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Elon Musk Tweets his Way to Buy Twitter!
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Elon Musk has done it! He’s signed definitive agreements to acquire Twitter for USD 44 billion in cash! I have been closely watching this space with much interest over the past several days, and as takeover battles go, I must say, this one turned out to be a virtual “walk-over”, to put it in cricketing terms! Of course, the Twitter board did try and incorporate a poison pill to fight Musk, but clearly, that pill wasn’t poisonous enough for Elon Musk, who responded by flashing his arsenal to the world – a mix of equity and debt capital of around USD 45 billion – thereby pressuring the Twitter Board.

As often happens in these takeover situations, the Twitter Board felt compelled to respond to Musk’s offer by adopting a limited duration shareholder rights plan (i.e., a poison pill) that would be triggered if any person’s ownership of Twitter crossed 15%, which would have made the “acquisition” a dead duck one for any unauthorized buyer. The Twitter board may have hoped that with the pill in place, it could possibly receive, or even actively solicit, competing offers from other bidders at a valuation that would be in their view, more reflective of Twitter’s intrinsic worth. Unfortunately for Twitter shareholders and the Board, NO competing offer surfaced, let alone a white knight, and therefore, they had no option but to take Musk’s offer! But WHY??? Is Musk the only one who thinks Twitter is worth owning? Surely, that can’t be true?

Almost certainly, ALL the mega tech corporations – Meta (FB), Microsoft, Google, Apple – would have very seriously considered making an offer, and may have arguably, even offered a better valuation than Musk’s offer did, but that did not happen. Not a peep from any of them. I think all of them may have talked to their antitrust lawyers and concluded that the deal wouldn’t get approved by the antitrust regulators. Musk as a buyer, on the other hand, faced no such antitrust hurdles.

There also wasn’t a SINGLE PE bidder for Twitter. Obviously, USD 44 billion is not a small deal, but surely, a couple of PE shops could have gotten together to put up a consortium bid? Surprising that not even one such competing PE offer turned up. While obviously, there were numerous issues with Twitter’s business, there’s nothing that is beyond the ability of an experienced PE consortium to fix after a “take private” deal.

Anyway, whatever the reasons, Elon Musk now is on the verge of becoming the private owner of Twitter, for a steal of a valuation – let’s not forget that just 6-7 months ago, Twitter was trading at USD 70 a share, compared to the USD 54 that Musk is now buying the company at!

Lexygen COVID-19 India Recovery Pledge 2.0
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Last year, when the pandemic hit India and a national lockdown was announced, we at Lexygen were one of the very first Indian law firms to do our bit for the alleviation of stark difficulties caused to Indian businesses, by announcing our Lexygen COVID Pledge, under which, over a period of 3 months, we donated approximately USD 70,000/ INR 50 lakhs worth of top-quality legal advice to a mix of startups and later-stage Indian businesses, that were helped a lot by the timeliness and strategic utility of our advice when they were facing much financial pain.

While our whole nation was hoping for a quick recovery from the pandemic in 2021, we have all been hit instead with a second wave of the pandemic that has been more virulent, and far more fatal than the first. While we as a nation grapple with the deep emotional damage caused by the innumerable deaths of friends, family and dear ones, this second wave also direly threatens India’s economic progress, which would even more massively dent our already hurting society. In our view, it is important to protect from the pandemic the fragile sections of our entrepreneurial ecosystem, as they are not just value-creators, but also job-creators.

Therefore, after much discussion, we at Lexygen are pleased and HONOURED to present the Lexygen COVID Pledge 2.0! We all agreed that given the circumstances, we should substantially increase from last year the amount of free legal advice that we’d provide. Below are the key features of the Lexygen COVID Pledge 2.0:

  1. For a period of 3 months, from May 17, 2021 till August 16, 2021, Lexygen will offer, on a ‘first-come, first-served’ basis, an aggregate of up to USD 150,000/ INR 1.10 crores’ worth of legal advice FREE OF COST, to the following categories of entities/persons (“Service Recipients”) who seek our help:
  • Any and all Indian startups are welcome as Service Recipients. However, startups that are engaged in healthcare/health-tech businesses with a strong COVID-related focus would be given priority.
  • Legitimate not-for-profit organizations that are undertaking or plan to undertake high-impact work in any of the areas relating to COVID-relief – access to hospital beds, ventilators, oxygen etc., rehabilitation of COVID-ravaged families are good examples.
  • Special funds that are being set up to raise structured capital for research & development, for direct sourcing of vaccines etc. and other similar COVID-related initiatives.
  • Any other entities/persons as we may determine in our discretion.
  1. In order to ensure that the Lexygen COVID Pledge 2.0 has a broader impact, we will spread the USD 50,000/INR 36 lakhs per month worth of free legal advice across 20-25 Service Recipients per month. We may at our discretion, increase or reduce this allocation to maximize impact.
  1. The broad areas of law on which we would provide advice under this Pledge would be corporate laws, FDI laws, contracts, labour laws, startups-related issues, legal metrology issues, commercial disputes resolution strategy, and so on.
  1. Whoever wishes to avail of our services under this Pledge may do so by sending us an email to info@lexygen.law. We will do our best to respond to all such emails within 2-3 business days.
  1. To generally streamline enquiries and requests under this Pledge, we may make and implement necessary rules at our absolute discretion.
  1. We will keep confidential and not make any announcements of the names of any Service Recipients who avail of our services and advice under this Pledge, unless they specifically agree to allow us to do so.
  1. An integral part of our Pledge is that we will strive to deliver the same very high “Lexygen Quality” work to Service Recipients under this Pledge as we provide to our paying clients!
  1. Lastly, and very importantly, we are well aware of, and sensitive to, the added workload and stress that our undertaking of the Lexygen COVID Pledge 2.0 places on all Lexygenians in these already busy times. To help alleviate this, we will give all Lexygenians contributing their time and expertise pursuant to this Pledge full billing credit for their time as if they had spent all such time on a fully billable matter!

We urge all of you eligible Service Recipients out there who believe you need our help under this Pledge to write to us (info@lexygen.law). We keenly look forward to serving you and hopefully, helping you to emerge stronger from this situation! Thank you!

Lexygen COVID-19 India Recovery Pledge
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We at Lexygen have had our ears close to the ground with respect to the COVID-19 outbreak and its potential implications to our society and economy for a while now. We have recognized the grave threat it poses and have been committed to do our bit to mitigate its viral advance. On March 11, 2020, when the first couple of cases were reported in Bangalore, when there were not even any Government-imposed restrictions on crowded public places, we announced a MANDATORY “Work From Home” policy and placed a formal travel ban (international and domestic) on all Lexygenians till March 31, 2020 – being arguably, the first law firm in India to do so! We now continue with our third successive week of mandatory WFH.

While the above measures by us would certainly help in fighting the spread of COVID-19, we also recognize that this crisis is not merely about limiting the spread of a pandemic. Its adverse effects will likely run much deeper and longer than the eventual containment of the pandemic itself. We already see many instances of the adverse impact at work. Companies that, only a month ago, were clocking several millions of Rupees in revenue, suddenly face a ZERO revenue situation with no certainty as to how much longer this will continue. Migrant workers are fleeing urban centres in droves, fearful of lack of jobs. Companies that were in discussions for deals are suddenly finding the funding tap drying up on them. All these impacts are REAL and they are HERE already. We at Lexygen have had discussions about how we could contribute and add value, in our own small way, to help address this deep pain in the Indian ecosystem.

Accordingly, we are pleased and HONOURED to announce the “Lexygen COVID-19 India Recovery Pledge” (the “Pledge”), the details of which are below:

  • Effective April 1, 2020 till June 30, 2020, Lexygen will offer, on a ‘first-come, first-served’ basis, an aggregate of up to 100 hours of legal advisory time per month ABSOLUTELY FREE OF COST, to companies and entrepreneurs in India who are facing dire financial and business difficulty on account of the COVID-19 pandemic. We don’t necessarily want to limit this offer only to “startups”, but would rather, base it on trust wherein we would ask YOU to judge for yourselves whether you need this support. This offer will be available to just about everyone who genuinely needs this support (including our valued Lexygen clients), but on a ‘first-come, first-served’ basis. We estimate the monetary value of our free advice offered under this Pledge at INR 20-23 lakhs per month (USD 28,000 to USD 32,000 per month), translating to INR 60-70 lakhs (USD 85,000 to USD 100,000) for the 3 months period.
  • In order to ensure that our contributions have a broader impact and are not limited to a very few companies, we will spread the 100 hours across 20-30 companies/entrepreneurs per month.
  • The broad areas of law on which we would provide advice under this Pledge would be corporate laws, FDI laws, material contracts, labour laws, startups-related issues, legal metrology issues, commercial disputes resolution strategy, and so on.
  • We would be keeping confidential the names of the companies/entrepreneurs who avail of our advisory services under this Pledge, and would only share the details in a public forum if specifically authorized or allowed to do so by the parties in question.
  • Whoever wishes to avail of our services under this Pledge may do so by sending us an email to info@lexygen.law. We will do our best to respond to all such emails within 2 business days.
  • To generally streamline enquiries and requests under this Pledge, we may make and implement necessary rules at our absolute discretion. All decisions by us as to who we accept to provide advice to under this pledge, and who gets how many hours of free advice etc., shall be final. Further, we will be unable to entertain any requests under this Pledge to advise or act against any of our clients.
  • We will require every company/entrepreneur to enter into a legally binding Terms of Engagement with us. Just to be clear, these Terms of Engagement WILL NOT contain any term requiring the company/entrepreneur to engage us for any future assignments or to pay us any fees at a later date. If we choose to advise you under this Pledge, the time given to you under the Pledge for that month will be absolutely free of cost.
  • We take IMMENSE PRIDE in the quality of our work, and the same philosophy will apply to services provided by us under the Pledge. We will give you the same quality of work that we would extend to any full-paying client of ours. In fact, in order to most effectively enforce this quality assurance, we will give all Lexygenians contributing their time and expertise pursuant to this Pledge full billing credit for their time as if they had spent this time on a fully billable matter!

We urge all of you Indian companies/entrepreneurs out there who believe you need our help under this Pledge to write to us. We keenly look forward to serving you and hopefully, helping you to emerge stronger from this crisis!

The Reliance-Aramco Deal – What it Means for Who!
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I woke up this morning to see the news about the Aramco-RIL deal plastered on the headlines of The Economic Times. I am still processing the implications of this mega deal in my head, but here are some of my quick thoughts on what this deal means – for RIL, for Aramco, and for India.

For Reliance Industries Limited

First and foremost, it signals a massive shift in RIL’s general approach of undertaking its projects and growth initiatives on its own, funded either by debt or by capital markets. This deal, taken together with its recently announced JV with BP for petro-retailing and its recent investment from Brookfield for the towers business, means that RIL management is quite clearly recognizing a new paradigm wherein partnerships with global giants in various verticals will bring huge stockpiles of capital along with tremendous expertise to the table for RIL.

Secondly, such a strategy would also obviously greatly pare down the debt exposure of the group. This is also consistent with Mukesh Ambani’s statement yesterday that RIL would become a zero net debt company in 18 months. This is again, a very interesting shift because RIL has historically relied a lot on debt (its current debt stands at $22 billion, according to RIL management), and this new approach of openness to partnerships will help RIL pursue big growth without a mounting debt burden.

Thirdly, and most importantly, this deal also indicates that RIL management places most future value on its oil-to-chemicals division and is expected to focus most of its future growth plans in this division rather than on its fuels division. I say this the most important implication because this demonstrates RIL’s keen awareness of the global pulse that is rapidly veering towards electric vehicles replacing fossil-fuel-based vehicles.

Fourthly, this deal is also a strong signal that RIL will be moving away from its historical model of being an operating company to a holding company model akin to a Tata Sons, for example, which makes a lot of sense to me, as it can help RIL unlock a lot more value in its various businesses.

Lastly, this new strategy comes at a cost, obviously. Aramco will, reportedly, get one board seat at RIL, and “two board seats in the board of the oil-to-chemicals division of RIL” (whatever that means!). Naturally, Aramco isn’t paying $15 billion for a 20% stake to be an idle shareholder, so RIL will need to get used to having a powerful strategic partner – even though, Aramco won’t be a shareholder at RIL level, they will have a very influential voice on the board.

For Aramco

Aramco, for all its size and domination in the global markets (I’m told its profits exceed those of Apple, Shell and Exxon-Mobil combined!), has never had a meaningful presence in India. This deal gives it a HUGE inroad into India just at the right time when the nation is gearing up for its next big phase of growth. And in partnering with RIL, Aramco gets one of the very best local partners to navigate and learn about the Indian market.

For India

Firstly, this deal will give a major fillip to the Indian economy if and when it goes through. Not only will it bolster the FDI figures for the year (unlike the Flipkart deal of last year, where most of the money went to foreign shareholders, this one will see actually see $15 billion come into the Indian economy), but it will generally create a very positive and enthusiastic buzz around the Indian economy, which we can surely use right now.

Secondly, the massive planned retirement of debt as announced by RIL and funded in no small part by this deal, will help the banking sector in India as it will free up a lot of capital to be lent to other businesses. It would also de-risk the banks from having such a large exposure to one group.

Lastly, the very fact that RIL is shifting its big efforts and capital away from fuels and on to oil-to-chemicals demonstrates that they believe that the Indian market too will be undergoing the EV revolution. And that’s great news indeed for our country and for the environment.

Majulah Singapura! Majulah Lexygen! Celebrating a DECADE of Lexygen Singapore!!!
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Today is Singapore National day. The inspiring Republic of Singapore celebrates 54 years of providing economic, political and social thought leadership across Asia and the world. Over these decades, despite often being dismissed by the West as “just a little red dot” – a reference to its tiny geographic size – Singapore has consistently managed to punch way above its weight not just economically, but also politically and diplomatically.

Since its independence in 1965, under the able and visionary leadership of the awe-inspiring Lee Kuan Yew, Singapore made very rapid strides in building a nation that steadily and defiantly gained the respect of the world (often grudgingly) not just for its meteoric economic rise from swampland to skyscraper-land, but also for the statesmanship and thought-leadership demonstrated by its political leadership. A story I heard when I first visited Singapore, and which I like to tell often (though I couldn’t vouch for its veracity), is that when Lee Kuan Yew made his first official visit to Madras in the late 1960s, he was so impressed by the city that he reportedly told a gathering that he was addressing, “My dream is to soon turn Singapore into another Madras”! Well, clearly he and his colleagues did FAR MORE than achieve that dream!

There is much that is similar in the DNAs of Singapore and Lexygen – we are both “tiny organizations” relative to the size of our competitors, and yet, have unfazedly focused on growing our profiles through consistently delivering top quality, we are both strongly committed to being vibrant meritocracies, we are both willing embracers of technology and innovation, we both are deeply committed to research as a key enabler, and lastly, we are both committed to a fairness of approach and to walking the talk.

We at Lexygen have been great friends of Singapore, and Singapore has been a great friend of ours, for a long time. It was exactly 10 years ago that we at Lexygen set up our Singapore office! I still vividly remember how welcomed we felt and how easy and efficient the Government of Singapore made it for us to enter the market and to set up our formal presence. And of course, I cannot possibly express adequate gratitude for the unstinting support and trust that our Singaporean and SEA clients have continued to shower upon us over the past decade. Without the trust and love that we have received from Singapore and Singaporean clients, we simply couldn’t have lasted there, let alone thrive, for such a long period! I am also very proud to highlight that even through the bleakest recessionary market conditions, we continued our commitment to Singapore and retained our office there, though it certainly wasn’t an easy decision.

As Singapore celebrates its 54th birthday, so are we celebrating our completion of a great first DECADE in Singapore! Majulah Singapura! Majulah Lexygen!

Policy on FDI in E-commerce – Government shifts the goalposts
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The Department of Industrial Policy & Promotion has, through Press Note No. 2 of 2018 dated December 26, 2018 (“Press Note 2”), revised the policy relating to Foreign Direct Investment (“FDI”) in e-commerce, which could have significant ramifications to the sector. While the Press Note 2 as well as the subsequent response to the media comments issued by the government on January 3, 2019 (“Response Note”) termed the revisions as merely clarificatory in nature, some of these “clarifications” have, in effect, changed the rules of the game.

At the outset, there is no change to the limit of FDI in e-commerce pursuant to the Press Note 2, and 100% FDI under the automatic route (i.e. without any approvals from the government) continues to be permitted in the marketplace model of e-commerce (wherein the e-commerce entity merely provides the trading platform and facilitates transactions between buyers and sellers), while the inventory based model of e-commerce (wherein the e-commerce entity owns the goods sold in its platform) continues to be out of bounds for FDI. However, certain conditions for FDI in marketplace model have been now made more stringent which might result in a rethink of the business models of the entities engaged in the marketplace model of e-commerce which have received FDI (each a “Marketplace Entity”), as discussed below.

● Under the existing regulations, the main check to ensure distinction between the marketplace and inventory based model of e-commerce was the condition that a Marketplace Entity cannot exercise ownership over the goods purported to be sold in its platform. The Press Note 2 has made the above condition more stringent by providing that the Marketplace Entity shall not exercise “ownership or control” over such inventory. Further, a provision has been added (“Deeming Provision”) that the inventory of a seller would be deemed to be controlled by the Marketplace Entity if such seller purchases more than 25% of its goods from the Marketplace Entity or its group companies. In this regard, “group companies” means a group of 2 or more enterprises, wherein one or more such enterprises are, directly or indirectly, in a position to (a) exercise 26% or more of voting rights in such other enterprise(s); or (b) appoint more than 50% of the members of board of directors in such other enterprise(s).

Since a Marketplace Entity was permitted under the existing regulations to enter into transactions with sellers registered on its platform on a B2B basis, some of the Marketplace Entities used to have arrangements with the sellers on its platform whereby the goods to be listed on the Marketplace Entity’s platform would be first sold to the sellers (affiliated to the Marketplace Entity or otherwise) by the Marketplace Entity or its group companies, thus providing additional revenue stream for the Marketplace Entities. Pursuant to the insertion of the Deeming Provision, the magnitude of such arrangements will come down substantially, as a seller would have to arrange for majority of its procurement from elsewhere.

It is, however, not clear as to how the Marketplace Entity should ensure that the purchases of the sellers on its platform are sufficiently broad-based – whether a mere certification from the sellers to the Marketplace Entity suffice or would there be an obligation on the Marketplace Entity to verify the books of the sellers in this regard. The above could also have unintended negative consequences on the sellers on the e-commerce platform. For instance, a seller (even one dealing with the Marketplace Entity on an arm’s length basis) would now be forced to procure its goods from other sources even if the commerciality dictates otherwise.

Interestingly, due to unclear drafting, there is another possible reading of the Deeming Provision that if more than 25% of the sale of goods of any seller is generated through a Marketplace Entity’s platform, then such Marketplace entity would be deemed to control the inventory of the vendor, and a clarification from the government in this regard would be helpful.

● Under the existing regime, the Marketplace Entity was not permitted to generate more than 25% of the value of sales through its platform in a financial year from one seller or such seller’s group companies. This conditionality has now been removed (presumably because of the easy workaround of creating multiple affiliate sellers that the Marketplace Entities employed). In its place, a new condition has been added that a seller cannot sell goods

through a Marketplace Entity’s platform if such seller has equity participation or if its inventory is controlled by such Marketplace Entity or its group companies.

The above condition should result in the ceasing of the existing practice of group or downstream companies of Marketplace Entities (and thereby the Marketplace Entities indirectly) selling products through the marketplace platform. There are also question-marks on the future of private labels or white labels of the Marketplace Entity or its affiliates being sold on the platform of such Marketplace Entity. While the Response Note, with regards to the private labels, mentions that Press Note 2 does not impose any restriction on the nature of products which can be sold on the e-commerce marketplace, the position is far from being clear. The major Marketplace Entities have several popular private labels and it would be a shame if such products cannot be sold through their e-commerce platforms owing to the above restriction.

In addition, clarification is also welcome on whether the “equity participation” would include even indirect investment in a seller by a Marketplace Entity through an intermediate entity in which the Marketplace Entity holds less than 26% stake (so as not to render such entity as a group company).

● To ensure that the Marketplace Entities deal with the sellers on their platform in a fair and non-discriminatory manner, Press Note 2 provides that the services which could be provided by a Marketplace Entity to the sellers such as warehousing, logistics, payment collection, financing, among others, as well as the popular practice of offering cashbacks to customers should be provided on an arms-length basis and in a fair and non-discriminatory manner. It has been clarified that if the terms of services provided to a seller are not similar to those offered to other sellers under similar circumstances, then such practice will be deemed unfair and discriminatory.

However, there is no clarity on how the similarity of circumstances of two sellers should be determined. The vagueness of the current language offers scope for creative interpretation and the Marketplace Entities could continue to have differential treatment of sellers pointing out their “dissimilarity of circumstances”. For instance, two sellers could be differentiated based on their difference in sale volumes, nature of products sold, the conditions for the use of platform, among others.

● A Marketplace Entity has now been prohibited from mandating any exclusivity obligations on a seller, whereby the seller is forced to sell its items exclusively on such Marketplace Entity’s platform.

The determination of whether such exclusivity is “mandated” by the Marketplace Entity is, however, going to be tricky. In this regard, merely a written agreement for exclusive arrangement should not be regarded as the clinching evidence of such prohibited behavior since often a seller may want to engage a Marketplace Entity to exclusively sell its goods for certain commercial benefits in return.

● The Marketplace Entities are required to comply with the conditions under Press Note 2 from February 1, 2019. Most of the major Marketplace Entities in India would have to significantly overhaul their existing business models and complex structures to comply with the new conditions, and the above deadline offers them too short a time to implement such changes. Therefore, the deadline would certainly need to be extended.

To conclude, the success of a policy, especially one which has billions of invested capital riding on it, should be gauged by its stability, clarity, and transparency. One may note that vague and unclear drafting continues to afflict the FDI policy on e-commerce in India. Further, any major change to the existing policy without the necessary “grandfathering” provisions tends to make the current and future investors nervous about investing in India, much like the period post the Vodafone tax fiasco. By not objecting to the businesses of the Marketplace Entities thus far, in spite of there being noises around their legitimacy from various quarters, the government had accorded its passive stamp of approval to these business models, and the Marketplace Entities would rightly feel shortchanged with the revised conditions (and even more so after the sector receiving unprecedented foreign capital in the recent past).

The biggest beneficiaries of the new policy, other than (of course) the small retailers in India, would be large Indian business conglomerates and retail chains wanting to enter the e-commerce sector as they wouldn’t have to operate under the restrictive policy framework for e-commerce entities having FDI. In addition, the policy creates significant barriers for start-ups operating in the sector since it might be more difficult for them to attract foreign capital.

It is hoped that the above issues are addressed by the government in the FDI policy and the new National E-commerce Policy which is expected to be rolled out in the near future.

Short term measures, long term headache?
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The Finance Act of 2017 had amended Section 10(38) of the Income Tax Act, 1961 (“IT Act”) to the effect that long term capital gains (“LTCG“) from transfer of equity shares of companies listed on stock exchanges, would be exempt from tax only if securities transaction tax (“STT”) was paid at the time of acquisition of such shares (“Amendment”). Prior to this change, any LTCG arising from sale of equity shares was exempt from tax if STT was paid at the time of such sale. Thus pursuant to the Amendment, exemption from LTCG tax would be limited to cases where STT was paid in both legs of purchase and sale of equity shares.

The Amendment is part of a string of Governmental actions seeking to curb unaccounted income and black money. The memorandum to the Finance Bill mentioned that the exemption provided under Section 10(38) was being misused by certain persons for declaring their unaccounted income as LTCG by entering into sham transactions; and hence, the above step was brought in as a measure to prevent such practices. The memorandum had also added that the Government would notify certain exemptions to the provision so as to protect genuine cases where the STT could not have been paid at the time of acquisition of the shares being sold, such as acquisition of shares in an IPO or FPO, bonus or rights issue by a listed company, acquisition by non-residents in accordance with the FDI policy, etc.

The proposed change, however, caused considerable consternation amongst promoters and investors alike, as there was hardly any guidance on whether all genuine transactions, for instance acquisitions prior to the listing of a company, would be protected.

The Government recently put up a draft notification concerning the sale transactions that would be exempted from the rigors of the Amendment. The notification provides for a negative list of three instances wherein the tax exemption under Section 10(38) would not be applicable if no STT was paid at the time of acquisition of such shares being sold. In all other cases, the seller (subject to the payment of STT during sale) would not be burdened with LTCG tax even if no STT was paid when such seller acquired the shares being sold.

The three kinds of transactions notified by the Government are:

1. Acquisition by way of preferential issue of listed equity shares in a company whose equity shares are not frequently traded on a recognized stock exchange, except in cases where the regulations relating to preferential issue under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 are not applicable to such issue;

2. Purchase of listed equity shares in a company which is not entered through a recognized stock exchange; and

3. Acquisition of equity shares of a company during the period between the delisting of such company and its relisting on a recognized stock exchange.

The Government has taken the right approach by introducing a negative list of acquisitions which would not offer LTCG tax exemption to the purchaser when subsequently selling those shares. The primary fear amongst the stakeholders pursuant to the Amendment was whether the Government would be able to capture and exempt all instances of genuine share transfers, and the approach of having a limited negative list is a step in the right direction. It is now abundantly clear that any acquisition of shares of a company prior to its listing would not be affected by the Amendment.

However, the notified list of acquisitions has the potential to capture even certain genuine transactions within its ambit.

For instance, second and third items in the list could be read to include issuance of ESOPs to employees by a listed company within their scope. This seems to be an oversight on part of the Government as the Revenue Secretary soon after the proposal at the Union Budget for Amendment had clarified that ESOPs would not be adversely affected by it.

Another issue with the broad language of the second item is that it captures all off-market purchases of listed company shares. It is commonplace for strategic buyouts and private equity acquisitions in listed companies to be structured through negotiated off-market deals. It is not clear at this point if the Government intentionally took away the exemption for all off-market acquisitions. If this indeed is the case, it could adversely impact the appetite amongst private equity players and strategic investors in doing secondary transactions in listed companies.

Also, since it might be difficult for the Government to list down each and every exceptions to the negative list and thereby ensure that no genuine transaction is affected by the Amendment, it would be worthwhile if the seller is given a chance to showcase the genuineness of a transaction and claim the LTCG tax exemption even if the concerned sale falls within the negative list of transactions.

The Government has sought comments from the stakeholders on the draft notification, and it is hoped that the final notification would address the above issues.

The Infosys-Panaya Deal – What is the Big Deal?
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We lawyers love disclaimers, and I am going to start this piece by making a rather important one – I haven’t actually read the letters/emails reportedly written by two whistleblowers to the SEBI (they are not available anywhere in the public domain yet), and am only offering my views and reactions in this piece based on the supposed contents of those letters as reported by prominent newspapers and news websites.

Also, while the letters/emails reportedly written by the two whistleblowers to the SEBI (the “Whistleblower Letters” – yes, we lawyers love defined terms too!) raise several points, the one that I am going to deal with in this piece (as the title suggests) is the question of whether the Panaya acquisition was done by Infosys at terms so inconsistent with market practice that the said whistleblowers found it necessary to question the integrity of the entire Infosys Board by suggesting that the high severance payout to former CFO Rajiv Bansal was “hush money”, ostensibly to buy his buy-in for the Panaya deal.

According to the press reports, one of the key complaints raised for the SEBI’s consideration in the Whistleblower Letters is the question of why and how the Infosys Board could approve the acquisition of Panaya at such a high premium to what Panaya was actually worth. The main data point on which this complaint appears to be founded is that the deal valued Panaya at $ 200 million, or a 25% premium to Panaya’s Series E fundraise from Israel Growth Partners (“IGP”) which had concluded barely a month prior to the announcement of the Infosys-Panaya deal. I must say, I was truly astounded when I read that THIS was the crux of a whistleblower complaint to the SEBI accusing the Infosys Board of poor governance and potentially, of lack of integrity!

Firstly, a company’s valuation being raised by 25% from the last funding round even in a short period of 1 month is hardly eyebrow-raising in technology deals – not even amongst non-internet/non-consumer companies. There are numerous examples of deals being sewn up at valuations far higher than the 25% premium that Infosys paid for Panaya since the IGP round.

Silicon Valley based AppDynamics did its last fundraise at a valuation of $ 1.9 billion. In December, 2016, it announced that it had filed a Form S-1 with the SEC to conduct its IPO. At an estimated $ 2 billion valuation, it was billed to be the largest tech IPO in a long while, and as such, generated a lot of market interest. Well, as we know, that IPO was not to be, as in January, 2017, AppDynamics shocked the world by announcing that it had agreed to be acquired by Cisco for $ 3.7 billion! Put another way, Cisco paid AppDynamics shareholders almost TWICE the anticipated valuation that the IPO would have given AppDynamics! If I were to paraphrase that in terms of the reported complaints in the Whistleblower Letters, “Cisco paid a price that valued AppDynamics at an almost 100% premium to its last recorded value of barely a month ago”. I don’t see anyone complaining that Cisco overpaid or accusing its Board of poor governance or negligence? I could go on and cite several other examples, but that’d only make this a very lengthy post and unnecessarily so.

The other important point that the reported allegations in the Whistleblower Letters totally miss is that a strategic buyer who is seeking to acquire a controlling stake almost always has to pay a half-decent control premium. No company that has successfully raised a Series E fundraise just a month ago is even going to consider selling itself to anyone that doesn’t offer at least a 25% premium! The Cisco Board was ready to pay a 100% premium over the anticipated IPO valuation of the AppDynamics IPO because they saw the strategic fit and value in that acquisition. Why is it that the Infosys Board has to be judged so harshly over a 25% premium for a controlling stake in a company that it clearly saw synergies with?

One more issue that the Whistleblower Letters have reportedly raised is that there was certain public information available that suggested that “all was not well at Panaya”. The news reports go on to suggest that the Whistleblower Letters were alluding to the fact that Panaya had undertaken a restructuring exercise in 2013 and 2014. Clearly, the Whistleblower Letters are contradicting themselves on this count, as on the one hand, they are pointing to Panaya raising funding from IGP at a $ 150 million valuation barely a month prior to the Infosys deal, and on the other, suggesting that “all was not well at Panaya”. If all was so badly not well, how would Panaya have managed to raise a Series E round just a month prior?

Last, but not the least, I am wondering why the authors of the Whistleblower Letters would choose to write a complaint to the SEBI about the Panaya deal now, after the passage of almost 2 years since the deal! Why not at any time sooner?

Logical questions, these? I would love to have your views.

Budget 2017: Adequate Wind beneath the Wings of Start-ups?
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While there have been sops and benefits provided to start-ups by the Government since the formal launch of the Startup India initiative in 2016, there have been a bevy of demands and requests from the industry to increase and better streamline the benefits and assistance. It is during the recent Budget announced in February 2017 (“Budget”) by the Finance Minister, which seems to be in-line with the Government’s vision and policies regarding the investment ecosystem so far, that a few important and forward looking changes have been announced, which should definitely give boost and impetus to the start-up ecosystem in India. Following are the key changes proposed in the Budget in this regard.

Carry Forward of Loss

Another change has been made with respect to carry forward of losses. Under Section 79 of the Income Tax Act, 1961, a company is allowed to carry forward losses for a period of 7 years and set-off against profits of future years. However, there existed a restriction which did not allow the carry forward and set-off in case 51% shareholding of the said company did not remain intact in the year of loss and in the year of the set-off. Since start-ups operate in a rapidly changing environment requiring multiple rounds of funding resulting in constant changes to their shareholding patterns, this resulted in start-ups not being able to meet the criteria set in Section 79. Now the Budget has permitted recognised start-ups to carry forward and set-off of losses even if the majority shareholding has changed hands, provided the shareholding of the promoter(s) of the start-up continues to remain unchanged. Permitting carry forward despite the changes to the shareholding is a welcome move since we have seen an increase in investments and buy-outs in the start-up ecosystem during recent times which result in substantial changes to the shareholding pattern of such start-ups.

Minimum Alternative Tax

The industry was expecting the removal of the Minimum Alternative Tax (“MAT”), however the Budget has merely allowed companies to carry forward their MAT to 15 years from the present period of 10 years. MAT is the minimum amount of tax (based on the registered book profit) that a company has to pay irrespective of its size and turnover and is around 20%. It is important to note that book profit may be very different from the net profit of the company as it does not take into consideration certain deductions or exemptions, hence, it is entirely possible that even if a start-up is making book profit, it may actually be incurring net losses too. Having said that, though this is not what the start-up industry expected (the expectation was for an exemption from MAT) it does give start-ups an additional time of 5 years to claim the MAT credit.

Capital Gains on Conversion of Preference Shares

The Budget has also made a significant positive change by abolishing capital gains on the conversion of preference shares into equity shares, which should give a shot in the arm to investments in start-up (and in other companies as well). The Budget has exempted conversion of shares from preference to equity from being considered as a ‘transfer’ and hence liable to capital gains. This should come as a big relief to start-up investors who prefer making their investments using convertible preference share due to a variety of reasons and should increase investments in start-ups.

Reduced Corporate Tax

The Budget has made a big change by reducing the corporate income tax for Micro Small and Medium Enterprises) (which apparently covers over 96% of such companies in India) from FY 2017-18 onward to 25% from the current rate of 30% for all companies that had a turnover or gross receipts up to INR 500 million in FY 2015-16. This would directly result in reduced tax outgo for such companies, resulting in better margins and their becoming more attractive to investors.

To sum up, though the Budget did not exactly meet all the expectations of the start-up industry, it would not be entirely wrong to say that the Budget did bring some much needed relief to the start-up ecosystem like a cool shower during an Indian summer.

Betting on the jockey
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"Bet on the jockey, not the horse” goes the adage; it highlights a key aspect of early-stage investing – people (read: key employees of a company), and their ideas/execution capabilities are as important as ‘product’. It follows that preserving the value brought in by ‘people’ is vital for early stage companies and investors in such companies. Keeping this in mind, this article will discuss an important piece of documentation seen in early stage deals – the key employee agreement entered into between a company and its key employees (“KEA”) – its drawbacks, and solutions used to address these drawbacks.

The important terms of a KEA are the intellectual property (“IP”) assignment, confidentiality, and non-compete/non-solicit covenants. These terms attempt to provide investors with protection against a situation where key employees leave a portfolio company, taking valuable trade secrets and client relationships with them, thereby eroding value for the investor. This can be a big risk in certain sectors where ‘people’ play an outsized role in a company’s success, or where IP is a major differentiator for the company.

Consequently, (1) in the due diligence stage of a deal, there should be a thorough analysis of existing KEAs to analyze whether they are sufficiently robust – if none are in place, KEAs should be insisted upon as a condition precedent to the deal, and (2) KEAs should be very carefully drafted to ensure adequate protection for the investor.

Two threshold commercial issues when dealing with KEAs are:

1. Who exactly is a ‘key employee’? There is no hard-and-fast rule here; the key employees of a company will vary with both sector and stage; obviously, the founder would be a ‘key employee’. A picture of who the key employees of a company actually are should emerge from the due diligence based on the investor’s understanding of the team and business model of the company.

2. Some key employees (especially the founders) may be hesitant to enter into restrictive employment agreements: founders will make the argument that they have put their equity into the venture, and are thus sufficiently aligned, and therefore should not be required to sign aggressive and restrictive KEAs; other key employees may not have an equity interest in the company and therefore will not feel aligned enough to make a big commitment to the company through such KEAs – more on this later.

Coming to the legal issues:

1. While IP assignment and confidentiality may be well-drafted and tight on paper, investors and companies would be well-advised to think through the practicalities of how to ensure that there is no leakage of data and trade secrets. Given that IP assignment and confidentiality clauses on paper are definitely not a ‘cure’ for leakage, it is best to rely on ‘prevention’ by ensuring adequate cyber security, conducting frequent checks, and putting in place a controlled work environments etc. However, neither the KEA nor other preventive measures are fool proof.

2. The real elephant in the room is the non-compete clause: while a non-compete that extends beyond the term of a KEA is standard in India, the enforceability of such a term is in doubt due to judicial precedents. In short, if key employee ‘A’ leaves Company B and immediately joins a competitor, there is not much that Company B can do about it, even if A has entered into a KEA with Company B wherein she agrees that that she will not compete with B for 1 year after leaving Company B. While one can effectively make non-solicit and confidentiality clauses do the job of a non-compete clause, courts may not look favourably upon this tactic, and hence, drafting a KEA requires a delicate balancing act in this regard.

Having regard to the above, investors should be concerned that KEAs do not turn out to be mere paper protections. A possible solution is to ensure that there is true interest alignment between companies and their key employees, so that psychologically and commercially, the key employees understand that they are better off staying than leaving, thereby eliminating the need to rely heavily on KEAs for protection.

There are different approaches to accomplishing this, depending on whether the KEA in question is the founder or not; to a large extent, these have already been adopted by the market, and are described below:

1. Investors typically insist on portfolio companies creating an ESOP at the time of investment – an ESOP is the best tool for creating interest alignment between non-founder key employees and a company. A good (and generous) ESOP will give key employees a clear roadmap to a point in the future when they will share ownership of the fruits of their labour, and will thus incentivize key employees to stay and share upsides with the founders.

2. When it comes to founders, the best approach may be a combination of a KEA and a ‘vesting’ clause in the deal documentation. Since founders already own equity, vesting essentially ‘suspends’ their ownership of their shares for a period of time in order to (i) incentivize founders to stay with the company until their equity ‘vests’ back with them, and (ii) ensure that a founder will not ‘walk away’ with her shareholding intact even if she is fired from the company for a violation of the KEA i.e., when a founder is a ‘bad leaver’, her shares are ‘clawed back’.

Both ESOPs and vesting clauses have their own set of issues that require careful consideration. For instance, vesting clauses are not exactly ‘market’ in India, and may result in pushback from founders. ESOPs must be structured carefully to (1) ensure that investors are not diluted, & employees adequately incentivized, and (2) allow liquidity events for all involved to proceed smoothly. As always, investors should seek advice from deal counsel who are conversant with these matters to ensure that their bets on jockey and horse come good.

Celebrating an Amazing Decade of The Lexygen Experience!
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Dear Clients, Lexygenians, Friends, Well-wishers and Critics of Lexygen,

I’m very happy and proud to have the privilege of writing this post on behalf of everyone at Lexygen, for today marks a big day in the fascinating journey of our firm!

This dream called Lexygen was born this very day ten years ago, after countless days and nights of ideation, critical review, introspection and sustained conviction – aided and abetted by copious measures of coffee and alcohol, and the invaluable inputs of accomplished friends from the legal profession and from other industries. The dream was to build a law firm that would be committed to “being a breath of fresh air” in the way legal services are provided.

Our model is based on placing the client first and consistently providing top-class, international-standard and commercially-oriented counsel to our clients. The model was born out of a strong need that I perceived in the market for a consistently responsive and constantly accessible service with a clinical obsession to excellence and commercial usefulness of work product. It was based on my strong belief that clients seek commercially sensible legal ADVICE, and not a three-pages-long disclaimer, for their money!

“Without prejudice to” our unstinting focus on client-satisfaction, the other key pillar that the Lexygen model stands on is our amazing pool of people – we have always striven to recruit people with the best potential and to groom them to become highly respected lawyers, while providing them with a great work environment and rewarding career. What’s more, we also place a HUGE premium on making sure that we are a very fun bunch of people who enjoy working and having fun together!

Over the past several days leading up to today, I have not only been repeatedly led down delicious memory lane about the decade past, but have also found myself constantly evaluating how we have fared in achieving the abovementioned goals. What have we achieved really over the past decade, and is that consistent with what our dream was?

We have acquired a reputable and highly loyal clientele that we are proud of. We have had the honour of perhaps, being the only “young” law firm in India to have advised on numerous complex and marquee deals. Our clients have consistently given us extremely high ratings (often, on their own accord, without our even seeking feedback) as to the innovation inherent in our advice, as also about our high level responsiveness and great work ethic. Our clients have always expressed vocally their high regard for our advice and for the ethical standards that we have unwaveringly stood for. Several of our clients have, over the years, come to see us not just as their external advisors but as their trusted partners in growth. We have acquired a strong reputation in the market as a “firm that consistently punches way above its weight”! On the people front, we have been fortunate to build an amazing team of passionate and driven people who have grown with the firm and who will undoubtedly take Lexygen to greater heights. We should take fierce pride in all of these achievements that we have managed in just a decade.

However, despite all the above, Lexygen is still a work-in-progress. We have miles to go yet before Lexygen truly lives out its immense potential, before it comes to epitomise every ambitious goal and value that we have set for ourselves, before Lexygen fully comes into its own as a pioneering law firm with a very strong sphere of global influence in the professional services industry. And now, my friends, is the upcoming decade for making all that happen, we Lexygenians truly believe that! When I write a similar post to mark Lexygen’s 20th anniversary, I hope to be able to say with much pride that we are on the home stretch to achieving these goals.

We could not have gotten here in such a short span of time without the energetic support and hard work from each and every Lexygenian, past and present, including our marvelous support staff, and I take this moment to salute their commitment and passion. It is indeed they who have made all this happen, of course, with the invaluable support and patronage of our loyal clients. On this wonderful occasion marking our tenth anniversary, I want to say a VERY BIG thank you to all the Lexygenians and to all our clients and friends.

Here’s to an incredibly successful decade ahead to Lexygen! I thank you all in advance for all the support that I will need from you in leading this wonderful organization to lofty heights from here on and to serve you even better over the coming years!

Takeover Code & Exemptions for Debt Restructuring
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Recently, there has been a spike in the number of ‘bad loans’ in the Indian banking system, in response to which the banking regulator put in place a debt restructuring framework called the Strategic Debt Restructuring (“SDR”) scheme enabling lenders to take control of defaulting corporate borrowers. Two other schemes for debt restructuring are also available to lenders – the Corporate Debt Restructuring (“CDR”) scheme, and the Joint Lenders’ Forum (“JLF”) scheme. These debt restructuring schemes have seen a degree of success.

During a debt restructuring, lenders may take haircuts, but they may also convert loans given to a borrower-company into equity. Converting loans to equity has certain advantages: it gives the company a longer runway to improve its performance without having to make principal and interest repayments, and may also give the lender a chance to unlock the value of the company in a stake sale.

However, taking an equity position in the company results in the lenders’ fortunes being very tightly bound to the fate of the company, and therefore, lenders must ensure that the company performs well. In such situations, even if the lenders gain control over the company, they may not wish to take on the burden of running a large company on a day-to-day basis, and are not always comfortable with showing the company’s management the door. This is driven by practical considerations: stability in top management roles after a lender-led takeover may be desirable from both an optical as well as an operational perspective (though in some cases, lenders may take control for the sole purpose of replacing the extant management).

A loan conversion may therefore result in a situation where the lenders have formed a de facto JV with the management/promoter, with each holding large equity stakes. In these cases, lenders would usually require the extant promoter to show more ‘skin in the game’ i.e., take up more equity in the company to show their commitment to a turnaround, before restructuring the debt. The event of the promoter taking up more equity may, however, become an issue in listed companies due to the rules issued by the Securities and Exchange Board of India (“SEBI”) governing substantial acquisitions of shares and takeovers (“Takeover Code”).

As per the Takeover Code, an acquirer of a listed company’s shares is required to make an ‘open offer’ i.e., offer to buy a minimum of 26% of the company’s shares from public shareholders, so as to offer them an exit, in these situations: (i) when the acquisition of shares/voting rights puts the acquirer in ‘control’ of the company, and (ii) if the acquirer already holds a 25% stake in the company (as a promoter usually would), and subsequently acquires an additional 5% stake in a financial year.

Making an ‘open offer’ is a costly affair (and in the case of a promoter-made open offers in a restructuring context, may shift the dynamics of ‘control’ of the company in a manner undesirable to lenders) – consequently, it could be a roadblock for restructuring packages if

lenders/promoters were required to make open offers in respect of shareholding increases that occur during implementation of restructuring packages, such as (i) loan conversion, or (ii) infusions by the promoter.

Therefore, the Takeover Code exempts lenders who acquire ‘control’ of a company when loans are converted into equity pursuant to restructurings under the SDR scheme from making an open offer. Further, the Takeover Code also exempts persons already in control (this would apply to promoters) who acquire shares pursuant to restructuring under the CDR scheme from making an open offer. Lastly, the Takeover Code also gives acquirers the option of approaching SEBI to obtain a case-specific exemption from making an open offer. However, there are no other exemptions from making an open offer in the context of a debt restructuring.

A recent SEBI order (“re Diamond Power”) now gives comfort that lenders/promoters will be exempted from having to make an open offer when there is an open offer-triggering increase in shareholding pursuant to a JLF restructuring. In re Diamond Power, a company underwent debt restructuring under the JLF scheme (debt restructuring under the JLF scheme was chosen over restructuring under the CDR scheme, since the JLF scheme was perceived to be a speedier method to restructure the debt). As per the terms of the restructuring package, the promoters were required to infuse debt into the company which would later be converted into equity. Upon such conversion, the promoters would trip the Takeover Code’s threshold for making an open offer, and thus, the promoters sought an exemption from having to make an open offer – as mentioned above, the Takeover Code contains no specific exemptions from making an open offer for acquisitions pursuant to a JLF restructuring, like it does for acquisitions pursuant to restructuring under the CDR scheme.

The whole-time member of SEBI reasoned that since (i) the JLF scheme was similar to the CDR scheme, (ii) the promoters were already in control of the company, and (iii) the promoters would be acquiring shares at a price greater than the market price of the scrip and thus would not be gaining an unfair advantage, the promoters could be exempted from making an open offer.

Re Diamond Power was followed by a favourable informal guidance given by SEBI exempting promoters from making an open offer during restructuring under the CDR scheme. Re Diamond Power also stands in contrast to another recent SEBI order where promoters were denied an exemption from making an open offer when asked to infuse funds via warrants by lenders. In that case, the proposed conversion price of the warrants was lower than the price the scrip was trading at, and the proposed infusion was not made under a JLF restructuring – the former seems to have led the whole time member of SEBI to conclude that an exemption from making an open offer would not serve the interest of public shareholders.

The takeaway from the above is that in line with the regulatory trend of making life easier for lenders, SEBI may look favourably upon requests for exemption from making an open offer in a debt restructuring context, while carefully scrutinizing the restructuring package on parameters like pricing and mode of restructuring to ensure that public shareholders are protected and promoters do not gain an unfair advantage. These points must be kept in mind when putting in place a restructuring package that might require a green light from SEBI.

Markets on the Internet and Foreign Investment
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The recent Press Note issued by the Department of Industrial Policy and Promotion on March 29, 2016 (“Press Note”) has contributed immensely to the hullabaloo surrounding the hot topic of foreign direct investment (“FDI”) in the e-commerce sector. There seems to be a great amount confusion on whether to applaud and give the Government a thumbs up for the changes effected by the Press Note or whether to ‘slow-clap’ and watch the Government continue to dole out piecemeal clarifications while silently waiting for the ‘big ticket changes’. This blog aims to add to that confusion clear the confusion after summarizing the changes brought about by the Press Note.

In an earlier post on this topic, Codhai had highlighted the need for clarity on a number of issues in the law pertaining to FDI in the e-commerce sector, beginning with the definition of the term ‘e-commerce’. The Press Note explicitly provides that the buying and selling of goods and services, including digital products, over networks of computers, television channels, and any other internet application used in an automated manner such as web pages, extranets, and mobiles would constitute ‘e-commerce’.

The Press Note goes on to clarify that an e-commerce activity wherein the inventory of goods and services is owned by the e-commerce entity and is sold to consumers directly would be termed as an inventory based e-commerce and that FDI is not permitted in such a model. While this prohibition is not a new revelation, the Government has made it amply clear that the B2C e-commerce sector is out of bounds for foreign investors except in very specific situations such as (i) online sale of goods manufactured in India, (ii) online sale by a single brand retail trading entity with a ‘brick and mortar’ presence in India, and (iii) online sale of single brand products owned by an Indian manufacturer.

The Government’s bold move to acknowledge the existence of a marketplace business model and explicitly state that 100% FDI is permitted in e-commerce entities that run on such a model was long awaited and well appreciated. As per the Press Note, the activity of providing an information technology platform on a digital and electronic network which acts as a facilitator between buyers and sellers would qualify as a marketplace e-commerce activity. This definition provides much needed clarity and legitimizes the business model of larger player in the market like Snapdeal that have repeatedly claimed that they are acting within the letter of the law while accepting foreign funding.

Since there are no free lunches and all offers come with ‘T&Cs’ attached, the Government has not lost the opportunity to include a number of riders to the above welcome change. An e-commerce entity with a marketplace model has been permitted to provide support services to sellers on its platform in respect of warehousing, logistics, order fulfillment, running call centres, payment collection and enter into transactions with such sellers on a B2B basis. However at the

same time, all post sales services, warranty or guarantee services, delivery of purchased goods, and customer satisfaction has been stated to be responsibility of the seller (and not the platform). It has also been specified that such entities will not be permitted to exercise ownership over the inventory which is purported to be sold and any ownership over the inventory will render the business to be an inventory model, thus any FDI in such an entity would be a violation of the law. A number of e-commerce players in the market such as Myntra, Jabong, Zivame, and BigBasket have a significant inventory-led business and this prohibition could prove to be a hindrance in the way they conduct their business.

Further, it has been clarified that a market place entity shall be prohibited from affecting sales from one vendor or its group companies beyond 25% of the total sales affected through its platform. Thus, companies like Flipkart and Amazon which earn a major part of their revenue from W.S. Retail and Cloudtail, respectively, may have to rework their structures and downsize the dominance of individual sellers on their platforms. Marketplace players will also have to display the names and details of the sellers prominently alongside products, which a lot of companies including Myntra and Jabong don’t strictly comply with currently.

Another blow to the marketplace model comes with the Press Note’s prohibition of platform owners from directly or indirectly influencing the sale price of goods or services on their platform. While all the major e-commerce players have offered heavy discounts and more often than not even indulged in predatory pricing, these strategies may have to be curbed with the introduction of this specific condition.

While the Government has definitely earned a +10 for clarifying the definition of key terms pertaining to the e-commerce sector and finally conceding to the existence of a marketplace business model, the ‘n’ number of qualifications and riders to the 100% FDI permission does not paint a completely pretty picture of this sector. Though we may not be able to expect game changing liberalizations such as FDI in an inventory based model in the near future, for the time being the industry shall have to be content that the Government is indeed slowly, but definitely, addressing stakeholders’ concerns and the investor community shall be watching the events unfold with bated breath.

Fund Managers: Welcome to India
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The last few years have seen the introduction of several pro-funds industry measures on the tax side in India. One notable measure was the insertion of a ‘safe harbour’ provision into the Income Tax Act, 1961 (“ITA”) to protect offshore funds (hereinafter, “funds”) from the adverse tax consequences of having an onshore fund manager (“Safe Harbour Rules”). Recently introduced rules now attempt to make the Safe Harbour Rules more effective, and provide the mechanics for their working (“New Safe Harbour Rules”). This blog post will offer a brief overview of the Safe Harbour Rules and the New Safe Harbour Rules.

Safe Harbour Rules: The Background

The presence of an onshore fund manager would expose a fund to two risks under the ITA:

(i) the fund might be perceived to be managed from India by the onshore fund manager; and

(ii) the fund’s income would be regarded as India-sourced since the onshore fund manager will be the fund’s ‘business connection’ in India (under the ITA, a non-resident’s income arising from ‘business connection’ in India is deemed to be India-sourced).

Due to these risks, the fund management industry migrated out of India. For example, a fund set up in the Cayman Islands and investing in emerging markets in South East Asia would usually choose not to have its advisory team located in India so as to avoid having its income dragged into the Indian tax net.

Safe Harbour Rules: The Issues

In an effort to make India an attractive destination for the fund management industry, the Safe Harbour Rules were introduced in 2015. The Safe Harbour Rules exempted ‘eligible’ funds from key provisions of the ITA by providing that: (i) an eligible fund managed by an eligible fund manager would not be regarded as being managed from India; and (ii) an eligible onshore fund manager would not be a ‘business connection’ of an eligible fund.

However, the Safe Harbour Rules came with numerous strings attached – to be a eligible fund, such fund: must be broad based i.e., have more than 25 limited partners (“LPs”); must not have LPs with interests in the fund exceeding certain limits (e.g., Indian LPs cannot hold more than 5% of the fund’s corpus); must be resident in a country that has a Double Taxation Avoidance Agreement (“DTAA”) or tax information exchange agreement with India; must not (directly or indirectly) control Indian companies; and must have a monthly average corpus of INR 1 billion. In addition, to access the Safe Harbour Rules’ exemptions, an eligible fund manager cannot be connected to, or be an employee of, the concerned fund; must be remunerated by such fund at arm’s length, and cannot receive more than 20% of such fund’s profits.

These conditions were hard to comply with, given the variety of structures that are employed by funds (by way of an example, in a situation where the fund in question is merely a Singapore or Mauritius based intermediate holding entity of a pooling vehicle based elsewhere, such fund would not be able to satisfy the ‘broad based’ criterion since it would have just one, or at best, a few investors). More generally, the above conditions would affect/compromise key commercial and economic considerations of the fund (by way of another example, the condition specifying that no LP should hold an interest greater than 10% in a fund would disqualify funds that may have a large anchor investor).

As a result, the Safe Harbour Rules were viewed as impractical, and met with a negative response from the funds industry.

The New Safe Harbour Rules

The New Safe Harbour Rules clarify that the criteria regarding the number of LPs in an eligible fund, the extent of their interests, and the connection between the LPs can be satisfied by ‘looking through’ the LP entities. This clarification will prove useful when evaluating master-feeder structures, or LPs that are fund-of-funds, under the Safe Harbour Rules.

The New Safe Harbour Rules also relax the timelines for complying with certain criteria for eligible fund status. For example, if a fund, at a certain stage of the fund raising process, has raised commitments only from Indian LPs, or has not yet obtained applicable registrations in its home state, these would not immediately operate to deprive such fund of ‘eligible fund’ status under the Safe Harbour Rules.

Regarding the condition that an eligible fund must not control any Indian company, the New Safe Harbour Rules provide an objective test (the trigger being: holding more than 26% of the investee’s share capital or voting power) for determining control – but provide no guidance on whether holding affirmative rights would constitute ‘control’ of an Indian company.

Significantly, the New Safe Harbour Rules clarify the manner of computing the ‘arm’s length price’ (the minimum price at which an eligible fund must remunerate its eligible fund manager), and relax the ‘arm’s length price’ condition substantially if a fund complies with all other conditions prescribed by the Safe Harbour Rules. However, there is no relaxation of the Safe Harbour Rules’ condition that no more than 20% of an eligible fund’s profits can flow to the onshore fund manager (and connected entities) – this restriction might cause issues when putting in place the fee structure of a fund.

The New Safe Harbour Rules also provide for an advance ruling procedure: a fund can approach the Central Board of Direct Taxes (“CBDT”) for an ‘approval’ regarding its status as an eligible fund under the Safe Harbour Rules. This is a very welcome development given that the approval seems to be a time-bound process that should give certainty to a fund regarding the potential tax outcomes of its structure.


The Finance Bill, 2016 has proposed that funds based in certain notified countries having no DTAA with India will be able to benefit from the Safe Harbour Rules. With these developments, and going by the old adage that actions speak lounder than words, it appears that the Government’s invitation to the fund management industry is heartfelt and sincere.

However, certain roadblocks still remain. The Safe Harbour Rules’ conditions regarding the extent of LPs’ interests in an eligible fund still need to be navigated through, as does the condition that an onshore fund manager cannot be an employee of, or be connected to, an eligible fund. The Safe Harbour Rules’ condition that an eligible fund cannot hold a controlling stake in an Indian company has not been diluted, thereby denying buyout funds the ‘eligible fund’ status. The condition that an eligible fund must have a monthly average corpus of INR 1 billion has also not been rationalized.

Specifically with regard to India-focused funds, the New Safe Harbour Rules do not really address the concern that an onshore fund manager may be a ‘permanent establishment’ of the fund in India under a DTAA, which is a significant issue for India-focused funds.

Going forward, it remains to be seen whether funds/fund managers are willing to sacrifice a degree of flexibility in exchange for tax certainty by complying with the Safe Harbour Rules – in the event they are, close attention must be paid to the fine print of the New Safe Harbour Rules during the fund formation process (as well as on an ongoing basis), particularly, the timelines for satisfaction of the Safe Harbour Rules, the composition of LP entities ‘one level up’, and the possibility of obtaining a CBDT approval to ensure ‘eligible fund’ status and the corresponding beneficial tax treatment.

Business Income or Capital Gains? Question Resolved!
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The Central Board for Direct Taxes (“CBDT”) has, vide Letter F. No.225/12/2016/ITA.II dated May 2, 2015 (“Letter”), issued a clarification regarding the characterization of income arising from the transfer of unlisted shares. The clarification has been issued to resolve the oft litigated matter of characterization of income from the sale of shares (i.e., whether such income is business income or capital gains) and in furtherance of the CBDT Circular No. 6/2016 dated February 29, 2016 (“Circular”). The Circular characterized income arising from the transfer of listed shares & securities that are held for more than 12 months as capital gains, unless the taxpayer itself treats such shares as its ‘stock-in-trade’.

There has been a prolonged debate over whether income from the transfer of shares should be treated as profits and gains from business or profession (“Business Income”) or capital gains. Before delving into the reason for such dispute, it is necessary to understand the difference between Business Income and capital gains and the tax treatment of incomes falling under each of these heads.

As per the provisions of the Income-tax Act, 1961, a capital asset is any property held by a person that is not associated with its business or profession and does not include stock-in-trade. When shares are held by a taxpayer as stock-in-trade, income from the transfer of such shares are characterized as Business Income, and the taxpayer has the option to set-off such income with any expenses or losses incurred from its business or profession. When shares are held by a taxpayer as capital assets, income from their transfer is taxed under the head ‘capital gains’. Capital gains refers to the profits earned from the transfer of capital assets, which can be classified into two categories – long term capital gains (“LTCG”) i.e., profits or gains earned from the transfer of capital assets held for a period of more than 36 months, and short term capital gains (“STCG”) i.e., profits from the transfer of assets held for less than 36 months (the holding period for determining whether capital gains is LTCG or STCG has recently been reduced to 24 months). LTCG with respect to unlisted shares is taxed at the rate of 10%, and LTCG with respect to listed shares is exempt from tax.

The absence of proper guidance on the subject led to litigation as taxpayers often experienced difficulty in proving the intention for which the shares or securities were acquired. The characterization of a transfer was a subjective question and decided on a case-to-case basis. Earlier, LTCG was exempted from tax and STCG was taxed at a much lower rate than Business Income. This wide disparity between the tax rates for capital gains and Business Income gave rise to several disputes. In order to reduce their tax burden by treating the income arising from transfer as capital gains, taxpayers resorted to litigation. Also, the uncertainty of being charged a higher tax rate if the income was characterized as Business Income increased the risk factor for investors affecting their decisions for such investments. Clearly there was a need to streamline the provisions and assign a definite category under which income arising from transfer of shares should fall under for the purposes of tax treatment.

In 2007, after the Authority of Advanced Rulings’ observations in the case of Fidelity Northstar Fund and Ors., In re, which laid down parameters for identifying whether the income arising from the transfer of shares was in the nature of capital gains or Business Income, the CBDT issued a circular laying down principles for determining the same. The circular provided certain criteria for characterizing income such as the treatment given to the shares by the taxpayer in its books of accounts, quantum of purchase and sale, intention of the taxpayer when acquiring the shares, holding period and the method of valuation etc. Although, this provided guidance not only to the assessing officers (“AOs”), but to the taxpayer as well, the criteria were essentially subjective, due to which numerous taxpayers contested the matter in courts.

In February 2016, the CBDT issued the Circular, setting out the circumstances under which income arising from the transfer of shares or securities was to be characterized as capital gains, and further stating that the tax authorities were not to challenge such characterization. The Circular provided the taxpayer with a choice to treat the listed shares either as stock-in-trade or capital assets. If the taxpayer opts to treat the shares as stock-in-trade, the income arising from such transfer would be treated as Business Income, and if the taxpayer chose to treat its shares as capital assets, income arising from their transfer would be characterized as capital gains. But once such choice is made, the taxpayer cannot adopt a contrary stand in subsequent years.

Since the Circular did not mention any guidelines for the treatment of income from the transfer of unlisted shares, a lack of clarity remained, and the CBDT issued the Letter in continuation of the Circular, clarifying that income arising from the transfer of unlisted shares would be treated as capital gains, irrespective of the period for which the shares were held. However, AOs have the authority to take an appropriate view regarding the characterization of the transfer (i) where the genuineness of transactions in unlisted shares is questionable, (ii) where a question pertaining to lifting the corporate veil arises and (iii) where there is a transfer of control and management of the underlying business along with the shares.

This is a welcome clarification, in line with the CBDT’s aim to provide uniformity in the characterization, and certainty in the assessment, of income from transfer of shares and securities. It will be highly beneficial for taxpayers to pay tax at a lower rate when their income from transfer of unlisted shares is characterized as capital gains rather than Business Income. In addition, the Letter provides the much needed certainty to private equity and venture capital funds who primarily invest in shares of unlisted companies. Though, on the whole the Letter might substantially reduce litigation, there are some grey areas leaving room for controversy.

The Letter states that it is a clarification for determining the tax-treatment of income arising from transfer of ‘unlisted shares’. The specific mention of ‘unlisted shares’ indicates that it extends only to shares and not other securities such as debentures. Also, the exceptions provided do leave some scope for further litigation. Genuineness of a transaction is a highly fact-specific question leaving grey areas for unnecessary litigation. There could also be substantial disputes regarding characterization of the transaction where the transfer of shares also involves a transfer of control and management of the underlying business.

Generally, with the transfer of a majority of the shares and securities of a company, the transfer of decision making power, control and authority over the management i.e., the transfer of control and management of the business also take place. Such transfer of the control and management of the business is itself a transfer of capital asset. To classify the same as a transfer under business income would be unfair, hence leaving room for confusion and difference in interpretation, which may again lead to litigation.