Corporate restructuring is undertaken by the companies for achieving certain goals. But a company has to navigate through the maze of issues involving mergers, amalgamations, demergers, acquisition, etc., and legal implications of such transactions. Lex Witness bureau takes you through the complex issues involved in corporate restructuring of a company.
The business is all about creating wealth for the nation in general and shareholders in particular, depending upon the outlook of a firm. But the wealth creation ability of a firm is dependent on its ability to manage many factors in its business environment right from politics, investments, environment, market, competition, and the key is to remain cut above the rest. Otherwise, a firm finds itself looking down the barrel resulting in the loss of capital and erosion in the base of shareholders. It may take many forms and may involve financial, operational, organizational and marketing restructuring. The device or the method or the mechanism for sustaining a firm’s cutting edge is known in the corporate world as corporate restructuring which is an extremely interesting exercise and can work wonders for the fortunes for a firm provided it is done thoughtfully considering all necessary aspects described in detail in this story. It can help in achieving quick and effective growth in scale and value provided it is undertaken considering the overall business goals and should be done only after thorough economic, industry and company evaluation.
Corporate restructuring comprises of financial restructuring, operational restructuring, organizational restructuring or market restructuring. Put simplistically the market is a jungle which a business man or a business corporation tries to negotiate/navigate to achieve desirable outcomes so as to remain profitable, competitive and relevant. To achieve the objective of eternal relevance and profitability amongst other things a business enterprise depending upon the situation expands itself by way of acquisitions, mergers either through amalgamation or absorption; or reverse merger, takeovers, joint ventures and strategic alliances; or it contracts itself through demerger which may be in the form of a spin off wherein company distributes its shareholding in subsidiary to its shareholders thereby not changing the ownership pattern or split off wherein shareholders of an existing company form a new company to takeover specific division of existing company or split up when existing company is dissolved to form new companies, sell off sale of a non-profit making division by a company; or it is done to retain corporate control through buyouts leveraged buyout or subdivision of shares and buybacks. Whichever may be the term or whatever may be the method the Karma of a businessman is to ensure efficiency and that includes tax efficient transactions.
The term corporate restructuring as understood in the corporate parlance, if looked at from purely tax and legal perspective can be broadly divided into the transactions qualifying either as a merger/amalgamation which is defined in the Section 2 (1B) of the Income Tax Act, 1961, Demerger Acts defined in the Section 2 (19AA) of the same Act, and some other forms of capital reduction. These terms are broadly analysed hereunder from purely legal and tax perspective for a closer and better understanding of them based on the first principles.
As a general rule the tax authorities charge total income of an assessee to tax while allowing for expenses, concessions, exemptions, etc. so as to arrive at the net income on which the tax is charged.
Especially in the corporate restructuring transactions, it is the tax on capital gains which is the key tax liability. However subject to certain conditions a merger or demerger is exempt from tax. The understanding is that the transfer of capital assets results in capital gains. A capital asset is defined under section 2(14) of the I.T. Act, 1961 as property of any kind held by an assessee such as real estate, equity shares, bonds, jewellery, paintings, art etc. but does not include some items like any stock-in-trade for businesses and personal effects. Transfer has been defined under section 2(47) to include sale, exchange, relinquishment of asset, extinguishment of rights in an asset, etc. Certain transactions are not regarded as ‘Transfer’ under section 47. For tax purposes, there are two types of capital assets: long term and short term. Long term asset is that which is held by a person for three years except in case of shares or mutual funds which becomes long term just after one year of holding. Sale of such long term assets gives rise to long term capital gains. There are different scheme of taxation of long term capital gains. These are as per Section 10(38) of Income Tax Act, 1961 long term capital gains on shares or securities or mutual funds on which Securities Transaction Tax (STT) has been deducted and paid, no tax is payable. STT has been applied on all stock market transactions since October 2004 but does not apply to off-market transactions and company buybacks; therefore, the higher capital gains taxes will apply to such transactions where STT is not paid. And In case of other shares and securities, person has an option to either index costs to inflation and pay 20% of indexed gains, or pay 10% of non indexed gains. The indexation rates are released by the I-T department each year. In case of all other long term capital gains, indexation benefit is available and tax rate is 20%. All capital gains that are not long term are short term capital gains, which are taxed.
But a slump sale is taxable as profits or gains arising from it are taxable as long-term capital gains if the undertaking is owned and held by the assessee for more than 36 months prior to date of transfer. Otherwise, they are taxable as short-term capital gains.Net worth of the undertaking so transferred shall be deemed to be the cost of acquisition, No indexation benefit is allowed on case of a slump sale. Buyback refers to the purchase of own shares by a company from its shareholders in lieu of consideration. Consideration received by a shareholder from the company for purchase of its own shares is taxable as a long-term capital gain, if shares were held for more than 12 months prior to transfer to the company. Indexation benefit is available for long term capital gains. otherwise, they are taxable as short-term capital gains in the year in which the shares are purchased by the company.
In an amalgamation, what types of shares are considered for determining “continuity of shareholding”?
The Indian tax laws are silent on the type of shares that need to be issued by the amalgamated company to the shareholders of the amalgamating company pursuant to the amalgamation. Hence, a view may be adopted that both equity and preference can be issued on amalgamation. Further, there is no lock in prescribed under the Indian tax laws in respect of shares issued on amalgamation.
Please tell about determination of issues related to TDS in a transaction between amalgamating and an amalgamated company?
This is a practical issue commonly encountered by companies after filing a scheme for amalgamation with the High Court. An amalgamation gets effective from the ‘appointed date’ which is typically before the ‘effective date’ i.e. the date of filing the copy of order of High Court with the registrar of companies. In between these two mentioned dates, the amalgamating company operates on behalf of amalgamated company. Consequently, in case of any transaction is effected during the aforementioned period between the amalgamating company and the amalgamated company that requires tax to be withheld – the amalgamating company should comply with the provisions (deduct and deposit) and once the merger is effected, the amalgamated company may subsequently revise the returns accordingly
What is the position of losses in case of demerger of closely held companies?
Section 72A(4) of the Income Tax Act, 1961 (‘ITA’), starts with the expression ‘notwithstanding anything contained in any provisions of this Act,’ whereas section 79 of ITA starts with ‘notwithstanding anything contained in this Chapter.’ Further, section 72A (4) was introduced in 1999 when section 79 was already on the statute book. A view may be taken that the non obstante provision in section 72A (4) overrides section 79 and hence notwithstanding anything contained in section 79, the loss of demerged company can be carried forward and set off by the resulting company. However such loss should pertain to the undertaking being transferred as part of the demerger.
In a number of judgments, it has been held that when two or more laws operate in the same field and each contains a non obstante clause overriding the provisions in any other law, then for resolving the interse conflict, one test that may be applied is that the latter enactment must prevail over the earlier one.
What is the succession liability in the event of a slump sale?
As per the provisions of the ITA, where a business, being carried on by any person, is succeeded by any other person (‘successor’) who continues to carry on that business, then the successor is liable to be assessed in respect of the income of the previous year accruing after the date of succession.
In case any liability is payable in respect of any period prior to the date of succession is not recoverable from the predecessor of the business, the tax authorities have the powers to recover the same from the successor. Further, as per section 281 of the ITA prior permission is required from the tax authorities for transfer/ creation of charge on the assets of any taxpayer. The Central Board of Direct taxes (‘CBDT’) has recently issued Circular No 4/2010 [F No 402/69/2010-ITCC] prescribing the guidelines to be followed by a tax officer for granting permission to transfer or create a charge on the assets of the taxpayer as contemplated under section 281 of the ITA. The guidelines prescribe a form to be completed by the taxpayer if the taxpayer desires to transfer an asset or attempts to create a charge on the asset. This form is required to be filed by the taxpayer at least 30 days prior to the date of the proposed transaction. With section 281 approval, the buyer’s risk for succession liability may be mitigated.
What are the tax lessons from SC verdict in Vodafone case for cross border M&A transactions?
The Supreme Court by holding that an indirect transfer of capital assets located in India would not be subject to tax in India, has provided guidance for adopting a look at approach for a transaction rather than a look through/dissecting approach for determining whether the transaction is a sham transaction or not. The Supreme Court has provided guidance on aspects relating to the analysis of the holding structures and the relationship between the holding company and its subsidiaries, reading of share purchase agreements and recognizing the legal form/substance of the transaction. Further, the Apex Court also observed certainty is integral to rule of law. Certainty and stability form the basic foundation of any fiscal system and tax policy certainty is crucial for taxpayers (including foreign investors) to make rational economic choices in the most efficient manner.
However, we understand that the government is in the process of introducing sharp anti-abuse provisions under the proposed Direct Tax Code ('DTC') for taxing such indirect transfers. The draft provisions under DTC propose to tax indirect transfers in India in case the fair market value of investments held by the parent entity in India is more than 50% of the overall fair market value of investment held in all jurisdictions (including India).
Availability of tax benefit to the “successor” if the entire “undertaking” is sold by way of itemized sale?
In case of a slump sale the undertaking as a whole is transferred to the successor of business, and thus a view may be taken that the tax benefits which are attached to the undertaking may also get transferred to the successor along with the undertaking. However, in case of an itemized sale only the individual assets are transferred /liabilities are assigned to the successor of the business. Since, the tax benefits are attached to such undertaking as a whole, a view may be adopted that the tax benefits attached to an undertaking would not be available to the successor of business in case of an itemized sale.
Mergers are tax neutral subject to the fulfilment of certain conditions. The corporate world sees merger either as a forward merger or a reverse merger. But If we examine the three terms, i.e. merger/amalgamation/acquisition, from purely tax perspective it becomes clear that the Tax Administration of the country does not distinguish between a merger and an amalgamation rather uses the two synonymously without bothering to define the third i.e. “Acquisition”. In effect all the three terms are deemed to be covered under the Section 2 (1B) of the Income Tax Act, 1961 only. The definition of the term under defines “Amalgamation” essentially stating: ‘in relation to companies amalgamation is the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company). Provided the Property, Liabilities and Shareholders of the amalgamating and the amalgamated company/companies immediately before the transaction of the amalgamating company or companies becomes the property, liabilities and shareholders (i.e. not less than nine-tenths in value of the shares, other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) of the amalgamated company by virtue of the amalgamation otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first mentioned company.
The tax implications of these transactions, as per Mr. Ajay Vohra, Managing Partner of Vaish Associates, a leading Tax Firm in the country, that there is no capital gain on transfer of capital assets either in the hands of the amalgamating company or its shareholders as per the provisions of section 47 (vi) and Section 47(vii). Whereas the Depreciation in the year of transfer is available pro rata to the transferor, Further depreciation is allowed to amalgamated company on the basis of tax written down value in the hands of the amalgamating company. On the issue of Tax holidays Mr. Vohra maintains that the benefit of Section10A/10B/10AA/80-IB/80-IC/80-I AB not available to the amalgamating company in the year of transfer and available to amalgamated company. On the issue of Expenditure on amalgamation, tax is deductible in hands of transferee company in five equal instalments. Further any cessation of liability of amalgamating company shall be taxed in the hands of the amalgamated company. Period during which the asset was held by the transferee company will be considered for determining holding period. Cost of acquisition of asset deemed to be cost to the previous owner. Accumulated business loss and depreciation of the amalgamating company owning an industrial undertaking, hotel or of a banking company shall be deemed to be the accumulated loss and depreciation of the amalgamated company or specified bank for the previous year in which the amalgamation is effected subject to the fulfilment of the following conditions by the amalgamated company:[Section72A] (a) Hold continuously for a minimum period of five years from the date of amalgamation at least three-fourths in the book value of fixed assets of the amalgamating company acquired in a scheme of amalgamation, (b) Continue the business of the amalgamating company for a minimum period of five years from the date of amalgamation (c) Fulfil such other conditions as may be prescribed to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purpose. The benefit of carry forward and set off of accumulated losses and unabsorbed depreciation of the amalgamating company owning an industrial undertaking would be available to the amalgamated company only if the following additional conditions are fulfilled: (a) the amalgamating company should have been engaged in the business for at least three years during which the accumulated loss has occurred or the unabsorbed depreciation has accumulated, and (b) the amalgamating company has held continuously as on the date of the amalgamation at least three-fourths of the book value of fixed assets held by it two years prior to the date of amalgamation
Demerger is also non taxable subject to certain conditions. Demerger in case of companies is the transfer by a demerged company of its one or more undertakings to any resulting company pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), being approved by the concerned high court. But the manner of transfer of such an undertaking should be as following: (i) Transfer of the Property and Liabilities: All the property of the undertaking and all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger. “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity. The liabilities which arise out of the activities or operations of the undertaking;(b) The specific loans or borrowings (including debentures) raised, incurred and utilised solely for the activities or operations of the undertaking; and (c) In cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose borrowings, if any, of the demerged company as stand in the same proportion which the value of the assets transferred in a demerger bears to the total value of the assets of such demerged company immediately before the demerger; Transfer must be at book values: The property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger; Issuing shares: The resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis; The shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company; Going concern basis: In essence going concern basis means that a Balance Sheet of a company must reflect the value of that company as if it were to remain in existence for and beyond the foreseeable future; Conformity with Section 72A (5): of the Income Tax Act The demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf.
On the key tax implications in this case Mr. Vohra views the key tax implications on demergers is that there is no capital gain on transfer of capital assets if the resulting company is an Indian company. Further as per section 47(vi d) there is no capital gain on issuance of shares by the resulting company to the shareholders of demerged company. The formula for calculating the cost of shares in resulting company is equal to the Cost of shares in demerged company multiplied by Net Book Value of assets transferred/net worth of demerged company pre-demerger. And there is no deemed dividend implications on issue of shares by resulting company while resulting company is chargeable to tax. For calculating the actual cost of transferred assets in the hands of resulting company is the cost in the hands of demerged company. Depreciation in respect of assets transferred to be apportioned in the ratio of number of days used by demerged/resulting company. The Written Down Value (WDV), [Explanation 2A to section 43(6)], of the block of assets in the hands of transferor company shall be reduced by WDV of the assets transferred in demerger while WDV of depreciable assets in the case of resulting company to be taken as the WDV as per Income Tax records at the time of demerger. Loans/borrowings not specifically relatable to the transferred undertaking to be apportioned in the ratio of assets transferred to total value of the assets. Transfer of accumulated loss and unabsorbed depreciation to resulting company allowed [Section72A]. Conditions notified u/s72A (5) to be fulfilled [No condition s prescribed as yet]. Undertaking includes- any part of an undertaking but must be A unit or division of an undertaking a business activity as a whole while Change in value of assets on account of revaluation to be ignored.
The Slump Sale essentially is transfer of a whole or part of business concern as a going concern. As per S. 2(42C) it means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. Explanation 2 to S. 2(42C) clarifies that the determination of value of an asset or liability for the payment of stamp duty, registration fees, similar taxes, etc. shall not be regarded as assignment of values to individual assets and liabilities. Thus, if value is assigned to land for stamp duty purposes, the transaction will not cease to be a slump sale.
Again Mr. Vohra on tax implications of Slum Sale views that the Capital gain on transfer of undertaking under slump sale is covered under Sec.50B of the Income Tax act, 1961. The formula for calculating Capital gains for a slump sale is that capital gains is equal to full value of consideration subtracted by the Net worth of undertaking while the Net worth is the aggregate value of WDV of the block of assets and book value of other assets of the undertaking while Value of liabilities of undertaking are to be subtracted from it. It is further maintained that the Change in value of assets on revaluation has to be ignored for computing net worth. In slump sale transaction the benefit of indexation is not available. And the Losses and unabsorbed depreciation remain with the transferor company. On short term and long term capital gains of the slump sale he maintains that the slump sale of the undertaking shall give rise to long term capital gains where the undertaking is held for more than thirty six months preceding the date of its transfer and short term capital gains will result if the undertaking is held for less than thirty six months.
In conclusion it can be said that the corporate restructuring can be a key strategy for business expansion and market competitiveness if India has to achieve the goals of 10 per cent economic growth rate which is a very serious exercise and is very crucial not just for competitiveness of a business but also for its relevance in the market it operates or aspires to operate and also for remaining profitable eternally. The business employs different strategies in the shape of corporate restructuring to achieve those objectives. But the key thing to be kept in mind before going on for such exercise is that the tax efficiency is taken care of in order to achieve success in that.
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