AAR says Tech Mahindra circumvented IPO rules

The Authority of Advance Rulings (AAR) has raised questions regarding Tech Mahindra’s corporate law practices by terming its option arrangement with its client AT&T entered prior to its IPO in 2006 as ‘circuitous’ and against public interests.

Justice PK Balasubramanyan, the chairman of AAR, on Monday refused to give ruling on Mahindra BT Investment (Mauritius)’s AAR application ‘with respect to issue of capital gains tax on its share transfer deal with AT&T citing circumvention of the Securities and Exchange Board of India guidelines by the company while coming out with its IPO.

The AAR is a fast track mechanism to address the tax liability issues of non-resident individuals and firms.

The case refers to capital gains tax liability arising out of Mauritian entity selling 9.87 million ‘option shares’ representing fully paid equity shares of Tech Mahindra to AT&T in March 2010 for $34.5 million, as part of client contract entered between the later two entities.

The IT company had entered into an ‘options arrangement’ prior to its IPO whereby SBC (now AT&T) would be granted options over the shares representing 8% of the enlarged fully diluted ordinary share capital of Tech Mahindra as at the date of that agreement on condition that certain specified milestones relating to commercial frame work agreement entered into by Mahindra-British Telecom and SBC Services are achieved.

To achieve this agreement, Tech Mahindra allotted option shares to its Mauritian entity which in turn sold the option shares representing fully convertible equity shares to AT&T.

As per the detailed judgment report available on the Taxsutra website, the counsel for Mauritian Investment Company had argued that the constitution of investment company was not for tax avoidance purpose but for speeding up the Tech Mahindra public issue.

“If the route now adopted had not been adopted, Tech Mahindra would have had to wait till the year 2010 before it could come out with a public issue,” said S.E. Dastur, the senior counsel for applicant.

The counsel explained that Tech Mahindra wanted to have a public issue of shares and that would not have been possible if it was obliged to AT&T to allot it shares as per the agreement between AT&T and Tech Mahindra and that obligation was outstanding.

According to Sebi (Disclosure & Investor Protection) Guidelines, 2000 under clause 2.6.1 thereof, there is a guideline that no unlisted company can make a public issue of equity share or any security convertible at a later date into equity share, if there are any outstanding financial instruments or any other right which would entitle the existing promoters or shareholders any option to receive equity share capital after the initial public offering.

The chairman of AAR felt that although the company managed to come out with public issue without Sebi’s objection, the public interest was not taken care of.

“The object of the (Sebi’s) Guideline 2.6.1. is clearly to protect the investing public by ensuring that while a company makes a public issue, it is not burdened with any outstanding financial instruments or a right which would entitle the existing promoters or shareholders any option to receive equity share capital after the initial public offering. I understand from this (counsel’s) argument that clause 2.6.1 of the SEBI Guidelines, 2000 was avoided, circumvented or evaded by this circuitous arrangement of entering into a contract with the applicant and by entering into another agreement (even prior in point of time) to sell those shares to be allotted,” he said.