Introduction
The concept of cross-border mergers gained momentum in India following the JJ Irani Committee's 2005 report1, which aimed to expand business internationally and harmonise Indian laws with international best practices. Prior to this report, Indian companies seeking international expansion had to establish branches or merge with foreign entities abroad. The report proposed a single forum for approving merger schemes with a 'deemed approval' mechanism. It also recommended providing Indian shareholders with new investment opportunities by allowing them to receive Indian depository receipts2 or foreign securities in place of Indian shares in cross-border mergers.
Cross-border mergers involve companies from different jurisdictions and require compliance with multiple legal frameworks, such as the Companies Act, 2013 ('CA13'), Foreign Exchange Management Act, 1999 ('FEMA'), Income-tax Act, 1961 ('IT Act'), and the Competition Act, 2002 ('CA02'). Due to the involvement of entities from different jurisdictions, double taxation avoidance agreements ('DTAA') also play a significant role.
Inbound & Outbound Mergers
Inbound mergers involve a foreign company merging into an Indian company. S. 394(4) of the Companies Act, 1956 ('CA56') defines a 'transferee company' to include only companies incorporated in India, permitting only inbound mergers and restricting Indian companies from merging with foreign entities. Conversely, outbound mergers, where an Indian company merges with a foreign company, became possible with the introduction of s. 2343 in CA13. This section is a part of ch. XV, titled Compromise, Arrangement and Amalgamations, is applicable to all cross-border mergers.
S. 234 of CA13, read with r. 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 ('Merger Rules'), governs cross-border mergers. Subsequently, the Reserve Bank of India ('RBI') notified4 the FEM (Cross-Border Merger) Regulations, 2018 ('Merger Regulations') to simplify compliance burdens. Under these regulations, a merger or amalgamation scheme that complies with the Merger Regulations is deemed to have prior RBI approval for the purposes of r. 25A of the Merger Rules is necessary before submitting the scheme to the National Company Law Tribunal ('NCLT') for approval. Upon satisfaction of all prescribed requirements, an application to the NCLT shall be accompanied by a certificate issued by a duly qualified professional, as defined by the relevant regulations. Notably, the Merger Regulations define and classify inbound5 and outbound6 mergers.
The Triumvirate of Cross-Border Mergers in India
R. 25A(3)of the Merger Rules requires the merger scheme to be filed before the NCLT for approval, and all merging entities must seek various no-objection certificates ('NOC') and permissions. These collectively constitute the regulatory framework involved in cross-border mergers: CA13, Merger Rules, and Merger Regulations.
S. 234(2) of CA13 provides that the merger scheme must outline the terms of payment of consideration to the shareholders of the merging entity in cash, depository receipts, or a combination thereof. This ensures proper structuring of receipts for shareholders. In outbound mergers, the foreign entity must be in prescribed jurisdictions to fall under the RBI's deemed approval route as per the Merger Regulations. Jurisdiction is also addressed by s. 234(1) of CA13 and r. 25A(2)(a) of the Merger Rules allows Indian companies to merge with foreign companies in jurisdictions notified by the Central Government.
R. 25A of the Merger Rules mandates compliance with ss. 230 to 232 of CA13. Additionally, r. 25A(2)(b) requires that the transferee company ensure valuation by a recognised professional is conducted according to internationally accepted accounting and valuation principles. Moreover, mergers involving companies in countries sharing a land border with India necessitate additional declarations, as per r. 25A(4) of the Merger Rules.
The Merger Regulations specify that compliance guarantees are deemed prior to RBI approval. They cover key areas such as securities transfer, sectoral caps, pricing guidelines, entry routes, and FEMA reporting requirements. These regulations also address branch or office setups outside India, borrowings and guarantees, acquisitions and asset transfers, bank accounts, and valuation. Entities are given a two-year period to ensure full compliance, facilitating the completion of merger-related transactions and asset transfers.
Brothers of the Night's Watch – IT Act & CA02
The IT Act and CA02 play significant roles in cross-border mergers, often benefiting the Indian economy by incentivising inbound mergers and protecting Indian markets from anti-competitive combinations. The distinction between inbound and outbound mergers is primarily in their tax treatment. Inbound mergers benefit from an exemption from capital gains tax on the transfer of capital assets as per s. 47 of the IT Act, whereas no such exemption applies to outbound mergers, potentially resulting in significant tax liabilities for Indian companies and their shareholders. Additionally, s. 72A of the IT Act, which allows the carry forward of tax losses, does not apply to outbound mergers. Thus, tax neutrality7 exemptions under the IT Act are available only for inbound mergers.
The CA02 regulates cross-border mergers that could adversely affect competition within India's market by using asset and turnover thresholds to determine applicability. CA02 does not prohibit all mergers but focuses only on those perceived as threatening the Indian market. Following the 2007 amendment, CA02 mandates that merging entities notify the Competition Commission of India ('CCI') of any transaction exceeding the prescribed thresholds, requiring prior approval. The CCI has investigative powers under ss. 20, 29, 30, and 31 of CA02 to assess the impact of mergers on competition and to impose penalties for violations. Additionally, CA02 stipulates a 210-day waiting period for cross-border mergers after notification to the CCI. It also grants the CCI extra-territorial jurisdiction to address combinations outside India that could harm domestic competition.
Judicial Precedents on Regulatory Approvals in Cross-Border Mergers
The regulatory compliances and legal frameworks governing cross-border mergers present varied challenges, ranging from tax implications to cultural adjustments in different markets. Issues such as the ultimate ownership of the company, management of bank accounts and branch offices, payouts to shareholders, addressing any grievances, and structuring the merger deal may seem trivial in isolation. However, non-compliance or failure to consider these factors can have snowballing implications, potentially leading to the proposed scheme not receiving judicial sanction.
In the case of Right Match Holdings Limited8, a Mauritian company merging with an Indian company, the NCLT approved the merger scheme but noted several procedural requirements. The scheme fell under the deemed approval category as per reg. 9 of the Merger Regulations, implying automatic clearance without express RBI approval, barring any objections. The IT Department's report indicated pending liabilities but did not object to the scheme's approval, provided their right to recover dues remained unaffected. The NCLT noted an issue raised by the Bombay Stock Exchange ('BSE') regarding non-compliance with a SEBI circular, which was duly addressed by the merging companies. No pending proceedings under CA13 or CA56 were found against either company. Statutory auditors confirmed compliance with prescribed accounting standards. The Tribunal emphasised that shareholders and creditors are best suited to judge the scheme's merits, as they are familiar with market trends and the companies' commercial decisions. It further stated that the Tribunal's role is to ensure the scheme's fairness, justness, and reasonableness without interfering in corporate decisions approved by shareholders and creditors. Citing the Apex Court's decision in Hindustan Lever Limited9, the Tribunal reiterated that it does not exercise appellate jurisdiction over such schemes but ensures no law is violated or public interest compromised.
In another case involving an inbound cross-border merger between Tata Chemicals10 and its wholly-owned Mauritian subsidiary, the NCLT examined the purpose of the merger in depth while sanctioning the scheme. The NCLT emphasised that the scheme's objective was to rationalise the corporate structure, optimise legal entity management, and reduce regulatory compliances. The merger aimed to enhance operational efficiency, generate revenue, and achieve cost optimisation by consolidating the overseas subsidiary into the parent company. Consequently, the scheme was deemed commercially and economically viable, fair, and reasonable. It was further noted that the Regional Director's report highlighted that the scheme met regulatory requirements and was not prejudicial to shareholders or public interest. Additionally, the IT Department and the Securities and Exchange Board of India ('SEBI') had been duly notified, and no objections were raised. The RBI indicated a lack of inclination to vet the scheme individually, which implied deemed approval under reg. 9 of the Merger Regulations, as the Indian company presented compliance certificates.
From these cases, it is clear that the NCLT deems implied approval from the RBI when manual vetting is not required. Additionally, once the procedural requirements and regulatory compliances are ensured, the NCLT places faith in the shareholders' and creditors' decisions without questioning the commercial veracity of the merger scheme.
In a landmark ruling involving Sun Pharmaceutical Industries Ltd.11, the NCLT held that demergers are not permitted under the cross-border regime. This decision set a benchmark, laying down that demergers are not permitted under the regime, even if it marked an outbound cross-border arrangement intended to streamline and consolidate the Indian company's overseas investment structure. This case involved a scheme proposing the demerger and transfer of two specified investment undertakings to two wholly owned subsidiaries, Sun Pharma (Netherlands) B.V. and Sun Pharmaceutical Holding USA Inc. Despite obtaining no adverse observations from the BSE and the National Stock Exchange ('NSE') and demonstrating compliance with RBI guidelines, the NCLT was tasked with interpreting statutory provisions related to cross-border mergers. The Tribunal scrutinised ss. 230, 232, and 234 of CA13 and noted that while ss. 230 and 232 permit compromises and arrangements, including demergers within Indian companies, s. 234 expressly refers only to mergers and amalgamations without mentioning demergers. It was highlighted that r. 25A of the Merger Rules also does not cover demergers. The NCLT went back to the extent of examining the draft Merger Regulations and observed that the definition of cross-border merger in the draft Merger Regulations initially included the term 'demerger.' Still, this term was deliberately omitted in the final notified regulations. Hence, it was held that the deliberate exclusion of 'demerger' from the final regulations indicated a legislative intent to restrict cross-border demergers, even if there was complete regulatory compliance, no objections, and a bona fide purpose benefitting the Indian company. While declining to sanction the scheme, the Tribunal emphasised that statutory provisions should be understood in their plain and ordinary sense without extending their scope through judicial precedents. This case highlights limitations imposed by the existing framework and reflects the gaps therein for stakeholders to navigate.
Structuring Considerations in Cross-Border Mergers
Tax planning is critical in structuring a cross-border merger, including deciding between an asset purchase or a share purchase and considering the use of holding companies, subsidiaries, and other entities. The merger's purpose – whether for business expansion, access to new markets, business expediency, labour tapping, diversifying market risks, or logistical contingencies – determines the direction of the merger and the most beneficial structuring for that purpose. The next consideration is evaluating the assets of the merging entities, including tangible assets such as properties, plants, and machinery, as well as intangible assets such as intellectual property rights and goodwill.
This evaluation goes hand in hand with tax structuring, which plays an important role in making the merger a tax-efficient arrangement that minimises tax liabilities for the merging entities. Tax structuring in cross-border mergers includes assessing transfer pricing considerations wherein related entities are directly involved, ensuring intercompany transactions adhere strictly to the arm's length principle. The tax treatment of capital gains from the sale of assets or shares during the merger is also crucial to fully utilise available exemptions, rollover relief provisions, and the setting off and carrying forward losses. Withholding tax considerations in cross-border mergers, such as payments of dividends, interest, and royalties, in light of applicable DTAAs, are another critical area to address. DTAAs help avoid double taxation and provide additional relief for merging entities. In India, the legal principle regarding DTAAs is that in case of a conflict between the provisions of the IT Act and the concerned DTAA, whichever is more beneficial for the assessee shall prevail. This principle can greatly aid Indian companies involved in cross-border mergers.
Regarding merger deal structuring, factors such as risk tolerance and exit strategies play an influential role and should align with the merger's purpose. The merger scheme must comply with the prescribed regulatory framework and outline available financing options and capital allocation. Market conditions and size are also worth considering in order to predict the merger's outcome and whether the two-year period provided to pace out the merger to comply with FEMA Regulations is sufficient. Market size and prevailing market conditions, shaped by country policies, determine a fair and competitive purchase price. These structuring considerations are important to ensure the efficient merging of operations, systems, and market responses of the merging entities.
Other Considerations in Cross-Border Mergers
Tax neutrality, especially in outbound mergers, is a challenging issue. Under s. 47(vi) of the IT Act, the transfer of capital assets is exempt from tax liability if the resulting entity is Indian, meaning such transactions are not considered a 'transfer' under s. 2(47) of the IT Act. Additionally, s. 47(vii) extends this exemption to shareholders if the resulting entity is Indian. However, no similar exemptions apply to outbound mergers, which complicates achieving tax neutrality in these cases. Outbound mergers also carry risks related to establishing a permanent establishment in India, which can attract further tax liabilities.
Recent regulatory updates also impact cross-border mergers. With the notification of the FEM (Overseas Investment) Rules, 2022 ('OI Rules')12, the FEM (OI) Regulations, 2022 ('OI Regulations')13, and the issuance of the FEM (OI) Directions, 2022 ('OI Directions')14, the OI regime now provides governing guidelines for investments in foreign entities by resident Indians. R. 11, read with sch. I of the OI Rules permits an Indian entity to make overseas direct investments through cross-border mergers. R. 13, read with sch. III of the OI Rules outlines the conditions under which outbound mergers can benefit from tax exemptions, including adherence to the Liberalized Remittance Scheme (LRS) limits prescribed by the RBI.
Beyond the issues already discussed, cross-border mergers face numerous other challenges. These include withholding tax obligations, applicable stamp duties, setting the appointed date for merger effectiveness, tax indemnities on asset transfers, and the ability to carry forward and set off losses. Other considerations involve the taxability of employee transfers, taxation of non-compete payments, transfer pricing adjustments, and post-merger issues. The Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 2011, also plays a significant role in cross-border mergers, safeguarding the interests of Indian shareholders. Additionally, the General Anti Avoidance Rules ('GAAR') may need consideration, particularly in outbound mergers, as they may be seen as methods of eroding the Indian tax base by the foreign entity.
Conclusion
India, one of the world's largest consuming markets, offers attractive tax-neutral benefits for merged entities, provided they remain within Indian territory. However, while legislative amendments such as the introduction of s. 234 in the CA13 have made outbound mergers possible, but the regulatory environment still heavily favours inbound mergers. This bias is evident in the differential tax treatment under the IT Act, where exemptions and benefits are more readily available for inbound mergers than outbound ones. The lack of similar incentives for outbound mergers can deter Indian companies from pursuing international merger opportunities, potentially limiting their global competitiveness.
What is often not explicitly addressed is the power dynamics inherent in cross-border mergers, where one of the merging entities will typically assume a dominant role. In contrast, the larger entity influences the smaller one. In this context, the distinction between having power and a persuasive position becomes pivotal. Although the larger merging entity may exert significant influence over the smaller one, this does not equate to absolute power. Legally, the smaller merging entity retains its autonomy and must comply with its local laws and regulations. This autonomy must be respected in a merger, as the smaller merging entity's legal and operational decisions are subject to local laws and regulations. To summarise this effectively, in the landmark judgment of Vodafone International Holdings15, the Supreme Court provides insight into the autonomy of companies incorporated abroad:
"the legal position of any company incorporated abroad is that its powers, functions and responsibilities are governed by the law of its incorporation. No multinational company can operate in a foreign jurisdiction save by operating as a good local citizen. If the owned company is wound up, the liquidator, and not the parent company, would get hold of the assets of the subsidiary. The difference is between having power or having a persuasive position."
Footnotes
1 Dr. Jamshed J Irani Report (2015) Report on Company Law. rep. Available at: http://www.primedirectors.com/pdf/JJ%20Irani%20Report-MCA.pdf
2 A Depository Receipt is a negotiable certificate issued by a bank that represents shares in a foreign company traded on a local stock exchange, allowing investors to hold equity in foreign countries without directly trading on international markets.
3 MCA Notification No. F No. 1/37/2013 CL. V, dated 13.04.2017
4 RBI Notification No. FEMA 389/2018-RB, dated 20.03.2018
5 Reg. 2(v) of Merger Regulations defines Inbound Merger – where the resultant company is an Indian company.
6 Reg. 2(viii) of Merger Regulations – where the resultant company is a foreign company.
7 Tax neutrality refers to provisions that allow certain transactions to occur without triggering tax liabilities.
8 Right Match Holdings Limited & R Systems International Limited, 2021 SCC OnLine NCLT 5484
9 Hindustan Lever Employees Union v. Hindustan Lever Limited, 1995 Supp (1) SCC 499
10 Bio Energy Venture-1 (Mauritius) (P) Ltd. with Tata Chemicals Ltd. & Ors., 2020 SCC OnLine NCLT 9076
11 Sun Pharmaceutical Industries Ltd. (De-merged Company), 2019 SCC OnLine NCLT 737
12 MoF Notification No. G.S.R. 646(E), dated 22.08.2022
13 FEMA Notification No. FEMA 400/2022-RB, dated: 22.08.2022
14 A.P. (DIR) Circular No. 12, dated 22.08.2022
15 Vodafone International Holdings BV v. Union of India & Anr., (2012) 6 SCC 613
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