter with a partner or through a wholly
owned subsidiary
Local knowledge is power
Localization of products
Risks and how to mitigate
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Primary Risk Assessment
Global financial crisis has created challenges
and opportunities
Indian investment has become more competitive
as US Dollars and other currencies strengthen
Market volatility has led to decreased valuation
Will there be a further meltdown to buy at a
lower cost?
Governance model
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Secondary Risk - Dealing with imponderables
Different legal systems
Different business cultures
High cost of finance
Developing infrastructure
Changes in treaties and agreements
2012 – a challenging year impacted by external and domestic circumstances
Huge fiscal deficit and rising inflation are a cause for concern
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Foreign Direct Investment
Under the current FDI policy, foreign investment
is permitted in all sectors, except the following:
o Atomic energy and railways
o Lotteries, gambling and betting
o Agriculture (excluding floriculture, horticulture, seed development, animal
husbandry, pisciculture, aquaculture and cultivation of vegetables, mushrooms,
etc. under controlled conditions and services related to agro and allied sectors)
o Plantations (excluding tea plantations)
o Retail trading (other than single brand retail)
o Real estate (except construction development projects)
o Chit funds, nidhi companies, or trading in transferable development rights
o Manufacturing of cigars, cheroots, cigarillos and cigarettes, and tobacco and
tobacco substitutes
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Investment Route
FDI can be made under:
o Approval Route; or
o Automatic Route
Approval from the Foreign Investment Promotion Board (“FIPB”) is required in cases where FDI does not qualify under the Automatic Route, such as:
o Specified sectors or FDI beyond sectoral cap
o Investments other than equity shares and compulsorily and mandatorily convertible preferential shares or debentures
o Investments for consideration other than cash except for capitalisation of external commercial borrowing, due for repayment and interest as well as technology royalty dues for payment
o Investment in warrants and partly paid shares
o Investment in entities other than a company engaged only in downstream investment activities for holding purposes or which does not have any operations or downstream investments
FDI involving equity inflow of more than INR 12 billion is placed before the Cabinet Committee of External Affairs
All other cases of FDI would fall under the Automatic Route and does not require the approval of FIPB
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Funding Options
Equity capital
External commercial borrowing
Compulsorily Convertible Preference Shares
Compulsorily Convertible Debentures
Global Depository Receipts
American Depository Receipts
Foreign Currency Convertible Bonds
Foreign Currency Exchangeable Bonds
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Computation of Foreign Investment
Guidelines for calculating FDI in an Indian company
where sectoral caps apply
FDI in an Indian company will include the following:
o Direct Investment by a foreign investor is fully counted towards foreign investment limits
o Indirect foreign investment through an Indian company “owned” or “controlled” by non-residents
o “Ownership” means more than 50% shareholding and “controlled” means the right to appoint majority directors of the company
Foreign investment will include FDI, investment by FIIs, NRIs, ADRs, GDRs, foreign currency convertible bonds, convertible preference shares, convertible currency debentures
If the Indian company is owned and controlled beneficially by a resident Indian citizens, any downstream investment made by such an Indian company will be considered as domestic investment and not counted towards foreign investment limits
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Other Investors
Foreign Venture Capital investors can invest in eligible securities of an Indian
Venture Capital Undertaking or Venture Capital Fund by private arrangement or
purchase from a third party
Qualified Foreign Investors are allowed to purchase rupee denominated units of
equity schemes of domestic mutual funds
Foreign Institutional Investors (FIIs)
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FIIs
Investments by FIIs
o Registered FIIs may apply to RBI through the Securities Exchange Board of India (“SEBI”) for permission to purchase shares and CCDs of an Indian company under portfolio investment scheme
o FIIs are permitted by RBI to purchase shares or CCDs of an Indian company through registered brokers on recognized stock exchanges
o FIIs are permitted to purchase shares or permitted debentures through private placement
o The total holding of each FII and SEBI approved sub-account of FII cannot exceed total paid up equity capital or 10% of the paid up value of each series of convertible debentures
o Total holdings of all FIIs or sub-accounts of FIIs added together cannot exceed 24% of the paid up equity capital or the paid up capital of each series of CCDs
o Limit of 24% may be increased to the specified sectoral cap or statutory ceiling if Indian company passes a Board of Directors resolution and the shareholders also approve of the same
o FIIs can invest in unlisted bonds or NCDs of a infrastructure company
o FIIs can invest in NCDs or bonds of a listed company
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16
Acquisitions
Entity Level
Merger/ Amalgamation
Share buyout
Business Level
Slump Sale Demerger Asset Purchase
(piecemeal)
Mergers & Acquisitions
Commercial considerations Tax considerations
Funding
Value addition
Business objectives
Deal size & other commercial parameters
Tax certainty
Minimum India tax cost
Tax efficient exit
Tax efficient income repatriation
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Comparative Overview
# Tax neutrality can be achieved where transfer is at book value (other than immoveable property and shares)/ WDV
## Tax neutrality can be achieved where transfer is at net worth
*Subject to fulfillment of conditions
**Court driven process
***Fresh period of 8 years available subject to fulfillment of conditions
Parameters Asset sale Slump sale Share
Transfer
Demerger Merger
Tax neutrality #
##
*
*
Feasibility when time is of the
essence
**
**
Unabsorbed tax losses ***
Continuity of tax holding benefit upon
the execution of the transaction in the
hands of transferor
Funding requirements
Stamp duty Relatively
lower
Indirect taxes
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Competition Act
The de minimis exemption
Applies to acquisitions of shares, voting rights, control or assets of a “small
target” where the target enterprise has either
Assets less than INR 250 crores (INR 2.5 billion) in India; or
Turnover less than INR 750 crores (INR 7.5 billion) in India
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Competition Act
Thresholds, in sum: standalone acquirer
Standalone Acquirer +
Target
India Presence Only
Assets INR 1500 crores
/ USD 333 million
Turnover INR 2250 crores
/ USD 500 million
Worldwide presence
Assets > USD 750
million
Including India presence of
USD 166 million
Turnover USD 2250
million
Including India presence of
USD 500 million
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Competition Act
Thresholds, in sum: group acquirer
Group Acquirer + Target
India presence only
Assets INR 6000 crores
/ USD 1.33 billion
Turnover INR 18000
crores / USD 4 billion
Worldwide
Presence
Assets USD 3 billion
Including India presence of INR 750
crores / USD 166 million
Turnover USD 9 billion
Including India presence of INR
2250 crores / USD 500 million
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Takeover Code
A mandatory open offer is triggered on:
Acquisition of substantial shares or voting rights entitling the acquirer to 25% or
more voting rights in the target company
Creeping acquisition of more than 5% voting rights in a financial year by the
acquirer who already holds 25% or more voting rights in the target company
Acquisition of control over the target company, irrespective of shares or voting
rights held by the acquirer
Once triggered, the acquirer has to offer to acquire minimum
26% of the total shares of the target company from public
shareholders
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Takeover Code
Public
Announcement
linked to mode of
acquisition
Public
Announcement to
only target company
and stock
exchanges
Limited Public
Announcement and
detailed Public
Statement
Mode of Acquisition Timing of PA
Negotiated Agreement Date of Agreement
Market Purchases Prior to placing order with broker
Conversion of convertibles 2nd working day preceding conversion
date
Indirect acquisition 4 days of earlier of the date of:
(a) Primary agreement;
(b) Announcement of acquisition or
decision of making such acquisition
Preferential Allotment Date of special resolution
Voluntary Offer Date of making the voluntary offer
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Watch-Out Issues
Pricing
Indian law restrictions on price at which acquisition can take place
For unlisted companies, price to be determined in accordance with discounted cash flow method
Listed companies, price as per guidelines and is essentially market linked
Transfer Restrictions
Flip flop in relation to enforceability of transfer restrictions in public companies
Bombay High Court has ruled that transfer restrictions are not possible in a public company
Delhi High Court has taken a contrary view
Unless Supreme Court rules on the subject, the following will always remain a questionable issue in case of a public company
o Lock-in
o Right of first offer
o Right of first refusal
o Drag and Tag along rights
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Watch-Out Issues
Exit Price
At fair value after DCF valuation for unlisted company
Put & Call Options
Uncertainty whether put & call options are enforceable
FCPA
FCPA audit at the time of investment
FCPA program to be developed for day to day management
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Watch-Out Issues
General Anti Avoidance Rules (“GAAR”)
Conceptually, GAAR codifies the ‘substance over form’ principle
GAAR would empower tax authorities to determine tax consequences of an
arrangement declared as an Impermissible Avoidance Arrangement (“IAA”)
Consequences of IAA may vary from case to case
Draft guidelines released by the Finance Ministry
Expert Committee set up by the PM to release the second draft guidelines, work
out the roadmap and finalise
Genuine transactions for restructuring or taking advantage of beneficial legal
provisions may be open to challenge
Expert Committee to re-examine controversial issues
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Watch-Out Issues
Confidentiality
Deal leaking results in price ramping in case of public listed companies
Hold Backs / Escrow
Hold back of consideration for purchase of share not allowed
Escrow for indemnities requires Reserve Bank of India’s approval
Enforcement
Indian court procedure slow and cumbersome
Prefer arbitration at a neutral venue
Policy Changes
Retrospective amendments
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Sign Off Note
Challenges of doing business in a foreign land
Cultural clash, a factor that cannot be ignored
Managing multinational environment in-house,
need to deal with local government, partners etc.
– a new challenge
Building dedicated global team
Adaptability to changes and crisis
– key to success
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