Taxation for Merger and Acquisition

Earlier, it used to be a competition. Now, it’s time for collaboration. Mergers and Acquisitions have been one of the prominent ways to survive and thrive businesses in this cut-throat competitive environment. It helps businesses to have synergy gains, reduce competition by collaborating or acquiring them, and have competitive advantages through vertical and horizontal expansion. However, one of the key aspects of mergers and acquisitions is taxation. Whenever a merger happens, various sections of the taxation laws come into play. Let’s have an in-depth understanding of the taxation aspects of merger and acquisition transactions.

Income Tax Act, 1961
The Income Tax Act, 1961 uses amalgamation in order to address M&A transactions. Definitions of certain terms shall be understood before proceeding with the tax implication on mergers and acquisitions.

Glossary

Amalgamation: As per Section 2(1B) of the Act, "amalgamation", in relation to companies, means 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) in such a manner that—
all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation;
all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation;
shareholders holding not less than 3/4th in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders 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.

Amalgamating Company: In simpler terms, amalgamating company is the company that is getting transferred or being sold to another company. The amalgamating company may or may not retain its legal identity.

Amalgamated Company: In simpler terms, an amalgamated company means the company that is acquiring another company and will retain its legal identity.

Capital Asset: As per Section 2(14), "capital asset" means—

1. property of any kind held by an assessee, whether or not connected with his business or profession;
2. any securities held by a Foreign Institutional Investor which has invested in such securities in accordance with the regulations made under the Securities and Exchange Board of India Act, 1992 (15 of 1992);
3. any unit-linked insurance policy to which exemption under clause (10D) of section 10 does not apply on account of the applicability of the fourth and fifth provisos thereof,

but does not include—

1. any stock-in-trade [other than the securities referred to in sub-clause (b)], consumable stores or raw materials held for the purposes of his business or profession;
2. personal effects, that is to say, movable property (including wearing apparel and furniture) held for personal use by the assessee or any member of his family dependent on him, but excludes—

• jewellery;
• archaeological collections;
• drawings;
• paintings;
• sculptures; or
• any work of art.

The income tax act provides various taxation reliefs for merger and acquisition transactions. Therefore, where any M&A fulfill the requirements of the above definition, the following sections becomes applicable to govern the taxation of these transactions:

Capital Gains
In following cases, relief from capital gains tax is provided to the companies entering into amalgamation:

Section 47(vi): Transfer of any capital asset by the amalgamating company to the Indian amalgamated company.

Section 47(via): In case of amalgamation entered between two foreign companies, transfer of any capital asset (being shares held in an Indian Company), by the amalgamating foreign company to the amalgamated foreign company if the following conditions are fulfilled:

• At least 25% of the shareholders of the amalgamating foreign company continue to be the shareholders of the amalgamated foreign company and,
• The transfer does not attract capital gains tax in the country where the amalgamating company is incorporated.

Section 47(viaa): Any transfer of a capital asset by a banking company to a banking institution in case of amalgamation sanctioned and brought into force by the Central Government under Section 45(7) of the Banking Regulation Act, 1949.

Section 47(viab): Transfer of a capital asset by the amalgamating foreign company to the amalgamated foreign company, where such capital assets are the shares of a foreign company that derives their value substantially from the shares of an Indian Company. However, the following conditions shall be satisfied:

• At least 25% of the shareholders of the amalgamating foreign company continue to be the shareholders of the amalgamated foreign company and,
• The transfer does not attract capital gains tax in the country where the amalgamating company is incorporated.

Section 47(vii): Here, the shareholder is relieved from capital gains tax in case of transfer of his shares at the time of amalgamation. Any transfer of shares (being capital assets) held by him in the amalgamating company where the following conditions are satisfied:

• Against such transfer, the shareholder of the amalgamating company shall receive the shares in the amalgamated company. This does not apply where the shareholder is the amalgamated company itself and,
• The amalgamated company is an Indian company itself.

Tax Reliefs for Losses and Depreciation

Section 72A: For the following cases of amalgamation, the accumulated losses and unabsorbed depreciation of the amalgamating company shall be treated as accumulated losses and unabsorbed depreciation allowance of the amalgamated company and all other provisions relating to set-off and carry forward loss shall apply accordingly:

• The amalgamation of a company owning an industrial undertaking, hotel or ship with another company or,
• The amalgamation of a banking company as referred to in Section 5(c) of the Banking Regulation Act, 1949 with a specified bank or,
• The amalgamation of one or more public sector companies with one or more public sector companies or,
• An erstwhile public sector company with one or more companies in case of the share purchase agreement entered into strategic disinvestment restricted immediate amalgamation of the said public sector company however the amalgamation is carried out within 5 years after the end of the previous year when such restriction on amalgamation ends.

Section 72AA: Section 72AA overrides Section 2(1B)(i) to (iii) and 72A to provide that the accumulated losses and unabsorbed depreciation of amalgamating company shall be deemed to be the accumulated losses and unabsorbed depreciation of amalgamated company in the following cases of amalgamation under the scheme sanctioned and brought into force by the Central Government under relevant sections of the relevant acts:

• The amalgamation of one or more banking companies with another banking institution
• One or more corresponding new bank(s) with another corresponding new bank(s)
• One or more Government companies with another Government company

Relaxations under various provisions dealing with business and profession
Apart from the above, the government has provided various tax relaxations for merger and acquisition transactions under the provisions of the Income Tax Act dealing with income under the head PGBP. These relaxations are as under:

Section 35(5): In case of transfer of any asset that represents capital expenditure on scientific research, the amalgamated company is allowed to avail of the deductions and section 35, dealing with expenditure on scientific research, shall apply accordingly to the amalgamated company. The amalgamating company shall be disallowed to avail of any deduction under Section 35(2)(ii) or (iii).

Section 35DD: The assessee shall be allowed a deduction for expenditure incurred for amalgamation up to 1/5th of the amount of such expenditure for each of the 5 years beginning from the previous year in which the amalgamation took place.

Section 35D(5): Preliminary expenses associated with the commencement or expansion of the business, as specified under the Income Tax Act, are allowed as deduction. The deduction can be claimed as 1/5th of the amount for each of the successive 5 years. However, if the company gets amalgamated before the completion of 5 years, then the amalgamated company shall be entitled to claim the remaining amount of deduction for the remaining period beginning from the year in which the amalgamation took place.

Section 35ABB(6): In case of capital expenditure incurred to obtain a license for operating telecommunication services, the deduction is allowed on a fractional basis for each year during the term of the license. In case the amalgamating company transfers such license to the amalgamated company during amalgamation, then the amalgamated company shall be entitled to claim the remaining amount of deduction over the term of the license as would have been allowed to the amalgamating company.

Section 35ABA(2): As per this sub-section, section 35ABB(6) shall also apply for expenditure incurred for obtaining the right to use the spectrum for telecommunication services.

Section 36(1)(vii): Where under the scheme of amalgamation, the debts of the amalgamating company are taken over by the amalgamated company and subsequently, such debts become bad debts, then the amalgamated company shall be allowed the deduction of such bad debts.

Section 36(1)(ix): In case the family planning expenditure is incurred by the company under section 36(1)(ix) and subsequently, such company is transferred under the scheme of amalgamation, then the amalgamated company shall be allowed to claim a deduction of the expenditure in the same manner as the amalgamating company was entitled to.

Goods and Services Tax Act, 2017
GST law has put in place certain provisions for transfer of credit due to amalgamation or merger entered into between two or more companies. Following are the provisions governing this aspect:

As per Section 18(4) of the CGST Act 2017, if there is a change in the constitution of the business on account of amalgamation, merger, demerger, sale, transfer, or lease along with a specific provision for transfer of liabilities, then the registered person (transferor) can transfer the input tax credit lying in his electronic credit ledger to the amalgamated person. However, if there is no provision for transfer of liabilities, then the registered person shall not be allowed to transfer the ITC.

Rule 41 lays down the detailed procedure for the transfer of such ITC. As per Rule 41:

• The registered person being the transferor shall furnish the details pertaining to such merger or amalgamation in Form ITC-02 electronically requesting to transfer the unutilized input tax credit lying in the electronic credit ledger.
• A copy of the certificate from a Chartered Accountant or a Cost Accountant that the amalgamation, merger, demerger, sale, transfer or lease of business has been undertaken with a specific provision for transfer of liabilities shall also be submitted by the transferor.
• The transferee shall accept the details on the common portal as furnished by the transferor upon which the unutilized ITC shall get transferred to the transferee. The transferee shall account for the inputs and capital goods in his books of accounts.