In what will be the world’s largest acquisition deal in the e-commerce space if concluded, Walmart Inc. (“Walmart”) recently announced its intent to acquire 77% of Flipkart Pvt Ltd (“Flipkart”) for a sum of $16 Billion. While this landmark deal is likely to be a gamechanger in the Indian e-commerce landscape, there are several issues that may need to be resolved before this transaction is completed and operationalised. In this post we examine some of the tax considerations the transaction is likely to face under Indian tax laws.
Flipkart commenced operations as Flipkart Online Services Pvt Ltd (“FOSPL”) in 2007, operating the website Flipkart.com as an online bookstore. In 2011, FOSPL transferred its business to Flipkart India Pvt Ltd (“FIPL”). Further, Flipkart Pte Ltd (“FPL”) was incorporated in Singapore in the same year as a non-resident holding company of FIPL and other group entities.
Even though FPL was originally registered as a public company in Singapore, the company has undertaken an extensive share buyback program of around $350 million in May 2018 to enable conversion to private company status in Singapore, which is seen as an enabler in the transaction with Walmart.
Discussions between Walmart and Flipkart started in September 2016, when Walmart expressed an interest in acquiring a minority shareholding in Flipkart. From thereon, this transaction has transformed into its present form, where Walmart will acquire a controlling stake in FPL, the Singapore based holding company of Flipkart. This transaction is seen as Walmart’s effort to counter Amazon in the Indian market.
The transaction in its present form involves Walmart acquiring 77% stake in FPL for a sum of approximately $17.69 Billion. This acquisition will give Walmart control over FIPL as well as other group subsidiaries.
Among the major shareholders who will be selling their shares in Flipkart to Walmart:
- SoftBank – 22.30%
- Tiger Global – 16.99%
- Naspers – 13.76%
- eBay – 6.55%
- Sachin Bansal – 5.96%
- Accel Partners – 2.88%
- Binny Bansal – 1.63%
- Others – 6.93%
2. Potential tax considerations
The tax considerations that may arise during the course of this transaction can be categorised under four broad heads:
- Tax liabilities on Indian shareholders;
- Tax liabilities on foreign shareholders;
- Carry-forward of losses;
- Taxation of Employee Stock Ownership Plan (“ESOP”).
A. Taxes payable by Indian Shareholders
As per the scheme of the Indian Income Tax Act, 1961, (“IT Act”), Indian residents are required to pay tax in India on their global income. As per Section 45 of the IT Act, all profits or gains arising from transfers of capital assets are chargeable to income-tax under the head “capital gains” and deemed to be income of the previous financial year. Shares are included in the definition of “Capital Asset” under section 2(14) of the IT Act, and hence share transfers are subject to payment of capital gains tax under the IT Act.
The applicable tax rate on capital gains differs according to the nature of the capital asset and the time for which it was held prior to transfer. Accordingly, capital gains may be treated as Long Term Capital Gains (“LTCG”) or Short Term Capital Gains (“STCG”), depending upon the holding period of the capital asset. For unlisted shares, STCG is applicable when the shares were held for a period of less than 24 months prior to transfer, while LTCG is applicable if the holding period of the shares was more than 24 months.
In the present case, the only shareholders resident in India that are transferring shares to Walmart are the founders of Flipkart- i.e. Sachin and Binny Bansal. The founders have held their shares in Flipkart since the company’s inception, thus they are required to pay LTCG tax at a rate of 20% plus applicable surcharge and cess, with indexation benefit being available upon a transfer of their shares to Walmart.
Indexation is a process by which the cost of acquisition of the asset is adjusted to account for inflation, which is likely to artificially raise the value of the asset. The value of acquisition is thus calculated in a manner such that it is inflation-adjusted with market prices at the time of transfer.
B. Taxes payable by Foreign Shareholders
The current transaction is structured in a manner that Walmart will acquire a controlling stake in the Singapore based holding company of Flipkart i.e. FPL, which will indirectly give it full control over the operations of the Company in India without the transfer or subscription of any shares in India.
After the famous Vodafone case from a few years ago, transfer of shares of a foreign company which derives substantial value from India is also taxable in India. Section 9(1)(i) of the IT Act states:
S. 9(1) The following incomes shall be deemed to accrue or arise in India:
(i) “all income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.”
As per the scheme of the IT Act, this section becomes applicable in situations where the value of the Indian asset owned by the foreign entity is more than 50% of all the assets it owns. In the present case, more than 50% of the assets of FPL are derived from India and consequently this transaction should be chargeable to tax in India under section 9(1)(i) of the IT Act.
Since the transaction envisages sale of shares by foreign shareholders, the taxability of transfer of shares by such foreign shareholders also needs to be examined from the perspective of Double Taxation Avoidance Agreements (“DTAA”) between India and the country of residence of these foreign shareholders, if any. Based on information available in the public domain, we understand that these foreign investors are registered in the USA and Mauritius. Hence, India’s DTAAs with these countries will need to be examined to understand the tax implications in this respect.
As per Article 13 of the India-US DTAA, India has the right to tax capital gains arising out of the transfer of capital assets situated in India as per its domestic tax laws in case the investors are tax residents of the USA. In this background, it is likely that the transfer of shares of FPL by its investors based in the USA will be liable to tax in India on account of Section 9(1)(i) of the IT Act, as discussed above. In this situation, capital gains under Section 45 of the IT Act will apply, and it is likely that the transfer of shares of FPL by investors based in the USA is likely to be charged at 20% tax on their capital gains.
With respect to investors based in Mauritius, the India-Mauritius DTAA allows India the right to tax capital gains for assets situated in India. However, Article 13 contains grandfathering provisions that render any shares acquired before 1 April 2017 not taxable in India and taxable only in Mauritius. As a result, the transfer of shares of FPL by its Mauritius registered investors may not attract any tax in India as per the India-Mauritius DTAA, if the investments were made prior to 1 April 2017. If the investments were made after 1 April 2017, a tax equivalent to 50% of the tax chargeable in India may be applicable, as per Article 13(3)(B) of the DTAA.
One risk to be kept in mind is that if the investors have structured their investments through Mauritius solely for the purposes of saving tax even though they are residents of other countries, provisions of the General Anti-Avoidance Rule (“GAAR”) may be invoked by the Indian tax department to charge tax in India.
Given the complications in determining place of residence of investors and the lack of information in the public domain on the details of the transaction, the tax risks for foreign shareholders of FPL remain uncertain with respect to the current transaction.
C. Carry Forward of losses
As per Section 79(a) of the IT Act, if there is a change in shareholding by more than 49% of a company, any losses incurred by the company cannot be carried forward to future years to claim tax benefits. Therefore, it may not be possible to carry forward any tax losses suffered by Flipkart in India after the transaction with Walmart is completed.
There is a limitation of 8 years to carry forward any tax losses under Section 72 of the IT Act. From a practical standpoint, the online marketplace model that Flipkart operates takes several years to return profits, and it is likely that this may far exceed the 8-year limitation period to carry forward losses under the IT Act. As a result, it is possible that Flipkart may not have been able to carry forward its losses even in the absence of change in shareholding envisaged in the present transaction. Thus, it is possible to say that denial of the ability to carry forward losses due to the change in shareholding may not have a significant impact on the tax implications of this transaction.
D. Taxation of ESOPs
ESOPs are a way to incentivise participation in a company by providing the company’s employees the option to own shares in the company upon fulfilment of certain conditions. The option granted under an ESOP gives an employee a right, but not an obligation to purchase the company’s shares.
Employees are taxed for their ESOPs at two stages- first, when the ESOPs vest in the employee as a difference between the price at which the ESOP is allotted and the fair market value of the shares on the date of vesting, and second as capital gains when the employee transfers the shares for profit. From a reading of publicly available information pertaining to the present transaction, Flipkart too has an extensive ESOP scheme. However, it remains unclear as to whether these ESOPs pertain to the Singapore based holding company i.e. FPL, or to Flipkart India i.e. FIPL.
There are two ways in which Flipkart’s ESOPs may be treated to facilitate the acquisition by Walmart- they may be acquired by the company as a part of a buy-back scheme prior to the acquisition by Walmart and then transferred to Walmart subsequently, or the employees may transfer their shares to Walmart directly. The first outcome is far more likely from a business perspective, since Walmart would prefer to acquire these shares as one block from Flipkart, instead of having to deal with small shareholders individually.
If the buyback route is followed, Section 10(34) of the IT Act will be applicable, and the profits made by shareholders will not be taxed as capital gains. Instead the company will be required to pay additional tax on the buyback of shares. This is advantageous for the employees holding ESOPs.
On the other hand, if the transaction is structured in a way that employees transfer their vested shares to Walmart directly, the profits made by these employees will be taxable as capital gains as per Section 46A of the IT Act.
There is lack of clarity on the entity that Flipkart’s ESOPs are vested in, and the mechanism by which ESOPs will be transferred to Walmart. This is another potential issue that may arise when the Indian tax authorities examine this transaction.
3. Concluding remarks
Walmart’s acquisition of a majority shareholding in Flipkart, while a landmark transaction in terms of sheer magnitude and impact on the market, is also a potential landmine with respect to the tax considerations involved. If newspaper reports are anything to go by, the transaction has already caught the attention of Indian tax authorities, who have requisitioned the transaction documents to gain a better understanding of the commercial intent of the parties.
It is a long road ahead for the parties, and only time will tell if this is another huge tax dispute in the making. The position of law is much clearer than the Vodafone case, when the applicability of indirect transfer provisions under Section 9(1)(i) of the Act was first examined. Since then India has signed and amended a number of DTAAs with various countries to ensure that profits made in India are taxed in India and foreign entities do not make profits in India without being accountable for them. That said, there are several other considerations involved in the present transaction, and it’ll be interesting to see how these issues are handled by the parties concerned and the tax department.
This post was co-authored by Viraj Joshi and Ashish Nath Jha. Viraj is an Associate in the Delhi Office of GameChanger Law Advisors. Ashish is a 4th year B.A. LLB Hons. student at Gujarat National Law University, who is interning with us over the summer.
For any further queries on this topic, please contact Viraj Joshi (firstname.lastname@example.org)