Tapping global accruals for working capital requirements in India?
Pandemic COVID-19 has created unprecedented economic conditions. The impact is deep globally, more so on the SMEs (Small to Medium enterprises). A glance at the latest reported financial data shows the encompassing need for liquidity. The general sense is that “Cash is King” and that collection from receivables has become extremely important during these times
The above gets you thinking – How feasible would it be, to recover cash in times when the entire economy is conserving liquidity?
Instead of stressing already stressed supply chain, we are seeing companies especially foreign owned subsidiaries in India tap their global reserves and accruals. I have in this article briefly summarized various options available for the same.
I. Equity infusion from foreign shareholder:
Foreign shareholder subscribing to Indian equity is one of the preferred routes for injecting liquidity into the Indian subsidiary. Equity subscription would generally be for long term use as remittance of such invested capital is not freely permitted. Further dividends can be declared on such investment which may be taxable as per applicable tax treaty. The same also entails compliance under FEMA (Foreign Exchange Management Act) rules and require companies to furnish valuation & compliance certificate, filing allotment forms PAS-3 to MCA (Ministry of Corporate Affairs), apart from fulfilling other secretarial requirements.
In short term, per our understanding, this option maybe tax in-efficient (considering complex investment repayment norms) as compared to ECBs (External Commercial Borrowings) or debentures.
II. External Commercial Borrowings (ECB):
ECBs are commercial loans raised by eligible resident entities from recognized non-resident entities. These should conform to parameters such as minimum maturity, permitted and non-permitted end-uses, maximum all-in-cost ceiling, etc.
Indian entities may borrow money from a ‘Foreign equity holder’. Such Foreign equity holder includes entities directly holding 25% or indirectly holding 51% of the Indian entity. Further group companies with common overseas parent may also be allowed to lend to Indian entity.
If an ECB is raised from a foreign equity holder and utilised for working capital purposes, general corporate purpose or repayment of Rupee loans, the MAMP (Minimum Average Maturity Period) may be upto 5 years.
ECB proceeds cannot be utilized for the following activities:
▪ Real estate activities.
▪ Investment in capital market and equity investment.
▪ Working capital purposes & general corporate purposes except from foreign shareholder
▪ Repayment of Rupee loans except from foreign equity holder.
▪ On-lending to entities for the above activities.
Under the aforesaid framework, all eligible borrowers can raise ECB up to USD 750 million or equivalent per financial year under automatic route. Further, in case of FCY denominated, ECB raised from direct foreign equity holder ECB liability-equity ratio for ECBs raised under the automatic route cannot exceed 7:1. However, this ratio will not be applicable if the outstanding amount of all ECBs, including the proposed one, is up to USD 5 million or equivalent. Further, the borrowing entities will also be governed by the guidelines on debt equity ratio issued, if any, by the sectoral or prudential regulator concerned.
The borrower may approach RBI with an application in Form ECB through their AD Category I bank. A loan agreement shall be executed between the company and its parent entity. AD Bank shall review the terms of ECB agreement before proceeding the application to the Reserve Bank of India.
Therefore, an Indian subsidiary may raise up to 5 million USD for purposes of working capital/ general corporate purposes if the same is raised from a Foreign equity holder.
III. Issue of Debentures
Indian entities can also explore the option of issuing compulsory convertible debentures (CCD) or non-convertible debentures (NCD) to its group entity. In case, NCD have to be issued, there is a requirement to either securitize these debentures or list them on an exchange as per relevant provisions of the Companies Act in India. Further Non-Convertible debentures are akin to issue of ECB as explained above.
CCDs, if issued, shall be converted into equity share of the company at a future specified date. A company can issue CCDs for a maximum period of ten years. In case CCDs are issued, the interest payable on such debentures till conversion shall be tax deductible and maybe repatriated abroad after withholding applicable taxes. If CCDs are issued to a non-resident, company is required to file Form FC-GPR to Reserve Bank of India. The CCDs shall be allotted within 60 days of receiving of application money. Form FC-GPR should be filed within 30 days of allotment of CCDs.
Companies prefer CCDs as a fixed return can be paid out as interest to the investor entities. Further interest is tax deductible for Indian balance sheet and entails lower withholding taxes as compared to dividends. At end of conversion term, such debentures are converted into equity shares.
IV. Raising Inter-Company service invoices:
Raising invoices for services provided to global entities may also be considered. In certain cases, raising an inter-company invoice from India would be the easiest and most tax efficient way to transfer funds in case services are being rendered by Indian entity to the parent entity. For example, if an Indian subsidiary is providing certain IT services to its global parent and fee is being charged to the parent entity in the United Kingdom (UK). In case any amount is received into India, the same maybe treated as export of service and not liable to Goods & Services Tax. Further the company may avail export benefits on such services rendered. Also, it is possible that such payments are categorized as fee for included services as per India-UK DTAA and not liable to any withholding taxes.
Raising invoices in a service arrangement is one of the simplest and tax efficient methods of funding the Indian operations.