Depository Receipt regime may be hit by Budget fine print

Tax benefits not extended to new regime; move likely to affect appetite for shares of unlisted companies looking to raise capital abroad

The Union Budget may play spoilsport for the new liberal depository receipt (DR) regime. The Finance Bill notes that a new depository regime has been put in place, but that the tax benefits would only apply to cases valid under the old one. This means that non-residents trading in certain DRs could now be subject to the same taxes as those imposed on people trading in shares of unlisted companies here, besides creating tax ambiguities when such DRs are converted to shares.

The new depository receipt (DR) regime allows for DRs to be issued against equity shares of listed or unlisted players as well as debt instruments. The DRs can also be issued by shareholders without involving the company, through the so-called unsponsored DR route. Only equity issuances by already listed companies were earlier allowed. Tax exemptions would only be carried forward for such programmes, according to the Budget documents.

SPEED BUMPS AHEAD FOR DEPOSITORY RECEIPTS

• Scope of depository receipts had been expanded to include unlisted companies
• Non-equity securities, too, were included
• Budget says tax exemptions would only apply to old regime
• This creates tax ambiguities for the liberalised regime
• Non-residents could be subject to tax on DR trades
• Uncertainty over tax on conversion between DRs and shares

“Since the tax benefits under the Act were intended to be provided in respect of sponsored GDRs and listed companies only, it is proposed to amend the Act in order to continue the tax benefits only in respect of such GDRs as defined in the earlier depository scheme,” notes the text of the Finance Bill.

Rajesh H Gandhi, partner — tax at Deloitte Haskins & Sells, says the move is likely to affect appetite for shares of unlisted companies looking to raise capital abroad.

“The suggestion is that the depository receipts of only listed firms are would be eligible for the tax benefit mentioned under the old regime. This would mean that non-residents who trade in DRs of listed companies would arguably be subject to capital gains tax. There is also ambiguity on tax implications of DRs (of both listed and unlisted companies) when they are converted to shares,” he said.

While some take the view that conversion of depository receipts into shares is a taxable event, others take the opposite view. Also, the law does not provide any methodology for determination of the cost of acquisition of shares converted from DRs.

Such tax woes could add to problems that companies looking to raise capital already face.  Unlisted firms already face headwinds in capital-raising. “There will be appetite if the company is good, but it becomes more challenging for unlisted firms,” said Harish HV, partner, Grant Thornton India

Legal experts believe that the move would create headwinds for the new regime. A note from law firm Khaitan and Co pointed out the difference in taxation. “The Bill proposes that the concessional rate of 10 per cent for long-term capital gains on transfer of GDRs… will apply to all classes of investors… (but) ... this benefit will not be available to GDRs with an underlying security not being listed equity shares,” it said.

“In what may act as a dampener to the new scheme, Budget 2015 indicates that tax benefits under the domestic law were intended to be provided only in respect of sponsored issuances of GDRs by Indian listed companies; that the government does not intend on extending the tax provisions of the old scheme to other forms of transactions in depository receipts,” said a note from law firm BMR.

The amendments are effective from April 1, 2016.

Global Investments Company BNY Mellon had estimated that worldwide the DR market is worth around $700 billion as part of a report released when it pitched for a more liberalised regime in 2013. Institutions such as Mellon have business involving helping companies set up DR programmes.

The government's tax decision comes on the heels of Mellon saying that several filings for unsponsored depository receipts have been made.

The depository receipt route last year had hit one of its lowest points in over 20 years, according to PRIME Database statistics for 2014. There was only one issue last year, matching 1998 in having the lowest number of issuances since 1991.