Foreign Amalgamations? A word of caution for Indian Tax exemption
Published: Jun 16, 2021
By Shankar Iyer, Direct Tax Leader, DAA Consulting
WHILE mergers of foreign companies are commonplace, one may have to look into the aspect of their shareholdings in Indian companies more carefully and much in advance. In case of any innocuous oversight in the machination in these transactions, there could be potential tax implications in India which could have been completely avoided in hindsight, had one just pondered through the steps in foreign amalgamation process more carefully and checked beforehand for any potential Indian tax implications.
Under Indian tax law, in case shares in an Indian company are held by a foreign parent / company, then transfer of such shares in Indian company pursuant to scheme of amalgamation ("Scheme") of foreign parent with another foreign company would be exempt from any capital gains tax in India subject to fulfilment of certain conditions.
Let's say, there is a Scheme between two foreign sister companies (say, A Co and B Co) held by a common foreign parent (say, Z Co). A Co held shares in an Indian company (I Co) and hence the case becomes relevant for discussion here. Further to amalgamation of A Co into B Co, there would not have been any change in shareholding pattern of B Co and it would have continued, as before, to be the subsidiary of Z Co. The 'innocuous oversight' - no shares are issued by B Co to shareholder of A Co (ie to Z Co) upon such amalgamation. However, the same may qualify as amalgamation in the jurisdiction of A Co and B Co, respectively.
Under Indian Income tax Act, 1961 ("IT Act"), Section 47(via) provides an exemption from capital gains tax in India for any transfer, in a scheme of amalgamation, of a capital asset being a share held in an Indian company, by the amalgamating foreign company to the amalgamated foreign company, if-
(a) at least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company, and
(b) such transfer does not attract tax on capital gains in the country, in which the amalgamating company is incorporated
Apparently, pursuant to the aforesaid Scheme, both cumulative conditions are satisfied i.e. Z Co which was at least 25% shareholder in amalgamating company A Co, continued to remain shareholder in amalgamated company B Co and secondly, the amalgamation was tax neutral in that foreign jurisdiction. So apparently, no glitches and exemption from capital gains tax ought to be granted under Section 47(via) w.r.t transfer of shares in Indian company from A Co to B Co under Scheme - right?
Well, Not Exactly.
Let me explain, the phrase used in the beginning of Section 47(via) is 'any transfer, in a scheme of amalgamation'. What becomes relevant here is the term "Amalgamation" and the same has been defined by Section 2(1B) of IT Act as under:
"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-
(i) 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;
(ii) 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;
(iii) shareholders holding not less than 3/4 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;
In other words, the amalgamation of A Co into B Co should also qualify as such under the definition of "amalgamation" prescribed under Section 2(1B) of IT Act in order to qualify for such exemption provided under Section 47(via) of IT Act.
While all other conditions are generally satisfied, the third condition (bold and underline) deserves critical attention. It states that shareholders holding at least 75% shares in amalgamating company become shareholders in amalgamated company by virtue of the amalgamation. While Section 47(via) would specifically override the 75% criterion and read the same down to 25%, the definition of "amalgamation" under Section 2(1B) of IT Act would presage and nevertheless require such 25% shareholder to 'become shareholder' in B Co by virtue of the amalgamation. That is to say, at the least, a single share ought to be issued by B Co to Z Co pursuant to scheme of amalgamation of A Co into B Co, in order for Z Co to qualify as 'becoming shareholder by virtue of the amalgamation' irrespective of the fact that Z Co was already the parent shareholder of B Co even prior to the amalgamation and continues so even post amalgamation without issue of shares by B Co to Z Co upon amalgamation. The key issue is balancing (a) applicability of rigidity of definition of "amalgamation" under Section 2(1B) (i.e. Z Co 'becoming' shareholder in amalgamated company B Co 'by virtue of amalgamation') with (b) the effective net result required under Section 47(via) (i.e. Z Co before and after 'continued to remain shareholder in amalgamated foreign company B Co' nevertheless). Here, one would be really impelled to side with the argument that so long as the condition under Section 47(via) of 'continued to remain shareholder in amalgamated foreign company' was satisfied, there was really no problem in India with respect to the exemption from capital gains tax granted for transfer of shares in Indian company pursuant to such foreign amalgamation.
However, the definition of "amalgamation" is the primal condition mentioned at the start of the beneficial provision of Section 47(via) and subsequently the other conditions are mentioned. The rigour of Section 2(1B) defining the term "amalgamation" would be watered down only to the extent specifically mentioned by Section 47(via) i.e. 75% criterion read down to 25%. Thereafter, definition of "amalgamation" would nonetheless prevail and mandate that such "25% foreign shareholder" in amalgamating foreign company 'become shareholder in amalgamated foreign company by virtue of amalgamation'. In the absence of issue of any shares by amalgamated foreign company B Co to Z Co (being at least 25% shareholder of amalgamating foreign company A Co) pursuant to scheme of amalgamation, the exemption from capital gains tax in India w.r.t transfer of shareholding in Indian company from A Co to B Co under such scheme of amalgamation would technically not be available as the transaction does not qualify as "amalgamation" defined in Section 2(1B) of IT Act.
Lesson - One would need to check Indian tax laws more carefully before such group restructuring exercises.