This article is written by Baneet Kaur Kohli, pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. The article has been edited by Zigishu Singh (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).

Introduction

The provisions pertaining to compromises, arrangements and amalgamation are contained in Section 230 to Section 240 of Chapter XV of the Companies Act, 2013. The lawmakers finally introduced the provisions with respect to cross border mergers (Indian company merging with a foreign entity). The enabling provision in this regard is a significant step taken by the Government, helping companies having a global presence to restructure their operations. At the same time, the Reserve Bank of India (RBI) also issued draft regulations pertaining to cross border mergers, requiring a prior ‘deemed’ approval from RBI. Hence, allowing companies in India to merge with foreign companies in specified jurisdictions. However, certain tax provisions on mergers with foreign companies (which is taxable) need more clarity. 

Following are some of the analysis on cross border mergers from point of view of the Companies Act, 2013 and Rules thereunder, FEMA / RBI regulations and Income-tax Act 1961.

Companies Act, 2013 

Section 234 of Companies Act, 2013 was brought into force with effect from 13th April, 2017. MCA also notified Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2017 (“Rules 2017’) by inserting Rule 25A enabling Merger or Amalgamation of an Indian company with a foreign company and vice versa. In light of the above-mentioned amendments, the 2013 Act currently allows both inbound and outbound cross border mergers.

However, such cross border mergers would entail two primary conditions: 

1. ‘Deemed’ Prior approval of Reserve Bank of India (RBI),
2. Specified overseas jurisdictions where such cross border mergers and amalgamations of Indian Companies are permitted.

Sub-rule (2) of Rule 25A of Rules 2017 enables merger of an Indian company into the foreign company incorporated in ‘specified jurisdiction’ as mentioned below: 

(a) Jurisdiction whose securities market regulator is a signatory with SEBI’s International Organisation of Securities Commission’s (IOSCO) Multilateral Memorandum of Understanding or Bilateral Memorandum of Understanding.

(b) Jurisdiction which is unidentified in the public statement of Financial Action Task Force (FATF) as: 

• Jurisdiction comprising of strategic AntiMoney Laundering,
• Jurisdiction opposing financing of terrorism to which counter measures apply,
• Jurisdiction incapable to address the deficiencies, or
• Jurisdiction which is not working with FATF to list the deficiencies.

(c) Jurisdiction whose Central Bank is a member of Bank of International Settlements (BIS)

FEMA and RBI preview on cross border merger 

In order to facilitate approval for cross border mergers, RBI has proposed Foreign Exchange Management (Cross Border Merger) Regulations, 2017 (‘Draft RBI Regulation, 2017’), which states these conditions need to be complied with, in order to obtain its approval.

RBI proposed these draft RBI Regulations 2017 to address any concerns that may arise when a foreign company and an Indian company enter into a scheme of merger, demerger, amalgamation, or rearrangement. The companies involved in the scheme are required to act in accordance with the conditions laid down in these regulations.

RBI has provided certain definitions which inter alia include cross border mergers, foreign company and the resultant company. As per RBI Regulations 2017, Cross border merger means any merger, demerger, amalgamation or arrangement between Indian companies and foreign companies in accordance with the Co. Rules. However, Section 234 of the 2013 Act permits outbound mergers with India. However, it talks about mergers but does not include the terms “compromise/arrangement” leading to an element of the argument that whether outbound demergers will be permitted under the provisions of Section 234 of the Act, 2013 or not.

At the outset, the definition of “foreign company” under Draft RBI regulations 2017 and under the 2013 Act means any company or body corporate incorporated outside India regardless of whether it has a place of business in India. 

The Draft RBI Regulation 2017 was drafted to regulate and monitor mergers, demergers, amalgamation and arrangements between Indian companies and foreign companies.

Key highlights of the RBI draft regulations governing cross border mergers for its deemed approval

For inbound mergers 

The following applies to cross border mergers where the resultant company is an Indian company:

• Issue or transfer of security to a non-resident by an Indian company shall be compliant with FEMA (Transfer or issue of security by a person resident outside India) Regulation, 2000 (i.e., FEMA 20).
• Existing overseas debt of the foreign company that becomes the debt of Indian company should confirm to Foreign borrowing norms or Foreign Exchange Management (Guarantee) Regulations 2000 as applicable.
• Pursuant to the merger, Indian companies may acquire/hold/transfer any assets outside India. In such a scenario the Indian company would abide by the Foreign Exchange Management Act, 1999 or Rules or Regulations framed thereunder (FEMA).

For outbound mergers

The following applies to cross border mergers where the resulting company is a foreign company:

• Securities of the resultant foreign company may be acquired or held by a resident of India, as per the applicable Indian Foreign exchange regulations.
• The resultant foreign company will be liable towards any outstanding borrowings of the Indian company as per the Scheme sanctioned by National Company Law Tribunal.
• Any asset or security in India that may be acquired, held and transferred by the resultant foreign company is permitted as per the provisions of relevant Indian Foreign Exchange Regulations.

In case of contravention of FEMA provisions 

Under both the inbound and outbound merger, if assets or securities held by resultant companies are violating the provisions of FEMA. The said assets/securities would be required to sell by the resultant company within 180 days from the sanction of the scheme of merger or sell proceeds to be repatriated to India or outside India as the case may be. This may attract huge tax and stamp duty implications and also involve penalties on account of violation of FEMA regulations.

Valuation

• Under Draft RBI Regulation 2017: For the purpose of cross border merger as per Draft RBI Regulation 2017, the valuation of Indian company and foreign company should be in accordance with internationally accepted pricing methodology for valuation of shares on arms’ length basis which is duly certified by a chartered accountant/public accountant/merchant banker authorised to do in either jurisdiction.
• Under Rules 2017: As per Sub-rule (2) of Rule 25A of Rules 2017 requires the Transferee company to verify that valuation is run by the valuers who are members of a recognised professional body in the jurisdiction of Transferee Company. Valuation should be in accordance with internationally accepted principles on accounting and valuation. Declaration to this effect shall be enclosed with the application made to RBI for obtaining its approval. Sub Rule (1) of rule 25A of Rules 2017 apply only in the case of outbound merger i.e., when an Indian company merges into a foreign company.

All cross border merger transactions undertaken in accordance with the above regulations would not be required to file an application to seek prior approval from RBI and shall be considered as deemed approval of RBI.

Income Tax Act, 1961

The Income Tax Act, 1961 (ITA), at present, contains exemption in case of tax neutral mergers subject to compliance with certain conditions which are as under:

• All assets and liabilities of the transferor entity become the assets and liabilities of the transferee company, and
• At least 75% in value of the shareholders of the transferor entity (other than shares already held by the transferee entity) become shareholders of the transferee company by way of amalgamation.

Previously, consideration for inbound mergers was in the form of shares. However, 2013 Act provisions also allow consideration in the form of depository receipts and cash. In such cases, mergers may not remain income-tax neutral. In the absence of specific tax provisions, the taxability arising on the merging company and shareholders is open to interpretation.

As for foreign companies merging into Indian companies, tax implications will not arise, in case it does not have any assets situated in India. Similarly, in the hands of shareholders, there would be no capital gains implications on the transfer of shares of the merger of Foreign company in India unless the shareholders are Indian tax residents or such shares derive their value substantially from assets in India (resulting in the trigger of indirect transfer provisions under the Indian tax laws). In case such a transaction may be taxable in the hands of shareholders, the capital gains would logically be computed based on the fair value of the shares of the merged company received as consideration. 

Conclusion

The added provisions are a significant step taken by the Government, helping companies having a global presence to restructure their operations. The Reserve Bank of India’s (RBI) draft has allowed companies in India to merge with foreign companies in specified jurisdictions. However certain tax provisions on mergers with foreign companies (which is taxable) need more clarity. 

References

1. MCA Notification No. GST 368 (E) dated 13th April, 2017
2. https://www.iosco.org/about/?subSection=mmou&subSection1=signatories
3. https://www.sebi.gov.in/sebi_data/internationalAffr/IA_BilMoU.html
4. RBI draft rules vide Notification No. FEMA. _____ /2017-RB read with press release dated April 26, 2017 (2016- 2017/2909)

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