Several domestic startups and corporations are leaning towards structuring their operations by establishing a holding company overseas
The rationale for extending an arm outside the country’s borders by Indian founders is for a host of reasons, which mostly include corporate and tax concessions that are offered by the host country
Prior to establishing an overseas office, all factors must be considered, including whether it will be more profitable for Indian founders to keep their business operations limited to the entity incorporated in India and having subsidiaries established globally
It is not uncommon that many domestic startups, as well as many corporations, are leaning towards structuring their operations by establishing a holding company overseas, with its wholly-owned subsidiary company incorporated in India. This is known as reverse flipping. The rationale for extending an arm outside the country’s borders by the Indian founders is undertaken for a host of reasons, which mostly include corporate and tax concessions that are offered by the host country.
While India has, with its ease of doing business initiative, acted as a host country for many foreign investors/businesses looking for investment/ a place of business, by either incorporating a foreign company in India or investing in an Indian company as angel/strategic investors. Nevertheless, with the ease being limited, many consider the mechanism of flipping the structure, in other words called, externalisation of the holding structure.
The Foreign Exchange Management (Overseas Investment) Rules, 2022 and the Foreign Exchange Management (Overseas Investment) Regulations, 2022 clarify that the flipping culture has been acknowledged by the Reserve Bank of India. The requirement of investment in a bonafide business activity is stated as a prerequisite for making an investment overseas by a resident in India. This investment can either be made directly in a foreign entity or through a step-down subsidiary or a special purpose vehicle that will be incorporated overseas.
Though this culture has been in the limelight even much before these rules expressed the manner under which this reverse flipping can be adopted by business players in the Indian market. However, it becomes crucial to understand how the following factors act as an aid or an impediment to the growth of the business in the longer run.
Need To Construct A Corporate Structure Beyond Domestic Boundaries
The requirement to change the domicile of business essentially stems from the vision of the Indian founders wanting to adopt the reverse flipping culture. It may be undertaken to achieve growth beyond the pan-India area, enabling the business to tap international customers by providing its services/products through a foreign company and having easier access to a larger public capital market.
Many Indian founders have chosen countries such as Singapore, Mauritius, and the USA, to incorporate a domiciled company, with its wholly-owned subsidiary being present in India.
For instance, a Singapore-based country will be able to tap investments and raise capital at a global level due to the transparent and accountable standards adopted by such a nation. At the same time, it offers flexibility in the structuring of the transactions, which, as opposed to India, imposes several regulatory limitations in terms of intellectual property rights, foreign direct investment, taxation, etc.
Factors Governing The Decision To Flip
Apart from extending a better presence in the global market and offering transparency and flexibility in structuring the transactions, demanding less regulatory framework for achieving the purpose, making it an easier choice for attracting investments, there are many other factors which bring the lean feel more lucrative from the perspective of Indian founders.
At this juncture, many have considered this route, due to the manner under which the businesses can structure a transaction that provides a better exit to investors in the secondary market, without going public. At the time of going public in India, there are a lot of corporations that find it challenging to get an optimal valuation, whereas in countries such as Singapore, there is a likelihood of better valuations, due to the developed ecosystem it offers. There are other factors, such as lower tax rates and a simpler tax code offering ease in compliance. Countries such as Singapore, also do not levy any capital gains tax at the time of exits.
The National Framework for Innovation and Enterprise (NFIE) is a national programme to grow innovation and entrepreneurship in Singapore. Such countries offer various schemes, incentives, etc., which makes the idea of preferring the headquarters outside India. Some of such incentives are stated as follows: –
- Startup tax exemption scheme
- Loans provided for expansion
- Double tax deduction scheme for internationalization
- Tax exemption under fixed capital expenditure
- Enterprise development grant
- Pioneer tax incentive
- Development and expansion incentive
- Accelerating digital transformation
- Progressive wage credit scheme
- Withholding tax (WHT) exemption
Acts As An Element To Growth Or Can Be Looked As An Impediment To Progress
For any Indian founder, it is necessary to understand whether having the business headquartered in India offers more benefits than opting for reverse flipping. It is not denied that the regulatory framework of India provides uniform treatment to both Indian-domiciled companies as well as foreign companies having a subsidiary in India.
Nevertheless, this is not true for all the sectors, such as areas including foreign direct investment in online retail where the treatment of foreign companies and their subsidiaries are not at par with Indian home-grown companies. This is also seen in the defence space where Indian companies are provided preferential treatment over their foreign counterparts.
Even the factor of having its business linked to countries, such as China, if reverse flipping is adopted of having headquarters in China may prove to be more difficult than having foreign direct investment in an Indian entity from such countries as the founders may be prone to several regulations as there is increased scrutiny, especially with countries India does not enjoy favourable terms. It is critical to understand whether using reverse flipping will simplify the transaction in terms of the additional compliances and permissions required under Indian law, or whether the Indian domain may be more beneficial to the business sector.
As externalisation is not a one-size-fits-all approach, it is critical for every Indian founder/entity to individually analyse its business structure and sector to which the business caters to determine whether flipping acts as an aid or an impediment to growth. Prior to establishing an overseas office, all factors must be considered, including whether it will be more profitable for Indian founders to keep their business operations limited to the entity incorporated in India and having subsidiaries established globally.