[Urja Dhapre is a 3rd-year B.com LL.B. student and Vibhore Batwara is a 5th-year B.com LL.B. student at Institute of Law, Nirma University, Ahmedabad]
With a creative navigation of raising capital from the public, the resurgence of Special Purpose Acquisition Companies [SPACs] is being highly recorded, especially in the United States - inverting the conventional route of an Initial public offering [IPO]. SPAC is a shell or a blank check company set up for the sole purpose of raising funds to acquire another company. In other words, it is a large pool of cash listed on an exchange, providing a backdoor IPO route to other companies. Owing to the recent momentum of SPACs in the USA coupled with stringent foreign exchange regulations and tax hurdles, India has not witnessed any SPAC- like structure yet. However, few Indian companies have been subject to acquisition by a SPAC.
Targets of acquisition are swayed with a potential advantage of getting listed in overseas markets, with greater liquidity and better valuations, thereby avoiding a rather arduous process of listing. Taking into account the revival of SPACs, this article tries to examine SPACs and their functioning with the interplay of Indian regulations. The authors have restricted the scope of the article to an Indian target being acquired by a foreign SPAC.
Working of SPACs
SPAC is a company formed to raise funds via an IPO to acquire a different company. Since the initial IPO by SPAC is done without specifying a target, they are generally sponsored by reputable investors or fund houses. The investors in a SPAC IPO get units of it consisting of an equity share and a warrant (to purchase stock at a later date). The proceeds of IPO are transferred into a trust while the investor scouts for businesses to acquire, typically within a timeline of 18 to 24 months. If a target is identified, the SPAC shareholders have to approve the transaction for the deal to conclude. However, if the SPAC fails to acquire a target within the specified time frame, money raised is returned to the initial investors, along with a specified rate of interest. The approval of the proposed transaction leads to the merging (or acquiring) of the target with the SPAC, letting the SPAC survive as an operating company [De-SPACing].
Offshore Direct Listing or SPAC or an IPO?
The Companies (Amendment), Act 2020 crystallized the position of public companies to list their securities directly on a foreign stock exchange. Alternatively, the burgeoning mechanism of SPACs can be used by companies as a route to go public, ultimately leading to the listing of securities on a stock exchange. The ability of SPACs to raise capital, after weighing its considerable advantages, would have a substantial impact on the number of companies choosing this route over an Offshore Direct Listing [ODL] or a traditional IPO.
Ordinarily, an IPO process is quite elaborative and time-consuming initiating from marketing the IPO by intermediaries to finalizing the price and allocating shares. On the other hand, as the Indian regulations are yet to be amended to provide clarity on direct listings, the current position of law stands such that companies have to first go public and then issue American Depositary Receipts or Global Depositary Receipts to list overseas, making the process cumbersome. Moreover, in addition to the limited 10 exchanges selected for overseas listing by the 2020 amendment, SEBI’s panel in 2018 suggested only certain companies with a minimum of 10% of paid-up capital on an Indian Stock Exchange should be allowed to directly list overseas.
SPACs in comparison are more fleeting with no restriction of dual listing or listing in limited jurisdictions. Further, the target companies are attracted to price certainty and high valuations as the negotiations of the same are held between closed doors without any uncertainty and timing issues of conventional IPOs, where share prices are concluded by a book-building process and underwriters making the most from the ‘IPO pop’ in addition to the often-cited peril of the whole IPO failing.
Key regulations affecting SPACs
Companies Act implications
In pursuance of the target company being identified for an outbound merger, the foreign company is required to be listed in one of RBI’s specified jurisdiction as per Annexure B to Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016 [Merger Rules].
Accordingly, for any transaction concerning a cross-border merger, Rule 25A of the Merger Rules provide for a deemed approval of the RBI presuming the conditions mentioned in the Cross Border Merger Regulations, 2018 are fulfilled. On non-fulfilment, specific approval of the RBI is required.
The conclusion of a De-SPAC transaction with the parent SPAC combining with the target letting the foreign entity survive will attract the elements of Section 234 of the Companies Act 2013.
Foreign Exchange considerations
Foreign Investment in India is governed by the Non-Debt Instrument Rules 2019 [NDI Rules] and the FDI policy. Concerning the shareholders of the acquiring company, if they are resident individuals, their fair market value of foreign securities has to be under the prescribed threshold of the Liberalised Remittance Scheme. For Non-Indian residents to acquire securities, the FDI Norms set a floor price in the case of acquisition of permitted equity instruments (either by way of purchase or by way of subscription from resident shareholders).
Moreover, the transfer of shares of a listed company will be as per the SEBI guidelines and of an unlisted company will be as per the fair value worked out in an internationally accepted pricing methodology on an arm’s length basis [Regulation 21 of the NDI Rules].
The office of the target Indian company will be deemed to be the branch office of the parent SPAC company and the resultant company under the Cross Border Merger Regulations, 2018 will be allowed to hold or acquire any asset under the permissible limits.
The resultant company may acquire or hold or transfer any immovable property in India as permitted by the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018. If the asset or security cannot be held or acquired by the resultant company, it shall sell such asset or property within two years.
Further, another issue which can arise is in situations where the promoters of the Indian target are issued shares in the SPAC, which again has ownership of the target by virtue of the merger. RBI can perceive this structure from a round-tripping tangent, leading to possible litigation and some level of uncertainty.
Permanent Establishment (PE) Risk – As stated above, post a De-SPAC transaction involving an Indian target, the business is continued through a deemed branch office in India; consequentially, there is a significant risk that such branch office may be categorized as a PE of the foreign company from the tax perspective. Once PE is established the income attributed to India would be taxed on a net basis as ‘Business Profits’ enshrined in Article 7 of the tax treaties. There are no specific criteria in determining the attribution of income to PE and hence the same is done on a case to case basis by doing a FAR analysis (Functions performed, Assets utilized and Risks assumed), which brings about a lot of subjectivity. The establishment of a PE would require the foreign entity to maintain books of accounts, conduct statutory audits, exposure to Minimum Alternate Tax (MAT) liability, mandatory return filing, and other obligations.
Merged Foreign Company- When the Indian target merges with the SPAC, the Indian promoter would want to swap his shares in the Indian company with shares in the merged entity, without involving any cash consideration (unless exit is warranted). However, the merged entity being a foreign company the transaction will not be tax neutral. The Indian target and/or its shareholders (depending on how the deal is structured) will face capital gain tax liability, up to the effective date, as if there was an actual sale of the capital asset.
Indirect transfer tax – It is highly possible that post the De-SPAC transaction the entity listed in the US may derive its substantial value from assets located in India. Consequently, the share of such foreign company would be deemed to be situated in India as per Explanation 5 to Section 9(1)(i) of the Income Tax Act, 1961. In such a scenario when a SPAC investor exits, capital gain liability may also arise under Indian law (even though the transaction involves non-resident unitholders as well as shares of a foreign company) if the SPAC investor has more than 5% right of management or control in the foreign company.
Time is the essence when it comes to finalizing a transaction with SPACs, given the limited time to strike and conclude a deal with all the relevant compliances of the host country. The recent momentum that these companies have gained in the US markets can be anticipated to create an impact on Indian companies wanting to go public on the overseas exchange via this route, especially the tech-start-ups, which would be allowed to bypass Indian regulations which are quite conservative (especially the 3-year operating profit requirement, under Regulation 6 of SEBI’s Issue of Capital and Disclosure Requirements, 2018). Also to overcome the above discussed regulatory and tax hurdles, externalization of structures can be adopted to gain the advantage of being listed overseas through SPACs.
With liquidity in the world markets growing at a rapid pace, SPACs have fueled their growth on it. They are enabling access to growth-stage companies for retail participants, which would otherwise be in a Venture Capital or Private Equity portfolio until ready for an IPO. It would be interesting to watch the SPAC development in India.