India: Tax Issues In M&A Transactions

Last Updated: 28 June 2019
Article by Nishith Desai

1.Tax Considerations on M&A Transactions

I. Introduction

The Indian Income Tax Act, 1961 ("ITA") contains several provisions that deal with the taxation of different categories of mergers and acquisitions. In the Indian context, M&As can be structured in different ways and the tax implications vary based on the structure that has been adopted for a particular acquisition. The methods in which an acquisition can be undertaken are:

1. Merger: This entails a court approved process whereby one or more companies merge with another company or two or more companies merge together to form one company;

2. Demerger: This entails a court approved process whereby the business / undertaking of one company is demerged into a resulting company;

3. Share Purchase: This envisages the purchase of the shares of the target company by an acquirer;

4. Slump Sale: A slump sale is a sale of a business / undertaking by a seller as a going concern to an acquirer, without specific values being assigned to individual assets;

5. Asset Sale: An asset sale is another method of transfer of business, whereby individual assets / liabilities are cherry picked by an acquirer.

In the sections that follow, we have provided further insights into each of the specific methods of acquisitions.

II. Merger

A merger of companies is typically conducted through a scheme of arrangement under Sections 391-3941 of the Indian Companies Act, 1956, and requires the approval of the High Court. In order for a merger to be tax neutral, it must satisfy specific criteria and qualify as an Amalgamation under the ITA. These criteria are in addition to the requirements under the Companies Act. Hence, an Amalgamation must necessarily be conducted under a scheme of arrangement approved by the High Court.

The ITA defines an Amalgamation as the merger of one or more companies with another company or the merger of two or more companies to form a new company. For the purpose of the ITA, the merging company is referred to as the "amalgamating company" and the company into which it merges or which is formed as the result of merger is referred to as the "amalgamated company". An Amalgamation must satisfy the following criteria:

1. All the properties and liabilities of the amalgamating company must become the properties and liabilities of the amalgamated company by virtue of the Amalgamation; and

2. Shareholders holding at least 3/4th in value of the shares in the amalgamating company (not including shares held by a nominee or a subsidiary of the amalgamated company) become shareholders of the amalgamated company by virtue of the Amalgamation.

It is only when a merger satisfies all the above conditions, that the merger will be considered as an Amalgamation for the purposes of the ITA. Where a merger qualifies as an Amalgamation, subject to fulfilling certain additional criteria, the Amalgamation may be regarded as tax neutral and exempt from capital gains tax in the hands of the amalgamating company and also in the hands of the shareholders of the amalgamating company (discussed below). In certain circumstances, the amalgamated company may also be permitted to carry forward and set off the losses of the amalgamating company against its own profits.2

In the context of a merger/Amalgamation, Section 47 of the ITA specifically exempts the following transfers from liability to capital gains tax.

1. Transfer of capital assets by an amalgamating company to the amalgamated company if the amalgamated company is an Indian company.

2. Transfer of shares in an Indian company by an amalgamating foreign company to the amalgamated foreign company if both the criteria below are satisfied:

  • At least 25% of the shareholders of the amalgamating company continue to remain shareholders of the amalgamated company. Hence, shareholders of amalgamating company holding 3/4th in value of shares who become shareholders of the amalgamated company must constitute at least 25% of the total number of shareholders of the amalgamated company.
  • Such transfer does not attract capital gains tax in the amalgamating company's country of incorporation.

3. Transfer of shares in a foreign company in an amalgamation between two foreign companies, where such transfer results in an indirect transfer of Indian shares.3 The criteria to be satisfied to avail this exemption are the same as above.

4. Transfer of shares by the shareholders of the amalgamating company in consideration for allotment of shares in amalgamated company is not regarded as transfer for capital gains purpose. This exemption is available if the amalgamated company is an Indian company.4

For such shareholders, the cost of acquisition of shares of the amalgamated company will be deemed as the cost at which the shares of the amalgamating company were acquired by the shareholder.

III. Demerger

A demerger is a form of restructuring whereby one or more business undertakings5 of a company are transferred either to a newly formed company or to an existing company and the remainder of the company's undertaking continues to be vested in the first company. The consideration for such transfer will flow into the hands of the shareholders of the demerged undertaking either through issue of shares or other instruments (for it to qualify as a tax neutral demerger) or by way of cash.

A demerger must also be conducted through a scheme of arrangement under the Companies Act with the approval of the High Court. The ITA defines a demerger under Section 2(19AA) as a transfer pursuant to a scheme of arrangement under Sections 391-394 of the Companies Act, 1956, by a "demerged company", of one or more of its undertakings to a "resulting company" and it should satisfy the following criteria:

1. All the properties and liabilities of the undertaking immediately before the demerger must become the property or liability of the resulting company by virtue of the demerger.

2. The properties and liabilities must be transferred at book value.

3. In consideration of the demerger, the resulting company must issue its shares to the shareholders of the demerged company on a proportionate basis (except where the resulting company itself is a shareholder of the demerged company).

4. Shareholders holding at least 3/4th in value of shares in the demerged company become shareholders of the resulting company by virtue of the demerger. Shares in demerged company already held by the resulting company or its nominee or subsidiary are not considered in calculating 3/4th in value.

5. The transfer of the undertaking must be on a going concern basis.

6. The demerger must be subject to any additional conditions as notified by the Central Government under Section 72A(5) of the ITA.

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