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The thriving Indian economy and its vast potential at the time of the “funding winter” across the globe have resulted in the trend of “reverse-flipping”. Startups in India, which had once flipped their entire ownership structure to more developed and tax-efficient jurisdictions, are now reverse-flipping in India, by integrating the ownership of the flipped entity into an operating Indian entity. This trend is further fuelled by a booming IPO market in India that enables investors to make a lucrative exit.
The most common structure used to reverse-flip is through an inbound merger, in which the non-resident entity (NRE) merges with the Indian entity (IE) and the shareholders of the NRE become shareholders of the resultant IE.
Rudra Kumar Pandey
Partner
Shardul Amarchand
Mangaldas & Co.
There is increasing M&A activity by Indian companies on a global scale and inbound mergers have gained significant momentum. Following this trend, prominent startups such as Groww and Pepperfry have reverse-flipped through inbound mergers. Others, such as Pine Labs, Razorpay, Zepto and Meesho are considering doing the same.
Legislative amendments have paved the way for this movement. In 2017, section 234 of the Companies Act, 2013 (act), was enacted and the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 (Merger Rules), were amended to allow cross-border mergers, subject to the prior approval of the Reserve Bank of India (RBI) and compliance with the act.
In 2018, the RBI introduced the Foreign Exchange Management (Cross Border Merger) Regulations, 2018, streamlining the procedure for inbound mergers by introducing the concept of deemed approval. Any transaction in furtherance of an inbound merger is deemed to be approved, provided it complies with the said regulations.
An inbound merger, being a court-driven process, typically takes a minimum of six to nine months. Hence, a number of matters need to be considered when reverse-flipping through inbound mergers such as only if the inbound merger qualifies as an amalgamation under the Income Tax Act, 1961, that the transfer of capital assets from an NRE to an IE and the transfer of shares by the shareholders of an NRE in lieu of shares of the IE are tax-exempt.
Anshul Chhirang
Senior associate
Shardul Amarchand
Mangaldas & Co.
Further, after inbound mergers, employee stock ownership plans (ESOP) have to comply with the act, which prescribes a minimum of one year from grant to vesting of ESOPs. If ESOPs are granted to non-residents, they must comply with the Foreign Exchange Management Act, 1999 (FEMA). High tax rates on the exercise of ESOPs further complicates inbound mergers, making retention of the talent pool difficult for startups looking to reverse flip.
Government approval may also be needed should any shareholder of the IE, after an inbound merger, resides or the beneficial ownership of which is situated in a country sharing a land border with India. This may lead to delay or rejection of the merger. Other approvals may also be required depending on the sector in which the IE is engaged.
Should the NRE have borrowed from overseas lenders, the IE, after the merger must ensure that such borrowings comply with the External Commercial Borrowings framework within two years, requiring negotiations with lenders. The IE can only hold or acquire assets allowed for an Indian company under the FEMA. If the IE holds assets not allowed after the inbound merger, it has to dispose of them within the prescribed timeframe.
While the government has taken positive steps to encourage reverse-flipping including the Ministry of Corporate Affairs, which is considering amending the Merger Rules to further streamline and expedite the process of mergers, the procedure for inbound mergers remains cumbersome, lengthy and time-intensive.
Startups may consider reverse-flipping into the International Financial Services Centre in GIFT City (GIFT IFSC). The Padmanabhan Committee report has also recommended measures to encourage reverse-flipping in GIFT IFSC, such as a tax-neutral treatment for reverse-flipping; tax relaxations on the exercise of ESOPs and dividend payments, and relaxations of the listing requirements for startups on IFSC exchanges. Such measures are yet to be implemented. The involvement of the government in fostering the startup ecosystem is driving reverse-flipping. The union budget for 2024-2025 has proposed abolishing the angel tax, which is expected to boost investment in startups and may further fuel the trend of reverse-flipping.
Rudra Kumar Pandey is a partner, Anshul Chhirang is a senior associate at Shardul Amarchand Mangaldas & Co. Shreya Bhatnagar, an associate, also contributed to the article.
Shardul Amarchand Mangaldas & Co
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Okhla Phase III, Okhla
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