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An immediate critical decision has to be made about the absolute maximum price to be paid for the acquisition at the start of the takeover process.
Whether it is about selling a business, buying a business or merging of two or more businesses, there are a number of legal and tax issues that need to be addressed. The best way to predict, address and resolve such issues is to consult a legal and tax professional in the early stages of the transaction. This is an essential procedure as many of the issues that arise during a merger and/or an acquisition deal can have a long term impact on the acquirer company’s financial viability.
The Indian Income Tax Act, 1961 (“ITA”) contains several provisions that deal with the taxation of different categories of mergers and acquisitions. In the Indian context, M&As can be structured in different ways and the tax implications vary based on the structure that has been adopted for a particular acquisition.
The possible ways of sale of business, as contemplated by Indian tax laws, are either acquisition by ‘sale of shares’ or by ‘sale of assets’. The transaction of sale of shares does not contribute to any step-up in the cost of the underlying business. For the seller, it entails capital gains tax implications, subject to reliefs or exemptions (if any). Sale of assets can either be through ‘slump-sale’ or on ‘itemised sale’ basis. Individual assets transferred via ‘itemised-sale’ attract capital gains tax implications or result in business income or loss to the seller, depending upon the nature of assets (i.e., capital asset or stock). In case of a slump sale, i.e., transfer of the entire business undertaking as a going concern for a lump sum, capital gains tax implications has to be evaluated for the seller. For the buyer, such transactions pose challenges in terms of allocation of the purchase price, with fair value or reasonable commercial basis being the method accepted by the tax authorities.
In the case of shares listed on a stock exchange, if the shares have been held for a period exceeding 12 months and the shares are sold on the floor of the stock exchange after payment of securities transaction tax (STT), any profits on such sale are exempt from payment of capital gains tax. If the shares are not listed, the minimum period of holding required for availing the beneficial rate of tax on long-term capital gains increases to 24 months. This means that if the shares are sold after a period of 24 months from the date they were acquired, the profits from the sale are taxed at the rate of 20%.
In case the seller is a non-resident, the applicable tax rate on long-term capital gains is 10%2. However, for non-residents, no benefit of indexation or exchange rate fluctuations is allowed while computing the taxable profits. In the event that shares have been held for a period not exceeding 24 months, any profits on such sale are taxed as normal income at the applicable rate of tax i.e. 30% for residents and 40% for non-residents.
While there is no requirement for withholding of taxes if the seller is an Indian resident, a requirement arises if the seller is a non-resident. Typically, buyers insist on a withholding of tax at the full rate, even if the seller is a resident of a favourable treaty country, unless the seller furnishes a certificate from the income tax department certifying a nil or a lower rate for withholding tax on the transfer. Sometimes buyers also agree to withhold lower or nil taxes, subject to contractual indemnities and insurance under the share purchase agreement or obtaining a favourable ruling from the Authority of Advance Ruling.
The impact from a pricing perspective is dependent on whether the transaction involves domestic parties or non-residents. In a deal involving resident buyers and sellers, there are no exchange control requirements for the deal price. However, under the Indian tax laws, if the shares are sold at a value which is lower than the book value of the share, the deficit between the book value and the consideration is deemed as income and taxed in the hands of the buyer at the applicable rate of tax.
In case a resident Indian seller transfers shares to a non-resident buyer, then under the Indian exchange control laws, the transfer needs to take place at a minimum of the fair value of the share determined in accordance with internationally accepted methodologies of valuation. However, in a reverse case, i.e. a non-resident transferring shares to a resident, the fair value of the shares becomes the price ceiling instead of a price floor.
The impact on continuity of any accumulated tax losses is determined by whether the company whose shares are transferred is ‘a company in whom the public is substantially interested’ or not. The tax law lays down certain conditions for the company to be classified as a ‘company in which the public is substantially interested’. In summary, a listed company, any subsidiary of the listed company and any 100% step down subsidiary of the listed company, all qualify as companies in which the public is substantially interested, subject to compliance with certain conditions. The Indian tax laws provide that in the case of a company in which the public is not substantially interested, if there is a change in 51% or more of the voting power at the end of the year in comparison with the previous year in which a loss is incurred, then such loss shall lapse and no set-off of the loss shall be allowed in the year in which the change in shareholding takes place.
Tax issues arise in cross border deals when two different jurisdictions seek to tax the same sum of money or income or the same legal person thereby resulting in double-taxation. Many countries are aware that double taxation acts as an obstacle for engaging in any cross border trade or activity. Therefore, with the primary view to encourage mutual cooperation, trade and investment, the countries enter into bilateral Double Taxation Avoidance Agreements (“DTAA”) to limit their taxing jurisdictions voluntarily through self-restraint.
Under ITA, any person making a payment of a sum to a non-resident that is chargeable to tax under the ITA would be required to withhold tax on such sum at the appropriate rate. Such withholding is required to be made either at the time of payment or at the time of credit of income to the account of the non-resident. However, if the amount paid is not taxable in India, there is no requirement to withhold tax on such payments. But, if the amount paid has an element of income that is taxable in India, then even a non-resident who making such remittance is obligated to withhold as per the ITA.
The merger of two foreign companies involving the transfer of shares of an Indian company, is normally tax exempt provided that the merger satisfies the criteria for an Amalgamation and, (i) at least 25% of the shareholders of the merging company remain shareholders in the merged company, and (ii) such transfer does not attract capital gains tax in the country in which the merging company is incorporated.
1. Business reorganisations have always invited the attention of the tax authorities due to complexity of tax issues involved.
2.The tax implications on each M&A deal vary in accordance with the structure of the deal
3. While framing a scheme of merger or amalgamation, a company has to fulfil the conditions prescribed under the company law, but it has also to look after one very important aspect which is the taxation aspect
4. Any failure to take proper account of the tax implications might make the concerned companies and their shareholders repent later when they will not be in a position to retrace their steps.