Nishith Desai : Issue 11

LEGAL UPDATE: INDIA
Issue 11 ... July - September 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

AIG Ruling Endorses Mauritius Route
FIIs Allowed to Invest up to 100% in Debt Instruments
Revised Norms for Divestment by FIIs
FIIs Voting Rights Limited to 24% of the Paid-up Capital
Varsity Funds, Charitable Trusts, Qualify for FII Status
Expansion of the Annex III List
More Freedom for Companies Planning Restructuring
Draft Takeover Regulations
Supreme Court Upholds Transborder Trade Mark Rights
Levers, Smithkline Battle Over Brush Patent

AIG Ruling Endorses Mauritius Route

In August 1996, the Authority for Advance Rulings (Authority) in its ruling on the application filed by the American Insurance Group (AIG), upheld AIGs investment into India through Mauritius.

The Authority was set up under the Income-Tax Act, 1961 for the purpose of providing non-residents with an opportunity to determine in advance, their tax liability on investments made in India.

Earlier this year, the Authority denied a ruling in the case of NatWest Bank, UK which had invested in India through two shell companies in Mauritius, on the grounds that the investment was made prima facie for the avoidance of tax.

AIG was planning to float an offshore fund, namely, AIG Indian Sectoral Equity (Fund) in conjunction with Infrastructure Leasing & Financial Services (IL&FS) for investment in infrastructure projects in India.

As per the transaction which was put before the Authority, an AIG subsidiary in Mauritius was to invest in an Indian Contributory Trust (CT) which would in turn invest in India. AIG filed its application with the Authority in order to determine the tax liability on the income arising from the CT.

AIGs case was distinguished from that of NatWest, in that, the subscribers to the Fund belonged to different countries worldwide. Since there was a need for a common platform for investment into India, it was necessary to choose a neutral jurisdiction from which the investment in to India could be made.

It was argued on behalf of AIG that if the investors in the Fund were to directly invest into India, they would have had to obtain individual approvals for the investment which would have been a long and cumbersome process.

Also, Mauritius has recently emerged as a low cost offshore financial center and is popular because of its favorable double taxation avoidance treaty with India. Mauritius has also developed good infrastructure for fund management. AIG stated in its application that it was for these reasons that it decided to set up its Fund in Mauritius. The Authority therefore ruled that there was good commercial justification for setting up the Fund in Mauritius.

During the hearing, the income-tax department tried to take shelter under the NatWest ruling by stating that the transaction was designed prima facie for avoidance of tax. The Authority however, observed that though tax was an important consideration for routing the investment through Mauritius it was not the only consideration and therefore, the ruling cannot be denied on the basis of avoidance of tax. The Authority ruled that since AIG was able to show genuine commercial reasons for setting up a subsidiary in Mauritius, there was no reason to deny a ruling on the grounds that the investment was prima facie for the avoidance of tax.

Several tax practitioners now point out that henceforth investments structured through Mauritius or Cyprus may now avail of the benefit of the tax treaties India has with these countries, provided there is adequate commercial justification for routing the investments through these countries. This ruling has put to an end all apprehensions about the applicability of the India-Mauritius tax treaty.

The law offices of Nishith Desai structured AIGs proposed investment and participated along with Mr. Soli Dastur in the hearing before the Authority.

FIIs Allowed to Invest up to 100% in Debt Instruments

On September 6, 1996, the union finance minister, Mr. P. Chidambaram announced a series of measures to boost the sluggish stock markets.

Foreign Institutional Investors (FIIs) will now be permitted to invest up to 100% in debt instruments. This decision has opened the doors for the creation of dedicated debt funds in the country. It is also likely to boost the appetite for corporate and institutional debt, especially through the private placement route. The relaxation however, continues to exclude government debt.

The long term capital gains tax rate of 20% has been extended to partnership firms. Previously, the tax rate was 30%.

There will be no capital gains tax payable on investments made in domestic mutual funds.

Revised Norms for Divestment by FIIs

On September 18, 1996 the Reserve Bank of India (RBI) announced revised valuation norms for divestment of unlisted or thinly traded shares by foreign investors, including Foreign Institutional Investors (FIIs). The RBI will henceforth clear on an automatic basis, divestment by non-residents in favor of residents, up to a total value of Rs. 2 million per company per annum. As regards pricing, the RBI will accept the mutually agreed price, so long as the valuation is based on any method currently being used and accepted by the RBI.

The non-resident seller will have to obtain the prior clearance of the RBI for divestments worth more than Rs. 2 million (per company and per annum), in respect of thinly traded shares or shares of unlisted firms. The price at which the divestment is made shall be arrived at using any of the three options listed below:

The shares may be sold at the price based on the Earnings Per Share (EPS) linked to price earnings (P/E) multiple or the price based on the Net Asset Value (NAV) linked to its Book Value (BV) multiple (i.e. Price:BV ratio), whichever is higher.

For computing the price based on the EPS, the EPS based on the latest audited balance sheet of the company will be used in conjunction with the average P/E multiple of the Bombay Stock Exchange (BSE) 100 Index for the calendar month immediately preceding the month in which the application was made. The P/E multiple will however, be discounted by 40%.

For computing the price based on the NAV, the NAV of the shares as per the latest audited balance sheet of the company will be used in conjunction with the average BV multiple of the BSE National Index during the calendar month immediately preceding the month in which the application is made. The BV multiple will also be discounted by 40%; orSale of shares on a screen-based stock exchange at the prevailing market price in small lots so that the entire holding is sold in not less than five trading days; or

Sale of shares at a price based on independent valuations. An application in this regard must be accompanied by two separate valuation reports, one by the statutory auditors and the other by a chartered accountant or the Securities and Exchange Board of India (SEBI) registered Category-1 merchant banker, giving a reasoned report in support of the price. The RBI will clear such proposals at the lower of the two valuations and its decision will be final.

According to the RBI, a script will be considered as thinly traded, if on the main stock exchange(s) in India, the annualized trading turnover in that share during the 6 calendar months prior to the month in which the application is submitted, is less than 2% (of the total number of shares) of the listed stock.

FIIs Voting Rights Limited to 24% of the Paid-up Capital

The Securities and Exchange Board of India (SEBI) has clarified that the total voting rights of all Foreign Institutional Investors (FIIs) in a company cannot cross the limit of 24% of the paid-up capital of that company.

Thus, if FIIs hold Global Depository Receipts (GDRs)/American Depository Receipts (ADRs) in a company, the total holding of such FIIs in the company may, on conversion of the GDRs/ADRs (GDRs/ADRs by themselves do not carry any voting rights) increase to beyond 24% of the total paid up capital.

Thus for example, if the total FII holding in a company is 20%, and if the FIIs also hold GDRs/ADRs in the company then SEBI would permit the conversion of GDRs/ADRs into the underlying shares of the company only to the extent of 4% of the paid-up capital of the company.

In the meantime, an official from the Reserve Bank of India (RBI) has clarified that the conversion of GDRs by FIIs into underlying shares of Indian companies would be treated independently of the 24% FII holding cap applicable to equity of Indian companies. Thus, non-residents will be permitted to purchase GDRs floated by Indian companies. However, if FIIs purchase such GDRs, they will not be permitted to convert the GDRs into underlying shares of the company, if the total FII holding in such company has already touched the 24% limit.

Varsity Funds, Charitable Trusts, Qualify for FII Status

The Securities and Exchange Board of India (SEBI) has widened the definition of Foreign Institutional Investor (FII) and is now allowing funds such as university funds, endowments, foundations, and charitable trusts/societies with a track record to invest in the Indian securities market.

SEBI has also cleared amendments on FII investments approved in the Budget 1996-97. FIIs can now invest in unlisted companies and each FII can hold up to 10% of the total issued capital of an individual company.

Expansion of the Annex III List

On September 9, 1996, the Industry Ministry proposed a massive expansion of the Annexure III list. It has drawn up a separate schedule which will define the fresh areas where automatic approval will be allowed. The schedule will be over and above the 36 high priority industries.

More Freedom for Companies Planning Restructuring

The Department of Company Affairs (DCA), is planning to do away with the Union Governments interference in the restructuring, streamlining, and winding up decisions of companies, provided the move receiving the backing of two-thirds of the shareholders of such company. This provision is being included in the list of amendments to the Companies Act, 1956 that is being moved by the finance minister in the current session of Parliament.

The other amendments include granting of voting rights to SEBI recognized funds, debarment of corporate defaulters from raising fresh deposits, and permission to companies to issue non-voting shares.

Draft Takeover Regulations

The Bhagwati Committees report on takeovers (draft regulations) was released by Justice P. N. Bhagwati (the chairperson of the Committee), on August 28, 1996. The Bhagwati Committee was constituted by the Securities and Exchange Board of India (SEBI) to revise the existing takeover code. The draft regulations will be finalized only after a public debate. The Bhagwati Committee will meet on September 28, 1996 to finalize the draft regulations which are expected to be notified by November-December 1996 and enforced thereafter. Until then, the current Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1994 (Takeover Code) will continue to be in force.

If you would like a copy of the paper prepared by our firm, which analyses the provisions of the draft regulations, please visit us on our internet home page or feel free to write to us.

Supreme Court Upholds Transborder Trade Mark Rights

In a landmark judgment, the Indian Supreme Court upheld the right of the US-based Whirlpool Corporation in the mark Whirlpool on the grounds of transborder reputation and has restrained the Usha Shriram Group (Usha Group), India from using the trade mark.

The Usha Group, through Chinar Trust, has registered the Whirlpool trade mark for washing machines. Section 28 of the Trade Marks Act, 1958 (TMA) gives the registered proprietor of the trade mark an exclusive right to use the mark.

Under the TMA, the registration of a trade mark has to be renewed every seven years. The Usha Group had registered the trade mark in 1968. It renewed the registration in 1993 and was using the Whirlpool mark for marketing its washing machines.

Whirlpool Corporation is the owner of the Whirlpool mark worldwide and it was planning to introduce refrigerators and washing machines in the Indian market through its Indian subsidiaries.

It filed a suit before a single judge of the Delhi High Court seeking an injunction on the ground that the Usha Group was violating its trade mark and was passing off their products as the international brand name of Whirlpool corporation. Whirlpool Corporation contended that the Whirlpool trade mark was internationally recognized and that it enjoyed a transborder reputation. Based on this, the Court passed an injunction against Usha Group restraining it from manufacturing, selling, and using the name Whirlpool for washing machines. The Usha Group appealed to a division bench of the High Court which confirmed the injunction.

The Usha Group appealed to the Supreme Court against the order. The Supreme Court dismissed the appeal stating a mere registration of a trade mark, in absence of any honest adoption of the mark or its use, cannot grant a company the right to use the name which is in extensive use over a long period by another company. The Court preferred Whirlpool Corporations common law right to use its internationally reputed name over the statutory right granted by law to the Usha Group.

In another case however, the Delhi High Court rejected the argument of the multinational, Proctor & Gamble (P&G), in a trade mark case relating to overseas reputation.

P&G holds more than fifty trade mark registrations world wide of its toilet soap, Safeguard. It planned to market Safeguard in India and objected to the use of Safeguard by Shirpa Laboratories. P&G therefore, filed a suit stating that the use of its trademark by the Indian company constituted passing off. The court passed an order restraining Shirpa Laboratories from using the trade mark.

On appeal, the Delhi High Court reversed the order. The High Court allowed the Indian company, Shirpa Laboratories, who was using the trade mark Safeguard for the past 13 years on its ayurvedic antiseptic cream, to continue using the trade mark. Shirpa Laboratories had also advertised its product widely in India.

The judge noted that there was a vast difference between a coined word and a descriptive word. The Court also said that P&G had failed to prove that a descriptive word like Safeguard had acquired a secondary meaning distinctive to the product. The Court has however allowed P&G to plead its case before the Registrar of Trade Marks when the matter comes up for grant of a trade mark.

From the Courts order it is clear that the spill-over reputation of a multinational company with regard to a particular product needs to be tested in every case separately. Thus to that extent, the rule set in the Whirlpool case has to be qualified case-to-case and cannot be treated as absolute.

Levers, Smithkline Battle Over Brush Patent

In an interesting development, Smithkline Beecham (Smithkline) has accused Hindustan Lever Ltd. (HLL), a subsidiary of Unilever, of stealing a design and has served it with a legal notice.

The controversy relates to an S shaped (zigzag) band on the toothbrush handle developed by Smithkline, and which it registered in the UK in 1988 and in the US in 1992. The branded product, Aquafresh was then used in a host of countries and turned out to be a huge hit.

With India becoming an attractive market, Smithkline planned to introduce Aquafresh with its distinctive design. However, after the pre-launch publicity, it found that another tooth brush with same S band was introduced by fellow multinational HLL and had already hit the Indian market under the brand name Pepsodent Popular.

HLL though, claims that it has not copied Smithklines design, but had that it bought the design from a small Indian company Kewalraj who had in turn registered the design in 1991. Thus, HLL claims that Smithkline does not have a patent on the product. Furthermore, since there is no transborder reputation in design and patents, the design becomes common knowledge if it is not registered in India.

This case sends a warning to multinationals and large corporations to ensure that they register and protect their intellectual property rights in India.

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