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Why Indian HNIs invested in blank-cheque shell cos are facing tax scrutiny

Tax notices might be linked to information sharing between India and Bermuda, a popular jurisdiction for incorporating SPACs, similar to the Cayman Islands.

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Illustration: AJAY MOHANTY

Sunainaa Chadha NEW DELHI
Several high net-worth individuals (HNIs) in India are reportedly facing tax notices for their investments in Special Purpose Acquisition Companies (SPACs), commonly known as "blank cheque companies." The notices come amid increased scrutiny by the Income Tax Department (ITD) on offshore investments, particularly those made in jurisdictions like Bermuda and Cayman Islands.

SPACs are shell companies listed on stock exchanges that raise capital through an IPO with the sole purpose of acquiring or merging with a private company. This allows the private company to go public without the traditional IPO process. While popular globally, SPACs are a relatively new investment avenue in India, and their tax implications remain unclear.

The Liberalised Remittance Scheme (LRS) allows Indian residents to send up to $250,000 per year abroad for various purposes, including buying securities. However, the applicability of LRS to SPACs was ambiguous before August 2022, when regulations were tightened. Even before these changes, tax and foreign exchange law experts advised against using LRS for SPAC investments due to the lack of clarity.

Bermuda information Triggers Scrutiny:

An Economic Times report suggests that the tax notices might be linked to information sharing between India and Bermuda, a popular jurisdiction for incorporating SPACs, similar to the Cayman Islands. This information sharing agreement may have provided the ITD with details about Indian investors involved in these structures.

While SPACs are gaining traction globally, their tax implications in India remain unclear. The ITD's actions could indicate a closer look at potential tax liabilities associated with these investments.

What is SPAC? 
A SPAC is a ‘blank-cheque’ shell corporation, newly formed and set up solely to raise capital through a public offering. SPACs are listed on major equity markets (say NASDAQ or NYSE), but without any business.

"Simply put, a SPAC goes to the public for fundraising and listing, even before the acquisition target is identified. The final objective is to acquire a target operating company utilising the proceeds collected from public shareholders and PIPE funding," said PWC in a note. 

Once the merger or acquisition is complete, the private company becomes a subsidiary of the publicly traded SPAC. This essentially takes the private company public without the traditional IPO process.

When a SPAC raises money by issuing units through an IPO, no tax implications ought to surface in India since a SPAC is a blank-cheque company with no underlying Indian assets.

 SPACs became popular globally around 2019-2020. This new investment avenue attracted high net-worth individuals (HNIs) in India seeking fresh opportunities.

"India, recognizing the potential of SPACs, introduced supportive regulations such as the International Financial Services Centres Authority (Issuance and Listing of Securities) Regulations, 2021, aimed at facilitating the listing of unlisted companies in International Financial Services Centres (IFSCs). Despite these efforts, navigating the regulatory landscape surrounding SPAC investments remains challenging for the investors," said Kishore Kunal, Advocate-On-Record, Supreme Court of India.

Why the tax notices?

Undisclosed Offshore Investments: Many Indian investors who bought SPAC units or shares apparently did not report these investments on their Income Tax (I-T) return's Foreign Assets (FA) schedule. This is a mandatory disclosure and considered a violation.

"This would be a potential violation of disclosure requirements for any offshore assets an individual might hold. The Income Tax department may be leveraging data from various sources, including foreign financial institutions, to identify such discrepancies. There's still ambiguity surrounding the tax treatment of SPACs themselves. Since SPACs, or "blank cheque" companies, are a relatively new investment vehicle, there might be a lack of clear guidelines on how income generated from them is taxed in India. These notices could be the department's way to gather information and potentially determine any tax liabilities that may exist for these offshore SPAC holdings. The Income Tax department probably to clarify the situation and potentially recover tax dues on any unreported income from these offshore investments," said Ritika Nayyar, Partner, Singhania & Co.

Liberalised Remittance Scheme (LRS) Ambiguity: The investors might have avoided disclosure because it was unclear if the LRS, a program allowing Indians to send money abroad, could be used to invest in a SPAC. The ambiguity lies in the fact that a SPAC, at the time of investment, doesn't have a real business. LRS, monitored by the Reserve Bank of India (RBI), permits a resident individual to remit up to $250,000 a year to open overseas bank accounts, buy securities and immovable properties among other things. However, since August 2022, regulations explicitly restrict using LRS to invest in unlisted entities, which includes SPACs before they merge with a target company.

Bermuda, a popular jurisdiction for incorporating SPACs, is a signatory to the Common Reporting Standard (CRS), an international agreement for automatic exchange of financial information between countries. This information sharing might have provided the ITD with details about Indian investors involved in these structures.

"The tax notices primarily target the capital gains being incurred by the investors on SPAC transactions. Under the Indian Income Tax Act (ITA), mergers and amalgamations are tax neutral, but this doesn’t remain the case for outbound mergers. Furthermore, when profits are repatriated back to the Indian investor, they are subjected to withholding tax obligations. Thus, leading to the department issuing notices to the HNIs," said Kunal.

"There are two key aspects to investments in SPACs, from a tax perspective these investments need to be duly accounted for and disclosed in the tax returns. Non disclosure could invite penalties and even action under the black money act. On the other hand is the question of validity of these investments under foreign exchange regulations. As per current FEMA Indian entities are allowed to invest only businesses carrying our bona-fide business activities outside India. SPACs on the other hand are black cheque companies in the search for businesses to merge with. This leads to a controversy on whether or not investments in SPACs would be permitted under the automatic route per FEMA," said Pallav Pradyumn Narang, Partner, CNK.

Is there a loophole? 
While one may argue that business connection is enough to tax in India, recent tax amendments made in the ITA specifically exclude income earned by foreign sources for individuals not taxed elsewhere. Income earned by foreign SPACs cannot be taxed in the hands of an individual if the individual is not a resident of India in the previous year, offering a loophole for investors, explained Kunal.

While SPAC listings sound appealing to Indian investors looking for foreign capital markets, they pose high risks due to the complexity of the Indian regulatory framework. The intricate restrictions under FEMA and RBI, coupled with an unclear taxation regime, add to investors' concerns. Under the ITA, SPAC investments are likely to trigger anti-abuse provisions, if the acquisitions are done below fair market value leading to substantial tax liabilities for investors.

For example: Consider an HNI investor in India invests in a Singapore-based SPAC through a complex offshore structure, believing it minimizes his tax liability. However, during routine data exchange between Indian and Singaporean authorities, a discrepancy is flagged. The Indian Income Tax department notices he hasn't declared his holding in the SPAC in his ITR. Even if the investment was legal, he now faces the hassle of explaining the discrepancy and potentially penalties for non-disclosure, explains Nayyar.

This scenario illustrates how even if an HNI investor isn't deliberately trying to exploit loopholes, the newness and lack of clarity surrounding SPACs can create unintended complications with Indian tax authorities. 

"While SPACs offer a fast track to accessing foreign markets, the regulatory framework in India remains a hurdle. Any outbound merger requires NCLT and RBI approval, which, though possible, is a task in itself. This, coupled with recent actions by the tax department, calls for careful consideration by investors when venturing into offshore markets through SPAC investments," said Kunal.
Topics : Taxation

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First Published: May 15 2024 | 10:12 AM IST

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