[By Mohammad Aqib Gulzari]
The author is a student at the University School of Law and Legal Studies, GGSIPU, Delhi.
Introduction
The American phenomenon of ‘Special Purpose Acquisition Companies’ (SPAC), popularly known as ‘blank cheques companies’, has caught the eyes of investors around the world and taken the international capital market by storm. SPACs are primarily shell companies designed to take companies public without going through the traditional method of Initial Public Offering (IPO). According to a recent market statistics report by the ‘SPAC Tracker’ for April 2021, SPACs have managed to raise an all-time record-breaking USD 98 billion with a total of 308 listings on US stock exchanges in just the first four months of 2021.
The modus operandi of a standard SPAC is simple. The SPAC, an already-listed company, targets an unlisted operational company and merges with it to form a single listed entity. This is referred to as a De-SPAC transaction — i.e., a reverse merger wherein the acquisition of a private company is executed by an existing public company so that the private company can bypass the extensive and complex process of going public. These De-SPAC transactions are often led by industry experts who leverage their expertise of the market to raise capital and create synergy for every stakeholder. Under American law, the transaction is required to be completed within a period of 2 years; if it is not completed, or if a target company is not identified by the management team of SPAC, the money is returned to the investors without any hassle. Under the laws of India and the UK, however, such redemption is not allowed.
Nevertheless, SPACs are increasingly becoming popular in India (e.g. Flipkart and Grofers). This is so even though not a single SPAC has been listed on the Indian stock market to date, owing to legal impediments and an unfavourable regulatory regime. In this context, this article attempts to present a clear picture of SPACs in India from a legal standpoint considering the investors’ as well as the regulatory concerns and examines the feasibility of the SPACs structure and operation within the Indian domain.
Unfavourable Regulatory Framework for SPACS in India
The Companies Act, 2013 (Act) is perhaps the biggest roadblock for SPACs in India. De-SPAC transactions stand in direct contravention of the Act as well as other Indian laws discussed below, such as SEBI Regulations, FEMA, RBI Master Directions, and the Income Tax Act, 1961 (ITA).
As per Section 248 of the Act, the Registrar of Companies (ROC) is empowered to invalidate and strike off the names of the companies which do not commence operation within one year from the date of incorporation, unless they seek a dormant status under Section 455. In exercise of this power, the ROC, under the mandate of MCA, invalidated 2,26,166 shell companies in 2017-18, 2,25,910 in 2018-19, and 14,848 in 2019-20. [No company was invalidated in 2020-21 as more than 11,000 companies had applied for a “voluntary invalidation”—another avenue provided under Section 248(2).] Since a De-SPAC transaction requires two years to complete, it will inevitably be hit by Section 248 of the Act.
Thus, the Act would require significant amendments for SPACs to establish a structure in India and meet their objectives such that SPACs can be allowed to remain in existence for a period of two years from the date of incorporation.
Outbound Merger: Overseas Direct Investment Regulations
In case of an outbound SPAC merger, i.e., where a foreign listed SPAC acquires an Indian target company, Indian shareholders are subject to Overseas Direct Investment regulations in the matter of holding shares in the listed merged entity post-De-SPAC, either as consideration for a merger or as a share swap. Such holdings by shareholders must comply with the RBI Master Direction on liberalized remittance which caps the Fair Market Value (FMV) of the security or holdings in an overseas entity at USD 250,000 annually. The value of the security is bound to exceed the FMV, resulting in contravention of laws at the hands of the Indian shareholders if they own a greater stake in the merged foreign entity. Thus, the issue calls for modifications in the said regulations to enable the Indian shareholders to own larger stakes in foreign entities through De-SPACing.
Predicaments in Listing the SPAC on Indian Capital Market
Due to non-compliance with SEBI norms, SPACs cannot be listed on the Indian capital market. SEBI has laid down eligibility criteria for an IPO under Regulation 6(1) of SEBI (Issue of Capital And Disclosure Requirements) Regulations, 2018 which require companies to have net tangible assets of at least 3 crores INR in the preceding three years, minimum average consolidated pre-tax operating profits of 15 crores INR during any three of last five years, and net worth of at least 1 crore INR in each of the last three years.
While SPACs may list themselves using an alternate route under Regulations 6(2) and 32(2) which allow companies to go public through a book-building process pursuant to which 75% of the IPO must be allotted to qualified institutional buyers. Thereby, curtailing investment opportunities for retail investors as they can only be allotted 10% of the IPO.
Taxation Conundrum
The De-SPAC transaction will be taxable under Section 45 of the ITA which states that any capital gain derived by a person, from the transfer of the capital asset, is taxable in India. The SPACs acquire the entire share capital of the target company via two methods either for cash consideration or in exchange for its shares. In both cases, capital gains will ensue in the hands of the shareholders.
De-SPAC transaction is not tax neutral in India as it is not explicitly exempted from capital gains tax under Section 47 of ITA which provides for the exemption from capital gains tax for Indian amalgamating companies pursuant to a scheme of amalgamation. In order to complete such transactions without undue tax imposition, an enabling provision must be added in the ITA to accord more clarity and allowing SPACs in India to be provided with a tax-neutral treatment as in the case of Indian companies under Section 47.
Examining SPAC Structures Within the Indian Domain
One cannot discuss the legal regulation of SPACs in the Indian context without also discussing the Governmental response to “shell companies” in general. The Central Government’s endeavour to check the rise of shell companies has direct consequences for SPACs in India. Indian regulators have reason to be wary of shell companies on account of their previous involvement in tax evasion and related economic offences. The Government has been actively attempting to formulate a working definition for the shell companies. E.g., the Prime Minister’s Office instituted a Task Force on Shell Companies in 2017 with a mandate to define, identify and eviscerate the shell companies involved in illegal activities. In pursuance of this, the Securities and Exchange Board of India (SEBI) suggested defining a shell company as “any entity, having no significant operational assets or business activity of its own but acting in a pass-through capacity as a conduit.”
The vagueness which characterizes the definition of “shell companies” was highlighted by the High Court of Gauhati in Assam Co. India Ltd. vs. UOI. The Court was considering an investigation initiated by SEBI in which SEBI had treated the petitioner company as a “shell company” despite it being involved in an active business. While refusing to sustain the investigation, the Court expressed concerns over the use of the phrase “shell company” by regulatory authorities in the absence of a cogent statutory definition.
Like the phrase “shell companies”, the term “SPAC” is also not defined anywhere in Indian law. However, since SPACs are like shell companies in terms of their operational mechanism, they are likely to be engulfed by the prohibitions imposed on “shell companies” in general. Hence, while a cogent structure governing shell companies is imperative, regulators must ensure that they do not inadvertently create a predicament for other compliant and legal entities including SPACs, and a balanced approach must be adopted in formulating the law.
Conclusion: “A Sober Look at SPACs”
While the SPAC may be a viable option to raise funds, it is not necessary that the SPAC-led transactions are free from encumbrances and would yield profits for all. Goldman Sachs reported that out of all the SPAC-led transactions in 2020, the average performance rate and return was a mere 2% which performed even worse than the traditional IPOs. As per the study by the Wall Street Journal, the SPACs which went public in the year 2015-2016 are now trading way below their IPO share price leaving the investors wary of their investments.
The future of SPAC remains unclear as investors are finding it as a hybrid method of raising funds whilst the critics claim it to be only a trend nearing its end. In either case, there is an imminent requirement to place a comprehensive regulatory and governance framework in place to establish a legally backed structure for SPACs in India and remove existing predicaments in its operations. It will be a revolutionary milestone in the capital markets industry and especially for the Indian ‘unicorns’ who are out of the IPO race due to their nascent structures and unfavourable laws.