Basab Pradhan

Class action lawsuit against TCS

Last week was a pretty interesting week for the business of global business
– our focus in this blog. Google, Microsoft, Yahoo and Cisco were raked over
the coals in a congressional hearing for aiding censorship in China. More on
this later. First let’s look at the class action lawsuit against TCS in
California.

An Indian employee of TCS America sued TCS for ‘unjustly
enriching itself by requiring all of its employees in the U.S. who are not U.S.
citizens to endorse and sign over their federal and state tax refund checks to
Tata’. The law firm involved, Lieff Cabraser is a well-known plaintiff’s law
firm that pursues class-action lawsuits and has quite a track record doing it.
It regularly features on the National Law Journal’s ‘Plaintiffs’ Hot List’.

A law firm specializing in class-action lawsuits takes no
upfront fees from its clients (the plaintiffs – in this case the TCS
employees). It works for a cut of the settlement that the plaintiffs get. Since
they are dealing with individuals, they could get as high as 30% of the
settlement. Since this is an all or nothing game, the law firm will be very
careful in picking their lawsuits – the target should have deep pockets and
there should be a reasonably good chance of winning the case. Once they sink
their teeth into something they are very hard to shake loose. All of this is
bad news for TCS.

The news on the lawsuit has few details. It seems like TCS
had contracts with Indian employees working in the US that allowed TCS to take
the tax refunds from the IRS (US tax authorities) back from the employees. To
the American public this will sound totally egregious. So why would TCS do
this?

My guess is that TCS had good intentions. They probably
wanted to guarantee a certain post-tax income to their Indian employees in the
US. The amount of tax one pays in the US can vary widely depending upon not
just your monthly income but also the duration of your stay (if it is less than
a year), which state you are resident in and dozens of other federal and state
tax rules. The employee’s tax can vary widely depending upon which client they
are assigned to and the duration of their engagement. So (TCS perhaps thought)
why not relieve the employee from worrying about all this? Why not guarantee a
post tax income to every employee? To do that TCS would have to be able to take
employee tax refunds back from employees if the refunds pushed the employee’s
income including the refund over the promised post-tax income.

Noble intentions, but they seem to have had unintended
consequences. I hope TCS resolves the matter quickly and satisfactorily. PR is
a major weapon for trial lawyers. If this thing goes all the way, they will
drag the Tata name through the American press. There will be collateral damage
to everyone in the Indian offshore industry. I hope it doesn’t come to that.

Another TTDMSTM

Here’s another one for Things That Don’t Make Sense To Me.

In Indian restaurants, why is the quarter plate kept on the left of the plate? Think about it. We’ve been brought up eating with one hand – the right hand. Assuming the rotis go on the quarter plate shouldn’t they be on the right? Why should the table be set by Western customs?

And while we’re on the subject, should the glass be on the right or the left? My vote is it goes on the left.

Indian Real Estate Funds

The world of business is fascinating. There are parts of it that are science – you can predict outcomes based upon the conditions and a set of rules. Or you know that you could if you knew enough about the rules and could measure all the conditions. And there are parts of it that aren’t science. Or if they are, they are more of a ‘social science’. I find joy in both CAPM and Leadership theory. Both make sense to me.

But then, I have another category – Things That Don’t Make Sense To Me. Over time I have generally found that most things in the TTDMSTM category don’t make sense to me only because I haven’t found the answer to my question, or haven’t found the right person to ask. But sometimes they just don’t make sense. The Indian Real Estate Funds question is one I have put to many people and haven’t yet found a satisfactory answer. So if anyone out there has a good answer I’ll be eager to hear from them. Here it is:

In the US there is a vehicle called REIT, which is essentially a publicly listed company that invests in real estate. Management fees are low and they are available to the public to invest in (both facts are linked in a way).

In India in the last few years real estate funds have been mushrooming like rabbits. Every company that has an asset management side of the house, and many that don’t, either has a real estate fund or is starting one. Which is not surprising, since the thesis that real estate is a good investment in a booming economy with crowded cities is reasonable. However, all these funds are structured so that they make a lot of money for the fund managers at the expense of the investors. Most of them have the economics of a Venture Fund – 2% Management Fees; 20% Carry. (20% Carry means that the Fund managers will keep 20% of the returns of the Fund over a certain hurdle rate of return).

There is a big difference between the risks in a Venture Fund and a Real Estate Fund. VC thumb rules say that a third of a VC’s investments go bust, a third are chart-busters with the remaining third somewhere in between. This is a high-risk business. It is also a business where the expertise of the fund managers in attracting and backing good ventures hugely determines the success of the fund.

Investing in real estate is not like that at all. The risk on individual properties is much more contained. Also, the level of expertise is not that high. A local real estate broker will know far more about a property than an MBA who manages the fund. I am not saying that the quality of management, the reputation of the firm and so on doesn’t add value, but 20% carry for just diversifying one’s real estate holdings sounds like a ‘get rich’ scheme – for the Fund managers.

As you may have guessed, I have so far not bought into any Indian real estate fund. If they come up with a REIT like instrument that is publicly traded, regulated and has low mutual fund like fees, I will gladly invest in that. Or if someone can explain what justifies the fees. If it is simply supply and demand for such funds, that’s not a good enough reason. I’ll wait.

Before you get influenced by this post, let me tell you about another TTDMSTM of mine – GOOG (Google). For a long time, my wife was on my case to buy GOOG. I didn’t. My reason – its P/E didn’t make sense to me. Where were they going to get that kind of growth from? Recently, when GOOG dropped over 20% from its high of $475, I told my wife that I felt vindicated about not buying GOOG. She sneered "I told you to buy it at $180!"

Company structure – Cross border issues

When we set up our company we went through some very detailed thinking on how to structure the company. Our business model involved research operations in India but our markets were going to be largely in the US and other developed markets outside India. We ended up incorporating in the US with a wholly owned Indian sub, which is kind of the vanilla solution, but in the process went through a decision process that may be interesting to other entrepreneurs.

Some people we talked to had set up a corporate structure that was designed for tax efficiency. They had a holding company in Mauritius or some other zero tax country, with subs in every country that they operated in. This gave them a very flexible corporate structure with great tax efficiency. Any of the subs could be sold or go public independently without an incidence of capital gains. And so on.

Another thought was to incorporate the parent company in India and have a wholly owned sub in the US. That had corporate income tax advantages as well as tax advantages in the event of a liquidity event. Also, doing an IPO in India would have a lower bar and probably get a better valuation as well.
In the end we decided to incorporate a Delaware company and have a wholly owned sub in India. While this is almost certainly less tax efficient it has other advantages that don’t show up on a spreadsheet exercise. If you are looking to get quality venture money into the company (and we are), you can’t go wrong with a US company. US VCs are comfortable with a US legal jurisdiction and not all of them are completely open to an Indian jurisdiction. Indian VCs on the other hand regularly fund US incorporated companies.

Also, the management of the company is largely in the US (4 out of 5 founders are here). Being an Indian company makes it operationally a tad more difficult. For instance, under Indian company law, board meetings must be attended in person, not on the phone.

In the end, the argument that tipped the scales for us was ‘simplicity’. The US-parent-Indian-sub structure was simple and a natural fit. Anything else would have made things complex to manage and complex to explain to an outside investor. Sure, we would probably have liked to have been more tax efficient. But then you have to make a whole lot of profit before you start worrying about the income tax on it!

While this solution works for us, everyone has a different business model and their own preferences. Be sure to talk to a lawyer and an accountant who know cross-border issues. And don’t forget to check within your network of entrepreneurs.