Between April 22 and July 15 this year, Reliance Industries Ltd (RIL) announced the largest, fastest fund-raise so far in India Inc – more ₹1.5-lakh crore through a stake sale of about 33 per cent in its subsidiary Jio Platforms to 13 marquee foreign investors.
The stake sale happened at top-dollar valuations. Interestingly, 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.
Jio Platform’s total equity as of March 2020 comprised equity share capital (₹4,961 crore) plus other equity (₹1,77,064 crore). This ‘other equity’ was optionally convertible preference shares (OCPS) issued to RIL. It was earlier believed that when investors bought stake in Jio Platforms, they were given equity shares by converting the OCPS held by RIL. So, the amount of OCPS would have reduced while the share capital increased, keeping the total equity the same. Thus, dilution of earlier shareholders (except RIL) did not happen when shares were issued to new investors. Ergo, the stake sales seemed to have been structured as a transfer of shares from RIL — or, so it was thought.
Side-stepping the tax
But this arrangement would have left RIL 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 per cent), given that Jio Platforms was incorporated only late last year. Not a nice situation for RIL — one that could have jeopardised its plan of becoming net-debt free.
The potential tax pain seems to have been side-stepped by a simple method — fresh issue of shares by Jio Platforms to the various investors. To Facebook, the first investor, and also a strategic one, Jio Platforms issued both equity shares and 0.01 per cent CCPS (compulsorily convertible preference shares) at ₹488.34 per share. Google, the latest investor and also a strategic one, was issued equity shares at the same price — ₹488.34 apiece. All the other investors were issued equity shares at a higher price — ₹549.31 a share. With these total share proceeds of ₹1,52,318 crore, Jio Platforms redeemed OCPS worth ₹1,29,046 crore held by RIL and retained ₹23,272 crore with itself( see table for break-up ).
One stone, many birds
This fresh issue of shares by Jio Platforms helped kill many birds with one stone.
RIL got repaid a chunk of its OCPS, thus reducing its own net-debt position significantly. The redemption of OCPS held by RIL is essentially repayment of funds earlier infused by RIL into Jio Platforms, and will not attract tax.
Jio Platforms could retain a portion of the funds for its own purposes.
Since 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. Suresh Surana, founder of tax consultancy RSM India, explains, “In case the shares are issued at a price which is higher than the fair value, then the amount in excess of the issue price over the fair value, is deemed to be income in the hands of the issuing company per Section 56(2)(viib) of the Income Tax Act. However, this provision is not applicable when shares are issued to non-residents (this would include foreign institutional investors and strategic foreign investors). As such, when shares are issued by the company to non-residents investors, there is no tax liability for the issuing company on this account.”
No dilution of investor stakes
But when fresh shares were issued to new investors, how did the shareholding of the earlier investors not get diluted? This is where a specific provision in Jio Platform’s altered Articles of Association (AOA) comes in: “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 the redemption and/or conversion of any OCPS in connection with such permitted share transaction).”
In the amended AOA, permitted share transactions comprise ‘incremental equity financings’ and ‘conversion share sales’. The former refers to fresh issue of shares to new investors while the latter refers to shares issued to new investors by conversion of OCPS held by RIL. Jio Platforms seems to have opted for ‘incremental equity financings’.
The start-up model
Also, Jio Platforms seems to have opted for a fund-raising model adopted by many start-ups that raise capital from a series of investors within a time window. 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, will 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 do not get their stakes diluted when new investors are brought in. In the case of Jio Platforms, though the deals with the different investors were announced on various dates, the shareholder resolutions for the allocation of shares to all the investors were passed on July 6, 2020.
It is unclear though how RIL and Jio Platforms in their June quarter results releases said that after completion of these investments, RIL would hold 66.48 per cent in Jio Platforms. Going by the documents on the MCA website, RIL’s holding in Jio Platforms after the stake sales should be 66.96 per cent — a difference of about 0.5 percentage points that translates into a tidy sum of ₹2,400 crore.