INTRODUCTION

‘Flipping’ refers back to the means of transferring the complete possession of an Indian entity to an entity included overseas, together with a switch of the important thing belongings akin to mental property. The resultant construction is an Indian firm changing into an entirely owned subsidiary of a international firm, with the day-to-day operations being carried out in India. Effectively, the possession of the entity is externalised overseas, whereas the worth of such entity might proceed to vest with the Indian entity. 

While flipping is mostly thought of to be simpler on the preliminary levels of the life cycle of an entity, mature constructions have additionally flipped out of India in the previous few years for a myriad of causes. A predominant purpose for flipping has typically been the entry to a world pool of buyers, ease of itemizing on abroad exchanges, greater valuations in inventory exchanges overseas, broader buyer base in new geographies, comparatively simpler regulatory regimes, founder preferences and taxation advantages accruing to worldwide buyers of their host jurisdictions.¹ Singapore, Cayman Islands, United Kingdom and the United States of America have been fashionable examples of nations to which Indian entities have ‘flipped’.

However, there’s a marked rise in ‘reverse flipping’ into India not too long ago. As the title suggests, reverse flipping refers back to the means of internalising by way of an integration of possession and worth of an entity again into India. Thus, the shares of the international and Indian shareholders (that had been initially held on the international holding firm degree) are swapped for shares of the Indian firm, pursuant to which the international firms / offshore holdings are dissolved or merged into the Indian entity and all of the shareholders on the offshore degree personal the shares of the Indian entity. While this may increasingly have a couple of hostile implications (together with tax implications) on the buyers, the overall motivation for a reverse flip is the elevated certainty of an exit at the next valuation in India.

In this text, we look at the Indian ecosystem to hint potential causes for a rise in reverse flipping (alternatively known as “internalisation”) by entities and set out varied concerns for entities contemplating a reverse flip into India within the close to future.

Why is reverse flipping on the rise in India?

The Economic Survey 2022-23 has noticed that there’s a conducive atmosphere for a rise in internalisation into India as a result of varied initiatives, reforms and schemes focused in the direction of start-ups by the Government of India, better entry to capital throughout the prevalent personal fairness and enterprise capital setup, the rising maturity of Indian markets, and the current adjustments in guidelines concerning round-tripping.² Key authorities initiatives focused in the direction of start-ups embody the schemes falling underneath the broader aegis of the National Initiative for Developing and Harnessing Innovations, the Fund of Funds for Start-ups and the Atal Innovation Mission, geared toward encouraging the event of indigenous merchandise and offering monetary help / seed funding to Indian start-ups throughout their childhood. With varied reforms and the current liberalization of laws, the Government of India has not solely enhanced the convenience of doing enterprise in India however has additionally reinstituted the misplaced religion of international institutional buyers in India.  

An essential issue contributing to this development is the altering angle of founders and the administration, who’ve begun acknowledging the worth created, elevated funding curiosity, model relationships fostered and energy of the shopper base in India and its direct proportionality to attractiveness by way of a near-future exit by the use of an preliminary public providing (“IPO”). With considerations in regards to the impending funding winter persevering with to plague startups in 2023,³ tough situations within the world markets and the steep fall within the valuations of new-age tech corporations, it has turn out to be crucial for entities to revisit and re-strategise their enterprise fashions for natural development and elevated buyer centricity. If the worth related to the work of those entities lies inside India, a return to India could also be extra useful to their enterprise operations and contribute to constructive market notion. Even in any other case, there’s a discount within the administrative / managerial overhead bills incurred and relevant statutory compliances to be adhered to, because the operations of the entity will solely be restricted to 1 nation.

Established firms akin to PhonePe⁴ and Pepperfry⁵ have not too long ago internalised into India – which solely demonstrates the rising recognition of resorting to the method of internalisation.

Key concerns in respect of reverse flipping

While reverse flipping might prima facie appear fascinating given its rising recognition and a relatively extra supportive regulatory atmosphere creating in India, it is crucial for entities, their managements and taking part shareholders to judge a number of authorized and business concerns which will come up whereas shifting their domicile again into India.

Some of those concerns embody:

1. Structuring the internalisation

The most essential step within the means of internalisation is discovering the fitting construction which inserts into the authorized, regulatory and tax contours of the related jurisdictions in query. While an in-bound merger (whereby a international entity merges into the Indian entity, the belongings and operations of the international entity are finally owned and managed by the Indian entity, and the shareholders of the international entity are issued shares of the Indian entity as consideration) appears to be the only of the constructions for internalisation, we now have additionally explored a share swap association the place the shareholders of the international entity swap their shareholding in such international entity with the shares of the Indian entity.

A diagrammatic illustration of those constructions (i.e. the in-bound merger into India and a share swap association) is as depicted beneath: 

[N.B.: In relation to both the aforesaid diagrams, the arrows in black indicate the structure of the entity prior to undertaking the reverse flip, that will be impacted by the reverse flip i.e. the shares currently held in the structure, that will be cancelled / swapped upon consummation of the inbound merger / share swap or sale (as applicable). The arrows in red reflect the steps and the resultant structure that will exist upon consummation of the reverse flip in either scenario.] 

In India, the method of mergers is court-driven and must be accepted by the National Company Law Tribunal (“NCLT”). According to Section 234 learn with Section 230 of the Companies Act, 2013 (“CA 2013”), events wishing to consummate a merger should strategy the NCLT for prior approval by offering all materials info regarding the merger in a ‘scheme’. During the method of evaluation of the scheme, the NCLT might name upon conferences of all members / collectors of the entity and ship notices to different regulators such because the Registrar of Companies and Regional Director.⁶ Upon receipt of objections / representations from these regulators and authorities (if any), the NCLT will analyse the scheme and grant its approval. In India, the method of acquiring approvals for such schemes is long-drawn and takes at the very least 6-9 months.  

Besides analyzing the relevant Indian legal guidelines, internalisation brings a further layer of complexity by way of requiring an evaluation of needed actions which may be required for the out-bound mergers underneath the company regulation of the host nation by which the international entity is included.

The challenges which will probably come up differ from jurisdiction to jurisdiction. For occasion, in Singapore, an outbound merger with an Indian entity has not been examined and should require prior clarifications and approvals of the regulators earlier than effectuating one.⁷ In Cayman Islands, the dissolving entity is required to fulfill the home Registrar of Companies that the merger pursuant to which it’s to dissolve: (i) shouldn’t be prohibited by the constitution paperwork of the corporate; and (ii) no excellent petition for winding up / liquidation of the corporate is pending in every other abroad jurisdiction aside from the proposed merger.⁸ Parallelly, the corporate should additionally name for a gathering of its Board of Directors to approve a written plan of the merger,⁹ after which submit all related paperwork for issuance of a ‘strike-off’ certificates indicating dissolution of the entity underneath Cayman firm regulation.¹⁰ In Mauritius, reverse flips are prone to be topic to the provisions of Section 247 of the Companies Act, 2001 which prescribes the process for “short-form amalgamations” in case: (i) an organization and corporations which can be instantly or not directly wholly owned by it are to amalgamate; or (ii) two or extra firms, every of which is instantly or not directly wholly owned by the identical firm, amalgamate as one.¹¹ Under the Delaware General Corporate Law relevant to Delaware outbound mergers, prior approval of the Board and shareholders of the amalgamating firms is required.¹² However, the regulation particularly additionally gives that even when the resultant entity is a international company, it could be required to observe the method underneath this regulation in relation to any obligations / enforcement of any obligations as relevant to the resultant entity and arising from the merger.¹³ With all these concerns, there’s an elevated risk of delay in timelines, since there’s regulatory uncertainty that prevails throughout the two jurisdictions. Thus, in case internalisation is taken into account by the use of a cross border merger, the success thereof would depend upon approvals by the authorities and due regard to the timelines and procedures for consummation of such constructions in all related jurisdictions.

2. Tax implications

If the reverse flip is carried out by the use of an in-bound merger, the shareholders of the international amalgamating entity will be capable to declare exemption from capital beneficial properties tax arising out of such switch, topic to such transaction qualifying as an ‘amalgamation’ underneath the provisions of the Indian Income Tax Act, 1961 (“IT Act”). The time period “Transfer” underneath the IT Act contains extinguishment and/or relinquishment of capital belongings. Accordingly, in case a reverse flip is carried out by the use of a cross-border merger (which doesn’t meet the situations set out underneath the IT Act to be thought of an exempt switch), it might tantamount to cancellation of shares of the international entity as held within the Indian entity and consequently, capital beneficial properties upon extinguishment of such shares can also be taxable within the palms of international entity.

However, if the reverse flip includes a swap of shares held by the international shareholders within the international entity with the shares of the Indian entity, the international shareholders will likely be topic to tax in India on the delta between the worth of shares of the Indian entity on the time of such reverse flip and the price of acquisition of the shares of the international entity.

As an instance, the capital beneficial properties taxes paid by the shareholders of PhonePe (in case of swap of shares) throughout its shift to domicile in India was as excessive as nearly INR 8,000 crores.¹⁴ Investors that may bear these taxes would typically advocate for sturdy exit provisions (typically, by way of an IPO) in alternate for such taxes, making the strain of brief to medium-term efficiency on the entity greater.

Further, as per the provisions of the IT Act, any earnings arising from a switch of share or curiosity in a international firm or entity, is taxable in India (within the palms of the international shareholders), if such share or curiosity derives substantial worth from belongings positioned in India within the method set out within the IT Act. Accordingly, in case of a reverse flip by the use of swap of shares, the oblique switch tax provisions shall should be evaluated, from the angle of extinguishment of shares of the shareholders of the international firm.

During structuring internalisation, it could even be essential to contemplate potential considerations which may be raised by international buyers of the tax evaluation threat and vagaries of the taxation system in India, on condition that they are going to now be topic to tax in India.

Tax treaty advantages that had been beforehand obtainable to international shareholders might not essentially be obtainable to them within the resultant Indian entity, except India has signed a Double Taxation Avoidance Agreement (“DTAA”) with the nation they’re residents in. As an instance, any funding within the shares of an Indian entity till April 1, 2017, by an entity resident in Singapore was grandfathered from capital beneficial properties tax in India. Accordingly, any capital beneficial properties arising from the alienation of such investments (if such investments are made after April 1, 2017) will likely be topic to capital beneficial properties tax in India as per the DTAA between India and Singapore.

In relation to the international shareholders, it’s also essential to contemplate the tax implications that can come up on the time of exit from the Indian entity within the close to future by the use of an IPO or a switch.

Lastly, you will need to be aware that the amassed losses obtainable within the monetary statements of the Indian and offshore degree previous to internalisation might lapse and might not be obtainable for set off if sure shareholding thresholds are breached.

3. Compliance with the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Cross Border Regulations”)¹⁵ and allied legal guidelines

As talked about above, the method of in-bound mergers is broadly regulated by the provisions of Chapter XV of the CA 2013. The related guidelines are the Companies (Compromises, Arrangements and Amalgamations) Rules 2016. Under Rule 25A of those guidelines, prior approval of the Reserve Bank of India (“RBI”) is required for in-bound mergers. In this regard, the RBI framed the Cross Border Regulations which gives that merger transactions in compliance with these laws shall be deemed to have been accepted by RBI, and therefore, no separate RBI approval ought to be required. In different instances, cross-border merger transactions shall require prior RBI approval.¹⁶

According to the Cross Border Regulations, issuance or switch of securities to an individual resident exterior India by the use of an in-bound merger (in case of internalisation, a switch of shares to the international buyers / shareholders) must be undertaken in accordance with the pricing tips, entry routes, sectoral caps, attendant situations and reporting necessities for international funding as laid down underneath Foreign Exchange Management (Non-debt Instruments) Rules, 2019,¹⁷ together with due regard to the provisions of the not too long ago enacted Foreign Exchange Management (Overseas Investment) Rules, 2022. Additionally, for all ensures and excellent borrowings of the international firm that are obtained from international sources and turn out to be the borrowings of the resultant entity, the Cross Border Regulations prescribe that such ensures and borrowings must adjust to exterior business borrowing / commerce credit score norms or different international borrowing norms (as relevant) inside two years from the date of the in-bound merger.¹⁸

Under the Cross Border Regulations, the resultant entity shouldn’t be restricted from holding belongings or securities exterior India except barred by the Foreign Exchange Management Act, 1999 (“FEMA”) or the foundations / laws framed hereunder. In case such holding is barred, the resultant entity should promote such asset or safety inside a interval of two years from the date the scheme has been sanctioned by the NCLT, and the sale proceeds shall be repatriated exterior India instantly by way of banking channels.¹⁹ However, if such holding shouldn’t be barred, they are often freely transferred within the method prescribed by the FEMA and the foundations / laws framed hereunder²⁰ – making switch of belongings akin to goodwill and mental property possible.

4. Feasibility of IPOs

For current institutional buyers, an exit inside a definitive timeline is essential to realization of the worth of their funding. Since an IPO continues to be the some of the most well-liked mode of exit for these buyers, it turns into essential for firms to reveal shorter and medium-term plans to checklist on the first markets.

With the surge in profitable IPOs on the Indian market in 2021 and subsequent lowered IPO exercise throughout most of 2022,²¹ commercially, it can proceed to stay tough to find out whether or not the Indian marketplace for IPOs will stay enticing for the resultant internalised entity. Although the development is anticipated to vary for the bigger good in 2023,²² the general market sentiment and response in the direction of a to-be listed firm’s merchandise / companies and sector on the time of a contemplated exit (i.e. as soon as the NCLT approval for the merger is acquired), can’t be conclusively predicted.

Furthermore, current buyers may even have to contemplate the switch restrictions prescribed by SEBI of the shares held by them. According to the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018, the revised non-promoter shareholder lock-in requirement for all shares held by such investor within the pre-IPO interval, is 6 months from the date of allotment within the IPO.²³

5. Press Note 3 (2020 Series) approvals (“PN3”)

Given {that a} reverse flip might entail the entry of international buyers in India, it could require prior approvals from the Government of India because the PN3 could also be triggered. According to the PN3, prior approval is required when an investing entity is located in a rustic sharing land borders with India, or the place the useful proprietor of an funding into India is located in or is a citizen of any such neighboring nation.²⁴

Thus, it is crucial for entities contemplating a reverse flip to evaluate the applicability of PN3 to every of their international retail and institutional shareholders properly upfront. However, presently, there are important uncertainties related to the procedures regarding the PN3 itself, starting from lack of readability in regards to the scope of “beneficial owner” to an absence of clear timelines for the processing of PN3 functions.²⁵ Additionally, any people who’re the nationals of such neighbouring nation would require prior safety clearance from the Ministry of Home Affairs previous to accepting a directorship on the board of the Indian firm.²⁶ While the PN3 software can have the impact of delaying timelines for the restructuring, as a result of elevated variety of rejections of such functions in current occasions,²⁷ the events will must be equally ready for a rejection, by which case the complete flip might flop. 

6. Other regulatory and sectoral approvals

Apart from the PN3, quite a few different regulatory and sectoral approvals could also be triggered relying upon the sector that the entity is working in. For occasion, a previous approval of the Government of India / RBI could also be required if the internalised entity is enterprise enterprise in a sector falling underneath the ‘approval route’ as set out within the Consolidated Foreign Direct Investment (“FDI”) Policy of India.²⁸

Approvals can also be triggered relying upon the character of enterprise or licenses held by the entities concerned within the reverse-flip. By manner of instance, prior written approval of the RBI is required for “change in control” of non-banking monetary firms²⁹ and housing finance firms.³⁰ Since the international entity will likely be dissolved and all shareholders will transfer into the Indian entity, there’s a change within the management, possession and shareholding construction (together with a probable change within the administration) of such entity and accordingly, all relevant approvals linked to ‘control’, ‘management’ and / or ‘shareholding’ in an entity must be procured. As one other occasion, cost aggregators can also have to notify the RBI about any change in management or administration, and the RBI might place restrictions upon the administration relying on its examination of the declaration.³¹

An entity can also have to look at whether or not an intimation / approval of the Competition Commission of India (“CCI”) will likely be triggered on account of the internalisation. Parties must consider whether or not there’s an acquisition of management pursuant to the consummation of the construction and the small print of the deal worth / asset measurement and turnover of the entities concerned. Depending on the construction finalized, a notification underneath the Competition Act, 2002, could also be required to be offered to the CCI, not solely by the entities concerned but in addition the international buyers (being acquirers).³²

Accordingly, all of the regulatory and sectoral approvals that will likely be required, not solely in India but in addition within the host international locations of the offshore entity, must be totally analysed whereas assessing the construction and timelines for enterprise an internalisation into India.  

7. Employee Stock Option Plans (“ESOPs”)

With respect to staff engaged by the international entity previous to internalisation, such staff can both proceed their employment with the surviving Indian entity as a part of the reverse flip or they are often discharged from the employment with the international entity after settling and paying them in full on the offshore degree. In case the staff comply with the switch of their employment to the Indian entity, any inventory choices granted / promised to these staff (exterior India) will must be structured as per the necessities underneath the Indian company legal guidelines and can must be exchanged for inventory choices issued by the Indian firm, submit the flip. Issue of inventory choices by the Indian firm to its non-resident staff and administrators will moreover be topic to the entry routes, sectoral caps, attendant situations and reporting necessities for international funding as laid down underneath Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

Further, in accordance with the Indian company legal guidelines, there have to be a minimal cliff of 1 12 months from the grant of choice of an ESOP earlier than such ESOPs are vested.³³ In the context of a reverse flip, entities might face objections from its staff who will likely be pressured to attend for a further interval of 1 12 months and will be unable to train their vested choices for such extra interval till the statutory necessities are met, upon the migration of the ESOP plan into India.

While this may increasingly indirectly affect the commercials of the reverse flip, entities should consider the profiles of staff holding ESOPs and think about potential objections that they might obtain or elevated attrition as a result of disincentivisation of staff.

CONCLUSION

The valuations on Indian market have gotten enticing, and plenty of entrepreneurs are realising that the markets, the place their model has relationships with clients, are anticipated to reward them higher. It comes with little question that the rise within the variety of start-ups and the internalisation of the domicile again into India may have financial advantages for India and can result in an increase in creation of job alternatives. However, the presence of operations and shareholders throughout a number of jurisdictions results in quite a lot of interconnected components that must be collectively assessed and aligned whereas analyzing the feasibility of internalisation, to make sure that the outcomes outweigh the concerns and hurdles for its consummation.

FOOTNOTES

¹See typically, “Box XI.5: ‘Flipping and Reverse Flipping: the recent developments in Start-ups”, Economic Survey 2022-23 (Government of India), obtainable at https://www.indiabudget.gov.in/economicsurvey/.

²Ibid.

³“India’s startup economy stares at deepening funding winter in 2023”, Business Insider India (January 7, 2023), obtainable at https://www.businessinsider.in/business/news/indias-startup-economy-stares-at-deepening-funding-winter-in-2023/articleshow/96807902.cms.

⁴Tarush Bhalla, “It cost PhonePe Rs 8,000 crore to come to India, says Sameer Nigam”, Economic Times (January 25, 2023), obtainable at https://economictimes.indiatimes.com/tech/startups/about-20-unicorns-have-asked-about-domicile-shift-phonepes-sameer-nigam/articleshow/97307712.cms?from=mdr. 

⁵Order of the National Law Company Tribunal on the Merger by Absorption between Trendsutra Cyprus Limited and Trendsutra Client Services Limited, obtainable at https://ii1.pepperfry.com/media/downloads/Scheme-of-Amalgamation-1-feb.pdf.

⁶Section 230(5), Companies Act, 2013.

⁷See typically, Section 246, Insolvency, Restructuring and Dissolution Act 2018 (Singapore); Sections 212 and 215, Singapore Companies Act 1967 (Singapore).

⁸Sections 237(7), 237(8), 237(10), Part XVI, Companies Law (2020 Revision) (Cayman Islands).

⁹Section 237(7) learn with Section 233, Part XVI, Companies Law (2020 Revision) (Cayman Islands).

¹⁰Section 237(14), Part XVI, Companies Law (2020 Revision) (Cayman Islands).

¹¹See typically, Section 247(2), Part XVI, Mauritius Companies Act 2001 (Mauritius).

¹²See typically, §251 and 252, Title 8, Delaware General Corporate Law (Delaware, USA).

¹³§ 252(d), Title 8, Delaware General Corporate Law (Delaware, USA).

¹⁴Tarush Bhalla, “It cost PhonePe Rs 8,000 crore to come to India, says Sameer Nigam”, Economic Times (January 25, 2023), obtainable at https://economictimes.indiatimes.com/tech/startups/about-20-unicorns-have-asked-about-domicile-shift-phonepes-sameer-nigam/articleshow/97307712.cms?from=mdr. 

¹⁵Foreign Exchange Management (Cross Border Merger) Regulations, 2018, obtainable at: https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=11235&Mode=0.

¹⁶Regulation 9(1), Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

¹⁷Regulation 4(1), Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

¹⁸Regulation 4(3), Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

¹⁹Regulation 4(5), Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

²⁰Regulation 4(4), Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

²¹ “In India, IPO proceeds are down 56 percent in 2022 despite its biggest listing ever”, Economic Times (December 15, 2022), obtainable at: https://timesofindia.indiatimes.com/business/markets/in-india-ipo-proceeds-are-down-56-percent-in-2022-despite-its-biggest-listing-ever/articleshow/96243119.cms.

²²Bhakti Makwana, “The IPO momentum will continue in 2023 at least for small IPOs: Prime Database”, Business Insider (India) (January 10, 2023), obtainable at https://www.businessinsider.in/stock-market/news/the-ipo-momentum-will-continue-in-2023-at-least-for-sme-ipos-prime-database/articleshow/96728596.cms.

²³Please see our evaluation of this improvement at: https://nishithdesai.com/NewsDetails/4804. 

²⁴Press Note 3 of 2020, obtainable at: https://dpiit.gov.in/sites/default/files/pn3_2020.pdf.

²⁵Please see our evaluation of the PN3 and related considerations at: https://www.nishithdesai.com/NewsDetails/8265. 

²⁶Please see our evaluation of this improvement at: https://www.nishithdesai.com/NewsDetails/6147. 

²⁷See typically, Dhanendra Kumar, “Rationalise FDI approvals under PN3”, The Hindu Business Line (June 14, 2022), obtainable at https://www.thehindubusinessline.com/opinion/rationalise-fdi-approvals-under-pn3/article65527759.ece (noting that 66 of 347 PN3 functions have been accepted since 2020).

²⁸Consolidated FDI Policy (Effective from October 15, 2020), obtainable at https://dpiit.gov.in/sites/default/files/FDI-PolicyCircular-2020-29October2020_0.pdf. 

²⁹Direction 3, Non-Banking Financial Companies (Approval of Acquisition or Transfer of Control) Directions, 2015, obtainable at https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9833.

³⁰Direction 45, Non-Banking Financial Company – Housing Finance Company (Reserve Bank) Directions, 2021, obtainable at https://rbidocs.rbi.org.in/rdocs/content/pdfs/MD100017022021_A.pdf.

³¹Guideline 5.2, Guidelines on Regulation of Payment Aggregators and Payment Gateways, Reserve Bank of India, obtainable at https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11822&Mode=0.

³²Section 6(2), Competition Act, 2002.

³³Rule 6(a), Companies (Share Capital and Debentures) Rules 2014.