Private Equity and Debt in Real Estate

M UM BAI
S IL IC O N VAL L EY
BANG AL O R E
S IN G APO R E
MU MB AI B KC
N EW D E LH I
MU N IC H
Private Equity and Debt

in Real Estate
November 2014
Copyright 2014 Nishith Desai Associates
www.nishithdesai.com
Private Equity and Debt in Real Estate
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Contents
ABBREVIATIONS 01
1.
PREFACE 02
I. Legal and Regulatory changes introduced in 2014
02
2. REGULATORY FRAMEWORK FOR FOREIGN INVESTMENT
04
I.
Foreign Direct Investment 04
II.
FVCI Route 07
III.
FPI Route 07
IV.
NRI Route 12
3. LEGAL FRAMEWORK KEY DEVELOPMENTS
14
I.
Shares with Differential Rights 14
II.
Listed Company 14
III.
Inter-Corporate Loans and Guarantee 14
IV.
Deposits 15
V.
Insider Trading 15
VI.
Squeeze out Provisions 15
VII.
Directors 15
VIII. Control and Subsidiary and Associate Company
16
IX. Merger of an Indian company with offshore company.
16
4.
TAXATION FRAMEWORK 17
I.
Overview of Indian Taxation System 17
II. Specific Tax Considerations for PE Investments
18
5.
EXIT OPTIONS / ISSUES 22
I.
Put Options 22
II.
Buy-Back 22
III.
Redemption 23
IV.
Initial Public Offering 23
V.
Third Party Sale 23
VI.
GP Interest Sale 23
VII.
Offshore Listing 24
VIII.
Flips 24
IX.
Domestic REITs 24
6.
DOMESTIC POOLING 28
I.
AIF 28
II.
NBFC 28
7.
THE ROAD FORWARD 29
I.
REITs 29
II.
Partner issues 29
III.
Arbitration / Litigation 29
IV.
Security Enforcement 29
ANNEXURE I
BUDGET 2014: A GAME CHANGER FOR REITS?
31
ANNEXURE II
REITS: TAX ISSUES AND BEYOND
36
ANNEXURE III
OFFSHORE LISTING REGIME: HOW TO RAISE FUNDS AND MONETIZE
INVESTMENTS 38
ANNEXURE IV
REGULATORY REGIME FORCING COS EXTERNALISATION
40
ANNEXURE V
NBFC STRUCTURE FOR DEBT FUNDING 42
ANNEXURE VI
FOREIGN INVESTORS PERMITTED TO PUT: SOME CHEER,
SOME CONFUSION 49
ANNEXURE VII
INDIAN GAAR: RULES NOTIFIED 53
ANNEXURE VIII
FOREIGN INVESTMENT NORMS FOR REAL ESTATE LIBERALIZED
56
ANNEXURE IX
THE CURIOUS CASE OF PRICING GUIDELINES
62
ANNEXURE X
SPECIFIC TAX RISK MITIGATION SAFEGUARDS FOR PRIVATE EQUITY
INVESTMENTS 67
ANNEXURE XI
BILATERAL INVESTMENT TREATIES 69
ANNEXURE XII
FLIPS AND OFFSHORE REITS 71
ANNEXURE XIII
BOMBAY HIGH COURT CLARIFIES THE PROSPECTIVE
APPLICATION OF BALCO 74
ANNEXURE XIV
CHALLENGES IN INVOCATION OF PLEDGE OF SHARES
77
Abbreviations
Abbreviation
Meaning / Full Form
AAR
Authority for Advanced Rulings
AIF
Alternate Investment Funds
AIF Regulations
SEBI (Alternative Investment Funds) Regulations, 2012
CBDT
Central Board of Direct Taxes
CCDs
Compulsorily Convertible Debentures
CCPS
Compulsorily Convertible Preference Shares
DCF
Discounted Cash Flows
DDT
Dividend Distribution Tax
DIPP
Department of Industrial Policy and Promotion
DTAA
Double Taxation Avoidance Agreements
ECB
External Commercial Borrowing
FATF
Financial Action Task Force
FDI
Foreign Direct Investment
FDI Policy
Foreign Direct Investment Policy dated April 17, 2014
FEMA
Foreign Exchange Management Act
FIPB
Foreign Investment Promotion Board
FII
Foreign Institutional Investor
FPI
Foreign Portfolio Investor
FVCI
Foreign Venture Capital Investor
GAAR
General Anti-Avoidance Rules
GP
General Partner
HNI
High Net worth Individuals
InvIT
Infrastructure Investment Trust
InvIT Regulations
Securities And Exchange Board of India (Infrastructure Investment Trusts) Regulations
IPO
Initial Public Offering
ITA
Income Tax Act, 1961
LP
Limited Partner
LRS
Liberalized Remittance Scheme
NBFC
Non-Banking Financial Services
NCD
Non-Convertible Debenture
NRI
Non-Residential Indian
PE
Permanent Establishment
PIO
Person of Indian Origin
PIS
Portfolio Investment Scheme
PN2
Press Note 2 of 2005
QFI
Qualified Foreign Investor
RBI
Reserve Bank of India
REITs
Real Estate Investment Trusts
REIT Regulations
Securities And Exchange Board of India (Real Estate Investment Trusts) Regulations
REMF
Real Estate Mutual Fund
Rs./INR
Rupees
SEZ Act
Special Economic Zones Act, 2005
SBT
Singapore Business Trust
SEBI
Securities and Exchange Board of India
SPV
Special Purpose Vehicle
TISPRO Regulations
Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India)
Regulations, 2000
1. Preface
Year 2014 witnessed interesting changes from a
regulatory, legal and tax perspective. Following
a long dormant phase in the capital markets and
drying up of foreign investment into India, the
reforms proposed to be brought about by the Budget
2014-15 announced by the newly elected Central
Government have attempted to resolve some of
the growth and liquidity issues faced by the Indian
economy over the past few years. A snapshot of some
of those changes, which are detailed later in this
paper is provided below:
I. Legal and Regulatory Changes

Introduced in 2014
A. Real Estate Investment Trusts
(REITs) and Infrastructure
Investment Trusts (InvITs) Introduced
One of the most common mechanisms of rollover
of assets to a REIT was not existent in India till
very recently. Recently, SEBI released the REIT
Regulations on September 26, 2014. Along with
REIT Regulations, SEBI also introduced the InvIT
Regulations.
Please refer to Annexure I1 for a detailed analysis of
the tax reforms proposed in respect of REITs and
InvITs by the Budget 2014-15. However, the REITs
regime has not taken of due to several tax and nontax issues, please refer to Annexure II2 for our article
published in Live Mint discussing some of the key
issues.
B. Foreign Portfolio Investor (FPI)

Introduced, Replaces Existent
Portfolio Investment Regimes
SEBI notified the SEBI (FPI) Regulations, 2014,
harmonizing the portfolio investment routes of
Foreign Institutional Investors (FIIs) and Qualified
Foreign Investor (QFIs) into a new class - the FPI.
FPI will be a dis-intermediated platform for trading
in securities without SEBI approval. The FPI regime
has come into force from June 1, 2014.
C. Offshore listing allowed for Unlisted

Indian Companies
Hitherto unlisted companies in India were
prohibited from issuing American / Global
Depositary Receipts (ADRs / GDRs) and Foreign
Currency Convertible Bonds (FCCB) without
a simultaneous or prior listing on a domestic
exchange in India. However, RBI and the Central
Government have now removed this requirement
of prior or simultaneous listing on a domestic
exchange, reverting to the position pre-2005, when
the requirement was introduced. Private companies
can now list their ADRs / GDRs / FCCB in an overseas
stock exchange.
The Central Government has recently prescribed
that SEBI shall not mandate any disclosures, unless
the company lists in India.
Please refer to Annexure III and Annexure IV for
articles analyzing the reasons why Indian companies
are being driven to list offshore and raise funds
abroad.
D. Companies Act, 2013

The Government of India has recently brought
into force most provisions of the Companies Act,
2013 (CA 2013), which replaced the erstwhile
Companies Act, 1956 (CA 1956). The Ministry of
Corporate affairs decided to implement CA 2013 in a
phased manner. The phased implementation of CA
2013 commenced on September 12, 2013 when 98
sections were notified with immediate effect. This
was followed by phase two, when on March 26, 2013,
further 183 sections were notified that came into
effect on April 01, 2014. CA 2013 marks a seminal
shift in Indias corporate law regime by introducing
new concepts like one person company, class
action suits, etc. which were hitherto not recognized
under CA 1956 and establishes new benchmarks
for corporate governance by, inter alia, codifying
directors duties, prescribing more stringent
independence criteria for independent directors and
expanding the definition of related parties.
Please refer to Chapter 3 for detailed analysis of the
CA 2013 provisions.
1. http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Articles/The_Securities_and_Exchange_Board_of_India.pdf
2. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/reits-tax-issues-and-beyond-1.html?no_
cache=1&cHash=a54570354bb5bc1969d720fba3cad33a
E. Control
Definition of control under the FDI Policy has
been amended by FIPB to bring it in line with the
definition of control as provided under CA 20133
and SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011.4 The amendment
has enlarged the scope of the control. Existing
downstream investments by domestic companies
with foreign investment will have to be examined
more closely to ascertain if they are affected by
the new definition of control. In addition, the
amendment may even apply to existing structures
making any further downstream investment subject
to scrutiny.
F. Non-Banking Financial Companies

(NBFC)
Please refer to Annexure V5 for detailed note on

investment through an NBFC.
Also, RBI has by way of its circular dated June 6,
20146, relaxed the provisions relating to pledge of
shares held by non-resident shareholders in Indian
listed companies in favor of NBFCs, to enable the
Indian companies to leverage themselves for bona
fide business purposes.
G. Put Options Permitted under the

Foreign Direct Investment Regime
RBI has now permitted optionality clauses in
agreements for foreign direct investment eligible
instruments issued to non-residents, provided the
valuation norms prescribed for such optionality
clauses are adhered to. The valuation norms prohibit
any assured returns to the non-resident.
The transfer of shares of a company in the financial

sector, including NBFCs, from a resident to a nonresident required a no-objection certificate from
the RBI, thereby causing delay in the transfer. The
requirement of a no-objection certificate has been
dispensed with, thereby facilitating such transfers.
Please refer to Annexure VI7 for detailed analysis on

put options.
Earlier, for change of control of non-deposit taking

NBFC, a separate approval from was not required.
Only requirement was to give a 30 thirty days
written notice prior to effecting a change of control;
and unless the RBI restricted the transfer of shares or
the change of control, the change of control became
effective from the expiry of thirty days from the date
of publication of the public notice. However, RBI
has now prescribed requirement of prior written
approval for any change in control.
CBDT notified GAAR provisions which shall

come into effect from April 1, 2015, but will apply
retrospectively to income arising from structures
from August 30, 2010. In the run-up to the Budget
2014-15, there was some hope that GAAR would
be further deferred for at least another year. GAAR
now continues to be effective starting April 1, 2015
and applies to all investments post August 2010.
It provides extensive powers to the tax authorities
to disregard tax driven structures that are abusive,
non-arms length or lack commercial substance.
Due to the ambiguity in the GAAR provisions, it was
expected that detailed guidelines would be released.
Unless the Government provides more certainty on
the application of GAAR, it will result in significant
litigation and negatively impact investor sentiments.
While NBFCs were permitted to issue unsecured

debentures earlier, they have now been restricted to
issue only fully secured debentures. In addition, the
exemption of an issuance to only 49 members by
way of private placement has also been withdrawn
for NBFCs. Also NBFCs have been given status of
financial institution under CA 2013.
Please refer to Chapter 6, point for brief analysis of
the analysis of the above changes with respect to
NBFCs.
H. General Anti-Avoidance Rules

(GAAR): Finally here
Please refer Annexure VII8 for detailed analysis on

GAAR.
3. Section 2(27), CA 2013

4. Regulation 2(e) SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
5. http://www.nishithdesai.com/New_Hotline/Realty/Realty%20Check%20-%20Debt%20Funding%20Realty%20in%20India_Jan2012.pdf
6. A.P. (DIR Series) Circular No. 141
7. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/cheers-for-offshore-funds-put-optionspermitted.html?no_cache=1&cHash=02e2afb88f85c0c69750945d7ac21f59
8. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/taxing-times-copyright-or-copyrightedarticle-the-debate-continues.html?no_cache=1&cHash=c751ebe0e7a84969cb48b0d50ffbb1c8
2. Regulatory Framework for Foreign Investment

Foreign investments into India are primarily
regulated by primarily three regulators, the Reserve
Bank of India (RBI), the Foreign Investment
Promotion Board (FIPB) and the Department
of Industrial Policy and Promotion (DIPP). In
addition to these regulators, if the securities are listed
or offered to the public, dealings in such securities
shall also be regulated by the Indian securities
market regulator, Securities and Exchange Board of
India (SEBI).
Foreign investment into India is regulated under
Foreign Exchange Management Act, 1999 (FEMA)
and the regulations thereunder, primarily Foreign
Exchange Management (Transfer or Issue of
Security by a Person Resident Outside India)
Regulations, 2000 (TISPRO Regulations). Keeping
in view the current requirements, the DIPP (an
instrumentality of the Ministry of Commerce &
Industry), and the RBI make policy pronouncements
on foreign investment through Press Notes / Press
Releases / Circulars which are notified by the RBI
as amendments to the TISPRO Regulations. These
notifications take effect from the date of issue
of Press Notes / Press Releases / Circulars, unless
specified otherwise therein.
In order to bring clarity and certainty in the policy
framework, the DIPP for the first time issued a
consolidated policy relating to FDI in India on
April 1, 2010, which is now revised annually and
represents the current policy framework on FDI.
The latest policy as of the date of this paper is dated
April 17, 2014 (FDI Policy).
Foreign investment can be classified into the
following investment regimes
i. Foreign Direct Investment (FDI);
ii. Foreign Venture Capital Investment regime, for
investments made by SEBI registered Foreign
Venture Capital Investors (FVCI);
iii. Foreign Portfolio Investor regime, for
investments made by SEBI registered Foreign
Portfolio investor (FPI);
iv. Non Resident Indian regime, for investments
made by non-resident Indians and persons of
Indian origin (NRI).
Separately, Indian entities are not permitted to avail

of External Commercial Borrowings (ECB), which
are essentially borrowings in foreign currency, if the
end use of the proceeds of the ECB will be utilized
towards investment in real estate. However, recently,
the ECB norms were relaxed to allow ECB in low cost
housing. This paper does not discuss ECB.
We now discuss each of the investment routes
together with their attendant regulatory challenges.
Tax issues are dealt with later on under a separate
taxation head in this paper.
I. Foreign Direct Investment

As per the FDI Policy, no Indian company that has
FDI9 can engage in Real Estate Business. The term,
Real Estate Business, is not defined in the current
FDI Policy. The Ministry of Commerce and Industry
issued a press release (Press Release) on October
29, 2014, that the Union Cabinet has approved the
amendment of the FDI Policy. The Press Release
issued by the Ministry of Commerce and Industry
proposes to define the term as dealing in land
and immoveable property with a view to earning
profit or earning income there from and does not
include development of townships, construction of
residential/ commercial premises, roads or bridges,
educational institutions, recreational facilities, city
and regional level infrastructure, townships. This
definition would be included in the FDI Policy only
when the same is duly amended, which is yet to
happen.
While the prohibition on FDI in real estate business
has long been the case, the process of deregulating
foreign investments into real estate was initiated in
2001 and the turning point for foreign investments
into the real estate sector came in 2005 with the issue
of Press Note 2 of 2005 (PN2) by the DIPP.
PN2 permitted FDI in townships, housing, builtup infrastructure and construction-development
projects (which would include, but not be restricted
to, housing, commercial premises, hotels, resorts,
hospitals, educational institutions, recreational
facilities, city and regional level infrastructure)
subject to fulfillment of certain entity level and
9. FDI policy refers to FDI as a category of cross border investment made by a resident in one economy (the direct investor) with the objective of
establishing a lasting interest in an enterprise (the direct investment enterprise) that is resident in an economy other than that of the direct investor.
The motivation of the direct investor is a strategic long term relationship with the direct investment enterprise to ensure the significant degree of
influence by the direct investor in the management of the direct investment enterprise. Direct investment allows the direct investor to gain access to
the direct investment enterprise which it might otherwise be unable to do. The objectives of direct investment are different from those of portfolio
investment whereby investors do not generally expect to influence the management of the enterprise. It further mentions that it is the policy of the
Government of India to attract and promote productive FDI from non-residents in activities which significantly contribute to industrialization and
socio-economic development. FDI supplements the domestic capital and technology.
project level requirements. PN2 required that real

estate companies seek foreign investments only for
construction and development of projects, and not
for completed projects.
Finance Minister in his Budget 2014-15 speech
had announced that the investment conditions
prescribed under the FDI Policy will be altered to
boost the foreign investment in the real estate sector.
Though, the DIPP has not released the press note in
this respect yet, but the Press Release lays down the
amendments proposed in the FDI Policy. Following
are few of the key changes sought to be introduced
by the Press Release:
A. Minimum area for the Project

Development has been Changed
i. Development of Serviced Plots
Minimum land area requirement has been done
away with, while earlier the minimum land area of
10 hectares was prescribed for the development of
serviced plots.
ii. Construction-Development Projects
Minimum area has been reduced for the construction
development projects. Press release prescribes that
the minimum area for a construction development
project shall be 20,000 sq. meters of floor area
whereas earlier the minimum area prescribed was
50,000 sq. meters of built-up area.
iii. Combination Project
There is no change prescribed in the development
of a combination project, like as provided in the FDI
Policy, either of the conditions prescribed for the
serviced project or construction development project
will have to be complied with.
B. Minimum Capitalization
The press release makes no distinction in the
minimum capitalization for wholly owned
subsidiaries and joint ventures with the Indian
partners as provided in the FDI Policy. The minimum
capitalization prescribed is US $ 5 million.
C. Affordable Housing
The projects which will allocate atleast 30% of the
project cost for the low cost affordable housing
will be exempted from the complying with the
minimum land area and the minimum capitalization
requirements as mentioned above.
D. Complete Assets
Press Release clarifies that 100 percent FDI under the
automatic route is permitted in completed projects
for operation and management of townships, malls/
shopping complexes and business centres.
It has been long debated whether FDI should be
permitted in commercial completed real estate.
By their very nature, commercial real estate
assets are stable yield generating assets as against
residential real estate assets, which are also seen as
an investment product on the back of the robust
capital appreciation that Indian real estate offers.
To that extent, if a company engages in operating
and managing completed real estate assets like a
shopping mall, the intent of the investment should
be seen to generate revenues from the successful
operation and management of the asset (just like a
hotel or a warehouse) as against holding it as a mere
investment product (as is the case in residential
real estate). The apprehension of creation of a
real estate bubble on the back of speculative land
trading is to that naturally accentuated in context of
residential real estate. To that extent, operation and
management of a completed yield generating asset
is investing in the risk of the business and should be
in the same light as investment in hotels, hospitals
or any asset heavy asset class which is seen as
investment in the business and not in the underlying
real estate. Even for REITs, the government was
favorable to carve out an exception for units of a
REIT from the definition of real estate business on
the back of such understanding, since REITs would
invest in completed yield general real estate assets.
The Press Release probably aims to follow the
direction and open the door for foreign investment
in completed real assets, however the language is not
entirely the way it should have been and does seem
to indicate that foreign investment is allowed only in
entities that are operating an managing completed
assets as mere service providers and not necessarily
real estate. While it may seem that FDI has now
been permitted into completed commercial real
estate sector, the Press Release leaves the question
unanswered whether these companies operating and
managing the assets may own the assets as well.
Please refer to Annexure VIII10 for a detailed analysis
of the press release.
Though the DIPP has not released the press note
amending the FDI Policy, however, it can be expected
that the press note will not be different from the
press release.
10. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/newsid/2638/html/1.html?no_cache=1
Regulatory Framework for Foreign Investment

i. Instruments for FDI

As per the FDI Policy, FDI can be routed into Indian
investee companies by using equity shares, fully, and
mandatorily/Compulsorily Convertible Debentures
(CCDs) and fully and Compulsorily Convertible
Preference Shares (CCPS).11 Debentures which are
not CCDs or optionally convertible instruments are
considered to be ECB and therefore, are governed by
clause (d) of sub-section 3 of section 6 of FEMA read
with Foreign Exchange Management (Borrowing or
Lending in Foreign Exchange) Regulations, 2000 as
amended from time to time. RBI recently amended
the TISPRO Regulation to permit issuance of partly
paid shares and warrants to non-residents (under the
FDI and the FPI route) subject to compliance with
the other provisions of the FDI and FPI schemes.
Please refer to Annexure IX12 for a detailed analysis

of the amendment of TISPRO Regulation permitting
issuance of partly paid shares and warrants to nonresidents.
Since, these CCPS and CCDs are fully and
mandatorily convertible into equity, they are
regarded at par with equity shares and hence the
same are permissible as FDI. Further, for the purpose
of minimum capitalization, in case of direct share
issuance to non-residents, the entire share premium
received by the Indian company is included.
However, in case of secondary purchase, only the
issue price of the instrument is taken into account
while calculating minimum capitalization.
Herein below is a table giving a brief comparative
analysis for equity, CCPS and CCDs:
Particulars
Equity
Basic Character
Participation in governance Assured Dividend Convertible

and risk based returns
into Equity
Assured Coupon Convertible into

Equity
Liability to Pay
Dividend can be declared

only out of profits
Fixed Interest payment - not dependent

on accrual of profits
Limits to Payment No cap on dividend
CCPS
CCD
Fixed dividend if profits accrue
Dividend on CCPS cannot exceed 300 basis points over and above the
prevailing SBI prime lending rate in the financial year in which CCPS is
issued. No legal restriction on interest on CCD, however in practice it is
benchmarked to CCPS limits.
Tax Efficiency
No tax deduction, dividend payable from post-tax income Dividend taxable @ 15%13 in the hands of the company
Liquidation
Preference
CCD ranks higher than CCPS in terms of liquidation preference. Equity gets the last preference.
Others
Buy-back or capital
reduction permissible
Interest expense deductible

Withholding tax as high as 40% but it
can be reduced to 5% if investment
done from favourable jurisdiction
CCPS and CCDs need to be converted to equity before they can be bought
back or extinguished by the Indian company.
ii. Pricing Requirements
the following conditions being satisfied:
TISPRO Regulations regulate the price at which

a foreign direct investor invests into an Indian
company. Recently, RBI amended the TISPRO
Regulations wherein it rationalized the pricing
guidelines from the hitherto Discounted Cash Flows
(DCF) / Return on Equity (RoE) to internationally
accepted pricing methodologies. Accordingly, shares
in an unlisted Indian company may be freely issued
or transferred to a foreign direct investor, subject to
i. The price at which foreign direct investor

subscribes to / purchases the Indian companys
shares is not lower than the floor price computed
on the basis of the internationally accepted
pricing method. However, if the foreign investor
is subscribing to the memorandum of the
company, the internationally accepted pricing
methodologies does not apply14;
11. Please refer below to paragraph (3)(1) on put options

12. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/rbi-issues-reforms-for-fdi-investments.
html?no_ca
13. All tax rates mentioned herein are exclusive of surcharge and education cess.
14. RBI clarified in its A.P. (DIR Series) Circular No. 36 dated September 26, 2012, that shares can be issued to subscribers (both non-residents and NRIs)
to the memorandum of association at face value of shares subject to their eligibility to invest under the FDI scheme. The DIPP inserted this provision
in the FDI Policy, providing that where non-residents (including NRIs) are making investments in an Indian company in compliance with the provisions of CA 1956, by way of subscription to its Memorandum of Association, such investments may be made at face value subject to their eligibility
to invest under the FDI scheme. This addition in the FDI Policy is a great relief to non-resident investors (including NRIs) in allowing them to set up
new entities at face value of the shares and in turn reduce the cost and time involved in obtaining a DCF valuation certificate for such newly set up
companies.
ii. The consideration for the subscription / purchase

is brought into India prior to or at the time of the
allotment / purchase of shares to / by the foreign
direct investor.
If any of the above conditions is not complied with,
then the prior approval of the FIPB and / or the RBI
would be required. If the foreign investor is an FVCI
registered with the SEBI, then the pricing restrictions
would not apply. In addition, if the securities are
listed, the appropriate SEBI pricing norms become
applicable.
Please refer to Annexure IX 15 for a detailed analysis
on the rationalization of the pricing guidelines.
II. FVCI Route

SEBI introduced the SEBI (Foreign Venture Capital
Investors) Regulations, 2000 (FVCI Regulations) to
encourage foreign investment into venture capital
undertakings.16 The FVCI Regulations make it
mandatory for an offshore fund to register itself with
SEBI.
FVCIs have the following benefits:
A. Free Pricing
The entry and exit pricing applicable to FDI regime
do not apply to FVCIs. To that extent, FVCIs can
subscribe, purchase or sell securities at any price.
B. Instruments
Unlike FDI regime where investors can only
subscribe to only equity shares, CCDs and CCPS,
FVCIs can also invest into Optionally Convertible
Redeemable Preference Shares (OCRPS),
Optionally Convertible Debentures (OCDs) and
even Non-Convertible Debenture (NCDs).
C. Lock-in
Under the SEBI (Issue of Capital and Disclosure
Requirements) Regulations, 2009 (ICDR
Regulations) the entire pre-issue share capital
(other than certain promoter contributions which
are locked in for a longer period) of a company
conducting an initial public offering (IPO)
is locked for a period of 1 year from the date
of allotment in the public issue. However, an
exemption from this requirement has been granted

to registered FVCIs, provided, the shares have been
held by them for a period of at least 1 year as on the
date of filing the draft prospectus with the SEBI. This
exemption permits FVCIs to exit from investments
immediately post-listing.
D. Exemption under the SEBI

(Substantial Acquisition of Shares
and Takeovers) Regulations, 2011
Takeover Code (Takeover Code)
SEBI has also exempted promoters of a listed
company from the public offer provisions in
connection with any transfer of shares of a listed
company, from FVCIs to the promoters, under the
Takeover Code.
E. QIB Status
FVCIs registered with SEBI have been accorded
qualified institutional buyer (QIB) status and are
eligible to subscribe to securities at an IPO through
the book building route.
However, the RBI while granting the permission/
certificate mandates that an FVCI can only invest
in the following sectors, viz. infrastructure sector,
biotechnology, IT related to hardware and software
development, nanotechnology, seed research and
development, research and development of new
chemical entities in pharma sector, dairy industry,
poultry industry, production of bio-fuels and hotelcum-convention centers with seating capacity of
more than three thousand.
III. FPI Route

On January 7, 2014, SEBI introduced the SEBI
(Foreign Portfolio Investment) Regulation 2014
(FPI Regulations). FPI is the portfolio investment
regime. The Foreign Institutional Investor (FII)
and Qualified Foreign Investor (QFI) route have
been subsumed into the FPI regime. Exiting FIIs,
or sub-account, can continue, till the expiry of the
block of three years for which fees have been paid
as per the SEBI (Foreign Institutional Investors)
Regulations, 1995, to buy, sell or otherwise deal
in securities subject to the provisions of these
regulations. However, FII or sub-account shall be
15. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/rbi-issues-reforms-for-fdi-investments.
html?no_cache=1&cHash=aa112b7416545ec9dccccab2a900687f
16. Venture capital undertaking means a domestic company:- (i) whose shares are not listed in a recognised stock exchange in India; (ii) which is engaged
in the business of providing services, production or manufacture of articles or things, but does not include such activities or sectors which are specified in the negative list by the Board, with approval of Central Government, by notification in the Official Gazette in this behalf.

required to pay conversion fee of USD 1,00017on or

before the expiry of its registration for conversion
in order to buy, sell or otherwise deal in securities
under the FPI Regulations. In case of QFIs, they may
continue to buy, sell or otherwise deal in securities
subject to the provisions of these regulations, for a
period of one year from the date of commencement
of FPI Regulations, or until he obtains a certificate
of registration as FPI, whichever is earlier. Under
the new regime SEBI has delegated the power to
designated depository participants (DDP) who will
grant the certificate of registration to FPIs on behalf
of SEBI.
A. Categories
Each investor shall register directly as an FPI,
wherein the FPIs have been classified into the
following three categories on the basis of risk-based
approach towards know your customer.
i. Category I FPI
Category I includes Government and governmentrelated investors such as central banks,
Governmental agencies, sovereign wealth funds
or international and multilateral organizations or
agencies.
ii. Category II FPI
Category II includes the following:
i. Appropriately regulated broad based funds;
ii. Appropriately regulated persons;
iii. Broad-based funds that are not appropriately
regulated but their managers are regulated;
iv. University funds and pension funds; and
v. University related endowments already registered
with SEBI as FIIs or sub-accounts
The FPI Regulations provide for the broad-based
criteria. To satisfy the broad-based criteria two
conditions should be satisfied. Firstly, fund should

have 20 investors even if there is an institutional
investor. Secondly, both direct and underlying
investors i.e. investors of entities that are set up
for the sole purpose of pooling funds and making
investments shall be counted for computing the
number of investors in a fund.
iii. Category III FPI
Category III includes all FPIs who are not eligible
under Category I and II, such as endowments,
charitable societies, charitable trusts, foundations,
corporate bodies, trusts, individuals and family
offices.
B. Investment Limits
The FPI Regulations states that a single FPI or an
investor group shall purchase below ten percent
of the total issued capital of a company. The
position under the FII Regulations was that such
shareholding was not to exceed ten percent of the
share capital.
Under the FPI Regulations ultimate beneficial
owners investing through the multiple FPI entities
shall be treated as part of the same investor group
subject to the investment limit applicable to a single
FPI.
C. ODIs/P Note
An offshore derivative instrument (ODIs) means
any instrument, by whatever name called, which is
issued overseas by a foreign portfolio investor against
securities held by it that are listed or proposed to be
listed on any recognized stock exchange in India, as
its underlying units. Participatory Notes (P-Notes)
are a form of ODIs.18
P-notes are, by definition a form of ODI including
but not limited to swaps19, contracts for difference20,
options21, forwards22, participatory notes23, equity
17. Specified in Part A of the Second Schedule of the FPI Regulations

18. Section 2(1)(j) of the FPI Regulations
19. A swap consists of the exchange of two securities, interest rates, or currencies for the mutual benefit of the exchangers. In the most common swap
arrangement one party agrees to pay fixed interest payments on designated dates to a counterparty who, in turn, agrees to make return interest payments that float with some reference rate.
20. An arrangement made in a futures contract whereby differences in settlement are made through cash payments, rather than the delivery of physical
goods or securities. At the end of the contract, the parties exchange the difference between the opening and closing prices of a specified financial
instrument.
21. An option is a financial derivative that represents a contract sold by one party to another party. It offers the buyer the right, but not the obligation, to
call or put a security or other financial asset at an agreed-upon price during a certain period of time or on a specific date.
22. A forward contract is a binding agreement under which a commodity or financial instrument is bought or sold at the market price on the date of
making the contract, but is delivered on a decided future date. It is a completed contract as opposed to an options contract where the owner has the
choice of completing or not completing.
23. Participatory notes (P-notes) are a type of offshore derivative instruments more commonly issued in the Indian market context which are in the form
of swaps and derive their value from the underlying Indian securities.
linked notes24, warrants25, or any other such

instruments by whatever name they are called.
Below is a diagram that illustrates the structure of an

ODI.
Returns on underlying portfolio

Eligible FPIs
Investment
holdings
to hedge
exposures
under the ODI
as issued
Counterparty (holder of ODI)

Fixed or variables payments.
Eg: LIBOR plus a margin on a sum equivalent
to a loan on the value of the underlying
portfolio of the issued ODI
Distributions including dividends

and capital gains
Portfolio of listed securities on any

recognized stock exchange in India
Fig 1: Investment through ODIs.
The position of the holder of an ODI is usually that

of an unsecured counterparty to the FPI. Under
the ODI (the contractual arrangement with the
issuing FPI), the holder of a P-note is entitled only
to the returns on the underlying security with no
other rights in relation to the securities in respect of
which the ODI has been issued. ODIs have certain
features that prevent the holder of such instruments
from being perceived as the beneficial owner of
the securities. These features include the following
aspects: (i) whether it is mandatory for the FPI to
actually hedge its underlying position (i.e. actually
hold the position in Indian securities), (ii) whether
the ODI holder could direct the voting on the shares
held by the FPI as its hedge, (iii) whether the ODI
holder could be in a position to instruct the FPI to
sell the underlying securities and (iv) whether the
ODI holder could, at the time of seeking redemption
of that instrument, seek the FPI to settle that
instrument by actual delivery of the underlying
securities. From an Indian market perspective, such
options are absent considering that the ownership
of the underlying securities and other attributes
of ownership vest with the FPI. Internationally,
however, there has been a precedence of such

structures, leading to a perception of the ODI holder
as a beneficial owner albeit only from a reporting
perspective under securities laws.26
The FPI Regulations provide that Category I FPIs
and Category II FPIs (which are directly regulated
by an appropriate foreign regulatory authority) are
permitted to issue, subscribe and otherwise deal
in ODIs.27 However, those Category II FPIs which
are not directly regulated (which are classified
as Category-II FPI by virtue of their investment
manager being appropriately regulated) and all
Category III FPIs are not permitted to issue, subscribe
or deal in ODIs.
FPIs shall have to fully disclose to SEBI any
information concerning the terms of and parties
to ODIs entered into by it relating to any securities
listed or proposed to be listed in any stock exchange
in India (Fig 1).
Please refer to our research paper Offshore Derivate
Instruments: An Investigation into Tax Related
Aspects 28, for further details on ODIs and their tax
treatment.
24. An Equity-linked Note is a debt instrument whose return is determined by the performance of a single equity security, a basket of equity securities, or
an equity index providing investors fixed income like principal protection together with equity market upside exposure.
25. A Warrant is a derivative security that gives a holder the right to purchase securities from an issuer at a specific price within a certain time frame.
26. CSX Corporation v. Childrens Investment Fund Management (UK) LLP. The case examined the total return swap structure from a securities law
perspective, which requires a disclosure of a beneficial owner from a reporting perspective.
27. Reference may be made to Explanation 1 to Regulation 5 of the FPI Regulations where it is provided that an applicant (seeking FPI registration) shall
be considered to be appropriately regulated if it is regulated by the securities market regulator or the banking regulator of the concerned jurisdiction in the same capacity in which it proposes to make investments in India.
28. Offshore Derivate Instruments: An Investigation into Tax Related Aspects
http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Offshore_Derivative_Instruments.pdf

D. Listed Equity
The RBI has by way of Notification No. FEMA.
297/2014-RB dated March 13, 2014 amended the
TISPRO Regulations to provide for investment by
FPIs. Under the amended TISPRO Regulations, the
RBI has permitted Registered Foreign Portfolio
Investors (RFPI) to invest on the same footing as
FIIs.
A new Schedule 2A has been inserted after Schedule
2 of the TISPRO Regulations to provide for the
purchase / sale of shares / convertible debentures of
an Indian company by an RFPI under the Foreign
Portfolio Investment Scheme (FPI Scheme).
The newly introduced Schedule 2A largely
mirrors Schedule 2 of TISPRO which provides for
investments in shares / convertible debentures by
FIIs under the portfolio investment scheme (PIS).
Accordingly, an FPI can buy and sell listed securities
on the floor of a stock exchange without being
subjected to FDI restrictions.
Since, the number of real estate companies that are
listed on the stock exchange are not high, direct
equity investment under erstwhile FII route was
not very popular. FPI investors are also permitted to
invest in the real estate sector by way of subscription
/ purchase of Non-Convertible Debenture (NCD),
as discussed below.
Regulations, FPIs are permitted to invest in, inter

alia, listed or to be listed NCDs issued by an Indian
company. FPIs are permitted to hold securities only
in the dematerialized form.
Currently, there is an overall limit of USD 51 Billion
on investment by FPIs in corporate debt, of which
90% is available on tap basis. Further, FPIs can also
invest up to USD 30 Billion in government securities.
Listing of non-convertible debentures on the
wholesale debt market of the Bombay Stock
Exchange is a fairly simple and straightforward
process which involves the following intermediaries:
i. Debenture trustee, for protecting the interests of
the debenture holders and enforcing the security,
if any;
ii. Rating agency for rating the non-convertible
debentures (there is no minimum rating required
for listing of debentures); and
iii. Registrar and transfer agent (R&T Agent), and
the depositories for dematerialization of the nonconvertible debentures.
The entire process of listing, including the
appointment of the intermediaries can be
completed in about three weeks. The typical cost of
intermediaries and listing for an issue size of INR
One Billion is approximately INR One Million.
Herein below is a structure chart detailing the steps
involved in the NCD route:
E. Listed NCDs
Under Schedule V of the amended TISPRO
Regulations, read with the provisions of the FPI
FPI
Offshore
Buy
India
Step 3: Trading of
NCDs on the floor
of stock exchange
Stock Exchange (WDM)
Step 2
Listing of NCDs
NCDs
Issuing Company
Warehousing Entity
Cash
Step 1: Issuance of NCDs
Fig 2: Investment through NCDs
10
Recently, the RBI and SEBI permitted direct

subscription of to be listed NCDs by the FII (now
FPIs), thus doing away with the requirement of
warehousing entity. These to be listed NCDs have to
listed on a recognized stock exchange within 15 days
of issuance, else, the FPI shall be required to disposeoff the NCDs to an Indian entity / person.
Under this route, any private or public company can
list its privately placed NCDs on the wholesale debt
market segment of any recognized stock exchange.
An FPI entity can then purchase these NCDs on the
floor of the stock exchange from the warehousing
entity. For an exit, these debentures may be sold
on the floor of the stock exchange29, but most
commonly these NCDs are redeemed by the issuing
company. So long as the NCDs are being offered
on private placement basis, the process of offering
and listing is fairly simple without any onerous
eligibility conditions or compliances.
The NCDs are usually redeemed at a premium that
is usually based on the sale proceeds received by the
company, with at least 1x of the purchase price being
assured to the NCD holder.
Whilst creation of security interest30 is not
permissible with CCDs under the FDI route, listed
NCDs can be secured (by way of pledge, mortgage

of property, hypothecation of receivables etc.) in
favor of the debenture trustee that acts for and in the
interest of the NCD holders.
Also, since NCDs are subscribed by an FPI entity
under the FPI route and not under the FDI route,
the restrictions applicable to FDI investors in
terms of pricing are not applicable to NCD holders.
NCDs, in fact, are also in some situations favored by
developers who do not want to share their equity
interest in the project. Further, not only are there no
interest caps for the NCDs (as in the case of CCDs or
CCPS), the redemption premium on the NCDs can
also be structured to provide equity upside to the
NCD holders, in addition to the returns assured on
the coupon on the NCD.
Separately, purchase of NCDs by the FPI from the
Indian company on the floor of the stock exchange
is excluded from the purview of ECB and hence,
the criteria viz. eligible borrowers, eligible lenders,
end-use requirements etc. applicable to ECBs, is not
applicable in the case of NCDs.
The table below gives a brief comparative analysis
for debt investment through FDI (CCDs) and FPI
(NCDs) route:
Particulars
CCD FDI
Equity
Ownership
Initially debt, but equity on conversion Mere lending rights; however, veto rights can ensure certain degree
of control.
ECB
Qualification
Assured returns on FDI compliant

Purchase of NCDs by the FPI from the Indian company on the floor
instruments, or put option granted to of the stock exchange is expressly permitted and shall not qualify
an investor, may be construed as ECB. as ECB.
Coupon
Payment
Interest pay out may be limited to SBI

PLR + 300 basis points. Interest can
be required to accrue and paid only
out of free cash flows.
Arm's length interest pay out should be permissible resulting in

better tax efficiency. Higher interest on NCDs may be disallowed.
Interest can be required to accrue only out of free cash flows.
Redemption premium may also be treated as business expense.
Pricing
Internationally accepted pricing

methodologies
DCF Valuation not applicable
Security
Interest
Creation of security interest is not

permissible either on immoveable or
movable property
Listed NCDs can be secured (by way of pledge, mortgage of

property, hypothecation of receivables etc.) in favor of the
debenture trustee who acts for and in the interest of the NCD
holders
Only permissible for FDI compliant

Sectoral
conditionalities activities
Equity Upside
NCD - FPI
Sectoral restrictions not applicable.
Investor entitled to equity upside upon NCDs are favorable for the borrower to reduce book profits or tax
conversion.
burden. Additionally, redemption premium can be structured to
provide equity upside which can be favourable for lender since
such premium may be regarded as capital gains which may not be
taxed if the investment comes from Singapore.
Administrative No intermediaries required

expenses
NCD listing may cost around INR 10-15 lakh including intermediaries
cost. In case of FPI, additional cost will be incurred for registration
with the DDP and bidding for debt allocation limits, if required.
29. There have been examples where offshore private equity funds have exited from such instruments on the bourses.
30. Security interest is created in favour of the debenture trustee that acts for and on behalf of the NCD Holders. Security interest cannot be created
directly in favour of non-resident NCD holders.
11

IV. NRI Route

A. Investment in Listed Securities
Similar to FPIs, the NRIs can also purchase the
shares of a real estate developer entity under the PIS.
Under Schedule 3 of the TISPRO Regulations, NRIs
are permitted to invest in shares and convertible
debentures on a stock exchange subject to various
conditions prescribed therein. The regulations
prescribe the following limits on the investment by
NRIs:
i. The total investment in shares by an NRI cannot
exceed 5% of the total paid up capital of the
company and the investment in convertible
debentures cannot exceed 5% of the paid up
value of each series of convertible debentures
issued by the company concerned; and
ii. The aggregate of the NRI investments in the
company cannot exceed 10% of the paid up
capital of the company. However, this limit could
be increased up to the sectoral cap prescribed
under the FDI policy with a special resolution of
the company.
B. Direct Investment in Unlisted

Securities
i. Investment on repatriation basis
Investment by NRI in unlisted securities on
repatriation basis is in a manner similar to any
other investment allowed under Schedule 1 of
TISPRO Regulations; however, as stated earlier the
onerous requirements of minimum area, minimum
capitalization, lock-in etc. applicable for FDI in
construction development projects are not required
to be met by NRIs per paragraph 6.2.11.2.
ii. Investment on Non-repatriation Basis
Under Schedule 4 of TISPRO Regulations, NRIs on
a non-repatriation basis are permitted to purchase
shares or convertible debentures of an unlisted

Indian company without any limit and permission
to purchase. The above permission is not available to
NRIs for certain prohibited companies.31
C. Direct Acquisition of Immovable

Property
The Foreign Exchange Management (Acquisition
and Transfer of Immovable Property in India)
Regulations, 2000, deal with direct acquisition of
immovable property by a person resident outside
India. Under the regulations a person resident
outside India has been classified into two sections:
i. A person resident outside India, who is a citizen
of India i.e. an NRI.
ii. A person resident outside India, who is of Indian
origin i.e. a person of Indian Origin32 (PIO)
Both NRIs and PIOs have been under the regulations
allowed to directly purchase or sell immovable
property other than agricultural property, plantation
or a farm house in India. However there are certain
conditions imposed under the regulations on the
payment of the purchase price and on repatriation of
the sale consideration received.
i. Purchase Price Conditions
The payment of the purchase price can be made only
by the following means:
Funds received in India through normal banking

channels by way of inward remittance from any
place outside India; or
Funds held in any non-resident account

maintained in accordance with the provisions
of the FEMA and the regulations framed by RBI
from time to time.
ii. Repatriation of Sale Proceeds

NRIs/ PIOs are allowed to freely repatriate the sale
proceeds provided:
31. Prohibited companies means - company which is a chit fund or a nidhi company or is engaged in agricultural/plantation activities or real estate business or construction of farm houses or dealing in transfer of development rights
32. A PIO means an individual (not being a citizen of Pakistan or Bangladesh or Sri Lanka or Afghanistan or China or Iran or Nepal or Bhutan) who
1. at any time, held an Indian Passport or
2. who or either of whose father or mother or whose grandfather or grandmother was a citizen of India by virtue of the Constitution of India or the
Citizenship Act, 1955 (57 of 1955).
12
The immovable property was acquired in

accordance with the regulations;
The amount remitted outside India does not

exceed the amount paid for the acquisition of the
immovable property;
In case of residential property, the repatriation is

not for the amount received on sale of more than
two residential properties.
However, any upside that is obtained on sale of such

property after being subject to applicable capital
gains tax and withholding can be remitted outside
India through a Non-Resident Ordinary Rupee
Account. However, the amount so repatriated cannot
exceed USD 1 (One) million a year.
13
3. Legal Framework Key Developments

CA 2013 recently replaced CA 1956. CA 2013
introduces several new concepts and modifies
several existing ones. Some of the relevant new
provisions introduced by CA 2013 are as follows:
i.
Shares with Differential Rights
ii. Listed Company

iii. Inter-Corporate loans
iv. Deposits
v. Insider trading
vi. Squeeze out provisions
vii. Directors
viii. Subsidiary and Associate Company
ix. Merger of an Indian company with offshore
company.
I. Shares with Differential Rights

Under CA 1956, private companies were allowed
to issue shares with differential rights for their
contractual agreements because of an exemption
available to them.33 However, with the replacement
of CA 1956 with CA 2013, this flexibility is no
longer available to private companies. Now, private
Companies, like public companies, can issue only
equity and preference shares and shares with
differential rights subject to certain conditions, as
discussed below.34 Accordingly, preference shares
with voting rights on an as-if-converted basis may
not be permitted now.
The Companies (Share Capital and Debentures)
Rules, 2014 for issuance of equity share capital35
prescribe several conditions for any company issuing
equity shares with differential voting rights to
adhere to, such as:
i. Share with differential rights shall not exceed
26% (twenty six per cent) of the total post issue
paid up equity share capital, including equity
shares with differential rights issued at any point
of time;
ii. The company shall have a consistent track record
of distributable profits for the last 3 (three) years;
iii. The company should not have defaulted in filing
financial statements and annual returns for the
preceding 3 (three) financial years.

With this change, structuring different economic
rights for different class of equity shareholders
may become difficult given the conditions
that companies have to comply with under the
Companies (Share Capital and Debentures) Rules,
2014. For instance, investors in real estate expecting
a preferred IRR could earlier take their preferred
returns by way of dividends on different class of
equity, which may be difficult now. Any returns
on preference shares will be capped at a dividend
of around 13% (SBI prime lending rate + 300 basis
points).
II. Listed Company

CA 2013 defines listed company as a company which
has any of its securities listed on any recognized
stock exchange.36 Even private companies with their
NCDs listed on any recognized stock exchange will
be considered as a listed company. CA 2013 places
a whole gamut of obligations on listed companies,
such as:
i. Returns to be filed with the registrar of
companies if the promoter stake changes;
ii. Onerous requirements relating to appointment of
auditors;
iii. Formation of audit committee, nomination
and remuneration committee and stakeholders
relationship committee;
iv. Secretarial audit.
III. Inter-Corporate Loans and

Guarantee
Under CA 1956, loans made to or security provided
or guarantee given in connection with loan given
to the director of the lending company and certain
specified parties required previous approval of
the Central Government. However, section 185 of
CA 2013 which has by far been the most debated
section of CA 2013, imposes a total prohibition on
companies providing loans, guarantee or security
to the director or any other person in whom the
director is interested, unless it is in the ordinary
33. Section 90(2) of CA 1956 exempts applicability of Sections 85 to 89 to a private company unless it is a subsidiary of a public company
34. Sections 43 and 47 of CA 2013
35. Chapter IV, Share Capital and Debentures, Rules under CA 2013
36. Section 2(52), CA 2013
14
course of business of the company to do so. Whilst

the restriction contained in CA 1956 applied
only to public companies, CA 2013 has extended
this restriction to even private companies. Such
restriction would create significant difficulties
for companies which provide loans, or guarantee/
security to their subsidiaries or associate companies
for operational purposes.
IV. Deposits
Under CA 2013, acceptance of deposits by an Indian
company is governed by stricter rules. Securities
application money that is retained for more than
60 days without issuance of securities shall be
deemed as a deposit. CA 2013 lays down stringent
conditions for issuance of bonds and debentures
unsecured optionally convertible debentures are
treated as deposits. CA 2013 also specifies additional
compliances for deposits accepted prior to the
commencement of CA 2013.
V. Insider Trading
CA 2013 now has an express provision for insider
trading wherein insider trading of securities of
a company by its directors or key managerial
personnel is prohibited.37 SEBI had notified the SEBI
(Prohibition of Insider Trading) Regulations, 1992
to govern public companies. The provision governs
both public and private companies. Hence, nominee
director appointed by a private equity investor
may also be subjected to insider trading provisions.
However, the practical application of section 195 of
CA 2013, with respect to a private company remains
to be ambiguous.
VI. Squeeze out Provisions

Under CA 2013 an acquirer or person acting in
concert, holding 90% of the issued equity share
capital has a right to offer to buy the shares held by
the minority shareholders in the Company at a price
determined on the basis of valuation by a registered
valuer in accordance with prescribed rules.38 The
corresponding provision under the 1956 Act was
permissive and not mandatory in nature.39 In this
regard, private equity investors may want to exercise
some caution while the majority shareholders
approach the 90% shareholding threshold in a
company. Interestingly, there is no provision that

minority shareholders will be bound to transfer their
shares to an acquirer or person acting in concert
and the section lacks the teeth required to enforce a
classic squeeze up.
VII. Directors
CA 2013 introduces certain new requirements with
respect to directors40 such as:
i. Independent Director: Independent Directors
have been formally introduced by CA 2013,
earlier the listing agreements41 provided for
appointment of independent directors. CA 2013
provides that Every listed public company
shall have at least one-third director of the total
number of directors as independent directors.
The term every listed public company is
ambiguous as it is the only instance in CA 2013
which applies to the listed public company and
not just listed company. This is relevant because
under CA 2013, a listed company also includes
a private company which has its NCDs listed on
the stock exchange.
ii. Resident Director: Every company to have a
director who was resident in India for a total
period of not less than 182 days in the previous
calendar year.
iii. Women Director: Prescribed class of companies
shall have atleast one woman director.
CA 2013 has for the first time, laid down specific
duties of directors, as follows:
i. To act in accordance with the articles of the
company;
ii. To act in good faith in order to promote the
objects of the company for the benefit of its
members as a whole and in the best interests of
the company, its employees, the shareholders,
and the community and for the protection of
environment;
iii. To exercise his duties with due and reasonable
care, skill and diligence and shall exercise
independent judgment;
iv. Not to involve himself in a situation in which
he may have a direct or indirect interest that
conflicts or possibly may conflict, with the
interest of the company;
37. Section 195, CA 2013

38. Section 236, CA 2013
39. Section 395, CA 1956
40. Section 149, CA 2013
41. Listing agreements set out the conditions that a company or issuer of share has to abide. Clause 49
15
Legal Framework Key Developments

v. Not to achieve or attempt to achieve any

undue gain or advantage either to himself or
his relatives, partners, or associates and if such
director is found guilty of such, he shall be
liable to pay an amount equal to that gain to the
company;
vi. Not to assign his office and any such assignment
shall be void.
Having said the above, the liability of an independent
director and non-executive director has been
restricted to such acts of omission or commission
which had occurred with his knowledge, attributable
through board processes, and with his consent or
connivance or where he had not acted diligently.
VIII. Control and Subsidiary and

Associate Company
CA 2013 defines the term control and the definition
of subsidiary and associate company has changed:
i. According to CA 2013, control,42 shall include
the right to appoint majority of the directors or
to control the management or policy decisions
exercisable by a person or persons acting
individually or in concert, directly or indirectly,
including by virtue of their shareholding or
management rights or shareholders agreements
or voting agreements or in any other manner.
It is for the first time that the control has been
defined in the company law.
ii. Subsidiary Company: An entity will be subsidiary

of the holding company, if holding company
controls the composition of the board of directors
of the company or controls (directly or indirectly)
more than one half of the total share capital.43
iii. Associate Company: An entity will be an
associate of the company, if the company has a
significant influence over the entity, but it is not
the subsidiary company of the company.44
The concept of control as provided in the definition
of subsidiary company is narrower than what is
provided in the definition of the control.
IX. Merger of an Indian Company

with Offshore Company
Section 234 of CA 2013 permits mergers and
amalgamations of Indian companies with foreign
companies. However, the provisions of Section 234
go on to say that such mergers and amalgamations
are permitted only with companies incorporated
in the jurisdictions of such countries notified from
time to time by the Central Government. Hitherto,
only inbound mergers were permitted, whereby a
company incorporated outside India could merge
with an Indian company.
42. Section 2(27), CA 2013

43. Section 2(87), CA 2013
44. Section 2(6), CA 2013
16
4. Taxation Framework
I. Overview of Indian Taxation
System
Income tax law in India is governed by the Income
Tax Act, 1961 (ITA). Under the ITA, individuals and
entities, whether incorporated or unincorporated,
if resident for tax purposes in India, shall be taxed
on their worldwide income in India. Companies are
held to be resident in India for tax purposes a) if they
are incorporated in India; or b) if they are controlled
and managed entirely in India. Therefore, it is
possible for companies incorporated outside India
to be considered to be resident in India if they are
wholly controlled in India. Non-residents are taxed
only on income arising from sources in India.
India has entered into more than 80 Double Taxation
Avoidance Agreements (DTAAs or tax treaties).
A taxpayer may be taxed either under domestic law
provisions or the DTAA to the extent that it is more
beneficial. In order to avail benefits under the DTAA,
a non-resident is required furnish a tax residency
certificate (TRC) from the government of which it
is a resident in addition to satisfying the conditions
prescribed under the DTAA for applicability of the
DTAA. Further, the non-resident should also file
tax returns in India and furnish certain prescribed
particulars to the extent they are not contained
in the TRC. For the purpose of filing tax returns
in India, the non-resident should obtain a tax ID
in India (called the permanent account number
PAN). PAN is also required to be obtained to claim
the benefit of lower withholding tax rates, whether
under domestic law or under the DTAA. If the nonresident fails to obtain a PAN, payments made to
the non-resident may be subject to withholding
tax at the rates prescribed under the ITA or 20%,
whichever is higher.
A. Corporate Tax
Resident companies are taxed at 30%. A company
is said to be resident in India if it is incorporated in
India or is wholly controlled and managed in India.
A minimum alternate tax (MAT) is payable by
companies at the rate of around 18.5%. Non-resident
companies are taxed at the rate of 40% on income
derived from India, including in situations where
profits of the non-resident entity are attributable to a
permanent establishment in India.
B. Tax on Dividends and Share Buyback

Dividends distributed by Indian companies are
subject to a distribution tax (DDT) at the rate of 15%,
payable by the company. However, the domestic law
requires the tax payable to be computed on a grossed
up basis; therefore, the shareholders are not subject
to any further tax on the dividends distributed to
them under the ITA. An Indian company would
also be taxed at the rate of 20% on gains arising to
shareholders from distributions made in the course
of buy-back or redemption of shares.
C. Capital Gains
Tax on capital gains depends upon the holding
period of a capital asset. Short term capital gains
(STCG) may arise if the asset has been held for less
than three years (or in the case of listed securities,
less than one year) before being transferred; and
gains arising from the transfer of assets having
a longer holding period than the above are
characterized as long term capital gains (LTCG).
The 2014 Finance Budget proposes a minimum
holding period of 3 years for LTCG with respect to
unlisted securities.
LTCG earned by a non-resident on sale of unlisted
securities may be taxed at the rate of 10% or 20%
depending on certain considerations. LTCG on sale of
listed securities on a stock exchange are exempt and
only subject to a securities transaction tax (STT).
STCG earned by a non-resident on sale of listed
securities (subject to STT) are taxable at the rate of
15%, or at ordinary corporate tax rate with respect
to other securities. Foreign institutional investors
or foreign portfolio investors are also subject to
tax at 15% on STCG and are exempt from LTCG
(on the sale of listed securities). The 2014 Budget
also proposes to treat all income earned by Foreign
Institutional Investors or Foreign Portfolio Investors
as capital gains income. In the case of earn-outs or
deferred consideration, Courts have held that capital
gains tax is required to be withheld from the total
sale consideration (including earn out) on the date of
transfer of the securities / assets.
India has also introduced a rule to tax non-residents
on the transfer of foreign securities the value of
which may be substantially (directly or indirectly)
derived from assets situated in India. Therefore,
the shares of a foreign incorporated company can
17
Taxation Framework
be considered to be a situate in India and capable

of yielding capital gains taxable in India, if the
companys share derive their value substantially45
from assets located in India. However, income
derived from the transfer of P-notes and ODIs derive
their value from the underlying Indian securities
is not considered to be income derived from the
indirect transfer of shares in India because holding
such derivative instruments which are linked to
underlying shares in India does not constitute an
interest in the Indian securities.
Tax is levied on private companies and firms that
buy/ receive shares of a private company for less
than their fair market value. Therefore, where the
consideration paid by a private company or firm
is less than the fair market value of the shares, the
purchaser would be taxed on the difference under
these provisions.
D. Interest
Interest earned by a non-resident may be taxed at a
rate between 5% to around 40% depending on the
nature of the debt instrument. While a concessional
withholding tax rate of 5% for interest on long
term foreign currency denominated bonds is
available until July 1, 2017, the eligibility of rupeedenominated non-convertible debentures for the
same benefit expires on June 1, 2015.
E. Minimum Alternate Tax

Where the tax payable by the investee company
is less than 18.5 percent of its book profits, due to
certain exemption such company is still required to
pay atleast 18.5 percent (excluding surcharge and
education cess) as Minimum Alternate Tax.
F. Safe Harbor Rules

Safe harbour rules have been recently notified with
the aim of providing more certainty to taxpayers
and to address growing risks of transfer pricing
litigation in India. Under this regime, tax authorities
will accept the transfer price set by the taxpayer if
the taxpayer and transaction meet eligibility criteria
specified in the rules. Key features of these rules are:
i. The rules will be applicable for 5 years beginning
assessment year 2013-14. A taxpayer can opt for
the safe harbor regime for a period of his choice
but not exceeding 5 assessment years. Once opted
for, the mutual agreement procedure would not
be available.
ii. Safe harbor margins have been prescribed

for provision of: (i) IT and ITeS services; (ii)
Knowledge Process Outsourcing services;
(iii) contract R&D services related to generic
pharmaceutical drugs and to software
development; (iv) specified corporate guarantees;
(v) intra-group loan to a non-resident wholly
owned subsidiary; (vi) manufacture and export of
core and non-core auto components.
iii. For provision of IT and ITeS services, KPO and
contract R&D services, the rules would apply
where the entity is not performing economically
significant functions.
iv. Taxpayers and their transactions must meet the
eligibility criteria. Each level of the authority
deciding on eligibility (i.e. the Assessing
Officer, the Transfer Pricing Officer and the
Commissioner) must discharge their obligations
within two months. If the authorities do not
take action within the time allowed, the option
chosen by the taxpayer would be valid.
v. Once an option exercised by the taxpayer has
been held valid, it will remain so unless the
taxpayer voluntarily opts out.
The option exercised by the assessee can be held
invalid in an assessment year following the initial
assessment year only if there is change in the facts
and circumstances relating to the eligibility of the
taxpayer or of the transaction.
G. Wealth Tax
Buildings, residential and commercial premises held
by the investee company will be regarded as assets as
defined under Section 2(ea) of the Wealth Tax Act,
1957 and thus be eligible to wealth tax in the hands
of the investee company at the rate of 1 percent on
its net wealth in excess of the base exemption of INR
30,00,000. However, commercial and business assets
are exempt from wealth tax.
H. Service Tax
The service tax regime was introduced vide Chapter
V to the Finance Act, 1994. Subsequent Finance Acts,
(1996 to 2003) have widened the service tax net by
way of amendments to Finance Act, 1994. Service
tax is levied on specified taxable services at the rate
of 12.3646 percent on the gross amount charged by
the service provider for the taxable services rendered
by him. The Finance Act, 2004 has introduced
construction services as a taxable service and thus
45. Although, substantial has not been defined under ITA, as per draft DTC 2013, substantial is proposed to be 20%
46. Excluding currently applicable education cess of 3 percent on service tax
18
such services provided by the investee company

would be subject to service tax in India. Further, the
Finance Act, 2007, has brought services provided
in relation to renting of immovable property, other
than residential properties and vacant land, for use
in the course or furtherance of business or commerce
under the service tax regime.
I. Stamp Duty and Other Taxes

The real estate activities of the venture capital
undertaking would be subject to stamp duties and
other local/municipal taxes, property taxes, which
would differ from State to State, city to city and
between municipals jurisdictions. Stamp duties may
range between 3 to 14 percent.
II. Specific Tax Considerations for

PE Investments
A. Availability of Treaty Relief
Benefits under a DTAA are available to residents of
one or both of the contracting states that are liable
to tax in the relevant jurisdiction. However, some
fiscally transparent entities such as limited liabilities
companies, partnerships, limited partnerships,
etc. may find it difficult to claim treaty benefits.
For instance, Swiss partnerships have been denied
treaty benefits under the India-Switzerland DTAA.
However, treaty benefits have been allowed to
fiscally transparent entities such as partnerships,
LLCs and trusts under the US and UK DTAAs, insofar
as the entire income of the entity is liable to be taxed
in the contracting state; or if all the beneficiaries are
present in the contracting state being the jurisdiction
of the entity. On the other hand, Swiss partnerships
have been denied treaty benefits under the IndiaSwitzerland.
Benefits under the DTAA may also be denied on the
ground of substance requirements. For instance, the
India-Singapore DTAA denies benefits under the
DTAA to resident companies which do not meet the
prescribed threshold of total annual expenditure
on operations. The limitation on benefits (LoB)
clause under the India-Luxembourg DTAA permits
the benefits under the DTAA to be overridden by
domestic anti-avoidance rules. India and Mauritius
are currently in the process of re-negotiating
their DTAA to introduce similar substance based
requirements.
B. Permanent Establishment and

Business Connection
Profits of a non-resident entity are typically not
subject to tax in India. However, where a permanent
establishment is said to have been constituted
in India, the profits of the non-resident entity are
taxable in India only to the extent that the profits
of such enterprise are attributable to the activities
carried out through its permanent establishment
in India and are not remunerated on an arms
length basis. A permanent establishment may be
constituted where a fixed base such as a place of
management, branch, office, factory, etc. is available
to a non-resident entity; or where a dependent
agent habitually exercises the authority to conclude
contracts on behalf of the non-resident entity.
Under some DTAAs, employees or personnel of
the non-resident entity furnishing services for the
non-resident entity in India may also constitute a
permanent establishment. The recent Delhi High
Court ruling in e-Funds IT Solutions/ e-Funds
Corp vs. DIT47 laid down the following principles
for determining the existence of a fixed base or a
dependent agent permanent establishment:
i. The mere existence of an Indian subsidiary or
mere access to an Indian location (including a
place of management, branch, office, factory,
etc.) does not automatically trigger a permanent
establishment risk. A fixed base permanent
establishment risk is triggered only when the
offshore entity has the right to use a location in
India (such as an Indian subsidiarys facilities);
and carries out activities at that location on a
regular basis.
ii. Unless the agent is authorized to and has
habitually exercised the authority to conclude
contracts, a dependent agent permanent
establishment risk may not be triggered. Merely
assigning or sub-contracting services to the
Indian subsidiary does not create a permanent
establishment in India.
iii. An otherwise independent agent may, however,
become a permanent establishment if the agents
activities are both wholly or mostly wholly
on behalf of foreign enterprise and that the
transactions between the two are not made under
arms length conditions.
Where treaty benefits are not available, the concept
of business connection, which is the Indian
domestic tax law equivalent of the concept of
permanent establishment, but which is much wider
47. TS-63-HC-2014 (DEL); MANU/DE/0373/2014
19
Taxation Framework
and has been defined inclusively under the ITA,

would apply to non-resident companies deriving
profits from India.
C. Indirect Transfer of shares in India

No explanation has been given under the ITA as
to when such securities may be considered to have
derived value substantially from assets located
in India. However, such transfers may be subject
to relief available under the relevant DTAA. As
discussed, these provisions should not impact
p-notes or ODI holders.
As mentioned earlier, substantial has not been
defined under ITA, based on the recommendation of
high level government committee, draft DTC 2013,
provides for a threshold of 20% or more assets are
situated in India. However, given the ambiguity of
the provisions governing indirect transfer of shares
in India, the impact of these provisions have to be
examined on a case-by-case basis and necessary risk
mitigation strategies have to be adopted to address
the concerns of buyers or sellers. Please refer to
Annexure XII for a detailed analysis.
D. General Anti-Avoidance Rule

India has introduced general anti-avoidance rules
(GAAR) which provide broad powers to tax
authorities to deny a tax benefit in the context of
impermissible avoidance agreements, i.e., structures
(set up subsequent to August 30, 2010) which are
not considered to be bona fide or lack commercial
substance. GAAR will come into effect from April
1, 2015 and would override DTAAs signed by India.
Therefore, the transfer of any investment made
subsequent to August 30, 2010 shall be subject to the
GAAR from April 1, 2015. The applicability of the
GAAR is subject to a de minimis threshold of INR 3
crore. GAAR is not attracted in the case of a foreign
institutional investor which is not claiming benefits
under the DTAA and has invested in in listed or
unlisted securities in compliance with the law. The
option of obtaining an advance ruling is available
even in the context of GAAR structures. Care has
to be taken while developing and implementing
structures to address GAAR and in this context, it is
important to document the business and strategic
rationale for each step in a structure.
Please refer to Annexure VII for a detailed analysis.
E. Transfer Pricing Regulations

Under the Indian transfer pricing regulations, any
income arising from an international transaction is
required to be computed having regard to the arms
length price. There has been litigation in relation
to the mark-up charged by the Indian advisory
company in relation to services provided to the
offshore fund / manager. In recent years, income
tax authorities have also initiated transfer pricing
proceedings to tax foreign direct investment in
India. In some cases, the subscription of shares of a
subsidiary company by a parent company was made
subject to transfer pricing regulations, and taxed in
the hands of the Indian company to the extent of
the difference in subscription price and fair market
value.
F. Withholding Obligations
Tax would have to be withheld at the applicable
rate on all payments made to a non-resident, which
are taxable in India. The obligation to withhold
tax applies to both residents and non-residents.
Withholding tax obligations also arise with respect
to specific payments made to residents. Failure to
withhold tax could result in tax, interest and penal
consequences. Therefore, often in a cross-border the
purchasers structure their exits cautiously and rely
on different kinds of safeguards such as contractual
representations, tax indemnities, tax escrow, nil
withholding certificates, advance rulings, tax
insurance and legal opinions. Such safeguards have
been described in further detail under Annexure X.
G. Structuring Through Intermediate

Jurisdictions
Investments into India are often structured through
holding companies in various jurisdictions for
number of strategic and tax reasons. For instance,
US investors directly investing into India may face
difficulties in claiming credit of Indian capital gains
tax on securities against US taxes, due to the conflict
in source rules between the US and India. In such
a case, the risk of double taxation may be avoided
by investing through an intermediary holding
company.
While choosing a holding company jurisdiction it
is necessary to consider a range of factors including
political and economic stability, investment
protection, corporate and legal system, availability
of high quality administrative and legal support,
48. Fees for Technical Services
20
banking facilities, tax treaty network, reputation and

costs.
India has entered into several BITs and other
investment agreements with various jurisdictions,
most notably, Mauritius. It is important to take
advantage of structuring investment into India,
may be the best way to protect a foreign investors
interest. Indian BITs are very widely worded and
are severally seen as investor friendly treaties.
Indian BITs have a broad definition of the terms
investment and investor. This makes it possible
to seek treaty protection easily through corporate
structuring. BITs can also be used by the investors to
justify the choice of jurisdiction when questioned for
GAAR.
HEAD OF TAXATION
MAURITIUS
Please refer to Annexure XI for detailed note on BITs.

Over the years, a major bulk of investments into
India has come from countries such as Mauritius,
Singapore and Netherlands, which are developed
and established financial centers that have favorable
tax treaties with India. Cyprus was also a popular
investment holding jurisdiction, but due to a recent
blacklisting by India due to issues relating to
exchange of information, investments from Cyprus
could result in additional taxes and disclosure
till this position changes. The following table
summarizes some of the key advantages of investing
from Mauritius, Singapore and Netherlands:
SINGAPORE
NETHERLANDS
Capital gains tax on sale of Mauritius residents not taxed. Singapore residents not
No local tax in Mauritius on
taxed. Exemption subject
Indian securities
capital gains.
to satisfaction of certain
substance criteria and
expenditure test by the
resident in Singapore. No local
tax in Singapore on capital
gains (unless characterized as
business income).
Dutch residents not taxed if

sale made to non-resident.
Exemption for sale made
to resident only if Dutch
shareholder holds lesser
than 10% shareholding in
Indian company. Local Dutch
participation exemption
available in certain
circumstances.
Tax on dividends
Indian company subject to

DDT at the rate of 15%.

Withholding tax on
outbound interest
No relief. Taxed as per Indian 15%

domestic law.
10%
Withholding tax on
15% (for royalties). FTS 48 may 10%
outbound royalties and fees be potentially exempt in India.
for technical services
10%
Other comments
To consider anti-abuse rules

introduced in connection
with certain passive holding
structures.
Mauritius treaty in the

process of being renegotiated.
Possible addition of
substance rules.

There are specific limitations

under Singapore corporate
law (e.g. with respect to
buyback of securities).
21
5. Exit Options / Issues

One of the largest issues faced by private equity
investors investing in real estate under the FDI route
is exit. Following are some of the commonly used
exit options in India, along with attendant issues /
challenges:
I. Put Options
Put options in favour of a non-resident requiring an
Indian resident to purchase the shares held by the
non-resident under the FDI regime were hitherto
considered non-compliant with the FDI Policy by
the RBI. RBI has legitimized option arrangements49
through an amendment in the TISPRO Regulations.
The TISPRO Regulations now permit equity shares,
CCPS and CCDs containing an optionality clause to
be issued as eligible instruments to foreign investors.
However, the amendment specifies that such an
instrument cannot contain an option / right to exit at
an assured price.
The amendment, for the first time, provides for a
written policy on put options, and in doing that sets
out the following conditions for exercise of options
by a non-resident:
i. Shares/debentures with an optionality clause
can be issued to foreign investors, provided that
they do not contain an option/right to exit at an
assured price;
ii. Such instruments shall be subject to a minimum
lock-in period of one year;
iii. The exit price should be as follows:
a. In case of listed company, at the market price
determined on the floor of the recognized stock
exchanges;
b. In case of unlisted equity shares, at a price
not exceeding that arrived on the basis of
internationally accepted pricing methodologies
c. In case of preference shares or debentures, at a
price determined by a Chartered Accountant
or a SEBI registered merchant banker per any
internationally accepted methodology.
II. Buy-Back
In this exit option, shares held by the foreign
investor, are bought back by the investee company.
Buy-back of securities is subject to certain
conditionalities as stipulated under Section 68 of
CA 2013. A company can only utilize the following
funds for undertaking the buy-back (a) free reserves
(b) securities premium account, or (c) proceeds of
any shares or other specified securities. However,
buy-back of any kind of shares or other specified
securities is not allowed to be made out of the
proceeds of an earlier issue of the same kind of shares
or same kind of other securities.
Further, a buy back normally requires a special
resolution50 passed by the shareholders of the
company unless the buyback is for 10% or less of
the total paid-up equity capital and free reserves
of the company. Additionally, a buy back cannot
exceed 25% of the total paid up capital and free
reserves of the company in one financial year, and
post buy-back, the debt equity ratio of the company
should not be more than 2:1. Under CA 1956, it was
possible to conduct two buy-backs in a calendar year,
i.e., one in the financial year ending March 31 and a
subsequent offer in the financial year commencing
on April 1. However, in order to counter this practice,
the CA 2013 now requires a cooling off period of one
year between two successive offers for buy-back of
securities by a company.
From a tax perspective, traditionally, the income
from buyback of shares has been considered as
capital gains in the hands of the recipient and
accordingly the investor, if from a favourable treaty
jurisdiction, could avail the treaty benefits. However,
in a calculated move by the Government to undo this
current practice of companies resorting to buying
back of shares instead of making dividend payments,
the government, vide Budget 2013-2014 levied a tax
of 20%51 on domestic unlisted companies, when such
companies make distributions pursuant to a share
repurchase or buy back.
The said tax at the rate of 20% is imposed on a
domestic company on consideration paid by it which
is above the amount received by the company at the
time of issuing of shares. Accordingly, gains that
49. http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=8682&Mode=0
50. Under CA 2013, a Special Resolution is one where the votes cast in favor of the resolution (by members who, being entitled to do so, vote in person or
by proxy, or by postal ballot) is not less than three times the number of the votes cast against the resolution by members so entitled and voting. (The
position was the same under CA 1956).
51. Exclusive of surcharge and cess.
22
may have arisen as a result of secondary sales that

may have occurred prior to the buy-back will also be
subject to tax now.
The proposed provisions would have a significant
adverse impact on offshore realty funds and foreign
investors who have made investments from
countries such as Mauritius, Singapore, United States
of America and Netherlands etc. where buy-back of
shares would not have been taxable in India due to
availability of tax treaty benefits. Further, being in
the nature of additional income tax payable by the
Indian company, foreign investors may not even be
entitled to a foreign tax credit of such tax.
Additionally, in the context of the domestic investor,
even the benefit of indexation would effectively
be denied to such investor and issues relating to
proportional disallowance of expenditure under
Section 14A of the ITA (Expenditure incurred in
relation to income not includible in total income)
may also arise. This may therefore result in the buyback of shares being even less tax efficient than the
distribution of dividends.
As an alternative to buy-back, the investor could
approach the courts for reduction of capital under
the provisions of section 66 of CA 2013; however,
the applications for such reduction of capital need
to be adequately justified to the court. From a tax
perspective, the distributions by the company to
its shareholders, for reduction of capital, would be
regarded as a dividend to the extent to which the
company possesses accumulated profits and will be
taxable in the hands of the company at the rate of
15%52 computed on a grossed up basis, distribution
over and above the accumulated profits (after
reducing the cost of shares) would be taxable as
capital gains.53
III. Redemption
In recent times, NCDs have dominated the market.
NCDs can be structured as pure debt or instruments
delivering equity upside. The returns on the NCDs
can be structured either as redemption premium or
as coupon, the tax consequences of the same is set
out earlier in this paper. The redemption premium
in certain structured equity deals can be pegged to
the cash flows or any commercially agreed variable,
enabling such debentures to assume the character
of payable when able kind of bonds. A large amount
of foreign investment into real estate has been
structured through this route. However, not much
data is available on how many such bonds have been

redeemed and at what IRRs. The instances of default
are few and it does seem that in most cases such
debentures are indeed providing returns and exits to
the investors as contemplated.
IV. Initial Public Offering

Another form of exit right which an investor may
have is in the form of an Initial Public Offering
(IPO). However, looking at the number of real
estate companies which have listed in the previous
decade in India, this may not be one of viable exit
options. The reason why real estate companies do
not wish to go public in India is manifold.
For instance, real estate companies are usually selfliquidating by nature. Thus, unless the flagship or
the holding company goes public, there may not
be enough public demand for and interest in such
project level SPVs. There is also some reluctance
in going for an IPO due to the stringent eligibility
criteria (for instance 3 year profitability track record
etc.) and the level of regulatory supervision that the
companies (usually closely held) will be subjected to
post listing.
V. Third Party Sale

In this option, the investor sells its stake to a third
party. If the sale is to another non-resident, the lockin of 3 years would start afresh and be applicable
to such new investor. Also, since FDI in completed
assets is not permitted, the sale to a non-resident can
only be of an under-construction project.
In a third party sale in real estate sector, it may
also be important to negotiate certain contractual
rights such as drag along rights. For instance, if
the sale is pursuant to an event of default, and the
investor intends to sell the shares to a developer, it
is likely that the new developer may insist on full
control over the project, than to enter a project with
an already existing developer. In such cases, if the
investor has the drag along rights, he may be able to
force the developer to sell its stake along with the
investors stake.
VI. GP Interest Sale54

A private equity fund is generally in the form of a
limited partnership and comprises two parties,
52. Exclusive of surcharge and cess

53. CIT v G. Narasimhan, (1999)1SCC510
54. Reaping the Returns: Decoding Private Equity Real Estate Exits in India, available at http://www.joneslanglasalle.co.in/ResearchLevel1/Reaping_the_
Returns_Decoding_Private_Equity_Real_Estate_Exits_in_India.pdf
23
Exit Options / Issues

the General Partner (GP) and the Limited Partner

(LP). The GP of a fund is generally organized as a
limited partnership controlled by the fund manager
and makes all investment decisions of the fund. In
a GP interest sale, the fund manager sells its interest
in the limited partnership (GP Interest) to another
fund manager or strategic buyer. While technically
sale of GP Interest does not provide exits to the LPs as
they continue in the fund with a new fund manager,
it provides an effective exit to fund managers
who wish to monetize their interests in the fund
management business.
VII. Offshore Listing

The Ministry of Finance (MoF) by a notification55
has permitted Indian unlisted companies to list
their ADRs, GDRs or FCCBs abroad on a pilot basis
for two years without a listing requirement in
India. In pursuance to this, the Central Government
amended56 the Foreign Currency Convertible Bonds
and Ordinary Shares (Through Depositary Receipt
Mechanism) Scheme, 1993 (FCCB Scheme). RBI
also directed57 the authorized dealers towards the
amendment to the FCCB Scheme.
Regulation 3(1)(B) of the FCCB Scheme, prior to the
amendment restricted unlisted Indian companies
from issuing GDRs/FCCBs abroad as they were
required to simultaneously list in Indian stock
exchanges.
The notification amended the regulation 3(1)(B) to
permit Indian unlisted companies to issue GDRs/
FCCBs to raise capital abroad without having to
fulfill the requirement of a simultaneous domestic
listing.
But it is subject to following conditions:
The companies will be permitted to list

on exchanges in IOSCO/FATF compliant
jurisdictions or those jurisdictions with which
SEBI has signed bilateral agreements (which are
yet to be notified).
The raising of capital abroad shall be in

accordance with the extant foreign FDI Policy,
including the sectoral caps, entry route,
minimum capitalization norms and pricing
norms;
The number of underlying equity shares offered

for issuance of ADRs/GDRs to be kept with the
local custodian shall be determined upfront and
ratio of ADRs/GDRs to equity shares shall be
decided upfront based on applicable FDI pricing

norms of equity shares of unlisted company;
The funds raised may be used for paying off

overseas debt or for operations abroad, including
for the funding of acquisitions;
In case the money raised in the offshore listing

is not utilized overseas as described, it shall
be remitted back to India within 15 days for
domestic use and parked in AD category banks.
The Central Government has recently prescribed

that SEBI shall not mandate any disclosures, unless
the company lists in India.
VIII. Flips
Another mode of exit could be by way of rolling the
real estate assets into an offshore REIT by flipping the
ownership of the real estate company to an offshore
company that could then be listed. Examples of such
offshore listings were seen around 2008, when the
Hiranandani Group set up its offshore arm Hirco
PLC building on the legacy of the Hiranandani
Groups mixed use township model. Hirco was listed
on the London Stock Exchanges AIM sub-market.
At the time of its admission to trading, Hirco was
the largest ever real estate investment company IPO
on AIM and the largest AIM IPO in 2006. Another
example is Indiabulls Real Estate that flipped some
of its stabilized and developing assets into the fold
of a Singapore Business Trust (SBT) that got listed
on the Singapore Exchange (SGX). However, both
Hirco and Indiabulls have not been particularly
inspiring stories and to some extent disappointed
investor sentiment. Based on analysis of the
listings, it is clear that there may not be a market for
developing assets on offshore bourses, but stabilized
assets may receive good interest if packaged well and
have the brand of a reputed Indian developer. Hence,
stabilized assets such as educational institutions,
hospitals, hotels, SEZs, industrial parks et al may find
a market offshore.
Please refer to Annexure XII for a detailed note on
exit by rolling assets to offshore REITs.
IX. Domestic REITs

Recently, SEBI introduced the REIT Regulations.
REITs would serve as an asset-backed investment
mechanism where an Indian trust is set up for the
holding of real estate assets as investments, either
55. The Press Release is available on:http://finmin.nic.in/press_room/2013/lisitIndianComp_abroad27092013.pdf

56. Notification no. GSR 684(E) [F.NO.4/13/2012-ECB], dated 11-10-2013
57. RBI A.P. (Dir Series) Circular No. 69 of November 8, 2013
24
directly or through an Indian company set up as a

Special Purpose Vehicle (SPV). However, there was
no clarity on the proposed tax regime, which is a key
element for enabling a successful REIT regime.
The Finance Act, 2014 has made certain amendments
to the Income Tax Act, 1961 (ITA) to clarify the
income tax treatment of REITs and InvITs. These
provisions have been incorporated depending on the
stream of income that the REIT would be earning
and distributing. The Finance Act, 2014 introduced
the definition of business trust in the Income Tax
Act, 1961 which includes REITs. REITs will have
a tax pass through status for income received by
way of interest or receivable from the SPV as per s.
10 (23FC), 10 (23FD) and 115UA of the Income Tax
Act, 1961. Long term capital gains on sale of units as
well as dividends received by REITs and distributed
to the investor shall be tax exempt. Interest income
received by the REIT is tax exempt and foreign

investors shall be subject to a low withholding tax
of 5% on interest payouts. Thanks to clarity in tax
treatment, global investors can soon participate in
core real estate assets in India. The regime for InvITs
would provide a massive boost to infrastructure
growth and development in India.
Even though the REITs Regulations have been
released, so far the regime has not taken off on
account of non-tax and tax issues.
Please refer to Annexure I for the detailed analysis
of the tax changes introduced in the Budget 2014 in
context of the REITs. Also, please refer to Annexure
II for our article published in Live Mint on the
tax and non-tax issues that make the Indian REIT
unattractive.
25
6. Domestic Pooling
Domestic pools of capital may be structured
primarily in two ways:
with the above conditions. The AIF Regulations lay

down several investment restrictions on category II
AIFs. These restrictions are as follows:
I. AIF
i. A Category II AIF cannot invest more than

25 percent of its corpus in any one investee
company.
In 2012, SEBI notified the (Alternative Investment

Funds) Regulations, 2012 (AIF Regulations) to
regulate the setting up and operations of alternate
investment funds in India. As provided in the AIF
Regulations, it replaces and succeeds the erstwhile
SEBI (Venture Capital Funds) Regulations, 1996.
The AIF Regulations further provide that from
commencement of such regulations, no entity or
Person shall act as an AIF unless it has obtained a
certificate of registration from the SEBI. The AIF
Regulations define Alternative Investment Funds
as any fund established or incorporated in India
in the form of trust, company, a limited liability
partnership or a body corporate which is a privately
pooled investment vehicle which collects funds from
investors, whether Indian or foreign, for investing
in accordance with a defined investment policy for
the benefit of investors, and is not covered under the
SEBI regulations to regulate fund management.
The real estate funds shall be registered with SEBI as
a Category II Alternate Investment Fund and shall be
governed by the provisions of the AIF Regulations.
The AIF Regulations prescribe that the raising of
commitments should be done strictly on a private
placement basis and the minimum investment
that can be accepted by a fund from an investor
is INR 1,00,00,000 (Rupees One Crore Only). The
AIF Regulations also prescribe that a placement
memorandum detailing the strategy for investments,
fees and expenses proposed to be charged, conditions
and limits on redemption, risk management tools
and parameters employed, duration of the life cycle
of the AIF should also be issued prior to raising
commitments and be filed with the SEBI prior to
launching of a fund. Further, the AIF Regulations
also prescribe that the manager or a sponsor of an
AIF shall have a continuing interest in the AIF of
not less than 2.5% of the corpus or INR 5,00,00,000
(Rupees Five Crore Only), whichever is lower, in the
form of investment in the AIF and such interest shall
not be through the waiver of management fees.
The AIF Regulations provide that a close ended
AIF may be listed only after the final closing of the
fund or scheme on a stock exchange subject to a
minimum tradable lot of INR 1,00,00,000 (Rupees
One Crore Only). Accordingly, the Fund will not be
in a position to list its securities without complying
26
ii. A Category II AIF may invest in units of Category

I and II AIFs but not in the units of fund of funds.
iii. An AIF may not invest in its Associates except
with the approval of 75% of the investors by
value of their investments in the AIF. For this
purpose Associates means a company or a
limited liability partnership or a body corporate
in which a director or trustee or partner or
sponsor or manager of the AIF or a director or
partner of the manager or sponsor holds, either
individually or collectively, more than 15% of
its paid-up equity share capital or partnership
interest, as the case may be.
An investee company has been defined to mean
any company, special purpose vehicle or limited
liability partnership or body corporate in which
an AIF makes an investment. A registered AIF will
be subject to investigation/inspection of its affairs
by an officer appointed by SEBI, and in certain
circumstances the SEBI has the power to direct the
AIF to divest its assets, to stop launching any new
schemes, to restrain the AIF from disposing any of
its assets, to refund monies or assets to Investors
and also to stop operating in, accessing the, capital
market for a specified period.
However, a Category II AIF is not permitted to
receive foreign investment under the extant
exchange control regulations without prior approval
of the FIPB. Though in a few cases, such approval
has been granted in cases where the investment was
required for the purposes of making the sponsor
commitment, no approval has thus far been granted
for LPs willing to invest in the AIF. Based on reports,
SEBI is in discussions with the RBI and FIPB to allow
foreign investment beyond sponsor commitment
in AIFs, but as we understand the RBI and the FIPB
are not yet comfortable with such permissions on a
policy level.
II. NBFC
In light of the challenges that the FDI and the FPI
route are subjected to, there has been a keen interest
in offshore realty funds to explore the idea of setting
up their own NBFC to lend or invest to real estate.
An NBFC is defined in terms of Section 45I(c) of the

RBI Act, 1934, as a company engaged in granting
loans/advances or in the acquisition of shares/
securities, etc. or hire purchase finance or insurance
business or chit fund activities or lending in any
manner provided the principal business of such
a company does not constitute any non-financial
activities such as (a) agricultural operations (b)
industrial activity (c) trading in goods (other than
securities) (d) providing services (e) purchase,
construction or sale of immovable property. Every
NBFC is required to be registered with the RBI, unless
specifically exempted.
Following are some of the latest changes with respect
to NBFC:
A. Transfer of Shares from Resident to

Non-resident58
Earlier there was only a requirement of giving 30
thirty days written notice59 prior to effecting a
change of control of non-deposit NBFC (the term
control has the same meaning as defined in the SEBI
Takeover Code), and a separate approval was not
required; and unless the RBI restricted the transfer of
shares or the change of control, the change of control
became effective from the expiry of thirty days from
the date of publication of the public notice.
However, recently, the RBI vide its circular dated
May 26, 201460, has prescribed that in order to
ensure that the fit and proper61 character of the
management of NBFCs is continuously maintained
for both, deposit accepting and non-deposit
accepting NBFCs, its prior written permission has to
be obtained for any takeover or acquisition of control
of an NBFC, whether by acquisition of shares or
otherwise. This RBI circular requires prior approval
in the following situations also:
i. any merger/amalgamation of an NBFC with
another entity or any merger/amalgamation of an
entity with an NBFC that would give the acquirer
/ another entity control of the NBFC;
ii. any merger/amalgamation of an NBFC with
another entity or any merger/amalgamation of
an entity with an NBFC which would result in
acquisition/transfer of shareholding in excess of

10 percent of the paid up capital of the NBFC;
iii. for approaching a court or tribunal under Section
391-394 of CA 1956 or Section 230-233 of CA 2013
seeking order for mergers or amalgamations with
other companies or NBFCs.
The abovementioned RBI approval is sought from
the DNBS (Department of Non-Banking Supervision)
division of the RBI.
Separately, earlier, any transfer of shares of a
financial services company from a resident to a
non-resident required prior approval of the Foreign
Exchange Department of the Reserve Bank of India
(FED), which took anywhere in the region of 2 4
months. In a welcome move, as per a recent RBI
circular dated November 11, 2013, the requirement
to procure such an approval was removed if:
i. any fit and proper/ due diligence requirement

as regards the non-resident investor as stipulated
by the respective financial sector regulator shall
have to be complied with; and
ii. The FDI policy and FEMA regulations in terms of
sectoral caps, conditionalities (such as minimum
capitalization, etc.), reporting requirements,
documentation etc., are complied with.
B. Only Secured Debenture can be

Issued 62
NBFCs can only issue whether by way of private
placement of public issue fully secured debentures.
The security has to be created within a month
from the date of issuance. If the security cover is
inadequate, the proceeds have to be placed in an
escrow account, till the time such security is created.
C. Private Placement 63
As per Section 67(2) of CA 1956, private placement
means invitation to subscribe shares or debenture
from any section of public whether selected as
members or debenture holders of the company
concerned or in any other manner. Section 67(3)
prescribes that shares or debenture under such
offer can be offered to maximum of fifty persons.
58. http://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=8561&Mode=0
59. The public notice had be published in one English and one vernacular language newspaper, copies of which were required to be submitted to the RBI.
60. DNBS (PD) CC.No.376/03.10.001/2013-14
61. Under the Master Circular on Corporate Governance dated July 1, 2013, RBI had emphasized the importance of persons in management who fulfil the
fit and proper criteria. The Master Circular provides as follows:
it is necessary to ensure that the general character of the management or the proposed management of the non-banking financial company shall not
be prejudicial to the interest of its present and future depositors. In view of the interest evinced by various entities in this segment, it would be desirable that NBFC-D with deposit size of Rs 20 crore and above and NBFC-ND-SI may form a Nomination Committee to ensure fit and proper status of
proposed/existing Directors.
62. RBI/2012-13/560 DNBD(PD) CC No. 330/03.10.001/2012-13 and RBI/2013-14/115 DNBS(PD) CC No.349/03.10.001/2013-14
63. Ibid
27
Domestic Pooling
However, NBFCs where excluded from Section

67(3). But RBI has now restricted private placement
to not more than 49 investors, in line of the private
companies which are to be identified upfront by the
NBFC.
not to facilitate requests of group entities/

parent company/ associates. Core Investment
Companies have been carved out from the
applicability of this restriction.
D. Deployment of Funds and

Miscellaneous
ii. NBFCs have been restricted from extending

loans against the security of its own debentures,
whether issued by way of private placement or
public issue.
i. NBFCs can issue debentures only for deployment

of the funds on its own balance sheet and
Please refer to Annexure V64 for detailed investment

note on investment through NBFCs.
64. http://www.nishithdesai.com/New_Hotline/Realty/Realty%20Check%20-%20Debt%20Funding%20Realty%20in%20India_Jan2012.pdf
28
7. The Road Forward

The Indian real estate industry is at a stage where
the private equity players have seen a lot of exits,
with some making excellent multiples while others
burning their fingers deep. However, a larger chunk
of exits are expected to be witnessed in the next 2-3
years when the sector completes its first full cycle,
which is where the key challenge lies. Some of the
challenges that Indian real estate sector faces are as
follows:
I. REITs
The Budget 2014-2015 has put REITs back on the
fast track by proposing to take steps to bring clarity
in tax treatment of REITs, including a partial tax
pass-through regime for REITs. This will result in
the REIT not being subject to any tax in respect of
such interest income, whereas the investors will be
subject to tax on the same.
The much awaited framework for REITs has also
been announced and thanks to the present clarity in
tax treatment, global investors can soon participate
in core real estate assets in India. Long term capital
gains on sale of units as well as dividends received
by the REIT and distributed to the investor shall be
tax exempt. Interest income received by the REIT is
tax exempt and foreign investors shall be subject to a
low withholding tax of 5% on interest payouts.
In spite of the positive proposals brought forward by
the government to establish an investment-friendly
regime, there still remain certain issues with respect
of taxation of REITs. It should be noted that almost
all countries provide for a complete pass through
regime for REITs if the prescribed regulatory criteria
is met and a move towards that will further increase
interest in this space. It is hoped that the Finance
Ministry would address the above issues going
forward and possibly simplify the REIT taxation
regime.
Please refer to Annexure I for the detailed analysis
of the tax changes introduced in the Budget 2014 in
context of the REITs. Also, please refer to Annexure
II for our article published in Live Mint on the
tax and non-tax issues that make the Indian REIT
unattractive.
II. Partner Issues

Uncooperative partner has been the largest issue
for private equity players. Promoter - investor
expectation mismatch are now increasingly seen.
Enforceability of tag along rights, drag along rights,
put options or even 3rd party exits clearly hinge on
the cooperation of the local partner. Besides, with
exit price capped at the DCF valuation, cooperation
of the investee company typically controlled by the
Indian promoters is crucial as projections for DCF
can only be provided by the investee company.
III. Arbitration / Litigation

Indian courts have been known for their
lackadaisical approach to dispute resolution.
Hitherto, even international arbitration was not
free from the involvement of the Indian courts,
which was a concern for offshore investors. Now,
with the decision of the Supreme Court in the Balco
case, the jury is out that parties in an international
arbitration can agree to exclude the jurisdiction of
the Indian courts. In India, any dispute may be set to
comprise of two stages. The first being the liability
crystallization process, and other being the award
enforcement process. The liability crystallization
that typically took several decades sometimes, can
now be shorted to less than a year as well where
the process is referred to institutional arbitration
under the auspices of LCIA etc. Once an award has
been delivered, the enforcement process is rather
straightforward.
Please refer to Annexure XIII65 for detailed note on
Balco judgement.
IV. Security Enforcement

Enforcement of security interest is still a challenge in
India. For instance, enforcing a mortgage in India is
a court driven process and can take long sometimes
even extending beyond couple of years. The situation
was better in case of pledge of listed shares which
was considered the most liquid security, as it could
be enforced without court involvement. However,
the court stay on the invocation of pledge of shares of
Unitech66, in spite of a breach of the terms, has raised
65. http://www.nishithdesai.com/information/research-and-articles/nda-hotline/nda-hotline-single-view/article/bombay-high-court-clarifies-the-prospective-application-of-balco.html?no_cache=1&cHash=02aa560249d89d9e5e0b18c12f25eddc
66. Court saves promoter pledge, http://www.moneycontrol.com/news/management/court-saves-promoter-pledge_520897.html, last visited on April 8,
2012
29
The Road Forward

questions on this form of security as well.67

Please see Annexure XIV68 for an article on
challenges in invocation of pledge.
67. For the first time, a High Court (highest court of law in a state in India) stayed the invocation of a pledge and that too via an ex-parte (without the
defending party being present or heard) injunction handed out on a Sunday.
68. http://www.livemint.com/Companies/l5mzgtPyZRxqtimiq4CsxH/Concerns-among-PE-firms-over-enforcing-realty-share-pledges.html
30
Annexure I
Budget 2014: A Game Changer for Reits?
Budget 2014-15 (Budget) has introduced tax
incentives for the real estate investment trusts
(REITs) regime, and also provided for relaxations in
foreign direct investment (FDI) regime. With the
tax incentives in place, the Securities and Exchange
Board of India (SEBI) is likely to formally announce
the REIT regulations that are currently in draft form.
In this hotline, we discuss some of the key changes
and its Budget 2014 impact on the real estate sector.
For a detailed analysis of the impact of Budget 201415 on other aspects as well, please refer to our hotline
India Budget 2014: New Beginnings and New
Direction.
I. Changes in Relation to Reits

A. Background
As a background, the Securities and Exchange Board
of India (SEBI) had released the draft
regulations on REITs (Draft Regulations)
for comments on October 10, 2013. The Draft
Regulations as released are available here.
(http://www.sebi.gov.in/cms/sebi_data/
attachdocs/1381398382013.pdf) Though the
Draft Regulations were received positively, it
was imperative that attendant tax and regulatory
incentives were also announced. Now, with the tax
incentives announced and effective from October 1,
2014, it seems almost certain that the SEBI will put in
place an operating framework for REITs by October
2014. Please refer to our article titled REIT Regime
In India: Draft REIT Regulations Introduced for a
detailed analysis of, and our suggestions on, the Draft
Regulations.
B. Structure of REIT
Before we move on the tax incentives proposed in
the Budget, we set out below a quick snapshot of
the REIT structure as contemplated under the Draft
Regulations. REITs in India are required to be set up

as private trusts under the purview of the Indian
Trusts Act, 1882.
i. Parties
The parties in the REIT include the sponsor, the
manager, the trustee, the principal valuer and the
investors / unit holders. Sponsor sets up the REIT,
which is managed by the manager. The trustee holds
the property in its name on behalf of the investors.
The roles, responsibilities, minimum eligibility
criteria and qualification requirements for each
of the abovementioned parties are detailed in the
Draft Regulations. Sponsors are required to hold a
minimum of 15% (25% for the first 3 years) of the
total outstanding units of the REIT at all times to
demonstrate skin-in-the-game.
ii. Use of SPV
REITs may hold assets directly or through an SPV.
All entities in which REITs control majority interest
qualify as an SPV for the purpose of the Draft
Regulations.
iii. Investment and Listing
Units of a REIT are compulsorily required to be listed
on a recognized stock exchange.
iv. Potential Income Streams
REITs are principally expected to invest in completed
assets. Income would consist of rental income,
interest income or capital gains arising from sale of
real assets / shares of SPV.
v. Distribution
90% of net distributable income after tax of the REIT
is required to be distributed to unit holders within 15
days of declaration
The illustration below gives the typical REIT
structure:
31

Investor*
Sponor*
*Mininmum Public Float:

>25% of REIT Units
*Mininmum Sponser
Investment: >15% of REIT
Units
REIT
Trustee
Manager
SPV
Real Estate Asset(S)
Real Estate Asset(S)
C. Proposed Tax Regime under the

Budget
The Finance Bill, 2014 (Bill) proposes to amend the
Income Tax Act (ITA) to provide for the income
tax treatment of REITs. These provisions have been
incorporated depending on the stream of income
that the REIT is earning and distributing:
i. Units of REIT Akin to Listed Shares
The Bill proposes that when a unit holder disposes
off units of a REIT, long term capital gains(LTCG)
(units held for more than 36 months) would be
exempt from tax and short term capital gains
(STCG) would be taxed at 15% since units would
be treated as listed securities under the ITA. In
addition to the above, the Bill has also proposed that
securities transaction tax is to be payable on transfer
of units of a REIT.
ii. Tax Treatment of the Sponsor

The Bill proposes to make the transfer of shares of
the SPV into a REIT in exchange for issue of units of
the REIT to the transferor (or the sponsor) exempt
from capital gains tax under the ITA. However,
although the units of a REIT would be listed on a
recognized stock exchange, specific amendments
are proposed to exclude units of REITs from the
exemption of tax on LTCG / STCG if sold by the
sponsor; and the cost of acquisition of the shares of
the SPV by the sponsor shall be deemed to be the cost
of acquisition of the units of the REIT in his hands.
Analysis
Although the Draft Regulations allow REITs to

hold real estate assets either directly or through
an SPV, the tax benefit for a sponsor to set up a
REIT has been extended only to cases where real
estate assets are held by the REIT through an SPV.
This can be a substantial dampener for sponsors
looking to set up REITs holding direct assets since
transfer of real estate assets instead of an SPV to a
REIT may involve a tax leakage.
An additional issue that is outstanding is in cases

where assets are held in a partnership or a limited
liability partnership and on the tax treatment in
order to transfer the partnership interest to the
REIT.
Analysis
Treatment of listed REITs unit akin to listed shares
with respect to rates for LTCG and STCG is a major
relaxation for the unit holders, and will give a major
impetus to the REIT regime. Though the requirement
of holding the units for at least 36 months for
characterization as long term capital gains, unlike
12 months in case of listed shares, is understandable
since REITs are meant to be akin to holding real
estate directly which is any ways subject to 36
months holding period, this may be a disincentive to
invest in REITs.
32
iii. Income in the nature of interest

The Bill provides for a pass through treatment in
respect of any interest income that is received by

the REIT from an SPV. This will result in the REIT
not being subject to any tax in respect of such
interest income, whereas the investors will be
subject to tax on the same. However, there would
be a levy of withholding tax that would be imposed
on distribution by the REIT to its unit holder. This
withholding tax would be at the rate of 10% if
paid to resident unit holders and 5% if paid to nonresident unit holders.1 In case of non-resident unit
holders, the 5% tax would be the final tax payable
by the non-resident, while in case of residents, they
will be subject to tax as per the tax rate applicable to
them.
Analysis
To avail the tax pass through on interest income,
the sponsor would have to trade-off by paying tax
on transfer of the SPV / assets. This is so because, (a)
the REIT cannot acquire any debt securities without
a tax incidence for the sponsor (the exemption is
only for shares); and (b) if the monies areraised by
REIT from the public, and infused into a newly
created SPV by way of debt, which acquires the asset
from the sponsor, there is no tax exemption for the
sponsor in such case. To that extent, the benefit of
this relaxation is highly questionable.
iv. Income in the Nature of Dividend
Where dividends are distributed by the SPV to the
REIT, the existing provision dealing with Dividend
Distribution Tax (DDT) under Section 115-O of the
ITA would apply and the SPV would face a 15% tax
on distribution with no further liability on the REIT
as a shareholder. Further, the Bill proposes that any
income distributed by the REIT to its unit holder
that is not in the nature of interest or capital gains is
exempt from income tax. Therefore, distributions of
dividends received from the SPV by the REIT to the
unit holders would be exempt from tax in India.
Analysis
Though distribution of monies received by the REIT
as dividend to the until holders is exempt from tax in
the hands of the unit holders, still the applicability of
both, the corporate tax and dividend distribution tax,
in the hands of SPV makes this route of distribution
tax inefficient. Since, unlike listed developers, REITs
are mandatorily required to distribute 90% of net
distributable income after tax to investors, the
applicability of dividend distribution tax is a major
dampner. To ensure real pass through, it would have
been better if the government had dispensed with
the dividend distribution tax in case of REITs.
v. Income in the Nature of Business Profits/Lease

Rentals/Management Fee
Chapter XII-FA is proposed to be added to the ITA by
which Section 115UA is to be included for dealing
with the taxation of income earned by a REIT that is
not in the nature of capital gains, interest income or
dividend. All such income is proposed to be taxed in
the hands of the REIT at the maximum marginal rate
i.e. 30%. Such income, while distributed by the REIT
to the unit holders would be exempt in the hands of
the unit holders.
Analysis
This would apply in a situation where the REIT is
holding the assets directly or in situations where
they are charging fees to the SPV. There is no
relaxation in such case, as even under the existing
tax regime, tax once paid by a trust would have been
exempt in the hands of the unit holders. To ensure
true pass through to REIT, the gains should have
been tax exempt in the hands of REIT and should
have rather been taxed in the hands of the unit
holders.
vi. Income in the Nature of Capital Gains
Where the REIT earns income by way of capital
gains by sale of shares of the SPV, the REIT would be
taxed as per regular rates for capital gains i.e. 20%
for LTCG and slab rates for STCG. However, further
distribution of such gains by the REIT to the unit
holder is proposed to be exempt from tax liability.
Analysis
Please refer to our analysis in point (v) above.
II. Relaxation in the FDI Regime

In line with the commitment of the government to
have housing for all by 2022, and also to promote the
Prime Ministers vision of one hundred Smart Cities,
the Finance Minister in the Budget has proposed key
reforms for foreign investment in the real estate and
development sector.
A. Relaxation in Minimum Area and

Minimum Capitalization
The Finance Minister has proposed to reduce the
requirement of minimum project size from 50,000
square metres to 20,000 square metres, and the
capitalization requirement (for a wholly owned
subsidiary) from USD 10 million to USD 5 million
respectively.
33

Analysis
Previously, in order to qualify for FDI, the project

size had to be a minimum of 50,000 square metres
and at least USD 10 million had to be infused
for a wholly owned subsidiary. This was a major
challenge since in Tier I cities which formed a
bulk of the demand demography, finding such a
large project was difficult, whereas in Tier II and
III cities where such projects were available, the
demand was not sufficient enough to warrant
investor interest. This relaxation has partially
addressed the long standing demand of the
industry, which was expecting a reduction to
10,000 square metres, since even 20,000 square
metres could be difficult for some Tier I cities (ex
Mumbai).
The relaxation is a positive step towards

providing impetus to development of smart cities
providing habitation for the neo-middle class, as
contemplated in the Budget.
B. Promoting Affordable Housing

The Budget has proposed introduction of schemes to
incentivize the development of low cost housing and
has also allocated this year a sum of INR 40 billion for
National Housing Bank for this purpose. In addition
to the above relaxation, to further encourage this
segment, projects which commit at least 30% of the
total project cost for low cost affordable housing
have been proposed to be exempted from minimum
built-up area and capitalisation requirements under
FDI. The Finance Minister has also proposed to
include slum development in the statutory list of
corporate social responsibility (CSR) activities.
Analysis
34
The INR 40 billion allocated for NHB will

increase the flow of cheaper credit for affordable
housing to the urban poor and lower income
segment. Further, the relaxation of 20,000
square metres requirements in case of projects
committing at least 30% project cost to low cost
affordable housing, would provide a major fillip
to affordable housing projects where the size of
the project is less than 20,000 square metres.
A critical element however will be the way
affordable housing is defined. The Budget does
not lay down the criteria for classification of
affordable housing. Under external commercial
borrowing regulations, the criteria for affordable
housing includes units having maximum
carpet area of 60 square metres, and cost of such
individual units not exceeding INR 30 lakh.
The Companies Act, 2013 has introduced CSR

provisions which are applicable to companies
with an annual turnover of INR 10 billion and
more, or a net worth of INR 5 billion and more,
or a net profit of INR 0.05 billion or more during
any financial year. Companies that trigger any
of the aforesaid conditions are required to spend
least two per cent (2%) of their average net profits
made during the three immediately preceding
financial years on CSR activities and/or report
the reason for spending or non-expenditure.
The proposition of the Finance Minister to
include slum development in the statutory list of
corporate social responsibility activities is quite
encouraging, as it not only provides developers
an avenue to meet their CSR requirements, but
also at the same time could give a huge impetus
to this segment.
III. Conclusion
REITs are beneficial not only for the sponsors
but also the investors. It provides the sponsor
(usually a developer or a private equity fund) an
exit opportunity thus giving liquidity and enable
them to invest in other projects. At the same time,
it provides the investors with an avenue to invest in
rental income generating properties in which they
would have otherwise not been able to invest, and
which is less risky compared to under-construction
properties.
For a REIT regime to be effectively implemented,
complete tax pass through is essential, as is the case
in most countries having effective REIT regimes.
Though the tax incentives for REITs introduced in
the Budget is definitively a positive move, however,
the tax incentives only result in partial tax pass
through to REIT, at the maximum. It is hoped that
the Finance Minister would address the issues as
mentioned in this piece going forward and possibly
simplify the REIT taxation regime.
Before REITs actually takes off, few other changes
need to be introduced, especially from securities
and exchange control laws perspective. Currently,
units of a REIT may not even qualify as a security.
Since, units of a REIT have to be mandatorily listed,
the first step will be to define units of a REIT as a
security under the SCRA. The next step will be to
amend exchange control regulations to allow foreign
investments in units of a REIT. Capital account
transaction rules will also need to be amended to
exclude REITs from the definition of real estate
business, as any form of foreign investment is
currently not permitted in real estate business.
Under current exchange control laws, investment
in yield generating assets may qualify as real estate

business.
on its message of growth and development,

especially in the real estate sector.
The relaxations proposed in the Budget pertaining to

affordable housing is a really positive move as there
is a major demand for housing in this segment. All
in all, the Budget represents the new governments
positive attitude and willingness to follow through
Prasad Subramanyan,
Deepak Jodhani and
Ruchir Sinha
You can direct your queries or comments to the

authors
35
Annexure II
Reits: Tax Issues and Beyond
Apart from the Tax Challenges, There are Non-Tax Issues also that make the Indian
Reit Unattractive
The Securities and Exchange Board of India (Sebi)
recently introduced the final regulations for real
estate investment trusts (REITs) and infrastructure
investment trusts (InvITs). These regulations come
on the back of recent tax initiatives introduced in
the budget this year. While the initiative is indeed a
positive step, the tax measures governing REITs or
business trusts (as they are referred to in the Incometax Act) do not offer much encouragement, neither
to the sponsor nor the unit holders.
From a sponsors perspective, capital gains tax
benefit has been given only in cases where shares of
the special purpose vehicle (SPV) holding the real
estate are transferred to a REIT against units of a
REIT, and not when real estate is directly transferred
to a REIT. By doing so, there is an unnecessary
corporate layer imposed between the REIT and the
real estate asset, which could result in a tax leakage
of about 45% (corporate taxes of 30% at the SPV
level and distribution tax of 15% on dividends,
exclusive of surcharge and cess). To the sponsor,
there is no tax benefit (but mere deferral) because
she gets taxed when the REIT units are ultimately
sold on the floor at a much more appreciated value,
even though the units of a REIT would be listed and
exempt from capital gains tax if held by other unit
holders for more than three years.
While capital gains tax incidence may still be
avoided by relying on principles of trust taxation,
there will still be no respite from minimum alternate
tax (MAT), which could become applicable on
transfer of shares to the REIT. Considering that
sponsors would like to transfer the shares at higher
than book value to ensure commensurate fund
raising for the REIT, the issue of MAT seems to be
most critical.
From a REIT taxation perspective, although a passthrough of tax liability to investors for REIT income
was promised, since the SPV is required to pay full
corporate and dividend distribution taxes, where
is the pass-through? What is even worse is that no
foreign tax credit may be available for such taxes
paid in India.
The only way to achieve tax optimization seems to
be by way of infusion of debt into the SPV by a REIT.
In such a situation, interest from the SPV to the
REIT will be a deductible for the SPV, thus allaying
36
both distribution taxes and corporate taxes. Interest

from the SPV would be tax exempt at the REIT
level and only a 5% withholding will be applicable
on distributions by the REITs to the foreign unitholders. This should help neutralize REIT taxation at
India level, considering that the 5% withholding tax
paid in India should also be creditable offshore.
The critical question that would then come up is
how the SPV would use this debt. The debt can either
be used to retire existing debt, or be structured to
retire promoter equity in the SPV. If the debt is used
for retiring equity, the risk of deemed dividend
characterization would need to be carefully
considered. Though other creative structures may
be devised to minimize tax exposure for the sponsor,
it will be critical to dress up the SPV appropriately
with the right amount of debt and equity, before the
SPV is transferred to the REIT.
Apart from the tax challenges set out above, there are
also several non-tax issues that make the Indian REIT
story unattractive. The requirement for a sponsor to
have a real estate track record is likely to rule out a
substantial portion of yield generating assets. This
eliminates the possibility of non-real estate players
such as hotels, hospitals, banks and others (such as
Air India) becoming sponsors of REITs.
Most importantly, the marketability of Indian REITs
compared with other fixed-income products remains
weak since the expected yield on REITs may not
exceed 5-6% compared with an around-8% yield
offered by government securities. Though REITs
may offer a higher return considering the capital
appreciation, offshore investors seem reluctant to
buy the cap rate story attached to a REIT.
Having said that, REITs are likely to offer
monetization opportunities to private equity funds
and developers, which have till now been unable to
find institutional buyers for completed real estate
assets. As the appetite for developmental projects
has reduced, REITs will offer opportunities to foreign
investors to invest in rent generating assets, an asset
class otherwise prohibited for foreign investments.
It, however, remains to be seen how the Indian REIT
story matches up to the Singapore REIT structure
for Indian assets, or the more trending lease-rentaldiscounting structure, or the even more innovative
commercial mortgage-backed security structure,
which seem to be more appealing to potential

sponsors.
This article was published in Live Mint dated
October 21, 2014. The same can be accessed from
the link.(http://www.livemint.com/Money/
TyjZw3k6mcIQLNw8H8nNKL/REITs-Tax-issues-andbeyond.html)
Sriram Govind and
Ruchir Sinha
authors
37
Annexure III
Offshore Listing Regime: How to Raise Funds
and Monetize Investments
Governments recent initiative to allow unlisted
companies to list on offshore markets through the
depository receipt (DR) mechanism without the
requirement of simultaneous listing in India is likely
to be a major shot in the arm for many sectors, and
also offer exits to private equity players looking to
monetize their investments. Though offshore listing
was permitted later last year by Ministry of Finance,
such listings could not happen as SEBI had not
prescribed the disclosures for such listings.
Government has only recently prescribed that
SEBI shall not mandate any disclosures, unless
the company lists in India. Once the air around
disclosures to SEBI has been cleared, we can expect
offshore listing of DRs to grow on the back of the
reasons set out below.
First, offshore listing will offer the opportunity to a
slew of young Indian companies to tap the overseas
markets, which unlike domestic markets remain
quite vibrant. 2012 saw only 3 mainboard listings as
against 256 in the US.
Second, offshore listing would allow Indian
entrepreneurs the platform to tap investors that
have a much better understanding of the value
proposition of the business. For instance, innovative
tech, biotech, internet services are likely to receive
a better valuation on NYSE / NASDAQ as against
domestic markets.
Today, markets have become associated with
sectors - NYSE / NASDAQ is known for tech, SGX
for real estate and infra, LSE/AIM for infra and
manufacturing. DRs would allow the opportunity
to list on exchanges that are most conducive to the
sector.
Third, foreign investors will find it more amenable
to invest in DRs denominated in foreign currency
as against INR, which has depreciated by more
than 50% since 2007. Hedging cost is likely to be an
important driver for the growth of DRs. Many private
equity players suffered the wrath of their LPs due to
the steep rupee depreciation, despite the company
outperforming the expectations.
Fourth, while the offshore listing regime is meant for
fund-raising (it requires that funds must be brought
back into India within 15 days unless utilized
offshore for operations abroad), with a little bit of
38
structuring, the proceeds can also be used to provide

tax free exits to offshore private equity players.
Since there is no end use prohibition, proceeds of the
DR can be structured to retire existing debt or private
equity. With a growing number of secondary direct
funds looking at India, DRs can be the preferred
way to invest in India, retire existing investors and
monetize the investment later on the floor of the
exchange.
Fifth, from a tax perspective, investors can finally
breathe easy. There will be no tax on the sale of
DRs on the stock exchange. Hence, investors need
not worry about GAAR and substance in the treaty
jurisdiction or risk of indirect transfer taxation.
Sixth, listing of DRs is likely to be much cheaper
than listing of shares on foreign exchanges and
sometimes the compliance costs of ADR / GDR may
be lower than the compliance costs of domestic
listing.
Seventh, offshore listing would give depth to Indian
capital markets as well, and brighten the chances
of the company going public in India after having a
successful show on the offshore markets.
Eighth, listing on offshore exchanges like NYSE /
NASDAQ / SGX has its own snob value and is likely
to benefit many of the younger companies in gaining
reputation and recognition overseas.
Ninth, an increasing number of acquisitions,
especially in the tech space are happening by way
of swaps, or in other words, the shareholders of the
target company receiving consideration in form of
shares of the acquirer company.
This is a common strategy to keep the interests of
both the parties aligned post acquisition. With most
targets for tech companies being offshore, such swap
deals are hard to achieve, as there may be few takers
for Indian unlisted shares. To that extent, DRs being
dollar denominated can be used as currency for
acquisitions.
However, notwithstanding the enormous benefits
that the offshore listing regime brings, its success
remains circumspect as the scheme has only been
allowed for 2 years on a pilot basis. The specter of
what will happen after 2 years (6 months of which
have already elapsed) and the fear of the government
requiring simultaneous listing in India (as was

done in 2004) is likely to keep many issuers away.
Having said that, offshore listing regime unveils a
huge opportunity for fund raising, particularly for
young IT / ITES, biotech companies etc. which do not
feature on the list of either private equity or banks.
What remains to be seen is the if the Government
allows for DRs with underlying debt instrument as
against equity.
This article was published in The Economic Times

dated June 10, 2014. The same can be accessed
from the link. (http://articles.economictimes.
indiatimes.com/2014-06-10/news/50478612_1_drssimultaneous-listing-compliance-costs)
Ruchir Sinha and
Nishchal Joshipura
authors
39
Annexure IV
Regulatory Regime Forcing Cos
Externalisation
Doing Business away from Indian Tax Oversight and ease of Fund-Raising Among
Reasons for India Incs Tryst with Foreign Shores
With Indian companies rapidly expanding their
presence internationally, there has been an increased
keenness in companies operating in high growth
sectors to migrate their holding company structures
from India to reputed offshore jurisdictions. For
lack of a better word, lets refer this process of
structuring/ restructuring as externalisation as that
term may fit the reference better than globalisation
or internationalisation, both of which have much
wider imports.
There are several drivers for externalisation. First,
it moves the businesses away from Indian tax and
regulatory challenges into jurisdictions that may
be more conducive from an operational standpoint
and also substantially mitigates tax leakage and
regulatory uncertainty. Unwritten prohibition
on put options, retroactive taxation of indirect
transfers, introduction of general anti-avoidance
rules fraught with ambiguities, etc, are a few
examples why Indian companies may want to avoid
direct India exposure.
Second, from a fund raising perspective, it offers
Indian companies to connect with an investor base
that understands their business potential and thus
values them higher than what they would have
otherwise been valued at in domestic markets.
Infosys, Wipro, Rediff, Satyam are classic examples of
companies which preferred to tap the global capital
markets (NYSE and Nasdaq) without going public in
India.
Third, with the Indian currency oscillating to
extremes, one of the biggest concerns for foreign
investors is currency risk. By investing in dollars
in the offshore holding company (OHC), foreign
investors can be immune from the currency risk and
benefit from the value appreciation of the Indian
companies. Many foreign investors that invested in
2007 when the rupee was at around 42 to a dollar
have suffered substantially with the rupee now being
at 62 to a dollar.
Fourth, and this is more of a recent issue, with the
coming of the new Companies Act, 2013, which
provides for class-action suits, enhanced director
liability, statutory minimum pricing norms (beyond
40
exchange control restrictions), there will be keenness

to flip the structure to an OHC and ring-fence
potential liabilities under the Companies Act, 2013.
Lastly, such offshore jurisdictions also provide for
great infrastructure and governmental policies that
are discussed with businesses and are more closely
aligned to growth of the businesses as against
meeting revenue targets. With most clients offshore,
there may be certain amount of snob value that may
be associated with establishment in such offshore
jurisdictions.
Indian tax and regulatory considerations play a
very important role in externalisation. From a tax
standpoint, flipping the ownership offshore may
entail substantial tax leakage, and to that extent it
is advisable if the flip is undertaken at early stages
before the value is built up in the Indian asset.
Another challenge from a tax perspective is the
choice of jurisdiction for the holding company in
light of the impending general anti -avoidance rules
that may disregard the holding company structure if
it is found lacking commercial substance. To protect
the tax base from eroding, some of the developed
countries like the US have anti-inversion tax rules
which deter US companies from externalising
outside the US.
From a regulatory standpoint, one of the challenges
is to replicate the Indian ownership in the OHC,
especially since swap of shares or transfer of shares
for consideration other than cash requires regulatory
approval, which may not be forthcoming if the
regulator believes that the primary purpose of
the OHC is to hold shares in the Indian company.
Indian companies may be restricted from acquiring
shares of the OHC on account of the OHC likely
qualifying as a financial services company and
Indian individuals may be restricted to acquire
shares of the OHC under the new exchange control
norms since OHC will not be an operating company.
The extent of operations to be evidenced remains
ambiguous. OHCs acquisition of Indian shares will
also need to be carefully structured as the OHC will
not be permitted to acquire Indian shares at below
fair market value from an Indian tax and exchange
control perspective.
India has recently allowed Indian companies to

directly list on offshore markets, but the conditions
that such listing can only be for 51% shares of the
Indian company and that the proceeds of such
issuance must be used overseas within 15 days may
not allow the true potential of offshore listings to be
unleashed. The utilisation of the direct listing regime
remains to be seen as the Sebi is yet to come out with
a circular setting out disclosures required for such
listing.
However, considering the challenges faced by India
Inc, the need to move away from India for growth
seems inevitable in current times.
This article was published in The Economic Times

dated January 15, 2014. The same can be accessed
from the link. (http://articles.economictimes.
indiatimes.com/2014-01-15/news/46224745_1_
indian-companies-indian-currency-new-companiesact)
Ruchir Sinha and
Nishchal Joshipura
authors
41
Annexure V
NBFC Structure for Debt Funding
In light of the challenges that the FDI and the FPI
route are subjected to, there has been a keen interest
in offshore funds to explore the idea of setting
up their own NBFC to lend or invest in Indian
companies.
An NBFC is defined in terms of Section 45I(c) of the
RBI Act, 1934 (RBI Act) as a company engaged
in granting loans/advances or in the acquisition
of shares/securities, etc. or hire purchase finance
or insurance business or chit fund activities or
lending in any manner provided the principal
business of such a company does not constitute
any non-financial activities such as (a) agricultural
operations, (b) industrial activity, (c) trading in
goods (other than securities), (d) providing services,
(e) purchase, construction or sale of immovable
property. Every NBFC is required to be registered
with the RBI, unless specifically exempted.
The Act has however remained silent on the
definition of principal business and has thereby
conferred on the regulator, the discretion to
determine what is the principal business of
a company for the purposes of regulation.
Accordingly, the test applied by RBI to determine
what is the principal business of a company was
articulated in the Press Release 99/1269 dated April
8, 1999 issued by RBI. As per the said press release, a
company is treated as an NBFC if its financial assets
are more than 50 per cent of its total assets (netted

off by intangible assets) and income from these
financial assets is more than 50 per cent of its gross
income. Both these tests (50% Tests) are required
to be satisfied in order for the principal business of a
company to be determined as being financial for the
purpose of RBI regulation.
Recommendation of the Working Group on the

Issues and Concerns in the NBFC Sector chaired
by Usha Thorat has been issued by RBI in the
form of Draft Guidelines (Draft Guidelines).
Draft Guidelines1 provide that the twin criteria of
assets and income for determining the principal
business of a company need not be changed.
However, the minimum percentage threshold of
assets and income should be increased to 75 per
cent. Accordingly, the financial assets of an NBFC
should be 75 per cent or more (as against more
than 50 per cent) of total assets and income from
these financial assets should be 75 per cent or more
(as against more than 50 percent) of total income.
The NBFC could be structured as follows.
Structure diagram
Off-shore Fund
Off-shore
India
Non-Banking Financial Company
Indian Company
1. The Working Group report was published by the RBI in the form of Draft Guidelines on its website 12th December 2012
42
The Offshore Fund sets up an NBFC as a loan

company, which then lends to Indian companies.
The NBFC may either lend by way of loan or through
structured instruments such as NCDs which have a
protected downside, and pegged to the equity upside
of the company by way of redemption premium or
coupons.
I. Advantages of the NBFC Route

A. Assured Returns
The funding provided through NBFCs is in the form
of domestic loans or NCDs, without being subjected
to interest rate caps as in the case of CCDs. These
NCDs can be structured to provide the requisite
distribution waterfall or assured investors rate of
return (IRR) to the offshore fund.
B. Regulatory Uncertainty
The greatest apprehension for funds has been
the fluid regulatory approach towards foreign
investment, for instance put options. The NBFC
being a domestic lending entity is relatively immune
from such regulatory uncertainty
C. Security Creation
Creation of security interest in favour of nonresidents on shares and immoveable property is
not permitted without prior regulatory approval.
However, since the NBFC is a domestic entity,
security interest could be created in favour of
the NBFC. Enforceability of security interests,
however, remains a challenge in the Indian context.
Enforcement of security interests over immovable
property, in the Indian context, is usually a time
consuming and court driven process. Unlike banks,
NBFCs are not entitled to their security interests
under the provisions of the Securitization and
Reconstruction of Financial Assets and Enforcement
of Security Interest (SARFAESI) Act.
into the Indian entity.
E. Tax Benefits to the Investee

Company
As against dividend payment in case of shares, any
interest paid to the NBFC will reduce the taxable
income of the investee company. However, an NBFC
may itself be subjected to tax to the extent of interest
income so received, subject of course to deductions
that the NBFC may be eligible for in respect of
interest pay-outs made by the NBFC to its offshore
parent.
II. Challenges Involved in the

NBFC Route
A. Setting up
The first challenge in opting for the NBFC route is
the setting up of the NBFC. Obtaining a certificate
of registration from the RBI for an NBFC is a time
consuming process. This process used to take
anywhere in the region of 12 14 months earlier,
which wait period has now significantly reduced,
but it may still take as much as 6 months, or in some
cases, even longer.
Draft Guidelines provide that NBFCs with asset size

below Rs. 1000 crore and not accessing any public
funds shall be exempted from registration. NBFCs,
with asset sizes of Rs.1000 crore and above, need to be
registered and regulated, even if they have no access
to public funds.
Draft Guidelines also provide that small nondeposit taking NBFCs with asset of Rs. 50 crores or
less should be exempt from the requirement of RBI
registration. Not being deposit taking NBFCs and
being small in size, no serious threat perception is
perceived to emanate from them.
D. Repatriation Comfort
Even though repatriation of returns by the NBFC to
its offshore shareholders will still be subject to the
restrictions imposed by the FDI Policy (such as the
pricing restrictions, limits on interest payments etc.),
but since the NBFC will be owned by the foreign
investor itself, the foreign investor is no longer
dependent on the Indian company as would have
been the case if the investment was made directly
Due to the elaborate time period involved in setting

up the NBFC, one of the common alternatives
adopted, especially in case of non-deposit taking
NBFCs was to purchase an existing NBFC. This
was because earlier there was only a requirement
of giving 30 thirty days written notice2 prior to
effecting a change of control of non-deposit NBFC
2. The public notice had be published in one English and one vernacular language newspaper, copies of which were required to be submitted to the RBI
43

(the term control has the same meaning as defined

in the SEBI Takeover Code), and a separate approval
was not required; and unless the RBI restricted
the transfer of shares or the change of control, the
change of control became effective from the expiry of
thirty days from the date of publication of the public
notice.
However, recently, the RBI vide its circular dated
May 26, 20143, has prescribed that in order to
ensure that the fit and proper4 character of the
management of NBFCs is continuously maintained
for both, deposit accepting and non-deposit
accepting NBFCs, its prior written permission has to
be obtained for any takeover or acquisition of control
of an NBFC, whether by acquisition of shares or
otherwise. This RBI circular requires prior approval
in the following situations also
i. any merger/amalgamation of an NBFC with
another entity or any merger/amalgamation of an
entity with an NBFC that would give the acquirer
/ another entity control of the NBFC;
ii. any merger/amalgamation of an NBFC with
another entity or any merger/amalgamation of
an entity with an NBFC which would result in
acquisition/transfer of shareholding in excess of
10 percent of the paid up capital of the NBFC;
iii. for approaching a court or tribunal under Section
391-394 of the Companies Act, 1956 or Section
230-233 of Companies Act, 2013 seeking order for
mergers or amalgamations with other companies
or NBFCs.
The abovementioned RBI approval is sought from

the DNBS (Department of Non-Banking Supervision)
division of the RBI.
Separately, earlier, any transfer of shares of a
financial services company from a resident to a
non-resident required prior approval of the Foreign
Exchange Department of the Reserve Bank of India
(FED), which took anywhere in the region of 2 4
months. In a welcome move, as per a recent RBI
circular dated November 11, 2013, the requirement
to procure such an approval was removed if:
i. any fit and proper/ due diligence requirement

as regards the non-resident investor as stipulated
by the respective financial sector regulator shall
have to be complied with ; and
ii. The FDI policy and FEMA regulations in terms of
sectoral caps, conditionalities (such as minimum
capitalization, etc.), reporting requirements,
documentation etc., are complied with.
Since, the requirement of obtaining RBI approval in
case of change in control even for non-deposit taking
NBFC is relatively very new, only time will tell
how forthcoming RBI is in granting such approvals
and to that extent, how favourable is this option of
purchasing NBFC.
B. Capitalization
The NBFC would be subject to minimum
capitalization requirement which is pegged to the
extent of foreign shareholding in the NBFC as set out
in the FDI Policy.
Percentage of Holding in the NBFC Minimum Capitalisation

Up to 51% FDI
USD 0.5 million, with entire amount to be brought upfront.
More than 51% FDI
USD 5 million with entire amount to be brought upfront.
More than 75% FDI
USD 50 million, with USD 7.5 million to be brought upfront and the balance in 24
months.
3. DNBS (PD) CC.No.376/03.10.001/2013-14

4. Under the Master Circular on Corporate Governance dated July 1, 2013, RBI had emphasized the importance of persons in management who fulfil the
fit and proper criteria. The Master Circular provides as follows:
it is necessary to ensure that the general character of the management or the proposed management of the non-banking financial company shall
not be prejudicial to the interest of its present and future depositors. In view of the interest evinced by various entities in this segment, it would be
desirable that NBFC-D with deposit size of Rs 20 crore and above and NBFC-ND-SI may form a Nomination Committee to ensure fit and proper status
of proposed/existing Directors.
44
Considering the need for capitalization, it is not

uncommon to see non residents holding less than
75% stake in the NBFC even though a significant
portion of the contribution comes from nonresidents. Premium on securities is considered for
calculating the minimum capitalization.
not regarded as a transfer under the provisions of

the Income-tax Act, 1961, conversion of CCPS into
equity may be considered as a taxable event and long
term or short term capital gains may be applicable.
Lastly, CCPS will follow CCDs in terms of liquidation
preference.
In addition to the above, every NBFC is required to

have net owned funds5 of INR 20 million (INR 2.5
million provided application for NBFC registration is
filed on or before April 20,1999).6
However, unlike other companies, a combination of

nominal equity and a large number of CCDs may not
be possible in case of NBFCs. Though all non-deposit
accepting NBFCs are subjected to NBFC (Non-Deposit
Accepting or Holding) Companies Prudential norms
(Reserve Bank) Directions (the Prudential Norms),
once such NBFC has total assets in excess of INR 1
billion (USD 20 million approximately)9, the NBFC
is referred to as a systemically important NBFC.
Unlike other NBFCs, a systemically important NBFC
is required to comply with Regulation 15 (Auditors
Certificate), Regulation 16 (Capital Adequacy
Ratio) and Regulation 18 (Concentration of Credit
/ Investment) of the Prudential Norms. The choice
of instrument is largely dependent on the capital
adequacy ratio required to be maintained by the
NBFC for the following reason.
C. The Instrument
Before we discuss the choice of an instrument for the
NBFC, lets discuss the instruments that are usually
opted for investment under the FDI route
CCDs essentially offer three important benefits.
Firstly, any coupon paid on CCDs is a deductible
expense for the purpose of income tax. Secondly,
though there is a 40% withholding tax that the nonresident recipient of the coupon may be subject to,
the rate of withholding can be brought to as low as
10% if the CCDs are subscribed to by an entity that
is resident of a favorable treaty jurisdiction. Thirdly,
coupon can be paid by the company, irrespective
of whether there are profits or not in the company.
Lastly, being a loan stock (until it is converted), CCDs
have a liquidation preference over shares. And just
for clarity, investment in CCDs is counted towards
the minimum capitalization.
CCDs clearly standout against CCPS on at least the
following counts. Firstly, while any dividend paid
on CCPS is subject to the same dividend entitlement
restriction (300 basis points over and above the
prevailing State Bank of India Prime Lending Rate at
the time of the issue), dividends can only be declared
out of profits. Hence, no tax deduction in respect of
dividends on CCPS is available. To that extent, the
company must pay 30%7 corporate tax before it can
even declare dividends. Secondly, any dividends can
be paid by the company only after the company has
paid 15%8 dividend distribution tax. In addition,
unlike conversion of CCDs into equity, which is
Regulation 16 of the Prudential Norms restricts a

systemically important NBFC from having a Tier II
Capital larger than its Tier I Capital.
Tier I Capital = Owned funds10 + Perpetual debt

instruments (upto15% of Tier I Capital of previous
accounting year) -Investment in shares of NBFC
and share/ debenture/bond/ loans / deposits with
subsidiary and Group company (in excess of 10% of
Owned Fund)
Tier II Capital = Non-convertible Preference shares

/ OCPS + Subordinated debt + General Provision and
loss reserves (subject to conditions) + Perpetual debt
instruments (which is in excess of what qualifies
for Tier I above) + Hybrid debt capital instruments
+ revaluation reserves at discounted rate of fifty five
percent;
5. Net Owned Funds has been defined in the RBI Act 1934 as (a) the aggregate of paid up equity capital and free reserves as disclosed in the latest balance
sheet of the company, after deducting there from (i) accumulated balance of loss, (ii) deferred revenue expenditure and (iii) other intangible asset; and
(b) further reduced by the amounts representing (1) investment of such company in shares of (i) its subsidiaries; (ii) companies in the same group; (iii)
all other NBFCs and (2) the book value of debentures, bonds, outstanding loans and advances (including hire-purchase and lease finance) made to and
deposits with (i) subsidiaries of such company and (ii) companies in the same group, to the extent such amounts exceed ten percent of (a) above
6. Although the requirement of net owned funds presently stands at INR 20 million, companies that were already in existence before April 21, 1999 are
allowed to maintain net owned funds of INR 2.5 million and above. With effect from April 1999, the RBI has not been registering any new NBFC with
net owned funds below INR 20 million.
9. Note that an NBFC becomes a systemically important NBFC from the moment its total assets exceed INR 100 crores. The threshold of INR 1 billion
need not be reckoned from the date of last audited balance sheet as mentioned in the Prudential Norms.
10. Owned Fund means Equity Capital + CCPS + Free Reserves +Share Premium + Capital Reserves (Accumulated losses + BV of intangible assets +
Deferred Revenue Expenditure)
45

Thus, CCDs being hybrid debt instruments which

fall in Tier II cannot be more than Tier I Capital. This
disability in terms of capitalization is very crucial for
the NBFC and its shareholder as it not only impedes
the ability of the NBFC to pay out interests to the
foreign parent in case of inadequate profits, but is
also tax inefficient. There is currently an ambiguity
on whether NCDs are to be included in Tier II Capital
as they do not qualify in any of the heads as listed
above for Tier II Capital.
D. No Ability to Make Investments

Having discussed the funding of the NBFC itself,
lets discuss how the NBFC could fund the investee
companies. Under the FDI Policy, an NBFC with
foreign investment can only engage in certain
permitted activities11 under the automatic route,
and engaging in any financial services activity other
than such activities will require prior approval of
the Foreign Investment Promotion Board (FIPB),
an instrumentality of the Ministry of Finance of the
Government of India.
While lending qualifies as one of the permitted
categories (leasing and finance), investment is
not covered in the list above. Therefore, any FDI in
an NBFC that engages in investments will require
prior approval of the FIPB. Such an approval though
discretionary is usually granted within 3 months
time on a case to case basis. Therefore, an NBFC with
FDI can only engage in lending but not in making
investments.12
We are given to understand that in a few cases
where the redemption premium of the NCDs was
linked to the equity upside, RBI qualified such
instruments to be in the nature of investments
rather than just loan instruments. Once the nature
of the instrument changed, then nature of the NBFC
automatically changed from lending to investment,
and FIPB approval was immediately required in
respect of foreign investment in an NBFC engaged in
investment activity.
Core Investment Companies
A core investment company (CIC) is a company

which satisfies the following conditions as on the
date of the last audited balance sheet (i) it holds
not less than 90% of its net assets in the form of
investment in equity shares, preference shares,
bonds, debentures, debt or loans in group companies;
(ii) its investments in the equity shares (including
instruments compulsorily convertible into equity
shares within a period not exceeding 10 years from
the date of issue) in group companies constitutes not
less than 60% of its net assets ; (iii) it does not trade
in its investments in shares, bonds, debentures, debt
or loans in group companies except through block
sale for the purpose of dilution or disinvestment;
and (iv) it does not carry on any other financial
activity referred to in Section 45 I (c) and 45 I (f) of the
Reserve Bank of India Act, 1934 except for granting of
loans to group companies, issuing of guarantees on
behalf of group companies and investments in bank
deposits, money market instruments etc.
A CIC is not required to register with the RBI, unless
the CIC accepts public funds AND has total financial
assets in excess of INR 1 billion.
Public funds for the purpose of CIC include funds

raised either directly or indirectly through public
deposits, Commercial Papers, debentures, intercorporate deposits and bank finance but excludes
funds raised by issue of instruments compulsorily
convertible into equity shares within a period not
exceeding 10 years from the date of issue.
E. Deployment of Funds
NBFCs can issue debentures only for deployment
of the funds on its own balance sheet and not to
facilitate requests of group entities/ parent company/
associates. Core Investment Companies have been
carved out from the applicability of this restriction.
11. The activities permitted under the automatic route are: (i) Merchant Banking, (ii) Under Writing, (iii) Portfolio Management Services, (iv)Investment
Advisory Services, (v) Financial Consultancy, (vi) Stock Broking, (vii) Asset Management, (viii) Venture Capital, (ix) Custodian Services, (x) Factoring,
(xi) Credit Rating Agencies, (xii) Leasing & Finance, (xiii) Housing Finance, (xiv) Forex Broking, (xv) Credit Card Business, (xvi) Money Changing
Business, (xvii) Micro Credit, (xviii) Rural Credit and (xix) Micro Finance Institutions
12. The FDI Policy however under paragraph 6.2.24.2 (1) provides that: (iv) 100% foreign owned NBFCs with a minimum capitalisation of US$ 50
million can set up step down subsidiaries for specific NBFC activities, without any restriction on the number of operating subsidiaries and without
bringing in additional capital.
(v) Joint Venture operating NBFCs that have 75% or less than 75% foreign investment can also set up subsidiaries for undertaking other NBFC
activities, subject to the subsidiaries also complying with the applicable minimum capitalisation norms.
46
F. Credit Concentration Norms

A systemically important NBFC is not permitted to
lend or invest in any single company exceeding 15%
of its owned fund, or single group13 of companies
exceeding 25% of its owned fund. If however the
systemically important NBFC is investing and
lending, then these thresholds stand revised to 25%
and 40% respectively.
Exemption from such concentration norms may
be sought and has been given in the past where
the NBFC qualified the following two conditions
firstly, the NBFC did not access public funds14, and
secondly, the NBFC did not engage in the business
of giving guarantees. Interestingly, public funds
include debentures, and to that extent, if the NBFC
has issued any kind of debentures (including CCDs),
then such relaxation may not be available to it. In the
absence of such exemption, it may be challenging
for loan or investment NBFCs to use the leverage
available to them for the purpose of making loans or
investments.
G. Only Secure Debentures can be

Issued
NBFCs can only issue fully secured debentures
whether by way of private placement or public
issue. The security has to be created within a month
from the date of issuance. If the security cover is
inadequate, the proceeds have to be placed in an
escrow account, till the time such security is created.
Subbarao mentioned that SARFAESI Act was enacted

to enable banks and financial institutions to realise
long-term assets, manage problem of liquidity, asset
liability mis-matches and improve recovery by
exercising powers to take possession of securities,
sell them and reduce nonperforming assets by
adopting measures for recovery or reconstruction,
through the specialised SCs/RCs, which would be
registered with the RBI and purchase the NPAs of the
banks and FIs. According to him, two methodologies
were envisaged - first, the strategy for resolution of
the assets by reconstructing the NPAs and converting
them into performing assets, and second, to enforce
the security by selling the assets and recovering the
loan amounts
Subbarao further mentioned that SARFAESI Act
is not merely a facilitator of security enforcement
without the intervention of Court. It is a
comprehensive approach for restructuring the assets
and make it work and only when it does not work,
the recovery mode was envisaged.
He was apprehensive that since NBFCs have
followed the leasing and hire purchase models
generally for extending credit and they enjoy the
right of repossession, the only benefit SARFAESI Act
would extend to the NBFCs will be for enforcement
of security interest without the intervention of the
court, which may distort the very purpose for which
SCs/RCs were created, namely, reconstruction and
the inclusion would simply add a tool for forceful
recovery through the Act.
H. Enforcing Security Interests

NBFCs, unlike banks, are not entitled to protection
under the SARFAESI Act. This is a major handicap for
NBFCs as they have to undergo through the elaborate
court process to enforce their security interests,
unlike banks which can claim their security interests
under the provisions of SARFAESI Act without the
intervention of the courts. Representations were
made by industry associations seeking inclusion of
NBFCs within the ambit of SARFAESI Act, especially
in the current times when NBFCs are fairly regulated.
We understand that the then RBI Governor D.
Subbarao responded to the exclusion of NBFCs on
the ground that their inclusion under the SARFAESI
Act would distort the environment for which
Securitisation Companies (SCs)/ Reconstruction
Companies (RCs) were set up by allowing more
players to seek enforcement of security rather than
attempting reconstruction of assets.
Draft Guidelines provide that NBFCs should be given

the benefit under SARFAESI Act, 2002, since there is
an anomaly that unlike banks and public financial
institutions (PFIs), most NBFCs (except those
registered as PFIs under Section 4A of the Companies
Act) do not enjoy the benefits deriving from the
SARFAESI Act even though their clients and/or
borrowers may be the same.
I. Exit
Exit for the foreign investor in an NBFC is the most
crucial aspect of any structuring and needs to be
planned upfront. The exits could either be by way of
liquidation of the NBFC, or buy-back of the shares
of the foreign investor by the NBFC, or a scheme
13. The term group has not been defined in the Prudential Norms
14. Public funds includes funds raised either directly or indirectly through public deposits, Commercial Papers, debentures, inter-corporate deposits
and bank finance.
47

of capital reduction (where the foreign investor is

selectively bought-back), or the sale of its shares in the
NBFC to another resident or non-resident, or lastly, by
way of listing of the NBFC.15
Unlike most countries, liquidation in the Indian
context is a time consuming and elaborate process in
India, sometimes taking in excess of 10 years.
Buyback of securities is another alternative, however,
CCDs cannot be bought back. CCDs must be
converted into the underlying equity shares to be
bought back. Buy-back of securities is subjected to
certain conditionalities as stipulated under Section
68 of the Companies Act, 2013. A buyback of equity
shares can happen only out of free reserves, or
proceeds of an earlier issue or out of share premium.16
In addition to the limited sources that can be used for
buy-back, there are certain other restrictions as well
that restrict the ability to draw out the capital from
the company. For instance, only up to a maximum
of 25% of the total paid up capital and free reserves
of the company can be bought in one financial
year, the debt equity ratio post buy-back should not
be more than 2:1 etc. Buy-back being a transfer of
securities from a non-resident to a resident cannot be
effected at a price higher than the price of the shares
as determined by the discounted cash flows method.
Although, buy back from the existing shareholders
is supposed to be on a proportionate basis, there
have been certain cases such as Century Enka where
the court approved a scheme for selective buy-back
of 30% of its shareholding from its non-resident
shareholders.
From a tax perspective, traditionally, the income
from buyback of shares has been considered as capital
gains in the hands of the recipient and accordingly the
investor, if from a favourable treaty jurisdiction, could
avail the treaty benefits. However, in a calculated
move by the Government to undo this practice of
companies resorting to buying back of shares instead
of making dividend payments the Budget 2013- 2014
has now levied a tax of 20%17 on domestic unlisted
companies, when such companies make distributions
pursuant to a share repurchase or buy back.
may have arisen as a result of secondary sales that

may have occurred prior to the buy-back will also be
subject to tax now.
The proposed provisions would have a significant
adverse impact on offshore realty funds and foreign
investors who have made investments from countries
such as Mauritius, Singapore, United States of
America and Netherlands etc. where buy-back of
shares would not have been taxable in India due to
availability of tax treaty benefits. Further, being in the
nature of additional income tax payable by the Indian
company, foreign investors may not even be entitled
to a foreign tax credit of such tax.
Additionally, in the context of the domestic investor,
even the benefit of indexation would effectively
be denied to such investor and issues relating to
proportional disallowance of expenditure under
Section 14A of the ITA (Expenditure incurred in
relation to income not includible in total income)
may also arise. This may therefore result in the buyback of shares being even less tax efficient than the
distribution of dividends.
As an alternative to buy-back, the investor could
approach the courts for reduction of capital under
the provisions of section 68 of the Companies Act,
2013; however, the applications for such reduction
of capital need to be adequately justified to the court.
From a tax perspective, the distributions by the
company to its shareholders, for reduction of capital,
would be regarded as a dividend to the extent to
which the company possesses accumulated profits
and will be taxable in the hands of the company at the
rate of 15%.18 Any, distribution over and above the
accumulated profits (after reducing the cost of shares)
would be taxable as capital gains.
Sale of shares of an NBFC or listing of the NBFC could
be another way of allowing an exit to the foreign
investor; however, sale of shares cannot be effected at
a price higher than the price of the shares determined
by the discounted cash flow method. Listing of
NBFCs will be subject to the fulfillment of the listing
criterion and hinges on the market conditions at that
point in time.
The said tax at the rate of 20% is imposed on a

domestic company on consideration paid by it which
is above the amount received by the company at the
time of issuing of shares. Accordingly, gains that
15. The forms of exit discussed here are in addition to the ability of the foreign investor to draw out interest / dividends from the NBFC up to 300 basis
points over and above the State Bank of India prime lending rate.
16. As a structuring consideration, the CCDs are converted into a nominal number of equity shares at a very heavy premium so that the share premium
can then be used for buy-back of the shares.
18. Exclusive of surcharge and cess
48
Annexure VI
Foreign Investors Permitted to Put: Some
Cheer, Some Confusion
Amendment recognizes shares/debentures with

a built-in option/right as eligible instruments
which may be issued to foreign investors;
Such securities cannot have an assured exit

price, although the Amendment specifies
methodologies to determine the exit price;
The prescribed price determination measures

may make it more beneficial to invest in
compulsorily convertible securities rather than
equity shares;
A minimum lock-in period of one year has been

prescribed before the option can be exercised.
Put Options in favour of a non-resident requiring

an Indian resident to purchase the shares held by the
non-resident under the foreign direct investment
(FDI) regime were hitherto considered as
violative of the FDI Policy by the Reserve Bank of
India (RBI). The RBI has now legitimized option
arrangements through its recent amendment
(Amendment) to the Foreign Exchange
Management (Transfer or Issue of Security by a
Person Resident outside India) Regulations, 2000
(TISPRO), notified through its circular1 dated
January 09, 2013 (the Circular). TISPRO now
recognizes that equity shares, fully and mandatorily
convertible preference shares and debentures (FDI
Instruments) containing an optionality clause can
be issued as eligible instruments to foreign investors.
However, the Circular specifies that such an option
/ right when exercised should not entitle the nonresident investor to exit at an assured return.
The SEBI notification granted validity to contracts

containing clauses related to preemptive rights, right
of first offer, tag-along right, drag-along right, and
call and put options.
From an RBI perspective, the issue was more
from an external commercial borrowings (ECB)
perspective. RBI had issued a notification on June 8,
2007 vide Circular 73, setting out that non-residents
could only subscribe to FDI Instruments, and any
instrument that may be redeemable or optionally
redeemable will qualify as ECB. Interpreting that
Circular, the RBI regarded put options in favour
of non-residents as redeemable instruments, not
permitted under the FDI regime. That interpretation
was even extended to situations where the put
option was not on the company, but the promoters
of the company.
On a separate count, taking a cue from SEBI, the RBI
also took a view that a put option provision in an
investment agreement would qualify as a option
or an over the counter derivative, which is not
permitted under the FDI route. That view was taken
despite the fact that no separate price was paid for
the optionality, and the optionality could not be
traded independent of the FDI Instrument.
The validity and enforceability of put options has

always been a bone of contention from an Indian
securities law and exchange control perspective.
Having said that, there was no clear written policy

that restricted put options, and RBIs approach
was seen to be on a case-to-case basis, typically in
cases where the promoters (not willing to honor
the put) approached the RBI themselves. However,
the aggressiveness with which the RBI implements
such an unwritten policy was remarkable. The risk
of having a put was not just limited to it being not
enforceable, RBI in fact regarded the mere existence
of put in a contract as a violation of the FDI Policy
and initiated proceedings against the parties for
having provided for such options in their investment
contracts.
In the past, Securities and Exchange Board of India

(SEBI) had taken a stand, in context of public
companies, that option arrangements are akin to
forward contracts, hence restricted. SEBI relaxed its
position through a notification2 in October, 2013.
In fact, the Department of Industrial Policy

and Promotion (DIPP) had brought in a written
prohibition on options in the Consolidated FDI
Policy dated October 01, 2011, but deleted that
provision within 30 days of it in light of industry
I. Background
1. RBI Circular No. RBI/2013-2014/436 A.P. (DIR Series) Circular No. 86 (January 09 2013) available at: http://rbidocs.rbi.org.in/rdocs/Notification/PDFs/
APDIR0901201486EN.pdf
2. SEBI Notification No. LAD-NRO/GN/2013-14/26/6667 (October 03, 2013) available at: http://www.sebi.gov.in/cms/sebi_data/
attachdocs/1380791858733.pdf
49
Foreign Investors Permitted to Put: Some Cheer, Some Confusion

wide criticism. However, notwithstanding the

deletion of prohibition of options, RBI continued
with its approach that put options in favour of nonresidents were violative of the FDI policy. Please refer
to our hotline discussing the change in regulatory
policy here (http://tmp.nishithdesai.com/old/New_
Hotline/CorpSec/CORPSEC%20HOTLINE_Oct0311.
htm) and here (http://tmp.nishithdesai.com/old/
New_Hotline/CorpSec/CORPSEC%20HOTLINE_
Nov0111.htm).
II. Amendment
The Amendment, for the first time, provides for a
written policy on put options, and in doing that sets
out the following conditions for exercise of options
by a non-resident:
i. Shares/debentures with an optionality clause
can be issued to foreign investors, provided that
they do not contain an option/right to exit at an
assured price;
ii. Such instruments shall be subject to a minimum
lock-in period of one year;
iii. The exit price should be as follows:
In case of listed company, at the market price

determined on the floor of the recognized stock
exchanges;
In case of unlisted equity shares, at a price not
exceeding that arrived on the basis of Return on
Equity (RoE) as per latest audited balance sheet.
RoE is defined as the Profit after Tax divided by
the net worth (defined to include all free reserves
and paid up capital)
In case of preference shares or debentures, at a
price determined by a Chartered Accountant
or a SEBI registered Merchant Banker per any
internationally accepted methodology.
III. Analysis
In a market where IPOs are almost non-existent, put
options give tremendous comfort to offshore private
equity funds, should a trade sale not materialize
within their exit horizons. Put options become
even more important for certain asset classes like
real estate or other stabilized yield generating
assets where secondary sales and IPOs are not very
common in the Indian context. The Amendment is a
positive development for such players as commercial
justifications behind inclusion of options into
investment agreements have been recognized, and
Indian companies and their founders can no longer
treat such rights/options as mere paper rights.
50
A detailed analysis of the Amendment, its

ambiguities and practical challenges are set out
herein below.
A. Lock in
While a minimum lock in period of one year has
been specified, it is unclear as to which date it should
apply from. For example, if the date of optionality
agreement and issuance of securities are different,
which would be the relevant date? On a conservative
basis, it may be appropriate to reckon the lock-in
conditions from the later of the two dates.
There are also issues about whether the lock-in
restricts only the exercise of securities or also the
secondary transfer of securities, as well as whether
a secondary transfer would reset the clock in the
hands of the new investor. It appears that the one
year lock would be required only if the option is
being exercised (and not in case of all secondary
transfers), and would apply afresh in the hands of
each subsequent transferee.
B. Will DCF Pricing cap still Apply, if the

Exit Price for Options is Higher than
DCF
Under the current regulations, non-residents are
not entitled to sell the FDI Instruments to an Indian
resident at a price exceeding the price computed per
the discounted free cash flows (DCF) methodology.
However, the DCF cap applicable to FDI Instruments
will not be applicable to sale of FDI Instruments
with a put option. This is because the exit pricing
applicable in case of exercise of the option by the
non-resident has been introduced by amendment to
Regulation 9 of the TISPRO regulations, whereas the
DCF price cap is applicable to securities transferred
under Regulation 10 B(2) (by virtue of the RBI
circular dated May 4, 2010). Regulation 10B only
applies to transfers by non-residents, which are not
covered under Regulation 9. Therefore, the DCF cap
will not be applicable when determining the exit
price pursuant to exercise of put option.
The question remains on whether the option pricing
norms set out in the Amendment will only apply if
the option is exercised, or even if shares with options
are transferred to the grantor of the option without
the exercise of an option.
C. Exit price for Equity Shares

The Amendment provides that the exit price in
respect of equity shares of unlisted company should
not exceed the price arrived at on the basis of Return
on Equity (RoE) as per the last audited balance

sheet.
The formula is divorced from the traditional form of
calculating RoE (where the denominator is average
shareholder equity and not networth) and brings in
several impractical situations set out below.
Plain reading of the provision suggests that the exit
price would be capped at the RoE. Whilst it is not
clear, it appears that the RoE formula should be
interpreted to mean principal plus the RoE. That is
to say, if the invested amount was INR 100, and the
company generated profits of INR 20 each year for
five years, leading to a hypothetical net worth of 200,
the RoE would be equal to the profits of the sixth
year divided by 200. If the profit after tax in the sixth
year were INR 20, the RoE would be 20/200 or 10%.
Accordingly, the exit price for the foreign investor
would be capped at INR 110, which clearly may not
be reflective of the FMV of the instrument.
The formula for determining the exit price seems
to be at complete odds with the pricing suggested
for convertibles (any internationally accepted
valuation methodology), listed equity shares (ruling
market price), or even shares and convertibles
without optionality attached (discounted cash flow
valuation), which are likely to be much closer to
FMV than the RoE methodology.
For instance, if the formula is applied, accumulated
profits only decrease the RoE. The formula also
leaves the exit price contingent on the last audited
balance sheet, which may have unintended and
distortionary consequences. For example, if the
put option is to be triggered after a fixed period of
time (being five years, in the above example), and
the company incurs a loss in the sixth year, on a
conservative basis, the exit price may be capped at a
price lower than the investment amount.
If the put option is tied to an event of default,
the valuation mechanism may have unintended
consequences as the default may have an impact on
the profitability of the company in the year of exit.
Requiring an exit at RoE is clearly ambiguous. Ideally
the RoE can only be the basis to compute the exit
price. To that extent, it remains to be seen if the
RBI will permit the exit price on equity shares with
optionality attached to be a variable of the RoE that
brings the exit price closer to FMV, just as in case of
convertibles and listed shares
a price determined based on international accepted

pricing methodology, as determined by a SEBI
registered merchant banker or chartered accountant.
This valuation mechanism is likely to provide more
flexibility to investors at the point of exit, and hence
going forward we may see investors preferring more
of convertible securities as compared to equity
shares for their investments in Indian companies.
Having said this, it is unclear why different valuation
mechanisms were believed to be required for equity
shares and compulsorily convertible securities,
which are in any case treated on the same footing
and subject to DCF cap on an as if converted basis
under the current regulatory regime.
E. Status of Existing Option

Arrangements
The Circular clearly sets out that all existing
contracts must comply with the conditions set out in
the Amendment to qualify as being FDI compliant.
In light of this, a position could be taken that all
existing contracts that are not compliant with the
conditions set out in the Amendment become FDI
non-compliant, especially if they provide for options
with assured returns.
The terms of such put options contained in existing
contracts may need to be revisited to bring them
in compliance with the Amendment. However, if
the existing terms of issuance already provide that
the exit price should be subject to applicable law,
then the terms of the security may be considered to
have been amended by the law and should thus be
considered valid notwithstanding the Amendment.
F. Impact on Joint Ventures and M&A

deals
Options are not just contained in private equity
transactions. Even joint venture transactions and
sometimes M&A transactions contain put options
in favour of non-residents. These options are
usually pegged to fair market value (determined per
commercial negotiations) or at discount or premium
to the fair market value.
There may be a need to look at such joint venture
agreements, as the commercially negotiated price
will now be subjected to the pricing for options as set
out in the Amendment.
D. Determination of Price of
Convertibles Securities
IV. Conclusion
The Amendment provides the exit price for

convertibles upon exercise of put option should be
The Amendment is a welcome development as

it gives predictability and commercial flexibility
51
Foreign Investors Permitted to Put: Some Cheer, Some Confusion

to foreign investors, in relation to contractual

provisions, which are fairly standard in the
international investment context. However,
pegging the exit price for equity to RoE (and not a
multiple of RoE that brings the exit price closer to
FMV) is likely to be a cause of major concern for
investors. While preference shares may be preferred
from an exit pricing perspective, Companies Act
2013, which denies the flexibility of voting on
as-if-converted basis may galvanize the investors
to invest in common equity. The need to amend
existing contracts to bring them in line with the
Amendment may be a challenging task, especially
for most offshore private equity players that would
52
be hesitant to revisit investment agreements if

they are close to their exit horizons. What will also
be interesting is to see how the term exercise is
interpreted and whether RBI will require exit pricing
as set out for options to be applicable even when the
shares are transferred to the Indian resident granting
the option voluntarily, and not in exercise of the
option/right.
Aditya Shukla,
Shreya Rao and
Ruchir Sinha
authors
Annexure VII
Indian Gaar: Rules Notified
Some Relief, But Ambiguities Remain
The Central Board of Direct Taxes has recently
notified Rules that would govern Indias new General
Anti-Avoidance Provisions (GAAR). Although
the Rules introduce some safeguards, the real
concerns surrounding GAAR remain unaddressed.
Ambiguities continue to remain with respect to
concepts such as lack of commercial substance,
substantial commercial purpose, bona fide objects,
abuse and misuse of law. One remains clueless
about the interplay between GAAR and other antiavoidance and anti-treaty abuse provisions, as well as
the fate of Mauritius and other popular investment
routes. The limited grandfathering of specific
investments (prior to August 30, 2010) makes GAAR
more retroactive than prospective.
India like every other country is justified in
defending its tax base, and is in sync with the
global move to curb money laundering and abusive
tax schemes. However, these concerns have to
be balanced with the need for greater taxpayer
certainty, eliminating double taxation on a global
basis and enhanced accountability on behalf of tax
administrations.
The primary concern with GAAR may be
summarized as thus: Is there a real guarantee that
GAAR shall not end up as another weapon to
intimidate taxpayers (borrowing the UK GAAR
Committees words of caution)? This concern has
special relevance in an environment conventionally
known for protracted litigation, retroactive
law making, high pitched tax assessments and
corruption.
The GAAR Rules have been notified as a follow-up
to the Governments announcement in January this
year accepting specific recommendations of the
Shome Committee constituted in 2012 to critically
analyze the GAAR provisions. Earlier, the provisions
were also reviewed by the Parliamentary Standing
Committee on Finance which had also made some
important recommendations. Apart from the
limited grandfathering, the Rules introduce a few
procedural safeguards and some relief for P-note
holders. However, several key recommendations by
the Shome Committee and the Standing Committee
including certain safe harbours, and clarity on the
Mauritius route have been left out.
I. Background to GAAR
GAAR was introduced into Indias tax statute in
2012 and has been criticized widely on account of
the ambiguities in its scope and application, lack
of safeguards and possibility of misuse by the tax
authorities. GAAR empowers the Revenue with
considerable discretion in taxing impermissible
avoidance arrangements, disregarding entities and
recharacterising income and even denying tax treaty
benefits.
The introduction of GAAR led to immense hue
and cry among investors, which prompted the
Government to appoint an Expert Committee under
the renowned economist Dr. Parthasarthy Shome to
consult with stakeholders and review GAAR. (Click
here for our hotline with insights and analysis of the
Shome Committees report.) In its detailed report, the
Expert Committee had recommended a substantial
narrowing down of the scope of GAAR and other
protections in the interest of fairness and certainty.
Following the recommendations of the Shome
Committee, various amendments were introduced
through the Finance Act, 2013 including the
following:
GAAR shall be effective from April 1, 2015;
GAAR would apply only if the main purpose of

an arrangement is to obtain a tax benefit;
Factors such as the holding period of the

investment, availability of an exit route and
whether taxes have been paid in connection
with the arrangement may be relevant but not
sufficient for determining commercial substance;
GAAR cases shall be scrutinized by an Approving

Panel chaired by a retired High Court Judge,
a senior member of the tax office (of the rank
of Chief Commissioner of Income Tax) and a
reputed academician or scholar with expertise in
taxation or international trade and business.
The recently notified Rules seek to provide a few

exclusions and address certain procedural and other
matters not covered by the Finance Act, 2013.
53
Indian Gaar: Rules Notified

II. Application of GAAR: Specific

Clarifications
The Rules provide the following clarifications with
respect to the application of GAAR in India:
A. De Minimis Rule
GAAR shall not be applicable to any arrangement
where the tax benefit arising to all parties to the
arrangement does not exceed a sum of INR 30
million in the relevant financial year.
B. Limited Grandfathering and

Retroactivity
Investments made prior to August 30, 2010 have
been grandfathered and GAAR shall not apply to
exits from such investment. This was date when
the Government introduced the Direct Taxes Code
Bill (still pending before Parliament) which initially
proposed GAAR. The grandfathering is very limited
since GAAR may still apply to a range of transactions,
structures and arrangements set up prior to August
30, 2010. Further, investments made subsequent
to August 30, 2010 will be subject to GAAR. One
could therefore say that GAAR is retroactive in most
contexts. For GAAR to be truly prospective, it should
only apply to arrangements initiated subsequent to
implementation of GAAR.
C. Relief for FIIs?

The Rules also provide that GAAR shall not apply
to a Foreign Institutional Investor (FII) that does
not claim benefits of a tax treaty and subjects itself
to taxation under domestic law. The Rules do not
provide any real relief for FIIs, and difficulties with
respect to treaty relief in the face of GAAR would
continue to cause concern. FIIs (especially tax
exempt investors such as foreign pension funds,
endowments and mutual funds) also have to be
cautious about availability of credit in the home
country against any taxes paid in India on account of
GAAR.
D. Relief for P-note Holders

GAAR would not be applicable to any investment
made by a non-resident that directly or indirectly
invests in offshore derivative instruments or
otherwise through an FII. Even though some relief
has been provided to P-Note holders, difficulties may
arise if the FII passes on the tax costs to the P-Note
holders.
54
E. Timelines & Procedure

The Rules lay down the procedure for invocation
of GAAR. If the tax officer is of the view that an
arrangement is an impermissible avoidance
arrangement, he is required to issue a notice to
the taxpayer asking him to state reasons for the
non-applicability of GAAR. The notice to the
taxpayer has to contain details of the arrangement,
the tax benefit, basis and reason for considering
that (i) the main purpose is to obtain tax benefit;
and that (ii) the arrangement is an impermissible
avoidance agreement; along with a list of supporting
documents and evidence. The tax officer is also
required to make a reference to the Commissioner of
Income Tax (CIT) in Form 3CEG.
If relying upon the reference of the tax officer, the
CIT is of the view that GAAR need not be invoked;
the CIT is required to issue directions to the tax
officer in the Form 3 CEH within a period of 1 month
from the end of month in which the reference was
received by him. If the CIT reaches this conclusion
on the basis of taxpayers response to the notice, the
CIT shall issue directions to the tax officer within a
period of 2 months from the end of month in which
the taxpayer furnishes objections to the notice
received by him.
If the CIT does not accept the taxpayers objections,
he can make a reference to the Approving Panel
after declaring the arrangement as an impermissible
avoidance arrangement in Form 3CEI within 2
months from the end of the month in which the final
submission of the taxpayer was received.
III. Concluding Comments

The following suggestions should be considered
before GAAR is finally implemented:
A. Need for Safe Harbours

It would be helpful to provide statutory safe
harbours identifying specific scenarios where GAAR
will not apply. For instance, it may be clarified that
GAAR should not apply to question commercial
substance of a listed entity (domestic or foreign),
certain commercially driven structured finance
arrangements, court sanctioned merger or demerger
schemes, choice of funding through debt or equity,
or arrangements where foreign tax has been paid.
Not-for-profit organizations can also be outside the
purview of GAAR. The Government has recently
introduced specific safe harbours for transfer pricing
which, though limited in scope, was welcomed
by the industry.The Government may consider
introducing something similar for GAAR as well.
B. More Clarity on Commercial

Substance
A number of terms have been used in the GAAR
provisions which still remain ambiguous. It is
hoped that the Government will also release
detailed explanations, along with illustrations, on
the meaning of expressions such as commercial
substance, substantial object, bonafide, misuse or
abuse and other ambiguous terms that are used in
the provisions. The guidance provided by countries
such as Australia, UK and South Africa are far
superior to what is presently available in India.
C. Mauritius et al- GAAR and tax Treaty

Relief
In the tax treaty context it would be preferable to
include bilaterally negotiated anti-abuse provisions
rather than a unilaterally enforced GAAR. The
Shome Committee rightly recommended that
GAAR should not be invoked if the treaty has a
Limitation of Benefit (LoB) provision limiting
treaty entitlement in specific cases. For instance,
the tax treaty with Singapore has an LoB clause
because of which the capital gains tax exemption on
share transfers may not be available to a Singapore
entity that lacks commercial substance or is a shell
or conduit company. Certain expenditure or listing
requirements may be fulfilled so that the entity is not
treated as conduit or a shell company. To the extent
the entity satisfies the LoB criteria in the treaty,
GAAR should not apply to it.
It is reported that the India-Mauritius tax treaty is
currently being renegotiated and it is possible that
certain substance requirements may be introduced.
Interestingly, Mauritius has recently identified
certain additional criteria for companies (having
Global Business 1 licenses) to be considered as
being managed and controlled in Mauritius.1 The
additional considerations include having an office
premise in Mauritius, fulltime employment of
administrative/technical personnel one of whom
shall be a resident in Mauritius, settlement of
disputes by arbitration in Mauritius, holding of

assets worth at least USD 100,000 in Mauritius,
relevant qualifications and involvement by resident
directors, and reasonable expenditure in Mauritius
which is expected from any similar corporation
which is controlled and managed from Mauritius.
Companies are expected to comply with these
changes from January 1, 2015.
D. GAAR and Specific

Anti-avoidance Rules
Several countries including UK, Canada and
Australia consider that GAAR should be used
sparingly and as a last resort. GAAR should not be
invoked in situations where specific anti avoidance
rules (like transfer pricing) are applicable.
E. Change in Mindset and Increase in

Accountability
Ambiguous legal provisions such as GAAR
create further tension in the existing adversarial
environment in India characterized by the large
backlog of cases. It is estimated that over a trillion
rupees is stranded in various stages of tax litigation.
It is therefore not surprising that the Parliamentary
Standing Committee had recommended disciplinary
action for officials who made irrational and
unreasonable tax assessments that are eventually set
aside by the Courts.
To introduce GAAR and obtain a buy-in from
stake holders it is essential to eliminate adversarial
approach towards taxpayers, reduce compliance
costs, remove ambiguous legal standards and
introduce a charter of taxpayer rights which
guarantees enforcement of tax laws in a fair,
equitable and non-arbitrary manner.
Ashish Sodhani and
Mahesh Kumar
authors
1. The Financial Service Act, 2007 provides certain conditions that the FCS shall consider to determine whether a GBC1 is managed and controlled in
Mauritius
55
Annexure VIII
Foreign Investment Norms for Real Estate
Liberalized
Minimum area threshold reduced from 50,000 sq

ft. to 20,000 sq ft.
No minimum area threshold, if 30% project cost

is contributed towards development of affordable
housing.
Are investments in completed yield generating

real estate assets allowed?
In a recent press release issued in relation to its

meeting dated October 29, 2014 (Press Release),
Provisions
Revised Policy Pursuant to Press Release
Minimum Land Minimum area to be developed under each

Requirements project would be:
i. Development of serviced plots: No
minimum land requirement;
the Union Cabinet has cleared the further

liberalization of Foreign Direct Investment (FDI)
in construction-development sector, in line with
the announcements in the Finance Ministers budget
speech for 2014.
I. Changes
The changes sought to be made by the Press Release
are set out below.1
Existing Policy
Minimum area to be developed under each project would
be as under:
i. Development of serviced housing plots: Minimum land
area of 10 hectares;
ii. Construction-development projects:

ii. Construction-development projects: Minimum built-up
Minimum floor area of 20,000 sq. meters;
area of 50,000 sq. meters;
iii. Combination project: Any of the above two iii. Combination project:
conditions need to be complied with.
Any of the above two conditions need to be complied
with.
Minimum
Minimum capitalization of USD 5 million.
Capitalization
Requirements
Timing of
investment
For wholly owned subsidiary:

minimum capitalization of USD 10 million;
For joint ventures with Indian partners: minimum
capitalization of USD 5 million.
The funds would have to be brought in within 6 The funds would have to be brought in within 6 months of
months of commencement of the project.
commencement of business of the Company.
Commencement of the project has been
explained to mean date of approval of the
building plan/ lay out plan by the relevant
statutory authority.
No such concept of 10 years from commencement of

business earlier.
Subsequent tranches can be brought in till the

earlier of:
i. Period of 10 years from the
commencement of the project; or
ii. The completion of the project.
Lock-in
The investor is permitted to exit from the

The investor is permitted to exit from the investment at
investment at (i) 3 years from the date of final expiry of 3 years from the date of completion of minimum
installment, subject to development of trunk
capitalization.
infrastructure, or (ii) on the completion of the
project.
1. The changes brought in by the Amendment are expected to be formalized in the form of a Press Note or by way of inclusion in the FDI Policy, and till
such time the changes do not have the binding force of law.
56
Trunk infrastructure has not been defined,

For investment in tranches: The investor is permitted to
but is explained to include roads, water supply, exit from the investment at the later of (a) 3 years from the
street lighting, drainage and sewerage.
date of receipt of each tranche/ installment of FDI, or (b) at
expiry of 3 years from the date of completion of minimum
Repatriation of FDI or transfer of stake by a
capitalization.
non-resident investor to another non-resident
investor would require prior FIPB approval.
Prior exit of the investor only with the prior approval of FIPB.
Sale of
developed
plots only
Only developed plots are permitted to be sold.

Developed plots would mean plots where trunk
infrastructure is developed, including roads,
water supply, street lighting, drainage and
sewerage.
Sale of undeveloped plots prohibited. Undeveloped plots

would mean plots where roads, water supply, street lighting,
drainage and sewerage, and other conveniences, as
applicable under prescribed regulations, have not been
made available.
The requirement of completion certificate has The investor was required to provide the completion
been done away with.
certificate from the concerned regulatory authority before
disposal of serviced housing plots.
Minimum
development
No requirement of any such minimum

development.
At least 50% of the project must be developed within

a period of 5 years from date of obtaining all statutory
clearances.
Exemption
They are no longer exempt from the sale of

undeveloped plots.
Certain investments were exempt from complying with the

following requirements: (i) minimum land area; (ii) minimum
capitalization, (iii) lock-in, (iv) 50% development within 5
year requirements and (v) sale of undeveloped plots.
Affordable
Housing
Projects which allocate 30% of the project cost No such exemption.

for low cost affordable housing are exempt
from the minimum land area, and minimum
capitalization requirements.
Certificate from The investee company required to procure

architect
an architect empanelled by any authority
authorized to sanction building plan to
certify that the minimum floor area has been
complied.
No such requirement.
Completed
projects
It has been clarified that 100% FDI permitted

in completed projects for operation and
management of townships, malls/ shopping
complexes and business centers.
No such provision/ clarification
Responsibility
for obtaining
all necessary
approvals
Investee Company.
Investor/ Investee company.
II. Analysis
Particulars
Revised policy pursuant to Press Release
Minimum Land Minimum area to be developed under each

Requirements project would be:
i. Development of serviced plots: No
minimum land requirement;
Existing Policy
Minimum area to be developed under each project would
be as under:
i. Development of serviced housing plots: Minimum land
area of 10 hectares;
ii. Construction-development projects:

ii. Construction-development projects: Minimum built-up
Minimum floor area of 20,000 sq. meters;
area of 50,000 sq. meters;
iii. Combination project: Any of the above two
conditions need to be complied with.
iii. Combination project: Any of the above two conditions

need to be complied with.
57
Foreign Investment Norms for Real Estate Liberalized

A. Serviced Plots and Combination

Projects
Removal of minimum land requirements for serviced
plots is a substantial relaxation. It appears that in
case of combination projects as well, there shall be no
minimum land requirement. Such relaxation could
attract creative structuring for foreign investments in
smaller areas.
B. Construction-development Projects
In case of construction-development projects, the
minimum land requirement has been reduced from
Particulars
50,000 sq. meters of built-up area to 20,000 sq. meters

of floor area. The introduction of floor area concept,
as against the earlier benchmark of built-up area may
need to be examined. Floor area has been stated to
be defined as per the local laws/ regulations of the
respective state governments / union territories.
Definitions of floor area vary from state to state.
While floor area is defined for some areas, other
areas do not have any definition of the term, such
as the regulations for Greater Mumbai. It is to be
seen whether floor area in these regions would be
equivalent to built-up area or floor space index (FSI),
though in some cases, floor area is close to built-up
area.
Revised Policy Pursuant to Press Existing Policy

Release
Minimum
Minimum capitalization of USD 5
Capitalization
million.
Requirements
For wholly owned subsidiary: minimum capitalization of USD 10 million;

For joint ventures with Indian partners: minimum capitalization of USD
5 million.
In a market largely driven by debt such as listed

non-convertible debentures, a lower minimum
capitalization would be helpful considering
minimum capitalization can only consist of equity
and compulsorily convertible instruments. This will

also be helpful in tax structuring and optimization of
returns for investors.
Particulars
Existing Policy
Timing of
investment
The funds would have to be brought in within 6 months of

commencement of the project.
The funds would have to be brought in

within 6 months of commencement of
business of the company.
Commencement of the project has been explained to mean

date of approval of the building plan/ lay out plan by the relevant
statutory authority.
No such concept of 10 years from

commencement of business earlier.
Subsequent tranches can be brought in till the earlier of:

iii. Period of 10 years from the commencement of the project; or
iv. The completion of the project.
C. Commencement of Business of
Company to Commencement of
Project
the relevant authority. This is a welcome move

since this brings clarity as against dependence on
interpretation of commencement of business.
Commencement of business of the company

had not been defined in the FDI Policy. It was
seen practically that the regulators view was that
the period of 6 months was to be calculated from
the earlier of the date on which the investment
agreement was signed by the investor, or the date
the funds for the first tranche are credited into the
account of the company. However, the criterion
has now been changed to 6 months from the
commencement of the project of the company,
which has been explained to mean the date of
the approval of the building plan/ lay out plan by
D. Period for Subsequent Tranches
58
The FDI Policy did not have any restriction on the

maximum period till which the investor could
infuse funds. However, the Amendment states
that subsequent tranches of investment can only
by brought in till a period of 10 years from the
commencement of the project, which seems to
imply that the regulator is reluctant towards real
estate projects which have extremely long gestation
periods.
Particulars
Lock-in
The investor is permitted to exit from the investment The investor is permitted to exit from the investment
at (i) 3 years from the date of final installment,
at expiry of 3 years from the date of completion of
subject to development of trunk infrastructure, or (ii) minimum capitalization.
on the completion of the project.
For investment in tranches: The investor is permitted
Trunk infrastructure has not been defined, but
to exit from the investment at the later of (a) 3 years
is explained to include roads, water supply, street
from the date of receipt of each tranche/ installment
lighting, drainage and sewerage.
of FDI, or (b) at expiry of 3 years from the date of
completion of minimum capitalization.
Repatriation of FDI or transfer of stake by a nonresident investor to another non-resident investor
Prior exit of the investor only with the prior approval
would require prior FIPB approval.
of FIPB.
E. Exit on Completion
A welcome change is permitting investors to exit on
the completion of the project. Hitherto, each tranche
of investments were locked-in for a period of 3 years,
even if the project was completed. This posed a major
challenge for last-mile funding for projects, since the
investment was stuck even on the completion of the
project.
F. Lock-in of 3 years from Final

Instalment
The lock-in for ongoing or non-completed projects
for 3 years from the final tranche may need to be
examined. The earlier regulations required any
tranche to be locked in for a period of 3 years from
the date of receipt of such tranche only.
G. 50% in 5 years
Another positive move is the removal of the
minimum development of 50% in 5 years from the
date of obtaining all statutory clearances. Earlier,
there some ambiguity in relation to when the 50%
development requirement would trigger, since it
was unclear what all statutory approvals meant.
To remove this ambiguity, the requirement for the
minimum development of 50% in 5 years has been
removed. However, in spirit, the same has been
introduced by requiring trunk infrastructure to be
developed before any exit.
H. Trunk Infrastructure
Existing Policy
last tranche, trunk infrastructure (explained to

include roads, water supply, street lighting and
drainage and sewerage) must be developed. This
requirement did not exist previously, and has been
a recent introduction. This has also removed all
ambiguities in relation to the 50% development
requirement, since this is no longer linked to the
obtaining of statutory clearances.
I. Grandfathering
It is unclear whether existing investment, on the
anvil of exit currently would be required to satisfy
the trunk infrastructure requirements. This may be
a major barrier for investors who have completed
the 3 year period from their investment, and are
seeking exit, although trunk infrastructure has not
been developed. It is also unclear whether existing
tranches of investment would be locked in till the
end of 3 period from any future tranches, if any.
Grandfathering of the existing investments from the
requirements to comply with trunk infrastructure
and the lock-in period would be important for
existing investments.
J. Sale of stake From Non-resident to

Non-resident
While the exit of a foreign investor earlier required
FIPB approval, transfer of a non-resident investors
stake to another non-resident investor was not
expressly included. The Press Release now confirms
this.
To be eligible to exit at the end of 3 years from the

Particulars
Revised Policy Pursuant to Press

Release
Existing Policy
Requirement of
The requirement of commencement The investor was required to provide the completion
commencement certificate for certificate has been done away with. certificate from the concerned regulatory authority
serviced plots
before disposal of serviced housing plots.
59
Foreign Investment Norms for Real Estate Liberalized

A major relaxation which has now been introduced

is the removal of the completion certificate
requirement. Since these were service plots, a
completion certificate was not forthcoming.

Addressing this concern, this is no longer required as
long as trunk infrastructure is developed.
Particulars
Revised Policy Pursuant to Press Existing Policy

Release
Minimum
development
No requirement of any minimum

development.
At least 50% of the project must be developed within a period of 5 years

from date of obtaining all statutory clearances.
Earlier, there some ambiguity in relation to when

the 50% development requirement would trigger,
since it was unclear what all statutory approvals
meant. To remove this ambiguity, the requirement
for the minimum development of 50% in 5 years has

been removed. However, in spirit, the same has been
introduced by requiring trunk infrastructure to be
developed before any exit.
Particulars
Existing Policy
Affordable
Housing
Projects which allocate 30% of the project cost for low cost
affordable housing are exempt from the minimum land area,
and minimum capitalization requirements.
No such exemption.
Affordable housing projects have been defined to

mean projects which allot at least 60% of the FAR/
FSI for dwelling units of carpet area not being more
than 60 sq. meters. Out of the total dwelling units, at
least 35% should be of carpet area 21-27 sq. meters
for economically weaker section category.
This would encourage creative structuring of

investments into affordable housing. While the
intent clearly is to encourage investment into
affordable housing and housing for the economically
weaker section, the equilibrium between luxury
housing and affordable housing remains to be seen.
Particulars
Existing Policy
Completed
projects
It has been clarified that 100% FDI permitted in completed

projects for operation and management of townships, malls/
shopping complexes and business centers.
No such provision/ clarification
It has been long debated whether FDI should be

permitted in commercial completed real estate.
By their very nature, commercial real estate
assets are stable yield generating assets as against
residential real estate assets, which are also seen as
an investment product on the back of the robust
capital appreciation that Indian real estate offers.
To that extent, if a company engages in operating
and managing completed real estate assets like a
shopping mall, the intent of the investment should
be seen to generate revenues from the successful
operation and management of the asset (just like a
hotel or a warehouse) as against holding it as a mere
investment product (as is the case in residential
real estate). The apprehension of creation of a
real estate bubble on the back of speculative land
trading is to that naturally accentuated in context of
residential real estate. To that extent, operation and
management of a completed yield generating asset
is investing in the risk of the business and should be
60
in the same light as investment in hotels, hospitals

or any asset heavy asset class which is seen as
investment in the business and not in the underlying
real estate. Even for REITs, the government was
favorable to carve out an exception for units of a
REI from the definition of real estate business on
the back of such understanding, since REITs would
invest in completed yield general real estate assets.
The Press Release probably aims to follow the
direction and open the door for foreign investment
in completed real assets, however the language is not
entirely the way it should have been and does seem
to indicate that foreign investment is allowed only in
entities that are operating an managing completed
assets as mere service providers and not necessarily
real estate. While it may seem that FDI has now
been permitted into completed commercial real
estate sector, the Press Release leaves the question
unanswered whether these companies operating and
managing the assets may own the assets as well.
Particulars
Revised Policy Pursuant to Press Release Existing Policy
Responsibility for obtaining all necessary Investee Company.

approvals
Analysis: The obligation to obtain all necessary

approvals, including the business plans has now been
clarified to be that of the investee company in India,
doing away with the unnecessary hassles around this
for investor.
III. Conclusion
The changes introduced by way of the Press Release
are along expected lines after the Budget Speech
earlier this year. The minimum land requirement was
an impediment for foreign investment, since it was
difficult to find large tracts of land for development
to satisfy the minimum land requirements in
Investor/ Investee company.
Tier-I cities. Further, the demand was inadequate

for such investment to be made in Tier-II cities,
where minimum land requirements could be met.
Reducing or removal of minimum land requirements,
along with removal of the requirement to obtain a
completion certificate for sale of such plots would
encourage foreign investment into this space.
While the final press note is still awaited to clarify
certain aspects, this seems to be a positive move by
the government to attract further investment.
Abhinav Harlalka and
Ruchir Sinha
authors
61
Annexure IX
The Curious Case of Pricing Guidelines
RBI Introduces a new Standards for Pricing Guidelines Amongst other Reforms
All pricing guidelines rationalized from DCF

/ RoE to internationally accepted pricing
methodologies; and
Partly paid shares and warrants can now be

issued under automatic route subject to certain
terms and conditions.
The Reserve Bank of India (RBI) this week

introduced specific reforms with regard to foreign
direct investments (FDI) in India. Specifically,
these reforms are:
Revision of pricing guidelines in respect of

transfer / issue of shares (with and without
options) to provide for greater freedom and
flexibility for investors; and
Recognition of partly paid equity shares and
warrants as eligible instruments for the purpose
of FDI and foreign portfolio investment (FPII)
under the automatic route.
The reforms have been introduced through

relevant amendments to the Foreign Exchange
Management (Transfer or Issue of Securities to
Persons Resident Outside India) Regulations, 2000
(TISPRO Regulations) and the issuance of various
circulars.1 The amendment to TISPRO Regulations
for the revision of pricing guidelines can be found
here (http://rbi.org.in/Scripts/NotificationUser.
aspx?Id=9105&Mode=0) and relevant RBI Circular
No. 4 can be found here(http://www.rbi.org.in/
Scripts/NotificationUser.aspx?Id=9106&Mode=0).
The amendment to TISPRO Regulations with regards
to partly paid shares and warrants can be found
here (http://rbi.org.in/scripts/NotificationUser.
aspx?Id=9094&Mode=0) and the relevant RBI
Circular No. 3 can be found here (http://www.rbi.org.
in/Scripts/NotificationUser.aspx?Id=9095&Mode=0).
to revise the pricing guidelines with respect to FDI

in his First Bi-Monthly Monetary Policy Statement
where he stated that it had been decided to withdraw
all existing guidelines relating to valuation in case
of any acquisition/sale of shares and accordingly,
such transactions will henceforth be based on
acceptable market practices. 2
The reforms relating to partly paid equity shares
and warrants (under review since 2011) come as
a pleasant surprise to the market, and once again
will provide greater flexibility for facilitating and
structuring investments in Indian companies.
II. Policy Evolution

A. Partly Paid Shares and Warrants
Until October 1, 2010, partly paid shares and
warrants under the FDI policy were not considered
to be capital for the purpose of foreign investment.
However, Consolidated FDI Circular No. 2 of 2010
(effective from October 1, 2010) stated that partly
paid shares and warrants could be issued subsequent
to approval by the Foreign Investment Promotion
Board (FIPB). This policy underwent further
change through the Consolidated FDI Circular No.
1 of 2011 (effective from April 1, 2011), which noted
that the policy relating to partly paid shares and
warrants was under review. This position has been
maintained in consequent FDI policies as well.
B. Pricing Guidelines
I. Background
The pricing guidelines in case of listed shares have

always been based on the price of the share as on
the stock exchange3 and this continues under this
present set of regulations. However, the policy on
pricing guidelines with respect to unlisted shares has
been amended over a period of time.
Reflecting the evolution of pricing guidelines in

line with the change in the business environment,
the RBI Governor first indicated the RBIs intention
The erstwhile pricing guidelines were first

introduced on May 4, 2010 via A. P. (DIR Series)
Circular No.49 (2010 Circular) when the RBI
1. Specifically, relevant circulars are A.P.(DIR Series) Circular No.3 dated July 14, 2014 (Circular No. 3) and A. P. (DIR Series) Circular No. 4 dated July
15, 2014 (Circular No. 4).
2. Para 24, Reserve Bank of India, Dr. Raghuram G. Rajan, Governor, First Bi-monthly Monetary Policy Statement, 2014-15, April 1, 2014 available at
http://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=30911 (last visited on July 17, 2014)
3. Pricing guidelines are as prescribed by the Securities and Exchange Board of India (SEBI) (Issue of Capital and Disclosure Requirements)
Regulations, 2009 (ICDR Regulations) in case of preferential allotment
62
did away with valuation requirements as per the

Controller of Capital Issues (CCI) based guidelines
and instead introduced valuation requirements
based on the Discounted Free Cash Flow (DCF)
method of valuation.
Further, earlier this year, a separate set of pricing
restrictions was introduced only with regards to FDI
instruments having optionality clauses.4 The main
clarification issued under the Options Circular stated
that shares issued to non-residents with options
attached thereto would be allowed to be transferred
if there were no assured returns.
C. Specifically
Unlisted equity shares could not be sold at a price

greater than the price arrived at on the basis of
Return on Equity (RoE) as per the latest audited
balance sheet;
Unlisted compulsorily convertible debentures

(CCD) or compulsorily convertible preference
shares (CCPS) could be sold at a price worked
out as per any internationally accepted pricing
methodology at the time of exit.
It is not entirely clear why equity shares and

convertible securities (with optionality clauses) were
provided different treatment, but general market
sentiment leaned towards issuance of convertible
securities given the greater freedom provided to such
instruments. Please see our hotline on the Options
Circular and its impact, titled Foreign Investors
Permitted to Put: Some Cheer, Some Confusion
here (http://www.nishithdesai.com/information/
research-and-articles/nda-hotline/nda-hotline-singleview/article/cheers-for-offshore-funds-put-optionspermitted.html?no_cache=1&cHash=02e2afb88f85c
0c69750945d7ac21f59).
Since, the Options Circular, the RBI has clarified
that it would rationalize all pricing guidelines, more
formally reflected in the Bi-Monthly Monetary Policy
referred to above. The current set of reforms is in
furtherance of this intention.
the FPI route) subject to compliance with the other

provisions of the FDI and FPI schemes.
With regard to partly paid shares, certain conditions
need to be specifically complied with:
Pricing of partly paid shares must be determined

up front and at least 25% of the total
consideration amount is required to be paid up
front; and
The remaining amount is required to be brought

in within a period of 12 months of issuance.
Note: This 12 months period is not required where

the issue size exceeds INR 5 billion. Further, a
monitoring agency is required to be appointed
(in the manner envisaged under applicable SEBI
Guidelines) irrespective of whether the company is
listed or unlisted, who will monitor the repatriation
of monies into India within stipulated time.
For warrants, in line with the requirements of the
ICDR Regulations, following are the conditions that
need to be specifically complied with:
Pricing and conversion formula / price is required

to be determined up front and 25% of the total
consideration is required to be paid up front; and
The remaining amount is required to be brought

in within a period of 18 months.
The price at the time of conversion should not be less

than the fair value of the shares as calculated at the
time of issuance of such warrants. It must further
be noted that only companies in which investment
can be made under the automatic route, can issue
partly paid shares or warrants under this circular.
For companies under the approval route, prior FIPB
approval will be required to issue partly paid shares
or warrants.
All partly paid shares and warrants issued under
Circular No. 3 are required to be in full compliance
with the Companies Act, 2013 and the Income Tax
Act, 1961.
A. Partly paid shares and warrants

noted as eligible instruments
Circular No. 3 also clarifies that non-resident

Indians will also be eligible to invest on a nonrepatriation basis in partly paid shares and warrants
in accordance with the Companies Act, 2013,
applicable SEBI Guidelines, the Income Tax Act, 1961
and Schedule 4 to the TISPRO Regulations (which
deals with investment by NRIs on a non-repatriation
basis).
Post review by the government and the RBI, and via

Circular No. 3 as well as amendments to the TISPRO
Regulations, partly paid shares and warrants can
now be issued to non-residents (under the FDI and
Circular No. 3 does not specify the consequence of

not bringing in the remaining monies (with regard
to partly paid shares / warrants) within the above
mentioned period. However, as specified under the
III. Further Reforms
4. Reserve Bank of India, Foreign Direct Investment- Pricing Guidelines for FDI instruments with optionality clauses, A.P. (DIR Series) Circular No. 86
dated January 9, 2014 (Options Circular). Please note that TISPRO Regulations were also amended in furtherance of the Options Circular.
63

SEBI regulations, it would likely result in forfeiture

of the partly paid shares or warrants, although
operational details in this regard will need to be
specified.
B. Revised Pricing Guidelines
with respect to securities having options, based on

RoE, were set out in Regulation 9 of the TISPRO
Regulations read with the Options Circular.
Circular No. 3 and Circular No. 4 and the amendments
to the TISPRO Regulations have revised the pricing
guidelines to be as follows:
The DCF based pricing guidelines till date were set

out in the 2010 Circular. The pricing guidelines
Description
Previous Pricing Guidelines
Current Pricing Guidelines
Issue of shares
For listed securities:
No amendment to this provision.
Price worked out in accordance with the ICDR

Regulations issued by the Securities and
Exchange Board of India (SEBI Guidelines)
Transfer of shares from

resident to non-resident
(R to NR)
For unlisted securities:
Issue price to be not less than the fair value

of shares determined as per DCF method.
Issue price to be not less than fair value of

shares as per any internationally accepted
pricing methodology for valuation of shares on
arms length basis.
Transfer price to be not less than price at

which a preferential allotment of shares can be
made under the SEBI Guidelines;
Transfer price to be not less than fair value of Transfer price to be not less than fair value
shares determined as per DCF method.
worked out as per any internationally accepted
arms length basis.
Transfer of shares from non- For listed securities:
resident to resident
Transfer price to be not more than price at
(NR to R)
which a preferential allotment of shares can be
made under the SEBI Guidelines;
Transfer price to be not more than fair value

of shares determined as per DCF method.
Transfer price to be not more than fair value

worked out as per any internationally accepted
arms length basis.
Transfer of equity shares

having optionality clause*
Transfer price to be the market price prevailing No amendment to this provision.
*Kindly refer to our analysis at recognized stock exchange where shares
on scope of optionality
are listed.
clauses below.
Transfer price to not exceed price arrived at on Transfer price to not exceed price arrived at
the basis of RoE as per latest audited balance as per any internationally accepted pricing
sheet.
methodology on arms length basis.
Transfer of convertible
securities having
optionality clause*
*Kindly refer to our analysis

on scope of optionality
clauses below.
64
Transfer price to be price as worked out

Transfer price to not exceed price arrived at
as per any internationally accepted pricing
as per any internationally accepted pricing
methodology on arms length basis at the time methodology on arms length basis.
of exit.
As we have noted above, the pricing guidelines for

listed securities have been mostly left unchanged.
Although a case could be made for a more liberal
pricing regime when listed securities are traded off
the floor / or through off market transactions where
value may be a product of negotiation. It is however,
equally arguable that off market transactions also
have an impact on the market and therefore should
be subject to the same pricing regime.
IV. Guiding Principles

As required before, all pricing must be duly certified
by a chartered accountant or a SEBI registered
merchant banker, and should be adequately
disclosed in the financial statements of the company.
The fundamental principle to the newly issued
pricing guidelines is that a non-resident investor
should not be guaranteed any assured exit price at
the time of making of such investment or entering
into the investment agreement.
It must further be noted that for optionality based
instruments the conditions relating to lock-in for
one year or minimum lock-in period relating to the
activity (if applicable) shall continue to apply.
V. What Does Optionality

Clause Mean?
Although the above mentioned reforms go a
long way in rationalizing the pricing guidelines
applicable to FDI investments / disinvestments, there
is still some ambiguity with regard to certain transfer
permutations.
First, it is not clear if this optionality reference
applies only to put options or if it also applies to
other forms of exits as well. Second, a plain reading
suggests that even holding securities which have an
option / right to exit at an assured return irrespective
of the counter party for such rights, is not allowed
under exchange control law since such instruments
have been classified as ineligible instruments.
Given that quite a few foreign investors in India
currently hold multiple avenues for exit, this clarity
will help provide certainty to not just investors but
also to investee entities and promoters.
VI. Doing away with DCF

In a move that will only boost foreign investor
sentiments, the revised pricing guidelines will
definitely provide investors (and Indian companies)
more freedom and flexibility to negotiate investment
/ disinvestment transactions based on commercials

agreed between parties.
One of the issues with the DCF based pricing
guidelines was the dependency on the company for
arriving at an accurate valuation. Inputs relating to
cash flow projections, current and potential working
capital amounts, capital expenditure and other items
to determine an appropriate discount factor to cash
flows needed extensive company inputs. This left a
shareholder in a company relying on the company
cooperation to arrive at an accurate amount which
was not always available. Under the revised pricing
guidelines, fair value can be arrived at without
necessarily having to rely on extensive company
inputs. This allows investors to determine the fair
value and exit even where the company is not
cooperating.
Another disadvantage of the DCF based pricing
guidelines, (highlighted in our then hotline titled
RBI revises pricing norms for foreign investments
which can be found here (http://tmp.nishithdesai.
com/old/New_Hotline/M&A/M&A%20Hotline_
May1010.htm) was that the DCF based methodology
for fair valuation restricted the valuer from basing
his valuations on the assets approach or the market
comparables approach. This was particularly
problematic in industries with long gestation
periods, or for distressed companies which had huge
assets in their books but did not anticipate any future
cash flows. This is no longer an issue.
VII. Understanding
Internationally Accepted
Pricing Methodology At Arms
Length
An important item for consideration is potential
disputes regarding pricing methodologies for
agreements which refer to exits, purchase or sale
at fair market value. If an agreement does not
specifically state which methodology is to be
considered, under the revised pricing guidelines
it would be possible for parties with conflicting
interests to obtain valuations under different pricing
methodologies and arrive at completely different
(and yet completely justifiable) fair market values
for the same asset.
A view can, however, be taken that for existing
agreements entered into till May 2010 (the date
of the 2010 Circular) that CCI based pricing
methodology would be applicable, and for
agreements entered into after 2010 but before July
15, 2014 (i.e. the date of Circular No. 4) that DCF
65

based pricing methodology would be applicable. But

going forward, it would be advisable to ensure that
both parties agree to a pricing methodology up front
in order to avoid potential disputes at the time of
exit.
IFRS 13 Fair Value Measurement which sets out
the IFRS standards for measuring fair value identifies
two broad approaches to fair valuation: (a) market
based approach; and (b) income based approach.
Under market based approach, IFRS outlines two
techniques, identical / similar instrument technique
and comparable company valuation multiples
technique. Whereas under income based approach,
the DCF technique figures along-side dividend
discount model, constant-growth dividend discount
model and capitalization model.
In all cases, both IFRS and generally, it must be
noted that the choice of a valuation technique
is a decision based on the peculiar facts and
circumstances of a given transaction, sector and
nature of the investee entity. It is likely that now
onwards, most investment documents will clearly
lay out the methodology which the parties agree to
be the internationally accepted pricing method
for arriving at fair valuation instead of leaving it
ambiguous given the potential connotations under
the new pricing regime.
Previously, in transactions between related parties,
since transfer pricing guidelines (under tax law)
were also applicable, share transfers/subscriptions
between related parties resulted in the requirement
for pricing studies to determine arms length price
that were different from the DCF valuation which
was undertaken for exchange control purposes. The
liberalization may also mean that a singular study
analyzing and concluding the fair valuation at arms
length could be used for both tax and exchange
control purposes.
66
VIII. Conclusion
The biggest uncertainty for partly paid shares and
warrants has always been as to when the balance
amount will need to be brought in. By requiring
that the full pricing for the partly paid shares and
warrants be fixed up front and brought in within
12 and18 months, respectively, the RBI has ensured
some comfort is afforded to both the company
issuing the securities and the subscriber. This
flexibility also enables structuring of earn-outs, post
buy-out incentive payments to management and in
structuring re-ups.
This full scale revision of pricing guidelines
continues the RBIs evolution with regards to how
it seeks to regulate transfer / issuance of securities
of Indian companies by / to FDI investors. Where
previously, cross border transactions were heavily
regulated and monitored by the RBI, we are looking
at a shift which provides greater freedom and
respects party autonomy.
By entrusting valuation intermediaries like chartered
accountant and merchant bankers with the right
to guide parties to fair valuation based on facts
and circumstances of each transfer, the RBI also
follows through on the general trend in modern
Indian commercial laws where regulatory bodies
are looking to delegate more and more operational
regulation to intermediaries.
Prasad Subramanyan and
Kishore Joshi
authors
Annexure X
Specific Tax Risk Mitigation Safeguards for
Private Equity Investments
In order to mitigate tax risks associated with
provisions such as those taxing an indirect transfer
of securities in India, buy-back of shares, etc., parties
to M&A transactions may consider or more of the
following safeguards. These safeguards assume
increasing importance, especially with the GAAR
coming into force from April 1, 2015 which could
potentially override treaty relief with respect to tax
structures put in place post August 30, 2010, which
may be considered to be impermissible avoidance
arrangements or lacking in commercial substance.
I. Nil Withholding Certificate

Parties could approach the income tax authorities
for a nil withholding certificate. There is no statutory
time period prescribed with respect to disposal of
applications thereof, which could remain pending
for long without any clarity on the time period for
disposal. In the last few years, there have not been
many instances of such applications that have
been responded to by the tax authorities. However,
recently, in January 2014, an internal departmental
instruction was issued requiring such applications
to be decided upon within one month. The extent to
which the instruction is adhered to remains yet to be
seen.
II. Advance Ruling

Advance rulings obtained from the Authority
for Advance Rulings (AAR) are binding on the
taxpayer and the Government. An advance ruling
may be obtained even in GAAR cases. The AAR is
statutorily mandated to issue a ruling within six
months of the filing of the application, however due
to backlog of matters, it is taking about 8-10 months
to obtain the same. However, it must be noted that
an advance ruling may be potentially challenged in
the High Court and finally at the Supreme Court.
There have been proposals in the 2014-15 Budget
to strengthen the number of benches of the AAR to
relieve this burden.
III. Contractual Representations

Parties may include clear representations with
respect to various facts which may be relevant to any

potential claim raised by the tax authorities in the
share purchase agreement or such other agreement
as may be entered into between the parties.
IV. Escrow
Parties may withhold the disputed amount of tax
and potential interest and penalties and credit such
amount to an escrow instead of depositing the same
with the tax authorities. However, while considering
this approach, parties should be mindful of the
opportunity costs that may arise because of the funds
getting blocked in the escrow account.
V. Tax Insurance
A number of insurers offer coverage against tax
liabilities arising from private equity investments.
The premium charged by such investors may vary
depending on the insurers comfort regarding the
degree of risk of potential tax liability. The tax
insurance obtained can also address solvency issues.
It is a superior alternative to the use of an escrow
account.
VI. Legal Opinion

Parties may be required to obtain a clear and
comprehensive opinion from their counsel
confirming the tax liability of the parties to the
transaction. Relying on a legal opinion may be useful
to the extent that it helps in establishing the bona
fides of the parties to the transaction and may even
be a useful protection against penalties associated
with the potential tax claim if they do arise.
VII. Tax Indemnity

Tax indemnity is a standard safeguard used in most
M&A transactions. The purchasers typically seek
a comprehensive indemnity from the sellers for
any tax claim or notice that may be raised against
the purchaser whether in relation to recovery of
withholding tax or as a representative assessee. The
following key issues may be considered by parties
while structuring tax indemnities:
67
Specific Tax Risk Mitigation Safeguards for Private Equity Investments

A. Scope
The indemnity clause typically covers potential
capital gains tax on the transaction, interest and
penalty costs as well as costs of legal advice and
representation for addressing any future tax claim.
B. Period
Indemnity clauses may be applicable for very long
periods. Although a limitation period of seven years
has been prescribed for reopening earlier tax cases,
the ITA does not expressly impose any limitation
period on proceedings relating to withholding tax
liability. An indemnity may also be linked to an
advance ruling.
C. Ability to Indemnify
The continued ability and existence of the party
providing the indemnity cover is a consideration
to be mindful of while structuring any indemnity.
As a matter of precaution, provision may be
made to ensure that the indemnifying party or
its representatives maintain sufficient financial
solvency to defray all obligations under the
indemnity. In this regard, the shareholder/s
of the indemnifying party may be required to
infuse necessary capital into the indemnifying
party to maintain solvency. Sometimes back-to-
68
back obligations with the parent entities of the

indemnifying parties may also be entered into in
order to secure the interest of the indemnified party.
D. Conduct of Proceedings
The indemnity clauses often contain detailed
provisions on the manner in which the tax
proceedings associated with any claim arising under
the indemnity clause may be conducted.
E. Dispute Resolution Clause

Given that several issues may arise with respect
to the interpretation of an indemnity clause, it
is important that the dispute resolution clause
governing such indemnity clause has been
structured appropriately and covers all important
aspects including the choice of law, courts
of jurisdiction and/or seat of arbitration. The
dispute resolution mechanism should take into
consideration urgent reliefs and enforcement
mechanisms, keeping in mind the objective of the
parties negotiating the master agreement and the
indemnity.
TP Janani and
Ruchir Sinha
authors
Annexure XI
Bilateral Investment Treaties
India has entered into several BITs and other
investment agreements. Relying on the BITs in
structuring investment into India, may be the best
way to protect a foreign investors interest. Indian
BITs are very widely worded and are severally seen
as investor friendly treaties. Indian BITs have a broad
definition of the terms investment and investor.
This makes it possible to seek treaty protection easily
through corporate structuring. BITs can also be used
by the investors to justify the choice of jurisdiction
when questioned for GAAR.
The model clauses for Indian BITs include
individuals and companies under the definition
of an investor. Further, companies are defined to
include corporations, firms and associations. More
importantly, Indian BITs adopt the incorporation test
to determine the nationality of a corporation. This
is a very beneficial provision as a holding company,
which even though is merely a shell company,
would not be excluded from treaty benefits.
Further, the word investment is defined to
include every kind of asset established or acquired
including changes in the form of such investment, in
accordance with the national laws of the contracting
party in whose territory the investment. It
specifically includes the following within the ambit
of investment:-
ii. shares in and stock and debentures of a company

and any other similar forms of participation in a
company;
iii. rights to money or to any performance under
contract having a financial value;
iv. intellectual property rights, in accordance with
the relevant laws of the respective contracting
party; and
v. business concessions conferred by law or under
contract, including concessions to search for and
extract oil and other minerals.
The benefit of this is that even if the foreign parent
or subsidiary is merely a shareholder in a locally
incorporated Indian company, they would be able
to espouse claims under the treaty by the virtue of
their investment in the nature of shares in India.
This again aids corporate structuring and enables
an investor to achieve maximum treaty benefits.
Thus, if the parent company incorporated within
a non-treaty jurisdiction (P), carries out operation
in India through an Indian subsidiary (S) which
is held through an intermediary incorporated
within a treaty jurisdiction (I), the parent company
can seek protection of their investment in the
subsidiary through the treaty benefits accrued to the
intermediary (See fig 1).
i. movable and immovable property as well as

other rights such as mortgages, liens or pledges;
Incorporation in a
Treaty Jurisdiction
Shareholder
P
Parent Company
Shareholder
I
Intermediary
Incorporation
in USA
S
Subsidiary
Indian
Subsidiary
Fig 1: Operations through an India subsidiary which is held through an intermediary in a treaty jurisdiction.
69
Bilateral Investment Treaties

Further, it is an established principle under

international law that minority shareholder rights
too are protected under BITs. This gives a right to
the non-controlling shareholders to espouse claims
for losses to their investments. This also enables
an investor to diversify its investments through
different treaty jurisdictions which will enable the
investor to bring multiple claims under different

proceedings to ensure full protection of ones
investment (See fig. 2). The exact right guaranteed
to a particular structure will vary on case to case
basis and can be achieved to the satisfaction of the
investors by pre-analyzing treaty benefits at the time
of making the investments.
Shareholder
Subsidiary No.1
(Mauritius)
Parent Co.
(USA)
Shareholder
Investee Co.
(India)
Subsidiary No.2
(Netherlands)
er
old
h
e
ar
Sh
Shareholder
Shareholder
er
old
h
e
ar
Sh
Subsidiary No.1
(Cyprus)
Fig 2: Investment in Indian Investee Company through multiple Subsidiaries in different treaty jurisdiction.
An important point further in favour of the foreign

investor investing in India is that India has lucrative
BITs with almost all tax efficient jurisdictions
including Mauritius, Netherlands, Switzerland,
70
Cyprus, Singapore etc. This enables an investor to

achieve maximum benefit from ones investment.
Annexure XII
Flips and Offshore REITs
One of the means of exit for shareholders of a real
estate company and also a way of accessing global
public capital is by way of flipping the assets of the
real estate company into the fold of an offshore REIT
vehicle.
Herein below, is a typical structure that may be

adopted for flipping the assets into REIT vehicle
structured as a Singapore business trust that could be
listed on the Singapore stock exchange.
Investors
Investors
Offshore
Units in the
trust
SBT
Investors
Trust Management
Company
Singapore SPV
Singapore
100% owner
India
Promoter
Real Estate
Company
100% Equity /
Listed NCDs
Indian SPV
Real Estate Project
In this structure the promoter flips its interest in the

real estate asset in India offshore which can then be
utilized to raise global capital offshore or to give an
exit to offshore investors.
ii. SBT in turn sets up an SPV in Singapore to invest

in India. This is because a trust is not eligible to
treaty benefits under the Indian Singapore tax
treaty.
iii. The SPV then sets up the Indian SPV.
I. In this Structure
i. The individual shareholders of the Promoter
entity acquires an interest in the management
company in Singapore under the liberalized
remittance scheme (LRS) which sets up the
Singapore business trust (SBT). LRS permits
an Indian resident individual to remit upto USD
125,000 in any financial year for most capital /
current account transactions.
iv. The Indian SPV can then either purchase the real
estate project on a slump sale basis on deferred
consideration.
v. SBT can then raise monies by way of private
placement or through listing of its units on the
Singapore stock exchange. These monies can
then be utilized to settle the deferred purchase
consideration or purchase the real estate project.
71
Flips and Offshore REITs

vi. The proceeds from the sale of the real estate

project may then be utilized to provide an exit
to the shareholders in India, in particular the
foreign investor in the real estate company.
II. Key Considerations

Some of the key considerations that may be
considered while flipping assets into an offshore
entity are as follows
i. Jurisdiction of the offshore entity and
amenability to public markets
ii. Choice of Yield generating stabilized assets vs.
developing assets as most offshore markets favor
yield generating assets
iii. Need for on the ground presence and domestic
sponsor and track record
iv. Appetite for Indian assets
v. Tax Challenges
vi. Regulatory Challenges
III. Tax and Regulatory

Challenges
manage a trust that is entrusted with investing

India. Accordingly, whilst an Indian real estate
company will find it impossible to invest in the
asset management company overseas (referring
to the trustee-manager), even if the investment
were through an affiliated Indian NBFC, regulatory
approval may be challenging.
Accordingly, the promoters of the Indian Promoter
entity may subscribe to units of the trustee manager
under the LRS, which permits an Indian resident
individual to remit upto USD 125,000 in any
financial year to acquire shareholding in the trusteemanager. In our experience, Sponsor brand name
typically is necessary for marketing the SBT.
C. Need for Indian SPV

Typically, any fundraise initiative by the SBT may
not be received well by the investors unless the SBT
has the real estate project in its fold. Since the SBT
may not have adequate funds to purchase the real
estate project initially, it may like to purchase the
real estate project on a deferred consideration basis.
However, since purchase of Indian securities on a
deferred consideration is not permitted, the SPV may
setup the Indian SPV, which could purchase the real
estate project on deferred consideration basis, which
shall be discharged in manner set out above.
A. FDI Policy
D. Transfer Taxes on Flips
A foreign company or a subsidiary of a foreign

company is not permitted under the FDI Policy to
acquire completed real estate assets, and can only
invest in developmental assets as set out earlier in
this paper. To that extent, either the SBT can acquire
under construction real estate assets or other FDI
Compliant assets such as SEZs, industrial parks,
hospital etc. as provided in the FDI Policy and set out
above. Also, other restrictions of FDI in real estate as
set out earlier such as 3 year lock-in, DCF valuation
and other issues as set out earlier in this paper also
become applicable.
Any transfer of immoveable property is subject to

stamp duty to be paid to state government where
the property is located. The extent of stamp duty
varies from state to state usually ranging from 5 - 8%
on the market value of property or the actual sale
consideration whichever is higher. To determine the
market value, the local authorities have prescribed
the reckoner / circle rates for each area which are
generally revised on an annual basis.
B. Holding of the Trustee Manager

Under the extant Indian exchange control
regulations, only an Indian financial services
company can invest in another financial services
only with prior approval of the Indian financial
services regulator (department of non-banking
financial services in case of an NBFC investing
overseas) and the overseas financial services
regulator. However, based on our experience, such
approval from the Indian regulator may be difficult
to come through if the purpose of the overseas
investment is to reinvest the proceeds in India, or
72
In addition to the stamp duty, the Seller is obligated

to pay tax on the capital gains received by it from
the sale of the immovable property. If however, the
sale consideration is lower than the reckoner rate,
per Section 50C of the ITA the reckoner rate shall
be deemed to be the consideration for the transfer
of immovable property and the seller shall be taxed
accordingly. Having said that, Section 50C is not
applicable to immovable property which is held
as stock-in-trade and not capital asset however, the
Finance Bill, 2013-14 has inserted section 43CA
(Special provision for full value of consideration
for transfer of assets other than capital assets in
certain cases) in the ITA which is a provision similar
to Section 50C but applicable for assets other than
capital assets, and since most developers record the
real estate project as stock-in-trade, to that extent also

unlike before, the seller would now be taxed on the
value adopted/assessed/assessable by any authority
of a state Government for the purpose of payment
of stamp duty on such transfer, thus denying the tax
advantage of allowing the sale of the immoveable
property at book value.
E. Structured Debt Instruments

Considering the restrictions of FDI in real estate
(minimum area requirement, lock - in etc.) and
the limited asset classes that can be rolled into an
offshore REIT (being only FDI Compliant assets), SBT
may consider investing in the Indian SPV by way of

acquiring listed NCDs of the Indian SPV or the real
estate company under the FPI route as set out earlier
in this paper.
In addition to the above, NCDs may also be issued
where the investors are offered assured regular
returns and exit. This is because, the interest on
compulsorily convertible debentures may be capped
at SBI PLR + 300 basis points and any returns beyond
that may have to be structured by way of buy-back or
dividends which entails a higher tax rate.
73
Annexure XIII
Bombay High Court Clarifies the Prospective
Application of Balco
The Bombay High Court in Konkola Copper Mines
(PLC) v. Stewarts and Lloyds of India Ltd.1 has
now clarified that it would not be appropriate to
hold that the reasons which are contained in the
ruling in Bharat Aluminium Company and Ors.
v. Kaiser Aluminium Technical Service, Inc. and
Ors.2 (BALCO) would operate with prospective
effect, and thereby to a certain degree have removed
the ambiguity prevailing over the nature of
prospective application of the BALCO judgment.
The court explained that while the ratio of the
BALCO judgment i.e. Part-I of the Arbitration
and Conciliation Act, 1996 (Act) would apply
only to arbitrations seated in India, operates with
prospective effect, the interpretation of Section 2(1)
(e)3 of the Act as provided by the Supreme Court
would not be limited to a prospective application.
I. Facts
The Appellant had entered into certain contracts
with the Respondents for the supply of particular
materials. Dispute arose between the parties which
were then referred to arbitration. The contracts
entered into by the parties provided that the
arbitration shall be conducted in accordance with
the rules of arbitration of the International Chamber
of Commerce and that the venue of arbitration shall
be New Delhi. However, upon invocation of the
arbitration, the Appellant proposed Mumbai as the
place of arbitration. Such proposal was accepted by
the Respondent. The arbitral tribunal constituted,
passed an award in favour of the Appellant and the
Appellant prior to enforcement of the award filed a
petition under Section 9 of the Act, seeking certain
interim reliefs requiring disclosure and freezing of
assets.
The single judge hearing the petition under section
9 of the Act dismissed the same stating that in view
of the agreement between the parties Part I of the
Act stood excluded and the mere fact that parties had
agreed to the venue/place of arbitration as Mumbai,
would not confer jurisdiction on the court in India.
Both parties were aggrieved by the order, filed an
appeal as both parties asserted Part I of the Act
applied however, the dispute was whether the
jurisdiction was vesting with the High Court of
Bombay or with High Court of Kolkata where the
cause of action is said to have arisen.
The Respondent submitted that as the cause of action
for the dispute has arisen in Kolkata, the Calcutta
High Court would have jurisdiction over the dispute.
The Respondents provided that by virtue of the
judgment in Bhatia International v. Bulk Trading
S.A.4 (Bhatia International), Indian courts may have
jurisdiction even though the place of arbitration was
not in India and accordingly various High Courts
had held that place of arbitration was irrelevant for
deciding the question of jurisdiction under Section
2(1)(e) of the Act. It was submitted that the court
which would have territorial jurisdiction over the
place where the cause of action is said to have arisen
in relation to the dispute would be the court for the
purposes of section 2(1)(e) of the Act.
The Appellants on the other hand argued that
Parties had agreed to Mumbai as the place of
arbitration. Further the in the BALCO judgment, the
Supreme Court had clarified that the meaning of
Court as provided under Section 2(1)(e) of the Act
would include the court of the place of arbitration.
Therefore, the Bombay High Court had jurisdiction
to hear the petition under Section 9 of the Act.
Thus, the issue inter alia was whether the
interpretation of Section 2(1)(e) as provided
under the BALCO judgment would apply only
prospectively or would the interpretation be also
applicable to agreements entered into by the parties
prior to September 6, 2012.
1. Appeal (L) No. 199 of 2013 in Arbitration Petitioner No. 160 of 2013 with Notice of Motion (L) No. 915 of 2013; and Appeal (L) No. 223 of 2013 in
Review Petition No. 22 of 2013 in Arbitration Petition No. 160 of 2013
2. (2012) 9 SCC 552
3. Court means the principal Civil Court of original jurisdiction in a district, and includes the High Court in exercise of its ordinary original civil
jurisdiction, having jurisdiction to decide the questions forming the subject-matter of the arbitration if the same had been the subject-matter of a suit,
but does not include any civil court of a grade inferior to such principal Civil Court, or any Court of Small Causes
4. (2002) 4 SCC 105
74
II. Judgment
The court initially taking note of the agreement
reached between the parties provided that Mumbai
is the seat of the arbitration.
The court then analyzed that if Mumbai was the seat
of arbitration does Section 2(1)(e) confer jurisdiction
on courts whose original civil jurisdiction extended
over the place of arbitration, to deal with petitions
under Section 9 of the Act. In this regard, the court
noted that in BALCO, the honble Supreme Court
had held that section 2(1)(e), grants jurisdiction
to both the courts i.e. the court within whose
jurisdiction the seat of arbitration is located and the
court within whose jurisdiction the cause of action
is said to arise or the subject matter of the suit is
situated. Accordingly, by virtue of the interpretation
of Section 2(1)(e) in BALCO judgment, the Bombay
High Court would have jurisdiction over the petition
under section 9 as the place/seat of arbitration was
Mumbai. The court cited the following text from the
BALCO judgment:
In our view, the legislature has intentionally given

jurisdiction to two courts i.e. the court which would
have jurisdiction where the cause of action is located
and the courts where the arbitration takes place. This
was necessary as on many occasions the agreement
may provide for a seat of arbitration at a place which
would be neutral to both the parties. Therefore, the
courts where the arbitration takes place would be
required to exercise supervisory control over the
arbitral process. For example, if the arbitration is
held in Delhi, where neither of the parties are from
Delhi, (Delhi having been chosen as a neutral place
as between a party from Mumbai and the other from
Kolkata) and the tribunal sitting in Delhi passes an
interim order under Section 17 of the Arbitration
Act, 1996, the appeal against such an interim order
under Section 37 must lie to the courts of Delhi being
the courts having supervisory jurisdiction over the
arbitration proceedings and the tribunal. This would
be irrespective of the fact that the obligations to be
performed under the contract were to be performed
either at Mumbai or at Kolkata, and only arbitration
is to take place in Delhi. In such circumstances, both
the courts would have jurisdiction i.e. the court
within whose jurisdiction the subject matter of the
suit is situated and the courts within the jurisdiction
of which the dispute resolution i.e. arbitration is
located.
Thus, it was to be understood if such interpretation

of section 2(1)(e) as provided under BALCO would
be applicable to arbitration agreements entered into
prior to September 6, 2012.
The court noted that that the power of prospective
ruling has been evolved by the courts to protect the
rights of the parties and to save transactions which
were effected due to the law which was previously
applying.
Accordingly, it was seen that the Supreme Court
had given the principle i.e Part I would apply only
to arbitrations which have their seat in India, a
prospective application to protect the transactions
which were effected on the basis of the law laid
down in Bhatia International. The court observed
that the Supreme Court had molded the relief only
to the extent that the ratio i.e. that the Part I shall
apply only to arbitrations seated in India was to
apply prospectively. This would mean that for
international commercial arbitrations where seat is
outside India under arbitrations agreements before
September 6, 2012, the Part I may still apply unless it
is expressly or impliedly excluded.
The court thus noted that it would be inappropriate
to also apply the reasons contained in the BALCO
judgment prospectively.
Accordingly, the court proceeded to set aside the
order of the learned single judge and granted adinterim reliefs in terms of temporary injunction
against disposal of assets and sent the matter back for
disposal on the merits of the case.
III. Analysis
A lot of debate surrounded the prospective
application of the BALCO ruling. The BALCO
judgment completely changed the landscape of
the arbitration law in India and along with it the
approach which was adopted by the courts towards
arbitrations. The judgment discussed at length the
meaning, scope and purport of various provisions of
the Act before coming to the conclusion. However,
the prospective application to the judgment
gave rise to a significant amount of ambiguity
regarding whether such prospective application
would also extend to the reasons as provided or
the interpretation provided under the judgment to
certain provisions while arriving at the decision.
Accordingly, the present judgment of the Bombay
High Court does lend assistance to a certain degree
and is indicative of the fact that not everything
that has been provided under the BALCO judgment
is prospective in nature and the interpretation to
75
Bombay High Court Clarifies the Prospective Application of Balco

various provisions of the statute as provided would

not be limited to a prospective application.
As per the judgment, the question regarding
whether Part I would apply to an arbitration
where the arbitration agreement was entered into
prior to September 6, 2012 would be decided in
accordance with the principle laid down in the
Bhatia International case. However having once
decided that Part I applies, the question which court
would have jurisdiction to entertain applications
76
under Section 9 or Section 34 etc. would be decided

in accordance with the principles provided in the
BALCO judgment.
Prateek Bagaria,
Ashish Kabra and
Vyapak Desai
authors
Annexure XIV
Challenges in Invocation of Pledge of Shares
Promoters of Unitech obtained the injunction due
to the unreasonable notice period given to them, the
company said in an email release. Outstanding loan
amount was repaid in full by the promoters within
a few days of obtaining the injunction and ahead of
the schedule. The pledged shares got released nearly
three months ago.
The pledging of shares is a mechanism through
which an investor or a lender can ensure a company
or a borrower delivers a promised return or repays
a loan within the stipulated period. When the
company defaults on the pledge, the shares are sold.
PE funds that focus on real estate have got such
pledged shares from their portfolio companies.
The Unitech case has raised concerns among PE
investors about the enforceability of the pledge,
said Ruchir Sinha, co-head, real estate investments
practice, at law firm Nishith Desai Associates. Many
funds are looking to enforce the pledge today, but
are concerned if the company can take them to court
and obtain a stay order.
Realty valuations have been declining as some
companies have been facing allegations of
wrongdoing relating to bribes given for loans and the
allocation of telecom spectrum, besides falling home
sales and rising interest rates.
On 30 January, Unitechs promoters approached the
Delhi high court and secured an injunction against a
move by debenture trustee Axis Trustee Services Ltd
to sell pledged shares. The promoters of Unitech had
raised Rs 250 crore from high networth individuals
(HNIs) in 2010 through the issue of non-convertible
debentures and had pledged their shares in the firm
as security to raise these funds.
However, on 28 January, Unitechs stock price
dropped to Rs 51 per share, marking a 38% decline
since November 2009 and triggering the default.
The same day Axis Trustee Services informed the
promoters that it would sell the pledged shares
on the next working day, as per their agreement.
Unitech moved the high court, which said that if
the stay was not granted, the company would suffer
irreparable loss.
Invoking a pledge can be challenging even in a
publicly traded company, since the law requires
that a fund must immediately sell the shares upon
invocation; funds are often faced with the dilemma
of whether to invoke the pledge or not, said Sinha.
If they invoke the pledge, then they must ensure

that the shares are sold, which may, apart from
hammering the stock, earn a bad name for the fund,
he said. If they dont, and the share value falls, an
argument can be made that they suffered the loss due
to their failure to exercise their rights on time.
The situation is even worse in a private company as
there is generally no market for such shares, Sinha
said.
Any lender who has pledged shares as collateral
runs the risk of ending up in court, said a fund
manager at one of the large domestic real estate
funds, who declined to be identified as it was a legal
issue.
Ideally, in a case where the lender decides to invoke
the pledge even before the company defaults because
of weak market conditions, the company should
immediately provide for adequate additional security
to avoid legal proceedings, he said.
There are three major forms of security that are
available to lendersmortgages, guarantees and
share pledging. Realty funds are increasingly making
investments through structured debt instruments
and are looking at stringent security mechanisms
and stock pledges are one of the most liquid form of
security.
This is a strong tool being employed by institutional
investors today who are worried about their returns
from their investment, said Amit Goenka, national
director of capital transactions at Knight Frank
(India) Pvt. Ltd.
According to him, what is prompting investors to
enforce pledging of shares is that the risk associated
with real estate has risen and investors dont believe
they can get their returns on time.
There have been 10 investments worth $514 million
(Rs 2,282.16 crore today) in real estate this year,
according to VCCEdge, a financial research platform.
Last year, there were 34 investments worth $1.16
million compared with 28 investments worth $870
million in the year earlier.
Some of the big investments in the sector include
$450 million investment in DLF Assets Ltd by
Symphony Capital Partners Ltd, $296 million
invested in Phoenix Mills SPV by MPC Synergy Real
Estate AG and $200 million invested in Indiabulls
Real Estate Ltd by TPG Capital.
77
Challenges in Invocation of Pledge of Shares

Unfortunately, it is true that real estate funds want to

invoke pledges, said the general counsel of a local PE
fund that has raised foreign money. He declined to be
identified considering the sensitivity of the issue.
If you see all the real estate companies, the extent
to which shares have been pledged is increasing
day by day, he said. In some of those companies, it
78
has reached the limit and they have nothing else to

leverage. So, there is no other choice for those lenders,
but to invoke the pledge.
However, Sinha of Nishith Desai cautioned that
enforcing a pledge will affect the reputation of the
company as borrowers will become apprehensive of
taking PE money.
The following research papers and much more are available on our Knowledge Site: www.nishithdesai.com
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Research @ NDA
Research is the DNA of NDA. In early 1980s, our firm emerged from an extensive, and then pioneering, research
by Nishith M. Desai on the taxation of cross-border transactions. The research book written by him provided the
foundation for our international tax practice. Since then, we have relied upon research to be the cornerstone of
our practice development. Today, research is fully ingrained in the firms culture.
Research has offered us the way to create thought leadership in various areas of law and public policy. Through
research, we discover new thinking, approaches, skills, reflections on jurisprudence, and ultimately deliver
superior value to our clients.
Over the years, we have produced some outstanding research papers, reports and articles. Almost on a daily
basis, we analyze and offer our perspective on latest legal developments through our Hotlines. These Hotlines
provide immediate awareness and quick reference, and have been eagerly received. We also provide expanded
commentary on issues through detailed articles for publication in newspapers and periodicals for dissemination
to wider audience. Our NDA Insights dissect and analyze a published, distinctive legal transaction using multiple
lenses and offer various perspectives, including some even overlooked by the executors of the transaction. We
regularly write extensive research papers and disseminate them through our website. Although we invest heavily
in terms of associates time and expenses in our research activities, we are happy to provide unlimited access to
our research to our clients and the community for greater good.
Our research has also contributed to public policy discourse, helped state and central governments in drafting
statutes, and provided regulators with a much needed comparative base for rule making. Our ThinkTank
discourses on Taxation of eCommerce, Arbitration, and Direct Tax Code have been widely acknowledged.
As we continue to grow through our research-based approach, we are now in the second phase of establishing a
four-acre, state-of-the-art research center, just a 45-minute ferry ride from Mumbai but in the middle of verdant
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internationally renowned professionals to share their expertise and experience with our associates and select
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