Budget 2023 should ensure outbound mergers of Indian companies with foreign firms are tax neutral

By Amrish Shah
Mergers and Acquisitions (M&A) activity is expected to boost the rather lull environment businesses are trying to overcome. The government has been providing certain relaxations to improve this scenario and provide much-needed relief. However, certain relaxations in the M&A arena are the need of the hour
Deloitte India discusses key expectations and the rationale in this regard:
Expectation #1: Ensure outbound mergers to be practical, i.e., tax neutral
The Companies Act, 2013, permits the merger of an Indian company into a foreign company, subject to certain conditions.The merger of an Indian company with another Indian company is tax neutral if the prescribed conditions are satisfied. However, no specific exemption is provided under the Income-tax Act, 1961 for the merger of an Indian company with a foreign company.
Tax exemption will be provided on the merger of an Indian company with a foreign company by the specific clause in Section 47.
Expectation #2: : Extend transition of losses from amalgamating a ‘non-industrial undertaking’ company to an amalgamated company
• Under the existing provisions in Section 72A, the benefit of carry forward of losses and unabsorbed depreciation is, inter alia, allowed in cases of amalgamation of a company owning an ‘industrial undertaking’.
• The provision was incorporated when India was a capital-intensive country. The country is moving from a capital-intensive to a capital-light model; the services industry is also growing and contributing to the economy.
• To encourage rapid consolidation and growth and make India competitive in the services sector, the benefit under Section 72A (to carry forward of losses and depreciation on amalgamation) should be extended to service industries, amongst others.
Expectation #3: Rationalise taxation of contingent consideration
• India is an attractive market for international investors. With a focus on balancing profitable exits and correct valuations, most private equity players plan to introduce a combination of clauses in the shareholders agreement. This includes consideration payable in a contingent manner based on certain performance milestones that the promoters achieved.
• In essence, such clauses incentivise promoters for their good performance.
• There is no clarity on whether such contingent consideration is to be taxed in the year of transfer or receipt, after the consideration crystallises.
• It may be clarified by an explanation or clarificatory provision to Section 45 (in case of a contingent consideration), the contingent portion should be chargeable to tax as capital gains in the year in which the same is crystallised, irrespective of the year in which the transfer takes place (in line with the accrual concept - refer to Section 5 of the Act).
Expectation #4: Provide exemption to foreign shareholders in case of mergers and demergers
• Section 47(via) provides that transfer of shares of an Indian company transferred in a foreign amalgamation would not be regarded as a transfer, provided certain conditions are met.
• Similarly, Section 47(via) provides that transfer of shares of a foreign company that derive value substantially from assets located in India, in an amalgamation, would not be regarded as a transfer provided certain conditions are met.
• The above sections seem to indicate that the exemption is provided only to the amalgamating foreign company and not to its shareholders.
• Specific provisions should be incorporated in the Act to provide relief to the shareholders of the amalgamating foreign company such as Section 47(vii), which exempts shareholders in a domestic amalgamation.
A similar issue emerges for demergers. In the absence of exclusion from compliance with the Indian company law requirements in Section 47(vid), the benefit of shareholder exemption is not available to shareholders of the foreign demerging company in an overseas demerger. This has the effect of imposing a tax liability on the shareholders of the foreign demerging company and hence, against the principle of enabling tax neutrality for overseas demergers.
• A provison (as provided in Section 47[vid] and 47[vid]) should be incorporated in Section 47(vid) to provide exemption to the shareholders of the foreign demerged company despite the demerger not complying with the relevant Indian company law provisions.
Amrish Shah is Partner, Deloitte India