Background:-The draft Direct Taxes Code along with a Discussion Paper was released on 12 August 2009 for public comments to simplify direct tax legislation in India. Subsequently, comments were solicited from the public and examined by the Government. A Revised Discussion Paper was issued to respond to the major concerns and comments of stakeholders were released on 15 June 2010.
The Hon’ble Finance Minister has on 30 August 2010 presented the Direct Taxes Code, 2010 (DTC) in Parliament. It shall come into force on 1 April, 2012. This alert provides key highlights of the DTC from a Mergers & Acquisitions perspective.
Key Highlights
A) Special Provisions relating to business reorganization or conversion of a company into Limited Liability Partnership (LLP)
Revised proposals
- The provision for conversion of a company into LLP has been introduced in the DTC. The conditions for tax exempt conversion are as under:
i. all the assets and liabilities of the company immediately before the conversion become the assets and liabilities of the limited liability partnership;
ii. all the shareholders of the company immediately before the conversion become the partners of the limited liability partnership and their capital contribution and profit sharing ratio in the limited liability partnership are in the same proportion as their shareholding in the company on the date of conversion;
iii. the shareholders of the company do not receive any consideration or benefit, directly or indirectly, in
any form or manner, other than by way of share in profit and capital contribution in the limited liability partnership;
iv. the aggregate of capital contribution by the shareholders of the company in the limited liability partnership shall not be less than fifty per cent of the total capital of the limited liability partnership at any time during the period of five years from the date of conversion;
v. the total sales, turnover or gross receipts in business of the company in any of the three financial years preceding the financial year in which the conversion takes place do not exceed sixty lakh rupees;
vi. no amount is paid, either directly or indirectly, to any partner out of the accumulated profits of the company on the date of conversion, for a period of three years from the said date
- The above conditions are predominantly the same as introduced by „The Finance Act2010? in respect o conversion of private companies / unlisted companies into LLP. The condition with respect to the maintenance of the profit sharing ratio in the Finance Act 2010 has been changed to maintenance of capital contribution (condition iv. above).
- Tax credit in respect of tax paid on book profits would not be available upon conversion of private companies / unlisted companies into LLP.
Impact:-The exemption continues to be available only to companies with a sales turnover of sixty lakh rupees, which may not be very beneficial for large corporates.
B) Change in definition of slump sale
Revised proposals:- Slump sale has been defined in the DTC to mean the sale of any undertaking or division of a business for a lump-sum consideration without values being assigned to the individual assets and liabilities in such sale, other than the assignment of values to the assets or liabilities for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees.
Impact:-The above definition includes „division of a business? which was not covered in the Income-tax Act, 1961(ITA) and the earlier draft of DTC issued in August 2009.
C) Gains on slump sale to be taxed as capital gains
Revised proposals:-„Slump sale? has been excluded from the business income and is retained under the definition of transfer as opposed to the provisions of the earlier draft of DTC issued in August 2009.
Impact:-The inclusion of „slump sale? in business income and transfer in the DTC Bill of August 2009 had created anomalies in interpretation. This has been resolved now.
D) Further certain provisions introduced in the earlier draft of the DTC continue without any change:
- Business reorganizations involving one of the parties as a non-resident would not be subject to the tax exemption. Accordingly, cross border mergers and demergers would have tax implications.
- In case of amalgamation of foreign companies, 75 percent of the value of shareholders would have to continue holding shares in the amalgamated company to availing exemption from capital gains as opposed to 25% shareholders under the ITA.
- DTC provides for issue of „equity shares? to shareholders of the demerged company.
- Under DTC carry forward of losses of the demerged unit would be available upon satisfaction of the business continuity test as opposed to free carry forward of losses under the ITA.
- In case of „slump sale? the tax liability would depend the definition of „net worth? which has not been prescribed so far.
- There is no specific definition for the term undertaking? for slump sale? purpose.
