Know how RIL and Jio raised billions with no tax liability
Reliance Industries Limited said on June 19 that it had become net debt-free eight months ahead of March 2021 deadline it had set for itself. The target of making the oil-to-telecom organisation debt-free was outlined by Chairman and Managing Director Mukesh Ambani at RIL’s 42nd Annual General Meeting on August 12, 2019.
Reliance Industries Limited (RIL) announced the largest, fastest fund raise so far in India Inc of more than Rs 1.5 lakh crore though a 33% stake sale in its subsidiary Jio Platforms to 13 marquee foreign investors.
A marquee investor is either an individual or a corporate/institutional investor, well known for investing in companies that turn into success stories at a later date. But, neither RIL nor Jio Platforms may be paying any tax on the stake sales, thanks to some smart deal structuring, show documents filed by Jio Platforms on the Ministry of Company Affairs (MCA) portal.
How is sale of stake in subsidiary taxed?
- A subsidiary stock sale involves a parent company selling secondary shares of the subsidiary to the public on the stock market.
- The parent company must recognize taxable gain equal to the difference between the cash proceeds and the tax cost basis in the subsidiary’s shares.
- If the parent company does not distribute sale proceeds to its shareholders in the form of a regular dividend, the subsidiary stock sale is tax-free for the shareholders of the parent company.
- Otherwise, investors must pay taxes on any proceeds received from the divesting company.
Let us first understand Jio Platform’s equity structure better before we move forward
Jio Platform’s total equity as on March 2020 comprised equity share capital (Rs 4,961 crore) + Other equity (Rs 1,77,064 crore) of optionally convertible preference shares (OCPS) issued to RIL.
What was the initial assumption about sale of stake in Jio Platforms?
- It was earlier believed that when investors bought stake in Jio Platforms, they would be given equity shares by converting the OCPS held by RIL.
- So, the amount of OCPS would reduce while the share capital would increase. This would keep the total equity the same. Thus, dilution of earlier shareholders (except RIL) did not happen when shares were issued to new investors.
- Basically, the stake sales seemed to be structured as a transfer of shares from RIL.
- But this arrangement would have left RIL left liable to pay capital gains tax as it would have sold equity shares converted from the OCPS that it held in Jio Platforms to the investors at a premium.
- The gains on such transfer of securities would have been categorised as short-term (taxed at the highest applicable rate, in excess of 30%), given that Jio Platforms was incorporated only late last year.
Why would Short term capital gains (STCG) tax be leviable in the above situation?
- Any profit that is realised from disposition, transfer or sale of any investment property or asset is known as a capital gain. If holding term for these properties is less than 12 months (36 or 24 months in some case), then profit generated from their sale is termed at short term capital gain.
- However, since shares and stocks are faster-moving assets, a holding period of less than 12 months is considered to be short term.
- However, this period of 12 months is considered only for shares listed under a recognised stock exchange like Bombay Stock Exchange (BSE), National Stock Exchange (NSE), etc. For shares not traded through or listed under these stock exchanges, holding period is considered to be 36 months.
- STCG on shares can be calculated as given below:
- STCG = Sale value of an asset – (cost of acquisition + expenses incurred in the course of transfer/sale + cost of asset improvement)
The STCG tax leviable would have jeopardised RIL’s plan of becoming net-debt free.
How did Jio Platforms raise billions?
Jio Platforms opted for a fund-raising model adopted by many start-ups that raised capital from a series of investors within a time window. This is generally known as the start-up model. In this model, a company agrees with investors that a particular number of shares, eventually representing a certain percentage of the fully diluted share capital, would be allotted to them at the end of the fund raise from multiple investors. Also, adjustments if necessary, are made to the capital structure to maintain the agreed shareholding of investors. This way, earlier investors did not get their stakes diluted when new investors are brought in.
The potential tax was dodged by a simple method, the fresh issue of shares by Jio Platforms to the various investors.
- To Facebook, Jio Platforms issued both equity shares and 0.01% CCPS (compulsorily convertible preference shares) at Rs 488.34 per share.
- To Google, Jio Platforms issued equity shares at the same price of Rs 488.34 per share.
- All the other investors were issued equity shares at a higher price of Rs 549.31 a share.
- With these total share proceeds of Rs 1,52,318 crore, Jio Platforms redeemed/repaid the OCPS worth Rs 1,29,046 crore held by RIL and retained Rs 23,272 crore with itself.
Then how did RIL raise billions without paying tax?
- Through these shares by Jio Platforms, RIL got repaid a chunk of its OCPS, thus reducing its own net-debt position significantly.
- The redemption of OCPS held by RIL was essentially repayment of funds earlier infused by RIL into Jio Platforms, and would not attract tax.
- Jio Platforms could retain a portion of the funds for its own purposes. As it was Jio Platforms that issued the shares, RIL will not have to pay tax on the stake sale.
- Jio Platforms, too, would not have to pay tax though it issued shares at a tidy premium – that’s because the pricing of the shares took into account their fair value based on the report of an independent valuer.
- Even if the shares’ sale price was higher than the fair value, the tax law provides concessions if the buyer is a non-resident investor.
What are the tax provisions when shares are issued at a premium?
- There are many Companies, other than a company in which public are substantially interested that issue equity shares at a Premium which is more than the Face Value per share of the Company.
- This is largely due to the fact that over a period of time, the company has established their goodwill, reputation, brands or other intangible benefits that are not reflected in the financials of the Company.
- These companies, that issues fresh equity shares at a premium, are exposed to the risk of getting the premium amount considered as income of the company and may have to end up paying tax on such premium.
- As per Section 56(2) (viib), in case shares are issued at a value which is in excess of the Fair Market Value (FMV) of shares, then the excess amount over the fair value is deemed to be income in the hands of the issuing company.
- Such excess is treated as income of the company liable to be taxed under the head “Income from Other Sources”.
- However, these provisions are not applicable to when shares are issued to non-residents (including foreign institutional investors and strategic foreign investors)
- Basically, when shares are issued by the company to non-resident investors, there is no tax liability for the issuing company on this account.
Did the shareholding of the earlier investors get diluted, when fresh shares were issued to new investors?
- The answer to the above question is No.
- This happened as there was a specific provision in Jio Platform’s altered AOA which stated that, no dilution of any shareholder (other than RIL or any of its permitted transferees) shall occur as a result of any permitted share transaction (after taking into account redemption/conversion of any OCPS in connection with such permitted share transaction).
- In the amended AOA, permitted share transactions comprised ‘incremental equity financings’ and ‘conversion share sales.’
- ‘Incremental equity financings’ referred to fresh issue of shares to new investors while ‘conversion sale shares’ referred to shares issued to new investors by conversion of OCPS held by RIL.
- Jio Platforms opted for ‘incremental equity financings’ which was a permitted share transaction that would not lead to the dilution of existing shareholders.
However, it was unclear how RIL and Jio Platforms in their June quarter results releases said that after completion of these investments, RIL would hold 66.48% in Jio Platforms. Going by the documents on the MCA website, RIL’s holdings in Jio Platforms after the stake sales should be 66.96%. A difference of about 0.5% points would translate into Rs 2400 crore.