The significance of RBI’s new regulatory framework for cross-border mergers

Rajesh Begur

After a long wait, the Reserve Bank of India (RBI) last month officially notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

As we know the Company law in India is undergoing an overhaul which started with the advent of the new Companies Act, 2013. Last year the Ministry notified the Sections 230 to 240 of the Act relating to mergers and amalgamations (including cross border) along with the Companies (Compromises, Arrangement and Amalgamations) Rules, 2016 and with the New Regulations in place we can finally see the defined set of regulations permitting and facilitating cross border mergers and amalgamations in India. Certainly, it’s a welcoming step by the RBI and as expected, has received rave feedback from the corporate community.

Prima facie, the Government has effectively tried to induce clarity, predictability and streamline the processes from both FDI and ODI perspectives. Another area where the new regime could help is the listed space by providing an alternate avenue on the one hand and bringing the hostile takeovers under the RBI scrutiny as well on the other.

With the new regime, India has opened its doors for outbound mergers - a concept which was alien under the previous framework and will encourage multi-national entities for opting this mechanism to give effect to their corporate restructuring.

Also, for Indian players looking for global houses, the New Regulations can serve as a much-needed integration mechanism. Prior to these regulations, the outbound mergers and acquisitions numbers in India were far below the inbound mergers and acquisition – the “mergers” were practically missing from the “mergers and acquisition” modes! Going by the deal value the sectors like Healthcare (USD 2507 M), Energy & Resources (USD 4087 M) were the only sectors wherein significant outbound activities were witnessed- keeping the considerably overall low proportion (~ 25%) as compared to inbound numbers.

Interestingly, with the recent changes we are now more liberal than jurisdictions like UK and EU wherein merger regulations permit the cross-border mergers only amongst the closed communities i.e. EEA and EU respectively! Certainly, a remarkable jump in the outbound mergers is expected to happen in coming years.

How does the new framework reduce approval requirements?

Another key feature of the New Regulations is doing away with the requirement of RBI approval for both inbound and outbound mergers as envisaged under Rule 25 A of the aforesaid rules. This is undoubtedly the major departure and the key highlight of new framework.

More so, considering the regulatory path in India is always time consuming and cumbersome. This was long due and much anticipated after the recent step of abolition of FIPB.

Conversely, with the presence of specific regulators overseeing the respective industries (like IRDA for Insurance industry) and CCI being there to control anti-trust issues, we do not see any reason for a separate approval from RBI. Positively, it is expected that the time required for mergers would see a drop!

The entire design of New Regulations has been very fairly drafted so as not to prejudice the extant FEMA regulations. For instance, in case of any inbound merger, the resultant company has been permitted to issue or transfer any security to a non-resident but the same must comply with the pricing norms, downstream investment conditions and entry/sectoral restrictions prescribed under the FEMA regulations.

Similarly, in case of outbound mergers, a person may acquire securities outside India subject to FEMA regulations- specifically with the Liberalized Remittance Scheme in case of individuals. It is an undisputed fact that practically all the companies in India with cross border activities have some or the other FEMA non-compliance concern.

This calls for a complete health (read as “legal”) check of such entities before they are ready to cross borders deals! Accordingly, entities desiring of undertaking such cross-border mergers are advised to get their compliances in place with the aid of qualified professionals.

Another notable aspect is the requirement of the resultant merged entity to necessarily comply with FEMA regulations, specifically in relation to ECB guidelines (for loans or debts taken from the foreign company) and the assets acquired by the merged entity.

However, we expectantly note that- an appropriate window of 2 years has been provided to the parties to bring any such consequential non-compliances in line with FEMA regulations. Therefore, whereas the given requirement will not affect the transaction, but it once again triggers the requirement of appropriate structuring of loans/debts and assets so not to lose out on benefits after the merger!

Challenges merging entities may face under the new framework

The New Regulations begs for more clarity. For instance, it provides that any Indian office in case of an outbound merger and foreign office in an inbound merger shall be treated as “branch office”. This would in our opinion trigger the dual hurdle of – restricting the activities of such office and exposing it to higher taxation regime. Also, the possibility of such an entity being considered as permanent establishment owing to its nature of activities and connection with the overseas company can’t be denied! Therefore, entities would require spending some extra time and brainstorm while structuring their transactions to be tax efficient. We also look forward to seeing suitable amendments under the tax laws extending the capital gains tax exemptions to outbound mergers too.

Lastly, we note that from the scope of New Mergers, “demergers” have been dropped out. No clarification for the same has been provided so far, one of the possible reasons could be to keep the same away from “deemed approval” zone. Nonetheless, there appears to be still some time for cross border splits being available as an option for restructuring.

Having said that, a question arises – Are we finally there, yet? Without taking away the benefits which are surely going to come with the New Regulations, we believe that like any new law, the New Regulations are bound to face certain challenges and implementation hurdles. With awaited clarifications on the taxation aspects in place and appropriate structuring of the transaction, we believe that both the domestic and foreign players would be able to reap the benefits of this far-reaching law. We hope to see the anticipated jump in outbound mergers in specific and rise in cross border activities in M&A space in general given the flexible and time efficient regulatory mechanism finally in place!