In a strategic move, Nexus-backed Zepto is actively considering a reverse flip to India. According to sources close to the company, Zepto aims to follow the path of Eruditus, RazorPay, Pine Labs, and Groww in joining the reverse flipping trend.
However, considering the instance of PhonePe, facing a tax liability as substantial as $900 million, many of these unicorns are strategically biding their time and determining the most effective reverse flipping structure.
Zepto’s Ambitious Plans
Although Zepto has not yet settled on its reverse flipping structure, the startup is aiming to officially register itself as an Indian company by 2024. According to sources, the company intends to achieve EBITDA profitability targets in 2024 and subsequently pursue a public listing by 2026. In the fiscal year 2023, Zepto recorded a net loss of INR 1,272.4 crore.
As per a source, Zepto is exploring a share swap approach, in which shareholders of the Singaporean company would receive shares from the Indian entity, ultimately resulting in the liquidation of the Singaporean entity. However, confirmation regarding the share swap ratio, if it indeed takes place, could not be obtained. The Mumbai-based company did not respond to queries about the reverse flipping process.
Continue Exploring: Quick commerce unicorn Zepto raises $31.25 million in Series E funding, supported by Goodwater Capital and Nexus Venture Partners
To clarify, Kiranakart Technologies Private Limited is the Indian entity that oversees Zepto, with its Singaporean holding company being Kiranakart PTE LTD. In this scenario, the majority of shares in the Indian entity are held by the Singapore entity. Investors in Zepto receive shares of the Singaporean company, indirectly possessing shares in the Indian company.
Engaging in a reverse flipping process through a share swap would result in shareholders of Kiranakart PTE LTD receiving shares of Kiranakart Technologies Private Limited.
“From an Indian taxation point of view, investors are getting the shares of the Indian company for virtually nothing. But these shares will have a huge value when they are acquired. The purchase price will be zero and the tax liability will apply to the total value of the shares acquired,” according to a finance professional who was earlier a CFO at two ecommerce companies.
The quick-commerce unicorn is presently valued at close to $1.4 billion. Even though investors would acquire shares for zero, the value of each share in the company would measure up to this valuation.
Tax Implications and Considerations
Under Indian laws, investors might face potential taxation ranging from 33% to 42% for this transaction, leading to an expenditure of approximately $600 million at the highest tax rate of 42%.
“The tax liability will be very high, but the company is looking to take this step in pursuit of a public listing in the next two years,” the finance professional added.
Certainly, there are alternative choices for startups considering relocating to India. For example, Groww is exploring the amalgamation route, intending to merge its foreign entity with the Indian entity. It remains uncertain whether Zepto will choose this path or opt for a share swap.
As we will observe, both approaches present challenges, and companies, in particular, aim to steer clear of a substantial tax burden during the reverse flipping process.
In the scenario of reverse flipping through share swaps, the capital gains tax is levied on the variance between the value of shares of the Indian entity at the time of reverse flipping and the acquisition cost of the shares of the foreign entity.
However, the acquisition cost of shares and the valuation of the Indian entity are subjects of considerable dispute between businesses and tax authorities.
For instance, in the case of the telecommunications giant Vodafone, the Indian government issued a tax notice, sparking a legal dispute that stretched over 13 years before being resolved in favor of the company.
“In Vodafone’s case, the company’s views on the valuation and share acquisition price differed from the government’s view. Ideally any company looking to reverse flip needs to align its views with the government. Failing which, there could be a big tax liability and potentially prolonged litigation,” said the source quoted above added.
Should the company draw the taxman’s scrutiny for any unpaid taxes related to this transaction, the government is apt to enforce severe penalties and accrued interest on the outstanding tax amounts. In certain instances, the penalty may soar as high as three times the original tax obligation.
For instance, Vodafone’s potential tax liability had increased to more than INR 20,000 Cr from approximately INR 12,000 Cr after years of legal battles. It’s important to highlight that Vodafone ultimately secured a favorable ruling and is currently awaiting a settlement from the Indian government.
In addition to the capital gains tax, foreign shareholders might face additional tax ramifications upon exiting the Indian entity.
While the tax is applicable to Zepto investors, the presence of indemnity clauses in the shareholders’ agreement implies that the company is obligated to bear this cost, as demonstrated in the case of PhonePe. Despite securing a substantial funding round to offset a portion of the $900 million expenditure, it remains a significant financial burden for the company.
If a share swap occurs, Zepto faces the risk of forfeiting the opportunity to set off its accumulated losses from the preceding fiscal year against prospective profits. Additionally, employees holding stock options may need to transition to a new ESOP plan, resetting the vesting clock for their shares to zero.
As mentioned earlier, alternative methods for reverse flipping exist, including an in-bound merger where the Indian entity acquires the foreign entity.
For in-bound mergers of this nature, shareholders can seek exemptions from capital gains tax if the transaction meets the criteria for being classified as an “amalgamation.” An amalgamation implies the creation of a unified entity post-merger.
If the merger fails to meet the criteria for being labeled as an ‘amalgamation,’ the capital gains tax on the cancellation of shares held by the foreign entity in the Indian entity may be subject to taxation in the hands of the foreign entity.
Potential Share Swap Approach
Nevertheless, Zepto is leaning towards the share swap alternative, deeming it the quickest method for executing a reverse flip. This inclination stems from the belief that amalgamation procedures entail regulatory approval, according to one source.
For instance, Groww applied to the National Company Law Tribunal (NCLT) for approval of amalgamation in August of last year. The Bengaluru-based fintech unicorn is considering the amalgamation of its US holding company, Groww Inc, with its primary Indian entity, Billionbrains Garage Ventures Private Limited.
Razorpay is reportedly assessing whether Groww can obtain approval through the amalgamation process within a reasonable timeframe. However, if the NCLT approval for Groww is significantly delayed, Razorpay might opt for a share swap, similar to PhonePe’s approach.
The circumstances for US-registered companies like Groww and Razorpay are expected to be different from those of Singapore-registered entities such as Zepto and PhonePe. In this scenario, PhonePe serves as the most relevant example that can be applied to Zepto and LivSpace, another Singapore-registered startup seeking to reverse its flip.
Singapore imposes no tax on capital gains, while in the US, income profits are taxed at a rate of 21%. This contrast explains why PhonePe faced a substantial tax bill in India. Should Groww or Razorpay consider a reverse flip to India through a share swap agreement, the 21% US tax liability for their investors could potentially be counterbalanced against their Indian tax obligations.
Hurdles in the Reverse Flipping Process
Numerous hurdles exist for investors and companies engaging in reverse flipping, and these challenges persist despite longstanding requests from various investors and key stakeholders within the startup ecosystem.
The surge in reverse flipping is primarily driven by the plans of Indian unicorns to go public and the imperative for financial services and fintech players to align their shareholding and governance structures with Indian laws, especially in response to stricter regulations imposed by the Reserve Bank of India.
Moreover, in contrast to the United States, the Indian stock market is presently experiencing a bullish phase for new-age IPOs, given the significant expansion of the investor base in recent years.
“Given the market conditions in India, it’s only right for ‘IPO-able’ companies to look at ways to redomicile to India. Zepto is still trying to figure out the best way that would allow it to get this process completed in 2024,” said another source close to the leadership.
Larger startups are aiming to leverage the increased liquidity and risk appetite for technology stocks in the Indian market, reevaluating their IPO aspirations in 2022 and 2023. Companies such as Ola Electric, OYO, Swiggy, Awfis, and MobiKwik are among those preparing for their stock exchange debuts in 2024, while many others are targeting an IPO in 2025.
Having joined the unicorn club in 2023, Zepto witnessed its net loss skyrocketing by 3.35 times in FY23, reaching INR 1,272.4 Cr. Concurrently, revenue from operations experienced a remarkable 14.3-fold increase, totaling INR 2,024.3 Cr in FY23, set against expenses amounting to INR 3,350 Cr.
Nevertheless, the company did show a positive development in the net profit margin, improving from -277% to -63% in FY23. It also asserted its commitment to achieving EBITDA positivity by FY25, a target set just over a year from the present.
“People are starting to realise that quick commerce is not only a much more concrete guarantee than people thought a year-and-a-half ago, but it’s also gonna be a much bigger category. I think there is a realisation that quick commerce has the potential to disrupt ecommerce,” said one of the sources in the company.
The source added that the momentum in the quick commerce sector for groceries presents a significantly greater potential outcome compared to the current activities of ecommerce marketplaces.
Attaining profitability on an EBITDA level and outlining a pathway to net profits are crucial elements for Zepto’s aspirations for a public listing. Despite optimism, the market is not granting consumer services companies considerable leeway in terms of losses.
Zomato’s stock price witnessed a significant rally only after reporting profits in consecutive quarters. Meanwhile, Swiggy is strengthening its bottom line through revenue initiatives and workforce reductions as part of its preparations to go public. Zomato’s profitability has demonstrated that losses in this sector can be surmounted through focused revenue planning.
In contrast, Zepto is the most recent entrant in the arena, and it must demonstrate signs of profitability at a faster pace than Zomato and possibly Swiggy to garner support from the public markets.
