Saturday, September 26, 2020

Stake sale by Reliance Jio and Capital Gains

Between April 22 and July 15 this year, Reliance industries Ltd raised more than INR 1.5 Lakh crores through a stake sale of about 33% in its subsidiary Jio platforms to 13 marquee foreign investors. Neither RIL nor Jio platforms may be paying any tax on the stake sales due to the structure adopted for the deal.

 

The equity of Jio platforms as on March 2020 was equity share capital of INR 4961 crores plus other equity of INR 1,77,064 crores (Optionally convertible preference shares (OCPS) issued to RIL). Converting the OCPS and selling them to investors would have made RIL liable to pay capital gains tax as it would have sold equity shares converted from OCPS at a premium. The gains on such transfer would have attracted short-term capital gains, which would have been taxed at a rate in excess of 30%. This would have jeopardized its plan of becoming net debt free.

 

The potential tax pain seems to have been sidestepped by a simple method a fresh issue of shares by Jio platforms to the various investors. To Facebook and Google, Jio platforms issued fresh equity shares at INR 488.34 per share. All other investors were issued equity shares at a higher price – INR 549.31 a share. With this total share proceeds of INR 1.5 Lakh crores, Jio platforms redeemed OCBS worth INR 129046 crores held by RIL and retained INR 23272 crores with itself.

 

This fresh issue of shares by Jio Platforms helped RIL as it got repaid a chunk of its OCPS, thus reducing its own net-debt position significantly. Since redemption of OCPS held by RIL is essentially repayment of funds earlier infused by RIL into Jio Platforms, it will not attract any tax. Since RIL did not transfer any shares, it is not liable to any capital gains Tax. Jio Platforms, too, would not have to pay tax though it issued shares at a tidy premium —because the pricing of the shares took into account their fair value based on the report of an independent valuer. Even if the shares’ sale price was higher than the fair value, the tax law provides concessions if the buyer is a non-resident investor.  As such, when shares are issued by the company to non-residents investors, there is no tax liability for the issuing company on this account.

 

But when fresh shares were issued to new investors, how did the shareholding of the earlier investors not get diluted? This is where a specific provision in Jio Platform’s altered Articles of Association (AOA) comes in: “No dilution of any shareholder shall occur as a result of any permitted share transaction (after taking into account the redemption and/or conversion of any OCPS in connection with such permitted share transaction).” In the amended AOA, permitted share transactions comprise fresh issue of shares to new investors and issue of shares by conversion of OCPS held by RIL. Jio Platforms used the incremental equity-financing route.

 

Jio/RIL may have avoided paying Income Tax due to a loophole in the Income Tax act. Anyone can see that premium has been charged for sale of shares. It looks like appropriate artifices of law have been used to deny Taxes. The original equity shareholders purchased the shares at probably INR 10 per share. Google and Facebook have been sold shares @ INR 483, clearly at a price that is 48.3 times what the first shareholders paid. De facto, this is capital gains. De jure, it is being said that there is no capital gains in this transaction. Is the country going to let go the spirit of the law for the minutiae of the law? Will we put aside truth and move on? A recent arbitration judgement in The Hague reminds us of the Vodafone retrospective Act that was passed after the Supreme Court held that purchase of Hutchinson shares by Vodafone did not attract capital gains Tax. Are we going to plug the loophole and collect the Tax?

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