The SEBI Takeover Code should be amended to say that any acquirer will be successful in getting control of the company only if an open offer is successfully made to acquire up to 50 per cent of the firms equity share capital.
To make takeovers of companies in India more open, transparent and participative, it is important that certain anomalies in the SEBI (Securities and Exchange Board of India) Takeover Code and in the Income-Tax (I-T) Act are removed quickly to deliver a smooth and tax effective process of takeovers.
The first issue is of treatment of capital gains tax on shares sold in an open offer. As per the SEBI Takeover Code, any acquirer who wants to take control of the target company has to, under Regulation 10, 11 and 12, make an open offer to the shareholders for 20 per cent of the equity capital of the target company. Generally, these shares are acquired by the acquirer at a price higher than the market price.
The rationale behind SEBI asking the acquirer to buy 20 per cent of the shares of the target company from the minority shareholders is to give them an exit option generally at a higher price than the one prevailing on the stock exchanges. World over, such offers are welcomed. But India seems to be an exception. During the last few years, the open offers have evoked little response from resident shareholders despite the price offered in most cases being higher than the market price. The reason is simple: Taxation.
STT and capital gain tax
As per the I-T Act, any share which is held for more than 12 months and sold through the stock exchanges by paying Securities Transaction Tax (STT) on the profit, is exempt from capital gains tax. This exemption is available only if the shares are sold through the stock exchanges and the STT is paid.
In the case of an open offer, the shares are tendered through investment bankers acting on behalf of the acquirer; hence, even if the shares are held for more than 12 months, there is no exemption from long-term capital gain tax, and the normal 22.66 per cent is levied on such capital gains.
It is this unequal tax treatment that makes open offers unattractive for resident shareholders. There is no rationale for such harsh tax treatment on the sale of listed companies shares in an open offer.
This indeed is a sore point with resident shareholders, who have to pay a hefty long-term capital gain tax of 22.66 per cent if they tender their shares in an open offer as against FIIs who do not pay any tax. This anomaly, though perhaps unintended, results in a huge disadvantage for resident shareholders. Similar is the situation in the case of buyback of shares by a company or in the case of offer for delisting of the shares. In all these cases, the argument given is that since no STT is paid, these transactions will not have the benefit of capital gain tax exemption.
Minor amendment needed
This situation can easily be set right through a small amendment to the I-T Act. The issue of collection of STT in an open offer can be easily sorted out by making investment bankers responsible for the same, as do stock exchanges and trustees in the case of shares and mutual funds respectively. Whenever such shares are tendered in an open offer, investment bankers can collect STT and deposit the same with the exchequer.
Similarly, for buyback of shares, the company can be made the prescribed entity to collect STT. This will come as a major relief for resident shareholders, giving them an opportunity to participate in the open offer by bringing it on a par with the sale of shares through exchanges.
Another area which requires amendment in the SEBI Takeover Code is to define the control over a company by way of simple majority. As per the Takeover Code, any acquirer who gets hold of 15 per cent or more equity shares in a company or a controlling stake in a company under Regulation 10, 11 and 12, has to make an open offer of 20 per cent of the equity share capital of the target company. The Takeover Code thus casts an obligation on the acquirer to make an open offer of 20 per cent of the shares of company and after completion of such an open offer, the acquirer assumes the control of the company, irrespective of the shareholding of the acquirer.
This perhaps presupposes that the acquirer has already agreed to take controlling stake of the target company from the sellers, which may be 30 per cent or more shares, and making the open offer of 20 per cent, would give the acquirer simple majority in the company.
In fact, it has been observed that in many cases an acquirer has not even got 25 per cent of the equity capital in the company but assumes control over the company. This is major anomaly should be rectified quickly, especially because India is emerging as one of the most favourite investment destinations. And also because private equity players are making a beeline for Indian companies.
The Takeover Code should be so amended to incorporate that any acquirer will be successful in acquiring control of the company only if an open offer is made to acquire up to 50 per cent of the equity share capital of the company, including that of the selling shareholders, or 20 per cent, whichever is higher.
This will ensure that the acquirer assumes control over the company with 50 per cent or more of the voting shares; making an open offer of 20 per cent of the shares, whether successful or otherwise, is more a technical compliance exercise at present. This will put to rest the controversy as regard to who has the controlling stake in the company.
In most developed capital markets, whenever an acquirer wants to take over a listed company, it has to make an open offer to all the shareholders. In fact, in many countries, it is mandatory for the acquirer to make necessary financial arrangements for acquiring the entire outstanding share capital of the company.
With mergers and acquisitions (M&A) gaining momentum, it will be important that the Takeover Code is clear and unambiguous about who has the controlling shareholding. The simple majority of voting rights is the acid test to prove who is in control, and the Code should be amended to incorporate this.
Anil Singhvi (The author is Managing Director of Ican Investments Advisers Ltd, Mumbai.)