This article deals with the potential roundtripping issues that may arise when a De-SPAC is effected through an outbound merger or a share swap. The Reserve Bank of India has previously been of the view that roundtripping can occur even if funds are not actually routed to India by an Indian entity through a foreign entity.
Undertaking a De-SPAC through an outbound merger or a share swap may be subject to a host of regulatory hurdles, particularly, where Indian shareholders of the target are to acquire an interest in the overseas SPAC.
‘Round-tripping’ generally refers to a series of transactions that involve circulation of money across jurisdictions culminating in its return to the jurisdiction of origin, usually as foreign investment. From an Income-tax perspective, ‘round trip financing’ includes transactions that do not have substantial commercial purpose other than obtaining tax benefit. The Reserve Bank of India (RBI) has consistently objected to round-tripping.
The Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (ODI Regulations) permit an Indian corporate entity to invest in an overseas joint venture or wholly-owned subsidiary. The ODI Regulations do not expressly permit investment in India through round-tripping. Similarly, the Liberalised Remittance Scheme (LRS) simply refers to “…making investments abroad…” and does not deal with round tripping. Consequently, overseas direct investment (ODI) by an Indian corporate entity or individual resident in India in a foreign entity with such foreign entity either directly or indirectly investing in shares of an Indian company requires prior approval of the RBI. In addition to penalties, parties making investments in contravention of the ODI Regulations or the LRS may be required to unwind the non-compliant transaction.
The challenge with RBI considering requests on a case-to-case basis is that the timelines are generally outside the control of the contracting parties. The recent applications in respect of Press Note 3 of 2020 (prescribing that investments from countries sharing a border with India required approval) are a testament to the possible delays that may occur. As time is usually of the essence for De-SPACs, the requirement of RBI approval may discourage parties from undertaking De-SPACs through which Indian shareholders of the target receive shares of the overseas SPAC.
In recent years, there have been instances of parties creating overseas holding structures for Indian targets to avoid approaching Indian regulators for approval at the time of receiving investments or undertaking De-SPACs. This often results in a series of complex cross-border transactions to ensure that there is no violation of the ODI Regulations while also protecting the interests of the Indian shareholders. Indian shareholders (likely founders and employees) who are otherwise restricted from acquiring shares in the overseas entity need to be adequately compensated in such scenarios. Put option (i.e., option to sell its shares to the overseas company) and, or fresh issuance of cashless employees’ stock options in the listed entity post the De-SPAC are a couple of mechanisms which are likely to be evaluated for the Indian shareholders.
Despite the growing interest in overseas listing of Indian companies through SPACs, the number of transactions effectively consummated is limited. This is likely because compliance with the ODI Regulations will entail regulatory approvals which would delay the process. Additionally, given the RBI’s negative view of round-tripping, regulatory approval may not be forthcoming for such structures.
Criticism of the restrictions on round-tripping has been mounting for some years. In 2019, a High-Level Advisory Group (HLAG) constituted by the Minister of Commerce and Industry, Department of Commerce, Government of India stated that the stringent regulations adopted by the RBI with the objective of preventing ‘round tripping’ of funds have even impacted legitimate transactions. The HLAG further observed that the developments made in technology, KYC, and international co-ordination may help alleviate concerns related to such structures.
The HLAG recommended that ODI by an Indian corporate entity be permitted in a foreign entity having pre-existing foreign investment in an Indian entity provided that:
- the value of the foreign investment in India does not exceed 25% of the foreign entity’s consolidated net worth;
- further investment into India should not be made using funds directly or indirectly from India; and
- further investment into India should be made through the automatic route using proceeds from legitimate and bona fide overseas business activities.
The HLAG also recommended providing exemptions to companies listed in Financial Actional Task Force jurisdictions.
The RBI has yet to act on the HLAG’s recommendations. Parties are increasingly implementing more creative structures for cross-border M&A and owners of targets may not always want to exit from the targets, particularly, in the case of De-SPACs. The current restrictions on round-tripping are a hindrance to cross-border M&A. The RBI should review the restrictions on round-tripping and consider implementing the HLAG’s recommendations. Alternatively, a separate exemption should be given to Indian corporate entities and resident individuals in India acquiring shares of offshore entities pursuant to a De-SPAC or other cross-border acquisition of an Indian entity. This will boost cross-border M&A and provide Indian companies with a meaningful opportunity to implement and advantageously leverage SPACs.