INTRODUCTION
On January 15, 2024, the AI Chip Startup “Blaize” went public through a Special Purpose Acquisition Company (“SPAC”) merger and was valued at 1.2 billion dollars. This event has once again triggered debate over the application of SPAC in India despite being seen as an alternative to initial public offerings (“IPO”).
SPAC, as an alternative investment instrument, is an entity with no business operations which seeks to raise capital through an IPO. Subsequently, it uses the raised capital to merge with or acquire an unlisted company to enable its listing of shares for a specific period of time. The IPO of SPACs are funded by sponsors who are limited liability companies encompassing adept founders while the process of acquisition of target company is completed. Sponsors usually hold a stake in the SPAC in the form of public shares, public warrants, or private placement warrants. While the former two have public interest in a company via IPO, private placement warrants are “debt funds” which can be converted to equity. It is often referred to as a blank cheque company because it does not come into effect with a target company in mind. Once the target company is specified, accompanied by the consent of the SPAC’s shareholders, both the companies are merged. This is known as a De-SPAC transaction. In case the transaction is not completed within a time period of 18-24 months, the investors get a refund of the money.
SPACs can be traced back to the concept of blind pools, an investment fund where the investor invests capital without knowing the type of business activity where his funds will be deployed. However, they had a tarnished reputation on Wall Street in the late 20th century because of their connection to penny stock fraud investors who usually exaggerated statements to increase the stock price. While IPOs have restricted flexibility in determining the terms of the agreement, SPACs are more adjustable in deciding the terms with the shares having no lock-in periods. This blog aims to discuss the tax related challenges in SPACs transactions and subsequently answers the question whether this is the best course for getting listed in foreign stock exchange or not.
UNDERSTANDING THE DICHOTOMY OF CAPITAL GAINS TAX AND CROSS-BORDER JURISDICTION ISSUES
This section discusses some essential problems which surround the De-SPAC transactions.
Regulatory uncertainties and capital gains tax
Shares of companies, whether Indian or foreign, deriving value from Indian assets are considered under the head of capital assets located in India. Any gain arising from the transfer of an Indian capital asset, including non-residents is subject to taxation. The current regulatory framework in India, particularly the Income Tax Act, 1961 (“IT Act”), does not address the issue of taxes on SPAC explicitly creating a space for uncertainty with regard to potential capital gains tax liabilities. De-SPAC transactions are usually concluded through a reverse merger between the Indian target company and the SPAC entity. This is noteworthy because it makes the merger a Cross Border Outbound Merger which occurs when an Indian company merges with a company from another country resulting in the formation of a foreign company. Additionally, they are not tax neutral meaning that no capital gains tax is incurred unlike the typical mergers and acquisitions. Section 45 of the IT Act clearly states that any profit obtained from the transfer of capital assets are to be charged as income tax under the head of capital gains. However, Section 47 of the IT Act deals with those transfer of capital assets which are exempted from the purview of Section 45. Particularly, Clause (vi) of Section 47 discusses amalgamations wherein a “transfer by amalgamating company to amalgamated company” will not be charged with tax if the amalgamated company is an Indian company. Since the amalgamated company in a de-SPAC transaction will always be a foreign company, it will not be exempted from taxes under this Section. Additionally, if an asset is transferred for a price lower than its stamp duty value, Section 50C will come into effect. This necessitates the transfer of capital assets at a fair market value. However, in most cases, the fair value is higher than the original cost of acquisition, leading to a capital gains tax liability. Since Section 47(vi) does not apply in de-SPAC transactions, the Indian target company must bear the tax burden on capital gains arising from the transfer.
Revenue Attribution and POEM Considerations
Once the merger between the Indian company and SPAC is completed, the former is treated as the foreign branch of the merged company and as the Permanent Establishment (“PE”) for tax purposes. PE has been defined under Section 92F (iiia) of the IT Act as “a fixed place of business through which the business of the enterprise is wholly or partly carried on.” A foreign company’s PE is charged with tax at a rate of 40% on its net income against the normal rate of 30%. It is important to ensure that in case the business model changes in such a way that SPAC starts generating revenue in its home jurisdiction, that revenue should not be attributed to the activities of PE in India. This would mean that any repatriation of income from PE outside India is not taxed further. The only scenario in which the SPAC would be regarded as a tax resident of India so that less tax rate is attributed to it is when the Place of Effective Management (“POEM”) is found to be in India. The same is contingent upon the key management personnel being in India for a financial year or the major decisions being taken by the directors or officers of the SPAC when located in India.
Tax Rate Disparity and Practicality of the Merger
As per Section 115BAA of the IT Act, a domestic company is usually taxed at a rate of 22% if the conditions mentioned under the same are satisfied. This brings us to the big question: If Indian companies are otherwise subject to lower tax rates, is this merger required in practicality despite the additional taxation burden? What needs to be assessed is whether this additional tax rate is an even-handed trade-off for being listed on the foreign stock exchange even when other alternatives may be available. Is the de-SPAC merger beneficial despite the higher tax burden? If Indian companies are otherwise subject to lower tax rates domestically, does listing on a foreign stock exchange justify the additional tax costs? This assessment becomes important because alternative capital-raising methods might allow Indian businesses to expand internationally without incurring such heavy tax implications as discussed below.
Additional challenges related to tax arbitrage
Moreover, a company listed in foreign stock exchange has to face a few additional issues, the first being the exposure of employees to tax when a De-SPAC transaction involves a share swap with them or grants stock exchange options to them, as per Section 112A of the Act. In a typical De-SPAC transaction, employees of the Indian company may exchange their shares for shares in the newly merged foreign company (the SPAC). Since these new shares are not listed on an Indian stock exchange, they may not qualify for Section 112A benefits, leading to higher capital gains tax liability for employees. The second problem pertains to the complexity of determining the fair market value on tax imposed on the consideration paid or received owing to a diverse array of methodologies and valuation criteria delineated in the legislation. This is applicable under Section 50CA of the Act and Rule 11UA of the Income Tax Rules, 1962. Further, A SPAC transaction allows a taxpayer to choose favourable tax rules across multiple jurisdictions which align with their business needs instead of the Department of Revenue’s preferred approach. In case of conflict, the discrepancy in price can be seen as income and subsequently taxed upon under Section 66 read with Section 56 (2) of the Act. Lastly, if the target company becomes a subsidiary under such a transaction , any profit earned will also attract withholding taxes by the remitter.
ALTERNATIVES TO THE TRADITIONAL IPO AND SPACs SYSTEM
The Companies Act, 2013, under Section 2(44) read with Section 41, deals with Global Depository Receipts (“GDR”), a negotiable instrument used to access the global financial market. It is a certificate issued by a depository bank by purchasing shares of a foreign company and subsequently depositing it in the account. GDRs offer various advantages to investors which include convenient diversification of portfolios globally without facing challenges often present while buying foreign currency directly in the overseas market, for instance, currency conversion. Further, as per Section 115ACA, income tax payable on the gains arising from the transfer of GDRs shall be an aggregate of amount of income tax levied on income from dividends at a rate of 10%, income tax levied on long term capital gains at the rate of 10% and the amount of income tax that the resident employee would have been liable to pay if their total income had been reduced by the specified income amount. It is thus evident that GDRs offer a more straightforward and clearly defined tax regime as compared to SPACs. The latter, no doubt, is subject to similar tax rates in terms of capital gains but after the completion of mergers, the complexities increase as outlined earlier.
Moreover, a recent amendment to the Companies Act has enabled certain Indian public companies to list their securities on approved foreign stock exchanges without bearing any additional burden of tax. This will also lead to a diversified investor base, foreign exchange inflows and economic growth. By enabling direct listing abroad, the amendment enhances financial flexibility, strengthens corporate governance, and aligns India’s regulatory framework with global market practices. However, companies opting for cross-border listings must navigate foreign regulatory compliance, and investor protection norms, making strategic planning crucial for a successful overseas listing. Additionally, the FEMA non-debt rules 2019 were revised to permit the direct listing of equity shares of Indian public companies on international exchanges within the GIFT-IFSC which offers tax incentives including exemption of tax on capital gains from the transfer of equity shares of Indian companies. This will allow Indian companies listed in GIFT-IFSC to transform the Indian capital market landscape. It provides Indian businesses, particularly start-ups and those in emerging and technology-driven sectors, with an alternative route to access global capital beyond domestic exchanges. This move is anticipated to enhance the valuation of Indian companies in alignment with global benchmarks, attract greater foreign investment, unlock new growth opportunities, and expand the investor base.
CONCLUSION
The rise of SPACs as an alternative route for companies to go public has led to considerable debate, particularly regarding their taxation complexities and regulatory uncertainties. While SPAC mergers offer flexibility and quicker access to global capital, they also impose significant tax burdens on Indian companies, particularly in terms of capital gains tax, PE taxation. Hence, promoting SPACs requires equal attention to safeguard retail investors together with sponsors and all other stakeholders participating in SPACs. The market demands an improved and restructured corporate governance framework to properly govern SPACs while making them more functional within India. The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 and the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 must be re-evaluated to optimize SPAC listings within India. With better alternatives present to facilitate access to the global market, SPAC might not be the best choice for alternative investment funding in India. Ultimately, the decision as to what route to take rests upon the company seeking to list on the foreign stock exchange and it is clear that a thorough examination of multiple factors is essential before making a decision.
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