Nishith Desai : Issue 10

LEGAL UPDATE: INDIA
Issue 10 ... April - June 1996

Published by:
Nishith Desai International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.
E-mail: desai.nishith@gems.vsnl.net.in

The contents of the "Legal Update: India" should not be construed as legal opinion or professional advice. Since the sources are varied, at times it is difficult to verify the correctness of the information mentioned herein.

Content

New Government releases minimum common programme
AAR Rules Against NatWest:India-Mauritius Treaty
Venture Capitalists Likely To Get Price Exits More Profitably
SEBI Tightens Entry Norms For Companies Going Public
Foreign Entertainment Cos. Brought To Tax
Green Bench Starts Functioning
India Signs Tax Treaty With Philippines
Depreciation Stayed For Leasing Companies
Directors May Be Held Criminally Liable

Dear Readers,
Due to the recently concluded elections and the changing political scene in India, we delayed the publishing of this issue of the Legal Update: India.
We sincerely regret any inconvenience this may have caused you and we do hope you bear with us.
Thank you,

Nishith M. Desai

New Government Releases Minimum Common Programme

In a dramatic bid to further its social justice agenda, the United Front government released on June 5, 1996, its Minimum Common Programme (MCP).

The coalition government promises to reserve one-third of all government jobs for women. It has also pledged to reserve one-third of all parliamentary and assembly seats for women. The government says that the Constitution will be amended, if necessary, to fix the quota for women in government jobs.

Other highlights of the MCP are as follows:

Foreign investment in infrastructure is to be raised from 3.5% of the Gross Domestic Product (GDP) to 6% of the GDP during the next few years. Transparent rules are to be worked out to attract investment in this sector. Further, foreign investment is to be discouraged in consumer goods sector and welcomed in core and infrastructure sectors. However, the existing investments will not be disturbed. Small scale industries are also to be protected.

Increase in agricultural investments. The rural credit system to be restructured to double flow of credit to agriculture and agro-industries.

The insurance sector is to be opened for private and foreign investment.

The scope and functions of the Foreign Investment Promotion Board (FIPB) are to be reviewed and transparent rules are to be drawn up.

The fiscal deficit as percentage of GDP is to be brought down to below 4%. Tax reforms are to continue and tax evasion is to be curbed.

Government borrowing is not to be used for consumption expenditure and growth in domestic debt is to be slowed down.

Public Sector Enterprises (PSEs) are to be run on commercial lines and PSEs having comparative advantages are to be encouraged to become global giants.

States to be given greater autonomy in determining the priorities in their developmental programmes. The MCP also promises to update and implement the Prasad Bharati Act (media law) and says "no" to counter-guarantees fot projects. It also hints at the review of the telecom policy.

AAR Rules Against NatWest : India-Mauritius Treaty

The Authority for Advance Rulings (AAR) has recently held that the investment made by NatWest Bank (London) through its Mauritius-based subsidiaries in the equity capital of HDFC Bank, India was mainly for the purpose of avoiding tax in India.

Accordingly, it has rejected the application made by Natwest Markets (Mauritius) Number 1 Ltd. and Natwest Markets (Mauritius) Number 2 Ltd. (the two Mauritius based subsidiaries of NatWest Bank (London)) to claim the benefits of the agreement for avoidance of double taxation between India and Mauritius (treaty).

Under the treaty, a resident of Mauritius investing in shares of an Indian company can claim complete exemption from capital gains tax subject to certain conditions.

The AAR observed that the since the two investing companies are wholly owned subsidiaries of the Natwest Bank, UK, the beneficial ownership of these companies lies outside of Mauritius. Therefore, the AAR opined that the beneficial ownership of the dividends earned by these Mauritius resident companies lies with its shareholder in UK, thereby denying the concessional tax treatemt for dividends under the India-Mauritius tax treaty.

Interestingly, the AAR confirmed the tax exemption for capital gains earned by these companies in India.

According to an official in the finance ministry, the ruling does not set a precedent and is applicable only to this particular case. Thus, the benefits of the India-Mauritius tax treaty, as such, do not stand jeopardised. However, structuring a transaction through Mauritius would entail a greater degree of care.

Venture Capitalists Likely To Get Price Exits More Profitably

The Reserve Bank of India (RBI) is currently formulating a more realistic exit pricing mechanism for Foreign Venture Capitalists (FVCs) and other overseas investors investing in unlisted Indian companies through the Foreign Direct Investment (FDI) route.

According to the new formula, these investors will be allowed to fix their 'exit' prices close to market trends. FVCs may also be allowed to seek professional valuers' service to arrive at an appropriate 'exit' price.

The existing RBI guidelines stipulate that an overseas investor exiting from an investment through an offer for sale (bought-out deal) route, has to price the offer according to the erstwhile Controller of Capital Issues (CCI) guidelines. As per the CCI guidelines, the average of, the Net Asset Value (NAV) per share and the Profit Earning Capacity Value (PECV) at 15% capitalisation rate, is determined and this constitutes the final price of the share.

Although, FVCs have an option of exiting through the conventional public issue mechanism, but for the CCI formula pricing requirement, the bought-out deal route is the preferred avenue for making an exit.

RBI is also examining the possibility of fixing a benchmark value for a sale transaction and deals falling within the benchmark would not need any special clearance. At present, FVCs can obtain a single window clearance from the RBI only for investments in high-priority industries. If the foreign investor owns a controlling stake in a company and has located a buyer for his stake, the RBI may allow the investor to offload his block of shares at a premium of 25% over the appropriate exit price derived under the formula.

SEBI Tightens Entry Norms For Companies Going Public

The Securities and Exchange Board of India (SEBI) has announced tighter entry norms for companies going public. Companies tapping the primary market will have to have a dividend-paying track record for at least 3 of the 5 preceding years.

This new restriction will not apply to manufacturing companies, whose projects have been appraised by a public financial institution or a scheduled commercial bank and if such an institution also participates in the project finance and the equity of the issuer.

The SEBI is retaining the threshold limit of Rs. 50 million, as the post-issue paid up capital for companies accessing the capital market.

Foreign Entertainment Cos. Brought To Tax

The Central Board of Direct Taxes (CBDT) has vide its circular No. 742 dated May 2, 1996, regularised the tax rates payable by foreign telecasting companies.

The CBDT has observed that there is no uniform method of taxing foreign telecasting companies, especially, when they do not maintain country wise accounts of their revenue.

They have also observed that, generally, from the gross amount of the bills raised by the foreign telecasting company, advertising agents and the Indian agents, each retained 15% as their commission and the remaining 70% of the money was remitted to the foreign telecasting company. Indian agents of the foreign telecasting company, however, had to withhold tax on payments made by them to the foreign telecasting company.

Now, as a result of the circular, foreign telecasting companies which do not have a branch office or a Permanent Establishment in India, and function primarily through agents will be presumed to be earning income at the rate of 10% of their gross receipts, excluding the amount retained by the advertising agent and the Indian agent of the non-resident telecasting company as their commission, in India. They will be taxed at the rate of 55% on the same.

The Indian agents of these foreign telecasting companies would be liable to withhold tax at the aforementioned rates and foreign telecasting companies would not have to keep country wise accounts of their operations. These guidelines will be applicable up to March 31, 1998.

Setting Up Depositories

The Securities and Exchange Board of India (SEBI) has decided to restrict Indian corporates (other than public financial institutions and banks) from setting up depositories.

It has decided that only banks, foreign banks operating in India, public financial institutions, stock exchanges, institutions promoted by them in which they hold at least 75% equity, institutions outside India approved by the Central government, and foreign corporates providing custodial services will be allowed to sponsor a depository.

Depository companies will be required to have a capital of Rs. 1 billion. The regulations are expected to be notified shortly.

"Green" Bench Starts Functioning

The first green bench in the judicial history of India started functioning at the Calcutta High Court on June 3, 1996.

The bench deals exclusively with environmental and pollution control issues and was formed in compliance with the directives of the Supreme Court.

The directive came in the wake of a writ petition filed last year by the Howrah Ganatantrik Nagarik Samiti against the Howrah Municipal Corporation for allegedly destroying the towns greemery for commercial purposes.

State Govt. Finalises Port Privatisation Policy

The Maharashtra state government has finalised its policy for attracting private participation in the development of ports on a build-operate-own-transfer (BOOT) basis. In order to endorse its support and to signal stability, the state government is also expected to participate in the equity of these ports up to a limit of 11%.

Competitive bids for the development of 7 all-weather multi-user ports may soon be invited.

The ports will have to be developed by Special Purpose Vehicles (SPVs) floated by the private sector. The ports and all relevant government property will be leased to the SPVs for a period of 30 years, extendible by another 20 years.

The state government will however, insist on being represented on the board of directors of the SPVs with at least 2 nominees.

India Signs Tax Treaty With Philippines

On March 25, 1996 India signed a double taxation avoidance treaty with the Philippines. The treaty is applicable from March 21, 1994.

The salient features of the treaty are:

The withholding tax rate on dividends will be 15% in case the dividend is paid to a shareholder beneficially owning more than 10% of the shares in the company paying the dividend. In all other cases the withholding rate will be 20%.

In case of payment of interest, the withholding rate of tax will be 10% if it is paid to a financial institution. If interest is paid by a Philippine company to an Indian resident in respect of public issue of bonds, debentures or similar obligations the Philippine company would have to withhold tax at the rate of 10%.

In all other cases when interest is paid by a resident of one country to the resident of the other country, tax is to be withheld at the rate of 15%.

In case of payment of royalty, tax is to be withheld at the rate of 15%

Besides the above, the treaty has all the normal features of a double taxation avoidance treaty.

Depreciation Stayed For Leasing Companies

The Central Board of Direct Taxes (CBDT), which recently disallowed depreciation benefits to companies giving assets on financial lease, has assured lessors that they would be allowed to continue claiming the same.

Earlier, in its study paper, the CBDT proposed that in case of a financial lease which transfers all the risks and returns of ownership to the lessee, depreciation will be available only to the lessee.

The CBDT wanted to crackdown on those engaged in the leasing industry as they were, according to the CBDT, taking undue advantage of the liberal provisions in the Income Tax Act, 1961 regarding allowance of depreciation on leased assets.

The CDBT has now however, decided that lease agreements having a 'buy-back' clause, which permits the lessee to purchase the asset at the end of the lease period, would be treated as a hire-purchase transactions and the lessor would not be allowed depreciation on the leased asset.

CBDT is also likely to allow 100% depreciation only on new assets. Such a move on the part of the CBDT is a direct outcome of the move on the part of various State Electricity Boards (SEBs) to enter into sale-and-lease back transactions.

In case of a sale-and-lease back transaction a cash starved company would sell its assets to a cash rich company which in turn would lease the asset to the old company and claim depreciation on the leased asset.

CBDT is also planning to allow leasing companies depreciation on assets at the rate of 25% as against the current rate of 100%.

Directors May Be Held Criminally Liable

The provisions of the Indian Penal Code, 1860 (IPC), are now likely to be extended to cover directors as well as corporate entities.

The Law Commission has inserted two sections, namely, Section 94A and Section 94B, to deal with the concept of constructive liability, for which a bill is likely to be placed before the Parliament.

If the bill is passed, both the board of directors and the concerned company can be held responsible for offences committed by an employee in the day-to-day conduct of business of the company.

Offer To Public, Not Trade: MRTPC

The Monopolies and Restrictive Trade Practices Commission (MRTPC) has observed that no trade or trade practice is involved when a company merely offers an issue for subscription to the public for the purpose of raising capital for its trade or business.

The MRTPC passed the judgement on a compensation application by an applicant against the Videocon International Ltd. for denying him rights shares. The applicant had applied for 150 rights shares of the company which had announced an issue of 12,500,000 equity shares of a face value of Rs. 10, for cash at a premium of Rs. 110 per share.

The applicant had lodged a complaint with the MRTPC stating that the failure of Videocon International Ltd. to allot him rights shares as per his entitlement amounted to deficiency of service on the part of the company. He also alleged that the respondent was indulging in restrictive trade practices as admissible under the relevant sections of The Monopolies and Restrictive Trade Practices (MRTP) Act, 1969.

The counsel for the Respondent argued that in legal terms, a prospective investor does not become a consumer as defined under the MRTP Act because, the shares before allotment, do not even exist and thus, cannot in any way be held as goods.

Further, capital raised through a rights issue means making arrangements for carrying on trade and not the actual carrying on of trade, as defined under section 25 of the MRTP Act.

Since a rights issue is not a practice relating to the carrying on of any trade, it cannot constitute a "trade practice" as defined under Section 2(u) of the MRTP Act.

The MRTPC held that no "service" within the meaning of Section 2(r) of the MRTP Act is provided or made available to the prospective investors where the company simply issues the shares for subscription.

The MRTPC held that shares before allotment cannot be considered as "goods". Therefore, a prospective investor who applies for shares does not buy any goods, merely because he makes an application for allotment.

Published by:
Nishith Desai International Legal Research Center,
201-A Milton, Juhu Tara Road, Juhu Beach, Mumbai 400 049, INDIA.