- India’s capital-markets regulator plans to build a dedicated framework on Special Purpose Acquisition Companies (“SPAC”) to allow such ‘non-operational’ entities to also raise funds in initial share sales and list locally. At present, the Securities and Exchange Board of India (“SEBI”) allows listing of only ‘operating’ companies.
- To allow SPACs in India, SEBI has to either introduce a separate law or amend current regulations to allow listing of ‘non-operating’ or ‘investment’ companies.
- Under a blank-cheque company, as SPACs are known in the US, first a company is listed on the capital market and raises a particular sum. A company is created for the sole purpose of raising capital through an initial public offering (IPO). SPACs would only declare what they plan to do i.e. acquiring Target companies. Then they are allowed a specific time period, 18 to 24 months in the US, to acquire Target companies. But if they can’t, they return the money to the investors.
- Given the risks associated with the SPAC business model, the SEBI framework must priorities the needs of retail investors and minority shareholders.
- The market regulator would want to protect the minority shareholders who would invest in these structures. Stricter rules around returning the money, if the structure is unable to acquire anything, will be required. One of the solutions could be to ‘limit’ retail participation to protect small investors.
- SPACs would largely Target bulge-bracket foreign investors that want a piece of some unlisted companies, such as Indian Unicorns, which may get listed abroad in the future.
- SPAC is not like a company per se; so, assigning responsibility in case of a corporate governance issue also becomes crucial. SEBI regulations would also go into this as often the listed entity may have more than one company under its umbrella, which again could have separate promoters and auditors. The Companies Act, 2013, would also need necessary amendments before these structures are floated in India.
- SEBI had formed a committee to examine if “SPAC-like structures” could work in India. Over the past few months, several Indian companies have used the SPAC route to get listed in the US and other overseas markets.
- SEBI’s regulations come at a time when many Indian companies are looking to explore the SPAC route in the US. The regulator is reportedly concerned about maintaining control over Indian companies that become linked to SPACs in the US.
Concerns around India Tax Issues
- Indian start-ups and companies are hoping to raise billions of dollars through SPACs. There are at least a dozen companies that will get listed in the US through the SPAC route by the end of this year, say industry trackers.
- There are also concerns around tax issues, and these might make SPACs unattractive to local retail investors. Indian companies currently can’t list overseas and that could impact valuations that some of the unicorns could fetch if they list in India instead of the US Today, Indian investors may be skeptical investing in a structure that doesn’t have any underlying operating assets or business when it is listed but would acquire in the future.
- According to people in the know, some of the issues around taxation are also being looked at when transferring a company either through a reverse merger or any other route into SPAC.
SPAC from US tax Perspective
SPACs are publicly traded companies formed for the sole purpose of raising capital through an IPO and using the IPO proceeds to acquire one or more unspecified businesses in the future. The management team that forms the SPAC (the “sponsor”) forms the entity and funds the offering expenses in exchange for founder shares. There are various tax considerations and complexities that can have significant implications both during the SPAC formation process and down the road.
Selecting Jurisdiction for Incorporation
- An important initial consideration for the management team when forming a SPAC is whether the company will be incorporated in the US or offshore. The Cayman Islands or the British Virgin Islands are often used for offshore incorporation due to their favorable tax environments, although the choice of jurisdiction generally depends on the jurisdiction of the likely Target. If the Target will be a US corporation, a foreign SPAC will create complexities and potential tax leakage with respect to certain types of payments from the US Target to the SPAC.
- For example, payments from the US Target to a foreign SPAC, such as dividends or interest, should generally be subject to a 30% US withholding tax unless the rate is reduced or eliminated under a tax treaty between the US and the SPAC’s country of tax residence and assuming the SPAC recipient qualifies for benefits under the treaty.
- Determining treaty qualification can be complex, and treaties do not always reduce the withholding tax to zero. Further, the US does not have an income tax treaty with the Cayman Islands or the British Virgin Islands.
- Conversely, if the Target is a foreign corporation it may be inefficient to have the foreign Target owned by a US SPAC as the US SPAC would be subject to unfavorable US anti-deferral rules (e.g., Subpart F and GILTI) and complex reporting obligations with respect to the foreign Target.
Changing the Jurisdiction of a SPAC after Formation Can Be Difficult
- For example, if a SPAC formed in the US seeks to expatriate because it is acquiring a foreign Target, depending on how the outbound expatriation is structured, the SPAC may continue to be treated as a US corporation for all federal tax purposes or be subject to other unfavorable anti-inversion rules. The expatriation can also lead to US income tax at the level of the SPAC and in certain instances, to its shareholders as well.
- If a foreign SPAC seeks to reincorporate in the United States because it is acquiring a US Target, both the SPAC and its shareholders could potentially be subject to US tax in the domestication transaction. Depending on how the transaction is structured, the SPAC and its shareholders could also be subject to tax in their jurisdictions on the domestication transaction.
Passive Foreign Investment Company Implications
- The domestication of a foreign SPAC may give rise to significant, complex issues under the passive foreign investment company (PFIC) rules. A foreign corporation is a PFIC if at least 75% of its gross income for the tax year is passive income or if at least 50% of its assets for the tax year produce or are held for the production of passive income. Passive income generally includes dividends, interest, some rents and royalties, and gains from the disposition of passive assets.
- Once PFIC status is acquired, it cannot be lost in subsequent years in which the foreign corporation no longer satisfies the tests, unless the foreign corporation is “purged” of its PFIC taint, or certain elections are made for the first year of the US investor’s holding period during which the foreign corporation is a PFIC.
- If a foreign corporation is a PFIC, US investors in the PFIC are subject to unfavorable taxing regimes on income attributable to the PFIC and may also be subject to certain annual reporting obligations with respect to their ownership interests in the PFIC.
SPAC structures have been operational in the US for more than a decade; however, it could take time for this to work in India.