e&y paper

Maini Restructuring and debt raise Executive Summary

EY refers to the global organization, and/or one or more of the independent member firms of Ernst & Young Global Limited

12 November 2014

Draft For discussions only

Glossary

MPPL Maini Precision Products Private Limited

WOS Wholly Owned Subsidiary

MIPL Maini Industries Private Limited

NCD Non-Convertible Debentures

RPS Redeemable Preference Shares

NBFC Non-Banking Financial Company

ROC Registrar of Companies

Income Tax Act The Income-tax Act, 1961

Companies Act The Companies Act, 2013

Background and our understanding MPPL, is incorporated as a private limited company in India

Shares of MPPL are primarily held by the resident Indian promoters of the Maini Group

The Maini Group proposes to refinance debt which had been raised by the promoters of the Maini Group in respect of MPPL

The promoter had raised this debt in order to finance the purchase of 25.3% of the shares in MPPL from a third-party investor

We understand that the promoter had raised this debt from an Indian corporate

Further, we understand that MPPL is considering a business reorganization under which the auto division would be spun-off into Maini Global Aerospace Private Limited, a wholly owned subsidiary of MPPL (WOS).

In this context, the Maini Group has identified mechanisms for structuring the debt refinance in two separate scenarios

Scenario A - The auto business is spun-off into the WOS

Scenario B - The auto business is retained within MPPL, as presently In both scenarios, the alternative of MPPL subscribing to NCDs in MIPL instead of RPS is also being evaluated

This slide deck lays out a summary of the implications to MPPL, MIPL and the Promoter from the transactions envisaged in the above scenarios

For discussion purposes only

Objective

This slide deck lays out a summary of the implications to MPPL, MIPL and the Promoter from the transactions envisaged in the scenarios identified

The slide deck summarizes implications under

Income Tax Act, 1961

Applicable corporate law [Companies Act, 2013 and Companies Act, 1956 where applicable]


Debt Refinance Mechanics Scenario A Auto business is hived off

1. MPPL transfers the auto business to WOS for an agreed

lump-sum consideration (excluding land and building)

The consideration for the transfer would be outstanding.

2. Promoter transfers equity shares representing 25.3%

shareholding in MPPL to MIPL. As consideration, the debt

borrowed by Promoter from Lender would be assigned to

MIPL.

3. WOS would raise debt from a new lender (New Lender).

WOS to utilize proceeds of debt raised to settle the purchase consideration due to MPPL, towards the

business purchase.


4. MPPL would utilize the sale consideration received from

MPPL to subscribe to RPS in MIPL. We understand that

the shares would be subscribed to at par.

5. MIPL would utilize the funds received through issue of RPS

to repay the debt due to the Lender.

Debt Refinance Mechanics Scenario B Auto business is retained in MPPL

1. Promoter transfers equity shares representing 25.3%

shareholding in MPPL to MIPL. The debt borrowed by

Promoter from Lender would be assigned to MIPL, as

consideration for the share transfer.

2. MPPL would raise debt from a New lender


3. MPPL would to utilize the proceeds of debt raised to

subscribe to Redeemable Preference Shares in MIPL

4. MIPL would utilize the funds received from MPPL to repay

the debt raised from Lender.

Implications Executive Summary Scenario A

Scenario A - Summary of Implications Step 1 - Transfer of auto business from MPPL to WOS

Where the sale consideration for the business does not exceed the cost of acquisition of the assets in the hands of MPPL, no taxable income should arise to MPPL

For normal tax provisions, the Income Tax Written Down Value of fixed assets, and carrying value of other assets and liabilities as per books of account would be relevant

For MAT purposes, the carrying value of the assets / liabilities in the books of MPPL would be relevant

Transfer of the business to WOS would not be subject to the transfer pricing provisions

No VAT should apply, so long as the business is sold as a going concern for a lump-sum consideration (as against transfer of identified assets / liabilities)

Since no immoveable property is being transferred under the business transfer, possibility of structuring the business transfer in a manner which does not attract stamp duty as Conveyance need to discuss with the lawyers

Approval of the shareholders of MPPL would potentially be required for the transfer of the auto business, as a related party transaction under section 188 of the Companies Act


Step 1 - The entire Auto business would be transferred by MPPL to WOS for a lump-sum consideration. The consideration would remain outstanding.

Scenario A - Summary of Implications ( 1 /2) Step 2 - Transfer of MPPL shareholding

Any gains arising to the Promoter from the transfer of MPPL shares to MIPL would be taxable as capital gains . For this purpose, capital gains would be computed as -

Capital gains = Value of the liability transferred ( - ) Cost of acquisition of the MPPL shares

Any such capital gains would be taxable at 20%* if held for a period of more than 36 months prior to the transfer; a higher rate of 30% would apply in other cases.

No taxable income would arise to the Promoter if the value of the liability transferred to MIPL does not exceed the cost of acquisition of the MPPL shares in the hands of the Promoter

Where the sale consideration for the shares (i.e. value of the liability transferred to MIPL) is higher than their fair value, no taxable income arises to the MIPL on the share transfer

For this purpose, the fair value of the shares is to be computed on the basis of a prescribed formula** which is based on the Net Asset Value of the company, as on the date of the share transfer


Step 2 Promoter transfers equity shares representing 25.3% shareholding in MPPL to MIPL. As consideration, the debt borrowed by Promoter from Lender would be assigned to MIPL.

* Excluding surcharge and cess

** Rule 11UA

Scenario A - Summary of Implications ( 2 / 2) Step 2 - Transfer of MPPL shareholding

The share transfer would be subject to stamp duty at 0.25% on the consideration

The stamp duty on the share transfer would be mitigated if the shares are held in dematerialized form prior to the share transfer

Applicability of stamp duty to the assignment of the loan from Promoter to MIPL to be discussed with the lawyers

Approval of the shareholders of MIPL would potentially be required for the transfer of the shares from the Promoter to MIPL, as a related party transaction under section 188 of the Companies Act

Need to obtain approval of the Lender for assignment of the loan from the Promoter to MIPL

Since the Lender is an Indian company, post assignment, the loan would not be treated as a public deposit for MIPL.

Under the principal business tests, MIPL should not be treated as an NBFC, so long as either of the following tests are met -

Financial assets constitute not more than 50 per cent of the total assets; or

Income from financial assets constitute not more than 50 percent of the gross income.

Given that MIPL would continue to carry out its manufacturing operations, it is unlikely that MIPL would be classified as an NBFC


Scenario A - Summary of Implications Step 3 Debt raise from New Lender

No specific implications for WOS on raising debt from New Lender, and utilizing the proceeds to settle the purchase consideration for the business transfer

WOS can potentially claim the interest arising on the debt raised from New Lender as a deduction in respect of its business income (Post the business transfer, WOS would house the auto business)


Step 3 - WOS would raise debt from a New lender (New Lender); proceeds would be used to settle the purchase consideration for the business transfer

Scenario A - Summary of Implications ( 1 / 3) Step 4 Subscription to RPS in MIPL

The payment made by MPPL to MIPL towards subscription to RPS should not be treated as a deemed dividend, since the payment is not by way of a advance or a loan

The relevant deemed dividend provisions* are attracted only where the payment is by way of an advance or a loan

As an additional defence against the application of the deemed dividend provisions, MPPL can also consider capitalizing its entire accumulated profits by issue of bonus shares to its existing shareholders

The relevant deemed dividend provisions* apply only where the company has accumulated profits. For this purpose, accumulated profits which have been capitalized by issue of bonus shares are excluded.

Issue of bonus shares does not have any Income Tax implications for the shareholders and MPPL

The provisions relating to taxation of share premium** would not apply to MIPL, so long as MPPL has subscribed to the RPS at face value

In order to facilitate the subscription to RPS, MIPL would need to increase its authorized capital

Stamp duty and ROC fees associated with the increase in authorized capital of MIPL to be kept in mind


Step 4 - MPPL would utilize the sale consideration received from MPPL to subscribe to RPS in

MIPL, at par value

* Section 2(22)(e) of the Income Tax Act

** Section 56(2)(viib) of the Income Tax Act

Scenario A - Summary of Implications ( 2 / 3) Step 4 Subscription to RPS in MIPL

Section 19 of the Companies Act places certain restrictions on a subsidiary company holding shares in its holding company. For this purpose, a company shall be treated as a subsidiary of the other if

It controls the composition of the Board of Directors of the other company; or

It exercises or controls more than one-half of the aggregate of (a) Paid up equity share capital; and (b) Convertible Preference Share capital* Holding of non-convertible Redeemable Preference Shares is not by itself sufficient for one company to be treated as a subsidiary of the other.

In the present case, MIPL should not be characterized as a subsidiary of MPPL since

MPPL would not be holding any Equity Shares or Convertible Preference Shares in MIPL; and

The Articles of Association of MIPL would provide that holders of redeemable preference shares (such as MPPL) would not have the right to appoint directors on its Board**

It must be noted that the holders of RPS (i.e. MPPL) are not entitled to voting rights in a General Meeting of MIPL unless the preference dividend has not been paid for two years or more

Further, MIPL would not be treated as a holding company of MPPL, since it holds less than 50% of MPPLs equity share capital

Given this, there should be no restriction on MIPL holding shares in MPPL


* Section 2(87) of the Companies Act read with Rule 2(1)(r) of the Companies (Specification of Definitions Details) Rules, 2014

** Necessary amendments may be required to be made to the Articles of Association of MIPL in this regard

Scenario A - Summary of Implications (3 / 3) Step 4 Subscription to RPS in MIPL

Under Section 67(2) of the Companies Act, a public company is restricted from providing financial assistance to any person in connection with a purchase of any shares in that company

The above restrictions only apply to a public company; these restrictions do not apply to a private company as such

Given that MIPL and MPPL are both private companies, the restriction set-out under section 67(2) of the Companies Act should not apply


Scenario A - Summary of Implications Step 5 Repayment of debt from Lender

No specific implications in the event MIPL repays the debt raised from Lender

It is likely that any interest paid by MIPL on the debt from Lender would not be available as a deduction in the hands of MIPL


Step 5 - MIPL would utilize the funds received through issue of RPS to repay the debt raised

from Lender.

Implications Executive Summary Scenario B

Scenario B - Summary of Implications ( 1 /2) Step 1 - Transfer of MPPL shareholding

Any gains arising to the Promoter from the transfer of MPPL shares to MIPL would be taxable as capital gains . For this purpose, capital gains would be computed as -

Capital gains = Value of the liability transferred ( - ) Cost of acquisition of the MPPL shares

Any such capital gains would be taxable at 20%* if held for a period of more than 36 months prior to the transfer; a higher rate of 30% would apply in other cases.

No taxable income would arise to the Promoter if the value of the liability transferred to MIPL does not exceed the cost of acquisition of the MPPL shares in the hands of the Promoter

Where the sale consideration for the shares (i.e. value of the liability transferred to MIPL) is higher than their fair value, no taxable income arises to the MIPL on the share transfer

For this purpose, the fair value of the shares is to be computed on the basis of a prescribed formula** which is based on the Net Asset Value of the company, as on the date of the share transfer


Step 1 Promoter transfers equity shares representing 25.3% shareholding in MPPL to MIPL. As consideration, the debt borrowed by Promoter from Lender would be assigned to MIPL.

* Excluding surcharge and cess

** Rule 11UA

Scenario B - Summary of Implications ( 2 /2) Step 1 - Transfer of MPPL shareholding

The share transfer would be subject to stamp duty at 0.25%

The stamp duty on the share transfer would be mitigated if the shares are held in dematerialized form prior to the share transfer

Applicability of stamp duty to the assignment of the loan from Promoter to MIPL to be discussed with the lawyers

Approval of the shareholders of MIPL would potentially be required for the transfer of the shares from the Promoter to MIPL, as a related party transaction under section 188 of the Companies Act

Need to obtain approval of the Lender for assignment of the loan from the Promoter to MIPL

Since the Lender is an Indian company, post assignment the loan would not be treated as a public deposit for MIPL.

Under the principal business tests, MIPL should not be treated as an NBFC, so long as either of the following tests are met -

Financial assets constitute not more than 50 per cent of the total assets; or

Income from financial assets constitute not more than 50 percent of the gross income.

Given that MIPL would continue to carry out its manufacturing operations, it is unlikely that MIPL would be classified as an NBFC


Scenario B - Summary of Implications Step 2 Debt raise from New Lender

No specific implications for MPPL on raising debt from New Lender, and utilizing the proceeds to settle the purchase consideration for the business transfer

Where the proceeds of the debt would be used to subscribe to Redeemable Preference Shares in MIPL, it is likely that the interest on the debt would not be available as a deduction against MPPLs business income (due to operation of section 14A of the Income Tax Act)


Step 2 - MPPL would raise debt from a new lender (New Lender)

Scenario B - Summary of Implications ( 1 / 3) Step 3 Subscription to RPS in MIPL

The payment made by MPPL to MIPL towards subscription to RPS should not be treated as a deemed dividend, since the payment is not by way of a advance or a loan

The relevant deemed dividend provisions* are attracted only where the payment is by way of an advance or a loan

As an additional defence against the application of the deemed dividend provisions, MPPL can also consider capitalizing its entire accumulated profits by issue of bonus shares to its existing shareholders

The relevant deemed dividend provisions* apply only where the company has accumulated profits. For this purpose, accumulated profits which have been capitalized by issue of bonus shares are excluded.

The provisions relating to taxation of share premium** would not apply to MIPL, so long as MPPL has subscribed to the RPS at face value

In order to facilitate the subscription to RPS, MIPL would need to increase its authorized capital

Stamp duty and ROC fees associated with the increase in authorized capital of MIPL to be kept in mind


Step 3 - MPPL would utilize the proceeds from the debt raised in Step 2 to subscribe to RPS in

MIPL, at par value


** Section 56(2)(viib) of the Income Tax Act


Section 19 of the Companies Act places certain restrictions on a subsidiary company holding shares in its holding company. For this purpose, a company shall be treated as a subsidiary of the other if

It controls the composition of the Board of Directors of the other company; or

It exercises or controls more than one-half of the aggregate of (a) Paid up equity share capital; and (b) Convertible Preference Share capital* Holding of non-convertible Redeemable Preference Shares is not by itself sufficient for one company to be treated as a subsidiary of the other.

In the present case, MIPL should not be characterized as a subsidiary of MPPL since

MPPL would not be holding any Equity Shares or Convertible Preference Shares in MIPL; and

The Articles of Association of MIPL would provide that holders of redeemable preference shares (such as MPPL) would not have the right to appoint directors on its Board**

It must be noted that the holders of RPS (i.e. MPPL) are not entitled to voting rights in a General Meeting of MIPL unless the preference dividend has not been paid for two years or more

Further, MIPL would not be treated as a holding company of MPPL, since it holds less than 50% of MPPLs equity share capital

Given this, there should be no restriction on MIPL holding shares in MPPL


* Section 2(87) of the Companies Act read with Rule 2(1)(r) of the Companies (Specification of Definitions Details) Rules, 2014

** Necessary amendments may be required to be made to the Articles of Association of MIPL in this regard


Under Section 67(2) of the Companies Act, a public company is restricting from providing financial assistance to any person in connection with a purchase of any shares in that company

The above restrictions only apply to a public company; these restrictions do not apply to a private company as such

Given that MIPL and MPPL are both private companies, the restriction set-out under section 67(2) of the Companies Act should not apply


Scenario B - Summary of Implications Step 4 Repayment of debt from Lender

No specific implications in the event MIPL repays the debt raised from Lender

There is a possibility that any interest paid by MIPL on the debt from Lender would not be available as a deduction in the hands of MIPL


Step 4 - MIPL would utilize the funds received through issue of RPS to repay the debt raised

from Lender.

The debt alternative

The debt alternative Mechanics

In both scenarios, it is proposed that MPPL would subscribe to RPS in MIPL (Step 4 in Scenario A and Step 3 in Scenario B)

As an alternative to the RPS subscription, the following mechanism can be evaluated

Step 1 : MPPL capitalizes its accumulated profits by way of issue of bonus equity shares to its shareholders

Step 2 : MPPL then subscribes to Non-Convertible Debentures (NCDs) issued by MIPL (Alternatively, MPPL can extend an inter-corporate loan to MIPL)

Step 3 : MIPL utilizes the proceeds of the NCDs to repay the loan due to the Lender

All other steps would remain the same, as outlined in Scenario A and Scenario B earlier

The broad implications of this alternative are summarized subsequently


The debt alternative ( 1 / 2) Broad implications

Under the deemed dividend provisions*, an advance or a loan made by a company can potentially be treated as a taxable dividend in certain conditions

However, the relevant deemed dividend provisions* apply only where the company has accumulated profits. For this purpose, there is technical comfort that accumulated profits which have been capitalized by issue of bonus shares are to be excluded.

Consequently, in the event the entire accumulated profits of MIPL are capitalized by issue of bonus shares, any payment made by MIPL towards NCD subscription / inter-corporate loan should not attract the deemed dividend provisions

Section 186(7) of the Companies Act mandates that no company shall give a loan at a rate of interest lower than the prevailing yield of government securities of a similar tenor

Possibility of adopting a position that the provisions of section 186(7) do not apply to subscription of NCDs - to be discussed with the lawyers

In the event the provisions of section 186(7) do not apply, no minimum interest rate would apply to the NCDs the NCDs can carry a coupon / interest rate mutually agreed between the parties

Procedural compliances for issue of NCDs to be kept in mind. Further, the security etc for the NCDs would need to be discussed with the lawyers

Stamp duty and ROC fees in connection with increase in authorized capital and issue of shares to be kept in mind



The debt alternative ( 2 / 2) Broad implications

Interest received by MPPL on the MIPL NCDs / inter-corporate loan would likely be taxable at normal rates of tax, as Income from Other Sources

However, MPPL can potentially claim the interest paid to New Lender as an expenditure against the interest received from MIPL.

It is possible that the interest paid by MIPL on the NCDs / inter-corporate loan would not be available as a deduction in its hands


Scope Limitations

Scope Limitations

The slide deck is in summary form and would need to be read with our detailed comments

Our comments are based on the interpretation of the provisions of the relevant and applicable laws as in force on the date of our analysis and not binding on any regulatory or tax authorities. Therefore, there can be no assurance that the regulatory or tax authorities will not take a position contrary to our comments.

EY LLP has not undertaken any verification/audit of the information provided to us and have relied on the information / documents provided to us by MPPL.

The comments provided are solely for internal discussion purposes by MPPL and is not to be relied upon by any other person or entity. Hence, if you wish to disclose a copy of our presentation to any other person or entity, you must inform them that they may not rely upon our comments for any purpose without our prior written consent.

Our comments on corporate law, stamp duty and other legal matters are subject to confirmation of legal counsel.

EY LLP has no responsibility to update this presentation for events or circumstances occurring after the date of this presentation, unless specifically requested.

While our advice may be a factor to be taken into account, when deciding whether or not to proceed with a particular course of action, our suggestions are only recommendatory and we will not be responsible for any commercial decisions taken.


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