12 January 2015 EY Regulatory Alert Central Government notifies the Depository Receipts Scheme 2014 for facilitating issue of Depository Receipts outside India Executive summary Regulatory Alerts cover significant regulatory news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Regulatory alert summarizes the key provisions of the Depository Receipts Scheme, 2014 ( 2014 Scheme ) which was notified by the Central Government with effect from December 15, 2014. With the notification of the 2014 Scheme, the erstwhile provisions dealing with depository receipts in the Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993 ( 1993 Scheme ) stand repealed except to the extent they are relating to foreign currency convertible bonds. With the intention to liberalise the manner of accessing the global capital markets by Indian companies, the 2014 Scheme has made significant revisions in the provisions dealing with issuance of depository receipts. Key changes include permission to issue unsponsored depository receipts, issuance of depository receipts against all types of securities (and not only equity shares), expanding the definition of Issuer, Custodian, Depository, etc. The 2014 Scheme is based on the recommendations of the Sahoo Committee, which under the chairmanship of Mr. M.S. Sahoo undertook a comprehensive review of the 1993 Scheme and proposed significant revisions.
Background The issuance of depository receipt is one of the mechanisms used by Indian companies to get an access to foreign investors. In simple terms, a depository receipt is a foreign currency denominated instrument which is issued by an overseas depository to non-residents against securities of the Indian company. Hitherto, instruments issued by Indian companies to tap global capital markets, viz. American depository receipts (ADRs) or global depository receipts (GDRs) or convertible debt instruments in the form of foreign currency convertible bonds (FCCBs) were governed by the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipts Mechanism) Scheme, 1993, which had been amended from time to time. The Government has revised the legal regime for issuance of depository receipts in order to simplify the process of fund raising and ease administrative procedures. Accordingly, by virtue of a notification issued by the Ministry of Finance ( MOF ) on October 21, 2014, the issuance of depository receipts has been taken out of the 1993 Scheme and is now regulated by the Depository Receipts Scheme, 2014. The 1993 Scheme stands repealed to the extent that it applies to Depository Receipts ( DRs ). It will, however, continue to apply to FCCBs. Salient features of the 2014 Scheme Approval of Ministry of Finance Unlike the 1993 Scheme, a company need not obtain approval of MoF before issuing depository receipts. However, if an approval is required under FEMA / FDI policy for transfer or issue of securities to a non-resident, then such approval would still be required. Expansion of the definition of Domestic Custodian and Foreign Depository Under the 2014 Scheme, a regulated entity having the legal capacity to issue depository receipts in the permissible jurisdiction can act as a foreign depository. As per the 1993 Scheme, only a bank authorized by the issuer of underlying securities could issue depository receipts. Similarly, as per the 2014 Scheme, a domestic custodian has been defined to include a custodian of securities, an Indian depository, a depository participant, or a bank and having permission from SEBI to provide services as custodian. Under the 1993 Scheme, only a banking institution could be a domestic custodian of depository receipts. Permissible Securities - Under the 2014 scheme, the companies will be allowed to issue DRs in all kinds of permissible securities including shares, debentures, bonds, derivatives, units of a mutual fund, collective investment schemes, government securities and right or interest in securities. In the 1993 Scheme, companies could issue DRs only against equity shares of Indian companies. Expansion of the definition of Issuer - Under the 2014 Scheme, any Indian company, whether listed or unlisted, public or private, can access the international capital markets using depository receipts. Further, a person who holds permissible securities can also issue depository receipts. Such issuances can either be through a public offering of depository receipts or through a preferential allotment or any other manner as may be prevalent in the permissible jurisdiction which currently consists of 34 countries including US, UK, Netherlands, Singapore, Luxembourg etc. Technically there was a mechanism which was brought in October 2013 for unlisted Indian companies to raise capital, directly overseas without necessarily listing on Indian exchanges. However, the same did not really find favour in the Indian market. Also, there was no provision in the 1993 Scheme for any person (other than the issuing company) who holds securities of an underlying company to issue DRs. Under the 2014 Scheme, the holders of eligible securities can also transfer such securities to a foreign depository for the purpose of issue of depository receipts (with or without the approval of the issuer of such securities) through transactions on a recognised stock exchange, bilateral transactions or by tendering through a public platform.
Issuance of unsponsored DRs - The 1993 Scheme allowed companies to issue only sponsored DR. As per the 2014 Scheme, DRs can either be sponsored by the issuer company or even unsponsored (e.g. when an existing shareholder offloads its holding through the issue of depository receipts). Unsponsored DRs mean DRs issued without specific approval of the issuer of the underlying securities. Unsponsored DRs can be issued on the back of listed eligible securities only if such DRs give the holder the right to issue voting instruction and are listed on international stock exchange. Pricing - The 2014 Scheme does not prescribe any specific pricing norms for issuance of DRs. The only restriction imposed under the 2014 Scheme is that Permissible Securities shall not be issued to a foreign depository at a price less than the price applicable to a corresponding mode of issue of such securities to domestic investors under applicable laws. However, a preferential allotment or a qualified institutional placement made by a listed company shall be required to comply with the pricing guidelines as per the ICDR regulations. Taxation- The 1993 Scheme specifically laid down the manner of taxation of the DRs. The 2014 Scheme is silent on the manner of taxation. Under the Income tax Act, transfer of DRs between nonresidents is exempt from tax. However, the definition of Global Depository Receipts includes DRs issued on the back of ordinary shares or FCCBs and not against other permissible securities. Accordingly, Income tax Act would have to be amended to incorporate the revised definition of DRs. Further, at present, there is no specific exemption from capital gains tax contained in the IT Act for conversion of a DRs. The Sahoo Committee had recommended conversion of DRs into Permissible Securities and vice versa should not be considered as taxable events in India since the underlying securities should be treated as the same asset. However, the same does not form part of the notification. Clarity would also be needed as regards the cost of acquisition and holding period for computing the capital gains tax. Income tax provisions need to be provide clarity in order to make DRs a more effective mechanism of raising funds abroad. End use restrictions - Partial end use restrictions were specifically imposed on utilization of funds raised from issuance of DRs in the 1993 Scheme, these funds being prohibited from being deployed or invested in real estate and stock market. The 2014 Scheme does not provide for any end-use restrictions on the deployment of proceeds from issuance of DRs. Although, there are no restrictions on deployment of proceeds from issue of DRs, restrictions as applicable under FEMA shall still be applicable. Public shareholding and voting rights - As per the 2014 Scheme, the voting rights should be exercised by the foreign depository in respect of underlying securities; the depository may take instructions from DR holders. If the DR holders have the right to instruct the depository to vote on their behalf, they would have the same obligations as if it is the holder of the underlying equity shares under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 ( Takeover Code ). Also, shares of a company underlying the DRs shall form part of public shareholding (i) if the holder of the securities has the right to issue voting instructions and (ii) such DRs are listed on an international stock exchange. The 2014 Scheme has attempted to bring this provision in line with the Takeover Code which includes all depository receipts carrying an entitlement to exercise voting rights in the target company within the definition of shares for the purpose of the Takeover Code. Therefore, this would enable the DRs with voting rights to count for public shareholding as well as have obligations under the Takeover Code. Miscellaneous - In the 1993 Scheme, the issue of ordinary shares against the GDRs were treated as Foreign Direct Investment and the aggregate of the foreign investment through Global Depository Receipt mechanism was subject to a limit of 51% of the issued and subscribed capital of the issuing company (investment made through Offshore Funds or by FIIs were excluded from the limit of 51%). This
condition has been liberalised in the 2014 Scheme. As per the 2014 Scheme, the aggregate of eligible permissible securities which may be issued or transferred to foreign depositories for issue of depository receipts, along with permissible securities already held by persons resident outside India, shall not exceed the limit on foreign holding of such permissible securities under FEMA. Comments The 2014 Scheme effectively modernizes the process for overseas issuance of instruments by Indian companies. It is facilitative in nature, but at the same time contains some restrictions to guard against potential abuse of the mechanism. The provisions of the scheme are yet to be implemented by RBI, SEBI and MCA. Further, the much needed tax clarity is still missing from the scheme.
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