The True Nature of a Stock Swap

A stock swap is a transaction where an acquirer acquires shares of another company and, instead of paying cash for such acquisition, discharges consideration by issuance of its own shares. Business World has surveyed experts on the question as to whether a stock swap amounts to a “sale”. The response is as follows:

Yes : 33%
No : 10%
Maybe : 57%

A summary of the reasons for each answer has been set out in the survey (link provided above).

It appears that the answer "maybe" is probably more appropriate, as a lot would depend on the exact features of the transaction as well as the real intention between the parties. There can be no generalisation as to these matters, especially in a legal sense, as expressions such as "stocks swap", “reverse merger”, etc. are not statutorily defined, but are rather terms that emanate from market practice.

Competition Commission & Global Mergers

There has been a coordinated and consistent move by industry to ensure that merger regulations that have been proposed by the Competition Commission do not cover global mergers whose implications in India are not substantial. We have discussed this issue in the past on this blog (here, here and here). In fact, the draft regulations do contain some de minimis exceptions that seemingly placate industry concerns.

However, adopting a somewhat contrarian approach, in an article in the Economic & Political Weekly titled Are Merger Regulations Diluting Parliamentary Intent?, the authors Manish Agarwal and Aditya Bhattacharjea argue that such exceptions brought in through the draft regulations dilute the intention of the legislature in enacting the Competition Act (and the amendments in 2007). The authors state:

“These merger regulation provisions, in particular, the mandatory notification requirement and the lack of a “domestic nexus” criterion for foreign mergers have been sore points for the domestic as well as international business communities. It has been argued that the mandatory notification system will require notification of foreign mergers with little or no nexus to India and add to the cost of doing business as well as strain the resources of the CCI. The amendment Act has sought to address this concern by providing for a domestic nexus test. Accrodingly, the thresholds for worldwide turnover or assets have been amended, so that only those combinations where at least Rs. 500 crore of the combined worldwide assets or at least Rs. 1,500 crore of combined worldwide turnover of the merging parties is in India, would come under the purview of the Act. However, this amendmednt has not been well received in business and legal circles.
…

In order to address this and other procedural objections and to outline its approach towards merger review, the CCI published draft combinations regulations in January 2008, which list certain categories of transactions that will be treated by the CCI as not likely to cause an appreciable adverse effect on competition in India. They include a modified two-firm domestic nexus test according to which combinations in which at least two parties do not each have a minimum of Rs. 200 crore of assets or Rs. 600 crore of turnover in India will be considered benign. …”

The authors subject this modified two-firm domestic nexus test to an economic analysis and advance arguments that there could be scenarios where mergers could fall below the thresholds stipulated above, but would still raise significant competition concerns. Such arguments are certain to be met with stiff resistance from industry circles.

Vodafone Income Tax Case

The acquisition of shares in Hutch Essar by Vodafone from Hutchison in a multi-billion dollar M&A deal last year has resulted in a dispute on the taxability of capital gains on the transaction. This dispute is currently pending before the Bombay High Court, with a decision being awaited. The court’s verdict is expected to have serious implications on costs involved in implementing M&A transactions in Indian companies, especially when the buyer and seller are overseas entities.

In this behalf, CNBC-TV18 has an interesting discussion about the possible arguments in the case, and also the impact of the decision on future M&A deals. The background is described in the opening part of the discussion as follows:

“It is a landmark case that will severely impact the Mergers & Acquisitions (M&A) landscape in India. No matter which way it goes, the Vodafone versus IT department tax case will have an indelible impact on the M&A landscape of India. Last year British Telecom giant Vodafone paid Hong Kong based Hutchison International over USD 11 billion to buy Hutchison’s 67% stake in Indian telecom company Hutchison Essar. The transaction was done through the sale and purchase of shares of CGP, a Mauritius based company that owned that 67% stake in Hutch Essar.

Since the deal was offshore, neither party thought it was taxable in India. But the tax department disagreed. It claimed that capital gains tax most people paid on the transaction and that tax should have been deducted by Vodafone whilst paying Hutch. The matter went to court and was heard over the last two weeks.

Vodafone argued that the deal was not taxable in India as the funds were paid outside India for the purchase of shares in an offshore company that the tax liability should be borne by Hutch; that Vodafone was not liable to withhold tax as the withholding rule in India applied only to Indian residence that the recent amendment to the IT act of imposing a retrospective interest penalty for withholding lapses was unconstitutional.

Now the taxman’s argument was focused on proving that even though the Vodafone-Hutch deal was offshore, it was taxable as the underlying asset was in India and so it pointed out that the capital asset; that is the Hutch-Essar or now Vodafone-Essar joint venture is situated here and was central to the valuation of the offshore shares; that through the sale of offshore shares, Hutch had sold Vodafone valuable rights - in that the Indian asset including tag along rights, management rights and the right to do business in India and that the offshore transaction had resulted in Vodafone having operational control over that Indian asset. The Department also argued that the withholding tax liability always existed and the amendment was just a clarification.”

See also a previous news report about the case in the Business Standard.

Security for External Commercial Borrowings: Liberalised Regime

The Reserve Bank of India (RBI) has announced a series of measures to liberalise the regime for Indian borrowers to create security in favour of lenders in case of external commercial borrowings (ECBs). Now, borrowers are only required to obtain the ‘no-objection’ from the authorized dealers (AD) rather than to obtain the prior approval of the RBI for certain types of security (as was the practice until now).

The relevant Circular issued by the RBI yesterday notes:

“3. As a measure of rationalization of the existing procedures, it has been decided to allow AD Category – I banks to convey ‘no objection’ under the Foreign Exchange Management Act (FEMA), 1999 for creation of charge on immovable assets, financial securities and issue of corporate or personal guarantees in favour of overseas lender / security trustee, to secure the ECB to be raised by the borrower.

4. Before according ‘no objection’ under FEMA, 1999, AD Category – I banks may ensure and satisfy themselves that (i) the underlying ECB is strictly in compliance with the extant ECB guidelines, (ii) there exists a security clause in the Loan Agreement requiring the borrower to create charge on immovable assets / financial securities / furnish corporate or personal guarantee, (iii) the loan agreement has been signed by both the lender and the borrowers, and (iv) the borrower has obtained Loan Registratoin Number (LRN) from the Reserve Bank.”