This is written by Ishita Raghav, pursuing a Diploma in M&A, Institutional Finance, and Investment Laws (PE and VC transactions) from LawSikho.com. This article has been edited by Amitabh Ranjan (Associate, Lawsikho) and by Dipshi Swara (Senior Associate, Lawsikho).
Mergers and acquisitions have now become an essential part of the growing Indian economy. Companies choose this path to explore new opportunities and achieve higher returns however, these are not the only obvious reasons to pursue such an elaborative route; the path of mergers and/or acquisitions enables companies to eliminate competition, reduce tax liabilities, and even successfully set off losses of one entity against the profit of the other company. The term “Mergers” and “Acquisitions” are often misconstrued as synonyms of each other but nothing can be further from the truth – both of these terms have different legal meanings and implications in the market.
Mergers can be considered as a collaboration between two companies created with the aim of constructing an extended company, in the form of a new company. The primary aim behind mergers is to obtain higher business growth and goodwill in the market. The company that is merging itself to the other bigger company, ceases to exist, in the process. For example, company A merges with company B, to become a part of company B and loses its existence in the transaction.
Acquisition, on the other hand, is a transaction wherein one company is sold to another company, without losing their separate entities in due process. The companies involved in the transaction continue to exist in the market with the core management and all the major decision-making power of the target company rests with the acquiring company. For example, company A purchases (acquires) company B and both the companies continue to exist and function in the market.
While there are many elaborate discussions and articles written on compliances required before mergers or acquisitions are panned out, very little is discovered about the post-completion process. It is pertinent to note that transactions of this nature are highly sensitive and in order to achieve the benefits of a successful arrangement, companies must be aware of and adhere to post transactions compliances (and the after-effects) as well. This paper shall discuss briefly introduce some of the most important post Merger and Acquisition compliances, such as –
- Closing compliances with regard to stamp duty.
- Compliances under taxation provisions.
- General compliances under the companies act and rules.
Under the Indian Constitution, stamp duty and its evaluation are a subject of state list, and many states like Maharashtra, Karnataka have introduced separate stamp duty laws, whereas states like Tamil Nadu, Assam and North East have made changes in the schedule of the Indian Stamp Act,1899 (“Main Stamp Act”). To keep this article limited and with the sole purpose of general information, the paper shall highlight stamp duty charges levied on various transactions pertaining to mergers and acquisitions in the state of Maharashtra only.
As mergers and acquisitions deal with a high magnitude of risk and assets (or business) is shared between the parties, it would only be necessary to incorporate indemnity clauses to protect the risk bearer’s interest. The indemnity clauses provided in either the shareholders’ agreements or share subscription agreements would attract stamp duty provisions.
In the state of Maharashtra, indemnity clauses would be dealt with by Maharashtra Stamp Act 1958 (“MS Act”). Article 35, schedule 1 of the MS Act states the stamp duty for indemnity as Rs.500 (Rupees Five Hundred).
Conveyance agreements are sale agreements wherein possession of assets is transferred between the parties. The conditions for conveyance agreement include (i) Transfer of property both movable and immovable, (ii) Transfer by sale (or purchase interchangeably), (iii) Not provided under the Main Act.
According to Article 34 of the MS Act, stamp duty levied on movable property in the state of Maharashtra would be 3 (Three) percent of the market value of the said property. If the said asset is an immovable property and is further declared as residential or agricultural, the stamp dud levied is Rs.200 (Rupees Two Hundred).
Scheme of arrangements
Though the Main Stamp Act does not specifically state levying of stamp duty on transactions like mergers, demergers, acquisitions, slump sales; it is the Companies Act, 2013 and the relevant state acts, in our example, the MS Act which makes place for the required provisions.
Now with the recent order passed by the Maharashtra Government on March 16, 2020, Article 25 of Schedule 1, of the MS Act, the maximum stamp duty payable on orders of the scheme of arrangements in the state of Maharashtra has a ceiling limit of Rs.500 million. The rule is applicable to companies, including their parent and subsidiaries, and banking companies incorporated in India.
Tax provisions, concessions and consideration
Accounting of taxation requires more attention than what is presented by companies. Mergers and all the transactions that can bring change in control or ownership, spontaneously call for relevant taxation implications.
Taxation of purchase of assets or shares
In India, the acquisition of a company occurs either on the purchase of its shares or assets (in part or in whole). Further, these assets can be purchased either in the form of “Lump Sum Sale (or also known as, Slump Sale)” where the assets are sold to the acquiring company on a continuous ongoing basis.
The other form is where “Itemized Sale (or also known as, “Asset sale”)” occurs, where only a limited and specific category of assets are purchased. Here, the acquiring company practices cherry-picking of assets that are suitable for their business. In both these transactions, the purchase price denoted by the selling company is often accepted, subject to the addition of step-up cost.
Taxation of goodwill
Calculation of goodwill is generally considered in slump sale transactions, where the total purchase value paid to the company is higher than the market value of all its assets combined. Previously, under the Indian Income Tax Act 1962(“the Act”), depreciation charges were allowed on various intangible assets such as the goodwill of companies. The value of goodwill was realized when the purchase value of the transaction was observed to be higher than the asset’s value. However, the Finance Act, 2021 with the effect from April 2020, has amended the definition of goodwill and declared that goodwill shall not be considered as intangible assets anymore.
Depreciation charges on tangible assets
The Act provides for a specific rate of depreciation on tangible assets such as buildings, furniture e.t.c. and an additional depreciation of 20% on machinery used in businesses involved in manufacturing and production. It is to be noted that depreciation charges are levied on a “block of assets” where similar assets are grouped under a single block.
Tax attributes, losses and relaxations
Under the taxation laws, tax loss can be summarized as (a) Business loss and (b) unabsorbed depreciation.
Both of these losses can be carried forward to the next financial year for the purchasing company. The business losses can be carried forward to up to 8 years and whereas unabsorbed depreciation for an indefinite timeline. However, this benefit of carrying forward can be performed under certain conditions, one of which is fulfilling the “Continuity Test” as mentioned under Section 79 of the Act. It is mandatory under the test that all the beneficial owners continue to carry 51% voting rights in the company at the end of both the financial years, the year where the said businesses losses were incurred, and the current year where these losses are aimed to be set off against the profits. However, this principle does not apply to a change in ownership of a company due to IBC affected resolutions. It is taken to be understood that this benefit is only limited to business losses, and not applicable to unabsorbed depreciation and only to unlisted companies.
General compliances under the Companies Act, 2013 and the Rules
Now let us assume that two companies are getting merged into one. Let us briefly understand some of the major compliances that must be followed by these companies as per the Companies Act, 2013 and regulations (“Act”). In our example, the transaction that is occurring is – completion of the Scheme of Compromise, Arrangements, and Amalgamation under Sections 230 and 232 of the Act. The transferor company shall be called AB Ltd and the transferee company as YZ Ltd, where AB Ltd is amalgamating into YZ Ltd.
AB Ltd (transferor company)
- Adopting the merger order approved by the NCLT by calling a board meeting;
- Filling the merger order with the Registrar of Companies (ROC) under e- form INC 28*.
- If the company is receiving foreign investments, it must file form FC-GPR with the Reserve Bank of India (RBI) within 30 (thirty) days of the date of issuance of securities**.
- File form PAS-3 with the ROC within 30 days of the order***.
- Income Tax compliance: Intimation of the transaction to the Chief Commissioner of Income Tax (TDS) and such other concerned officers, with the merger order and a follow up application of PAN card.
YZ (transferee company)
- Adopting the merger order with the ROC by calling a board meeting;
- Calling and adopting extraordinary meetings to inform the shareholders about the allotment of shares and other formalities such as change the object clause mentioned in the MOA of the YZ Ltd;
- Income Tax compliance: Intimation of the transaction to the Chief Commissioner of Income Tax (TDS) and such other concerned officers, with the merger order. As mentioned before in this article, if the amalgamating company has any previous unabsorbed losses, the company here can avail the benefits of section 72 of the Income Tax Act by making required submissions.
Other miscellaneous compliances
- The transferee company, YZ Ltd., should update the effective date to the ROC.
- The YZ Ltd. should make and approve necessary changes in the invoices of the transferor company – AB Ltd.
- AB Ltd must conduct a procedure to surrender its registration certificate with the ROC.
- Both the companies must inform the banks, vendors, clients and customers about the merger and its effect on their respective businesses and dealings.
*Form INC-28: The form is filled with the ROC within 30 days of the application getting accepted by the NCLT. Both the companies, first the transferor company, AB Ltd, and then the transferee company, YZ Ltd must file this form. The form requires various key details to be filled by the filing company such as CIN of the company; authority who passed the order with the relevant date; the kind of transaction under the relevant section of the Act; date of filing the application with the tribunal; details of the transferor and transferee company; date of board resolution meetings etc.
** Form FC-GPR with RBI: This form is issued by the RBI when a company is receiving foreign investments. The conditions precedent for filing this form is that the foreign investment must comply with FDI policy and securities should be transferred to the foreign entity in the prescribed manner of foreign exchange management. The documents required for filing this form are not limited to Declaration by the authorized party that the form is as per RBI format; CS certificate, Valuation certificate (not needed for assigning rights issue shares); Memorandum of Association of the company; Board resolution; Foreign Inward Remittance Certificate and KYC details of the investors, etc.
*** Form PAS3 with the ROC: This e form is filled in accordance with sections 39 (4) and 42(9) of the Act along with rules 12 and 14 of the Companies (Prospectus and Allotment of Securities) Rules, 2014. The applicability of the form gets triggered every time a company having an existing share capital, makes an allotment of any securities. The details required under this form are CIN of the company; capital structure of the company; details of securities if the allotment is done via cash; details of securities of the allotment is conducted other than cash; bonus shares if any issued; list of allottees; shareholders or board resolution; valuation report issued by a registered valuer; a complete set of agreement, etc.
The above-explained provisions are some of the many necessary considerations that companies must keep in mind while initiating (and completing acquisition processes). From a business point of view, target companies may seem like attractive opportunities but companies should be mindful of many other aspects. The stamp duty charges are rather very expensive in real life, even worse when the two companies are in different states of the country. More often than not, acquiring companies have changed their registered office address from one state to another to avail some monetary gains. The same principle applies to taxation provisions, which need constant thorough understanding. A business deal can become a bad loss later on if it succumbs to tax penalties. That being said, when companies decide to go through the decision of undertaking merger or acquisition, they must keep an eagle eye over the pre as well as post-compliance issues and effects that the target or the acquiring company can be compelled to follow.
- Shamika Vaidya, ‘Stamp Duty In Different States For Mergers And Acquisition In India’ (iPleaders, 2019)
- ‘Your One-Stop Shop For All The Information On The Maharashtra Stamp Act 2021’ (nobroker.in)
- ‘Implications Of Stamp Duty On Schemes Of Arrangement’ (Lawteacher.net, 2019).
- (Www2.deloitte.com, 2020)
- Finance Express, ‘Short-Term Capital Gains: New Goodwill Rule Seen Imposing Tax Liabilities On Firm’ (2021).
- Vivek Gupta, ‘India – Taxation Of Cross-Border M&A’ (KPMG, 2021)
- B Mahadevan, ‘Analysis of Section 79-Carry Forward & Set Off Of Losses In Companies’ (TaxGuru, 2019).
- Lily Bali, ‘Checklist For Post Merger Legal Compliances’ (2017)
- ‘Filing Form FC-GPR’ (India Fillings) <https://www.indiafilings.com/learn/filing-form-fc-gpr/>
- ‘Instruction Kit For E form INC-28’ (Mca.gov.in)
- ‘Instruction Kit For Eform PAS-3’ (Mca.gov.in)
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