Streamlining Taxation in M&A Transactions: A Comprehensive Analysis

Introduction

Corporate restructuring activities, such as Mergers and Amalgamations, are extensively regulated under the Companies Act 2013. However, the taxation aspect, including changes in the taxation computation system and provisions regarding the treatment of different types of mergers and amalgamations, is governed by the Income Tax Act, 1961.

In the Indian taxation system, a capital gains tax is imposed on the transfer of various assets during an amalgamation scheme from the company being amalgamated to the other company. Following the merger of two companies, the assets transferred are not considered as a transfer and therefore do not attract Capital Gains tax provisions. Additionally, shareholders of both companies enjoy taxation benefits if both entities are based in India. Consequently, tax issues in Merger and Amalgamation Transactions can be categorized into two parts: tax issues in domestic merger and amalgamation transactions, and tax issues in international transactions.

Income Tax Act, 1961 and Mergers and Amalgamations

The Indian Income Tax Act, 1961 has laid down some essential conditions for any merger to be considered an amalgamation which are as follows:

1. The Equity and Preference owners should both be, shareholders of the merged firm in tune of 75% of the Company’s combined worth.
2. There should exist no time limit to qualify when the assets of the merging company should be passed to the merged company.
3. The merging company’s shareholders should be given both the cash and stockof combined company’s capital as compensation.

Capital Gains and Tax Liability

Capital gain, in taxation terms, refers to the difference between the cost of acquisition of an asset and the sale price when the capital asset is transferred within a fiscal year. When the spread i.e., the difference between the sale consideration and cost of acquisition is positive, it is called capital gain which is taxable in the hands of the transferor entity.

There are various implications of Capital Gains tax on various entities such as:

• The capital gains tax is levied upon the shareholders of the company –In an amalgamated or a merged entity, the shareholders are eligible for numerous options of payouts on selling their shares. In case there exists a tax liability on a specific type of receipts from payout option, the shareholders have the responsibility to pay capital gains tax upon the excess profit earned on the transaction. In various landmark cases, the Hon’ble Supreme Court has also held that preference shares of the merged company as a financial asset get extinguished upon the merger of two different companies and therefore, this constitutes a transaction eligible for Capital Gains Tax.
• In case the merged company is an Indian entity, according to the scheme of amalgamation, the transfer of any assets of capital nature of the business that are merged into the amalgamated company is not subject to the capital gains tax. Moreover, according to the Income Tax Act, the method of calculation of income must be based upon the transfer consideration which states that financial gains cannot occur if there is no consideration, and therefore, the corporation shall not be subject to any capital gains since it has received no compensation of any kind.
• In the case of a demerged company, if the company is an Indian entity, any transfer of money or assets made under the demerger scheme to the demerged company shall be free from the application of capital gains tax and therefore, the shareholders of the demerged company are entitled to more shares proportionately in the new company under the demerger scheme.
• If the new company so formed from a merger or amalgamation is also an Indian company, any transfer made to it by the demerged company does not attract the liability of capital gains tax.

Tax Issues In Cross Border Mergers And Amalgamations

According to Section 206AA of the Income Tax Act, upon the failure of any person to provide his PAN to the party responsible for collecting TDS, the latter party has the duty to deduct 20% Tax deducted at the source or the maximum applicable rate. However, in case of a treaty regulating the implications of tax under such situations, the courts shall be the competent authority to adjudicate upon such issues.

This will also differ in case the foreign entity has the Most Favoured Nation status given by India which would result in different tax treatment as decided by the competent authority or the central government.

Conclusion

Merger and Acquisitions in forms of amalgamations open a plethora of ways through which any company can save their taxes or lower them through operation of their income or strategic management of their assets.

The system pertaining to taxation in merger and amalgamation transactions is highly complex where the merger or amalgamation deal gives only a single chance to adopt a method of tax planning which would give an opportunity to save taxes in the future. Secondly, various details need to be taken care of while adopting a strategy for tax planning which goes hand in hand with the scheme of restructuring in order to enable a proper system of tax management.

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