Merger of EOU Pharmaceutical Companies: A Compliance & Regulatory Perspective

Executive Summary

The merger of a subsidiary listed pharmaceutical company operating as an Export Oriented Unit (EOU) with its holding pharmaceutical company presents a complex regulatory landscape requiring meticulous compliance across multiple statutory frameworks. This article explores the critical compliance considerations under GST, DGFT, Customs, Foreign Trade Policy (FTP), EOU regulations, NDPS Act, and the Drugs and Cosmetics Act, 1940.

1. EOU Status and Continuity Considerations

A. Transfer of EOU License

The Export Oriented Unit scheme, governed by Chapter 6 of the Foreign Trade Policy and administered by the Directorate General of Foreign Trade (DGFT), requires explicit approval for merger transactions. The surviving entity must apply to the Development Commissioner for continuation of EOU status, demonstrating:

• Continuation of manufacturing activities at the same location
• Maintenance of export obligations and Net Foreign Exchange (NFE) requirements
• Compliance with sectoral caps and investment conditions
• Fulfilment of outstanding export obligations by the merged entity

The Development Commissioner’s approval is mandatory before effectuating the merger to ensure uninterrupted operation and preservation of duty benefits on existing capital goods and raw materials.

B. Export Obligation Compliance

The merged entity inherits unfulfilled export obligations of both entities. A comprehensive audit of cumulative export performance against obligations under the EOU scheme is essential. Any shortfall triggers duty liability on imported capital goods and raw materials proportionate to the deficiency. The merger agreement should clearly delineate responsibility for pre-merger obligations and establish mechanisms for their satisfaction.

2. Customs and DGFT Compliance:

A. Treatment of Duty-Free Imports

EOUs enjoy exemption from customs duties on imported capital goods, raw materials, and consumables under Customs Notification No. 52/2003-Cus. The merger raises critical questions regarding:

• Continuity of exemptions: The transferred assets must retain their duty-exempt status, requiring intimation to customs authorities and amendment of relevant Bills of Entry
• Unutilized imported materials: Stock transfer of duty-free materials necessitates proper accounting and customs approval to prevent duty leakage
• Capital goods transfer: Transfer of capital goods imported duty-free requires prior permission from customs authorities, ensuring the transferee continues eligible use

B. Customs Bonding and Bank Guarantee

EOU units typically operate under customs bonds with bank guarantees covering potential duty liabilities. The merger necessitates:

• Substitution or novation of existing bonds
• Recalculation of bank guarantee quantum covering consolidated duty liability
• Approval from jurisdictional customs authorities for bond transfer
• Clearance of pending investigations or show-cause notices before merger completion

3. GST Implications and Compliance

A. Classification as Supply or Otherwise

The merger, being an arrangement between related parties involving transfer of a going concern, requires analysis under GST law. While Schedule III of the CGST Act excludes certain transactions from supply, the transfer must be structured to qualify as a non-taxable transaction. Key considerations include:

• Transfer of going concern: The transaction should involve transfer of the entire business unit as a going concern to potentially qualify for exclusion from GST levy
• Valuation issues: Any consideration beyond share exchange may attract GST implications requiring careful structuring
• Input Tax Credit (ITC) migration: Unutilized ITC on inputs, capital goods, and input services must be transferred to the successor entity following prescribed procedures under Section 18(3) of the CGST Act

B. Transitional Provisions and Compliance

The merged entity must ensure:

• Filing of final GST returns by the transferor entity
• Intimation to jurisdictional GST authorities regarding the merger
• Transfer of ITC through proper documentation and compliance with Rule 41 of CGST Rules
• Continuation of GST registration or fresh registration for the merged entity
• Settlement of any pending GST liabilities, refunds, or litigation

4. Drugs and Cosmetics Act Compliance

• Manufacturing Licenses and Approvals

The Drugs and Cosmetics Act, 1940, and Rules thereunder mandate separate manufacturing licenses for each manufacturing location. The merger triggers several compliance requirements:

• License transfer application: Application to the State Licensing Authority under Rule 70 for transfer/amendment of manufacturing licenses held by the transferor
• Change in constitution: Intimation regarding change in company constitution and management structure
• Site master file updates: Revision of site master files reflecting the merged entity’s ownership and organizational structure
• Good Manufacturing Practices (GMP) continuity: Ensuring uninterrupted GMP compliance during transition

• Product Registrations and Marketing Approvals

The transferor company’s product registrations require novation to the merged entity:

• Applications to Central Drugs Standard Control Organization (CDSCO), under the Ministry of Health for transfer of product approvals
• State-wise intimations for sale licenses and marketing authorizations
• Updated product literature reflecting the merged entity’s details
• Pharmacovigilance database consolidation and reporting continuity

5. NDPS Act Compliance Considerations:

Pharmaceutical companies manufacturing narcotic drugs and psychotropic substances operate under stringent controls imposed by the Narcotic Drugs and Psychotropic Substances Act, 1985, and rules thereunder.

A. License Transfer and Continuity

• NDPS licenses are non-transferable: Fresh applications may be required to the competent authority (Central Bureau of Narcotics or State Narcotics Commissioner) for manufacturing and possession licenses
• Inventory reconciliation: Comprehensive accounting of NDPS drugs inventory during transition with simultaneous reporting to enforcement authorities
• Security clearances: Fresh security clearances for key managerial personnel of the merged entity
• Storage and handling protocols: Ensuring uninterrupted compliance with prescribed storage, security, and handling norms

B. Regulatory Intimations

Timely intimation to the Narcotics Commissioner regarding ownership changes, along with no-objection certificates, prevents operational disruptions and regulatory penalties.

6. Foreign Trade Policy Considerations

A. Advance Authorization and EPCG Schemes

If either entity holds Advance Authorization or Export Promotion Capital Goods (EPCG) authorizations:

• Export obligation transfer: Explicit approval from DGFT for transfer of unfulfilled export obligations
• Bond novation: Transfer of customs bonds executed under these schemes
• Time extension applications: If required, due to transition disruptions
• Compliance certificates: Ensuring redemption or proper accounting of all authorizations

B. Special Economic Zone (SEZ) Interactions

If the EOU has procurement or supply relationships with SEZ units, the merger must preserve these arrangements with proper documentation and approvals from SEZ authorities.

7. Structural and Procedural Recommendations

Pre-Merger Due Diligence

Comprehensive regulatory due diligence should encompass:

1. Verification of all licenses, approvals, and authorizations held by both entities

2. Assessment of pending litigation, show-cause notices, or regulatory investigations

3. Evaluation of export obligation compliance and potential duty liabilities

4. Analysis of ITC accumulation and refund claims

5. Review of NDPS compliance history and any adverse observations

8. Merger Implementation Roadmap

A phased approach ensures regulatory compliance:

Phase A – Pre-Approval Stage

• Obtain in-principle approval from Development Commissioner (DC) for EOU status continuation
• Apply for license transfers under Drugs and Cosmetics Act
• Initiate discussions with customs and DGFT authorities

Phase B – Court/NCLT Approval Stage

• Incorporate regulatory approvals as conditions precedent in the scheme
• Ensure regulatory authorities are represented in proceedings if required
• Obtain clearances from sectoral regulators

Phase C – Post-Merger Integration

• Complete license transfers and registrations
• Migrate ITC and settle GST compliance
• Update all statutory records and filings
• Consolidate compliance calendars and reporting mechanisms

Conclusion

The merger of pharmaceutical companies with EOU status demands a sophisticated understanding of interconnected regulatory frameworks. Success requires proactive engagement with multiple regulatory authorities, meticulous documentation, and strategic planning to preserve valuable benefits while ensuring seamless compliance.

******

In case of any query and clarification regarding compliance, advisory and litigation in merger and acquisition and require any support, you may like to connect with us.

Abhinarayan Mishra FCA, FCS, LL.B, IP, RV; Managing Partner, SAM Law Associates LLP; KPAM & Associates, Chartered Accountants, New Delhi ; +91 9910744992; ca.abhimishra@gmail.com; samlawassociates18@gmail.com