Director, Deals, PwC India
Globally, Mergers and Acquisitions (M&A) has been a common approach to achieving expeditious growth. Countries have introduced various regulations to ensure adequate control and smooth flow of transactions. On the tax front, the laws of most countries have provisions that deal with the taxation of different forms of M&A transactions and provide exemptions where deemed appropriate.
In India, an important milestone has been the introduction of provisions for tax neutral mergers through the Finance (No. 2) Act, 1967, with the intention to facilitate the merger of uneconomic company units with other financially sound Indian companies to increase efficiency and productivity. After this, other ample provisions have provided tax incidence on certain types of M&A transaction or made exemptions for some. While a lot has been done, some provisions remain that result in adverse consequences and more clarity is necessary in some areas.
Some matters that are areas of concern in the context of deemed income implications for the transacting parties are as follows:
Transactions involving sale of shares of an unlisted Indian company are generally subject to capital gains tax under section 45 of the Income-tax Act, 1961 (Act) in the hands of the seller. However, when the sale consideration is below the tax FMV (broadly, the book value with certain adjustments) as provided for under the Income-tax Rules, 1962 (Rules), the following tax implications arise:
– In the hands of seller: The FMV of shares as computed under the Rules will be considered as the sale consideration for computing capital gains as per section 50CA read with section 48 of the Act; and
– In the hands of buyer: The difference between such FMV and the purchase price will be taxed as income from other sources under section 56(2)(x)(c) of the Act.
The above provisions create higher taxation for sellers and tax incidence for buyers on the transaction and are a matter of consideration in many distressed sale transactions.
The issue of equity shares on a preferential basis involves multiple steps, and such issue must follow the applicable provisions of the Companies Act, 2013 and the SEBI regulations. The price of issuance is pre-determined and must be approved by the board of directors before the proposal is placed before the shareholders of the company for their approval. After this, the allotment of shares happens to the investor.
The Rules provide that the date of valuation for determining the tax FMV would be the date on which the assessee receives the property or consideration. There may be a situation where the issue price, as approved by the board of directors during their meeting, might be lower than the FMV, as on date of the actual allotment of shares. This raises questions on the potential tax implications in the hands of the shareholder on account of receipt of shares at a value lower than the FMV as on the date of allotment.
While a reasonable view would be that the valuation date should be the date on which there is a binding agreement for investment into the Company, the fact that the shares are received only on allotment and that shareholders have the right to reject the preferential allotment creates doubts in adopting such a view.
The above ambiguity may also arise in case of transactions involving the transfer of shares in listed companies off market, where FMV increases between the date of agreement between the parties and the date of closing of the transaction. Clarity on the valuation date, as defined in the Rules, would help resolve the ambiguities.
When the transfer of immovable property happens at a price below the tax fair market value, the following implications arise:
The provisions also provide a safe harbour. In case the fair market value adopted does not exceed 110% of the consideration amount, the consideration received or accruing on the transfer of immovable property will be considered as full value of consideration for computing capital gains tax in the hands of seller and no further tax incidence shall arise in the hands of the buyer.
While the recently enhanced safe harbour of 10%, as stated above, provides some relief, considering the higher stamp duty values in many areas and plummet valuation in the sector, it is necessary to enhance the safe harbour further.
While the above-mentioned scenarios have been a matter of contention in various transactions, in the current pandemic, the above would become more critical. Both clarity and further relief on the aforesaid provisions would be of great help in the Indian M&A landscape.
The views expressed in this article are personal. The article includes inputs from Umesh Agrawal, Senior Associate, Deals, PwC India
 Rule 11UA(1)(c) of the Income-tax Rules, 1962
 Rule 11UA(1)(c) of the Income-tax Rules, 1962