India witnessed its highest level of deal-making in 2021 by both value and volume as the stock market boomed along with phenomenal IPO exits and long-awaited resolutions to some of the largest distressed assets, including by foreign investors.
While foreign investment in India continues to be regulated, foreign investment conditions are being progressively liberalised and the government seems keen to promote the ease of doing business; though still governed by a multitude of legislations, rules, regulations, notifications and policies.
The central parliament has the legislative power to enact most of the statutes relevant to M&A, and such statutes do not vary from state to state. Key statutes are set out here:
- The Companies Act, 2013 regulating corporations;
- The Indian Contract Act, 1872 regulating contracts;
- The Foreign Exchange Management Act, 1999 regulating inbound and outbound investments and cross-border mergers;
- The Securities and Exchange Board of India Act, 1992 which prescribes the framework for acquisitions involving listed companies;
- The Competition Act, 2002 regulating combinations and prohibits anti-competitive agreements; and
- The Income Tax Act, 1961 which prescribes the framework for direct taxation.
The statutes are typically accompanied by rules, regulations and notifications; and in some cases, press notes or other policy documents. Additional statutes may also be relevant, depending on the business and structure of the M&A transaction.
The central government – particularly the Ministry of Finance, and Department for Promotion of Industry and Internal Trade at the Ministry of Commerce and Industry (DPIIT) – issues the rules and policy framework for foreign investments. The Reserve Bank of India (RBI) regulates and implements the reporting mechanism for foreign investment. Other regulators are the Securities and Exchange Board of India (SEBI), when listed companies are involved, and the Competition Commission of India for antitrust approvals, where necessary.
A foreign investor typically needs to find answers to the following two questions if proposing to invest in India:
- Is foreign investment permitted in the business proposed to be set up or acquired? While most business sectors are open for foreign investment, a few are prohibited – namely atomic energy, gambling and lottery business, and chit funds; while certain sectors, such as defence and insurance, have conditions; and
- What will be the optimal entry route? India permits foreign investment in several forms, such as foreign direct investment (FDI), foreign portfolio investment (FPI), and foreign venture capital investment (FVCI). Depending on the M&A objectives, one of these entry routes may be preferable to the others.
Typically, foreign investment regulations cannot be circumvented by incorporating a company in India because a company such as this, controlled or majority-owned by non-residents and making downstream investment, would be subject to similar regulations applicable to non-residents.
M&A structuring typically involves:
- Share acquisition, either as a primary subscription or secondary purchase;
- Asset purchase, which may be structured as an itemised asset purchase, or a slump sale, which is a term under Indian tax laws and provides tax efficiencies if a sale qualifies as such; or
- Mergers, demergers or amalgamations, which are implemented by a special court, the National Company Law Tribunal (NCLT). While fast-track mergers without requirement of NCLT approval are possible in the case of mergers between holding companies and wholly-owned subsidiaries, and small companies, these mergers still require a confirmation from the government.
For listed companies, additional requirements apply, including:
- A mandatory tender offer is required to be made for at least 26% shareholding if an acquirer proposes to acquire 25% or more shareholding or control;
- In certain situations, a mandatory tender offer may also be required in the case of a change in shareholding and/or control of a shareholder; and
- Listed companies are required to maintain a minimum public shareholding (typically 25%) at all times.
Investments by non-resident entities in Indian companies are governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (FEMA NDI Rules) and press notes issued from time to time by the DPIIT.
- Investment routes. While FDI is investment through capital instruments in unlisted companies, or 10% or more of a listed company, FPI is investment through capital instruments by non-resident investors registered with the SEBI in less than 10% of a listed company. While 10% is the individual limit for an FPI, total holdings of all FPIs of a company cannot exceed 24% of the paid-up equity capital or the paid-up value of each series of capital instruments. FVCI is an investment by non-resident investors in venture capital funds or undertakings in specified sectors such as biotechnology, nanotechnology and infrastructure.
- Entry restrictions. FDIs may either fall under the automatic or approval route, depending on the sector and percentage of investment. FDI under the automatic route requires no approval from regulatory authorities, but needs to comply with applicable sectoral caps, pricing guidelines, and FDI-linked performance conditions. FDI under the approval route requires prior approval from the relevant sector regulator or the RBI. Pursuant to a press note released by the DPIIT in 2020, any FDI from entities incorporated in countries that share land borders with India – or where the beneficial owner of investment is situated in, or is a citizen of, any such country – will mandatorily fall under the approval route. In addition, the FEMA NDI Rules impose a blanket prohibition on FDI in certain sectors.
- Pricing guidelines and reporting requirements. The FEMA NDI Rules prescribe pricing guidelines for the issuance and transfer of securities of an Indian company to non-residents. All such issuance and transfer involving non-residents are required to be reported to the RBI within prescribed timelines and in the form and manner prescribed.
KEY M&A DEVELOPMENTS
- FDI thresholds in sectors such as insurance and defence have been raised from 49% to 74% under the automatic route, subject to compliance with sector-specific conditions. FDI thresholds in telecoms, petroleum and natural gas have increased to 100% under the automatic route, in case of the government granting in-principle approval for strategic disinvestment of public sector undertakings.
- FDI up to 20% under the automatic route is now permitted in the Life Insurance Corporation of India, the country’s largest insurance company, ahead of its IPO.
- The Ministry of Corporate Affairs has permitted startups to adopt fast-track mergers without obtaining NCLT approval, as is required for regular mergers.
- The SEBI has permitted acquirers to make combined offers for delisting the shares of a listed target company while making an open offer.
- The RBI has issued draft guidelines aiming to tighten overseas direct investment (ODI) and financial commitments provided by resident entities, while also aiming to liberalise ODI-FDI structures.
While the use of warranty and indemnity insurance is still at a nascent stage in India, there is a growing demand for such products, given the surge in foreign investments. Similarly, trends such as including break fee and reverse break fee provisions in investment documents are starting to gain prominence, although these largely remain untested from a regulatory perspective. The authors also see payment structures such as locked-box mechanisms, deferred payments and escrow arrangements gaining popularity; as well as increasing use of hell or high water clauses as a remedy to get mega-mergers through.
Furthermore, the authors expect the record M&A momentum of 2021 to continue gaining traction in 2022 – with a focus on fintech, electric vehicles, tech and data analytics, pharma and healthcare, and e-commerce and quick-commerce. Private equity investors are likely to participate in more control transactions; and the startup space is expected to remain vibrant. With abundant financial reserves and liquidity, valuations are expected to remain high, and more investments are expected to take the contested auction route than a negotiated one, and with capital markets playing hot and cold, private equity exits are more likely to be structured as dual-track exits, with simultaneous IPO and auction process in play.
With the growing relevance of environmental, social and governance (ESG) rights are going to play an even more important and central role in negotiations and overall management. More capital is also likely to be deployed for impact investments, especially those related to transitioning into cleaner and sustainable energy sources. All of this is likely to generate increased M&A opportunities.
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The Philippine economy’s resilience amid global uncertainty and the pandemic is unprecedented, with the National Economic Development Authority (NEDA) reporting GDP growth of 7.7% in Q4 2021 – edging full-year growth beyond the government’s 5-5.5% target to 5.6%. This bullish trend for one of Asia’s fastest growing economies is expected to continue in 2022, with GDP growth projected at 7-9%, bouncing back to pre-pandemic levels by Q3. Sustaining this momentum are the nationwide vaccination programme, looser mobility restrictions and public infrastructure spending prioritised by the government.
Significant foreign investment roadblocks are, meanwhile, removed in a shift in economic policy direction – making the Philippines more competitive against its neighbours. With the central bank reporting a 52.8% business confidence index, the Philippines is positioning itself among the world’s most attractive global destinations for business combinations.
Regulations affecting M&A transactions are not codified under one law. Depending on the structure, parties and businesses involved and transaction size, they are usually regulated by foreign investment restrictions under the Philippine Constitution and special laws, along with antitrust policies codified in the Competition Act and regulatory and corporate authorisations required under the Revised Corporation Code and Securities Regulation Code.
To drive economic recovery, new measures are being adopted to change the tax and legal landscape affecting M&A. These changes are primarily aimed at bringing new capital, ideas and technology at globally competitive prices.
EASING FDI RESTRICTIONS
Particularly critical for inbound M&A are restrictions on foreign direct investment (FDI), usually restricting equity and management. The Philippines has previously adopted a protectionist approach, with among the most restrictive FDI rules in the region. However, in a series of recent legislative enactments, Philippine policy is shifting to favour a more liberal free-trade environment.
Paving the way for this historic economic reform is an amendment to the Retail Trade Liberalisation Act, which reduced required minimum paid-up capital on entities engaged in retail to allow foreign equity to PHP25 million (USD480,000). This is a significant reduction from the previous requirement of USD2.5 million. Minimum investment per store for foreign retailers was likewise reduced to just under USD200,000 per store, from the previous USD830,000. Additionally, retail enterprises with more than 80% foreign ownership are no longer required to make a public offering of at least 30% of their equity.
A minimum paid-up capital requirement of USD200,000 is placed on foreign equity on domestic market enterprises, or those engaged in the sale of products or services to the domestic market. This particularly aims to protect local micro and small domestic market enterprises from foreign competition. But certain enterprises allowed to have a lower minimum paid-up capital of USD100,000 of foreign equity now include startups or startup enablers – aiming to make the country a leading startup hub. The number of mandatory Filipino direct hires is also lowered from 50 to just the majority of the enterprise’s employees, provided there is no less than 15 Filipino direct hires.
The most recent and anticipated foreign investment-friendly reform is an amendment of the 85-year-old Public Service Act. Public utility refers to a business engaged in regularly supplying the public with some commodity or service of public consequence. As a critical component to establishing a self-reliant community, the constitution formerly placed a 40% foreign equity restriction on public utilities. While the question of which enterprises may be deemed public utilities had been much disputed, it has been traditionally considered to include enterprises providing electricity, gas, water, transportation and telephone services to the public.
With the amendment, public utilities have now been identified and limited to the following: (1) distribution of electricity; (2) transmission of electricity; (3) petroleum and petroleum products pipeline transmission systems; (4) water pipeline distribution systems and wastewater pipeline systems including sewerage pipeline systems; (5) seaports; and (6) public utility vehicles. This effectively allows full foreign ownership of other entities traditionally considered public utilities such as subways, airports, airlines, railways, expressways and tollways. This liberalisation is moderated by certain safeguards, including 50% foreign equity restriction on entities engaged in the operation and management of critical infrastructure, but subject to reciprocity.
These amendments are expected to transform the foreign investment landscape and boost inbound M&As.
M&A NOTIFICATION REQUIREMENT
As an antitrust safeguard, M&A parties must notify the Philippine Competition Commission (PCC) if their transaction exceeds the specified threshold. Upon notice, the PCC will conduct a review to determine if the transaction will significantly reduce competition in the relevant market. An M&A agreement consummated in violation of the notification requirement is void and will subject the parties to an administrative fine.
To push an M&A rebound for economic recovery, the country has temporarily eased the compulsory notification requirement. Before the pandemic, the notification threshold was PHP6 billion for the size of the party, and PHP2.4 billion for the transaction size. Under the “Bayanihan to Recover as One Act”, a law granting the president additional authority to combat the pandemic, the threshold was temporarily adjusted to exempt M&A with transaction values below PHP50 billion for two years, or until 15 September 2022.
Corporate approvals are necessary for a corporation to enter into an M&A. Depending on the structure and subject to the stricter requirements under the corporations’ charters, approval of the board majority and shareholders representing at least two-thirds of the outstanding capital stock are required. The plan for mergers or consolidation must also be duly approved by the Philippine Securities and Exchange Commission.
The acquisition of a listed or public company is also subject to mandatory tender offer rules. The acquirer must undertake a tender offer to all shareholders for acquisitions triggering the threshold. The threshold is currently set at 35% of the outstanding voting shares – or such that would be sufficient to gain control of the board – whether by single acquisition or a creeping acquisition within 12 months, and any acquisition that would result in ownership of over 50% of the total outstanding equity securities. If 15% of the outstanding shares will be acquired within 12 months, only a declaration to that effect must be filed.
Foreign investments are not required to be registered with the central bank unless the repatriation of capital or remittance of related earnings in the Philippine peso is funded by foreign currency resources of authorised agent banks, their subsidiaries, or affiliate corporations. In such a case, the registered investment will be entitled to full and immediate repatriation using the banks’ foreign currency resources. For unregistered investments, the foreign currency to fund their repatriation should be sourced outside the banking system.
Tax consequences also hinge on the M&A structure. Share acquisitions, for example, are subject to capital gains tax (CGT) of 15% on net gain; documentary stamp tax (DST) of approximately 0.75% of the par value of the shares sold for unlisted shares; and a stock transaction tax of 0.6% of the selling price for listed shares.
In contrast, taxes on asset acquisitions depend on the asset classification at the seller’s hands. The sale of ordinary assets is subject to income tax and value-added tax (12%). DST and withholding tax are also imposed on the sale of certain assets such as real property. On the other hand, the sale of real property held as capital assets is subject to CGT (6%) and DST (1.5%). M&A transactions made purely for reorganisation purposes are exempt from tax. Proof of payment of these taxes must be presented and approved by the Bureau of Internal Revenue. A certification issued by the bureau is a precondition for registration of the transfer of title in the corporate books or registry of properties.
Notably, the Philippines recently adopted tax reforms to make the country a more attractive investment destination. This includes reduction of corporate income tax to 25% from 30% of net income for domestic and resident foreign corporations. Income received by non-resident foreign corporations from the Philippines is subject to reduced income tax of 25% on gross income, and 15% final withholding tax for dividends from domestic corporations, subject to certain conditions. Preferential tax rates may be availed of in certain conditions under existing tax treaties.
RIPE FOR M&A
The pandemic crisis induced a reshaping of the Philippine economy, inspiring structural reforms that caused asymmetric recovery across various sectors. With the government’s continuing efforts to revitalise the economy, coupled with key legislative and regulatory developments designed to improve the investment landscape, the Philippines is ripe for transformative M&A activities that can assist companies in positioning themselves as global market leaders.
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