Taxation in cross-border Mergers and Acquisitions

“Explore the complexities of taxation in cross-border Mergers and Acquisitions. Navigate the intricate landscape of global deals, legislations, and regulations. Learn about the impact of tax reforms, statutory aspects in India, and the role of ITA, GST, Stamp Duty, Companies Act, SEBI, GAAR, and various acquisition vehicles. Stay informed for effective cross-border transaction management.”

Abstract

As different mergers, acquisitions, amalgamation, consolidation deals are increasing across the globe; various legislations, regulations have been established to cope up the increasing needs. Amendments are also done in a very short time period and new rules, guidelines come very oftenly. Hence, it has become very crucial to navigate a range of extremely complicated issues connected with any cross border transactions to minimise the tax liability and avoid any penal consequences. 

Cross border transactions are generally two types namely – inbound and outbound. All have to follow and comply with different regulatory provisions and applicable taxes need to be paid accordingly. 

In India, taxation in cross border transactions are regulated by several statutes including The Companies Act, Income Tax Act, Indian Stamp Act, Transfer of Property Act, Competition Act, Insolvency and Bankruptcy Code, Consolidated FDI (Foreign Direct Investment) regulations, SEBI (Securities and Exchange Board of India) regulations, General Anti-Avoidance Rule etc. 

Introduction

With the rapid economic development and increase in ease of doing business, India is becoming a favorable business destination. Foreign companies are coming to India as well as Indian companies are expanding their business abroad. In such a booming economic environment, cross border deals in mergers and acquisitions are increasing inevitably. 

Not only in India, the world is seeing a solid growth every year. By the end of 2017 it was found that in that entire year;

• North America saw almost 6,000 deals worth US$ 1.4 trillion.
• European transactions amount to US$ 920 billion with 7235 deals
• About 3,750 deals totaling US$673.5 billion took place in the Asia-Pacific region (except Japan), while over 450 deals in Japan totaled US$40.1 billion.
• almost 600 deals worth US$80.4 billion occurred in Latin America, 
• and the Middle East and Africa stands with over 400 deals worth US$59.4 billion.

In the United States, the fundamental tax reform affected the cross border deals. The dividend exemption provision and the new limit on the deductibility of interest expenses to 30% of taxable income – may skyrocket the M&A activities involving the US. 

“Technology is propelling considerable M&A activity in Europe”. Structural reforms in different countries in South America helped to boost M&A deals significantly. 

Japan, Malaysia, Vietnam reduced corporate tax rates steadily and the lost tax revenues are being recovered through other measures. Tax reforms in Australia are driving more M&A activities. Outbound investment from China in specific sectors has slowed in the past few years. With the Evergrande crisis, several other real estate companies in China are on the edge to default. Other industries are also facing difficulties due to the “Domino Effect”. In the post-covid market, investors, losing confidence, are leaving China. 

So, the cross border transaction environment is mixed in the Asia-Pacific / Indo-Pacific region. 

Inbound and Outbound Transactions

Where a cross border merger, acquisition or amalgamation forms an Indian resultant company, it is said to be inbound. 

• The resultant company can transfer any security outside India in accordance with the FEMA (Foreign Exchange Management Act), ODI (Overseas Direct Investment) regulations. 
• Borrowing of the transferor company will become the borrowing of the resultant company. A time period of 2 years will be given within which the resultant company has to be compliant with the External Commercial Borrowings (ECB) regime. 
• If any asset acquired by the resultant company is not permitted by the Companies Act or any other legislation / regulation; the asset has to be sold within a period of 2 years after getting order from the National Company Law Tribunal (NCLT). 
• The resultant company can open a bank account to facilitate the transaction in the respective foreign jurisdiction for a maximum period of 2 years after approval of NCLT. 

And, if a cross border merger, acquisition or amalgamation forms a foreign resultant company, it is said to be outbound.

• Securities which are being transferred to any Indian resident, has to be compliant with the FEMA, ODI regulations.
• Borrowings or guarantees of the resultant company need to be repaid as per directed by the NCLT. 
• Office of the transferor company in India can be treated as branch office of the resultant foreign company and it has to be compliant with the FEMA regulations. 
• If an asset acquired by the resultant company is not done in a permissible manner, the company shall sell such asset within 2 years after getting order from NCLT.
• The resultant company can open a special non-resident rupee account to facilitate the transaction in India for a period of maximum 2 years. 
• Resultant company and other companies involved in such cross-border transaction need to follow RBI (Reserve Bank of India) guidelines.

The valuation will be as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules. 

Statutory Aspects in India

In India, cross border M&A transactions means mergers, acquisitions, amalgamation, business consolidation or restructuring between an Indian Company and a Foreign Company; and is permitted by The Companies Act, under section 234. The regulatory framework has been established by various statutes. 

• Income Tax Act (ITA)

The ITA recognises these forms of M&A activities – Amalgamation, Demerger or spin-offs, Asset Purchase, Transfer of Shares. 

A. Tax on Capital Gains

If any restructuring involves transfer of capital asset for a resident or capital asset situated in India of a non-resident, it will be a taxable event. Section 45 of the ITA levies tax on capital gains arising from the transfer of a capital asset. However, section 47 provides certain exemptions of section 45 :

• Transfer of capital asset in an amalgamation where the amalgamated company is an Indian Company.
• When a foreign company transfers it’s shareholding in an Indian Company to another foreign company in a scheme of amalgamation

ITA gives certain tax benefits in case of demerger. If the resulting company is an Indian Company, then the transfer of capital assets by the demerged company will be exempted from capital gains tax. Any transfer of foreign company’s shares, that derive their value substantially from Indian assets as a part of demerger, it will be exempted from capital gains tax in hands of the demerged company; provided that the shareholders holding atleast 3/4th in value of shares in the demerged company continue being shareholders in the resulting company, and such transfer doesn’t attract any tax on capital gains where the demerged company was incorporated. 

B. Capital Gains Tax For Transfer Of Shares

Capital Gains earned by a resident company from the transfer of capital asset situated anywhere in the world, will be taxable in India. AND for non-residents, only those capital gains earned from the transfer of capital asset situated within the territory of India, will be taxable. 

C. Capital Gains Tax For Slump Sale

If the undertaking which is being sold on lump sum amount, was held by the transferor Indian Company for more than 36 months; the capital gains will be taxed at 20% as a Long Term Capital Gains. And, if the undertaking was held for 36 months or less; the capital gains will be taxed at 30% as a Short Term Capital Gains.

D. Capital Gains Tax For Asset Sale

If the asset which is being sold, was held by the transferor Indian Company for more than 36 months; the capital gains arising from such sale will be taxed at 20% as a Long Term Capital Gains. And, if the undertaking was held for 36 months or less; the capital gains will be taxed at 30% as a Short Term Capital Gains. 

E. Tax On Business Income

Section 72A of the ITA says that amalgamation of a company owning an industrial undertaking with another company, the accumulated loss or unabsorbed depreciation, of the amalgamating company will be considered as the loss / allowance for depreciation of the amalgamated company. The amalgamated company can carry forward such loss and depreciation and set off such amount from future profits; provided that –

The amalgamated company :

• holds 3/4th of the book value of the fixed assets acquired from the amalgamating company continuously for 5 years after amalgamation
• continues to carry on the business of the amalgamating company for atleast 5 years after amalgamation

And, the amalgamating company : 

• had been engaged in the business in which the loss occurred or depreciation remained unabsorbed, for atleast 3 years
• held atleast 3/4th of the book value of the fixed assets continuously from 2 years before amalgamation till the date of amalgamation

F. Void Transfers

If there is tax litigation or assessment proceeding pending on any legal entity; all charge created or transfer envisaged on assets of such entity shall be void under section 281, if :

• it is not made for adequate consideration and there is a notice of such proceeding
• it is not made with the prior permission of the assessing officer. 

• Goods and Services Tax (GST)

GST is an umbrella tax that integrates various indirect taxes under it. 

In case of asset purchase, the slab rate of GST will vary depending on the type of asset which is subject in the transaction. 

No GST will be levied on slump sale or transfer of shares. 

• Stamp Duty

The court order for merger or demerger may be required to be stamped. The amount of stamp duty varies in different states. 

Stamp Duty applicable on share transfer form is 0.25% of, the value or the consideration paid for the shares. 

Transfer of unlisted securities will attract stamp duty of 0.015% and for listed securities, it will vary from 0.003% to 0.015%. 

Stamp Duty is payable on Shareholders Agreement / Joint Venture Agreement, Share Purchase Agreement also.

• Companies Act

Now, under the new Companies’ Act of 2013; such approval for mergers, demergers, liquidation or other restructuring is mandatory by the National Company Law Tribunal. 

• Securities and Exchange Board of India (SEBI)

As per SEBI regulations, public shareholder’s approval is necessary in any arrangements involving listed entities. Electronic voting is mandatory for schemes involving listed companies. Any merger, demerger, acquisition or similar arrangements involving a listed company needs to be complied with the SEBI regulations.

• General Anti-Avoidance Rule (GAAR)

It empowers the govt to declare any mergers, demergers, liquidation or other restructuring entered into by a taxpayer, to be an ‘impermissible avoidance agreement’ (IAA). And government can deny any tax benefits in such transactions.

Acquisition Vehicle

Several acquisition vehicles are available for foreign purchaser and tax, regulations, compliance are variable with such acquisition vehicles.

• Foreign Parent Company

Foreign parent company can invest directly and it has to comply with the consolidated FDI regulations.

• Local Holding Company

Any indirect foreign investment or acquisition through a holding Indian Company are called “Downstream Investment” (DI) under FEMA rules. 

Dividend Distribution Tax (DDT) is applicable at a rate of 15% (20.538% after grossing-up) on dividends in India. Parent company can obtain credit for DDT paid by it’s subsidiaries. 

• Non-resident Intermediate Holding Company

Intermediate holding company situated in other country can be used for investment into India. It may be favorable for the investor to avail some tax benefits. 

Evidence of substance in that holding company’s jurisdiction is required. Also, LOB (Limitation on Benefits) may be applicable. 

• Local Branch

RBI guidelines prohibit foreign companies to use local branch for acquiring Indian assets.

• Joint Venture

It is used when specific sectoral caps or restriction on foreign direct investment under FDI regulations. Joint Venture is considered to be indirect foreign investment and needs to comply with the FEMA guidelines. 

Conclusion

With the increasing cross-border transactions, it has become very important to regulate them and ensure proper taxation structure. The ease of doing business is also to be considered while regulating & imposing tax on such transactions, to attract foreign investments and keep the pace of economic growth.