Startups look to Budget for tax neutrality on outbound mergers

Industry players are looking at appropriate relaxations on outbound mergers — where the merged entity is a foreign entity and does not enjoy the principle of tax neutrality — in the upcoming Budget.

Indian companies cannot directly list overseas, which is why some create a holding company overseas to own Indian business. This is referred to as flipping as the ownership structure changes from domestic to foreign.

As Indian tech startups look at avenues to globalise their businesses and raise private and public funds outside India, flipping of the ownership structures may become more commonplace going forward.

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“With the relaxation in the new overseas investment regulations, it is likely that many Indian founders may look at creating an offshore holding-cum-operating structure. While the merger of a foreign company with an Indian company is exempt from capital gains tax in India, the reverse doesn’t enjoy the same treatment. Providing tax neutrality to an outbound merger will go a long way in the ability of Indian companies to raise growth capital,” said Vaibhav Gupta, partner, Dhruva Advisors.

According to Vishwas Panjiar, partner, Nangia Andersen, while outbound mergers have been permitted under regulatory norms, the lack of tax neutrality from capital gains tax in such cases makes them unattractive. “The rationale for not granting tax neutrality is twofold: to discourage outward flow of investment and to levy exit tax on the company/ shareholder,” Panjiar said.

Indian entities could not invest in foreign entities earlier if they had an India connection and an RBI approval was needed for the same. The apex bank would look at requests for approvals on a case-to-case basis.

The new ODI norms permit transactions by Indian entities in foreign entities, provided they do not have more than two layers of subsidiaries, directly or indirectly. Investors can now make an overseas investment for less than 10% stake in the foreign companies without the need for a joint venture.

The Securities and Exchange Board of India this year allowed outbound investments from Indian alternative investment funds or venture capital funds into foreign entities without an Indian connection.

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“Even if full tax neutrality is not granted, it may be prudent to consider deferring the tax to the point of sale rather than at the time of the merger itself. Similar provisions have been incorporated for migration of assets to REITs,” said Gupta.

“The government should allow tax neutrality (albeit partially) in case of outbound mergers considering that even in these cases the entities combine with corresponding adjustment at the shareholder level (which in most cases would be global Indian citizens) and no real income gets generated. Alternatively, the government can consider extending tax neutrality, at least, in case where the shares continue to be held by an Indian resident,” said Panjiar.

Two tax-friendly jurisdictions, Mauritius and Singapore, along with the US, the UK and the Netherlands make up the top five preferred jurisdictions for outbound investments from India, according to experts.

According to Sunil Badala, partner and head, financial services, tax, KPMG, any shift of holding company jurisdiction (either from or to India) is likely to trigger taxes in advance of any actual liquidation event.

“With a view to facilitate businesses to raise capital at better terms and valuation, such migrations should be permitted on a tax neutral basis and, tax should be levied only on actual liquidation and not on such restructuring. While REITs and InvITs are one set of examples, migration of offshore funds to GIFT City on a tax neutral basis is another example,” said Badala.

To be sure, several offshore fintech companies are now also evaluating a reverse trend to access the Indian public market. On October 3, Walmart-owned PhonePe, for instance, said it had reversed its overseas structure and was eyeing an India listing.

“Some of these are struggling because countries like Singapore don’t allow cross-border mergers (even though, Indian law allows such cross-border mergers). Investors and founders are weighing the commercial benefits of such migration vis a vis potential tax costs associated with such migration,” Badala said.