Regulatory challenges for SPACs in India

Special Purpose Acquisition Companies (SPACs) have been in the news recently in India, in the wake of India’s biggest renewable energy company, ReNew Power, opting this route to list itself on Nasdaq. ReNew has announced a business combination with RMG Acquisition Corporation II, a US-based SPAC.

Similarly, the online grocery seller, Grofers is also in talks with New York based SPAC for NASDAQ listing, Walmart Inc.’s Flipkart is also exploring the option of going public in the US with a blank-cheque company. Earlier, Videocon D2H and online travel agency Yatra have sealed SPAC deals worth millions of dollars.

With SPACs gaining traction and momentum in the USA and other western markets, there has been an emerging requirement for regulated SPACs in India as well, to facilitate and ease the listing of start-ups. Else, they may seek the foreign route for public listing, making India a hub for subsidiaries rather that start-ups.

What are SPACs?

SPACs are companies formed to raise capital in Initial Public Offering (IPO) with the purpose of using the funds to acquire one or more businesses identified after the IPO. Commonly referred to as ‘Blank Cheque Companies’, SPACs are formed with the sole purpose of acquiring another company (target company) and do not have any other commercial operations. The group of expert institutional investors, who form the SPAC, are supposed to identify a target within a fixed time frame of two years and invest the IPO proceeds therein, subject to the approval of the shareholders. Else, the proceeds from SPAC IPO are returned to the investors with interest.

Once the acquisition is complete, the SPACs reflect the identity of the target company. Consequently, the unlisted target gets listed automatically. Owing to the fact that SPACs allow a private company to go public and get a capital influx more quickly that it would have with the traditional IPO route, such structures have emerged as promising options for start-ups in India, who find it difficult to satisfy the criteria for listing through an IPO.

While SPACs have been in the global domain for quite some time, their massive growth has been witnessed recently due to the market volatility owing to the pandemic. While many companies postponed their IPO fearing the failure of the public issue, others chose to take the alternative route of merging with a SPAC.

Regulatory framework in India

The current regulatory framework of India is not supportive of the SPAC structure. For instance, the Companies Act 2013 authorizes the Registrar of Companies to strike-off the name of companies that do not commence operation within one year of incorporation. SPACs typically take 2 years to identify a target and perform due-diligence. If SPACs are to be made functional in India, enabling provisions will have to be inserted in the Companies Act.

Further, SPACs do not find acceptance even under the Securities and Exchange Board of India Act. The eligibility criteria for public listing, requires a company to have net tangible assets of at least ₹3 crore in the preceding three years, minimum average consolidated pre-tax operating profits of ₹15 crore during any three of last five years and net worth of at least ₹1 crore in each of the last three years.

The absence of operational profits, net tangible assets would prevent SPACs from making an IPO in India. US has witnessed an upswing in the popularity of SPACs. The US Securities and Exchange Commission (SEC) oversees all transactions pertaining to SPAC.

To ensure transparency and credibility, SEC has mandated exhaustive SEC filing, reporting and disclosure requirements for giving effect to transactions involving SPACs. Owing to the “well-regulated” feature of SPACs in the US, sponsors and investors have begun regarding SPACs as a better substitute to traditional IPOs.

Further, stock exchanges across the world have their own SPAC related regulations, for instance, the London Stock Exchange requires a listed entity to delist and reapply in case of reverse merger with a listed entity, the Australian Securities Exchange allows reverse merger on a case-to-case basis. Canada too has regulatory guidelines for SPACs and is enthusiastically encouraging the same.

For now, Indian legislature has not prescribed any comprehensive regulatory requirements for SPACs. However, India’s market regulator, Securities and Exchange Board of India (SEBI) has instituted a committee of experts to examine the feasibility of bringing regulations for SPACs in India, which might potentially augment the prospects of domestic listing of start-ups.

As India’s IPO market is sizeable and mature, SPACs have the potential to succeed in the Indian landscape as well. If India considers SPAC listing in India, flexible rules, covering aspects such as incorporation, compliance and governance shall have to be formulated.

Risk for retail investors

SPAC structures in India could enable listing of start-ups on domestic stock exchange without encountering the cumbersome, stringent and expensive listing process. Since SPAC route is opted by start-up for obtaining faster, easier listing, therefore, retail investors must be cautious of the risk such listing may entail.

Apparently, in the US, investors have the right to redeem their shares and claim a refund of the amount they invested, till the acquisition of a target. However, in India, redemption of shares of a listed company may not be permissible, in the absence of specific legal provisions. Therefore, the shares of the SPAC shall have to be exchange traded, the value of which may fall or rise substantially, exposing retail investors to risk.

Post-merger too, the shares of the merged entity shall have to be exchange traded and trend has shown that companies acquired by SPACs have underperformed in the wider market in the US. Therefore, regulators must frame the legal structure keeping investor interests in mind.

Taxation

Currently, foreign SPACs are acquiring Indian companies for offshore listing. Do Indian Tax Authorities allow foreign listed SPACs to acquire Indian start-ups without capital gains tax? That is not the case, as per the Income Tax Act, any gain derived by a person, from transfer of capital asset (being share in Indian Company) is taxable in India. Foreign SPACs acquire the entire share capital of the target company for cash consideration or in exchange of its own shares. In both the cases capital gains will ensue in the hands of the shareholders.

If SPACs are made functional in India, the amalgamation would be of two Indian entities, one being the target and the other being the Indian SPAC. Merger, under a scheme of amalgamation, as such, would be tax neutral. Further, there would be no tax incidence in the hands of the shareholders of the Indian target as well.

However, to avoid litigation and to accord more clarity in this regard, separate provisions under the Income Tax Act may be required. Start-ups are value drivers for India, SPAC framework may lift their sentiments by opening new avenues for capital inflow. India’s market regulators have embraced change and inventiveness in the past, however, it must tread the road carefully after taking into account critical matters such as investor protection and revenue leakage.

(The authors are Chairman and Director respectively of Nangia Andersen, a Delhi-based law firm)

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