The current low valuation of listed companies makes it an opportune time for acquisitions through share swaps. Under current Indian law, an Indian company can acquire foreign companies pursuant to the ADR/GDR share swap mechanism only if the Indian company is already listed on overseas stock exchanges. Additionally, Indian companies looking at acquiring US companies may be confronted with the concept of `reverse triangular' or `forward triangular' mergers, structures which are common in US.

Reverse/forward triangular merger  

The structure chart set forth below depicts the typical reverse triangular merger route. As depicted above, in a reverse triangular merger, the Indian company (X) would first set up a company in the US (Y). Y would then merge with and into the US target (target) pursuant to a merger agreement. At closing, the rights of the stockholders to the shares they hold in the target gets extinguished and instead, they have a right to subscribe to the shares/ADRs/GDRs, as the case may be, to be issued by X.

Exchange Control Issues

The RBI regulations for overseas direct investment provide for an automatic route with regard to ADR/GDR share swap transactions provided that the transaction complies with certain conditions.

Previously, this route was available only to companies in the information technology and entertainment software sector, the pharmaceuticals sector and the biotechnology sector.

In April 2001, both the ministry of finance and the RBI extended this facility to all Indian companies listed on overseas stock exchanges.

An Indian company acquiring an overseas company via the ADR/GDR share swap route would need to comply with the following conditions in order for the transaction to fall within the automatic route, the total value of the ADR/GDR share swap transactions (undertaken in each financial year) should not exceed $100 million or 10 times the export earnings of the acquirer during the preceding year; the consideration in the form of issue of ADRs/GDRs of the acquirer is backed by underlying fresh equity shares issued by the acquirer; the valuation of the shares of the foreign target is made as per the monthly average price of the target's stock on any stock exchange abroad for the three months preceding the month in which the acquisition is undertaken or as per the recommendations of an investment banker if the target's shares are not listed on any stock exchange abroad.

Since there are no issue proceeds in an ADR/GDR share swap transaction, the Indian acquirer may need to approach its authorized dealer for permission to remit monies relating to such expenses.

Plain equity share swap transactions pursuant to which the Indian acquirer acquires equity in a foreign company would generally require the prior approval of the Foreign Investments Promotion Board for the foreign company to receive shares in the Indian entity in consideration for the Indian company acquiring shares of the foreign company.
ADR/GDR share swap transactions however, are specifically exempt from the requirement of prior FIPB approval if certain prescribed conditions are complied with.

SEBI Guidelines- Issue of Shares
An issue that arises in share swap transactions when the Indian acquirer is listed in India is the applicability of the SEBI DIP Guidelines, 1999 for preferential allotments. The SEBI DIP Guidelines provide that any issue of shares on a preferential basis by an Indian listed company would need to comply with the prescribed pricing formula which is related to the weekly average high and low of the share price over a period of six weeks from the date on which the shareholder's of the Indian company pass the resolution approving the preferential allotment of shares to the foreign company.

Since the cornerstone of any share swap transaction is the share exchange ratio, which may not comply with the prescribed pricing formula, the Indian company may be required to file an application to the SEBI seeking an exemption from this provision.

Stock Options
Another issue that arises when an Indian listed company acquires a foreign company that has outstanding stock options that have already vested in their employees is the applicability of the SEBI ESOP guidelines.

The ESOP guidelines provide for a mandatory lock-in of one year from the date of grant of the option to the date of the vesting of the option. In such an acquisition, the outstanding stock options of the foreign target would have to be "assumed" by the Indian Acquirer. Unfortunately, the ESOP guidelines contain no provision for assumption of stock options. As a result, under the ESOP guidelines, the foreign employee will have to wait for an additional period of one year from the date of acquisition/merger before the stock options vests in him/her. This could prove to be a showstopper for some acquisitions where the Acquirer is mainly interested in acquiring the Target for its employees and the management team.

Taxation
The most relevant issue from the perspective of Indian tax would be whether there would be any capital gains tax liability in India on reverse/forward triangular mergers. The crux of deciding whether there is any capital gains tax liability lies in whether there is a "transfer" of a capital asset (which includes the extinguishment of the rights in a capital asset) for the purposes of the Income-Tax Act, 1961 (IT Act) which results in a capital gains tax liability in India if any of the shareholders of the foreign target are Indian residents, if such "transfer" is not specifically tax exempt.

The Supreme Court, in the Grace Collis case [(2000)(48 ITR323)] held that since the definition of the term "transfer" under the ITA included "extinguishment of any rights in a capital asset", and further since the rights of shareholders in the amalgamating company would be extinguished, the same would amount to a "transfer".Hence, as a result of this decision, amalgamations would be taxable it they are not specifically exempt under section 47(vii) of the ITA. This is a crucial point to note in cross-border amalgamations, where it would not be possible to comply with the provisions of Section 47(vii) of the ITA.

Often the Indian Acquirer would stumble upon a foreign Target that already has existing Indian operations. If the foreign Target has Indian operations in the form of a unit set up in an STP or a 100 per cent EOU, and if such unit is availing of income-tax exemption by way of a tax holiday under section 10A or 10B of the ITA then it would be important to structure the transaction appropriately so that there is no subsequent loss of tax benefit for the STP unit or 100 per cent EOU.

For instance, if the target is in the U.S, then the transaction can be structured as a reverse rather than a forward triangular merger. This may reduce the possibility of loss of tax benefits under section 10A /10B of the ITA. If however, there is a loss of tax benefits under section 10A/10B, then alternate tax benefits under section 80 HHE of the IT Act may be availed of.

Conclusion
To conclude, it can be said that there are different methods of structuring cross border acquisitions depending mainly on the reasons for the acquisition. The complexities that arise in each case are peculiar to the transaction. The challenge for legal professionals is to attempt to structure the transaction to meet the business needs of the client as well as tailor the transaction to fit within the conflicting legal, tax and regulatory regimes of the jurisdictions involved.