India - Taxation of cross-border mergers and acquisitions
Taxation of cross-border mergers and acquisitions for India.
Taxation of cross-border mergers and acquisitions for India.
The legal framework for business consolidations in India consists of numerous statutory tax concessions and tax-neutrality for certain kinds of reorganizations and consolidations. This report describes the main provisions for corporate entities. Tax rates cited are for the financial year (FY) ending 31 March 2021, and include a surcharge (12 percent for domestic companies and 5 percent for foreign companies having income over 100 million Indian rupees [INR] (about 1,428,500 US dollars [US$]) and an education cess (tax) of 4 percent (unless otherwise mentioned).
Finance Bill 2021
Direct tax, indirect tax and regulatory changes were introduced in the budget presented on 1 February 2021 (‘Finance Bill 2021’). As the next step in legislative process, the Finance Bill will be passed by both Houses of Parliament after some possible amendments and the President will need to provide assent to enact the bill as a law.
The key tax changes proposed in the Finance Bill are as follows.
Proposals impacting transaction structures
- Goodwill of a business or profession will not be considered as a depreciable asset and tax depreciation shall not be allowed even with respect to purchased goodwill. Amount paid for goodwill will be allowed as a cost of acquisition, however, any depreciation obtained in past years will be reduced from such cost of acquisition.
- Slump exchange transactions (transfer of undertaking for a lump sum consideration for non-monetary consideration) were considered to be non-taxable basis judicial precedents. However, the scope of slump sale taxation has been widened to cover such transactions as well.
Equalization levy (EL)
- EL was introduced in India on foreign e-commerce operators at 2 percent and covered online sale of goods or online provision of services or facilitation of the same. It is now further clarified that charge of EL could be triggered on either one or more of the following activities happening online: placing a purchase order, acceptance of offer, payment of consideration, and/or supply of goods or provision of services online. It has been clarified that transactions involving a royalty or fee for technical services will remain taxable as per the applicable rates and no further EL of 2 percent on the consideration amount will be charged (effective from 1 April 2020.
Litigation and dispute resolution
- Authority for Advance Rulings, which was set up to facilitate ascertaining the income-tax liability of a non-resident and to avoid long drawn and expensive litigation, shall be replaced with Board of Advance Rulings (BAR), which shall provide advance rulings in a timely manner.
- Introduction of faceless appeals with second level appellate authority (namely Income Tax Appellate Tribunal).
- Time limit for re-opening of tax assessment reduced from 4/6 years to 3 years (for cases other than that of significant tax evasion). This would reduce litigation and provide ease of doing business.
- Dividend payments made by special purpose vehicle (SPV) to real estate investment trust (REIT) and infrastructure investment trust (InvIT) from specified SPV exempted from tax withholding.
- Benefit of lower tax rates, as prescribed under double taxation avoidance agreements, proposed to be extended to foreign institutional investors (FIIs) (subject to compliance with other requirements). Currently, withholding at 20 percent was applicable on dividend payments to FIIs.
- Foreign investments into India (whether directly or indirectly) from countries sharing land border with India (China, Pakistan, Bhutan, etc.) shall be subjected to government approval.
- Increase in permissible foreign direct investment (FDI) limit in insurance sector from 49 percent to 74 percent subject to prescribed conditions.
Corporate tax rates
The general domestic corporate tax rate in India is 30 percent, which is further subject to a maximum surcharge of 12 percent and cess of 4 percent resulting in a 34.94 percent effective tax rate. A concessionary tax rate of 29.12 percent is available for domestic companies having a turnover of up to INR4 billion (about US$57 million).
If tax liability computed under the normal provisions is less than the tax liability on book profits, then tax is paid under minimum alternate tax (MAT) at 21.55 percent on the book profits.
In September 2019, the government of India reduced corporate tax rates of domestic companies to provide stimulus to the economy, attract investment and generate employment in the country.
The key tax changes are as follows.
- An option for a concessional tax at the rate of 25.17 percent (including 10 percent surcharge and 4 percent cess) in the case of domestic companies with effect from FY 2019–20 subject to certain conditions that primarily require the company to forego tax benefits, holidays and exemptions. Companies exercising such an option have been excluded from the applicability of MAT.\
- An option for a concessional tax at the rate of 17.16 percent (including 10 percent surcharge and 4 percent cess) in the case of a new domestic manufacturing company. Companies exercising such an option have been excluded from the applicability of MAT.
- MAT, wherever applicable, for Indian companies has been reduced from existing 21.55 percent to 17.47 percent.
Asset purchase or share purchase
The acquisition of the business of an Indian company can be accomplished by the purchase of shares or the purchase of all or some of the assets. In some cases (in addition to capital gains taxes), other transfer taxes, such as stamp duty, may also be levied. A detailed comparison of the various types of purchases is provided at the end of this report.
Purchase of assets
A purchase of assets can be achieved through either a purchase of a business on a going-concern basis or a purchase of individual assets. A business could be acquired on either a ‘slump-sale’ or ‘itemized sale’ basis. The sale of a business undertaking is on a slump-sale basis when the entire business is transferred as a going concern for a lump-sum consideration — cherry-picking of assets is not possible. An itemized sale occurs either where a business is purchased as a going concern and the consideration is specified for each asset or where only specific assets or liabilities are transferred — cherry-picking of assets by the buyer is an option. The implications of each type of transaction are described later in this report.
The actual cost of the asset is regarded as its cost for tax purposes. This general rule may be subject to some modifications depending on the nature of the asset and the transaction. Allocation of the purchase price by the buyer on an acquisition through a slump sale is critical from a tax perspective because the entire business undertaking is transferred as a going concern for a lump-sum consideration. The tax authorities normally accept allocation of the purchase price on a fair value or other reasonable commercial basis. Reports from independent valuations providers are also acceptable.
For itemized sale transactions, the cost paid by the acquirer as agreed up front may be accepted as the acquisition cost, subject to certain conditions. Therefore, under both slump sales and itemized sales, a step-up in the cost base of the assets may be obtained (see ‘Finance Bill 2021’ for recent developments).
Goodwill arises when the consideration paid is higher than the total fair value/cost of the assets acquired. This generally arises in situations of a slump sale. The tax law only permits depreciation/amortization of intangible assets, such as know-how, patents, copyrights, trademarks, licenses and franchises or any similar business or commercial rights. Therefore, when the excess of consideration over the value of the assets arises because of these intangible assets, a depreciation allowance on goodwill was available on the basis of past judicial precedents. However, in the Finance Bill 2021, it has been proposed that goodwill of a business or profession will not be considered as a depreciable asset (see ‘Finance Bill 2021’ for recent developments).
Depreciation charged in the accounts is ignored for tax purposes. The tax laws provide for specific depreciation rates for the tangible assets (buildings, machinery, plant or furniture), depending on the nature of the asset used in the business. Additional depreciation of 20 percent is available for new plant and machinery used in manufacturing or production provided prescribed conditions are met. Depreciation on eligible intangible assets (described above) is allowed at a flat rate of 25 percent. Certain assets, such as computer software, enjoy higher tax depreciation at 40 percent.
Depreciation is allowed on a ‘block of assets’ basis. All assets of a similar nature are classified under a single block — and any additions/deletions are made directly in the block.
The depreciation rates apply on a reducing-balance basis on the entire block. However, companies engaged in the generation and/or distribution of power have the option to claim depreciation on a straight-line basis. In the first year, if the assets are used in the business for less than 180 days, only half of the entire eligible depreciation for that year is deductible. When the assets are used for more than 180 days in the first year, the entire eligible depreciation for that year is allowed. Capital allowances are available for certain types of asset, such as assets used in scientific research or other specified businesses, subject to certain conditions.
Tax losses are normally not transferred irrespective of the method of asset acquisition. The seller retains them.
However, certain tax benefits/deductions that are available to an undertaking may be available to the acquirer when the undertaking as a whole is transferred as a going concern as a result of a slump sale.
Typically, no Goods and Services Tax (GST) implications arise on the sale of a business as a whole on a going-concern basis wherein all the assets and liabilities (including movable and immovable property, including stock-in-trade and other goods) are transferred for a lump-sum consideration (i.e. a separate price is not assigned to each asset or liability).
Unlike a slump sale, in an itemized sale, individual assets are transferred at a specified price for each asset transferred.
Accordingly, GST would apply to each asset based on the applicable tax rates (i.e. 5, 12, 18 or 28 percent).
Depending on the nature of the item sold, the transferee may be able to recover GST paid by the transferor through input credit.
The transfer of assets by way of a slump sale attracts stamp duty. Stamp duty implications differ from state to state. Rates generally range from 5 to 10 percent for immovable property and from 3 to 5 percent for movable property, usually based on the amount of consideration received for the transfer or the market value of the property transferred (whichever is higher). Depending on the nature of the assets transferred, appropriate structuring of the transfer mechanism may reduce the overall stamp duty cost.
Transfer of dematerialized securities chargeable to transfer tax are as follows:
- transfer of shares on delivery basis — 0.015 percent
- transfer of security (other than debenture) on non-delivery basis — 0.003 percent.
Purchase of shares
Businesses can be acquired through a purchase of shares. No step-up in the cost of the underlying business is possible in a share purchase, in the absence of a specific provision in the tax law. No deduction is allowed for a difference between the underlying net asset values and the consideration paid (see ‘Concerns of the seller’).
Tax indemnities and warranties
In a share acquisition, the purchaser takes over the target company together with all its related liabilities, including contingent liabilities. Hence, the purchaser normally requires more extensive indemnities and warranties than in the case of an asset acquisition.
An alternative approach is for the seller’s business to be transferred into a newly formed entity, so the purchaser can take on a ‘clean’ business and leave its liabilities behind. Such a transfer may have tax implications. When significant sums are involved, it is customary for the purchaser to initiate a due diligence exercise. Normally, this would incorporate a review of the target’s tax affairs.
Tax losses consist of normal business losses and unabsorbed depreciation (where there is insufficient income to absorb the current-year depreciation). Both types of losses are eligible for carry forward and available for the purchaser. Business tax losses can be carried forward for a period of 8 years and offset against future profits. Unabsorbed depreciation can be carried forward indefinitely.
However, one essential condition for setting off business losses is the shareholding continuity test. Under this test, the beneficial ownership of shares carrying at least 51 percent of the voting power must be the same at the end of both the year during which the loss was incurred and the year during which the loss is proposed to be offset. Such restrictions do not apply in the case of change in shareholding with regard to a resolution plan under IBC.
In order to promote business start-ups in India, eligible start-up companies are allowed to carry forward their first 10 years of losses as long as all the shareholders carrying voting power on the last day of the year of loss continue to hold those shares on the last day of the year of change in shareholding. This test only applies to business losses (not unabsorbed depreciation) and to unlisted companies (commonly called ‘closely held companies’).
Valuation of equity shares
Recipient-based taxation of specified property
Recipient-based taxation of specified property (e.g. shares, securities, jewelry, immovable property) for no or inadequate consideration is applicable to all taxpayers (including company and firms).
Further, the rules for valuation of equity shares were amended to compute fair market value (FMV) for tax purposes. The rules for valuation of equity shares require to take into account the FMV of underlying assets, such as the FMV of jewelry, artistic work, shares and securities, guidance value/stamp duty value in case of immovable property, and book value for the other assets.
Deemed FMV on transfer of unlisted shares in the hands of the transferor
The Indian tax laws provide for deemed FMV in the hands of the seller on transfer of unlisted shares at less than FMV. The FMV of shares for tax purposes is computed in the same way as it is for recipient-based tax.
Securities transaction tax (STT)
STT may be payable if the sale of shares is through a recognized stock exchange in India. STT is imposed on purchases and sales of equity shares listed on a recognized stock exchange in India at 0.1 percent based on the purchase or sale price. STT is payable both by the buyer and the seller on the turnover (which is a product of number of shares bought/sold and price per share).
Transfers of shares (on delivery basis) are subject to stamp duty at the rate of 0.015 percent of the market value of the shares transferred.
In the case of a pending proceeding against the transferor, the tax authorities have the power to claim any tax on account of completion of the proceeding from the transferee. Income tax law provides the mechanism for obtaining a tax clearance certificate for transfer of assets/business.
Choice of acquisition vehicle
Several possible acquisition vehicles are available in India to a foreign purchaser. Tax and regulatory factors often influence the choice of vehicle.
Local holding company
Acquisitions through an Indian holding company are governed by the downstream investment guidelines issued in 2009 under FDI policy. Broadly, any indirect foreign investments (through Indian companies) are not construed as foreign investments where the intermediate Indian holding company is owned and/or controlled by resident Indians. The criteria for determining the ownership and control of an Indian company are ownership of more than 50 percent of the shares along with control of the governing board. Downstream investments made by Indian entities are not considered in determining whether these criteria are met.
Post 1 April 2020, the dividends are taxed in the hands of shareholders. (Dividends in India were subject to a Dividend Distribution Tax (DDT) at the rate of 20.555 percent in the hands of the Indian company distributing the dividend.)
Foreign parent company
Foreign investors may invest directly through a foreign parent company, subject to the prescribed foreign investment guidelines.
Non-resident intermediate holding company
An intermediate holding company resident in another territory could be used for investment into India, to minimize the tax leakage in India through, for example, source withholdings and capital gains taxes on exit. This may allow the purchaser to take advantage of a more favorable tax treaty with India.
However, evidence of substance in the intermediate holding company’s jurisdiction is required. Limitation of benefit (LOB) conditions are applicable where the tax treaty has an LOB clause (e.g. Mauritius, Singapore).
India has also approved the ratification of multilateral convention or instrument (MLI) to implement tax treaty-related measures. The MLI would modify India’s existing income tax treaties in an effort to address revenue loss through treaty abuse and base erosion and profit shifting (BEPS) strategies. MLI would also need to be considered while setting up an intermediate holding company.
Limited liability partnerships
The Limited Liability Partnerships Act was passed in 2009, paving the way for setting up limited liability partnerships (LLPs) in India. Under this law, a limited liability partnership (LLP) is a corporate entity that exists as a legal person separate from its partners and that is able to enter into binding contracts. LLPs are taxed as normal partnerships; that is, the profits earned by an LLP are taxed in its hands and shares of profit are exempt in the hands of the partners. Previously, FDI in LLPs was permitted only with government approval and LLPs were not allowed to make downstream investments. The India Exchange Control Regulations have been liberalized to allow foreign companies to be appointed as designated partners (DPs) of LLPs. Individuals appointed as DPs do not need to satisfy the residency test under the Indian Exchange Control Regulations.
Further, conversion of a company into an LLP has now been permitted under an automatic route, subject to the condition that 100 percent FDI is permitted under the automatic route to the company under consideration. Conversion of a company into an LLP is exempt from domestic capital gains tax if prescribed conditions are met.
Withholding tax (WHT) on sale by non-resident
WHT applies at the applicable rates to any payment made to a non-resident seller for the purchase of any capital asset on account of any capital gains that accrue to the seller.
Applicable tax treaty provisions also need to be evaluated in order to determine the WHT rates.
The Reserve Bank of India (RBI) regulates the establishment of branches in India. The prescribed guidelines do not permit a foreign company to use the branch as a vehicle for acquiring Indian assets.
Joint ventures are normally used where specific sectoral caps are applicable under the foreign investment guidelines. In such scenarios, a joint venture with an Indian partner is set up that will later acquire the Indian target. In planning a joint venture, the current guidelines for calculating indirect foreign investments should be considered.
Choice of acquisition funding
A purchaser using an Indian acquisition vehicle to carry out an acquisition for cash needs to decide whether to fund the vehicle with debt, equity or a hybrid instrument that combines the characteristics of both. The principles underlying these approaches are discussed below.
Tax-deductibility of interest makes debt funding an attractive method of funding. Debt borrowed in foreign currency is governed by the RBI’s External Commercial Borrowings (ECB) guidelines, which were liberalized in January 2019 to encourage foreign investment and improve the ease of doing business.
The ECB Regulations notified by the RBI outline various conditions for foreign currency debt classified as ECB. This specifically includes definitions of (among others) ‘eligible borrower’, ‘recognized lender’, forms of ECB, end-use restrictions and all-in-cost ceilings.
RBI broadened the eligible list of borrowers by allowing all entities eligible for FDI to borrow through the ECB route. Further, it reduced the minimum maturity conditions, and standardized rules for borrowers from different sectors.
In July 2019, RBI further liberalized the ECB norms by relaxing the end-use restrictions with respect to working capital, general corporate purpose and repayment of rupee loans. Eligible borrowers were allowed to raise ECBs from recognized lenders with a minimum average maturity period of 10 years for working capital purposes and general corporate purposes. Such changes increase the lending options and allow various new lenders in the ECB space.
Borrowing funds from an Indian financial institution is worth considering as interest on such loans can be deducted from the operating profits of the business to arrive at the taxable profit. This option is likely to have the following advantages:
- no regulatory approvals required
- flexibility in repayment of funds
- no ceiling on rate of interest
- no hedging arrangements required
- no WHT on interest.
However, bank loans may have end-use restrictions.
Further, the SEBI Regulations permit issue of listed non-convertible debentures (NCDs) as another instrument for public debt fundraising subject to provisions specified under listing regulations. As these instruments are not within the ECB framework, there are fewer restrictions (e.g. no sectoral caps, investment limits or end-use restrictions as in the case of ECB). Unlisted NCDs continue to be governed by the ECB Regulations unless issued to entities registered as Foreign Portfolio Investor (EPI) with SEBI.
Deductibility of interest
Normally, the interest accounted for in the company’s books of accounts is allowed for tax purposes. Interest on loans from financial institutions and banks is normally only allowed when actually paid. Other interest (to residents and non-residents) is normally deductible from business profits, provided appropriate taxes have been withheld thereon and paid to the government treasury. In any case, interest expenditure for acquiring Indian company shares is not tax-deductible.
These capitalization provisions are applicable in India. Under these provisions, the total interest deduction for Indian companies and permanent establishments (PEs) of foreign companies is capped at 30 percent of earnings before interest, taxes, depreciation and amortization (EBITDA). Debt issued or guaranteed (including implicit guarantee) by non-resident Associated enterprises (AEs) are also covered. The interest disallowed can be carried forward for 8 years and is deductible in a subsequent year, subject to a cap of 30 percent.
Further, under General Anti-Avoidance Rule (GAAR) provisions (applicable from 1 April 2017), if an arrangement is declared to be an ‘impermissible avoidance agreement’ (IAA), then any equity may be treated as debt and vice versa.
WHT on debt and methods to reduce or eliminate it
Interest paid by an Indian company to a non-resident is normally subject to WHT of 21.84 percent. The rate may be reduced under a tax treaty, subject to its conditions.
Specified foreign investors (i.e. FIIs and qualified foreign investors [QFIs]) are subject to 5.46 percent WHT on an INR-denominated bond of an Indian company or a government security on which interest is payable after 1 June 2013 and before 1 July 2023. Similarly, there is a lower WHT of 5.46 percent on interest paid on ECBs to non-residents for borrowings between 1 April 2016 up until 1 July 2023.
Checklist for debt funding
- Foreign currency-denominated debt must conform to ECB guidelines.
- Consider the WHT on the interest expenses for domestic and foreign debt.
- Assess whether the profits in the Indian target entity are sufficient to make the interest deduction effective.
- Estimate EBITDA to assess interest deductibility under the thin capitalization rules.
- All external borrowings (foreign debt) from associated enterprises should comply with the transfer pricing rules.
Most sectors in India have been opened up for foreign investment, so no approvals from the government of India should be necessary for the issue of new shares in these sectors (see ‘Regulatory updates’ for recent developments with respect to foreign investments from countries sharing land border with India). Certain sectors are subject to restrictions or prohibitions on foreign investment that require the foreign investor to apply to the government of India for a specific approval. Pricing of the shares must comply with guidelines issued by the RBI.
Dividends can be freely repatriated under the current exchange control regulations. Dividends can be declared only out of profits (current and accumulated), subject to certain conditions.
Under the provisions of Indian tax laws, dividend income is taxable in the hands of the shareholders receiving such income. Dividend payments are subject to WHT at 10 percent for residents and 20 percent for non-residents, subject to treaty rates (rates exclusive of surcharge and cess). Deduction is available to remove the cascading effect of tax on inter-corporate dividends.
For outbound investments, gross dividends received by an Indian company from a specified foreign company (in which it has shareholding of 26 percent or more) are taxable at a concessional rate of 17.472 percent, subject to certain conditions. Further, credit of such dividends is not available.
Under current company law, equity capital cannot be withdrawn during the lifespan of the company, except through a buy-back of shares. Ten percent of the capital can be bought back with the approval from the board of directors, and up to 25 percent can be bought back with approval of shareholders, subject to other prescribed conditions.
India tax laws levy buy-back tax at the rate of 23.296 percent on the buy-back of shares by an unlisted company to the extent of the amount distributed over the amount received by the company from the shareholders on issuing the shares. Such buy-back tax has been extended to listed companies, vide Finance Act, 2019. The income arising to the shareholder as a result of such buy-back of shares is exempt from tax.
In India, mergers (amalgamations) are infrequently used for acquisition of business, but they are used extensively to achieve a tax-neutral consolidation of legal entities in the course of corporate reorganizations. Amalgamations enjoy favorable treatment under income tax and other laws, subject to certain conditions. The important provisions under Indian laws relating to amalgamation are discussed below.
Indian tax law defines ‘amalgamation’ as a merger of one or more companies into another company or a merger of two or more companies to form a new company such that:
- all the properties and liabilities of the merging companies immediately before the amalgamation become the properties and liabilities of the amalgamated company
- shareholders holding at least three-quarters of the shares in the amalgamating companies become shareholders of the amalgamated company (any shares already held by the amalgamated company or its nominees are excluded for purposes of this calculation).
Generally, the transfer of any capital asset is subject to capital gains tax in India. However, amalgamation enjoys tax-neutrality with respect to transfer taxes under Indian tax law — both the amalgamating company transferring the assets and the shareholders transferring their shares in the amalgamating company are exempt from tax. To achieve tax-neutrality for the amalgamating company (or companies) transferring the assets, the amalgamated company should be an Indian company. In addition, to achieve tax-neutrality for the shareholders of the amalgamating company, the entire consideration should comprise shares in the amalgamated company.
Further, India tax laws provide for exemption from capital gains arising pursuant to indirect transfer of shares resulting from a merger or demerger of two foreign companies.
Carry forward and offset of accumulated losses and unabsorbed depreciation
Unabsorbed business losses, including depreciation of capital assets, of the amalgamating company (or companies) are deemed to be those of the amalgamated company in the year of amalgamation. In effect, the business losses get a new lease of life as they may be carried forward for up to 8 years.
However, the carry forward is available only where:
- the amalgamating company owns a ship or hotel or is an industrial undertaking (manufacturing or processing of goods, manufacturing of computer software, electricity generation and distribution, telecommunications, mining or construction of ships, aircraft or rail systems)
- the amalgamating companies are banking companies.
The carry forward of losses on amalgamation is subject to additional conditions under the income tax law.
Other implications of amalgamation include the following.
- Where a business unit/undertaking develops/operates an infrastructure facility, telecommunication service, or is in the business of power generation, transmission or distribution, and the business unit/undertaking is merged, then the tax benefits it enjoys cannot be claimed by the amalgamated company, where specifically restricted under the tax law. Various tax incentives still may be available as long as no specific restriction applies under the law.
- The basis for claiming tax depreciation on assets of the amalgamating company (or companies) acquired on amalgamation remains the same for the amalgamated company. No step-up in the value of assets acquired on amalgamation is possible for tax purposes.
- The total depreciation on assets transferred to the amalgamated company in that financial year is apportioned between the amalgamating and amalgamated company in the ratio of the number of days for which the assets were used by each entity during the year. Thus, depreciation up to the effective date of transfer is available to the amalgamating company and depreciation after that date is available to the amalgamated company.
- Amalgamation expenses can be amortized in five equal annual instalments, starting in the year of amalgamation.
- Unamortized instalments of certain deductions eligible to the amalgamating company (or companies) are allowable for the amalgamated company.
Corporate reorganizations involving amalgamations of two or more companies require the approval of the National Company Law Tribunal under the amended Companies Act, 2013. As noted, the provisions for inbound and outbound mergers have become effective. The Indian regulatory authorities have notified provisions facilitating cross-border mergers/amalgamations/arrangements between Indian and foreign companies.
These regulations enable an inbound merger (merger of a foreign company into an Indian company) as well as an outbound merger (merger of an Indian company into a foreign company situated in certain permitted jurisdictions) subject to prescribed conditions.
Any transaction on account of a cross-border merger undertaken in compliance with the notified regulations shall be considered to have deemed approval of the RBI subject to obtaining other applicable regulatory approvals.
Further, provisions for mergers of specified small companies and start-up companies, and of wholly owned subsidiaries with holding/parent companies, can be undertaken without court approval (commonly called ‘fast-track mergers’). Such mergers must be approved by the Jurisdictional Corporate Law Regulator, which typically takes 3 to 4 months.
The transfer of assets, particularly immovable properties, requires registration with the state authorities for purposes of authenticating transfer of title. Such registration requires payment of stamp duty. Stamp duty implications differ from state to state. Generally, rates of stamp duty range from 5 to 10 percent for immovable properties and from 3 to 5 percent for movable properties, usually calculated on the amount of consideration received for the transfer or the market value of the property transferred (whichever is higher). Some state stamp duty laws contain special beneficial provisions for stamp duty on court-approved mergers.
Typically, no GST implications may arise on sale of a business as a whole on a going-concern basis wherein all the assets and liabilities (including movable and immovable property and including stock-in-trade and other goods) are transferred under mergers/demergers.
Exchange control regulations
In India, capital account transactions are still not fully liberalized. Certain foreign investments require the approval of the government of India. A court-approved merger is specifically exempt from obtaining any such approvals where, post-merger, the stake of the foreign company does not exceed the prescribed sectoral cap. However, the India Exchange Control Regulations for outbound mergers are yet to be notified.
Takeover code regulations
The acquisition of shares in a listed company beyond a specific percentage triggers implications under the Takeover Code Regulations of SEBI. However, a court-approved merger directly involving the target company is specifically excluded from these regulations. A court-approved merger that indirectly involves the target is also excluded where prescribed conditions are met.
Therefore, a court-approved merger is the most tax-efficient means of corporate consolidation or acquisition, apart from these disadvantages:
- more procedural formalities and a longer time frame of 6 to 8 months
- both parties must be corporate entities and the transferee company must be an Indian company.
Competition Commission of India regulations
Any merger or amalgamation is regarded as a combination if it meets certain threshold requirements; if so, approval from the Competition Commission of India is required. Exemptions are available for an amalgamation of group companies in which more than 50 percent of the shares are held by enterprises within the same group.
GAAR empowers the tax authorities to declare an ‘arrangement’ entered into by a taxpayer to be an ‘impermissible avoidance agreement’ (IAA), resulting in denial of the tax benefit under domestic tax laws or a tax treaty. The GAAR provisions took effect as of 1 April 2017 (FY 2018).
An IAA is an arrangement the main purpose of which is to obtain a tax benefit and that results in the misuse of tax provisions, lacks commercial substance, is not for a bona fide purpose, or creates rights and obligations not created while dealing at arm’s length.
The GAAR provisions apply only if the tax benefit arising to all parties to an arrangement exceeds INR30 million in the relevant financial year.
The GAAR does not apply to arrangements where the court has explicitly and adequately considered the tax implications while sanctioning an arrangement. Also, any ruling by the Authority for Advance Ruling, the Principal Commissioner of Income-tax, Commissioner of Income-tax or the Income-tax authorities is binding in nature and results in non-applicability of GAAR.
The separation of two or more existing business undertakings operated by a single corporate entity can be achieved in a tax-neutral manner under a ‘demerger’. The key provisions under Indian law relating to demergers are discussed below.
Income tax law
Indian tax law defines ‘demerger’ as the transfer of one or more undertakings to any resulting company, pursuant to a court-approved scheme of demerger such that, as a result of the demerger:
- all the property and liabilities relating to the undertaking being transferred by the demerger company immediately before the demerger become the property and liabilities of the resulting company
- such property and liabilities are transferred at values appearing in the books of account of the demerged company (for determining the value of the property, any revaluation is ignored)
- in consideration of a demerger, the resultant company issues its shares to the shareholders of the demerged company on a pro rata basis
- shareholders holding three-quarters of the shares in the demerged company become shareholders of the resultant company (any shares already held by the resultant company or its nominees are excluded for the purposes of this calculation)
- the transfer of the undertaking is on a going-concern basis.
‘Undertaking’ is defined to include any part of an undertaking or a unit or division of an undertaking or a business activity taken as a whole. It does not include individual assets or liabilities or any combination thereof not constituting a business activity.
In a demerger, the shareholders of the demerged company receive shares in the resultant company. The cost of acquisition of the original shares in the demerged company is split between the shares in the resultant company and the demerged company in the same proportion as the net book value of the assets transferred in a demerger bears to the net worth of the demerged company before demerger. (‘Net worth’ refers to the aggregate of the paid-up share capital and general reserves appearing in the books of account of the demerged company immediately before the demerger.)
Generally, the transfer of any capital asset is subject to transfer tax (capital gains tax) in India. However, a demerger enjoys a dual tax-neutrality with respect to transfer taxes under Indian tax law: both the demerged company transferring the undertaking and the shareholders transferring their part of the value of shares in the demerged company are tax-exempt. To achieve tax-neutrality for the demerged company transferring the undertaking, the resultant company should be an Indian company.
Other provisions of the income tax law are as follows.
- The unabsorbed business losses, including depreciation (i.e. amortization of capital assets) of the demerged company directly related to the undertaking transferred to the resultant company are treated as unabsorbed business losses or depreciation of the resultant company. If such losses, including depreciation, are not directly related to the undertaking being transferred, the losses should be apportioned between the demerged company and the resulting company in the proportion in which the assets of the undertaking have been retained by the demerged company and transferred to the resulting company.
- The unabsorbed business losses of the demerged company may be carried forward and set off in the resultant company for that part of the total permissible period that has not yet expired by the resultant company and the demerged company in the same proportion in which assets have been transferred and retained pursuant to demerger.
- Where a business unit/undertaking that develops/operates an infrastructure facility or telecommunication service, or is in the business of power generation, transmission or distribution, etc., is demerged, then the tax benefits it enjoys cannot be claimed by the resultant company where the income tax law specifically disallows such a claim.
- If any undertaking of the demerged company enjoys any tax incentive, the resulting company generally can claim the incentive for the unexpired period, even after the demerger.
- The total depreciation on assets transferred to the resulting company in a financial year is apportioned between the demerged company and the resulting company based on the ratio of the number of days for which the assets were used by each during the year. Depreciation up to the effective date of transfer is available to the demerged company and thereafter to the resulting company.
- The expenses of a demerger can be amortized in five equal annual instalments, starting in the year of the demerger.
- A step-up in the value of the assets is not permissible either in the books or for tax purposes.
Any corporate reorganization involving the demerger of one or more undertakings of a company now requires the approval of the jurisdictional courts of the National Company Law Tribunal. Obtaining the approval normally takes 6 to 8 months.
The transfer of assets, particularly immovable property, requires registration with the state authorities to authenticate transfers of title. Such registration requires payment of stamp duty, which differs from state to state. The rates range from 5 to 10 percent for immovable property and from 3 to 5 percent for movable property. Rates are generally calculated based on the consideration received or the market value of the property transferred, whichever is higher. Some state stamp duty laws contain special stamp duty privilege for court-approved demergers.
Typically, there are no GST implications of a court-approved demerger on a going-concern basis.
Exchange control regulations
A court-approved demerger is specifically exempt from obtaining government approval where, following the demerger, the investment of the foreign company does not exceed the sectoral cap.
A court-approved demerger is the most tax-efficient way to effect a divisive reorganization, apart from these disadvantages:
- more procedural formalities and longer time frame of 6 to 8 months
- for tax-neutrality, consideration must be the issue of shares of the resultant company to shareholders of the demerged company.
Preference capital is used in some transaction structuring models. Preference capital has preference over equity shares for dividends and repayment of capital, although it does not carry voting rights. An Indian company cannot issue perpetual (non-redeemable) preference shares. The maximum redemption period for preference shares is 20 years.
Preference dividends can only be declared out of profits. Dividends on preference shares are not a tax-deductible cost. Preference dividends on fully convertible preference shares can be freely repatriated under the current exchange control regulations. The maximum rate of dividend (coupon) that can be paid on such preference shares should be in accordance with the norms prescribed by the Ministry of Finance (generally, 300 basis points above the prevailing prime lending rate of the State Bank of India).
The redemption/conversion (into equity) feature of preference shares makes them attractive instruments. Preference capital can only be redeemed out of the profits of the company or the proceeds of a new issue of shares made for the purpose. The preference shares may be converted into equity shares, subject to the terms of the issue of the preference shares.
On the regulatory front, a foreign investment made through fully compulsorily convertible preference shares is treated the same as equity share capital. Accordingly, all regulatory norms applicable for equity apply to such securities. Other types of preference shares (non-convertible, optionally convertible or partially convertible) are considered as debt and must be issued in conformity with the ECB guidelines discussed above in all aspects. Because of the ECB restrictions, such non-convertible and optionally convertible instruments are not often used for funding acquisitions.
SEBI permits contracts consisting of pre-emption rights, such as options, right of first refusal and tag-along/drag-along rights in shareholder or incorporation agreements.
RBI has notified that the use of options is subject to certain pricing guidelines that principally do not provide the investor an assured exit price and conditions as to the lock-in period. FDI regulations also permit issue of non-convertible/redeemable bonus preference shares or debentures (bonus instrument) to non-resident shareholders under the automatic route.
Another possibility is the issuance of convertible debt instruments. Interest on convertible debentures is normally allowed as a deduction for tax purposes. However, like preference shares, all compulsorily convertible debentures are treated the same as equity. Other non-convertible, optionally convertible or partly convertible debentures must comply with ECB guidelines.
Both slump sales and itemized sales are subject to capital gains tax in the hands of the sellers (see ‘Finance Bill 2021’ for recent developments). For slump sales, consideration exceeding the net worth of the business is taxed as capital gains. Net worth is calculated under the provisions of the Income Tax Act, 1961. Where the business of the transferor company is held for more than 36 months (24 months for immovable property), such an undertaking is treated as a long-term capital asset and the gains from its transfer are taxed at a rate of 23.296 percent for a domestic company. Otherwise, these gains are taxed at 34.94 percent.
Capital gains taxes arising on an itemized sale depend on the nature of the assets, which can be divided into three categories:
- tangible capital assets
- intangibles (e.g. trademarks, brand, patents).
The tax implications of a transfer of capital assets (including net current assets other than stock-in-trade) depend on whether the assets are eligible for depreciation under the India tax laws.
For assets on which no depreciation is allowed, consideration in excess of the cost of acquisition and improvement is taxable as a capital gain. If the assets of the business are held for more than 36 months (24 months for immovable property), the assets are classified as long-term capital assets. For listed securities or units of equity-oriented funds or zero coupon bonds, the eligible period for classifying them as long-term assets is 12 months.
The gains arising from transfers of long-term capital assets are taxed at a 23.296 percent rate for a domestic company and at 21.84 percent for a foreign company. When calculating the inflation adjustment, the asset’s acquisition cost can be the original purchase cost. Inflation adjustment is calculated on the basis of inflation indices prescribed by the government of India. (Where the capital asset was acquired on or before 1 April 2001, the taxpayer has the option to use the asset’s FMV as of 1 April 2001 for this calculation.)
Where the assets of the business are held for not more than 36 months (12 months for listed securities, units of equity-oriented funds and zero coupon bonds, and 24 months for immovable property), capital gains on the sale of such short-term capital assets are taxable at the rates of 34.94 percent for a domestic company and 43.68 percent for a foreign company.
For assets on which depreciation has been allowed, the consideration is deducted from the tax written-down value of the block of assets (explained below), resulting in a lower claim for tax depreciation going forward.
If the unamortized amount of the block of assets is less than the consideration received or the block of assets ceases to exist (i.e. there are no assets in the category), the difference is treated as a short-term capital gain and subject to tax at 34.94 percent for a domestic company and at 43.68 percent for a foreign company. If all the assets in a block of assets are transferred and the consideration is less than the unamortized amount of the block of assets, the difference is treated as a short-term capital loss and could be 43.68 percent offset against capital gains arising in up to 8 succeeding years.
Any gains or losses on the transfer of stock-in-trade are treated as business income or loss. The business income is subject to tax at 34.94 percent for a domestic company and at 43.68 percent for a foreign company. Business losses can be offset against income under any category of income arising in that year. If the current year’s income is inadequate, business losses can be carried forward to offset against business profits for 8 succeeding years.
The tax treatment for intangible capital assets is identical to that of tangible capital assets, as discussed earlier.
India’s Supreme Court has held in the past that goodwill arising on amalgamation amounts to an intangible asset that is eligible for depreciation. However, in the Finance Bill 2021, it has been proposed that goodwill of a business or profession will not be considered as a depreciable asset. Amount paid for goodwill will be allowed as a cost of acquisition (see ‘Finance Bill 2021’ for recent developments).
The sale of shares is taxed as capital gains for the seller. Further, for the purpose of computing the capital gains tax, where the consideration is less than the FMV of the unlisted shares as computed under the tax laws, the FMV is deemed to be the consideration.
When the shares are held for not more than 24 months (12 months for listed securities, units of equity-oriented funds and zero coupon bonds, and 24 months for immovable property), the gains are characterized as short-term capital gains and subject to tax at the following rates.
If the transaction is not subject to STT:
- 34.94 percent for a domestic company
- 43.68 percent for a foreign company.
If the transaction is subject to STT, short-term capital gains arising on transfers of equity shares are taxed at the following rates:
- 17.472 percent for a domestic company
- 16.38 percent for a foreign company or FII.
Where the shares have been held for more than 24 months (12 months for listed securities, units of equity-oriented funds and zero coupon bonds and 24 months for immovable property), the gains are characterized as long-term capital gains and subject to tax as follows.
If the transaction is not subject to STT:
- The gains are subject to tax at a 23.296 percent rate for a domestic company and at 21.84 percent for a foreign company. Resident investors are entitled to an inflation adjustment when calculating long-term capital gains based on the inflation indices prescribed by the government of India. Non-resident investors are entitled to benefit from currency fluctuation adjustments when calculating long-term capital gains on a sale of shares of an Indian company purchased in foreign currency.
- A concessionary rate of 10.92 percent applies on the transfer of capital assets being unlisted securities in the hands of non-residents (including foreign companies). The concessionary rate must be applied to capital gains without the benefit of exchange fluctuation and indexation.
Under the previous provisions, if the transaction was subject to STT on sale, long-term capital gains arising on transfers of equity shares through the recognized stock exchanges in India are taxable at 10 percent (plus applicable surcharge and cess), provided securities transaction tax is paid. When computing capital gains arising on or after 1 April 2018, the cost base for such shares would be their FMV as at 31 January 2018 or the actual cost for the shares, whichever is higher.
Company law and accounting
The new Companies Act, 2013, governs companies in India.
Corporate restructuring in India is also governed under the Companies Act, 2013, which incorporates the detailed regulations for corporate restructuring, including corporate amalgamation or demerger. The National Company Law Tribunal must approve all such schemes. The provisions allowing corporate amalgamations or restructuring provide a lot of flexibility. Detailed guidelines are prescribed for other forms of restructuring, such as capital reduction and buy-back.
Accounting norms for companies are governed by recently notified International Financial Reporting Standards (IFRS)-converged Indian Accounting Standards (Ind AS). Ind AS are applicable for Indian companies listed on a stock exchange or an unlisted Indian company having a net worth of INR2.50 billion or more, as issued under the Companies Act. Other companies are governed under the old Accounting Standards as issued under the Companies Act. Normally, for amalgamations, demergers and restructurings, the Ind AS and old Accounting Standards, as applicable, specify the accounting treatment to be adopted for the transaction.
Under the Ind AS on amalgamation, all assets and liabilities of the transferor are recorded at their respective fair values. Further, goodwill arising on merger is not amortized; instead it is tested for impairment. The accounting treatment of mergers within a group requires all assets and liabilities of the transferor to be recognized at their existing book values only.
The old Accounting Standard prescribes two methods of accounting: merger accounting and acquisition accounting. In merger accounting, all the assets and liabilities of the transferor are consolidated at their existing book values. Under acquisition accounting, the consideration is allocated among the assets and liabilities acquired (on a fair value basis). Therefore, acquisition accounting may give rise to goodwill, which is normally amortized over 5 years.
Taxability on indirect share transfers
Where a foreign company transfers shares of a foreign company to another company and the value of the shares is derived substantially from assets situated in India, then capital gains derived on the transfer are subject to income tax in India. Further, payment for such shares is subject to Indian WHT. Shares of a foreign company are deemed to derive their value substantially from assets in India if the value of such Indian assets is at least INR100 million and represents at least 50 percent of the value of all the assets owned by such foreign company.
The India Tax Administration has now notified rules for computing the FMV and consequent gains attributed to assets located in India. The value of assets, both tangible and intangible, is deemed to be their FMV on the ‘specified date’ without reduction of liabilities (if any) for the asset.
The rules also require the Indian entity and the transferor entities to report the information in prescribed forms.
After an acquisition, all intercompany transactions, including interest on loans, are subject to transfer pricing regulations.
Foreign investments by a local company
Foreign investments by an Indian company are regulated by the guidelines issued by the RBI. Broadly, an Indian entity can invest up to 400 percent of its net worth (as per audited accounts) in joint ventures or wholly owned subsidiaries overseas, although investments exceeding US$5 million may be subject to certain pricing guidelines. Currently, there are no controlled foreign companies’ regulations in India.
Comparison of asset and share purchases
Advantages of asset purchases
- Faster execution process, because no court approval is required (court approval is required for an acquisition of a business through a demerger).
- Assets and liabilities can be selectively acquired and assumed.
- Possible to restate the values of the assets by the acquirer for accounting and tax purposes, subject to appropriate valuation in a slump sale and subject to carrying out the transaction at a specified price in an itemized sale of assets.
- Possible to capture the value of brand(s) and intangibles and claim depreciation thereon excluding goodwill (see ‘Finance Bill 2021’ for recent developments on tax depreciation on goodwill), subject to appropriate valuation in a slump sale and subject to carrying out the transaction at a specified price in an itemized sale of assets.
- No requirement to make an open offer, unlike in a share acquisition.
Disadvantages of asset purchases
- The transaction may not be tax-neutral, unlike amalgamations and demergers, among others.
- Approvals may be required from the financial institutions (among others) to transfer assets or undertakings, which may delay the process.
- Continuity of incentives, concessions and unabsorbed losses under direct or indirect tax laws or the Export and Import Policy of India must be considered.
- Stamp duty may be higher.
- GST implications need to be considered in an itemized sale of assets. GST is applicable on the movable assets transferred.
Advantages of share purchases
- Faster execution process, because no court approval is required (except where the open offer code is triggered or government approval is required).
- Typically, STT is levied on a sale of equity shares through a recognized stock exchange in India at the rate of 0.1 percent for each such purchase and sale.
- Gains arising on the sale of assets subject to STT held for more than 12 months are taxable at 10 percent (plus applicable surcharge and cess), provided STT has been paid.
- On a sale of shares (other than listed securities) held for more than 24 months, a rate of tax of 23.296 percent applies for a domestic company after considering a cost inflation adjustment for gains on transfer of such shares and a concessionary rate of 10.92 percent applies for non-residents (including foreign companies) without benefit of exchange fluctuation and indexation.
- GST may not apply.
- Stamp duty rates are much lower than asset/business purchases.
Disadvantages of share purchases
- The transaction may not be tax-neutral, and capital gains taxes may arise for the sellers.
- Not possible to capture the value of intangibles.
- Not possible to step-up the value of assets acquired.\
- Consideration paid for acquisition of shares is locked-in until the shares are sold.
- May require regulatory approval from the government and from regulators such as SEBI.
- Valuation of shares may be subject to the pricing guidelines of the RBI.
- On an acquisition of shares of listed companies, acquiring more than 25 percent would trigger the SEBI Takeover Code, which obliges the acquirer to acquire at least 26 percent of the shares from the open market at a price determined under a prescribed SEBI formula. This may substantially increase the transaction cost and the time needed to complete the transaction because the shares would only vest in the acquirer after the open offer is complete.
Insolvency and Bankruptcy Code, 2016
The Insolvency and Bankruptcy Code, 2016 (IBC) provides for a special forum to oversee insolvency and liquidation proceedings.
The key features of the IBC are as follows.
- A specialized forum to oversee all insolvency and liquidation proceedings.
- Empowering all classes of creditors to trigger resolution process in case of non-payment of a valid claim.
- Provides for an insolvency professional to take control of the corporate debtor.
- Offers a finite time limit within which the debtor’s viability can be assessed and a resolution process can be agreed upon.
- Provides the power of commercial decision to revive or liquidate the company to the creditors.
- Provides for a well-defined mechanism for payment of debt in the event of a liquidation.
Acquisition and deals for distressed assets have gone up in India since the implementation of the IBC with many financial players such as private equity firms and pension funds also showing interest in putting money in distressed assets.
Constant improvements and updates to IBC have followed in response to the feedback received and practical experience of processes under execution.
KPMG in India
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This country document does not include COVID-19 tax measures and government reliefs announced by the Indian government. Please refer below to the KPMG link for referring jurisdictional tax measures and government reliefs in response to COVID-19.
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This country document is updated as of 1 February 2021.