Taxation Of Mergers And Acquisitions In India Accounting Essay

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Governing Statutes:- The Indian taxation system is governed by the Income Tax Act, 1962 which determines the levy and collection of tax in India. As per the act Companies come under the meaning of person [2] and all persons whose income under the five falls under Section 5 read with Section 9 of the Act are subject to tax. The Indian income tax is annually amended by the Finance Acts passed in the parliament and the same have to considered. Along with the Act the in a cross-border M&A as foreign entities are involved the Double Taxation Avoidance Agreements (DTAAs) signed by India with other states will also come into play if the acquiring entity or the target entity are a foreign national and their resident state has signed a DTAA with India.

A. Taxation of Mergers

Merger that will not be called as amalgamation as per income-tax act - In the Act there are no separate definitions of mergers, amalgamations and acquisitions therefore mergers are treated as amalgamation under the act for taxing purposes. However the same is not required in acquisition since in acquisition the reorganization is through sale transfer of share capital. Only the provisions related to Capital Gains apply. Therefore the present discussion is focuses on merger and will apply mutatis mutandis to acquisitions if need be.

The definition 'amalgamation' in Section 2( 1B) of the Act includes merger in it its purview however the Section specifically provides that in the following two cases there is no amalgamation for the purpose of the Act, though the element of merger exists :- [3] 

(i)Where the property of the company, which merges, is sold to the other company and the merger is the result of a transaction of 'sale'.

(ii)Where the company, which merges, is wound up in liquidation and the liquidator distributes its property to the other company.

One of the most popular and tax-efficient means of corporate consolidation in India is amalgamation. amalgamation enjoys favorable treatment under income tax and other laws, subject to fulfillment of stipulated conditions. [4] 

The benefits and tax concessions available to a merger is the conditions in Section 2(1B) are met with and the amalgamated company is an Indian company are as follows:- [5] 

Non-chargeability of capital gain on the transfer of a capital asset including shares held by shareholder at the time of amalgamation, [6] 

Eligibility of amalgamated company for the deduction in respect of any asset representing expenditure of a capital nature on scientific research, [7] 

Eligibility of the amalgamated company for the deduction in respect of acquisition of patent rights or copy rights, [8] 

Similar deduction in respect of expenditure on know-how, [9] 

Amortisation of expenditure for obtaining telecom licence fees. [10] 

A.1. Tax impact on the amalgamating company & its shareholders

Benefit to the shareholders of amalgamating company - As the provisions Capital Gains in Section 45 are not applicable to a shareholder relating to capital gains will not apply to any transfer by a shareholder when a shareholder in the scheme of amalgamation transfers the shares held by him in the amalgamating-company if the following conditions as per Section 47 (vii) are satisfied:

The transfer is made in consideration of allotment to him of shares in the amalgamated company; and

The amalgamated company is an Indian company.

The question is which arises is that whether in the absence of or on failure to satisfy the conditions specified in section 47(vii), a shareholder receiving shares in the amalgamated company will be taxed under Section 45 or not. The case CIT v. Rasiklal Maneklal [11] answers the same. The decision in Rasiklal Maneklal exempts shareholder from paying any capital gains tax, since an amalgamation does not involve exchange or relinquishment of the assets or the amalgamation of any right therein or the compulsory acquisition under any law. Amalgamation does not involve an exchange or relinquishment of shares by the amalgamating company. [12] However, no benefit will be available under Section 47(vii) if the shareholders of amalgamating company are allotted something more than shares in the amalgamated company, viz., bonds or debentures. [13] 

Benefits to the amalgamating (Transferor) company:

Depending benefits arise to the transferor company depending on the nationality of the same

IN CASE OF AN INDIAN AMALGAMATING COMPANY - As per Section 47(vi) there will be no capital gains tax on transfer of a capital asset by the amalgamating company to the amalgamated company in the scheme of amalgamation if the amalgamated company is an Indian company.

In ClT v. Surat Cotton Spinning & Weaving Mills Private Limited [14] , it was held that the book value of item in the books of transferor company would represent cost to the transferee- company. In Shaw Wallace and company Limited v. CIT [15] where the net assets of the subsidiaries were taken over by the assessee at a much lower value than the value of shares held by the assessee in the subsidiary companies. It was held that the difference cannot be claimed as a capital loss. Under the general law, a parent company cannot be said to have made any gain or loss under such a scheme. Forbes Forbes Campbell & Company Ltd. v. CIT [16] , the Bombay High Court held that the excess value of the net assets of the subsidiary company on the date of its amalgamation over the cost of the parent company's shareholding in the subsidiary is not chargeable to tax on capital gains under Section 45 of the Income-tax Act, 1961.

IN CASE OF TRANSFER OF SHARES HELD IN AN INDIAN COMPANY BY A FOREIGN COMPANY - There will be no capital gain on transfer of shares held in an Indian company in a scheme of amalgamation by the amalgamating foreign company to the amalgamated foreign company if the following conditions are satisfied as per Section 47 (via):

At least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company, and

such transfer does not attract tax on capital gains in the country in which the amalgamating company is incorporated.

Exchange/Sale of shares -

PURSUANT TO AMALGAMATION - Shareholders of the target company would become the shareholders of the amalgamated company by receiving shares in lieu of their existing shareholding. Conceptually such an 'exchange' is 'transfer'. However, the Act does not regard it as a transfer, where the exchange is in consideration of allotment of shares in the amalgamated company and such company is an Indian company [17] . Though any cash or other benefit given, fully or partially, in exchange for the shares would result in taxable capital gains.

POST AMALGAMATION - Where share-holders subsequently decide to sell the shares of the amalgamated company (acquired pursuant to the merger), the gains on sale would be liable to tax as capital gains. For computing such capital gains the cost of acquisition and the period of holding would be as under [18] :

Cost of acquisition of their original holding in the amalgamating company prior to the amalgamation; and

Period of holding would include the period during which the shares of the amalgamating company were held before the amalgamation.

A.2. Tax impact on the amalgamated company -

Expenses in connection with amalgamation - Typically, certain costs like stamp duty, Court fees, consultancy fees, etc., incurred to effect a merger may be significant. [19] Section 35 DD of the Act allows the amalgamated company to claim, on a deferred basis, the expenditure incurred wholly and exclusively for the purpose of the amalgamation. The deduction allowed is 1/5th of such an expenditure over a period of 5 successive years, starting with the year of amalgamation.

The Application of Dividend Distribution Tax post the merger - As per the Section 2(22) of the Act certain distributions, payments, etc., made by a company are deemed to be dividends in the hands of the receiver. Companies are liable to pay dividend distribution tax at specified rates on dividends, when dividends including deemed dividends atre distributed by them.

Only if the issue/allotment of shares of the amalgamated company to the shareholders of the amalgamating company may falls under the scope of 'deemed dividend' and, then the amalgamated company is liable to pay DDT.

However, the Central Board of Direct Taxes (CBDT) has clarified25 that where a company merges with another company in a Scheme of Amalgamation, the provision relating to dividend distribution [Section 2(22)(a) or (c) of the Act] is not attracted.

Thus, the amalgamated company would not be liable to DDT on such allotment of shares.

A.3. Carryf orward and Set-off of Losses and Depreciation

The Act allows the that business losses and unabsorbed depreciation allowance are allowed to be carried forward and set off against income for eight years after which such losses expire or unabsorbed depreciation is absorbed. [20] In fact this position is considered one of the key advantages of mergers as it allows the transfer of losses and unabsorbed depreciation subject to certain conditions.

Section 72A stipulates certain conditions and if they are met with then all the accumulated losses and the unabsorbed depreciation which were arising before the the amalgamating company would be deemed to be the loss or depreciation of the amalgamated company for the previous year in which the amalgamation is effected.. the conditions are as follows:-

(i)There is an amalgamation of a company owning industrial undertaking, ship or hotel with another company or a banking company with the SBI or any subsidiary of the SBI. Section 72A is also applicable in the case of an amalgamation of a public sector airlines with another public sector airlines. [21] 

(ii)The amalgamating company has been engaged in the business in which the accumulated loss occurred and depreciation remains unabsorbed for three or more years. [22] 

(iii)The amalgamating company has held continuously as on the date of the amalgamation fixed assets held by it two years prior to the date of amalgamation. [23] 

(iv)The amalgamated company continues to hold at least three- fourths in the book value of fixed assets of the amalgamating company, which is acquired as a result of amalgamation for five years from the effective date of amalgamation. [24] 

(v)The amalgamated company continues the business of the amalgamating company for a minimum period of five years from the date of amalgamation. [25] Or any other conditions as prescribed [26] .

If the the above mentioned conditions are not followed then the set off , loss or depreciation allowed in the previous year in the hands of the amalgamated company will be income in the hands of the amalgamated in the year in which these conditions are not complied with and would be liable to tax accordingly. [27] 

A.3 Return of income for the year of merger

In case the approval for the merger is not granted by the jurisdictional High Court by the date of filing of the Returns of Income of amalgamating and the amalgamated company, both the companies would have to file their Returns of Income as if the amalgamation has not taken place. [28] Due disclosure by way of a note should be made in the return of income stating that the returns shall be appropriately revised after the approval of the Scheme of merger is obtained from the High Court. [29] There will also be taxability of bad debts of the amalgamating (target) companies in the hands of the amalgamated company. Debts provided for and considered in computing income of the amalgamating predecessor company, may be claimed as a deduction by the amalgamated company if the same become irrecoverable subsequently. [30] 

A.4. International Taxation Aspects

If there exists a DTAA between the State of the foreign company and the India then the provisions of the DTAA will apply and override the Act as per Section 90 of the Act which further allows an assessee to even choose the domestic law provisions if more favourable. Whatever taxes are levied especially on the repatriation of income post the scheme of merger whether by means

B. Taxation in case of Acquisitions

Indian businesses can be acquired by the purchase of shares or the purchase of all or some of the assets. Thus in case of cross-border acquisitions only capitals gains tax are levied subject to Section 9 of the Act and the applicable DTAA if any. However the same is takeover wherein the shares are directly purchased from a recognized stock exchanges in India such transfers are exempt from tax, provided Securities transaction tax is paid. Other gains on sale of assets are taxable. Apart from capital gains taxes other expenses such as Stamp duty etc would also be applicable. However the sale of assets is may be subject to VAT or any other indirect tax.

Thus in case of acquisitions law related to the levy capital gains tax are the governing factor.

B.1. Capital gains and its tax aspects

-Capital Gains is the profit arising on account of the difference between the a higher cost of acquisition (herein- after called CoA) and the sale price arising from any 'transfer' of a 'capital asset' as defined under Section 2(47) and Section 2(14)of the Act respectively;2 during the financial year. Such gain is liable to be taxed on the hands of transferor as income subject to Section 35 of the Act..

however, if such income is taxable or not depnds on the nature of the assets whether the asset being transferred is - long-term or short-term. Generally, assets continuously retained before transfer for a period of 36 months are long-term assets. The rest are short-term assets. The period of holding is 12 months in the case of shares. Gains from transfer of a capital asset are computed as per the provisions contained in Section 48 and subject to other provisions under chapter VI (E) of the Act if need by. The deductions as provided by Section 48 which are deducted from the full value of consideration received (or accruing) are as follows:-

Expenditure incurred wholly or exclusively in connection with such a transfer;

Cost of acquisition or indexed cost of acquisition of the asset (in case of non-residents, the indexation benefit is not available and adjustments on account of foreign exchange fluctuation are accounted for);

Cost of improvement, if any, thereto. The benefit of "cost inflation index" is provided in the computation of taxable capital gains with reference to the cost of improvement.

Subject to prescribed conditions, certain transactions even though amounting to transfer under Section 2(47) 13 are expressly exempt from capital gains tax. Some of them are as follows:-

Transfer of capital assets by a holding company to its fully-owned subsidiary or vice versa, provided the transferee is an Indian company.

Transfer in a scheme of qualified merger/amalgamation or de-merger.

Transfer of capital assets, when a sole proprietary concern or partnership firm is succeeded by a company.

International Taxation Aspects

In case of cross border acquisitions the Sections 45, 2 (1), and 2 (27) are to be read with Section 5 and 9 if the acquirer company or the target company are not an Indian Company

In a cross border acquisition however apart from the above the Capital Gains clause in the relevant DTAA is also applicable. Furthermore post the Finance Act, 2012 indirect transfers are also subject to tax as per the Explanations 4 and 5 added to Section 1(i) read with Explanation 2 added to Section (47). The changes in the Finance Act have created a situation wherein, a capital asset is deemed to be situated in India, even if it is any share or interest in a company or entity incorporated. Subject to the fact that such share or interest derives its value substantially from assets located in India. The transfer of such an asset in any manner whether taking place in India or not is taxable. Furthermore if the deemed capital asset is even transferred indirectly flowing from the transfer of shares of two companies incorporated in India then also such a transfer is liable to be taxed in India.

These changes have widened the tax net and create a sitituation wherein if A and B two companies situated in Mauritius enter into an agreement to sell 90% of A's shares to B, in which A hold's 100% shares of C a company operating India. Then for the purpose of this capital gains the shares of A which derive value from Indian Assets being shares of C are deemed to be situated in India and are therefore liable to be taxed as per Section 45 in India. These changes were introduced with retrospective effect and when brought about the chnages sparked a nation wide debate regarding their validity.

B.2. Acquisition through Purchase of Assets

Acquisition through purchase of assets can be done either by a

a 'slump-sale' or 'itemized sale' . Transfer of assets through these means whould attract stamp duty a state levy the rates of which depend on the nature and value of asset being sold..

A 'slump sale' is when the entire business undertaking is transferred for a lump sum consideration as going concern then the provisions and benefits regarding slump sale as present in the Act will apply. An itemized sale on the other hand is where certain selected assets and liabilities as devided are transferred for individual consideration for each. In case of an 'itemized sale', is Value Added Tax levied on the separate items being sold.

Purchase price: The cost of the asset is taken as the cost for computing the capital gains. However the same is dependent on the nature of the asset and is important from a taxing perspective.

In case of slump sale as the

entire business undertaking is transferred as a going concern for a lump-sum consideration. The accepted cost of the asset is taken as the fair value arrived at a on reasonable commercial basis.. In the case of itemized sale transactions, the cost paid by the acquirer as agreed upfront may be accepted as acquisition cost, subject to certain conditions. [31] 

B.3. Acquisition through Purchase of shares

This is a more common means of acquisition especially cross border acquisition. No issues of step up costs or VAT arise in such an acquisition. The sale of shares may be taxed either as capital gains in the hands of the seller or subject to Securities Transaction Tax (STT) depending on the means of sale of shares. The levy of capital gains has been discussed earlier in this chapter which are applicable without any change. Therefore in this Section only the levy of STT is discussed. STT is payable only when the sale of shares is through a recognized stock exchange in India. It is levied on the purchases and sales of listed equity shares at the rate of 0.125 percent in case of delivery based sale and in case of non-delivery based transactions, it is levied at 0.025 percent and is payable by the seller only Transfer of shares which are not in de-materialized form taking place outside the stock exchange are subject to stamp duty on basis ofthe market value of the shares transferred.

B.4. Choice of acquisition vehicle

Several possible acquisition vehicles are available to a foreign purchaser. tax and regulatory factors often influence the choice of vehicle. It can be in the form of local holding company, foreign parent company, local branch or joint ventures. The same is decided on the basis and need structure of the acquisition and the benefit available through a DTAA.

2.2. Tax benefits arising through mergers and acquisitions

The general tax benefits arising under the Income Tax, Act have been discussed above. In this section the benefits which a company derives through the structuring of a deal are discussed. These include both those arising during the time of reorganization or those which are available post the merger and acquisition.

In a cross border M&A treaties play an important role in determining the benefits available to acquirer company. A DTAA through it's various clauses provides that in case of double taxation, which country has the taxing rights. Then an income being double taxed will be subject to the law and rates as of the State as specified by the DTAA. This leaves scope for tax planning as the withholding tax rates which are applicable to Capital Gains, Dividend, Interest etc vary from state and in fact some countries do not levy tax on certain incomes. E.g. In Mauritius capital gains are exempt from tax, in Australia there is no tax on dividend income.

In such scenario deals are often structured in a manner so as to minimize the tax payable by investing in the desired destination through low tax jurisdictions which allows lesser tax rates on accounts of DTAA benefits. Such structuring is called tax planning and the same had been held legal. In the Azadi Bachao [32] the Court was of the opinion that tax benefits arising from an existing corporate structure do not amount to invasion however if the structure is a sham and created only to avoid paying taxes then there is tax evasion which is not permissible. This view has been upheld by Supreme Court in the landmark case of Vodafone International Holdings B.V. v Union of India. [33] 

Thus, there exists a very line of difference between tax planning and tax evasion which has been first discussed by the Westminster Principle as upheld by in the Vodafone Case. Tax planning is legitimate however tax evasion is not.

The benefits which arise out of tax planning in a cross-border M&A are lower tax withholding tax rates. In case of acquisition of manufacturing units the benefits of tax holidays available to them.

However if these cross border M&As are designed only for the purpose of tax evasion then they are illegitimate structures not recognized by taxing authorities. In many cases cross border M&As are employed specifically for tax evasion purposes. The issue of evasion is dealt with in the next chapter.