Finally, foreign companies, with or without a presence in India, can list on Indian stock exchanges. The Department of Company Affairs (DCA) has issued the Companies (Issue of IDRs) Rules, 2004 (the Rules).
The Rules have been issued four years after the insertion of Section 605A in the Companies Act, 1956 (the Act). This Section paved the way for foreign companies to make a public offer of Indian Depository Receipts (IDRs). The Rules, however, seem to carry with it the baggage of the past, as most of the eligibility criteria listed in it are prohibitive. This could prove to be a road-block and prevent the IDR regime from taking off in India.
Eligibility Criteria: Foreign companies satisfying certain criteria will be eligible for issuing IDRs (See Who's Eligible?). In addition, it will have to comply with eligibility criteria that the Securities and Exchange Board of India (Sebi) is expected to lay down soon for this purpose. The DCA has probably aimed a bit too high in providing that the issuing company has to have a pre-issue paid up capital of $100m and an average turnover of $500 m. This is way beyond the reach of most foreign service companies, who may be remotely interested in raising funds in India.
Currently, product companies are mostly looking at more developed markets for better valuation, while software or outsourcing service companies are looking at raising funds from countries like India.
Further, the criteria for the declaration of dividends may pose a problem for foreign companies. For example, in the US, it is not common for companies to declare dividends; all the profits of a company are typically re-invested into the business of the company. It might have been better to prescribe criteria of distributable profits as laid out in the SEBI (Disclosure and Investor Protection) Guidelines, 2000.
Matters Of Procedure: The issue may require approvals from the ministry of finance (MoF), SEBI and from local securities authorities, such as the Securities Exchange Commission (SEC) in the US. Also, the issuing company has to list on one or more stock exchanges having nationwide trading terminals, which means that the listing can only be done on BSE, NSE or both. As the IDRs have to be listed, currently privately-placed IDRs may not be possible.
The Rules provide that the repatriation of proceeds of the IDRs issue shall be subject to foreign exchange laws. This means that a specific approval of the MoF would have to be sought for repatriation of the proceeds. Redemption of the IDRs would not be possible for a year. Further, the issue should be capped at 15% of the company's post-issue net worth; and the IDRs have to be denominated in Indian rupees, irrespective of the denomination of the underlying securities.
Who can invest: Any person resident in India as defined under the Foreign Exchange Management Act, 1999; which includes any person or body corporate registered or incorporated in India, can purchase IDRs. This could mean that apart from individuals and companies, even foreign institutional investors (FIIs) should be eligible to purchase IDRs. However, foreign venture capital investors (FVCIs) and venture capital funds (VCFs) would not be eligible to invest, as the current regulations governing them permit them to invest only in IPOs of certain domestic companies.
Tax Impact: Dividends declared by the issuer will be distributed by the domestic depository to the IDR holders. While domestic dividends are tax-exempt in the hands of shareholders, foreign dividends are fully taxable. The implication would be that the IDR holders would have to pay tax in India on the same.
If tax has been withheld on dividends in the issuer's country, the IDR holders will have to be given tax credit for the same in India. While sale of IDRs in India may trigger capital gains tax in India, there should not be any capital gains tax implications on sale of underlying shares in foreign countries, as most countries do not levy capital gains tax on non-residents.
Grab That Opportunity: IDRs will open up new avenues for foreign companies wanting to acquire or take over Indian companies. This will facilitate stock-swap transactions where Indian promoters have to be offered stock in foreign companies in excess of the current limit of $25,000. The Rules do not stipulate anything about the voting rights of the IDR holders. The accounts of the issuing company will have to be recast according to Sebi's guidelines or the listing agreement, so that it is in tune with Indian accounting practices and easier for investors to understand.
The IDR route is attractive for small and mid-cap foreign companies, which are familiar with Indian markets or have promoters of Indian origin. Typically, these companies would be based in the US and SE Asia.
With the cost of compliance increasing for companies that want to be listed in the US and other markets, listing in India may be an attractive option for foreign companies that view India as a potential market. However, the Rules appear to be out of sync with the dynamics of international markets as most of the prospective companies may not be able to meet with all the eligibility criteria.
As the Rules stand today, companies such as Microsoft would not be eligible to issue IDRs, as they might not have distributed dividends for the past five years. Unless the Rules are revised and tuned in with international practices, it will fail to attract foreign companies to Indian markets and IDRs may just remain a mirage.
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