Mergers And Amalgamation Perspective Accounting Essay

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The Income-tax Act, 1961 is the charging Statute for levying of Tax on Incomes in India. It provides for levy, administration, collection and recovery of Income Tax. Income Tax Act applies to whole of India Including the State of Jammu and Kashmir. It came into force from 1st April 1962. When it was passed by parliament, many people hailed it as a simple and tax payer friendly piece of legislation. But with the process of time it has become a complicated piece of legislations. The reason is that during its existence of more than 50 years it has been amended more than 5000 times. It is also subject to many criticisms. This is because the Act has lost its original structure due to the infinite amendments made to it every year. On the complexity of the Indian Income Tax Act, 1961, the famous tax expert N. A. Palkhiwala once wrote:

"Today, the Income Tax Act, 1961, is a national disgrace. There is no other instance in Indian jurisprudence of an Act mutilated by more than 3300 amendments in less than thirty years. Simple provisions like Section 11 to 13 (which deal with exemption of the income in charitable trusts) have suffered no less than fifty amendments.

The tragedy of India is the tragedy of waste of national time, energy and man power. Tens of millions of man-hours, crammed with intelligence and knowledge of tax gatherers, tax payers and tax advisors are squandered every year in grappling with the torrential spate of mindless amendments. The feverish activity achieves no more good than a fever [1] ."

But this is soon to change. Recently the Government of India has brought out a draft statute called the "Direct Taxes Code" intended to replace the Income Tax Act, 1961 and the Wealth Tax Act, 1957.

For more than 10 years, the Government has been seriously on the job of revamping the tax law. The Income-tax Act, 1961 had stood the test of time. It was considered archaic and too complicated to understand. The idea of simplifying the tax law has been engaging the attention of successive tax reformers. The Draft Code proposed a number of changes in the way income is taxed under the Income Tax Act, 1961. The Discussion Paper released with the Draft Code states the following reasons for introducing the Draft Code: Simplify tax legislation to make it easier to comply with;

1. Widening of the tax base by (a) removing exemptions, (b) reducing ambiguities in the law, and (c) preventing tax evasion which leads to erosion of the tax base;

2. Remove deductions and exemptions as these reduce efficiency and distort economic behaviour.

To implement these principles, a number of changes were made to the existing tax rates, available deductions and exemptions, and tax administration in the Draft Code. The Revised Discussion Paper released by the Ministry responded to a number of issues raised with respect to the Draft Code. It stated that some provisions in the Draft Code would be changed to address major issues. The Bill accordingly rolls back some provisions of the Draft Code, as discussed in the revised Discussion Paper [2] .

The bill seeks to replace the current Income Tax Act with new systems, removing exemptions and making the tax administration more efficient. The parliamentary standing committee on finance postponed the adoption of its report on the bill that would have paved its passage in Parliament. Many members felt that the DTC bill should take into account the recent SC judgment and make suitable amendments to the tax law to ensure that corporates pay taxes even if they strike merger and acquisition deals in overseas tax havens [3] .

After taking the advice of several committees and experts including Kelkar Committee Report, Standing Committee on finance the Government has now come up with the DTC Bill, introduced in the Parliament on August 30, 2010 and referred to the Select Committee for vetting. All precautions were taken like opening up the debate on a draft DTC, a revised discussion paper and now the final DTC Bill. [4] 

The proposed Direct taxes Code, which will replace the archaic Income Tax Act, 1961, is bulkier than the existing law, as the new legislation also seeks to substitute the current Wealth Tax Act. While proposed Direct Tax Code has 319 sections and 22 schedules, there are 298 sections and 14 schedules in existing Act. Direct Tax Code has 20 Chapters divided into nine parts [5] .

2 Redefining Business Reorganization

The Direct Tax Code has introduced the concept of 'business reorganization' in taxation law, thereby consolidating the provisions applicable to various types of reorganizations' under a single umbrella. The term business reorganization is now defined to mean the reorganization of two or more residents, involving an amalgamation or demerger.

Clause 314(41) of the DTC Bill 2010 gives an exhaustive definition of Business reorganization. It will means reorganization of business of two or more residents involving an amalgamation, a merger under a scheme sanctioned and brought into force by the Central Government under the Banking Regulation Act, 1949 or a demerger [6] .

The definition restricts amalgamation and demerger only to reorganization between residents. This is intended to be a new provision hitherto not found in the law. The definition of amalgamation in Section 2(1B) in the Income Tax Act, 1961 is broadly reflected in the definition in Clause 3(14) (15) of the Direct Tax Code Bill. The Direct Tax Code goes a step further and chooses to define amalgamating company and amalgamated company in Clause 314. There has always been a persistent demand that every form of business reorganization should be made tax neutral. After all, the object behind such reorganization is not to reduce or mitigate taxes. The idea is to improve the efficiency of business. It was Finance Act, 1999 which first introduced measures in the income-tax law streamlining the provisions for considering the after-effects of amalgamation, demerger, conversion of proprietary or partnership into company, and so on.

In view of the above, gains arising from reorganization involving a foreign company may not be eligible for tax neutrality unless such company is regarded as resident under the expanded definition. This seems to be a divergent move since the Companies Bill, 2009, proposes to permit merger of a foreign company with an Indian company and vice-versa. The meaning of the term 'amalgamation' has been expanded to include merger of all types of co-operative societies and succession of sole proprietary concerns, association of persons, body of individuals and firms by a company [7] .

Stringent conditions were laid down with regard to carry forward of unabsorbed depreciation and unabsorbed losses in case of amalgamation and demerger. Section 72A of the Income Tax Act insisted that the amalgamated company should be engaged in the business in which the accumulated losses occurred or depreciation remained unabsorbed for three or more years. It should also have held continuously as on the date of amalgamation at least three-fourths of the book value of fixed assets held by it two years prior to the date of amalgamation. The Direct Taxes Code (DTC) omits these conditions.

2.1 Amalgamation

The term 'amalgamation' has been defined so as to provide for amalgamation of companies, co-operative societies, unincorporated bodies and proprietary concerns. The term 'demerger' has also been defined in the Code. Further, the 'amalgamating' entity and, in the case of a demerger, the 'demerged' entity are referred to as 'predecessor' in a business reorganization. Similarly, the 'amalgamated' entity and the 'resulting' entity are referred to as 'successor' in business reorganization.

2.1.1 Amalgamation of companies

Amalgamation of companies [8] will mean a merger of one or more companies with another company (amalgamated company) or merger of two or more companies to form one company (amalgamated company) subject to the following conditions:-

All the assets and liabilities of the amalgamating company or companies immediately before the amalgamation shall become the property of the amalgamated company.

(b) Shareholders holding seventy five per cent or more (in value) of the shares in the amalgamating company (other than shares already held by the amalgamated company or by its nominee) shall become shareholders of the amalgamated company by virtue of the amalgamation.

The scheme of amalgamation shall be in accordance with the provisions of the Companies Act. Earlier this provision was not there so it's one of the good improvements over the Income Tax Act, 1961.

 The amalgamating and amalgamated companies shall be entitled to the following benefits in the case of business reorganization through amalgamation:-

(a) The transfer of investment assets in amalgamation will not be considered as a transfer for the purposes of capital gains in the hands of the amalgamating company, if the amalgamated company is an Indian company.

(b) The transfer of investment assets (including shares held in an Indian company) by a foreign company to another foreign company in a scheme of amalgamation will not be considered as a transfer for the purposes of capital gains in the hands of the amalgamating company provided the scheme of amalgamation satisfies the conditions applicable to amalgamations contained in the Code.

(c) The exchange of shares in an amalgamating company for shares in the amalgamated company will not be considered as a transfer for the purposes of capital gains in the hands of the shareholders of the amalgamating company, if the amalgamated company is an Indian company.

(d) The accumulated losses of an amalgamating company shall be deemed to be the loss of the amalgamated company in the year in which the amalgamation is effected subject to fulfillment of specified conditions.

The aforesaid benefits shall be available to all companies irrespective of the nature of their business [9] .Apart from categorically stating that the tax benefits reserved for business reorganization are available only if the two or more companies involved in the exercise are residents, meaning Indian companies, the Direct Taxes Code Bill, 2010 (the DTC) gives a no-holds-barred support for amalgamations and demergers. [10] 

2.1.2 Amalgamation of Co-operative Societies

Amalgamation of co-operative societies [11] shall mean a merger of one or more co- operative societies with another co-operative society (amalgamated co-operative society) or merger of two or more co-operative societies to form one co-operative society (amalgamated co-operative society) subject to the following conditions:-

(a) All the assets and liabilities of the amalgamating co-operative society immediately before the amalgamation shall become the property of the amalgamated co-operative society.

(b) Shareholders holding seventy five per cent or more (in value) of the shares in the amalgamating co-operative society (other than shares already held by the amalgamated co-operative society or by its nominee) shall become shareholders of the amalgamated co-operative society by virtue of the amalgamation.

(c) The members holding seventy-five per cent or more voting rights in the amalgamating co-operative shall become members of the amalgamated co- operative.

The amalgamating and amalgamated co-operative societies shall be entitled to the following benefits in the case of business reorganization through amalgamation:-

The transfer of investment assets in amalgamation will not be considered as a transfer for the purposes of capital gains in the hands of the amalgamating co- operative society.

The exchange of shares in an amalgamating co-operative society for shares in the amalgamated co-operative society will not be considered as a transfer for the purposes of capital gains in the hands of the shareholders of the amalgamating co-operative society.

The accumulated losses of an amalgamating co-operative society shall be deemed to be the loss of the amalgamated co-operative society in the year in which the amalgamation is effected subject to fulfillment of specified conditions.

 The aforesaid benefits shall be available to all co-operative societies irrespective of the nature of their business.

2.1.3 Amalgamation of Sole Proprietary Concern

Under the Code, a sole proprietary concern may be amalgamated with a company subject to the following conditions:-

(a) All the assets and liabilities of the sole proprietary concern immediately before the amalgamation shall become the assets and liabilities of the company.

(b) The shareholding of the sole proprietor in the company shall be not less than 50 per cent of the total value of the shares in the company.

(c) The sole proprietor shall not receive any consideration or benefit, directly or indirectly, in any form or manner other than by way of allotment of shares in the company.

On amalgamation of a sole proprietary concern with a company, the following benefits shall be available:

(a) The transfer of investment assets in an amalgamation will not be considered as a transfer for the purposes of capital gains in the hands of the proprietor, if the company is an Indian company.

(b) The accumulated losses of the sole proprietary business shall be deemed to be the loss of the company in the year in which the amalgamation is effected, subject to fulfillment of specified conditions.

2.1.4 Amalgamation of Unincorporated Body

Unincorporated body means a firm, an association of persons or a body of individuals [12] ; Under the Code, an unincorporated body may be amalgamated with a company subject to the following conditions [13] :

(a) All the assets and liabilities of the unincorporated body immediately before the conversion shall become the assets and liabilities of the company.

(b) The aggregate of the shareholding of the participants of the unincorporated body in the company shall be not less than 50 per cent of the total value of the shares in the company.

(c) The shareholding of the participants of the unincorporated body in the company shall, as regards each other, be in the same proportion in which their capital accounts stood, as regards each other, in the books of the firm on the date of succession/amalgamation.

(d) The participants of the unincorporated body shall not receive any consideration or benefit, directly or indirectly, in any form or manner other than by way of allotment of shares in the company.

On amalgamation of an unincorporated body with a company, the following benefits shall be available:

(a) The transfer of investment assets in the amalgamation will not be considered as a transfer for the purposes of capital gains in the hands of the unincorporated body, if the company is an Indian company.

(b) The accumulated loss of the unincorporated body shall be deemed to be the loss of the company in the year in which the amalgamation is effected, subject to the fulfillment of specified conditions.

3. Tax Neutrality

Direct Tax Code Bill exempts gains arising on the transfer of investment assets in the hands of transferor entities and their shareholders/participants. Thus, the status of transfer of business capital assets on account of business reorganization is not clear. In all forms of business reorganization losses of the predecessor can be set-off by the successor subject to compliance with the test of continuity of business. These conditions are now applicable also to a demerger. The welcome change is that losses in cases of all types of business reorganizations are now eligible and not restricted to companies having industrial undertaking, hotels, ships, which was required under the existing provisions. Also the losses will be allowed to be carried forward indefinitely without imitation. Also the pre-amalgamation conditions regarding carrying on the business for three years or more and holding 75% of fixed assets, have been removed. [14] 

4. Exemption from Capital Gains Tax

Clause 47 of the Code provides that certain transfers of investment assets will not be considered as a transfer and no capital gains tax will be payable. This section is on the same lines as existing section 47 of Income Tax Act, 1961. However, it is significant to note that clause (xiii) of existing section 47 of Income Tax Act, 1961 which provides for exemption from tax when a partnership firm is converted into a company, subject to certain conditions, is absent in Clause 47 of the Code. This will mean that if the Code is enacted without this clause in section 47, a partnership firm which is converted into company after 1-4-2012 will not be entitled to claim this exemption. It may also be noted that Clause 47 (1) (J) of the Code provides for exemption from tax when a non-listed company converts itself into an LLP, on the same lines as provided in section 47 (xiii b) of Income Tax Act. Again, 47(1) (n) of the Code provides for exemption from tax when a sole proprietary concern is converted into a limited company. This provision is similar to section 47(xiv) of Income Tax Act [15] 

5 Definition of Slump Sale

Slump sale has been defined in the Clause 314 (234) of Direct Tax Code Bill, 2010 to mean the sale of any undertaking or division of a business for a lump-sum consideration without values being assigned to the individual assets and liabilities in such sale, other than the assignment of values to the assets or liabilities for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees.

The definition of investment asset also includes any undertaking or division of a business. Clause 53(5) provides that if there is any slump sale of any undertaking or division of a business, the cost of acquisition of such asset will be the 'net worth' of such undertaking or division. If such undertaking or division is sold after the end of one year from the end of the financial year in which it was acquired or established, the benefit of indexation u/s.51 and 52 of the Code will be available. Net worth of such undertaking or division will be worked out as may be prescribed by the CBDT u/s.314 (166). The term 'Slump sale' is defined in section 314(234) on the same lines as section 2(42C) of Income Tax Act [16] .

6 Gains on Slump Sale to be taxed as Capital Gains

Slump sale has been excluded from the business income and is retained under the definition of transfer as opposed to the provisions of the earlier draft of Direct Tax Code Bill issued in August 2009.

7 Certain Provisions Introduced in the Earlier Draft of the Direct Tax Code Continue Without any Change

Business reorganizations involving one of the parties as a non-resident would not be eligible to the tax exemption. Accordingly, cross border mergers and demergers would have tax implications.

In case of amalgamation of foreign companies, 75 percent of the value of shareholders would have to continue holding shares in the amalgamated company to availing exemption from capital gains as opposed to 25% shareholders under the Income Tax Act, 1961.

Direct Tax Code provides for issue of „equity shares to shareholders of the demerged company.

Under Direct Tax Code carry forward of losses of the demerged unit would be available upon satisfaction of the business continuity test as opposed to free carry forward of losses under the Income Tax Act.

In case of „slump sale the tax liability would depend the definition of „net worth which has not been prescribed so far.

There is no specific definition for the term undertaking for slump sale purpose. [17] 

8 Anti- abuse provisions

8.1 General anti-avoidance rules

The characteristics of the originally proposed rules have been retained. Additionally it is proposed that an arrangement would be presumed for obtaining a tax benefit. The provisions would be applicable as per the guidelines to be framed by the Central Government. Further the definition of lacking commercial substance has been amended to clarify that obtaining tax benefit cannot be the only criteria for applicability of GAAR. The proposed anti-avoidance measures could well result in a higher tax burden for foreign actors. As such the DTC risks a negative impact on foreign business investment, at least in the short term. That said, general uncertainty and drawn-out lawsuits are common features of the tax law as it stands, and multinationals would welcome a reduction in these problems. The new rules have the potential to end the uncertainties in tax laws that have led to litigation proceedings in the past [18] .

8.2 Controlled foreign company (CFC) rules

As indicated in the revised discussion draft, CFC rules have been incorporated to provide for the taxation of income attributable to a CFC to be taxed in the hands of the resident. A foreign company would be considered as a CFC which

for the purposes of tax is a resident of a country or territory with a lower rate of tax

the shares of the company are not traded on any stock exchange

one or more persons individually or collectively exercise control over the company

it is not engaged in any active trade or business

The specified income exceeds INR 2.5 million.

Rules pertaining to the computation of the income attributable to the CFC which would be required to be added to the income of the resident have been provided [19] .

9 Direct Taxes Code Bill, 2010 - Simplification of Tax Laws

It secures simplicity by transferring a number of sections to schedules and difficult portions of sections to definition clause 284, where the number of definitions has increased from 80 to 318. Besides, there are nearly 50 definitions in Chapter IV and IX, also under the heading 'interpretation'.

To tackle tax-evaders, the Code proposes to provide for deemed concealments, GAAR and tax charitable institutions at 15 per cent. There are many such arbitrary proposals.

The work of giving the country a new tax code should have been given to a Commission headed by a sitting or retired Judge of the Supreme Court with members from other disciplines such as accountants, economists, etc. Also, the Code, drafted without consultation with the apex body of the Income Tax department, that is, the CBDT, may not find acceptance by the department [20] .

10 Conclusion

There is no doubt that the direct taxes code now before the Parliament is altering the fiscal scenario for companies, both domestic and foreign. Before the Bill is enacted into law many important issues have to be thrashed out. Our tax law will have to keep in step with international trends.

The Direct Taxes Code Bill, 2009 was a modern piece of legislation based on faith in the assessee, which reduced both sops and tax rates, but had controversial features in taxing savings and minimum alternate tax (MAT). The revised DTC Bill, 2010 is nothing but a tax officer's delight, which will breed harassment and corruption. It keeps the present high tax rates, takes away incentives to infrastructure in real terms and gives sweeping powers to the tax authorities to overturn any transaction, including even tax promoted concepts of mergers and demergers. Such wide powers negate a regime of transparent regulations and reduce India's competitiveness for global investments. The bill proposes to phase out profit-linked incentives and switchover to investment-linked ones to encourage investment in productive activities instead of the one that gave them tax benefits. Most importantly, navigation through the tax laws will be much easier. Instead of a plethora of laws Income Tax Act, 1961, wealth tax Act, dividend distribution tax Act there will now be one Act.

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