HOW THE TRANSACTIONS OF MERGERS AND ACQUISITIONS ARE TAXED

Introduction

Mergers and Acquisitions (M&A) are transactions in which the ownership of companies, other business organizations or their operating units are transferred or combined. As an aspect of strategic management, M&A can allow enterprises to expand, reduce, and change the nature of their business or competitive position. Whatever type of transaction is being contemplated—an acquisition, disposition, merger, joint venture, IPO, restructuring or refinancing—the tax obligations must be carefully assessed and cash flows optimized.

Why Mergers and Acquisitions?

The reason behind mergers and acquisitions could be gaining the market shares, the internationalization and globalization of the company, opening new opportunities for growth, the creation of sustainable competitive advantages or fundamental change in the transformation of the company, its activities and focus.

Regulatory Framework That Governs M&A in India

Naturally, parties to an M&A will have their own set of ideas and conditions regarding the structure and process to be followed in M&A, and also regarding the rights and obligations arising out of such mergers and acquisitions. But it is also to be assured that it adheres to certain rules and laws so that it can be enforced or upheld in a court of law and the parties can be assured that their transaction may not be rendered as immaterial.

Taxation of M&A in India

Amalgamation is always a blending of businesses, attracting various fiscal statutes. In simple words, this mixture is the main creation of an entity, which can fold in the current business or any other entity or creating a new one by gaining businesses of multiple entities.

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The definition of amalgamation can be found in section 2 of the Income Tax Act, but there is no such definition of the merger. The IT Act mainly focuses on the following aspects

The term amalgamation used in the IT Act refers only to amalgamation in relation to the companies and not in reference to any other amalgamation between other forms of legal entities like a partnership or sole proprietorship. 

There are two kinds of combination (a) merger of one or more companies with another company, which is also known as absorptions. (b) the merger of two or more companies to form a new company.

 At the same time, certain transactions are excluded from this definition

where the property of the company which merges is sold to the other company, and the merger is a result of a transaction of sale.

A distribution of property to another company due to winding up of the transferor company.

Then, you have some transactions excluded from amalgamation completely. It comprises distribution of the property to another firm due to just winding up of Transferor Company.

At last, the term before amalgamation is emphasized to focus on transferring the assets and liabilities.

The essential aspect of a merger is that all the properties and liabilities of the transferor company must vest in the transferee company by virtue of the amalgamation. At least 75% shareholders of the transferor company need to become the shareholders in the transferee company, as per the Information Technology Act.

When Does a Merger Become an Amalgamation Under The IT Act

The following are the three conditions which if met, a merger will be treated as an amalgamation.

All the properties of the amalgamating company immediately before the amalgamation should become the property of the amalgamated company by virtue of amalgamation.

All the liabilities of the said amalgamated firm just before the merger, need to be the property of the firm by virtue of amalgamation, as well.

Shareholders holding not less than three-fourth (in value) of the shares in the amalgamating company, which is not the shares already held by the amalgamated company or by its nominee, should become shareholders of the amalgamated company by virtue of amalgamation.

Tax Benefits When Amalgamated By Way Of Absorption

The Income Tax Act recognizes when a company is amalgamated with another one, the transferor company loses its legal and corporate identity and ceases to exist immediately upon the completion of the amalgamation. This results in the loss of benefit by carrying forward of loss, as under the provision of the IT Act, only the person – the legal entity which has sustained the loss is directly attached to the assesses and not to the business nor the undertaking. Thus, if a sick company merges with a healthy company, the loss will not automatically flow to a healthy company. The healthy company can avail the benefits of the losses of the sick company only by obtaining government approval under Section 72A of the IT Act.

Concession of Tax under Section 2(1B) of The Income Tax Act

If an amalgamation satisfies the conditions laid down in section 2(1B) and the amalgamated company is an Indian company, it will get the following tax concessions.

• Non-chargeability of the capital gain on the transfer of a capital asset, including shares held by a shareholder at the time of amalgamation (Section 47(vi) and (vii)).
• Eligibility of amalgamated company for the deduction in respect of any asset representing an expenditure of a capital nature on scientific research (Section 35(5)).
• Eligibility of amalgamated company for the deduction in respect of acquisitions of patent or copyrights (Section 35A(6)).
• Similar deduction in respect of expenditure of know-how as provided in Section 35AB(3).
• Amortization expenditure for obtaining telecom licenses fees. (Section 35ABB(6)).
• Amortization certain preliminary expenses (Section 35D(5) r/w Rule 6AB).
• Amortization expenditure on amalgamation (Section 35DD).
• Amortization expenditure on prospecting etc. for certain minerals (Section 35E(7) r/w Rule 6AB).
• Writing off bad debts (Section 36(1)(vii)).
• Deduction in respect of any expenditure to promote family planning (Section 36(1)(ix)).
• Computation of written down value of the transferred fixed assets in the case of an amalgamated company (Explanation 2(b) to Section 43(6)).
• Continuance of deduction available (Section 80-IA and Section 80-IB).
• The benefit of carrying forward and set-off of accumulated losses and unabsorbed depreciation (Section 72A)

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Conclusion

Mergers and acquisitions are nowadays a major way to achieve strategic goals within a shorter period and with a secure result. M&A comes with some risks as well, in every step as to follow. Few studies have indicated a failure rate of seventy-five per cent for the transactions, which took place. But still, it is a preferable option for a sick company rather than winding up.