Modi Government 2.0 faces economic challenges that the Finance Minister Nirmala Sitharaman has attempted to address through her maiden budget.
The Budget mainly focuses on the Government’s vision to drive India to higher economic growth and become a five trillion-dollar economy in the next five years.
This article examines the key changes to direct tax laws from the perspective of Mergers and Acquisitions (M&A).
Carry forward of tax losses: Section 79 of the Income-tax Act, 1961 (Act) provides conditions for carry forward and set-off of losses in case of a company not being a company in which the public are substantially interested. Clause (a) of this section applies to all such companies, except an eligible start-up, while clause (b) applies only to such eligible start-up.
To facilitate the ease of doing business for a startup, it is proposed to amend section 79 to provide that loss incurred in any year prior to the previous year, in the case of closely held eligible start-up, shall be allowed to be carried forward and set off against the income of the previous year on satisfaction of either of the two conditions stipulated currently in clause (a) or clause (b).
Investment by Category II Alternative Investment Fund (AIF) exempt from deemed taxation: The existing provisions of section 56 of the Act, inter alia, provide that when a closely held company receives in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares, as exceeds the fair market value of the shares, shall be charged to tax. However, exemption from this provision had been provided to only Category I AIFs and is proposed to be extended to funds invested by Category II AIFs.
Interest paid to a non-resident on rupee-denominated bonds (RDB): The existing provisions of section 194LC of the Act provide that the interest income payable to a non-resident on RDB needs to be paid after withholding tax at 5% (plus surcharge and cess).
The Government, through a press release dated 17 September, 2018, had announced that interest payable on RDB during the period 17 September, 2018 to 31 March, 2019 would be exempt from tax. The exemption announced through this press release is proposed to be incorporated in the law by amending the relevant provisions of the Act.
B. Anti-abuse measures
Buy-back of shares in case of listed entities: Section 115QA of the Act provides for the levy of additional income-tax at the rate of 20% plus applicable surcharge and cess of the distributed income on account of buy-back of unlisted shares by the company. The consequential income arising in the hands of shareholders is exempted from tax under clause (34A) of section 10 of the Act. This provision was applicable only in case of unlisted companies. To curb the growing practice adopted by listed companies of cash repatriation through buy-back instead of dividend distribution, the applicability of this provision is proposed to be extended to all companies, including companies listed on a recognised stock exchange.
Gift to a non-resident – deemed income: Under the Act, a gift of money or property is taxed in the hands of the recipient, except for certain exemptions provided in section 56(2)(x). In certain situations, gifts by persons being residents in India to persons outside India were claimed to be non-taxable in India, as the income does not accrue or arise in India. To ensure that gifts by residents to persons outside India are subject to tax, it has been provided that income of the nature referred to under section 2(24)(xviia), i.e., income arising from any sum of money paid, or any property situated in India transferred, on or after 05 July, 2019, by a person resident in India to a person outside India, shall be deemed to accrue or arise in India.
C. Eliminate difficulties faced by taxpayers
Facilitating demerger of Ind-AS compliant companies: An existing condition for tax-neutral demergers is that the resulting company should record the property and liabilities of the undertaking at the value appearing in the books of accounts of the demerged company. As per the Indian Accounting Standards (Ind-AS), companies are required to record the property and liabilities of the undertaking at fair value. This requirement of recording property and liabilities at book value by the resulting company is proposed to be removed for demerger whose accounting treatment complies with the Ind-AS.
Pass-through status for loss of AIF: Section 115UB of the Act, inter alia, provides for pass-through of income earned by the Category I and II AIF, except for business income, which is taxed at the AIF level. Pass-through of profits (other than profit & gains from business) has been allowed to individual investors to give them the benefit of lower rate of tax, if applicable. An amendment is proposed to provide for pass-through of losses to investors as follows:
1. Business loss: can be carried forward and set-off only against the business income of the fund, and not passed onto the unit holder.
2. Other loss: can be passed on the unit holder, if such loss has arisen on a unit held by the unit holder for a period of at least 12 months.
Measures of relief in cases of oppression and mismanagement: The existing provisions of section 79 are not applicable to a company when any change in shareholding takes place in a previous year pursuant to a resolution plan approved under the Insolvency and Bankruptcy Code, 2016 (IBC) subject to certain conditions. Thus, loss in such cases can be carried forward and set off even if there is change in voting power or shareholding. This benefit is proposed to be extended to the following companies:
1. The National Company Law Tribunal (NCLT) on a petition moved by the Central Government under section 241 of the Companies Act, 2013, has suspended the Board of Directors of such company and has appointed new directors, who are nominated by the Central Government, under section 242 of the Companies Act, 2013: and
2. A change in shareholding of such company, and its subsidiaries and the subsidiary of such subsidiary, has taken place in a previous year pursuant to a resolution plan approved by NCLT under section 242 of the Companies Act, 2013, after affording a reasonable opportunity of being heard to the jurisdictional Principal Commissioner or Commissioner.
Some key aspects that could have been considered from an M&A tax perspective are:
1. Taxation of outbound mergers/ demergers;
2. Transfer of loss in case of a services entity (non-industrial entities) pursuant to a merger;
3. Carry forward of MAT credit pursuant to merger/ demerger;
4. Capital gains tax exemption to shareholders of a foreign company from indirect transfer tax pursuant to merger/ demerger between two foreign companies;
5. Replace Dividend Distribution Tax with withholding tax — to remove ambiguity on credit of DDT in the hands of shareholders;
6. Tax exemption on conversion of company to LLP – relaxation of turnover and asset criteria;
7. Tax exemption for merger of two LLP’s;
8. Tax exemption from deemed income under section 56(2)(x) of the Act for fresh issue of shares.
Author: Aditya Narwekar – Partner, M&A Tax, PwC India and Lakshmisha S – Director, M&A Tax, PwC India
The views expressed in this article are personal to the author. This article includes inputs from Anirudh Tadanki – Manager – M&A Tax, PwC India and Jiten Thakkar – Assistant Manager – M&A Tax, PwC India.