Tax implications of Amalgamations / Mergers / Demergers / Slump sales

Ms.B.Mala, Associate,

M/s Subbaraya Aiyar, Padmanabhan & Ramamani (SAPR) Advocates

TAX IMPLICATIONS OFAmalgamations/ MergersDemergers/Slump Sales

Synopsis

Introduction Amalgamation –Definition

Capital Gains

Section 72A

Section 79 / Reverse Merger

Effective date

Allowable Deductions

Synopsis

Shareholders of Amalgamating Co. Demerger - Definition

Capital Gains Resulting Co. Resulting Co.- Allowable Deductions

Shareholders

Synopsis

Sale of Undertaking

Slump sale – Relevant provisions

Itemised sale – Relevant provision

Procedure for Amalgamation

Introduction-Nature of transaction

Amalgamation/ Mergers Demerger Sale of undertaking-Slump Sale

Amalgamation/ Mergers

Amalgamations can provide certain strategic benefits to the companies.

1) two amalgamating companies can prevent a competitor from becoming a market leader.

2) it assists the company to create additional productive capacity thereby reducing the expansion cost.

3) it may lead to knowledge sharing between the companies.

.


India has become a major country entering into even cross border transactions with regard to business amalgamations. Today Mergers, Amalgamations, De-mergers are on the agenda of most industrial groups intending to diversify the scope of their operations.

Some of the well known amalgamations in India are:

Reliance Power and Reliance Natural Resources at a deal of US $11 billion

ICICI Bank acquired Bank of Rajasthan at about Rs 3000 Crore

GTL Infrastructure acquired Aircel Towers at US $ 1.8 billion.


Tata Steel acquired UK based Corus Group at a deal value of US $ 12 million.

Suzlon Energy acquired Belgium based Hansen Group at US $ 565 million.

Airtel acquired Zain in Africa with an amount of US $ 10.7 billion.

Ranbaxy Labs at a deal of US $ 324 million acquired Romania based Terapia SA

Tata Chemicals acquired British salt based in UK with a deal of US $ 13 billion.

Fortis Healthcare acquired Hong Kong's Quality Healthcare Asia Ltd for around Rs 882 Crore.

Amalgamation - Definition

Amalgamating Co.

All Property

All Liabilities

Amalgamated Co.

Property

Liabilities

Shareholders 75% Shareholders

Otherwise than purchase or distribution on winding up of the first mentioned Co.

Section 2(1B)

Amalgamation – Definition (contd.) Example:

75% of shareholders X Ltd amalgamated with Y Ltd. in a scheme of amalgamation. Immediately before the merger Y Ltd held 20% of the shares in X Ltd. Condition will be satisfied if shareholders holding not less than 75% in the value in the remaining 80% of shares in X Ltd, that is, 60% thereof become shareholders in Y Ltd by virtue of the amalgamation

The benefits / concessions under I T Act will be available only when all the conditions mentioned in the said Section are satisfied

Amalgamation – Definition (contd.)

In South African Supply and Cold Storage Co., In re [1904] 2 Ch. D 268, the court held that neither "reconstruction" nor "amalgamation" has any definite legal meaning. Each word is a commercial and not a legal term

Amalgamated Co- Capital Capital GainsGains

Amalgamated company is a foreign company relief under S. 47(via); only if


Amalgamating Co. Amalgamated Co.

Amalgamated company is an Indian company relief under S. 47(vi)

Capital gains exempt in the country of amalgamating company

Amalgamating Co.

Industrial Undertaking, ship, hotel or specified bank

Engaged in the business for (yrs)

Amalgamated Co.

Book value of assets > 75% of the book value (yrs)

NA

3 5

2 5@

Revival of amalgamating co. NA

@ Other conditions as per Rule 9CThe limit of 8 years to be reckoned from the year in which amalgamation

takes place

Conditions

Unabsorbed business loss and depreciation is available (Section 72A)

Amalgamated Co.- Section 72A

Amalgamated Co. - Section 72A (contd.)

A Ltd. having losses from 1998-99. The losses can be carried forward for set off till 2006-2007 i.e. for a period of 8 years

A Ltd gets amalgamated with B Ltd from 2003-2004-The losses can be carried forward till 2011-12

Prescribed conditions under Rule 9C

Achieving 50 per cent. of the installed capacity within 4 years

Maintain 50 per cent. of production within 5th year

Accountant’s certificate

Amalgamated Co.-Section 72A (contd.)


Section 72A applies to

(a) a company owning an industrial undertaking or a ship or a hotel with another company; or

(b) a banking company with a specified bank; or (c) one or more public sector company or companies

engaged in the business of operation of aircraft with one or more public sector company or companies engaged in similar business

brought forward business losses can be adjusted against the book profit of the amalgamated company u/s 115JB(2).


where any of the conditions laid down in sub sec (2) of sec 72A are not complied with, the set off of loss or allowance of depreciation made in any previous year in the hands of the amalgamated company shall be deemed to be the income of the amalgamated company chargeable to tax for the year in which such conditions are not complied with.

Amalgamated Co. - Section 72A / Section 79

Section 72A is not available to a company other than a company owning an industrial undertaking

In the case of amalgamation of any other company, if a private limited company, provisions of Section 79 would apply

Change in shareholding could disentitle unabsorbed losses being carried forward

Reverse merger could be possible in such cases

Amalgamated Co.- Section 79

Section 79-- where a change in shareholding has taken place in a previous year—Carry forward and set-off of losses may be lost

Section applies to companies in which public are not substantially interested

Provisions apply only to business loss and not to unabsorbed depreciation or unabsorbed development rebate [CIT v Shri

Subhulaxmi Mills Ltd. 249 ITR 795 (SC)] Deduction under section 10A/10B and 80 IA / 80 IB may be

available.

Amalgamated Co.-Section 79 (contd.)

Reverse Merger

Preservation of losses (profit making company merges into the loss making company)

Amalgamated Co.- Section 79 (Reverse Merger)

Example Proposal for Merger of B Ltd with A Ltd in 2009-10

Section 72 A not available

Section 79 applicable – losses of B Ltd not available to A Ltd

Effective date of merger from 1st April 2008– with Retrospective effect

Losses of B Ltd on consolidated return will therefore be set off in profits of A Ltd.

Amalgamated Co.-Effective date

Scheme approved by court without any change of transfer date

Effective date of amalgamation is date when scheme arrived at

Date of notification of scheme in Official Gazette is not effective date

Operations and resultant loss of transferor to be treated as of transferee after effective date

Amalgamated Co. Effective date (contd.) Marshall Sons & Co. (India) Ltd. v. ITO 223 ITR 809 (SC) Date of amalgamation of a company is the date with effect

from which, it is provided in the scheme of amalgamation, that the amalgamation shall take place, if the same is not altered by the Court sanctioning amalgamation

amalgamation shall be deemed to have taken place as and from that date even though the amalgamation was sanctioned by Court later and the amalgamating company was struck off the register of companies on a later date

In such a case, assessment is to be made and can always be made on the transferee company on the income of both the transferee and transferor companies

Amalgamated Co. Effective date (contd.) Orissa Mining Corporation Ltd. v. CIT 293 ITR 502

there is always a time gap between the amalgamation scheme and the period when the same is sanctioned by the court.

But after the said sanction, the effective date of amalgamation is the date when the scheme is arrived at and when the date is fixed under the scheme, unless the court specifies another date.

Amalgamated Co. Effective date (contd.) Where Scheme is effective from retrospective date

Beck India Ltd. v. Dy CIT 319 ITR (A.T.) 253 Scheme of amalgamation approved by High Court

subsequent to date of filing of return, Scheme sanctioning amalgamation with retrospective effect, Amalgamated company eligible for set off based on revised accounts

Returns filed on the basis of accounts finalized previously

Requirement to file revised returns on basis of Order of High Court after receipt of the Order.

Amalgamated Co. Effective date (contd.)

Issue-If one year from the end of the assessment year has lapsed, will revised return be treated as valid ?

Pentamedia Graphics Ltd. v. ITO 236 CTR (Mad) 204 : Once the scheme is sanctioned with effect from particular date, it is binding on statutory authorities.

Revenue to act as per the scheme sanctioned with the effective date and return filed reflecting the same cannot be ignored on the strength of s. 139(5).

Principle laid down in Marshall Sons & Co. (India) Ltd. v. ITO to be noted. Apex Court held that once scheme is sanctioned with effect from a particular date, it is binding on everyone including statutory authorities.

Amalgamated Co. Effective date (contd.) CIT v. J. K. Corporation Ltd. 331 ITR 303

Effect of Special Provisions Act--Special Provisions Act has overriding effect over Income-tax Act

BIFR can specify date from which its scheme becomes effective

BIFR sanctioning retrospective operation of scheme of amalgamation, assessee entitled to benefit of carry forward and set off of losses of amalgamating company.

Revised return of loss to be treated to have been validly filed entitling benefit of carry forward and set off of loss

The date of effect of the scheme is the date as mentioned therein.

IT authority has no competence to read scheme differently as far as date of effect is concerned

Depreciation (Section 32)

Amalgamated Co. Allowable Deductions

In the year of amalgamation Depreciation = Total dep. for the previous year X No. of days assets used (5th Proviso to S. 32(1)) Total no. of days

Actual cost = Income-tax W.D.V of the amalgamating co. (Explanation 7 to S. 43(1)) Unabsorbed depreciation of amalgamating company is not be deducted from written down value of assets taken over of amalgamated company

Amalgamated Co. Allowable Deductions (contd.)

Block of assets = W.D.V. of the block of assets of the amalgamating co. for the immediately preceding previous yr less dep. actually allowed in relation to the said preceding previous year (Expl. 2 to S. 43(6))

CIT v. Silical Metallurgic Ltd. 324 ITR 29 Unabsorbed depreciation of amalgamating company cannot be deducted while taking written down value of assets taken over of amalgamated company


Deduction under section 10A/ 10B (sub-section 7A), & section 10AA

Depreciation on intangible assets being self developed assets

Scientific research (S. 35) Licenses to operate telecommunication services (S.

35ABB) Amortization of preliminary expenses (S. 35D) Expenses for the purpose of amalgamation (S. 35DD) Amortisation of expenses under VRS (S. 35DDA)


Income taxable --Remission of loss, expenditure or trading liabilities - (S. 41(1))

Deduction for infrastructure development (S. 80-IA) This deduction is not available to any enterprise or undertaking which is transferred in a scheme of amalgamation on or after the 1st day of April, 2007

Reason- no justification for passing the benefit to someone who had not taken the entrepreneur risks and had acquired the eligible undertaking later when the risks had reduced

Deduction for purposes other than infrastructure development (S. 80-IB)


Deductions Not specifically provided in the Act Bad debts (S. 36(1)(vii)) Payments disallowable under section 40(a) Statutory payments (S. 43B) Gratuity—amalgamation agreement stipulating that

amalgamated company would take over employees of amalgamating company—Gratuity paid to employees taken over deductible

Credit for taxes paid [Advance tax, TDS, DIT Reliefs ]

Carry forward of MAT credit (S. 115JAA) Could this be a proportion of the total credit


Section 115-O Amalgamation sanctioned by the Hon’ble High Court. As on the

date of sanction dividend had been paid by the Assessee to amalgamating company

The incidence of tax u/s.115-O is on distribution of dividend. Any subsequent act by which dividend itself does not become taxable in the hands of the recipient of the dividend will not be relevant. The payment of dividend distribution tax is not dependent on the ultimate chargeability to tax in the hands of the recipient of the dividend-The TATA Power Co Ltd v. Addl CIT 2011-TIOL-594-ITAT- MUM

Shareholders of Shareholders of Amalgamating Co.Amalgamating Co.

Relief from capital gains tax on transfer of shares in an Indian company, in a scheme of amalgamation -- Section 47(vii)

Cost of acquisition = cost of acquisition of shares in amalgamating co. Entitled to substitute market value of shares of amalgamating company as on 1-4-1981, as cost of shares under section 55(2)(i)

Value of bonus shares not to be separately ascertainedPeriod of holding = period of holding of shares in amalgamating co. to be counted (S. 2(42A)(c))

Shareholders of Shareholders of Amalgamating Co. Amalgamating Co. (contd.) Under the existing provisions contained in sub-clause (a) of clause (vii) of the aforesaid section 47, in case of a merger, any transfer of capital asset being shares, held by a shareholder in

the amalgamating company, shall not be regarded as transfer, if- (a) such transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company, and

(b) the amalgamated company is an Indian Company. amendment w.e.f. 1-4-2013 to the aforesaid sub-clause so as to

provide that to the extent where the amalgamated company itself is the shareholder in the amalgamating company, it shall not be necessary for it to issue share or shares.

Shareholders of Shareholders of Amalgamating Co. Amalgamating Co. (contd.) If under the scheme of amalgamation, besides the

shares in the amalgamated company the shareholders of amalgamating company are allotted something more, say bonds or debentures in consideration of transfer of shares in amalgamating company, they cannot claim exemption under s. 47(vii). CIT v. Gautam Sarabhai Trust

Demerger - Definition

Dermerged Co. (Undertaking(s))

All Property

All Liabilities

Resulting Co.

Property (at book value)

Liabilities (at book value)

Shareholders Proportionate shares

Shareholders

75% Shareholders

The transfer should be pursuant to s. 391 to 394 of the Companies Act and on a going concern basis and as per the conditions to be notified by the CG

S.2(19AA)

Dermerger – Capital GainsDermerger – Capital Gains

Resulting co. is a foreign co. relief under S. 47(vic); only if


Demerged Co. Resulting Co.

Resulting co. is an Indian co. relief under S. 47(vib)

Capital gains exempt in the country of demerging company

Dermerger – Capital Gains Dermerger – Capital Gains (contd.) section 2 (19AA) amended w.e.f.1-4-2013

to exclude the requirement of issue

of shares to the shareholders of the demerged company where resulting company itself in a scheme of demerger is a shareholder of the demerged company.

Vodafone Essar Gujarat Ltd., 342 ITR135

Where the Scheme providing for transfer of assets to transferee company is without consideration—Held Not a demerger but a gift

Resulting Co.

Loss/ Depreciation – Section 72A (4)

Directly relatable Not directly relatable

Total Loss X Assets Transferred

Total assets before demerger

Depreciation (S. 32)

Resulting Co. Allowable Deductions (contd.)

In the year of demerger

Depreciation = Total dep. for the previous year X No. of days assets used(5th Proviso to S. 32(1)) Total no. of days

Actual cost = W.D.V. to the demerged co. (Expl. 7A to S. 43(1))

Block of assets = W.D.V. of the transferred assets as appearing in the books of account of the demerged company immediately before the demerger (Expl. 2B to S. 43(6))


Scientific research (S. 35)

Licenses to operate telecommunication services (S. 35ABB)

Amortisation of preliminary expenses (S. 35D)Expenses for the purpose of demerger (S. 35DD)Amortisation of expenses under VRS (S. 35DDA)

Deduction under section 10A/ 10B (sub-section 7A)


Income taxable-Remission of loss, expenditure or trading liabilities- (S. 41(1))

Deduction for infrastructure development (S. 80-IA) This deduction is not available to any enterprise or undertaking which

is transferred in a scheme of demerger on or after the 1st day of April, 2007

Reason- no justification for passing on the benefit to someone who had not taken the entrepreneur risks and had acquired the eligible undertaking later when the risks had reduced

Deduction for purposes other than infrastructure development (S. 80-IB)


Deductions Not specifically provided in the Act Bad debts (S. 36(1)(vii))

disallowance of payments under section 40(a) Statutory payments (S. 43B) Carry forward of MAT credit (S. 115JAA) Could

this be a proportion of the total credit

Resulting Co.- ShareholdersShareholders

Relief from capital gains tax on transfer of shares if consideration is shares in the resulting co.

Period of holding = Period of holding of shares in demerged co. to

be counted for shares of resulting co.(S. 2(42A)(g))

Cost of shares = Cost of shares X Net book value of assets transferred

(of the resulting co.) Net worth of demerged co. before demerger

Cost of shares of demerged co. = Original cost less Cost attributable to

shares of resulting co.

No deemed dividend (S. 2(22)(v)

Sale of Undertaking

Slump sale Itemised sale

Slump sale – Relevant provisions

Section 2(42C)- Definition of ‘Slump sale’

“Slump sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.”

Section 50B--Special provision for computation of capital gains in case of slump sale

Section 50B was inserted in the Act vide the Finance Act, 1999 w.e.f 1st April 2000, in view of the decisions that ‘slump sales’ were not taxable under the capital gain provisions because it was not possible to compute cost of acquisition.

Slump sale – Relevant provisions (contd.) the net worth of an undertaking is equal to the aggregate value of

total assets of the undertaking as reduced by the value of liabilities.

The aggregate value of the assets and the value of liabilities as per Expl. 2 is the w.d.v of the depreciable assets, book value of other assets and the book value of all the liabilities.

'aggregate value of total assets' shall require not only the inclusion of recorded but also unrecorded assets such as Goodwill and brand value, to which no specific cost can be attributed.

the value of assets is therefore the depreciated/book value of all the assets recorded in books of account and Nil in case of intangible/other unrecorded assets.

Similarly the value of liabilities shall be that recorded as per books of account plus the value of contingent liability, if any.

Slump sale-Relevant provisions (contd.)

Section 50B(1) – Long term or Short term Section 50B(2) – Cost of acquisition – net worth

Net worth = Aggregate value of total assets less

Aggregate value of liabilities Depreciable assets – Income-tax WDV

in the case of capital assets-Nil where the whole of the expenditure has been allowed or is allowable as a deduction under section 35AD, and

in the case of other assets, the book value of such assets. Revaluation of assets to be ignored

No Indexation benefit for long term assets

Slump sale-Relevant provisions (contd.)

Section 43(6)(c)(i)(C) – I.T. WDV to be reduced by seller from the block

Section 43(1) – Actual cost for buyer – allocation to various assets

No carry forward and set off of losses Sale as a going concern for a lump sum price -

immovable property transferred – because certain value was shown for assets for

paying stamp duty it does not bring it under purview of Sec 55

Section 50C –Not applicable

Itemised sale – Relevant provision

Assets on which depreciation not available - normal provisions of Act will apply

Assets on which depreciation is available – Section 50 – short term capital gain / loss

Section 43(6) – sale consideration to be reduced from block

Procedure for Amalgamation

Check Memorandum & Articles of Association and make suitable changes

Draft Scheme of Arrangement ( Amalgamation / Merger)

Consider it in the Board Meeting Apply to Court direction to call General Meeting Send to Central Government copy of application

made to High Court

Procedure for Amalgamation (contd.)

Send notices of General meeting with Scheme to shareholders

Notice period shall not be less than 21 days Notice can be by way of advertisement also At General Meeting approve scheme, increase

authorized share capital and to issue further shares as required

Forward at once notice and proceedings of meetings to Stock Exchanges

Procedure for Amalgamation (contd.) Report the result of meeting to Court Move Court for approval of the Scheme by

filing petition in 7 days in form 40 Advertise the date of hearing fixed by the Court On receipt of order from High Court file it with ROC Proceed on effecting the Scheme of

Amalgamation / Merger as approved by the High Court

Documents

Tax implications of Amalgamations / Mergers / Demergers / Slump sales