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This article is written by Paritosh Dhawan who is pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions)  from Lawsikho.

Introduction

Mergers & Acquisition (M&A) have been a prominent feature of the global market as in today’s booming economic and market conditions. Organizations all around the world have a zillion opportunities and struggles which they have to cross and tackle. Mergers & Acquisition is one of those most opted strategies by the organizations which are looking for a change. 

It provides numerous advantages to the organization like expansion, efficient use of resources, diversification, capital, avoidance of competition, tax benefits etc. Regulations and Policies applicable in India have promoted the development of Mergers & Acquisition activity domestically as well as Internationally. 

Mergers & Acquisition has been the most accepted strategy for corporate growth and if structured properly an organization can save a lot of money through tax benefits. 

 The Income Tax Act of 1961 is an extensive statute that targets the various rules, policies and regulations that govern the taxation laws in India. The said act includes various provisions that talk about dealing with taxation in different ways of structuring. M&A transactions are carried in various ways such as 

  • Asset Sale, 
  • Slump Sale,
  • Share Purchase, 
  • Amalgamation/Merger,
  • Demerger. 

Merger

A merger is a route of business transfer whereby the assets of two companies become vested in one company. The Income Tax Act, 1961 doesn’t define the term merger but only defines an “amalgamation” as defined under Section 2(1B) as the merger of one or more companies with another company, or the merger of two or more companies to incorporate a new company. 

For the provisions of the ITA, the company which is being merged is called the ‘amalgamating company’ and the company into which it merges or the resulting company as the outcome of the merger is called the ‘amalgamated company’. The company which has been merged ceases its corporate entity from the day the amalgamation is effective. 

A merger requires approval of the National Company Law Tribunal (NCLT) and it is typically processed through an arrangement as specified under Section 230 to 232 of the Companies Act, 2013. 

Further, The Income Tax Act, 1961  provides that in an amalgamation all the assets and liabilities of the amalgamating company immediately preceding the amalgamation must become the assets and liabilities of the amalgamated company as an outcome of the amalgamation. Also, the act provides that at least 3/4th of the shareholders in the amalgamating company shall become shareholders of the amalgamated company as an outcome of the amalgamation. Hence, only when a merger transaction follows the above mentioned two conditions, it can be termed as an amalgamation for the purposes of The Income Tax Act.   

What transactions are exempted from capital gains tax in an amalgamation? 

Section 47 of the Income Tax Act specifically exempts the following:

  1. In a scheme of amalgamation where the amalgamated company is an Indian company, any transfer of a capital asset by an amalgamating company to the said amalgamated company shall be exempted. {Section47(vi)}
  2. In a scheme of amalgamation where there is a transfer of shares by a shareholder subject to the following 2 conditions getting satisfied: {Section47(vii)}.
  • The transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company except where the shareholder itself is the amalgamated company, and
  • The amalgamated company is an Indian company;

The calculation of the acquisition of shares for such shareholders will be done at the cost at which the shares of the amalgamating company had been acquired by the shareholder. The period of the holding shall include the period during which the shares were held by the shareholders of the amalgamating company. 

In a scheme of amalgamation, any transfer of a capital asset such as being a share or shares held in an Indian company, by the amalgamating foreign company to the amalgamated foreign company, if— {Section47(vi a)}

  • A minimum of 25% of the shareholders of the amalgamating foreign company carry on as shareholders of the amalgamated foreign company, and
  • In the country where the amalgamating country is incorporated, no tax is levied on capital gains 
    In an amalgamation scheme between 2 foreign companies where as a consequence the transfer results in an indirect transfer of Indian shares along with the conditions as specified above, tax exemption can be availed. 

In conclusion, we can say that an amalgamation between two or more foreign companies can definitely be exempted from tax in India for the amalgamating foreign company, however, it will definitely result in Indian Capital Tax gains for the shareholders. 

Other Considerations

  • Indirect taxes 

As in an Amalgamation/ Merger, there is a transfer of the company on a going-concern basis the Goods & Services Tax is not usually applicable. However, it has been stated under Section 18(3) of the Central Goods & Services Tax Act, 2017  that availability of the input tax credit furnishes that where there is a change in the constitution of a registered person on account of an amalgamation, transfer of unutilized input tax credit in the electronic credit ledger shall be permitted if certain conditions are satisfied. 

  • Stamp duty

In India, the constitution segregates the power between the Center and the State Government towards levying stamp duty. Stamp duty is always paid when a Sale Deed or a Deed of Conveyance is executed.  The central Government enacts The Indian stamp Act of, 1899 which may or may not be adopted by the states. Certain states in India have their own respective stamp acts.  

Demerger

In comparison to an amalgamation, a demerger is a manner of slicing off a business of a company through a process that is driven by NCLT in compliance with the Companies Act, 2013. It involves the transfer of a part of a company to another company, generally as a going concern. The newly formed entity may be incorporated as a new company or maybe a company that already has its own legal entity. 

Indian Tax Laws 

Demerger has been defined under Section 2 (19AA) of The Income Tax Act as a transfer pursuant to a scheme of arrangement under the provisions of Indian Company Law, by a company that is demerged to a resulting entity and which meets the following conditions:

  • As a result of a demerger, the entire lot of assets & liabilities of the said business undertaking which are transferred by the demerger immediately prior to the demerger becomes the assets and liabilities of the said resulting company vis-a-vis the demerger. 
  • The assets and liabilities should be transferred at the book value immediately prior to the demerger (increase value due to revaluation is exempted) 
  • Excluding the situation where the new company itself is a shareholder of the demerged, the said resulting company on a proportion basis must issue its shares to the shareholders of the demerged company.  
  • In its value, at least 3/4th of the shares held by shareholders of the demerged company become the shareholders of the resulting company. It is also to be noted that, in calculating the 3/4th value the shares in the said demerged company which are already held by the resulting company/nominee/ subsidiary are not to be considered.
  • The business undertaking must be transferred on a going concern basis. 
  • In accordance with Section 72 A (5) of the Income Tax Act,  the demerger transaction should be in accordance with the additional conditions as levied by the Central Government. 

Therefore, only when the demerger transaction ticks all the aforesaid conditions it shall be termed a demerger. 

Implications of Tax – Demerging Company 

The tax laws, in particular, ascertain that in a situation of a tax neutral demerger, there shall be no capital gains tax on the demerging company on any transfer of capital assets to the resulting company (If an Indian company)

On the other hand, when there is a demerger of a foreign entity into a subsequent foreign entity where the capital assets are transferred, there shall be no tax implication on the capital gains in India if the following are complied with 

  • A minimum of 75% of shareholders of the demerging foreign company remain shareholders of the resulting foreign company.
  • The country in which the demerging foreign company is incorporated, the said demerger is not chargeable to capital gains tax. 

Implications of Tax – Resulting company 

  1. Carry forward of tax losses & unabsorbed depreciation:

The resulting company is to carry forward the accumulated tax losses and depreciation which is unabsorbed of the undertaking where: 

  • The company which is being transferred has a direct relation to it. 
  • There is no direct relation to it, then it has to be segregated between the demerging company and the resulting company in exactly the same percentage in which the assets have been ascertained by the demerging company and the resulting company.
  1.  Cost of assets & depreciation in the statement of the Demerging company qua the assets transferred, the opening written down value of the assets which are transferred is written down as the same value. 
  2. The demerging company is allowed a deduction in the tax treatment in respect of expenses incurred on the demerger transaction equally for 5 years commencing from the year the demerger takes place. 

Other considerations:

  • A Demerger does not attract any Goods & Services Tax. 
  • In India for the purposes of Stamp duty, the constitution segregates the power between the Center and the State Government towards levying stamp duty. Stamp duty is always paid when a Sale Deed or a Deed of Conveyance is executed.  The central Government enacts The Indian Stamp Act of, 1899 which may or may not be adopted by the states. Certain states in India have their own respective stamp acts. 
  • For the purposes of SEBI & stock exchange approvals, it is mandatory for the listed company to submit the scheme of merger along with all the important documents 

Asset sale

An asset sale, a way of transferring ownership of fewer items that allows the partners to handpick them as per their commercial considerations and also relieves the buyers of liabilities. In an organized sale of assets, for deciding the taxability of capital gains, a qualification is drawn between depreciable and non-depreciable assets.

Depreciable assets

Assets such as plants, machinery, devaluation on which is accessible. Section 50 of ITA acknowledges the calculation of capital gains of depreciable assets under section 50.

For depreciable assets, the way of calculation of capital gains relies upon whether the asset diminishes or keeps on existing post exchange. The capital gains acquired on the movement of depreciable assets are considered to be Short term capital gains.

Non-depreciable assets

Assets which are not held with the purpose of business use and devaluation on which is not accessible under Section 32 of ITA. The capital gains on such assets is computed according to section 45 and 48 of the ITA.

For non-depreciable assets, capital gains are computed as a difference between Cost of acquisition and sale considerations. The gain from the sale of every asset is resolved and the transferor is at risk of capital gains (assuming any) from the sale of every asset. 

Furthermore, whether the sale would bring about Short or long-term capital gains would be dissected separately contingent upon the holding time frame of every asset by the transferor.

Capital Gains 

Where block continues to exist Post Transfer:

Capital gains from the exchange would be considered to be short term and ought to be taxable in the hands of the transferor at the relevant tax rate, entirely independent of the time of holding of such assets.

The capital gains will be computed on the following considerations:

It shall be the difference between :

the sale consideration from the transfer of the said assets, accumulated  with the transfer of any other asset (s) within that block in the same financial year, 

and the aggregate of: 

  1. Expenditure incurred in the transaction; 
  2. Written Down Value of the Block  asset at the commencing of the financial year; and 

iii. Actual cost of any asset acquired during that year and forming part of that Block.

In cases where no capital gains have emerged from the assets, regardless of the amount exceeding its cost of acquisition, the value of the block is reduced by the amount of sale consideration of that asset, provided that the transferor ought to qualify for the reduced depreciation in the next financial year.

Where Block ceases to exist post-transfer:

Matters where all assets from a block are transferred to the point where it ceases to exist, Capital gains in such cases ought to be considered short term. Furthermore, such gains should be taxable appropriately regardless of the period of holding such assets.

The capital gain from such transfer is 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

  1. Written Down Value of the Block at the beginning of the year;
  2. The actual cost of any asset acquired during that financial year

Other considerations:

Indirect taxes-

In an asset sale, each asset is assumed to be a separate item and thus a distinct value is assigned to each asset. Goods and service tax(GST) as high as 28% is pertinent, relying upon the nature of assets sold.

Stamp Duty- 

The rate of Stamp duty in case of an asset sale is mostly state-specific. Stamp duty payable is administered by arrangements of the concerned stamp act where the document of transfer is executed. However, there is no obligation to pay the stamp duty if the instrument does not affect the transfer. 

On the other hand, on intangible assets like goodwill, Stamp Duty at the rate of 3% of its value needs to be paid on the instrument affecting its transfer.

Slump sale

In contrast to an asset sale, a slump sale is characterized under the ITA as the sale of any undertaking(s) for a singular amount considered, without relegating values to singular assets or liabilities. There have been various arguments put forth by The Delhi and Bombay High courts as to whether any transfer is to be considered as a ‘slump sale’, a fundamental component is that the exchange of the undertaking must be in monetary terms. As needs are, this issue is yet to be settled by legal Judicial Precedent.

The Income Tax Act states the following in regards to Slump sale-

The gains emerging from a slump sale will be dependent upon capital gains at the hands of the transferor during that period. Such gains would be short term unless the transferor held the undertaking for a period of 3 years or more.

The amount subject to capital gains tax shall be the consideration for the slump sale minus the net worth of the company, which has been defined as the gross value of the assets minus the value of liabilities of the company.

  1. The depreciated value of assets and liabilities, with few exceptions, is taken into consideration while deriving the capital gains tax.
  2. In cases where the whole undertaking has been transferred under various arrangements, the Income Tax Appellate Tribunal (“ITAT”), Mumbai has held that the equivalent would establish a Slump sale.

Other considerations:

Indirect Taxes-

There is no provision of Goods and Service Tax (GST) on sale of the business as a Slump sale on the grounds that the entity being sold is an undertaking or the business on a Slump sale basis, and ‘business’ essentially does not qualify under the meaning of ‘goods’. 

Stamp Duty-

Rate of Stamp duty in case of Slump sale is mostly state specific. Stamp duty payable is administered by arrangements of the concerned stamp act where the document of transfer is executed. However, there is no obligation to pay the stamp duty if the instrument does not affect the transfer. 

On the other hand, on intangible assets like goodwill, Stamp Duty at the rate of 3% of its value needs to be paid on the instrument affecting its transfer.

Share purchase

Share sale is one of the most common methods of mergers and acquisitions in India. Carried out mostly in cash, the major tax implications on share purchase are in the forms of Liability to tax on capital gains and section 56 of the ITA, if any.

The taxation on gains acknowledged on share transfers would rely upon whether such offers are held as capital assets or as stock-in-exchange. If held as capital assets, profits from the transfer of shares will be chargeable to tax under the head capital gain as indicated by segment 45 of the ITA.

Whereas, in case of stock-in-exchange, profit and gains from transfer of shares will be chargeable to tax under head profits and gains from business and profession.

The Central Board of Direct Taxes (“CBDT”) has warnings, set out the accompanying standards with respect to income emerging on sale of securities.

  1. The taxpayer, after a period of 12 months, has a one time opportunity to treat the income arising from sale of listed shares and securities to categorise as either business income or capital gains. Either option, once exercised, can not be reversed.
  2. Any gain arising from the sale of unlisted shares must be considered as capital gains, irrespective of the period of holding such shares except due to
  • Lack of genuinity in the transaction.
  • The said transaction breeds an issue relating to lifting of the corporate veil.
  • The exchange is made alongside control and the board of fundamental business. This, however, will not be applicable in case of transfer of unlisted shares (Category I & II) registered with the Securities and Exchange Board of India (SEBI). 

Capital Gains

According to section 45 of the ITA, Capital gain tax should be computed at the hour of the transfer, or on the date of the said agreement. The tax-payer is needed to pay capital gains concerning the year of his right to get instalment money, regardless of whether such instalment is conceded in entire or partially.

According to Section 48 of the Income Tax act, qua the capital gain is accumulated by deducting from the consideration received on account of transfer of capital asset:

  • The expenditure incurred wholly and exclusively in connection with such a transaction;
  • The Cost of Acquisition of the asset; and 
  • Any Cost of improvement of the capital asset

Short term capital gains  

  1. According to ITA, aTax rate of 15% is chargeable on the Sale of listed equity shares on the floor of the RSE (Securities Transaction Tax paid).
  2. For sale of both listed and unlisted securities, a rate of 15% and 30% is applicable for domestic companies and 40% in case of foreign companies.

Long-term Capital gains 

  1. In case of listed equity shares, A tax rate of 10%, without indexation or foreign exchange fluctuation benefit is chargeable in case of both domestic and foreign companies.
  2. For other listed securities, 20% is charged with indexation benefit; or 10% without indexation benefit, whichever is more beneficial is chargeable.
  3. In case of unlisted securities, a tax rate of 20% with indexation benefit for domestic companies, and 10% without foreign exchange fluctuation benefit is chargeable. 

Section 56 

Section 56 of Income Tax Assets provides that where any individual gets any property, other than unfaltering property, including portions of an organization, without consideration, or for a consideration, is taxable in the hands of the recipient under head income from other sources.

The rate of tax will, however, be in accordance with the taxpayer’s status.

  • In the case of an individual, as per prescribed slap rates.
  • For domestic companies, the corporate tax rate is between 15% to 30%.
  • In case of Domestic companies, 30%, and
  • For foreign entities, 40% will be charged.

Other Considerations:

Securities Transaction Tax

  • In case of Intraday sales, STT at the rate of 0.025% is payable by the seller.
  • In case of sale of shares on the floor of RSE, STT is levied on the turnover.

Indirect Taxes

The CGST act specifically excludes taxes on the sale and purchase of securities as it does not qualify to be under goods and services.

Stamp Duty

As per the amendment made by the finance act 2019, a rate of 0.015% of stamp duty is chargeable on the value of shares transferred.


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