This article has been written by Nimish Dhagarra, pursuing the Diploma Programme in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.

Introduction

Taxing statutes are strictly constructed. No tax can be imposed or collected except according to the authority of law. Statutes imposing taxes or monetary burdens are strictly construed. The logic behind this principle is that imposition of tax is kind of like imposition of penalty which can only be imposed if the language of the statute strictly says so. Three components of the taxing statute are –

1.subject of the tax

2. person liable to pay

3. the rate at which tax is levied. 

The Principle of strict construction is applied based on two well-settled principles- there is no equity in tax and in the case of two reasonable interpretations, the one favoring the assesses has to be expected. Words used in taxation should be given a meaning which is understood by the general public and which is popular. 

Now when it comes to amalgamation and M&A transaction, taxation plays an important role in driving such transactions as all the parties try to make the transaction as least capital intensive as possible because as we know that, such schemes of arrangements are entered into for the purpose of cost-cutting, pooling of resources, sharing of information, technology, know-how, IP, production techniques but most importantly are done for the purpose of availing tax advantages and limiting competition in the market.

Section 2(1B) of the Income Tax Act, 1961 defines amalgamation as- 

“amalgamation”, in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that— 

(i) all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation; 

(ii) all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation

(iii) shareholders holding not less than [three-fourths] in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation, 

otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned company;]  

Before going further into taxation implication of M&A transaction, it is important to understand the basics and the intention of legislature behind taxation statute which can be understood from the case of Gurusahai vs CIT in which the courts held that sections that impose charge or levy tax should be strictly construed but sections which are mentioned for the benefit of a certain community should be liberally construed. 

Also in the case of UP vs Kores India Ltd, the SC held that Courts are not required to extend the meaning to cover the subjects which on the face cannot be included in common parlance. It is only when specifically provided by statute then only it becomes subject to tax. 

Overview of tax implication on such transaction 

Acquisition in India can be done in two ways, either

1. The entire business is transferred don by way of merger/amalgamation or share buyout 
2. Acquisition through an asset sale, slump sale, or demerger.   

Depending upon the business strategy of the company such transactions are either executed through a scheme of arrangement between two companies resulting in merger/amalgamation under the Companies Act, 2013 or is executed through what is known as a Business Transfer Agreement which is a document which is used for acquiring a  part of business or undertaking or division or unit of a company and lays down the consideration and undertaking itself. It is said BTA is nothing but a deed of conveyance. Now taxation done in these transactions is of two-fold-

1. Stamp Duty which is levied on all legal instrument 

• In case of stamp duty, Section 5 and 6 of the Indian Stamp Duty Act, 1899 will be applicable and according to the provision, stamp duty will be evaluated on that individual asset which will usually be a percentage of the market value of the asset which will be state-specific. Few states have their own stamp duty act and some don’t. 

In the case of Inland Revenue vs Angus and Swadeshi Cotton Mills Co, In Re it was held that when it comes to ascertaining taxation the first question that needs to be asked is whether the subject matter on which duty has to be levied is an instrument or not. Such instruments are given in Schedule 1 of the Indian Stamp Act which consists of affidavits, debenture/share certificates, insurance policy documents, business transfer agreements, Assets transfer agreements, and many more.  In a landmark judgment of Hindustan Lever & Anr vs State of Maharashtra & Anr, the Supreme Court of India made some crucial observations. It was held that the term “Instrument” was coined to imply each and every document on the pretext of which a right or liability of any sort gets either created or transferred or limited or extended along with being extinguished and recorded. However, the term will not cover items mentioned under Entry 91 of List of Schedule 7 of the Constitution of India.

The liability to pay stamp duty arises when the particular instrument which falls under the Schedule of Stamp Duty act of a particular state is executed. In case the property is situated outside the state then the instrument will relate to the property situated outside such state. 

The general rule when it comes to the calculation of stamp duty is that duty has to be determined with reference to the instrument, not the transaction. That’s why there have been many implications in transactions where companies that are being merged are from two different states which have their own stamp duty act. In such a case the question arises as to which states stamp duty will be applicable on such an instrument. In the case where two different high courts have approved the scheme of arrangement and stamp duty has been paid off in the respective both the states, the obligation of paying stamp duty arises on the instrument and not the transaction at the end of the day, the parties cannot ask for credit saying they have already paid stamp duty for the same in the particular state first. This was laid down in the case of Chief Controlling Revenue Authority vs Reliance Industries Limited. 

Section 2(14) of the Indian Stamp Duty Act, 18999 defines defines ‘Instrument’ as- 

“Instrument Includes every document by which any right or liabilities is, or purports to be, created or transferred, limited, extended, extinguished or recorder.”    

In the case of slump sale or asset sale, stamp duty varies from either 5% to 10% in the case of immovable property and 2% to 3% in the case of the movable property depending from state to state. It is important to note that at the end of the day the rates are dependent upon the consideration that is being paid in the transaction. 

In case when shares of a company are transferred apart from those shares that are in a dematerialized form which are usually traded beyond the trading structure of stock exchanges, on such shares the acquirer is required to pay stamp duty. The rate at which stamp duty is to be paid is around 0.25% of the market value of these shares in question.

2. Capital gains tax

• The second cost implication will be that of capital gains tax, which is of two types- Short term capital gains tax and long-term capital gains tax. This tax will be on the assets acquired on such amalgamation and the cost in these transactions are taken as per Section 49 of the Income Tax Act, 1961. 

It is important to note that Section 47 (vi) and (vi)(d) of the Income Tax Act, 1961 provides that if the amalgamated company is an Indian company, it is exempted from capital gains tax but the exception is not allowed in case of  cross-border M&A. 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.

As mentioned in the above provision Indian companies are exempted from such complications the real implication arises when one of the parties is a non-resident. Cross border merger is a transaction where one company acquires the other company that is in a different country. Businesses usually engage in such mergers to simply expand their business operations in a different country without starting from scratch as due to the merger they have the required base to kick start their business operation activities. As such merger attracts lots of tax implications it is very important that the parties comply with the relevant taxing provisions and fillings to alleviate the tax risks. These transactions are capital intensive so parties will try to look at transactions from different angles to reduce the transaction to the least capital extension and the most important part is taxation.

Conclusion

When it comes to taxation implication with regard to other taxes such as capital gains tax our taxation statute is in consonance with the recent practices with a mechanism in place to check whether there has been lacuna on accounting of such taxes or not but the real problem that arises when comes to levying of stamp duty that too in a case where there are two states having their own stamp duty act. Payment of such stamp duty is an important element when it comes to such transactions as India is a developing country there has been a boom in the merger and acquisition and cross border merger in our country. India has been a hub for investors all around the world. When it comes to stamp duty there is a need for stamp duty laws to have some uniformity in their laws to prevent such technical problems from happening where there can be a situation where the orders of two high courts can be in question and in the clash with each other. These technical problems can hinder the process of merger and acquisition and in turn, demotivate or discourage companies to do so.  There is a need for India to establish a robust system in place for tax administration as India now being the centerpiece in the global market where investors all around the world are coming to get their money’s worth. 

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