This article has been written by Baneet Kaur Kohli pursuing the Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho) and Dipshi Swara (Senior Associate, Lawsikho).
The structuring of a transaction can be influenced by numerous factors. Let us discuss the structuring of any international transaction solely through the viewpoint of taxation. While structuring any international transaction, we must keep the following in mind:
- The taxation laws, business laws & the current practices and domestic laws currently prevailing in the foreign lands.
- The public & private laws as they would highly be influential while interpreting the international agreements.
- Understanding the homeland tax regime of all the countries involved in the ongoing transactions.
On one hand homeland tax is considered an obligation, on the other foreign tax is considered a cost. Therefore, it becomes imperative to structure cross-border transactions in a manner which is tax efficient. This article will discuss structuring the transaction by highlighting the tax implications and concerns arising during a cross-border M&A, and the way how Income Tax Act, 1961 is in accordance with the company laws in place to promote cross-border M&As in India.
Key areas to think about while structuring a cross-border merger
• Withholding tax minimization
• Reduction of any potential capital gains tax
• Effective use of holding companies
• Access to double tax treaty agreements
• Anti-avoidance measures
India was ranked 12th in foreign direct investment (FDI) inflows in 2018 – with a 20% growth in FDI inflows. Amounting to $42 billion in 2018 and $51 billion in 2019. In 2020 when global FDI had fallen by 42% due to the pandemic crisis, India managed to grow FDI inflows by 13%.
The principal laws that govern cross-border mergers and acquisitions are:
- The Companies Act, 2013
- SEBI (Security and Exchange Board of India) Substantial Acquisition of Shares & Takeovers Regulations 2011 and the Amendment Act, 2017
- Competition Act, 2002
- Insolvency and Bankruptcy Code, 2016
- Income Tax Act, 1961
- Department for Promotion of Industry and Internal Trade (DPIIT).
- Transfer of Property Act, 1882
- Indian Stamp Act, 1899
- Foreign Exchange Management Act, 1999 (FEMA)
- Other allied laws as could also be applicable to support the merger structure
Impacts of Indian taxation in cross-border transaction
While inbound mergers in India were always permitted under the Companies Act, 1956, it was the new Companies Act, 2013, that outlined the entry path for outbound mergers as well. Section 234 of the Companies Act, 2013 deals with the provisions for the cross-border mergers between Indian and foreign companies. Further, Companies (Compromises, Arrangements, and Amalgamation) Rules, 2016, as amended by the Companies (Compromises, Arrangements, and Amalgamation) Amendment Rules, 2017 therefore allows a foreign company to merge with a corporation registered under the Companies Act, 2013 & vice-versa. Only with the prior approval of the Reserve Bank of India (RBI). The RBI issued draft regulations concerning cross-border mergers for comments from the public on April 26th, 2017 then issued the Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 on March 20th, 2018 [FEMA 389/2018-RB].
Under the SEBI Takeover Code, if the acquisition of shares of a listed company exceeds 25 per cent by an acquirer, that would trigger the open offer threshold for the public shareholders. Prior approval of the appropriate stock exchanges and SEBI is required for all cases of mergers or demergers involving a listed company before approaching the National Company Law Tribunal.
Concerning the competition regulations, the prior approval of the Competition Commission of India (CCI) is required for all acquisitions exceeding the permissible financial thresholds, which are not within a common group. CCI evaluates an acquisition as to whether the said acquisition would lead to a dominant market position or not, mainly to avoid unfair and anti-competitive practices within the concerned sector.
Under stamp duty regulations, there is a provision for stamp duty on any issue or transfer of shares at a nominal rate of 0.25 %. However, no stamp duty will be leviable in case of any transfer or issue in a dematerialized form. Further, the conveyance of business under a valid business transfer agreement in case of a slump sale is subject to stamp duty at the same rate levied on the conveyance of assets.
Tax implications in cross-border transactions
Tax is a significant business cost to be considered while making any important business decisions. The new Direct Tax Code, which will replace the current Income Tax Act, 1961, seeks to stress transparency and taxpayer friendliness. Under the Income Tax Act, 1961, capital gains tax would be levied on such transactions as when capital assets are transferred.
Though certain mergers enjoy tax-neutrality under Indian tax law, the provisions for mergers and acquisitions are extremely complicated, and the tax system is certainly not neutral. In an inbound merger, a foreign company merges with an Indian company therefore amalgamated entity is an Indian company. Amalgamation enjoys tax-neutrality, and both the amalgamating company and the shareholders of the amalgamating company are exempted from tax. The amalgamated company should be an Indian company, and the amalgamation should be under Section 2(1B). In an amalgamation – all the properties, assets and liabilities of the merging/transferor companies immediately before the amalgamation should become the properties, assets and liabilities of the amalgamated company, and further, 75% shareholders of the amalgamating companies shall remain the shareholders of the amalgamated company. Further, to achieve the aim of tax-neutrality for the amalgamating company shareholders, the entire consideration transferred should be in the form of shares in the amalgamated company.
Similarly, an outbound merger is one where an Indian company decides to merge with a foreign company, and where the amalgamated entity is a foreign company. The transfer of capital assets through amalgamation by the amalgamating company to the amalgamated company will lead to the imposition of capital gains tax under the IT Act, and if the amalgamated company is an Indian Company, it will be exempted from tax implications.
However, this exemption is not available in the case where the amalgamated company is a foreign company, thus arising a tax liability in the hands of the profit generating transferee foreign company. Therefore, the notification of “cross-border mergers under the 2013 Act,” and the introduction of Cross-Border Regulations, 2018, necessitate adequate corresponding changes in the Income Tax Act to establish a favorable legal environment for the promotion of cross-border mergers and acquisitions in India.
Key tax provisions in India and the grounds concerning cross-border M&As
|Tax Provisions under Income Tax Act, 1961||Merits/Demerits & Impact on Cross-Border M&As||How it may attract more such transactions|
|Tax Neutral Merger,S. 2(1B)||Foreign investors and companies will hugely benefit from tax neutrality, and they will derive a better return on investment due to the tax exemptions provided||Similar tax neutrality for Indian investors making foreign investments will go a long way in promoting more cross-border M&As|
|Tax Neutral Demerger, S. 2(19AA)||Provides for tax neutrality for all the assets and liabilities acquired by way of the demerger||Easing off the shareholding requirements of 75% and conditions under S. 72A(5) will boost more demergers to and from India|
|Slump Sale, S. 2(42C)||The tax incentives, exemptions, and benefits of an existing business can be transferred to the new owner efficiently||Provisions should be harmoniously read with S. 50 B to maximize the tax benefits from a slump sale|
|Transfer, S. 47||No tax exemptions in the case of outbound mergers may deter the proliferation of cross-border M&A growth in India||Both inbound & outbound mergers should be treated at par with respect to tax levy, and similar exemptions should be provided for both|
|Carry Forward & Set-off of accumulated losses & depreciation, S. 72A||It provides for the carry forward and set off of accumulated losses and depreciation in case of qualifying merger/demerger, thus giving more flexibility to investors in making an informed decision regarding M&As||Provisions relaxing the 49% shareholding criteria, and allowance of unabsorbed depreciation, will positively maximize the tax benefits, thus promoting more cross-border M&A activity|
|Capital Gains Tax for unqualified M&As, S. 50C, 50CA, and 56(2) (x)||For all unqualified M&As, capital gains tax will be chargeable, which may deter foreign investors from investing in India, as the norms are still stringent in comparison to other economies||More sectors should be opened up and liberalized so that more transactions can benefit from tax exemptions, which will be an added incentive for investing and hence result in more cross-border M&As in India|
|Withholding Tax Obligations, S. 195||Payment by a resident to any nonresident, or any passive income in the form of interest, royalties, dividends, etc., is chargeable as withholding tax, which could act as a deterrent to cross-border M&A activity||This tax cost can be substantially minimized if read with DTAAs provisions and applying the treaty benefits to the transaction, thus promoting more cross-border M&As|
- Countries sharing land borders with India (China, Bhutan, Pakistan, etc.) cannot invest either directly or indirectly unless approved by the government.
- Insurance sector saw a permissible hike in the FDI limit from 49 % to 74 %, subject to prescribed conditions.
Introduction of Section 234 of the Companies Act, 2013 has embarked the journey of the Indian markets in ‘Outbound Mergers’ and acquisitions, which was previously prohibited as per the Companies Act, 1956. This has definitely created cross-border M&As as the most lucrative of all the deals in the coming era. Under the Income Tax Act, 1961 rules, a merger or amalgamation where the resulting entity is an Indian company is exempted from capital gains tax. However, where an Indian company merges with a foreign company, a similar exemption is not available, perhaps because such a deal was not previously allowed. Another potential tax issue for outbound mergers is that operations of the resulting foreign company in India, through a branch or otherwise, could amount to the company having a “permanent establishment” under Indian tax laws and thus attracting 26 per cent corporate tax on account of operations in India. Until the present tax regime that affects cross-border mergers is amended keeping in mind other corporate laws etc., the latest developments in tax structure, will not fully succeed. The recent changes in FDI policy in 2020 and tax reforms therein, including reduction of the corporate tax rate, concessional tax rates for power and infrastructure companies, tax holiday schemes for investors, and the abolition of dividend distribution tax, will go a long way in making India a favorite among foreign investors and create favorable opportunities for more cross-border M&As in India.
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