Indian Depository Receipts (IDRs): A Glimpse

By: Prof. Mallikarjun Bali

BLDEA’s VP Dr. P G H College of Engg & Tech.,

Bijapur

Since April 1992, the Government of India has allowed the Indian companies to tap the global Financial Market and to raise equity capital from the global investors through the issue of Depository Receipts (DRs). In the last around 20 years, more than 100 Indian companies entered the global financial Market and raised huge amount of equity funds. It was the Reliance Industries that issued, in May 1992, the first Global Depository Receipts (GDRs) in which raised around $150 Million.

Like ADR/GDR, the IDRs are the derivative instruments created against the underlying equity shares of the issuing (foreign) company

Introduction to IDRs:

• These are financial instruments that allow foreign companies to mobilize funds from Indian Capital Markets.

• IDRs are depository receipts denominated in Indian Rupees issued by a Domestic Depository in India.

• IDRs represents interest in the shares of a Non-Indian company’s equity.

• IDRs provides a chance to the Indian investors to hold equity shares of foreign company.

• It is created by the Indian Depository in India against the underlying equity shares of the issuing foreign company to raise funds from the Indian markets.

• IDRs are issued in the Demat form. However, at the option of the IDRs holders these can be converted into physical form.

• Like equity shares, these are unsecured instruments and negotiable from one investor to another investor

Process of Buying IDRs:• The process of buying IDRs is same as that of buying equity

shares of Indian Companies. • The facility of Application Supported by Blocked Amount

(ASBA) can also be used while applying to buy the IDRs. As we know that, in the ASBA scheme, the applicant money will not leave investor bank account till the applicant is finally allotted the DRs. The money is blocked by banks and continues to earn interest on it. If you are not allotted IDRs, the money is released.

• In May, 2010 UK based ‘The Standard Charted Bank, the first and the only entity, rose around Rs. 2490 crore through the issue of IDRs. The bank issued IDRs at a price of Rs. 104 per IDR and issue was subscribed by 2.2 times.

Legal Framework and Key Participants:

Issuance of IDRs will be governed by the following legislations:

• The Companies (the issue of IDRs) Rules, 2004 notified by the Ministry of Corporate affairs on 23rd Feb., 2004 and subsequent amendments made thereto.The rules provide the basic framework for issuance of IDRs.

• SEBI (Disclosure and Investor Protection) Guidelines, 2000 (DIP guidelines) and subsequent amendments made thereto.SEBI guidelines suggest as to the contents to be incorporated while preparing offer document.

• If issuer is a financial or banking companies having presence in India, either through a branch/subsidiary, such entity has to obtain prior approval from the Reserve Bank of India.

Principal Parties Involved in the Issue of IDRs:

• Issuer Company – The foreign company listed in their home market seeking to raise fund through this paper.

• Domestic Depository – An Indian entity appointed by the issuer company, registered with SEBI as a custodian of securities. This entity, on behalf of issuing company, issues IDRs to the Indian investors and acts as a Trustee on behalf of the IDR holders; rights and obligations are guided by the depository agreement.

• Oversees Custodian – It is the foreign entity appointed by the Domestic Depository, which holds shares on behalf of the Domestic Depositary and issuing company directly hands over its shares to this entity.

• Registrar and Transfer Agents – An entity appointed by the Domestic Depository which provides a host of services to the Domestic Depository, Issuer Company and IDR holders. The services includes, keeping records of IDR holders handling investor grievances, transfer of IDRs etc.

Exhibit No. 1: Showing Issuance of IDRs

Issuer (Outside India)

Domestic Depository

(In India)

Custodian (Outside India)

Holds shares for

Domestic Depository

Issuer of IDRs to

Investors in India

IDRs

Demat IDRs listed on NSE/BSE

IDR Holders – FIIs, NRIs, Retail, Non-

Institutional Investors

Eligibility Criteria:• As per the Companies IDR rules, as amended till date, the undernoted are the

eligibility criteria for the issue of IDRs:

Sl. No. Criteria Requirements

1 CapitalThe issuer company should have a pre-issue capital and free

reserve of at least US $ 50 million (app. 225 crore)

2Market

Capitalization

The foreign issuing company should have a market

capitalization of $ 100 million or more during last three years.

3Operating

History

Continuous trading record or history on a stock exchange in its

Parent Country for at least three immediately preceding years.

4 ProfitsA track record of distributable profits for at least three out of

immediately preceding five years.

5Other

Requirements

Fulfils such other eligibility criteria as may be laid down by

SEBI from time to time in this behalf.

As per SEBI – ICDR Regulations:

• An issuing company has to fulfill the following conditions:

Additional Requirements for

IDR issue

Issuing company is listed in the home country The issuing company is not prohibited to issue securities by any regulatory bodyIt has a track record of compliance with securities market regulations in its home country

Other conditions:Sl. No. Criteria Requirements

1 Issue Size The size of an IDR issue shall not be less than Rs. 50 crore

2

Minimum

application

amount

The minimum application amount shall be Rs. 20,000/-

3 Extent of issue

The number of underlying equity shares offered in a financial

year through IDRs offering shall not exceed 25% of the post-

issue number of equity shares of the issuing company.

4

Allocation of

shares/

Reservation of

quota

Retail individual investors 30% (including NRIs)

Non-institutional investors 20% (including NRIs)

Qualified institutional buyers 50% (Except Insurance

Companies and Venture Capital funds)

Exhibit No. 2: Showing the Key IDR Related Approvals

Approval From Approval on / for

SEBI -Draft Red Herring Prospectus-Depository agreement

Stock Exchanges

RBI

Board of Directors of

Issuers

-Issuance of IDRs-Approval of IDR prospectus

-Repatriation of IDR proceeds

-In Principle approval-Final listing and trading approval

Indian Regulators

Issuer Related

Key IDR Related Approvals (Cont.)

• Besides, no single individuals/single entity/group of entities in India, other than QIBs, shall hold, directly or indirectly, IDRs exceeding 5% of the issue. No single QIB, or a group of QIBs shall hold IDRs exceeding 15% of the issue.

Benefits to IDR Holders:

• As per extant law, Indian investor can make an investment in the equity shares of global companies to the tune of only $ 2,00,000. Besides, to make investment in such equity instrument, investors need to comply with several things: having demat account outside India to hold foreign securities, foreign bank account to hold funds, KYC with foreign brokers, etc.

• Another way for making global investment is to go through domestic mutual funds, which are allowed to invest in ADRs/GDRs up to 10% of the net assets managed by them, subject to the maximum of $50 million per mutual fund.

• The limit of holding of foreign securities worth of $ 2,00,000 is not applicable to IDRs as these denominated in Indian rupees. These instruments provide opportunities to invest in the listed foreign entity including MNCs and conglomerate.

• Indian investors can now lower risk by diversifying their portfolio. In other words, IDRs enables investors to diversify his holdings across regions to free from the region bias or the risk of the portfolio getting too concentrated in the home market.

• As these instruments are listed, brought and sold on the Indian stock exchanges, the impact of global market and exchange rate risks are reduced to the significant extent, though totally not eliminated. As the transactions are settled according to international standards, it reduces the risk of settlement failures.

• IDRs holders will enjoy the similar rights with that of equity shareholders except attending AGM and voting on special resolutions.

Benefits to the Companies:1. It helps the issuing company to boost its brand in India and target

business opportunities in India.2. Access to Indian capital pool and opportunities for future fund

raising.3. One of the main indicators credit analyst weigh in evaluating the

firms credit worthiness is its debt-equity ratio. An issue of IDR will enhance firms equity and make firms debt ratio smaller, allowing the company to qualify for credit on better terms.

4. It helps the issuing company to broaden the shareholders base.

Redemption:SEBI, on 3rd June, 2011 has issued a circular which states as follows: 1. The regulation does not permit for automatic fungibility of IDRs into underlying

equity share of issuing company. The exchange of IDRs into equity paper of issuing company is allowed only after the completion of one year from the date of closure of issue and that too if there is infrequently trading of these instruments in stock exchange(s). IDRs shall be deemed to be “infrequently traded” if the annualized trading turnover in IDRs during the six calendar months immediately preceding the month of redemption is less than 5% of the listed IDRs.

2. It is the issuer company that has to test the frequency of trading of IDRs on the half yearly basis ending on June and Dec., every year.

3. Issuer Company has to make announcement in news papers within 7 days of the closer of the half year ending on which the liquidity criteria is tested. Besides, the company has to inform the stock exchange(s).

4. The IDRs holders who intends to exchange their instruments into underlying equity shares of the Issuing Company has to submit application to domestic depository within 30 days from the date of such announcement for redemption.

Redemption (Cont.):

5. The entire redemption process shall be completed within 30 days from the date of receipt of application for the same.

6. After such redemption process, the domestic depository shall notify the revised

shareholding pattern of the issuer company to the concerned stock exchanges within 7 days.

7. Person Resident in India (other than companies and mutual funds) are allowed to

hold underlying shares only for the purpose of sale within a period of 30 days from the date of conversion of IDRs into equity shares.

The FEMA provisions shall not apply to the holding of the underlying shares on redemption of IDRs by the FIIs including SEBI approved sub-accounts of FIIs and NRIs. SEBI circulars also states that in the absence of two-way fungibility - the ability to purchase existing share on the London or Hong Kong stock exchange and deposit them into IDRs programme, allowing redemption freely result in reduction of number of IDRs listed, thereby impacting its liquidity in the domestic market.

Taxation Issues:The Indian Tax Laws contains no specific provisions for the taxation IDRs. As such tax benefits available to listed equity shares may not be available to IDR holders.

Any dividend distributed by Indian company is subject to Dividend Distributed Tax (DDT) of 15% and as such dividend is not subject to tax in the hands of shareholders. However, in case of IDRs as the dividend paying company is not required to pay DDT, the IDR holders are required to pay tax at the rate applicable to them.

The trading of equity papers on the Indian Stock Exchange are subject to Securities Transaction Tax (STT) – a levy both the buyers and sellers are required to pay tax at a specified rates since 2004. As such any gain arising to holders of listed equity paper is exempt from tax provided transfer must have been made after holding paper for at least for a year other wise, such gain is taxable at 15%.

The STT was introduced in 2004 and is applicable on all transactions including purchase and sale of equity shares in a company, purchase and sale of units of equity growth funds, sale of units of an equity growth fund to the mutual fund and sale of Derivative instrument.

But these IDRs are not subject to STT, therefore the beneficial regime of capital gain taxation will not be available to IDR holders. In other words, short term gains are taxable at normal rate of tax, while long-term gain is taxable at 20% with cost indexation benefits and 10% without cost indexation benefits (Exhibit 3 & 4).

Exhibit No. 3: Showing Tax Rate Applicable to Various Class of Investors

Nature of Income FII (%) Non Resident

Indian (%)

Resident individual

/ HUF / Association

of persons / Body of

Individuals (%)

Domestic Company

(%)

Other resident

(firm/local

authority) (%)

Dividend 20 20

Progressive slab rate,

maximum being 3030 30Business Income 40

Progressive slab rate,

maximum being 30

Short term capital

gains30

Long term capital

gains10

20

10

20

10

20

10

20

10

Exhibit No. 4: Showing Taxation of IDRs and Indian Equity Shares

Sl. No. Particulars Equity Shares IDRs

1 Section Covering Taxation 10 (38) and 111A deals with

Taxation of Gain

No Specific provision contained in the IT Act

1961 for the taxation of gain on transfer of

IDRs.

2 STT Applicable Not applicable

3 Capital Gain Taxation (In case of

Resident IDR holders)

Short term gain (Securities held

for less than one year)

Long term gain (Securities held

for one year or more than one

year)

-Taxable u/s 111A at a concessional

rate of 15%

-Exempted u/s 10 (38)

-At normal rate of Tax (plus applicable

surcharge and education cess)

-Taxable at 20% with cost indexation benefits

and at 10% without cost indexation benefits.

4 DDT As the company distributing

dividend pay tax, the Dividend is

exempted in the hand of

shareholders.

As the company does not pay DDT, the IDR

holder are required to pay Income Tax at

normal applicable rate of taxation.

Taxation of IDRs and Indian Equity Shares (Cont.)

If IDRs are held as a stock-in-trade, it will become a business asset and any profit made from such transfer will be treated as business income and will be taxed accordingly. Besides, the conversion of IDRs into equity shares may be considered as a taxable transfer.

Under the extant Income Tax Act, any transfer between two non-residents outside India is not treated as transfer and such, such gain is not subject to tax. But, the transfer of IDRs between two non-residents outside India may be considered as a taxable transfer and gains, if any, may be taxable in India.

Conclusion:

• Several companies across the globe have been showing a tremendous interest in raising capital from the International capital market to develop an investor base and to raise international capital.

• While, American Government allowed its investors to invest in offshore securities way back in 1927, but, the Government of India allowed the global companies to enter the Indian market and raise capital only in 2004. In fact, until 2010, no foreign company has shown interest to raise the fund from our capital market. It was the standard charted Bank of UK that, for the first time, tapped our market in May 2010 and rose around Rs. 2,490 crore by issuing the IDRs.

• IDRs are a significant step towards the internationalization of the Indian Security Markets. While there is an effort on the part of the Government to offer a possible diversification of markets and geographical risk, the potential of this instrument (IDRs) may not be realized till the Government addresses several issues which are acting as a barrier.

Conclusion (Cont.):

• Extant legal framework does not permit insurance companies to participate in the IDRs program.

• In fact, the Government allowed Indian companies to raise fund from the international market by their DRs in April 1992. Initially, one-way fungibility of DRs was allowed. Investors holding DRs were allowed to convert into underlying Indian shares after 45 days from the closing date of issue. Under one-way fungibility, DRs can be converted into underlying equity but vice-versa is not allowed. In Feb., 2001, Indian Government allowed two-way fungibility in depository receipts.

• The present legal framework does not permit fungibility but only redemption that too after one year from the date of closing of issues and also only if the IDRs are infrequently traded on the Stock Exchange(s) in India. It is clear that the process of conversion of IDRs into underlying equity shares is very lengthy and cumbersome.

• The Tax treatment of IDRs is not on par with other securities. It is widely perceived that investment in IDR is not a very tax friendly instrument.

• Unless the Government addresses these issues, probably, Standard Chartered IDRs would remain the one and the only IDR ever listed on Indian bourses.