Established companies like PhonePe, Pepperfry, and Groww have recently moved their domicile back to India, while Razorpay, Flipkart, and many others are planning to do the same, underscoring the growing popularity of “reverse flipping” or “internalisation.”
‘Flipping’ refers to the transfer of an Indian entity’s ownership and key assets, like intellectual property, to a foreign entity despite having most of their market, personnel, and founders in India. This move is often motivated by the desire to tap into larger pools of venture capital, specific investors’ terms and conditions, benefit from more favourable tax frameworks and enhance market penetration opportunities.
Reverse flipping is a counter-narrative to the flipping trend that involves relocating the company’s domicile and/or assets back to India after previously moving its headquarters overseas. Recently, there has been a notable rise in this trend, within the corporate landscape.
The prevailing techniques for reverse flipping typically include:
In an inbound merger, a foreign entity merges into an Indian entity, resulting in the Indian entity owning and controlling the assets and operations of the foreign entity. As consideration, the shareholders of the foreign entity receive shares of the Indian entity. In India, the process of obtaining approvals for such inbound mergers is lengthy and typically takes between 6 to 9 months for such transactions.
Transactions involving mergers and demergers are generally tax-neutral under Section 47 of the IT Act, exempting them from capital gains tax, including inbound mergers, provided certain conditions are met. Fintech start-up Groww has chosen to reverse flipping (from the USA to India) through this route.
In the case of a share swap, shareholders of the foreign entity exchange their shares in the foreign entity for shares in the Indian entity which takes very less time as compared to Inbound mergers. Foreign shareholders are taxed in India based on the difference between the value of the Indian entity’s shares during the reverse flip and the original cost of the foreign entity’s shares. Walmart backed PhonePe, and completed its reverse flipping (from Singapore to India) through a share swap, incurring approximately $1 billion in taxes in India, while no tax was paid in Singapore due to the absence of Capital Gains tax.
In our perspective, companies are opting for this strategic maneuver due to two primary motivations:
1. Initial public offerings and attractive valuations – Despite the significant tax outflow during the domicile shift, companies are still considering relocating their headquarters to India due to the attractive valuations in the Indian startup ecosystem. Late-stage Indian startups, too small to attract institutional investor interest abroad, are particularly drawn to this trend. Last year, PhonePe and its investors paid $1 billion in taxes to India on its $5.5 billion valuation. Subsequently, PhonePe raised funds in India, achieving a valuation of $12 billion. Given the substantial presence of 8 crore retail investors in the Indian market, initial public offerings (IPOs) emerge as the preferred exit route for investors. This trend presents favourable exit opportunities for investors.
2. Regulatory requirements – Reverse flipping is often pursued by companies based on the specific needs of the sector in which they operate. In the fintech sector, regulations set by financial authorities such as the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI) play a significant role. These regulations favour fintech entities being domiciled in India due to stricter scrutiny and comprehensive disclosure requirements regarding fund sources and domiciles. This regulatory environment has led many fintech firms to reverse-flip their holding structures to ensure compliance. Notable examples include companies like PhonePe and Groww, which have adjusted their domiciles to align with these regulatory demands. It will be interesting to observe if there are any other sectors that will be required to relocate their domicile back to India due to regulatory requirements.
It is imperative to consider potential concerns from foreign investors regarding tax assessment risks and the nuances of the Indian taxation system, as they transition to being subject to Indian tax laws.
Additionally, the availability of tax treaty benefits for foreign shareholders in the new Indian entity may depend on whether a Double Taxation Avoidance Agreement (DTAA) exists between India and their home country. Furthermore, careful timing of the reverse flip is crucial to mitigate potential tax costs.
While it’s possible for the company to realize a valuation increase in the future, potentially offsetting the initial tax costs—as seen with PhonePe—it’s crucial to remember that the tax dynamics of reverse flipping add a layer of complexity to corporate decisions and transactions, underscoring the importance of tax planning, compliance, and risk management in navigating this strategic maneuver.