The Hindu Business Line : IDRs: One more step in globalisation

The recently notified rules on issue of Indian Depository Receipts will help foreign companies raise funds in India by issuing depository receipts against their underlying equity shares. While certain exchange control and tax aspects still need to be crystallised, it remains to be seen if the concept finds takers, both at the issuer end and among Indian investors.

IN WHAT can be considered as one more example of the confidence prevailing in the Indian economy, the Department of Company Affairs (DCA) has notified the Companies (Issue of Indian Depository Receipts) Rules, 2004 (the IDR Rules). These rules pave the way for foreign companies to raise funds in India by means of issue of depository receipts against their underlying equity shares.

Although the concept of IDRs was mooted by the DCA as early as in 1997, when the Companies Bill 1997 introduced this concept for the first time, it did not find place in the actual amendments introduced in the Companies Act 1956, in 1999.

The provision enabling the issue of IDRs was introduced in the Companies Act by the Companies (Amendment) Act, 2000 in the form of section 605A of the Companies Act, which gave power to the Central Government to make Rules for the offer of IDRs and related matters.

The DCA had subsequently issued a draft of the IDR Rules in 2002 and invited comments from certain regulatory/professional bodies. The recently issued IDR Rules are the outcome of this whole legislative process. The objective of introducing this provision seems to be to provide Indian investors with one more alternative to acquire a share of the global pie as well as to allow global companies to access funds at, presumably, cheaper cost.

IDR rules

The concept of an IDR can be understood as a mirror image of the familiar ADRs/GDRs. In an IDR, foreign companies issue shares to an Indian Depository, which would, in turn, issue Depository Receipts to investors in India.

The Depository Receipts would be listed on stock exchanges in India and would be freely transferable. The actual shares underlying the IDRs would be held by an Overseas Custodian, which shall authorise the Indian Depository to issue the IDRs.

The Overseas Custodian is required to be a foreign bank having a place of business in India and needs approval from the Finance Ministry for acting as a custodian while the Indian Depository needs to be registered with SEBI.

An IDR issue needs to be approved by SEBI and an application in this regard has to be made a minimum of 90 days before the issue-opening date. The overseas company also has to file a due diligence report and a Prospectus or Letter of Offer with SEBI and the ROC. Further, the overseas company will have to obtain in-principle permission for listing on stock exchanges in India.

The overseas company undertaking the IDR issue needs to have a pre-issue paid-up capital and free reserve of at least $100 million and an average turnover of $500 million during the last three financial years. Incidentally, to put matters in perspective, the company ranked 500 in the 2003 list of Fortune 500 Companies had a turnover of more than $10 billion!

However, overseas companies also need to have earned profits in at least five years preceding the issue and should have declared dividends of at least 10 per cent each year during this period. Further, the pre-issue debt-equity ratio of such company should not be more than 2:1.

It is interesting to note that while Indian unlisted companies coming out with an IPO also need to comply with certain criteria relating to net worth and profitability, there is no criteria relating to the dividend distribution track record and debt-equity ratio.

The present IDR Rules do not require the overseas company to have a place of business in India. While there was some confusion on this aspect when the concept was introduced in the Companies Act (Amendment) Bill, 1997, the issue has been clarified, both in section 605A of the Companies Act as well as the present IDR Rules.

Further, it is also not mandatory for the issuing company to be listed overseas. However, the company would have to agree to the publication of its quarterly audited financial results in Indian newspapers, which may be a difficult condition for privately held companies.

Some of the other conditions prescribed under the IDR Rules are that the issue of IDRs during any financial year should not exceed 15 per cent of the paid-up capital plus free reserves of the issuing company and that the IDRs would not be redeemable into underlying equity shares before one year from the date of issue of IDRs. The IDRs would be denominated in Indian rupees, irrespective of the denomination of the underlying shares.

Exchange Control issues

The IDR Rules specify that the repatriation of proceeds of the IDR issue would be subject to prevalent exchange control regulations. Further, although there would be no restriction on the purchase or transfer of the IDRs as the investors would be Indian residents as defined under FEMA, any acquisition of underlying shares would be subject to compliance with the FEMA provisions prevalent at that time.

The IDR route is an addition to the options available to Indian investors for overseas investment — general permission for purchase of shares of listed foreign companies holding at least 10 per cent shares in an Indian listed company; acquisition of shares under the $25,000 route; and investments in Indian mutual funds, which are permitted to invest abroad up to $50 million each.

Considering that the present Exchange Control regulations contain specific provisions governing ADRs/GDRs , some amendments in the present outbound regulations to accommodate issues relating to IDRs may not be out of order. It is understood that SEBI will issue certain guidelines for regulating the issue and trading of IDRs and their redemption into equity shares.

Tax issues

Indian investors also need to consider the tax implications of investment in the IDRs/underlying equity shares. While the clause relating to IDR issue in the Companies Act (Amendment) Bill, 1997 had a provision stating that the Government would make rules for taxing gains on sale of IDRs, Section 605A introduced in the Companies Act does not contain this requirement.

In the absence of any specific provision in the Income-Tax Act, 1961 (IT Act) for taxing the gain on sale of IDRs, the general rules relating to capital gains taxation should continue to apply. As such, IDRs should be eligible for the beneficial tax rate for Long Term Capital Gains with a lower holding period of 12 months since IDRs would be a listed security.

However, the tax laws of the foreign jurisdiction where the overseas company is located would also be relevant in this regard. While the IT Act contains a specific provision in Section 47(vii-a) exempting gains on transfers of GDRs between non-residents, it needs to be analysed whether such a provision exists in the country of which the overseas company is a tax resident.

In the case of dividends declared by the overseas company, the same would not be covered under provisions of Section 115-O of the IT Act, which levies a dividend distribution tax on domestic companies.

Consequently, such dividend income would not be exempt in the hands of investors. It would be subject to tax withholding in the source country and investors would need to claim tax credit, wherever applicable, on such income. It needs to be noted that a person's residential status under FEMA could be different vis-à-vis his tax residence.

As regards conversion of IDRs into shares, while the IT Act exempts conversion of bonds/debentures/deposit certificates into shares under Section 47(x) from an Indian tax perspective, there may need to be incorporated a `direct' provision for the conversion of IDRs into underlying shares being tax neutral or a scheme, similar to that notified under Section 115AC, specifying the tax treatment relating to IDRs.

Further, a similar provision in the tax laws of the overseas jurisdiction may be useful in clarifying the tax implications of such conversion in the overseas jurisdiction.

To summarise, while the IDR Rules can be considered an important step in the direction of India's integration in the global economy, it remains to be seen whether there is an appetite at the end of the issuer as well as the Indian investor.

Also, there are various issues that need deliberation before a final verdict on the efficacy of this concept can be delivered and one looks forward to the issue of guidelines from SEBI/RBI/CBDT in this regard.

(The authors are chartered accountants with RSM and Company, Mumbai.)

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