Budget 2022 - Expectations from an M&A taxation perspective
Published: Jan 29, 2022
By D V Manohar, Rohit Kumar S & Risha Choudhary, Deloitte Haskins & Sells LLP
MERGERS and Acquisitions (M&A) in India reached an all-time high in 2021 driven by various factors like a fallout of COVID-19 pandemic, growth of industry disruptors across multiple sectors, increased digital adoption etc. It is anticipated that the deals momentum is likely to continue making 2022 another big year for M&A activity in India.
Income-tax plays a critical role in an M&A transaction. To ease M&A activity in India, it is suggested to revisit certain contentious tax issues impacting M&A.
Currently there is a lot of pre-deal internal group restructuring due to commercial considerations between buyer and seller. There is ambiguity and litigation for closely-held companies who propose to carry forward business losses in case of change in shareholding under section 79 of the Act. Tax laws provide that brought forward losses of a closely-held company are not allowed to be carried forward and set-off, if there is a change of beneficial shareholding carrying voting power of more than 49%. There are rulings which have held that section 79 of the Act ought to apply in case there is a change in the immediate registered shareholder, even though ultimate holding company remained the same. In case of group re-organisations, this causes genuine hardship to companies. It is recommended to amend and clarify that section 79 of the Act should not apply to intra group re-organization where the ultimate holding company remains the same.
Next aspect which needs attention is tax neutrality of mergers of two or more Limited Liability Partnerships (LLPs) and/or with a company. Currently, the Act only provides for tax neutrality with respect to merger of companies. Though, there are enabling provisions under Limited Liability Partnership Act, 2008, for merger of LLPs, income-tax laws are silent on implications of merger in the hands of partners/LLP and availability of carry-forward and set-off losses of the amalgamating LLP. As the government has been encouraging LLPs registrations in India, it is recommended that benefits available to companies on merger be extended to merger undertaken between two or more LLPs and/or with a company.
Another important area which needs attention is that of income-tax provisions dealing with cross-border mergers. While the government has taken adequate measures to provide the guidelines on outbound merger under Companies Act, 2013, and the Reserve Bank of India regulations, income-tax laws are silent on this subject. Considering increased cross border M&A activity, increased interest in outbound Special Purpose Acquisition Company (SPAC) deals, it is recommended that income-tax exemption be provided on the merger of an Indian company with a foreign company.
Income-tax laws provide tax exemption to amalgamating foreign company on transfer of shares of Indian company directly and on indirect transfer (i.e., on transfer of foreign company shares deriving substantial value from India) pursuant to merger of two foreign companies. However, no specific relief is available to shareholders of amalgamating foreign company in both the above scenarios. It is suggested that specific provisions be incorporated in the Act to provide relief to the shareholders of the amalgamating foreign company.
A provision which needs immediate attention is carry-forward and set-off of tax losses upon merger. At present, section 72A of the Income Tax Act, 1961 (the Act) provides for allowability of carry-forward and set-off of tax losses to transferee company only if transferor company is engaged in specified business activity which does not include service sector. India has a very large services economy. Further, due to disruptions caused by COVID-19 pandemic, service sectors such as tourism, restaurants, etc. have incurred huge losses. To encourage rapid consolidation, revival, and growth and to make India a competitive country in the service sectors, benefit of tax losses should be extended to service sectors.
Recent times have also seen huge litigation in angel tax provisions which seek to tax a closely-held company on issue of shares to residents for a consideration higher than fair market value as prescribed in the rules. The rules prescribe valuation as per adjusted net worth method or discounted cash flow (DCF) method. It may be noted that these sections were introduced with the intention to curb the menace of black money. However, genuine investments by residents are also being impacted as assessing officers are challenging the valuation reports provided and levying a tax on the closely-held company. It is suggested that this section should not be applicable to such class of investors who are genuine and are able to prove the source of funds. Alternatively, as businesses are evolving based on new business models, alternate valuation methods may be prescribed in addition to the above-mentioned prescribed valuation methods.
India has been an attractive market for international investors. With a focus on balancing profitable exits and correct valuations, most private equity players are increasingly introducing a combination of clauses in share purchase agreements, including the consideration payable by an acquirer in a contingent manner, based on certain performance milestones being achieved by promoters/ the target company. In essence, such clauses incentivize promoters for good performance in the future. There is no clarity on whether such contingent consideration is to be taxed in the year of transfer or in the year of receipt/ once the right to receive consideration crystallizes. It may be clarified by way of an explanation or clarificatory provision, that in case of a contingent consideration, the contingent portion should be chargeable to tax as capital gains in the year of receipt/ in the year in which the right to receive the same is crystalized, irrespective of the year in which the transfer takes place in line with the accrual concept.
There is a mismatch between the capital gains tax rate on long-term capital gains on sale of unlisted shares by non-residents, as compared to sale of shares by residents. Long term capital gains tax rate for non-residents on transfer of shares of an unlisted Indian company is 10% (without considering indexation benefit and exchange fluctuation benefit) vs 20% for residents (with indexation benefit). It is recommended to extend the beneficial rates of 10% (without considering indexation benefit) to residents as the rate difference is too wide and, generally, this appears to be unfair to residents albeit benefit of indexation being available to a resident with a 20% rate.
In India, tax laws are known to be complexity and to attract litigation. From an M&A perspective, it is imperative that the Finance Minister addresses some of the above issues in the upcoming Budget and provide certainty on the tax laws.
(D V Manohar is Partner with Deloitte Haskins & Sells LLP ,Rohit Kumar S is Director with Deloitte Haskins & Sells LLP & Risha Choudhary is Manager with Deloitte Haskins & Sells LLP The views expressed are strictly personal)
