Future of Multi-Layered Structures?
Last week, in a Conference hall on the 15th floor of the RBI headquarters in Mumbai, 12 people met in a closed door meeting. Now RBI holds plenty such consultative meetings; so why are we getting our knickers in a twist. Because this group of 12 -G12 - including 2 Finance Ministry officials, were discussing the future of overseas direct investments (ODI) made by Indian corporates using multi-layered structures. And the meeting invitation has an ominous note to it. The RBI says 'it has been observed that a number of foreign entities, with multi-layered structures involving special purpose vehicles (SPVs), have been set up/acquired by many Indian corporates. These SPVs act merely as holding entities between the Indian party and the ultimate operating foreign entity. The setting up or acquiring the step down subsidiary abroad as holding entity (SPV) has not been envisaged under the notification.'
The notification RBI is referring to is the FEMA notification of July 2004 that lays down regulations for direct investments outside India. Anyways, RBI called the meeting to examine the matter of setting up/acquiring multi-layered structure of foreign entities involving overseas direct investments by Indian corporates. What prompted this and how did the meeting go? I have 2 of those special 12 people on the show with me today -Vivek Mehra of Pwc and Hitesh Gajaria of KPMG.
Doshi: I am told there were two sets of concerns that were laid on the table, you had RBI which has its own concerns and then you have the two representatives of the Finance Ministry that had very separate different concern, can you take us through them?
Gajaria: I believe that a couple of months ago, the Ministry of Finance, Department of Revenue may have written to RBI asking it to relook at the outbound investment framework that they had put out way back in 2004 and even before that in 2000 when Foreign Exchange Management Act (FEMA) was enunciated and their concern seems to emanate from the fact that many outbound Indian corporates had multi-layered investment holding companies or SPVs before the actual investment went into the operating company. So from a Ministry's perspective, this ought not to be encouraged and I believe therefore they were trying to discuss with RBI where the RBI ought to change or amend its regulations.
Doshi: Why did the Ministry believe that this ought not to be encouraged, what were the reasons?
Gajaria: That came out in the discussion that we had.
Doshi: In the G12 meeting.
Gajaria: In the G12 meeting, as you say, where Mr Srinivasa Rao who is representing the foreign tax division actually enunciated that philosophically the Department of Revenue believes that multi-layered SPVs encourages 'treaty shopping'.
Doshi: But why would it matter to the Indian department of revenue because if at all it encourages treaty shopping, it is the foreign country where you are making this acquisition or ultimately doing business that is concerned with this matter, right?
Gajaria: I understand but from a philosophical perspective whether it is inbound investment and multi-layered structures affecting Indian tax or outbound investments multi-layered SPVs affecting taxes of actually foreign governments- the Ministry of Finance seems to feel philosophically that both these ought to be discouraged.
Doshi: So because we don't like treaty shopping, we don't want to encourage you Indian companies to treaty shop with any other foreign government?
Mehra: I am a little amused with this philosophy because the Foreign Investment Promotion Board (FIPB) regularly approves foreign investment into India through Mauritius, through Cyprus, through Singapore and the department of revenue.....(Interrupted)
Doshi: But that used to be the case. As you can see, the mood has considerably changed in North Block, they now want to block all of that whether through General Anti-Avoidance Rule (GAAR) or through treaty override or through all kinds of other situations, so maybe they want to expand the same treaty.....(Interrupted)
Mehra: That is a provision in the Income Tax Act but the Foreign Investment Promotion Board of FDI doesn't change.
Doshi: Philosophically I agree with you that this is an odd position to take but this seems to be the position that the finance ministry has taken in this RBI meeting.
Gajaria: Can I add something? What I understand, even in the FIPB meetings, the Department of Revenue always raises an objection when the investment is being made through Mauritius or Cyprus or wherever but on a holistic basis, the approvals are given because only revenue concerns do not drive Foreign Investment Promotion Board when they give their approvals.
Doshi: I am sure the department is making notes so as to pass on to their tax officers down the line, right?
Gajaria: I wouldn't know what they would do.
Doshi: So we have on the table what the Finance Ministry's concerns are regarding ODI through multi-layered SPVs or structures but Mr Mehra RBI itself also had some concerns- so let me ask you what RBI put on the table in that meeting?
Mehra: RBI's concerns largely were opacity and also whether through these means - what was discussed was is the 400% net worth limit being exceeded by these structures, the answer clearly from RBI itself was no. Is there opacity happening with this? Well, opacity also happens through multi-layered operating companies. RBI clarified that they have no problem if they are multi-layered companies provided they are all operating one below the other. You get opacity through that also. So the consensus was just ask for all the information. Let it be obligatory for every company to furnish all information. Another concern was, are you getting into prohibited activities? There are certain activities in overseas investments, which are prohibited, are you getting into those? You can get into those through holding companies, you can get into those through operating companies, so it is only a question of you certifying that neither the money that is going out of India is getting into any activity that is not permitted or prohibited and maybe even the accrual of income is not getting into those activities. There are certainly countries where you may not invest like Pakistan. Right?
So just by having a holding company, you don't avoid that. Even an operating company can do that. So it is a question of you certifying to RBI in your annual performance reports (APRs) that what activities you are doing and giving them the entire nine yards. That could solve the opacity problems.
Doshi: The concerns you are raising seems to be concerns that can be easily fixed by more disclosure. I am more worried about the tenor- the note of that invitation -has gone out in which the RBI seems to be indicating that while companies in this country may have been using multi-layered SPV structures to make acquisitions or invest overseas, RBI is saying our 2004 notification never envisaged more than one SPV or more than one overseas SPV and that is what concerns me the most because I don't understand, are they changing position with regards to interpretation of that circular?
Mehra: I feel this was very much - there was a circular when it was not allowed and then they allowed it. Now after many years, they have come back and said that we said a SPV, now once you set up an SPV, you can do anything below it and where does a singular not include the plural.
Doshi: I don't know if this is an interpretation battle or a legal battle or a grammatical battle because if you read the 2004 ODI regulations, they do refer to SPV in singular everywhere.
Gajaria: I understand but so do they refer in singular to many other things, for example joint venture party is all referred to in singular, wholly-owned subsidiary is also referred in singular.
Doshi: So is it your position that multiple SPVs have been allowed?
Gajaria: Exactly and I tell you what strengthens this. Now from 2004, let us say even when this new circular came, there have been at least six yearly annual performance reports filing before RBI where all these structures have been disclosed to them.
Doshi: The Novelis type?
Doshi: I am using those generically to describe multi-layered SPV.
Gajaria: So if they had any concern all these years, they should have expressed it then.
Mehra: You are absolutely right. Let me add to that. I have had a case which the RBI had investigated and they have found fault in certain aspects of round tripping but they never objected to multi-tiered structures and they had the entire structure with them. So if they thought that was not permitted, they would have objected to that too.
Doshi: I buy the point that till now RBI hasn't said otherwise and therefore we believe our interpretation of the regulation stands but the question is RBI is bringing it up today and I am guessing it brought it up in that meeting and that to me seems to be more sort of a cause for worry or concern than the issue regarding more disclosures or anything else? What was the outcome of this discussion?
Gajaria: Let me clarify - all of us when we started with our discussion first of all pointed this very fact out to the RBI that we are sadly surprised at the tenor and the tone of this letter which seems to suggest that multi-layered SPVs are not permitted under the regulations wherein that has not been the case and there have been umpteen instances of such things haven't been done.
Doshi: What did RBI say?
Gajaria: RBI did not react to that. They said yes, we understand, we hear you and the reason we are calling this meeting is to find out what do the various stakeholders have to say about it. So in a way, they did not say yes, they did not say no, they just let that issue be.
Doshi: That is more worrisome because the interpretation stays open
Gajaria: No, I would not. I tell you why.
Mehra: They have been ambivalent on this for a long time.
Doshi: Both of you tell me what does this mean, are multi-layered SPVs allowed or not allowed and if they are not allowed, what happens to the existing structures?
Gajaria: No, so I would not go to the extent of saying, RBI has said these are not allowed. All I would say is there was some confusion in the last month or so. I believe it may have been created by the Finance Ministry's note to the RBI.
Doshi: The Finance Ministry's concerns are entirely to clarify, right?
Gajaria: I understand that, absolutely but at some point in time maybe RBI may have been colored by what the Finance Ministry said, read up the regulations and maybe buying (Interrupted)
Doshi: So you have problems with treaty shopping, let me convert that into a misinterpretation of the regulation of 2004.
Mehra: Let me tell you how this will be sorted out. I have received permissions from RBI saying we see you have a multi-layered structure- pending our final decision in the matter- this maybe continued. If we ask you to truncate it, you will have to. So they know it is a suspended animation pending a final decision and this meeting was for that purpose.
So hopefully old SPVs, multi-layered structures will be permitted if the decision now is to go ahead. If the decision is not to have them, then they will try to tell everybody who comes to them truncate it but I don’t think they will penalized.
Doshi: So what you are saying is that the silver lining in this cloud is that they may not penalized but they may ask you to collapse several of these structures thereby having only one offshore SPV= that is disastrous in the kind of distortion or disturbance it can create, so what is the current position?
Mehra: It can be huge; you can have huge tax liabilities. But today the stand is that we have to still take a final decision in the matter.
Gajaria: So that is the position today. RBI has not made up its mind.
Doshi: Is it permitting multi-layered structures, the structures that you take to them is it saying yes, go ahead?
Gajaria: No. let me explain now. What is happening actually you don't have to go to RBI for 90% of the cases or 95% of the cases because they have under the automatic route fairly generous provisions where you need not seek their prior approval. It is in some cases where you are going to seek their prior approval i.e. for example, I will give you a real life case, somebody needs to provide a guarantee to obtain bank financing to a second level subsidiary or a third level subsidiary. That is where RBI is sitting on the file and issuing letters to say - is it possible that you come to us with the definite plan to either convert those SPVs into operating companies or to collapse those SPVs.
Doshi: So both of you are painting an ominous picture to me and my instincts were right when I read that invitation letter because it does seem that if RBI has been sitting on the fence for the last several months, it may be now close to making up its mind on whether it should allow for multi-layered SPVs offshore to exist or not or ask for all the existing such structures to collapse into one and not permit them in the future?
Gajaria: No, so let me turn the table completely the other way. Till that meeting, I would have agreed with you. In the meeting, we were pleasantly surprised because RBI allowed all stakeholders to say whatever they had to. In that very meeting, the officers down below the line were questioned when all of us gave our commercial reasoning for SPVs and they were asked to present before us what were their concerns and when it emanated that most of the their concerns could be fixed by proper disclosure, RBI - I believe in that meeting was fairly convinced that it ought not to enforce this issue of multi-layered SPVs being collapsed or converted.
Doshi: The question I want to ask you is (Interrupted)
Mehra: That is my impression also.
Doshi: If that is your impression also, then it seems that RBI will see the commercial logic that you all have presented to them that underlies the existence of such multi-layered structures. It will buy into that logic, maybe ask for more disclosures but the matter will get settled here and there will not be any big disturbances.
Mehra: We believe so.
Doshi: But we still have the pending issue of the Finance Ministry.
Mehra: Let me just mention one thing, I can always have an operating company and do treaty shopping through that.
Doshi: I know you can; therefore I am saying, we still have unresolved what your takeaway was regarding the Finance Ministry's concerns and whether you all were able to convince Mr Rao that it is not necessary for him to clamp down on these structures.
Mehra: Absolutely, just as India does not prohibit FDI through Mauritius, so there is an FDI policy, there is FEMA, this is also a FEMA policy of RBI.
Doshi: Did you convince Mr Rao? Were you able to leave the meeting convinced that the Finance Ministry understands the reasons for why you all structure SPVs, the way you do overseas and that they may not clamp down on it based on your arguments?
Mehra: I feel clamping down is the prerogative of the RBI; not the Department of Revenue. This is the domain of RBI, so it is a consultative process they have or a concern of the department of revenue and I don't think revenue should interfere in either foreign direct investment policy or in the overseas direct investment policy. They can do what they like to tax people but not (Interrupted)
Doshi: You don't think they should interfere but they very well could. What is the key takeaway on that front?
Gajaria: No, let me share with you another interesting inside. On that meeting, was also Mr YH Malegam who is on the board of RBI and Mr Malegam summed it up very well by addressing the concerns of the revenue by saying that Mr Rao instead of trying to worry about the ghost of treaty shopping, why doesn’t the government think of ways to encourage actually repatriation of dividend back to this country and in fact he gave concrete examples of what the revenue should look at to encourage business and encourage people to bring in money.
Doshi: That may solve a different problem of bringing the money back, that is an Indian revenue department issue, but the original philosophical issue that you brought up that Mr Rao expressed that has not been done with it-I want to know the conclusion on that.
Mehra: The philosophy, I said, it is very good to have a philosophy but if I pay more taxes overseas, I will pay less taxes in India. I think that realization to some extent did come though. Philosophy kept coming up again but the fact is if I pay taxes overseas, then I will pay less taxes in India.
Doshi: Has Mr Rao rested his case after that meeting?
Gajaria: I do not think he has rested his case. It will be fair for me to say, I don't think he was convinced 100%. However, he also very patiently understood the other point of view that it is not always that a clamp down will serve the purposes for which it is meant and it is interesting, he started on a philosophical note of treaty shopping and ultimately came to a situation to say but we are not getting any dividends back into the country. So even they were a bit confused on what they wanted to do.
Mehra: SPVs or holding companies overseas are taxed, treaty shopping is just one small objective- the main objective is having a sectoral holding company leveraging IPOs or funds by private equity or strategic investors overseas raising debt, having debt pushed down, your acquisition debt interest would be put against target companies- those are hundreds of commercial reasons but merely because treaty shopping could be done, doesn’t mean you stop a good structure.
Doshi: I and my audience understand the commercial rationale for why you have multi-layered SPVs including lower tax but maybe the finance ministry doesn't fully accept the various commercial rationales. I conclude on these two notes that if at the end of this, you have more disclosures- thanks to the RBI's concerns and maybe an incentivized structure to repatriate dividends -then this has been a good meeting with a good conclusion if not then this would end up being a very....(Interrupted)
Gajaria: Let me share with you, it was a good meeting, all the 12 agreed that this was the very positive step by taking everybody's view and everybody ended on a happy note, they all there had their say.
Mehra: On a happy, positive, encouraged note.