Although the flow of foreign private equity into India has been quite steady, there continue to be several ambiguities in the legal regime relating to private equity investment. Through interviews with experts, CNBC -TV18 identifies some of the issues. These include the following:
1. Governance rights: When private equity investors acquire rights in listed companies (such as veto rights on key decisions), there is a possibility that they may acquire “control” over the company thereby triggering public offer requirements under the SEBI Takeover Regulations. This primarily arises because of an expansive interpretation of the term “control” that has been adopted by SEBI.
2. Lack of flexibility on convertible instruments: A popular instrument used for private equity in the past was convertible preference shares. However, since May 2007, preference shares with a conversion option have been treated as external commercial borrowings (ECB) necessitating onerous approvals for investment.
3. Minimum pricing norms: This prevents private equity investors from taking a stake at a discount to market price, a matter we had posted on earlier.
4. Other issues identified in the discussion are the lack of the ability of private equity funds to carry out due diligence (except in limited circumstances), which is owing to insider trading regulations prescribed by SEBI, and also the inability of private equity (or other) investors to carry out leveraged transactions (which involve leveraging the assets of the target company) in India.
Many of these issues ultimately boil down to a single structural problem – the lack of a special regime governing private equity investors. Private equity is treated as any other form of investment and hence is subject to the same regulations that are applicable to other foreign investors (whether financial or strategic), which bring along with it associated regulatory difficulties and ambiguities. A somewhat elegant solution to this problem would be to treat private equity separately and to take into account the special features of private equity investment and to provide a separate window to such investors. Although such a separate regulatory regime for private equity funds has been contemplated in the past, no concrete steps have been taken in that direction yet. Perhaps it is time that these issues are revisited because private equity is a predominant source of funding for Indian companies seeking expansion, especially when market conditions are not necessarily opportune for capital raising from the public through IPOs.
Public Shareholding: Listed companies are required to maintain a minimum level of public shareholding in order to ensure continued listing. However, there is some ambiguity on whether such ‘public’ shareholding would cover only retail investors or whether that would include large investors such as mutual funds, foreign institutional investors, banks, high net worth individuals and similar such investors. CNBC-TV18 has a related report on this topic.
Taxation on Slump Sales
A ‘slump sale’ is one of the methods available to give effect to a transfer of a division or undertaking of a company to another company. Under this method, all the assets and liabilities of (or relatable to) the undertaking are transferred for a ‘lump sum’ consideration without assigning values to the individual assets and liabilities of that undertaking. Unlike certain other types of merger and acquisition transactions, such as qualifying amalgamations or demergers, that are exempt from capital gains taxation on account of transfer of the undertaking, slump sales give rise to liability for capital gains taxation in the hands of the transferor company. However, the manner of computation of capital gains tax for a slump sale has been specifically laid down in the Income Tax Act, 1961 and is different from the treatment that applies to transfers of other forms of capital assets.
The Hindu Business Line carries an article by H. P. Ranina explaining the capital gains tax implications of a slump sale. The article commences as follows:
The Hindu Business Line carries an article by H. P. Ranina explaining the capital gains tax implications of a slump sale. The article commences as follows:
“Section 50-B of the Income-Tax Act, 1961, is a special provision for computing capital gains chargeable to tax in the case of a slump sale. Such capital gains are deemed to be long term where the undertaking has been owned and held by the assessee for more than three years, irrespective of the period for which each individual asset of the undertaking has been held.The article then goes on to deal with the nuances of computing net worth, especially in a situation where the liabilities of the undertaking are greater than the assets, and particularly on the issue of whether there can ever be a ‘negative’ net worth.
Therefore, Section 50-B would prevail over the general provisions of the law. Sections 48 and 49 have been made applicable, subject to some modification, for computing capital gains in the case of a slump sale.
Defining ‘net worth’
The net worth of the undertaking transferred is deemed to be the cost of acquisition and cost of improvement for calculating the capital gains. The net worth is to be computed in accordance with Explanations 1 and 2 of Section 50-B.
As per Explanation 1, “net worth” has been defined as the aggregate value of total assets of the undertaking as reduced by the value of liabilities of such undertaking as appearing in the books of account.
Explanation 2 provides that the value of depreciable assets shall be taken as the written-down value (WDV) determined under Section 43(6)(c) of the Act, while the value of non-depreciable assets will be taken as per the books. The net worth so computed is to be certified by the report of the accountant as defined in Section 288(2).”
Training Directors
I had earlier posted about the Chartered Director test prescribed by the Institute of Directors in London, which is a qualifying examination for directors on corporate boards. In response, one our readers from Australia, Susie Reece Jones, has been kind enough to provide us with some details about the situation in Australia in this regard.
In Australia, there is almost a de facto pre-requisite that a director seeking board membership should have completed the Company Director’s Education Program with the Australian Institute of Company Directors (AICD). Whilst the program is not mandated, it is considered appropriate that directors have taken and complete the course. Membership of the AICD helps directors as well. The directors’ education course can be undertaken part- or full-time and encompasses a multitude of subjects including, but not limited to, corporate law. The course culminates in an examination for candidates. There are regular and frequent follow up courses (as the AICD website suggests) and these are generally well patronised. The demand for such courses also stands enhanced given increasing liability implications for corporate directors, and the need for awareness of possible risks and mitigating factors (such as directors’ and officers’ liability insurance policies).
On a more general note, Australia also has a strong talent pool of independent company directors. Board seats are indeed hard to obtain, as large public companies undertake a rigorous and transparent recruitment process for independent directors. There is also a focus on recruiting women on corporate boards (although not mandated by law), but this has yet to become the norm on Australian boards.
It is useful to look at such instances in other corporate governance regimes as the Indian corporate fraternity continues to set and improve its own best practices.
In Australia, there is almost a de facto pre-requisite that a director seeking board membership should have completed the Company Director’s Education Program with the Australian Institute of Company Directors (AICD). Whilst the program is not mandated, it is considered appropriate that directors have taken and complete the course. Membership of the AICD helps directors as well. The directors’ education course can be undertaken part- or full-time and encompasses a multitude of subjects including, but not limited to, corporate law. The course culminates in an examination for candidates. There are regular and frequent follow up courses (as the AICD website suggests) and these are generally well patronised. The demand for such courses also stands enhanced given increasing liability implications for corporate directors, and the need for awareness of possible risks and mitigating factors (such as directors’ and officers’ liability insurance policies).
On a more general note, Australia also has a strong talent pool of independent company directors. Board seats are indeed hard to obtain, as large public companies undertake a rigorous and transparent recruitment process for independent directors. There is also a focus on recruiting women on corporate boards (although not mandated by law), but this has yet to become the norm on Australian boards.
It is useful to look at such instances in other corporate governance regimes as the Indian corporate fraternity continues to set and improve its own best practices.
SEBI Eases Payment Norms in Public Offerings
On May 13, 2008, SEBI created a new method of payment or earmarking of funds for subscription to securities in a public offering. The press release states:
“Easing of payment process in public / rights issue:The Hindu Business Line highlights some of the benefits to investors:
The Board approved, in principle, the concept of marking lien on bank account as an alternative mode of payment in public / rights issues. The concept will enable the application money to remain in the bank account of the applicant till such time the allotment is finalized and thus eliminate the refund process. The modalities in this regard would be worked out separately.”
“This would also reduce the burden on registrars and merchant bankers. But bankers to the issue can no longer enjoy the floating interest, said officials associated with the IPO process.
Most important of all, investors would not have to wait for their refund money. It also ensures that a liquidity crisis such as that of January 2008 does not occur again.
At that time, many investors were unable to buy scrips which were at attractive lows, as their money was locked up in the Reliance Power and the Future Capital IPOs. Nor could they meet their margin money requirements.”
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