Flipping of Structures – Legal Framework

Flipping of Structures – Legal Framework

As Companies grow and have global footprints, we have seen founders wanting to flip the structures and have parent companies in countries like the United State of America, Singapore, Maturities, etc. Flipping of the structure generally means establishing the holding company outside India. Generally, flipping of structures is done for easier access to global investors, listing in overseas jurisdictions, etc. 

There are multiple options to flip the structure such as share transfer, swap of shares, outbound mergers, etc. One shall keep in perspective the income tax act, foreign exchange management act, Companies Act implications before penning down an efficient structure. In this article, I have discussed few key considerations:

A. Foreign Exchange Management Act, 1999:

Under the Foreign Exchange Management Act, 1999, the flip of structures will call for careful analysis of round-tripping issues. While round-tripping is not expressly defined, the restriction has inherently been there under the regulations on overseas direct investment by Indian residents. Further, in case of any transfer of shares or swap of shares, the Foreign Exchange Management Act, 1999 calls for certain fair valuations and reporting to the Reserve Bank of India ("RBI"). Further, RBI has allowed companies to set up Indian subsidiaries with prior approval by the RBI through an offshore company in which the Indian entity is a shareholder. 

B. Income Tax Implications:

In case of any restructuring involving the transfer of shares through plain vanilla transfer or swap of shares, income tax under the head capital gain may become payable subject to certain conditions. This is one of the important considerations while structuring any flip. it is also necessary to consider the commercial substance test under the General Anti-Avoidance Rules. Further, Place of Effective Management (“POEM”) is also an important test / consideration while structuring any flip. 

C. Intellectual Property (IPs):

In some cases, the founders prefer to transfer the IPs to overseas companies from IP protection, control, and valuation standpoint. Transfer of IP to an overseas company is permitted under FEMA subject to certain conditions which inter-alia includes the requirement to transfer the IP at fair market value. Transfer pricing regulations should be kept in mind while structuring the flip.  

D. Companies Act Considerations:

The valuation under the Companies Act, 2013 needs to be taken care of while implementing flip. Further, certain corporate actions such as board and shareholder approval need to be factored in the to-do list at the implementation phase.

E. Conclusion:

The flip of a structure is not a one-size-fits-all approach and need not necessarily be a move in the right direction for all companies. The business model of certain companies and their growth strategies may necessitate a flip in structure and the benefits may outweigh the complexities and the costs of such flip. Each case needs to be reviewed properly keeping in perspective the objective of flip.