Tax Incentives For Mergers And Acquisitions Of Companies Accounting Essay

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Business restructuring is an integral part of the new economic paradigm. As control and restrictions give way to competition and free trade, rationalization and reorganization are a necessary concomitant. The different rationales for business combinations, acquisitions, mergers, spin-offs, divestitures and demergers co-exist without any contradiction. In the words of Dhananjaya Y. Chandrachud, 'Corporate Restructuring is one of the means that can be employed to meet the challenges and problems which confront business. The law as evolved in the area of mergers and amalgamations has recognized the importance of the Court not sitting as an appellate authority over the commercial wisdom of those who seek to restructure business.' [1] 

Merger is but merely one of the many forms in which corporate restructuring may occur. The term generally denotes an arrangement whereby the assets of two companies vest in one. [2] The more specific legal term used in Companies Act, 1956 is 'amalgamation', in which two or more companies are fused into one by merger or by taking over by another. [3] Amalgamation may occur either by the transfer of two or more undertakings to a new Company, or by the transfer of one or more undertakings to an already existing company. Strictly speaking, amalgamation does not encompass within its scope the mere acquisition by a company of the share capital of another, leaving the latter to continue its undertaking. However, the context in which the term has been used time and again may indicate that it is intended to include such an acquisition. [4] On the basis of the underlying objectives and modalities involved, further classification of the different kinds of corporate restructuring is also possible, like Leveraged Buy-Outs (LBO) and Management Buy-Outs (MBO) etc. Merger may also take place as a part of 'reconstruction' [5] of two or more companies. The term takeover, though distinct from merger as per the proportion of acquisition, retention of control and the modalities involved, is often considered to be a part of the wider expression 'mergers and acquisitions' or 'M&A'. Various growth strategies are adopted by companies as part of their restructuring plans. In cases where the existing portfolio is sought to be retained, the strategies generally adopted include joint ventures, rights issue, new equity and preference issues. But in instances where the corporation is aiming at revamping its look, it goes for mergers, amalgamation and management buy-outs.

There are several advantages in mergers and acquisitions (M&A) - cost cutting, efficient use of resources, acquisition of competence or capability, tax advantage and avoidance of competition are a few. While takeovers are regulated by SEBI, M&A falls under the Companies Act. Companies often undertake M&A to get the benefit of carry forward and set off of operating losses or tax credit.

Amalgamation, being a business combination, attracts special treatment in various fiscal statutes. The term signifies the creation of an entity, which either took in its fold the existing business of other entities or the creation of a new entity by combining the business of different entities. Need to have special fiscal laws to minimize the ambiguities in ascertaining tax liabilities of the combined entity led to the specific tax provisions in the Income Tax Act 1961. This necessitates a special look at the tax incentives provided under the Income Tax Act in case of an M&A. While the IT Act involves several complex features and provisions pertaining to merging companies, paucity of time and space has precluded the researcher from discussing all those provisions in detail and only those provisions prescribing incentives in case of a merger have been examined in this project.


Definition of 'Amalgamation' [6] 

The term 'amalgamation', though not defined under the Companies Act, 1956 has been defined in the Income Tax Act in the following words:

Section 2(1B): amalgamation in relation to companies means the merger of one or more companies with another company [7] or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that -

(i) all the property of the amalgamating company immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation;

(ii) all the liabilities of the amalgamating company immediately before the amalgamation becomes the liabilities of the amalgamated company by virtue of the amalgamation;

(iii) shareholders holding not less than three-fourths in value of the shares in the amalgamating company (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation, otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned company.

The distinguishing character of this definition is that the shareholders, who hold at least three-fourths in value of the shares in the amalgamating company, continue as shareholders of the amalgamated company by virtue of the amalgamation. However, previously, this amount was nine-tenths, which was substituted with the present amount by the Finance Act, 1999. The term has been widely defined under the Act with an objective to encourage amalgamation in public interest, giving an opportunity of tax saving to the concerned companies.

In fact, tax provisions and the law relating amalgamation are often perceived as in a 'hand and glove' relationship, with the former having periodically enhanced the latter's scope by legislative amendments and departmental circulars.

Incentives provided by the Income Tax Act

In a growing economy like India, mergers of corporate entities have always been encouraged to facilitate a better functioning, more capital, improved infrastructure, more production and better outcome. This is the reason why governments provide so many benefits to corporations going in for merger. Taxation benefits feature high on the list because the various incentives given in this aspect are lucrative for any company looking to lower their financial burden and for companies aiming high financial gains. Following are certain incentives provided by the Income Tax Act, 1961 in the event of amalgamation and mergers

A. Carry Forward and Set off of accumulated loss and unabsorbed depreciation allowance

Section 72A applies to amalgamation of a company owning an industrial undertaking or a ship or a hotel with another company or that of a banking company, referred to in S. 5(c) of the Banking Regulation Act, 1949 with a specified bank, whereby accumulated loss shall be deemed to be the loss of the amalgamated company, and the unabsorbed depreciation of the amalgamating company shall be given allowance for the previous year in which the amalgamation was effected. The following conditions have to be fulfilled to avail this advantage: a) the amalgamating company has been engaged in business for three or more years and has 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 merger.

b) the amalgamated company holds continuously for minimum five years from the date of amalgamation at least three-fourths of the book value of fixed assets of the amalgamating company acquired in a scheme of amalgamation, continues the business of the amalgamating company for at least five years after acquisition and fulfils such other conditions (e.g. Rule 9C Income Tax Rules, 1962) [8] as may be prescribed to ensure that the amalgamation is for genuine business purposes.

The effect of this provision is that the benefit of depreciation and unabsorbed losses are available to the amalgamated company for eight years beginning from the previous year in which the amalgamation took place.

B. Expenditure incurred in effecting amalgamation

Under S. 35DD of the Act, if any assessee being an Indian company incurs any expenditure wholly and exclusively for the purpose of a merger, then the assessee shall be allowed a deduction of an amount equal to one-fifth of such expenditure for each of the five successive previous years beginning with the previous year in which the merger takes place. It was inserted by the Finance Act, 1999, with a view to facilitate a smooth merger.

C. Shipping Business

Indian shipping companies are allowed a deduction under S. 33AC, in respect of reserves created on the condition that it is utilized for acquiring a new ship for the purpose of business. However, if it is being sold or transferred within 3 years, the sum utilized for acquiring the ship will be treated as profits chargeable to tax in the year of such sale or transfer, thereby facilitating any kind of acquisition.

D. Depreciation

In the case of an amalgamation, the total depreciation allowance calculated for any year for any asset which are transferred will be apportioned as between the two sets of companies in the ratio of number of days for which the assets were used by them. The fifth proviso to S. 32(1)(ii) mandates for aggregate deduction in respect of depreciation of building, machinery, plant or furniture as tangible assets or know-how, patent, copyright, trademark, licence, franchises or any other commercial right as intangible assets involved in an amalgamation. This provision, along with others takes into account depreciation of assets of a company in the event of a merger and allows deduction of the same. In arriving at the written down value of assets for the purpose of claiming depreciation, it is the actual cost of the amalgamating company less depreciation actually allowed to the company and the unabsorbed depreciation which was not set-off or carried forward could not be taken into account. [9] 

E. Expenditure on Scientific Research

Under S. 35(5), where in a scheme of amalgamation, sale or transfer of any asset representing expenditure of capital nature on scientific research takes place between the two sets of companies, the provisions of S. 35 wherein companies are allowed certain deductions are applicable to the amalgamated company.

F. Expenditure on acquisition of patent or copyright and on know-how

As per S. 35A(6) of the Act, if under a scheme, the amalgamating company sells or transfers the patent or copyright to the amalgamated company, certain deductions under this provision shall also apply to the latter. Similarly, As per S. 35AB(3), if the amalgamating company is eligible for deduction for expenditure on know-how, then the amalgamated company will also be entitled to such deduction.

G. Bad Debts of the transferor company

A successor in business can claim deductions of bad debts in respect of debtors taken over from Predecessor Company.

H. Deduction in respect of profits of certain companies

Sections 80-IA [10] , 80HHA [11] , 80HH [12] , 80-I [13] provide certain incentives to industrial undertakings on the basis of profits derived by them. This benefit is also available to the amalgamated company for the unexpired period. [14] 

I. Levy of Interests

Sections 234A, 234B and S. 234C provide for levy of interests for late filing of return of income, default in payment of Advance Tax and for deferment of Advance Tax respectively. In a scheme of amalgamation, the amalgamated company cannot assume that its income will be more than the prescribed limit under the Act for the payment of Advance Tax and hence interest under these sections cannot be levied.

J. Investment Allowance

Under S. 32A (1), with respect of a ship, aircraft, machinery, plant etc that is owned by the assessee and is wholly used for the purpose of business, a deduction in the nature of investment allowance of a sum equal to 25% (20% for the ship, aircraft, machinery, plant etc. specified in S. 32(8B)) of the actual cost will be allowed. As per Section 32A (6), if any of these assets has been transferred by a scheme of amalgamation, then the amalgamated company shall continue to enjoy the balance of the said allowance outstanding to the amalgamating company, with the allowed period for such allowance being carried forward in the assessments of the former, but as long as the prescribed period of eight years has not lapsed, with the amalgamated company being subjected to the same conditions as the amalgamating company regarding those assets.

Applicability of Capital Gains Tax

S. 45 of the Act talks of levy of capital gains tax in the event of transfer of capital assets. S. 47 lists out transfers, which shall not be considered for capital gains tax. Subsection (vi) reads as follows: Any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company if the latter is an Indian company.

This is the position of law since the amalgamating company merges it self with the amalgamated company and thereby dissolves itself without winding up. The shareholders in the amalgamating company are allotted in lieu of their original shares and thus no capital gains tax is attracted. [15] This provision goes a long way in facilitating mergers and acquisitions by giving a huge tax relief.


After a detailed discussion on the provisions of Income Tax offering incentives for mergers and acquisitions, it remains to see the real picture.

Lacunae in the law

It is sometimes argued that the benefit of unabsorbed depreciation, carry forward of losses etc are available to specific sectors like manufacturing, telecom, shipping, hotels etc under S. 72A and not the service sector. The question arises as to why this benefit is not available to the service sector as a whole, especially when service sector in India is growing at a frenetic space. Accordingly, the tax benefits should be extended to the service sector as a whole, including airlines, healthcare, financial services, etc.

On the other hand, another problem with the tax incentive provision relates to the conditions that are generally attached. The post-merger conditions are especially quite restrictive e.g. the condition for continuing the loss-making business for 5 years and owning 75 per cent of the fixed assets for 5 years. A merger is generally effected to cut down on the losses being incurred by the amalgamating company. If the amalgamated company is forced to continue the same business, then it is not profitable for the undertaking at all.

There are also a few ambiguities present in the provisions because of the way they have been drafted. Under S. 80-IB, tax holiday is not available to the amalgamating company in the year of amalgamation. Accordingly, in case the merger is effective from a date other than April 1, the tax holiday is not available to either of the companies for the period beginning April 1 till the date of effect. A more rational approach would be to allow the tax benefit for the year to be split between the companies based on the date of effect, as is allowed in case of current year depreciation. [16] 

Misuse of the law

It has been noted on occasion more than one that companies routinely amalgamate and merge with their loss-making sister concerns to avoid paying taxes. Moreover they sometimes claim to have set up a wind energy plant or something like that and claim 100 per cent depreciation. These have been occurring with constant frequency and thus needs attention of the legislators. All these tax concessions or loopholes in the laws allow companies to legally reduce their tax burden by smart tax planning. It should be the prerogative of the government to investigate into each case of amalgamation before granting the incentives, and therefore amend the law accordingly.