Introduction

The Securities and Exchange Board of India (“SEBI”) in their 207^th Board meeting on September 30, 2024 (“SEBI Board Meeting”), has proposed to amend the provisions of Chapter III of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”). The primary agenda in the SEBI Board Meeting was to make the rights issue process faster and provide flexibility to allotment of shares to specified investors. In this article we seek to analyse the nuances of ‘rights issue’ in light of the recent proposed amendments to the law.

Faster rights issue process

At present, for non-fast track rights issues, on average, it takes approximately 50-60 days to complete the due diligence process and preparation of draft letter of offer (“DLOF”) or letter of offer (“LOF”) for undertaking the rights issue. Further, it is mandatory for all listed companies to appoint a merchant banker in case the size of the rights issue is more than INR 50,00,00,000 (Indian Rupees Fifty Crores Only). However, in the SEBI Board Meeting, the following changes are proposed to streamline the process and make the process faster:

• rationalization of content of LOF, which shall only include incremental information regarding rights issue viz. object of issue, price, record date, entitlement ratio etc.;
• discontinuing the requirement of filing DLOF with SEBI;
• simplification of content of the LOF and due diligence thereby reducing the role of merchant banker;
• dispensing with the requirement of mandatory appointment of a merchant banker, while allowing other intermediaries to perform sub-activities which are currently, carried out by the merchant bankers; and
• the stock exchanges and depositories to concurrently carry out activities such as validation of rights issue application, finalization of basis of allotment etc.

Further, currently, for non-fast track rights issues, it takes on an average 317 (three hundred seventeen) days to complete the process, i.e., from the date of the issuer company’s Board approval till the date of listing and trading, whereas for fast track rights issue, it takes on an average 126 (one hundred twenty six) days from the date of issuer company’s Board approval till the date of listing and trading. This also includes an average of 18 (eighteen) days for issue period i.e., from issue opening day to issue closure day and 7-8 (seven to eight) days after issue closure till the date of listing and trading^[1].

Through the proposed amendments, the entire rights issue process is to be completed within 23 (twenty- three) working days from the date of the meeting of the board of directors of the issuer company. This would make the process of rights issue faster than the fund raise through preferential allotment route, which currently takes 40 (forty)^[2] working days.

Rights Entitlements

It is important to first understand the concept of Rights Entitlement(s) (“RE(s)”). RE is the rights issued by the company to the existing shareholders to subscribe to the new shares that the existing shareholder of a company is eligible to apply for under the rights offer^[3].

Currently, Regulation 90(2) of the ICDR Regulations specifically deals with the priority of allotment, i.e., first, allotments are to be made to those who have applied to subscribe to their eligible REs, second to such persons in favour of whom REs have been renounced, and lastly, any remaining undersubscription is to be allocated proportionally to those requesting additional securities.

However, there is a lack of clarity as to whether the undersubscribed portion of REs can be renounced in favour of any other third party or they have to be specifically renounced in favour of other RE holders only.

Renunciation of rights entitlements to specific investors

In this regard, the proposed amendments to the ICDR Regulations now seek to allow the promoters to renounce their REs to any specific investor(s) and thus, enabling the issuer company to issue the under-subscribed portion of rights issue to such specific investor(s), provided all necessary disclosures are made.

This proposed change would provide various benefits such as quicker fund-raising vis-a-vis preferential issue, giving an opportunity to existing shareholders of the Indian listed company to participate in fund raising and provide flexibility to Indian listed companies to on-board specific investors as shareholder of the company. Additionally, by allowing allotment to specific investors may also result in additional benefits such as the safeguard against the failure of the issue and reducing the requirement of underwriting.

Other implications –Foreign Exchange Laws and Takeover Code perspective

Foreign Exchange Laws: The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) mandate that in case of a listed company, the rights issue to a non-resident is to be done at the price determined by such listed Indian company^[4]. Further, Rule 7A of NDI Rules, provides that in case of issuance of shares by an Indian listed company, pursuant to renouncement of REs by a resident to non-resident, the pricing guidelines have to be followed^[5].

In relation to the above, Rule 21 of the NDI Rules (which lays down the pricing guidelines) has to be considered which, states that, in case of Indian listed companies, the price of shares issued to a non-resident shall not be less than the price worked out in accordance with the Securities and Exchange Board of India guidelines (in the present case, the price arrived at as per ICDR Regulations). In this regard, it be noted that Regulation 73 of the ICDR Regulations specifies that an issuer company can determine the issue price of its rights issue in consultation with the lead manager for the rights issue.

Therefore, in case of listed Indian companies, to meet the requirements of NDI Rules read with ICDR Regulations, the price at which non-residents can subscribe to additional shares, either, through exercise of their own REs or by exercise of the REs renounced in their favour by a resident, will be the price determined by the Indian listed company in consultation with the lead manager for the rights issue.

Takeover Code: As per Regulation 10(4) of the SEBI (Substantial, Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Code”), obligation to make an open offer under Regulation 3(2) of the Takeover Code, is exempted in case of acquisition of shares by any shareholder of an Indian listed company (i) upto his entitlement pursuant to a rights issue; or (ii) beyond his entitlement, pursuant to a rights issue, subject to meeting the necessary conditions (including that the acquirer has not renounced any of his entitlements in such rights issue and the price of the rights issue not being higher than the price stipulated in Regulation 10(4)(b)(ii) of the Takeover Code).

Accordingly, the provisions of Regulation 10(4) need to be considered for availing benefit of exemption, from making an open offer, pursuant to acquisition of shares of an Indian listed company through rights issue.

Tax implications on subscription to rights issue and renunciation of rights entitlement

The receipt of shares at a price, less than their fair market value, is subject to tax under section 56(2)(x) of the Income Tax Act, 1961 (“IT Act”). This provision ensures that if any benefit is derived by a person on receiving shares of a company at a discount, in comparison with the fair market value of such shares, the value of such benefit is considered as income in the hands of the person acquiring the shares. The fair market value is computed under Rule 11UA of the Income Tax Rules, 1962.

The aforesaid provision does not contain express exclusion for rights issue of shares, which are normally issued at a discount to the existing share price of the company. However, this anti-abuse provision should not apply to rights issue of shares as no real benefit accrues to shareholder on acquiring additional shares since rights issue is offered by listed companies to all the shareholders on a proportionate basis. The tax implication shall remain same even if certain shareholders do not exercise their right to subscribe to the rights issue. Where certain shareholders participate in a rights issue and others do not, the fact that it results in an altered post-issue shareholding may not result in implication under Section 56(2)(x) of the IT Act in the hands of the participating shareholders.

Therefore, in case of a rights issue of shares by a listed company at a discount, there should not be any tax implication in the hands of the shareholders under section 56(2)(x) of the IT Act.

Further, any consideration received by a shareholder, on renunciation of RE in favour of any other person, is subject to tax as capital gains. The period of holding of such a capital asset (i.e. RE), for the purpose of computing capital gains, is to be considered from the date of offer of RE by the company.

Other proposed changes

SEBI has also proposed that the appointment of a monitoring agency will be made mandatory for all rights issue undertaken by a listed entity irrespective of the issue size, to monitor the use of proceeds of the issue. Further, while currently, only rights issue of INR 50,00,00,000 (Indian Rupees Fifty Crores Only) or more, by a listed entity, are covered under the purview of ICDR Regulations. However, with the proposed amendments, any rights issue including for offer size of less than INR 50,00,00,000 (Indian Rupees Fifty Crores Only), by any listed company, would now also be under the purview of the ICDR Regulations.

Conclusion

In conclusion, the amendments proposed by SEBI aims at streamlining the rights issue process and Indian listed companies may look forward to a more efficient and expedient way to secure funding by way of rights issue.

The introduction of mandatory monitoring agencies and expanding the scope of ICDR Regulations will further enhance transparency and ensure better utilization of funds raised. These reforms represent a progressive step towards modernizing the fund-raising landscape in India for listed companies and will likely boost confidence in a ‘rights issue’.

Footnotes:

[1] SEBI Proposal, Faster Rights Issue with flexibility of allotment to specific investors under Chapter III of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.

[2] Ibid.

[3] SEBI Frequently Asked Questions on Rights Entitlement (RE) issued under Rights Issue Process in terms of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 accessed at https://www.sebi.gov.in/sebi_data/faqfiles/sep-2020/1599631603070.pdf.

[4] Rule 7(d) of NDI Rules.

[5] Rule 7A of NDI Rules.