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Are PE Firms Taking Cover From Tax Uncertainty?

29 October, 2009

Private equity (PE) investors, it appears, are looking at insurance solutions to cover them from risks arising from changing tax rules in India, a recent news report in the Economic Times said. A growing number of overseas investors, especially PE funds, which put money in Indian companies, are buying tax-liability insurance covers, which provide protection from uncertainty in tax laws.

VCCircle spoke to a few leading lawyers, who are deeply engaged in the PE space, and found that such a trend, which may be in the nascent stage in India, is actually more rampant in the West. Comments:-
 
Vijay Sambamurthi, Founder, Lexygen: Recurring regulatory inconsistency could lead to significant loss of confidence among businesses. It is not good for our economy if overseas investors feel compelled to insure themselves against the risks of regulatory and tax uncertainty. This reminds me of the years following the Enron controversy, when insurance companies globally made a killing out of selling political risk insurance to businesses looking to invest in India.
But, I do not think it is yet a very established trend that PE investors are buying regulatory/tax uncertainty risk insurance for their India deals. But, that day, when it becomes commonplace, may not be far away if we continue to produce more such rabbits out of the hat like in the Vodafone case.
I have heard of a couple of instances where PE investors have bought insurance cover for their deals. But, these instances are not a major wave yet, and have thus far been limited to deal structures which involve sale of shares of an overseas company, which owns an Indian company’s shares.
There certainly is a very high degree of concern and uneasiness among investors since the Vodafone case, and I very frequently get queried in detail about the “Indian tax uncertainty risk” by concerned PE clients even in cases of straightforward investment. This really is the damage – material loss of investor confidence – which I don’t believe any amount of market-created solutions like insurance cover would entirely address. One just hopes that with reformist measures like the Direct Taxes Code underway, the key principle of providing certainty and consistency to global investors and businesses through our regulatory framework will not be missed.
 
Pranay Bhatia, Partner, Economic Law Practise: This is still a thought from what I understand from my friends in the PE space. I am not aware if a structured insurance product really exists and if PE transactions in India have taken such solutions, but this is certainly done internationally. There have been two ways till now in order to ensure that a sale or transaction is clean and reduces the contingent tax claims. A popular way has been the tax escrow account which has a limitation of four years. In the event, that the escrow account was not deployed, the money was returned to the seller of the shares.
 
Vijay Chauhan, Associate, Khaitan & Co: As such moves of PE investors are in the backdrop of the rulings in the case of Vodafone and E*Trade Mauritius wherein the lesson taken was that a cross-border investment should be more carefully structured and tax implications be given more attention to apart from commercial and business parameters. Resorting to any such tax liability insurance covers will save the investors in case of any possible tax liability claims of the Indian tax department, for any investment in India or outside India having Indian connection. Since a PE investment is objective, any possible tax liability may prove to be deterrent to the strategy to the investment of the PE investor. Internationally, such investment-based liability insurance coverage is available. Tax-liability insurance covers are one of the genre of such liability insurance coverages. In practice, any contingent tax liability arising out of any share transfer or subscription in favour of PE investor is divided (unless conversely agreed) between the investee company and investor to the extent of its investment.
The investment documents and escrow account sufficiently build provisions for any possible tax liability, among others. 

 


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Are PE Firms Taking Cover From Tax Uncertainty?

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