How Tax Plays into Amazon, Walmart Bids for Flipkart

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By Siri Bulusu

Amazon and Walmart are vying for the biggest company in India’s booming e-commerce sector—a deal that could give rise to a handsome tax bill and catch the attention of the country’s tax authorities.

Amazon.com Inc. and Walmart Inc. are currently negotiating offers to acquire a controlling stake of the Indian start-up Flipkart Online Services Pvt., a Bengaluru-based e-commerce firm that commands more than a third of India’s e-commerce market, according to an April 12 Bloomberg Intelligence report.

Flipkart may well be the key to many of Walmart and Amazon’s goals. It would give the giants access to an online retail market expected to more than triple, totaling $80.1 billion by 2022. It would give Walmart—which seeks a 51 percent stake—entrance to a country it hasn’t yet been allowed to invest in. And it would allow Amazon to expand its market hold, which lags at 27.7 percent.

It will also draw the eye of the country’s tax authorities, which are actively pursuing taxes from massive digital and multinational corporations.

An announcement is likely soon. The companies are said to have offered between $8 billion and $10 billion for Flipkart, practitioners told Bloomberg Tax, although official sale figures aren’t public. The companies didn’t return requests for comment.

“Flipkart wants to give a thank you to the current investors by giving a good rate of return, which only happens when a company like Walmart or Amazon comes in,” Arun Mohanty, partner at Lakshmikumaran and Sridharan Attorneys, told Bloomberg Tax April 12.

Here are some tax elements to consider as the dealmaking continues:

Learn from Vodafone

Flipkart investors will likely avoid selling fresh shares to the incoming shareholder, also known as a primary purchase of shares—an acquisition structure that triggered Vodafone’s $2 billion tax bill when it entered India’s telecom sector in 2007.

Vodafone’s tax saga began when the company acquired India-based telecommunications company Hutchinson Essar Ltd., the mobile operator, through a Cayman Islands-based subsidiary. Both Amazon and Walmart could similarly acquire Indian shares indirectly—subjecting their offers to a 20 percent long-term capital gains tax.

“The structure of the deal would result in a huge windfall for Flipkart investors who have long-awaited returns on a substantial investment, but will give rise to the same withholding tax that caught Vodafone,” Amar Gahlot, direct tax consultant at Lakshmikumaran & Sridharan Attorneys, told Bloomberg Tax.

The indirect transfer provision of the Income Tax Act, 1961—aimed at taxing capital gains arising from indirect transfer of shares deriving substantial value from Indian assets—was introduced to tax precisely this scenario, practitioners said.

The tax authority aggressively applies the provision in situations when an incoming shareholder, like Walmart, is evidently attempting to gain access to the Indian market, they said.

Purchasing Shares From Investors

Instead, Flipkart will most likely enter into a deal where Amazon or Walmart purchase shares directly from the existing investors, practitioners said.

The deal would be subject to a 20 percent capital gains tax, because shares are considered movable property, which is a capital asset.

“For secondary purchase, Flipkart is liable to capital gains tax subject to treaty protection and the purchaser has to withhold tax for payment to a non-resident,” Uday Ved, a Mumbai-based chartered accountant, told Bloomberg Tax.

The withholding provision would apply to Walmart or Amazon if they purchase directly from Flipkart’s non-resident investors such as Accel Partners or Tiger Global Management.

Permanent Establishment Questions

Given the current tax environment in India, the application of permanent establishment raises questions, especially for digital companies. A company’s permanent establishment, or fixed place of business, is the foundation for its tax treatment.

Application of permanent establishment has been highly contested in Indian tax courts, according to practitioners. The issue became thornier in India’s 2018 Finance Bill, which proposed to adjust the definition of a “business connection” to include “significant economic presence,” a change that could embolden the tax authority’s argument in litigation where permanent establishment is contested. The change could impose a 40 percent tax on any foreign company rendering digital goods or services to India.

But practitioners say application of a permanent establishment tax is unlikely to apply to any company acquiring a a majority of Flipkart shares.

“The tax department would have to prove that the business of Amazon or Walmart is being done in the garb of Flipkart—but that could absolutely not be the case since Flipkart has been independently operating for a decade,” Gahlot said.

Obtaining a Tax Benefit

Because of the potential size of the acquisition, it may land within the scope of India’s recently implemented General Anti-Avoidance Rule, according to practitioners.

The rule, applicable to all transactions made after April 1, 2017, enables Indian tax authorities to scrutinize and re-characterize transactions where the “main purpose” is to obtain a tax benefit.

“The Flipkart acquisition will definitely be subject to GAAR scrutiny by the tax department,” Gahlot said. But if the transaction is justified because it has commercial substance, the anti-avoidance rule can’t be applied.

Role of Break-Up Fee

Amazon is reportedly offering a $1 billion to $2 billion break-up fee to Flipkart to up the ante in negotiations. The offer comes on the heels of reports saying Walmart had completed the preliminary phase of negotiations and was advancing its bid with Flipkart.

A break-up fee, often around 5 percent of the total deal, is sometimes offered during merger and acquisition negotiations to discourage the seller from reneging on the deal. In this case, the breakup fee would be offered by Amazon in order to get ahead of Walmart in the process.

While breakaway fees are an uncommon practice in India, Mohanty said Flipkart should seek a reverse deal with Walmart to use its leverage to secure the acquisition.

“We can assume the Indian tax code has not really seen enough of these breakaway fees to know exactly how to tax it, but usually fees and considerations arising out of such contracts are very regularly put to scrutiny in the courts,” Mohanty said.

To contact the reporter on this story: Siri Bulusu in New Delhi at correspondents@bloomberglaw.com

To contact the editor on this story: Penny Sukhraj at psukhraj@bloombergtax.com

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