2018 in review – cross border merger regulations- a step in the right direction or unbolting of floodgates?
The Foreign Exchange Management Act, 1999 (“FEMA”) was enacted “to consolidate and amend the law relating to foreign exchange, with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India”. Over the years, there has been a shift in the approach of the Central Government towards foreign investments, progressively liberalizing (or attempting to liberalize) the regulations to encourage foreign investment in India. The numerous notifications, master circulars, master directions, guidelines and regulations issued by the Reserve Bank of India (“RBI”) evidence this ever evolving area of law, often to keep up with the political and economic policies of Governments.
The first half of 2018 saw a three-fold growth in cross-border transactions in India, including a four-fold growth in inbound transactions in comparison to the first half of 2017. This, coupled with the Central Government’s constant effort to climb up the ease of doing business index appears to have led to issue of 27 circulars by the Foreign Exchange Department of the RBI in 2018, in addition to rewriting certain regulations that were previously enacted in 2000. On of the most important enactments out of these is the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“FEMA Cross Border Regulations”). These regulations are particularly relevant as an indicator of the growth in both inbound and outbound cross border transactions in the past one year as well as of the regulatory intent of enabling and encouraging foreign investment into India in the immediate future.
Foreign Exchange Management (Cross Border Merger) Regulations, 2018
The Companies Act, 2013 (“Companies Act“) was the first time both, inbound and outbound cross border mergers were recognized under Indian corporate law (the predecessor Companies Act, 1956 limited cross border mergers to inbound mergers only, i.e., merger of a foreign company with an Indian company where the resultant company is Indian). Section 234 of the Companies Act (dealing with merger or amalgamation of company with a foreign company) was notified on April 13, 2017 and a year later, the RBI issued the FEMA Cross Border Regulations on June 1, 2018.
The FEMA Cross Border Regulations have codified various matters in relation to inbound and outbound mergers, amongst others such as issue of shares, acquisition of assets and treatment of offshore branches. The key provisions of the FEMA Cross Border Regulations are explained below:
a. Definition of Cross Border Merger
A cross border merger is defined as “any merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamation) Rules, 2016 notified under the Companies Act, 2013”. This definition covers mergers, amalgamations as well as arrangements. However, it is interesting to note that the parent provision i.e., Section 234 of the Companies Act, does not provide for arrangements. The reason for a wider definition may be to cover a future amendment to Section 234 of the Companies Act, if it were to be amended to include arrangements.
b.Deemed approval from the RBI
Section 234 of the Companies Act read with Rule 25A of the Companies (Compromises, Arrangement and Amalgamations) Rules, 2016 (“Rules”) required prior approval of the RBI for a cross border merger. However, with a view to facilitate cross border mergers and make them time-efficient, Regulation 9 of the FEMA Cross Border Regulations provides for the “deemed” RBI approval, for the purposes of the Companies Act and Rules, if such merger is in compliance with and within the parameters set out in the FEMA Cross Border Regulations. The managing director or the whole time director and the company secretary (if available) of the relevant companies are required to self-certify compliance with the FEMA Cross Border Regulations while making the merger application to the National Company Law Tribunal (“NCLT”) as required under the Companies Act.
c. Conditions for Inbound Mergers
An “inbound merger” is a merger between a foreign company and an Indian company in which the resultant company is Indian and all the assets and liabilities of the foreign company are transferred to the Indian company. The FEMA Cross Border Regulations prescribe the following conditions for inbound mergers:
- Issue of shares by the resultant Indian company: Any issue or transfer of security by the resultant Indian company to any person resident outside India pursuant to the cross border merger should be in accordance with the pricing guidelines, entry routes, sectoral caps, attendant conditions and reporting requirements for foreign investment as laid down in the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations (“TISPRO Regulations“).
- Offshore branches/offices of the merged foreign company: The offices of the merged foreign company outside India shall be deemed to be a branch/office of the resultant Indian company and are required to be maintained in accordance with the Foreign Exchange Management (Foreign Currency Account by a Person Resident in India) Regulations, 2015.
- Guarantees or outstanding borrowings of the merged foreign company: The guarantees or outstanding borrowings of the foreign company will be treated as outstanding debt of the resultant Indian company and are required to comply (subject to the relaxations mentioned herein) with the External Commercial Borrowing or Trade Credit norms or other foreign borrowing norms, as well as the Foreign Exchange Management (Borrowing or Lending in Foreign Exchange) Regulations, 2000 or Foreign Exchange Management (Borrowing or Lending in Rupees) Regulations, 2000 or Foreign Exchange Management (Guarantee) Regulations, 2000 as applicable. However, recognizing that strict compliance of a retrospective debt acquired through an inbound merger may not be possible or feasible, the RBI has provided two relaxations in respect of the same: (A) the resultant Indian company has a grace period of two years from the date of the merger to comply with these borrowing regulations, during which time there can be no remittance for the repayment of such liability from India; and (B) end use restrictions on the borrowings have been removed.
- Offshore assets of the merged foreign company: As in the case of debt of the merged foreign company, the resultant Indian company is also allowed to acquire and hold the offshore assets of the merged foreign company in accordance with applicable FEMA regulations. However, if the applicable FEMA regulations do not permit the resultant Indian company to acquire/hold such offshore asset, then the RBI has provided a period of two years from the date of merger to sell such assets and the sale proceeds may be used to extinguish an offshore liability that is not permissible under the FEMA regulations, and if not so used, should be immediately repatriated to India through banking channels.
d. Conditions for Outbound Mergers
An “outbound merger” is one between an Indian company and a foreign company, where the resultant company is a foreign company and all the assets and liabilities of the Indian company are transferred to the foreign company. The FEMA Cross Border Regulations prescribe the following conditions for outbound mergers:
- Permission to acquire securities of the resultant foreign company: The shareholders of the Indian company, who may be issued shares/stock of the resultant foreign company pursuant to an outbound merger are permitted to acquire and hold such foreign securities in accordance with the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. However, the valuation of such shares should comply with the limits prescribed under the Liberalized Remittance Scheme issued by the RBI from time to time (currently, the limit is of USD 250,000).
- Onshore offices of the merged Indian Company: The Indian offices of the merged India company shall be deemed to be branch offices of the resultant foreign company and continuance of such branches should be in accordance with the Foreign Exchange Management (Establishment in India of a Branch Office or a Liaison Office or a Project Office or Any Other Place of Business) Regulations, 2016.
- Guarantees or outstanding borrowings of the merged Indian company: The guarantees or outstanding borrowings of the Indian company will be treated as outstanding debt of the resultant Indian company and are required to be repaid as per the scheme of merger/amalgamation/arrangement sanctioned by the NCLT. Further, the resultant foreign company is prohibited from acquiring any Indian Rupee liability that is payable to an Indian lender which is not in conformity with the provisions of FEMA and the Indian lenders will have to issue a no-objection certificate to this effect.
- Onshore assets of the merged Indian company: The resultant foreign company has been permitted to acquire, hold and transfer assets in India, in compliance with applicable FEMA regulations. However, if the applicable FEMA regulations do not permit the resultant foreign company to acquire/hold such onshore assets, then the RBI has provided a period of two years from the date of the merger to sell such assets and the sale proceeds may be used to extinguish an onshore liability that is not permissible under the FEMA regulations, and if not so used, should be immediately repatriated outside India through banking channels.
The FEMA Cross Border Regulations do not provide for any distinct mode of valuation, but only require that the valuation for inbound and outbound mergers be in accordance with Rule 25A of the Rules.
As has been mentioned above, cross border mergers are already regulated under the Companies Act and the Rules, and now by the RBI through the FEMA Cross Border Regulations. In addition, companies are also required to take into consideration the provisions of the Indian Income Tax Act, 1961 (“IT Act”) in relation to the tax treatment of mergers. In particular, Section 47(vi) of the IT Act only exempts capital gains only in case of transfer of a capital asset where the resultant company is an Indian company, i.e., the IT Act currently only exempts gains arising out of inbound mergers. As such, capital gains arising out of outbound mergers may not be able to benefit from the exemption under the IT Act.
Further, companies will also have to be mindful of any conditions/restrictions imposed by the NCLT while sanctioning the scheme, such as in relation to treatment of assets and liabilities, repayment schedules, etc.
Thus, this is a complex area of law, with multiple regulators having concurrent jurisdiction and requirement to comply with various legislations and regulations. It is hoped that the area develops and matures with time, once the NCLT actually starts approving schemes for inbound and outbound mergers, interpretations of the income tax authorities and the RBI, all of which may continually address wrinkles that are bound to arise with newer regulations/areas of law.
It is also pertinent to remember that the NCLT, while approving these schemes for cross border mergers might also be constrained to consider foreign substantive and procedural laws applicable to the transferee or the transferor company.
The utility of these regulations, particularly in internal cross border restructuring of group companies cannot be ignored. Having said that, while these regulations are a welcome step which fill some important lacunae in the field of cross-border merges; whether the multiplicity of regulators having concurrent jurisdiction over the issue would actually ease doing of business in India, or deter the investors from investing in India is something that only time will tell.
Big thanks to our intern, Ashish Nath Jha (5th year, Gujarat National Law University) who helped with the research.