Traditionally, a listed company (Parent Co) wishing to integrate the operations of its listed subsidiary (Sub Co), usually contemplates a merger. However, there may be instances in which a merger is unfeasible for a plethora of reasons, viz.,industry-specific constraints (e.g. licences or contracts with specific restrictions on transfer), cultural differences with an acquired entity, etc. In such a scenario, to make a listed Sub Co a wholly owned unlisted subsidiary of the Parent Co, it will be necessary to undertake the process of delisting the Sub Co.
The delisting of securities is a rigorous exercise and involves a multitude of steps. Some of the key steps are as follows:
- Opening an escrow account and a reverse book-building process to arrive at the price;
- Significant outflow of funds to reach the prescribed threshold of delisting;
- Elaborate procedures covering various stakeholders, including Securities and Exchange Board of India (SEBI), merchant bankers, intermediaries, public shareholders, etc.
There is a significant risk of the entire process falling through if the minimum threshold is not met or the price discovered is not viable. Therefore, there is a much lesser degree of control over the success of the entire delisting process.
Given that these numerous constraints plague the delisting process, to provide relief and expedite the delisting process for certain categories of listed entities, i.e.,in cases involving listed Parent Co and listed Sub Co, the SEBI introduced a consultation paper[1] (Paper).
The Paper proposes that as part of the scheme of arrangement between the listed Parent Co and listed Sub Co under section 230 to 232 of the Companies Act, 2013, the listed Sub Co may get its shares delisted from the stock exchange(s) without following the process for voluntary delisting as set out in the delisting regulations,[2] provided that the listed Parent Co would offer fresh shares in its share capital to the public shareholders of the listed Sub Co in exchange of their shareholding in the listed Sub Co based on the share swap ratio to be calculated basis an independent valuation of shares of the listed Parent Co and the listed Sub Co.
This will result in the shareholders of the Sub Co becoming shareholders of the Parent Co. while the shares of the Sub Co. are delisted and it becomes a wholly owned subsidiary of the Parent Co. The following is a pictorial depiction:
The Paper also contemplates certain safeguards,including approval from SEBI and two-third of the public shareholders, and a minimum vintage of three years of listing of Sub Co’s shares. It further prohibits the parent from undertaking any restructuring for a period of 3 years from the date of the NCLT order.
Given the above, the delisting process of the listed Sub Co of the listed Parent Co, as proposed in the Paper, provides significant relief/advantages over the traditional delisting mechanism viz. no fund outflow, scheme once approved is binding on all stakeholders, possible to acquire 100% stake in Sub Co, no hardship of reverse book-building process.
While the Paper does endeavour to grant relief, the tax and regulatory framework may weigh on the viability of the option proposed in the Paper. Some of the key considerations are as follows:
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Under the Income-tax Act, 1961 (Act)[3], gains from the transfer of a capital asset shall be taxed on capital gains basis the period of holding of such capital assets. The term Transfer[4]is defined in the Act to inter alia include the exchange of a capital asset. Hence, the share swap envisioned in the Paper shall be subject to tax in the hands of the shareholders of the Sub Co.
This is in stark contrast to the transfer by shareholders of an amalgamating company who receives shares in the amalgamated Indian company as a consideration for the amalgamation, which is not be subject to tax owing to the relaxation provided under section 47(vii) of the Act. However, no such relaxation is provided under the Act in the case of share swap under the scheme. Consequently, the share swap proposed in the Paper shall be taxable in the hands of shareholders of Sub Co.
However, for the beneficial rate of tax under section 112A of the Act, the acquisition and transfer of the shares of Sub Co should have been subject to securities transaction tax (STT). While there are relaxations for certain modes of acquisition, which are discussed in the Notification,[5] no such relaxation is available for the disposal of shares. Therefore, where the conditionsare not met, the beneficial rate of 10% shall not be available to the shareholder.
In case of a tax neutral merger, the period of holding shares of the amalgamated company shall include the period of holding shares in the amalgamating company.[6] However, the period of holding of shares of the listed Parent Co issued pursuant to the scheme proposed in the Paper shall be reckoned from the date of allotment of such shares and shall not include the period of holding of the shares of Sub Co.
Accordingly, the shares of the listed Parent Co received pursuant to the scheme proposed in the Paper shall need to be held for a period exceeding 12 months from the date of allotment, for the gains to be regarded as long term in future.
Receipt-based tax
When the Fair Market Value (FMV), as defined in the Rules[7]of the shares of Sub Co received by the Parent Co, exceeds the value of consideration paid by the listed Parent Co for such acquisition, the difference shall be taxable in the hands of the Parent Co, as income from other sources.[8] There is no such relaxation available under section 56((2)(x), as is available for the shares received by the shareholders on amalgamation. However, given that the proposal requires share swap to be undertaken basis the respective fair values, there may not be any adverse receipt-based tax implications.
On similar lines, where the consideration (being the shares of listed Parent Co) received by the shareholders of the Sub Co exceeds the FMV of such shares (as determined under the Rules), then such differential amount shall be taxed in their hands as “income from other sources.”
Exchange control
Under the Indian exchange control regulations, a swap of equity shares shall be permitted under the automatic route, where foreign direct investment is permitted under the automatic route.However, in specific cases (including sectors with sectoral cap, which maybe breached or where the holding company is a core investment company, etc.), such swap maybe permitted only with the prior approval of the Reserve Bank of India.
Parting thoughts
The merger of the subsidiary into the listed Parent Co shall be efficient from the tax perspective for all stakeholders. However, in case of the non-feasibility of merger due to commercial or other reasons, where the amendments proposed in the Consultation Paper are included in the regulations, the proposed amendments shall endeavour to fasttrack the delisting process of the listed subsidiary and provide an opportunity to the Parent Co to acquire complete control of the subsidiary company and conserve funds.
In addition, the route under section 230 to 232 of the Companies Act, 2013 involves steps that may provide a much higher degree of control for the Parent Co, unlike a regular delisting process. However, the companies shall need to factor in the tax and other regulatory implications on such proposed delisting process. In case the tax and regulatory aspects also alignwith the objective of conserving value for stakeholders, the proposed scheme shall become even more attractive to all shareholders.
[1] Consultation paper on the proposed amendment to the Securities and Exchange Board of India (Delisting of Equity Shares) Regulations, 2009, dated 16 March 2020
[2]SEBI (Delisting of Equity Shares) Regulations, 2009 as amended from time to time
[3] Section 45 of the Act
[4] Section 2(47) of the Act
[5] Notification No. 60/2018/F. No.370142/9/2017-TPL dated 1 October 2018
[6] Sub-clause (ba) of clause (i) to Explanation 1 to section 2(42A) of the Act
[7] Rule 11UA of the Income-tax Rules, 1962 (Rules)
[8] Section 56(2)(x) of the Act
Author: Amit Jain, Partner, Deals, PwC India and Ashish Nahar, Director, Deals, PwC India.
The views expressed in this article are personal. The article includes inputs from Mahadevan R, Manager, Deals, PwC India and Vignesh S, Associate, Deals, PwC India.
