Earmarking another landmark step in corporate history, on 13 April, 2017, the Ministry of Corporate Affairs (MCA) brought into force the relevant corporate law provisions dealing with cross-border mergers and amalgamations. These new provisions bring global economies closer and open a host of opportunities by facilitating global acquisitions, sale transactions, consolidations and restructuring for Indian companies.
The newly enacted section 234 of the Companies Act, 2013, now permits merger and amalgamation of an Indian company with a foreign company and vice versa. MCA has also introduced the corresponding Rule 25A in the Companies (Compromises, Arrangements and Amalgamation) Rules, 2014, in consultation with the Reserve Bank of India (RBI). As per this Rule, prior RBI approval is required for a cross-border merger. The RBI has introduced draft Foreign Exchange Management (Cross Border Merger) Regulations, 2017, which provide that a cross-border merger shall be deemed to be approved by the RBI if it is in accordance with said regulations.
The cross-border merger regime is not a new concept under Indian corporate law provisions, as the erstwhile Companies Act also contained enabling provisions for inbound mergers (i.e. merger of a foreign company into an Indian company). In fact, the income-tax laws already prescribe a tax neutral status to inbound mergers for the merging company as well as its shareholders where specified conditions are met, viz. transfer of all assets and liabilities and continuity of shareholders holding minimum 75% shares.
While in the past inbound mergers have generally been implemented for consideration in the form of shares, the new corporate law provisions also permit payment of consideration in the form of depository receipts and cash. Where the consideration on mergers is discharged in the form of depository receipts or cash, such mergers may not remain income-tax neutral. In the absence of specific tax provisions for taxing such transactions, the tax implications on the merging company and shareholders remain ambiguous.
As regards an overseas merging company, in case it does not have any assets situated in India, there may be no tax implications in India. Similarly, in the hands of shareholders, there would be no capital gains implications on transfer of shares of the merging foreign company in India unless the shareholders are Indian tax residents or such shares derive their value substantially from assets in India (resulting in the trigger of indirect transfer provisions under the Indian tax laws). In case such a transaction is taxable in the hands of shareholders, the capital gains would logically be computed based on the fair value of the shares of the merged company received as consideration.
As regards outbound mergers, while the relevant provisions have been notified under the corporate laws, the conditions subject to which such mergers will be approved by the RBI would need to be seen. The draft RBI guidelines provide that such outbound mergers shall be deemed to be approved by the RBI if they are in accordance with the Foreign Exchange Management (Transfer or Issue of Foreign Security) Regulations, the Liberalized Remittance Scheme, etc., as applicable. The manner in which the contours of the deemed approval concept would work is yet to be seen. Unlike inbound mergers, the existing framework of Indian tax laws does not provide a taxation mechanism for outbound mergers. Accordingly, outbound mergers are likely to open a Pandora’s Box of uncertainties and potential issues from a tax standpoint.
A view exists that, like in the case of inbound mergers, tax neutral status should also be accorded to outbound mergers to simplify and facilitate corporate reorganization. On the contrary, given that an outbound merger leads to the shifting of both value and future profits of the Indian company to an overseas foreign jurisdiction, an amendment in Indian tax laws to provide a tax neutral regime for outbound mergers may not be forthcoming without building relevant safeguards in the Indian tax laws.
In addition to satisfying the conditions, such as transfer of all assets and liabilities and continuity of shareholders holding minimum 75% shares, that have already been specified for a merger to be tax neutral, such conditions may include a requirement that shareholders of the merging company should be Indian residents (as of now, for any merger to be tax neutral, the merged company is required to be an Indian company).
In the absence of any specific exemption, taxation of outbound mergers may be more complex than that of inbound mergers because the defence available in the case of inbound mergers – that the merging company is not an Indian company or the shareholders are not Indian residents – may not be available for outbound mergers. Nevertheless, non-resident shareholders of the merged Indian company may be able to claim exemption under the relevant tax treaty.
Although all potential tax issues arising from cross-border mergers may be difficult to envisage at this stage, it would be interesting to see how the income-tax provisions are amended to provide for the taxation of both inbound and outbound mergers.
Views expressed are personal to the author. Article includes inputs from Richa Singla – Associate Director – M&A Tax, PwC India and Vignesh Iyer – Assistant Manager – M&A Tax, PwC India