Country director of Grant Thornton India Pvt Ltd, Khozema Anajwalla once said that due to a friendly business approach about 95% of Fortune 500 companies are incorporated out of Delaware.
At the end of the 19th century, New Jersey decreed corporate-friendly laws so that it can attract business from New York. Following its footsteps, Delaware enacted a general incorporation act on March 10, 1899. By the virtue of this act, anyone could form a corporation by raising funds and filing articles of association with the state.
Today when the world is overwhelmed with the idea of start-ups it is favorable to have a holding company in a much friendlier jurisdiction for the business to thrive. However, investors prefer to invest in a holding company rather than a company in a familiar jurisdiction.
If you incorporate a company in Delaware, it can open some investment opportunities that are otherwise closed.
What is Delaware Flip?
Indian promoters subscribe to securities in the US holding company incorporated in Delaware by offering shares in their Indian Company on a share swap basis. This results in:
- US holding company having 100% paid-up capital in the Indian company.
- Indian promoters hold a 100 % stake in the holding company.
When it comes to corporates in the United States Delaware has the most comprehensive law. Even in complex situations, the laws are certain and predictable making it a favorite among investors. The following reasons make Delaware most encouraging:
- The rules related to the voting rights of the investors with a special class of shares are intuitive and very flexible.
- Stockholders of Delaware can work with a simple majority vote.
- Consent of minority shareholders is inconsequential and can affect a merger with another company.
- Assets can be sold to an acquirer with the consent of a majority of shareholders.
- There is an advantage of getting listed in many stock exchanges when a US company is chosen.
- Delaware C company provides ease of doing business in the corporate world.
WHY NON-US COMPANY CONSIDERS A DELAWARE FLIP?
- In the form of private equity and venture capital, USA proves to be a major source of investment.
- IPO becomes easier for a US-based corporation since the world’s biggest stock exchanges like NASDAQ or the NYSE are located in the U.S.
- investors prefer to invest in the company under familiar jurisdiction and where the rights and duties governed by directors and investors are much more affluent.
- Founders can move out of India and settle in the USA and also obtain visas through a well-structured process.
- Repatriating profits back to the USA is a big issue when a company goes public in India.
- A lot of opportunities to raise money in the USA due to massive competition among local US Businesses and arbitrage prospects.
Interesting Fact: ‘Inversion’ transactions are structured to ensure that the merger of a U.S company with a non-US company results in a lower tax jurisdiction for the parent company. The U.S based Burger King merged with Canada-based Tim Horton’s to benefit from such a transaction.
ISSUES TO CONSIDER BEFORE FLIPPING UNDER FEMA
Round Tripping under FEMA: When the funds are transferred from one country to another and then transferred back to the origin country to get tax benefits through concession, evasion, or avoidance, then such a practice is called round-tripping.
It promotes money laundering and hence RBI has always prohibited such transactions.
RBI does not allow an Indian resident to set up an overseas company that will further set up an Indian subsidiary or acquires a foreign company that has invested in an Indian company under an automatic route.
However, RBI has clarified its position on round-tripping through FAQs. It strictly prohibits such investments under the automatic route but has allowed them if prior approval of the RBI has been taken.
In May 2019 RBI clarified that a wholly-owned subsidiary or a foreign joint venture cannot be used by an Indian party to route investments back into India. If Indian companies or resident Individuals seeks exemption from such prohibition, prior approval is required.
Round tripping offers two scenarios:
- An overseas company is already in existence and intends to invest in an Indian company for commercial purposes.
- There are overseas targets under overseas direct investment (ODI) regulations and such a target is present in India.
RBI bans an automatic route for ODI investments in the following ways:
- Indian party is prohibited from setting up a subsidiary in India through Joint Venture or Wholly Owned Subsidiary.
- Indian party is prohibited to invest in a Joint Venture or Wholly Owned Subsidiary which has made prior investments in India.
Note: Individual residents do not include in the definition of ‘Indian Party’, however, RBI has clarified that Indian residents investing in foreign companies under LRS and rerouting funds back to India need prior approval from RBI as well.
Therefore, in the purview of liberalizing the restriction RBI approves round-tripping if practiced not for evading tax.
Transfer of IP: The IP of an Indian company must be transferred at a fair price or correct valuation as per Indian law. This can sometimes create problems since valuation can be questioned by tax officers.
Transfer of shares: When the flip involves share transfer, capital gain tax is levied. Such tax needs to be valued on share price which will be cheaper as compared to the stage when many rounds of funding have been received and business is quite profitable.
Active business outside India:If the company comes under the purview of Indian taxation laws as a foreign company, it becomes taxable in India. However, to avoid tax in India 50 % of the active business must be outside India.
A company shall be considered to have an active business outside India if:
- The company’s passive income < 50% of total income.
- No of employees in India and the assets and payroll expenses relating to such employees < 50% of a total number of company’s employees and assets and payroll expenses relating to employees over the last three years.
A company with active business outside India should hold the majority of its board meeting outside India to be presumed as a non-resident.
Considering the issues and abiding by the compliances there are many reasons why corporates are preferred in Delaware, to know more about the ‘Corporate Haven’ click here
Delaware a Physical Paradise!
Delaware has a population of approximately 1 million. But the companies registered in Delaware are more than 1 million. Its business-friendly laws ranked Delaware as the ‘world’s most opaque jurisdiction on the Tax Justice Network 2009 Financial Secrecy Index.
A huge sector of capitalists is opting for this kind of structuring and with the increase in foreign investments such flips are turning out a major route for a lot of start-ups.