This article is written by Asmita Topdar, pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from Lawsikho.com.
Table of Contents
Introduction
Mergers and Acquisition is a process which business houses undertake in order to diversify and expand in size or territory. Mergers and acquisitions have a thin line of demarcation between the two. In merger, two business entities join hands to form one new entity whereas in acquisition, one business entity acquires the other entity by bringing it into its own ambit and thus no new entity is created. There can be various routes of business transfers within Mergers and Acquisition (M&A) which the business entity can undertake depending on their requirements, which involves slump sale, share acquisition, asset purchase and merger. However, before proceeding for any business transfers, both acquirer and target company undergoes due diligence processes in order to verify and investigate any liability of other parties to the business transfer.
Basics of M&A deal structuring
M&A deal structuring is based on a mutual agreement outlining the rights and obligations of the parties on agreed terms and conditions to carry forward the business transfer. It is the process of prioritizing the objectives of a merger or acquisition and ensuring that the top-priority objectives of all parties involved are satisfied, along with considering the weight of risk each party must bear.[i] The deal structuring is initiated by the parties entering into negotiations to observe the risk associated and the manner in which it can be managed. The risks are managed through drafting the terms and conditions in the agreement, which is decided upon various factors like tax implications, employees, contract, pending litigations, cost of business transfer, transfer of past risks, stamp duty etc. To understand the details of these factors, one needs to undertake due diligence process which is like an investigation done mostly by the acquirer on target companies to understand any liability or future risks which can get associated with the acquirer post the business transfer. Due diligence can be bifurcated into accounting, legal, financial, environment and information technology due diligence. Based on the due diligence report, the M&A deal is structured and parties enter into transactional documents depending upon the chosen structure.
How is a merger or acquisition structured
A Merger or Acquisition can be structured as either Slump sale, Share Acquisition, Asset Purchase or Merger, depending upon the various factors as mentioned above. Let us discuss each of the structures independently to understand which structure will be beneficial in which scenario for the business houses to undertake M&A transactions.
Slump sale
Slump sale is also known as Business Transfer where business is transferred as a ‘Going Concern’. In this transaction, the whole set up of a business vertical of the entity is acquired as it is, without acquiring the entity housing the business. The transfer will be executed through a Business Transfer Agreement (BTA) which can be in the form of either Agreement to sell or Deed of Conveyance. However, if the agreement is in the form of Agreement to sell, it saves upon the stamp duty to be paid. Slump Sale can also be undertaken through a court approved Scheme of Amalgamation, however, it is time consuming. Thus, a BTA in the form of Agreement to sell is preferred.
Tax implications (capital gains tax) and stamp duty – Since cash is involved as consideration, it has its own tax implications. The capital gains realised on the transfer of undertaking, if held for more than 36 months it shall be taxed as long term capital gains while if it is held for months lesser than 36 months it will be taxed as short term capital gains.[ii] The acquisition also attracts stamp duty on execution of specific instruments. The rate of stamp duty to be paid on Slump sale is State specific.
Ease of transaction and approvals – Slump sale is a very complex procedure if compared to other modes of acquisition. Approval of shareholders is required before proceeding for slump sale by special resolution as provided under Section 180 of the Companies Act.[iii] All the past liabilities and assets get transferred to the acquirer along with any pending litigation.
Employees – In slump sale, employees get transferred to the new acquirer who will continue their work in the same business under the arm of the new acquirer. However, before such transfer employees will be required to give consent on such transfer. If they don’t give such consent, they will be entitled to retrenchment compensation under section 25 FF of Industrial Disputes Act, 1947.[iv]
Recent Slump sale transaction between Sanofi and Zentiva[v]
In June 2020, Sanofi India had announced that it has completed Slump sale and transfer of manufacturing facility located at Ankleshwar, Gujarat to Zentiva. The total consideration for the transaction has been calculated at Rs320.68cr. Initial consideration prior to closing as received by Sanofi stands at an amount of Rs293.34cr on the closing date. The balance consideration of Rs27.34cr will be transferred after post-closing condition fulfilment as per the terms and conditions Business Transfer Agreement. It is anticipated that the full transfer of products will be completed by September 2021.
Share acquisition
In Share Purchase Acquisition, the acquirer is looking to secure the entity housing the business as well as the set up. The acquisition takes place through Share Purchase Agreement, Share Subscription Agreements and Shareholders’ Agreements. Foreign direct investment (FDI) policy, The Foreign Exchange Management Act, 1999 (FEMA) and RBI Regulations becomes applicable in case any of the party is a foreign entity.
Tax implications (capital gains tax) and stamp duty – The Capital Gains tax payable can be mitigated if the acquirer / investor is in a country which has beneficial Double Tax Avoidance Agreement (DTAA).[vi] The rate of stamp duty is State specific and depends upon the value of shares sold. If the shares are in DMAT form, stamp duty is exempted.
Ease of transaction and approvals – Share purchase is the easiest mode of acquisition with less cumbersome procedure. There is also no need to take approvals from the shareholders of the existing company. However, there will be an increase in the compliances with the authorities to ensure the compliance of FDI policy, RBI and FEMA.
Employees – There is no transfer of employees. Employees remain the same, only they will be working under the arms of the acquirer.
ITC’s share acquisition of sunrise foods
Recently in May 2020, ITC announced its deal on share acquisition of Sunrise Food Private Limited, which is a Kolkata based spice maker company, at an upfront consideration of Rs2,150 crores on a cash-free and debt-free basis.[vii] ITC acquired 100% of equity shares of Sunrise Foods on July 27, 2020. This acquisition will help ITC to augment in the section of spice making, where it is already present under the brand name of ‘Aashirvad’.
Asset purchase
In Asset purchase, acquirer is only interested in acquiring the assets of the Target Company which can be utilised by acquirer in his business. The acquirer cherry picks the assets which he requires in his business. While acquiring the assets, the liabilities associated only with respect to the selected assets gets transferred to the acquirer. Parties enter into Asset Purchase Agreement in order to transfer the selected assets.
Tax implications (capital gains tax) and stamp duty – In case of non-depreciable assets, capital gains tax is calculated in accordance to section 45 and 46 of Income Tax Act. Capital gains can be long term or short term depending on the time period during which the transferor held the asset. Capital gains tax is paid by the transferor on the gains he received after the sale of assets. In case of depreciable assets, when an asset forms a part of a block of assets on which depreciation is allowed as deduction under the ITA at the rate applicable on the block, the capital gains arising from such transfer are taxed only as short-term capital gains irrespective of the period of holding of the asset.[viii] The capital gains form transfer of depreciable assets are determined as the difference, if any, between the sale consideration from the transfer of the concerned assets, together with the transfer of any other asset within that block in the same financial year, and the aggregate of:
(i) expenditure incurred in connection with such transfer,
(ii) depreciated value of the concerned block of assets at the beginning of the financial year, and
(iii) actual cost of any asset acquired during that year and forming part of that block.[ix]
Goods and Services Tax (GST) will become applicable on each asset thereby increasing the cost of acquisition. Value added tax (VAT) will become applicable which can vary from 0% to 13.5% depending on the nature of goods.[x] The rate of stamp duty is state specific and depends upon the instrument by which the asset is transferred. If the instrument is modelled as Agreement to sell, stamp duty shall be less when compared with conveyance deed.
Ease of transaction and approvals – In case of transfer of assets, section 179 of the Companies Act, 2013, requires the Board of Directors to pass resolution. Also, the Article of Association (AOA) of the company shall provide for such transfer.
Employees – Except the case where the acquirer is interested in Target Company’s employees along with other assets, there shall not be any transfer of employees to the acquirer. Employees of the Target Company will continue to work under the same.
Recent asset purchase by Orient refractories limited
In September 2019, Orient Refractories Limited entered into an asset purchase agreement with Manishri Refractories & Ceramics Private Limited to acquire certain assets /plant & machinery situated at Baichuana, Tangi, Distt. Cuttack, Orissa. The same will help the company in diversification of its existing product line by adding new products like Magnesia Carbon Bricks etc.[xi]
Merger
Merger is a court approved procedure, where a scheme of amalgamation is approved by NCLT and is dealt from section 391 to section 394 of the Companies Act, 2013. The process is tax neutral, provided specific criteria provided in Income Tax Act (ITA) must be complied with in addition to the above mentioned provisions of the Companies Act. The company which is formed as a result of the merger transaction is known as ‘Amalgamated Company’ while the companies who are parties to the merger to form this amalgamated company is known as ‘Amalgamating Company’. The liabilities of the amalgamating companies gets transferred to the amalgamated company. Shareholders holding at least 75% shares in the amalgamating companies become shareholders of the amalgamated companies by virtue of this amalgamation however these shareholders will not include nominee shareholders or shareholders of any subsidiary of the amalgamated company.[xii] These 75% shareholders should constitute at least 25% shareholding in the amalgamated company in order to get capital tax exemption under ITA.
Capital gains tax and other taxes – If the procedure of amalgamation is followed in accordance to ITA and Companies Act, 2013, the court approved merger will be tax neutral and no capital gains will be charged to the amalgamating companies and its shareholders.
Employees – The parties to the amalgamation can decide mutually as to the status of the existing employees. The companies, subject to their agreement, can either retain or partially remove the employees.
Procedure involved in M&A transaction
The length of an M&A process can take approximately from 6 months to several years depending upon the complexity of the deal. The procedure which needs to be followed by the parties during an M&A transaction is as follows[xiii] –
- Developing acquisition strategy – The parties involved in the business transfer have to strategize upon suitable form of acquisition for transferring the business. The parties can choose the suitable form from the structures discussed above depending upon various factors like purpose of transfer, employees, capital gains tax, cost of acquisition, GST, VAT, stamp duty etc.
- Signing NDA – Parties need to sign a Non-Disclosure Agreement (NDA) to ensure that neither party spills out any confidential information about the other party received during the due diligence process in the public domain.
- Due diligence – After choosing suitable form of acquisition, the acquirer needs to undertake due diligence of the target company to ensure its financial strength, any liabilities associated with it, pending regulatory approval etc.
- Making of first offer – After the completion of due diligence process, the acquirer shall make the first offer to the target about the price consideration taking into account all necessary assets and liabilities which the acquirer comes to know from the due diligence process.
- Negotiation – If the target company is not satisfied with the price consideration, it can put forth higher price consideration when the acquirer with help of his legal counsel needs to negotiate upon the price consideration and the associated terms and consideration of the Agreement to be entered into.
- Signing the agreement – The parties, after reaching negotiating stage, shall sign the necessary documents mentioned above based on the form of acquisition. In case of Asset Purchase transaction, Asset Purchase Agreement shall be entered into, for Slump Sale, Business transfer Agreement and for share acquisition, Shareholders’ Agreement along with Share Purchase and Share Subscription Agreement will be entered into.
- Closing of the transaction – After the signing of the Agreement, all the necessary payments shall be made by the acquirer to the target company based upon the terms and conditions of the agreement entered into by the parties. On payment, the target company shall make delivery of the asset/ business/ necessary contracts which shall determine the delivery and completion of the transaction.
Creating a proper M&A deal
Based on the procedure mentioned above, we know that for initiating M&A transactions, parties need to enter into a Term sheet along with a Non-disclosure Agreement to have safeguard against confidential information. Along with term sheet and NDA, below are some of the transactional documents which parties need to enter depending upon the chosen suitable M&A transaction.
- Term sheet – At the negotiation stage, both parties enter into a non-binding term sheet and gradually if required, parties can enter into a binding term sheet. However, even if parties enter into a non-binding term sheet, clauses like confidentiality, exclusivity, non-compete, non-solicitation, confidentiality, governing law and dispute resolution will be binding over the parties.
- Non-disclosure agreement (NDA) – Parties can either separately enter into NDA after entering into a term sheet or have a separate clause in the respective transaction document (based on chosen suitable form of M&A structure) regarding the confidentiality terms and conditions. However, it is advisable to enter into separate NDA for two reasons- firstly, it will have detailed terms and conditions regarding confidentiality and secondly, if the parties take longer period of time to enter into business transfer agreement after signing of the term sheet, it is always better as a precautionary measure to enter into NDA.
- Business transfer agreement (BTA) – For slump sale, parties shall enter into BTA, which can be modelled into either Agreement to sell or Conveyance Deed. In Agreement to sell, the transfer of the undertaking takes on a future date. At the prospective date, immovable property gets transferred through conveyance deed while the movable property is transferred through hand delivery or novation of contract. When BTA modelled as conveyance deed, no separate document is entered into, and the transfer of property takes place through the BTA itself. However, the stamp duty on BTA modelled as Agreement to sell is lesser than BTA modelled as conveyance deed, thus making it more preferable.
- Asset purchase agreement – Parties shall enter into asset purchase agreement while undertaking transfer of cherry picked assets.
- SHA and SPA – Shareholders agreement and share purchase agreement shall be entered into while undertaking share acquisition transactions.
Conclusion
M&A deals need to be structured in accordance with the needs of the acquirer and the target company. The purpose for which the parties are entering into the transaction determines how the deal needs to be structured. If the purpose is transfer of a business vertical or an undertaking, Slump sale shall be preferred. If the purpose is to cherry pick only particular assets and not the liability of the whole business house, then asset purchase shall be preferred and if the purpose is to acquire the whole business along with its liability, share acquisition can be undertaken. Apart from purpose, various other factors as discussed above, which are involved in every structure, also needs to be taken into consideration before proceeding with the transaction.
References
[i] The Lawyer Portal. 2020. How To Become A Corporate Lawyer – The Lawyer Portal. [online] Available at: <https://www.thelawyerportal.com/free-guides/areas-legal-practice/how-to-become-a-corporate-lawyer-corporate-law/> [Accessed 12 August 2020].
[ii] https://cleartax.in/s/slump-sale
[iii] http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research_Papers/Deal-Destination-Business-Transfer.pdf
[iv] https://indiancaselaws.wordpress.com/2014/08/19/employee-transfers-in-mergers-and-acquisitions/
[v] https://www.indiainfoline.com/article/news-top-story/sanofi-india-completes-slump-sale-of-manufacturing-facility-at-ankleshwar-stock-trades-flat-120060100233_1.html
[vi] http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Tax_Issues_in_M_A.pdf
[vii] https://indianexpress.com/article/business/companies/itc-acquires-sunrise-foods-for-rs-2150-crore-6526972/#:~:text=Diversified%20business%20entity%20ITC%20Ltd,%2C%20debt%2Dfree%20basis%E2%80%9D.
[viii] Nishithdesai.com. 2020. [online] Available at: <http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Tax_Issues_in_M_A.pdf> [Accessed 14 August 2020].
[ix] Nishithdesai.com. 2020. [online] Available at: <http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Tax_Issues_in_M_A.pdf> [Accessed 14 August 2020].
[x] Nishithdesai.com. 2020. [online] Available at: <http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Tax_Issues_in_M_A.pdf> [Accessed 14 August 2020].
[xi] https://www.legallyindia.com/corporatemna/khaitan-khaitan-acts-for-orient-refractories-on-6-7m-buy-of-odisha-plant-assets-20191204-11051
[xii] Nishithdesai.com. 2020. [online] Available at: <http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Tax_Issues_in_M_A.pdf> [Accessed 14 August 2020].
[xiii] https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma-process/
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