India has recently seen a growing preference among investors to invest in “platform deals.” When investors want to play big and have a long-term strategy, they create platforms to invest in sizeable assets in the same sector, rather than investing in individual assets. Platforms are often created as a co-investment vehicle for pooling funds from like-minded investors and can have varied strategies such as growth, IRR and yield that governs their investment decisions.
Such deals are common in infrastructure sector, specifically power, roads, telecommunication and real estate. Power platform set up by Tata Power, ICICI Ventures, along with CDPQ and Kuwait Investment Authority and the renewable energy platform of IDFC renewable energy platform are some recent examples in India.
Platform deals involve a high level of complexity for investors in terms of managing such deals. From setting up of a holding structure and determining an acquisition strategy based on the objective of the platform, expanding business and strategizing exits, each phase in the lifecycle of a platform is exposed to various tax challenges. In each of these phases, it is critical for investors to understand the interplay of tax and regulatory regimes, as it could have a significant role in the decision-making matrix.
At the outset, one of the most important questions to be analyzed is the jurisdiction of the platform. The choice of jurisdiction often hinges on factors such as maturity of the financial sector, access to regional capital markets, cost involved for maintenance of the holding company and ability to attract talent. From a tax perspective, factors such as existence of a sound tax treaty network, tax implications on remittances, and availability of beneficial tax regime for pooling vehicles/ fund managers are crucial for decision making. Historically, Singapore and Mauritius have been the preferred jurisdictions for setting up platforms for making investments in India, primarily on account of the favourable tax treaty that these countries had with India. While the tax treaties have been recently renegotiated and the capital gain exemption in the treaties has been withdrawn, the domestic tax laws of these countries offer a favourable tax regime. For example, Singapore offers a tax exemption to registered funds managed by a Singapore-based fund manager, subject to certain prescribed conditions. In Mauritius, the effective corporate tax rate is reduced to 3% after factoring the foreign tax credit. Further, since India, Singapore and Mauritius among other countries have recently signed the Multilateral Instrument for implementation of BEPS recommendations in their tax treaties, this may also have a bearing on the decision of investors.
Platforms also often set up an India holding company. This not only offers the flexibility to consolidate value at the India level, but also helps strengthen the balance sheet in India that facilitates debt funding for future projects. This structure has its limitations in the form of additional tax leakages in India due to a layered corporate entity structure. Additionally, such India holding companies often constitute an NBFC/ CIC and hence add to the compliance requirements of the group in India.
Once the platform is established, the investors decide whether to invest in greenfield or brownfield asset classes. In case of primary deals, the key issue that needs to be addressed is the form of funding the acquisition. Although the decision is primarily driven by the commercial drivers of the deal, the tax and regulatory consequences that may arise would vary on the basis of the choice of instrument adopted.
For instance, return on redeemable and convertible debt is treated as interest and taxed at a lower rate, as compared to returns on dividends that trigger a 21.36% tax on distribution. Unlike dividends, subject to the quasi thin capitalization norms introduced in India, interest on debt payouts are largely deductible for the Indian corporates. Further, the ability to repatriate principal is linked to whether the debt is convertible or redeemable.
Additionally, the regulatory regime has been significantly relaxed with respect to foreign borrowings by Indian corporates, and there are various windows under which an Indian corporate can borrow debt from overseas group companies. To encourage the inflow of foreign debt in the country, beneficial tax rates of 5.41% have been provided for interest payouts on non-convertible debentures (NCDs) and foreign currency borrowings. This window is particularly attractive to the investors since it offers a wider flexibility on deployment of funds.
The choice of funding instrument is also restricted by the debt equity mix that may be imposed by the lenders. Where the flexibility to debt fund the project does not exist, the complexity arises with respect to repatriation of surplus cash from the projects. Although there are options available for repayment of capital under the Indian corporate laws, such methods are time consuming and expensive to implement. The issue becomes paramount in asset classes such as solar power that start throwing up operating cash flows once the plant is commissioned.
One important aspect that is driving investment structures is the flexibility to migrate to an Infrastructure investment trust (InvIT), once the platform has reached a scale. One of the main advantages that an InvIT offers is its tax transparent status and the exemption from dividend taxes on distributions by project companies. The only tax applicable is a 5.41% tax on distribution of interest to non-residents and 10% withholding tax in case of distribution to residents. While only a couple of InvITs have been listed in India till date, it is still too early to comment on how this market will evolve in the future.
Therefore, investors need to be cautious at every step while closing a platform deal, considering numerous tax and regulatory challenges associated with decisions to be taken in each phase of the platform lifecycle. With the Indian framework becoming more liberalized for foreign investments and tax incentives in the infrastructure sector, it appears that investors, with big chunks of money to invest, would continue to get attracted towards such deals.
(Views expressed are personal to the author. Article includes inputs from Richa Singla – Associate Director – M&A Tax, PwC India and Khyati Aggarwal – Assistant Manager – M&A Tax, PwC India)