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Transcript of Course content-Merger and Acquisitions-By Augustin
1
Course content-Mergers and Acquisitions
Topics
Session
(2 hours)
Text Book
Meaning of merger, acquisition, take over,
restructuring- -why merger- different types
of merger. Case Study-1. Restructuring
strategy pays dividends. Case Study:-2
HP and Compaq merger, Case Study-3
TATA Chemicals and Hindustan Lever
Chemicals.
1 Management Accounting
and Financial Analysis
by M. Y. Khan and P. K.
Jain
Cost of capital- Under standing of Annuity
Tables. Future value-present value, Future
value of Annuity, Present value of Annuity
– weighted cost of Capital.- (Reference:-to
2 Financial management
by Dr. Prasanna Chandra
under the heading Time
value of Money)
Business Valuation:- Conceptual
Framework of valuation-Book value, Market
value, Intrinsic value
3 M.Y Khan Cost and
Management accounting
, Liquidation value, Replacement value,
Salvage value- Valuation of goodwill and
intangible assets, Fair value-Terms EPS, P/E
Ratio, Diluted EPS.-Exchange Ratio using
EPS and P/E Ratio.Case study-2.(
Reference:-)
4 Management Accounting
and Financial Analysis
by M. Y. Khan and P. K.
Jain. And Management
Accounting and financial
Analysis by V. Pattabhi
Ram and S.D. Bala
Approaches/Methods of Valuation- Asset
based approach to valuation, Earning based
approach:- Capitalisation Method, Price
Earning Ratio Method, DCF approach,
Market value approach and the Fair value
method to valuation- Other methods:-
Market value added approach, Economic
value added approach-Case Study-3
5 :-Management
Accounting and
Financial Analysis by M.
Y. Khan and P. K. Jain.)
Capital Budgeting:- Relevant cost and
relevant benefits-Opportunity cost future
cost, Sunk cost, Cash inflows and outflows-
Methods:-NPV, IRR- Effect of inflation on
Capital investment appraisal.Case Study-4.
6 Reference:-Cost and
management
Accounting by Colin
Drury
2
:Business Restructuring:- Amalgamation,
Demerger-Conversion of Sole proprietary
business into a company-conversion of firm
into Company-Transfer of assets between
Holding and Subsidiary company
7 . Reference:-Direct
Taxes by Dr. Singahnia
Direct Tax Implications:-Transferor
company-conditions to be fulfilled- Capital
gain tax:- short term and Long term Capital
gains, Past Losses adjustments, Depreciable
Assets and tax implications, setoff and carry
forward of losses, Unabsorbed Depreciation-
Case study-5
Transferee Company Point of view:-
Conditions to be fulfilled, Tax impacts:-
Expenditure on Scientific Research
Expenditure, Expenditure on Acquisition of
Patent Rights or copy rights, Expenditure on
Know how, Expenditure for obtaining
Licence to operate Telecommunication
services, Preliminary expenses, Expenditure
on Family Planning and Bad debts. Gift tax,
Expenditure related to Merger or Demerger-
Case Study-6.
8 and 9 Reference:-Direct Taxes
by Dr. Singahnia
3
: Sales Tax Impact on Merger and
Acquisition.
:Financial implications with respect to
Merger and Acquisition and Tax Planning.-
Case Study-7
Test
10
11
Reference:-Direct Taxes
by Dr. Singahnia
By Prof. Augustin Amaladas M. Com.,
AICWA.,PGDFM., DIM., B.Ed.
22 years of teaching and Industrial contacts
as a placement officer from St. Joseph‟s
College of Commerce, Bangalore.
Course
duration-
20 session
of 2 hours
each.
4
Why Does The Hutch and
Vodafone merger have problems -
with respect to tax?
Vodafone(Briton)
A Foreign company
HTIL(Whampoa group
of Li-Ka Shing.
Hong Kong
A foreign company
Hutchison Essor
Indian
Company
67%
Takes over
Asim Ghosh-12%
A.Singh and other companies
(Minority)
Essor group
Case Study-1
Tata pleases, Ford 'disappoints' British workers' union
London, March 26 (IANS) The head of Britain's largest workers union
Wednesday reiterated his support for Tata's acquisition of the luxury car
brands Jaguar and Land Rover, but said he was disappointed by seller Ford's
failure to retain a stake.
'If Jaguar and Land Rover had to be sold, then Tata was the best option,' said
Tony Woodley, joint general secretary of Unite, as Ford announced the sale
of the two British iconic cars to Tata Motors Ltd.
The deal, announced Wednesday, already has the union's seal of approval,
after it secured Tata's assurance that it will not shed jobs at the three Jaguar
and Land Rover factories at Solihull, Castle Bromwich and Halewood and
would continue to source Ford-made engine and components from its
factories in Bridgend and Dagenham.
'We would have much preferred Ford to keep the companies in the family,
so to speak, especially with Land Rover being so profitable,' Woodley said.
5
'But with the commitments Tata have given to the future of Jaguar-Land
Rover and the long-term supply agreements for components, especially
engines from Bridgend and Dagenham, we're obviously pleased they are in
the game.'
However, Woodley added that there was disappointment that Ford had
decided against taking a stake in the new future.
'That is a big disappointment,' he said.
According to sources in Unite, union officials would have liked to see Ford
take a minority stake, as it did while selling off the luxury car Aston Martin
to two Kuwaiti investment companies last year. Ford retained a $77 million
stake in Aston Martin.
This, the union officials feel, would have helped to 'lock in' long-term
commitments made as part of the agreement signed Wednesday between
Tata and Ford.
The nervousness may be explained by the fact up to 40,000 jobs were at
stake at a time of a global economic slowdown.
'On the positive side, Tata has not only given us a long-term commitment,
but they are an industrial company as well,' Unite's Andrew Dodgson told
IANS.
'Tata recognise the iconic brand value of Jaguar-Land Rover - that they are
British-engineered and British-made cars and so it is important to keep them
in Britain,' he added.
Ford acquired Jaguar for $2.5 bn in 1989 and Land Rover for $2.75 bn in
2000 but put them on the market last year after posting losses of $12.6 bn in
2006 - the heaviest in its 103-year history.
Tata was named by Ford as the preferred bidders in January as it beat off
competition from fellow-Indian carmaker Mahindra and Mahindra and
American buy-up specialist One Equity.
While the three Jaguar and Land Rover factories in Britain employ some
16,000 people, the number swells to between 30,000 and 40,000 when
ancillaries are taken into account, according to Dodgson.
Case Study-2
May 2007, India's Ministry of Civil Aviation announced that Air India
Limited (AI), India's national flag carrier and Indian Airlines Limited (IA),
the government owned domestic airline, would merge with effect from July
15, 2007. The new airline formed by the merger was to be called 'Air India,'
and would operate in both the domestic and international sectors. The
proposal to merge AI and IA had been first mooted in the 1990s. In February
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1999, a Parliamentary Standing Committee on Transport and Tourism had
recommended the merger of AI and IA in its report on the 'Functioning of
Air India'.
However, the process had formally been initiated only in September 2006,
when the Indian government assigned the duty of preparing the roadmap for
the merger to Accenture Inc., a management consulting, technology services
and outsourcing company. After being endorsed at various levels of the
administrative hierarchy, the plan for the merger was finally approved by the
Union Cabinet in March 2007.
A new company called the National Aviation Company of India Ltd.
(NACIL) was incorporated on March 30, 2007 under Sections 391 and 394
of the Indian Companies Act, 1956 to facilitate the merger. Under the terms
of the merger, all the undertakings, properties, and liabilities of AI and IA
were to be transferred to NACIL.
The AI-IA merger was expected to create one of the biggest airlines in the
world in terms of the fleet size. As of May 2007, the two airlines had a
combined fleet of 122 aircraft and 34,000 employees including 1,315 pilots.
The combined fleet size placed the merged entity among the top 10 airlines
in Asia, and the top 30 in the world. It would also be India's first airline with
more than 100 aircraft.
The motives for the merger were widely discussed in the media. India was
the fastest growing aviation market in the world, ahead of China, Indonesia
and Thailand, as of early 2007. The number of people traveling by air had
been increasing rapidly in the country. The main reason for this was thought
to be the advent of low cost airlines like Air Deccan and SpiceJet in the
country in 2003-2004, which brought air travel within reach of India's large
middle class. The entry of a number of new airlines had intensified the
competition in the aviation sector by 2004.
Mumbai: Merger of national carriers Air India and Indian Airlines has been
challenged in the Bombay High Court on the ground that it defies
Parliament‟s intent to keep international and domestic carriers separate.
The petition filed by Air India Cabin Crew Association (AICCA) also
questions the Constitutional validity of section 620 of Companies Act,
which empowers government to exempt any government company from
provisions of the Act.
7
Air India Limited and Indian Airlines Limited were created by a
Parliamentary statute, and, therefore, without the Parliament‟s nod they
cannot be amalgamated, the petition contended.
AICCA claims to the “sole recognised trade union” in Air India Limited, and
has 1,800 members. The petition is expected to come up for hearing in the
first week of December.
The merger (amalgamation) of AI and IA was sanctioned by the Ministry of
Corporate Affairs on 22 August this year. The move was aimed at bringing
about more efficiency and better utilisation of resources. A new company
called National Aviation Company of India was created to replace them.
However, AICCA contends that in sanctioning the amalgamation,
Parliament was bypassed.
Tracing the history of the national carriers, it points out that in 1953, eight
private airlines were nationalised under Air Corporations Act, which created
AI and IA. Further, in 1994, Air Corporations (Transfer of Undertakings and
Repeal Act) Act was passed, which converted AI and IA into Air India
Limited and Indian Airlines Limited, respectively.
Case Study-3
Second largest Bank in India is now formally in place . RBI has given
approval for the reverse merger of ICICI Ltd with its banking arm ICICI
Bank. ICICI Bank with Rs 1 lakh crore asset base bank is second only to
State Bank of India, which is well over Rs 3 lakh crore in size. RBI also
cleared the merger of two ICICI subsidiaries, ICICI Personal Financial
Services and ICICI Capital Services with ICICI Bank.
The merger is effective from the appointed dated of March 30, 02, and the
swap ratio has been fixed at two ICICI shares for one ICICI Bank share.
Reserve Bank, approval is subject to the following conditions:
(i) Compliance with Reserve Requirements
The ICICI Bank Ltd. would comply with the Cash Reserve Requirements
(under Section 42 of the Reserve Bank of India Act, 1934) and Statutory
Liquidity Reserve Requirements (under Section 24 of the Banking
Regulation Act, 1949) as applicable to banks on the net demand and time
liabilities of the bank, inclusive of the liabilities pertaining to ICICI Ltd.
from the date of merger. Consequently, ICICI Bank Ltd. would have to
comply with the CRR/SLR computed accordingly and with reference to the
position of Net Demand and Time Liabilities as required under existing
8
instructions.
(ii) Other Prudential Norms
ICICI Bank Ltd. will continue to comply with all prudential requirements,
guidelines and other instructions as applicable to banks concerning capital
adequacy, asset classification, income recognition and provisioning, issued
by the Reserve Bank from time to time on the entire portfolio of assets and
liabilities of the bank after the merger.
(iii) Conditions relating to Swap Ratio
As the proposed merger is between a banking company and a financial
institution, all matters connected with shareholding including the swap ratio,
will be governed by the provisions of Companies Act, 1956, as provided. In
case of any disputes, the legal provisions in the Companies Act and the
decision of the Courts would apply.
(iv) Appointment of Directors
The bank should ensure compliance with Section 20 of the Banking
Regulation Act, 1949, concerning granting of loans to the companies in
which directors of such companies are also directors. In respect of loans
granted by ICICI Ltd. to companies having common directors, while it will
not be legally necessary for ICICI Bank Ltd. to recall the loans already
granted to such companies after the merger, it will not be open to the bank to
grant any fresh loans and advances to such companies after merger. The
prohibition will include any renewal or enhancement of existing loan
facilities. The restriction contained in Section 20 of the Act ibid, does not
make any distinction between professional directors and other directors and
would apply to all directors.
(v) Priority Sector Lending
Considering that the advances of ICICI Ltd. were not subject to the
requirement applicable to banks in respect of priority sector lending, the
bank would, after merger, maintain an additional 10 per cent over and above
the requirement of 40 per cent, i.e., a total of 50 per cent of the net bank
credit on the residual portion of the bank's advances. This additional 10 per
cent by way of priority sector advances will apply until such time as the
9
aggregate priority sector advances reaches a level of 40 per cent of the total
net bank credit of the bank. The Reserve Bank‟s existing instructions on sub-
targets under priority sector lending and eligibility of certain types of
investments/funds for reckoning as priority sector advances would apply to
the bank.
(vi) Equity Exposure Ceiling of 5%
The investments of ICICI Ltd. acquired by way of project finance as on the
date of merger would be kept outside the exposure ceiling of 5 per cent of
advances towards exposure to equity and equity linked instruments for a
period of five years since these investments need to be continued to avoid
any adverse effect on the viability or expansion of the project. The bank
should, however, mark to market the above instruments and provide for any
loss in their value in the manner prescribed for the investments of the bank.
Any incremental accretion to the above project-finance category of equity
investment will be reckoned within the 5 per cent ceiling for equity exposure
for the bank.
(vii) Investments in Other Companies
The bank should ensure that its investments in any of the companies in
which ICICI Ltd. had investments prior to the merger are in compliance with
Section 19 (2) of Banking Regulation Act, 1949, prohibiting holding of
equity in excess of 30 per cent of the paid-up share capital of the company
concerned or 30 per cent of its own paid-up share capital and reserves,
whichever is less.
(viii) Subsidiaries
(a) While taking over the subsidiaries of ICICI Ltd. after merger, the bank
should ensure that the activities of the subsidiaries comply with the
requirements of permissible activities to be undertaken by a bank under
Section 6 of the Banking Regulation Act, 1949 and Section 19 (1) of the Act
ibid.
(b) The take over of certain subsidiaries presently owned by ICICI Ltd. by
ICICI Bank Ltd. will be subject to approval, if necessary, by other regulatory
agencies, viz., IRDA, SEBI, NHB, etc.
10
(ix) Preference Share Capital
Section 12 of the Banking Regulation Act, 1949 requires that capital of a
banking company shall consist of ordinary shares only (except preference
share issued before 1944). The inclusion of preference share capital of Rs.
350 crore (350 shares of Rs.1 crore each issued by ICICI Ltd. prior to
merger), in the capital structure of the bank after merger is, therefore, subject
to the exemption from the application of the above provision of Banking
Regulation Act, 1949, granted by the Central Government in terms of
Section 53 of the Act ibid for a period of five years.
x) Valuation and Certification of the Assets of ICICI Ltd
ICICI Bank Ltd. should ensure that fair valuation of the assets of the ICICI
Ltd. is carried out by the statutory auditors to its satisfaction and that
required provisioning requirements are duly carried out in the books of
ICICI Ltd. before the accounts are merged. Certificates from statutory
auditors should be obtained in this regard and kept on record.
National Aviation Company of India Ltd, the new entity formed after the
merger of Indian and Air India, today moved the Supreme Court seeking
consolidation of the cases challenging the merger of the two state carriers.
Case Study-4
Merger of Lord Krishna Bank with Centurion Bank legal'
K. C. Gopakumar
Counter affidavit filed against challenging the merger
All shareholders who wanted to exercise their vote were able to vote
without obstruction at the AGM'
Sec. 237 of Companies Act applicable only to companies other than
banking companies'
Kochi: There is absolutely no basis or ground to appoint any inspector to
investigate the affairs relating to the scheme of amalgamation of Lord
Krishna Bank with the Centurion Bank of Punjab, according to
B.Swaminathan, managing director and chief executive officer of the bank.
11
In a counter-affidavit filed in the High Court, he said section 237 of the
Companies Act was applicable only to companies other than banking
companies. Banking companies were controlled, supervised and inspected
by experts of the Reserve Bank of India (RBI), which could not be done by
inspectors to be appointed by the Central Government under section 237 of
the Companies Act.
The affidavit was filed in response to a writ petition filed before the Kerala
High Court by Umesh Kumar Pai, a minority shareholder, challenging the
merger and seeking to appoint inspectors to investigate the amalgamation
scheme.
The affidavit said no provision of the Companies Act could be invoked to
challenge the amalgamation proceedings initiated under section 44A of the
Banking Regulation Act. In fact, section 44A had overriding effect over
section 237 or any other provisions of the Companies Act.
The affidavit further said resolutions were moved one by one and
arrangements were made for members/proxies to exercise their votes. The
allegations that there was obstruction at the venue of the AGM were
baseless.
All the shareholders or proxies who wanted to exercise their votes were able
to vote without any obstruction. The allegation that there was no discussion
was false. The chairman of the meeting had invited shareholders for
discussion.
A resolution for the approval of the scheme of amalgamation was passed
with the requisite majority in accordance with the provisions of section 44A
of the Banking Regulation Act.
While 5,63,65,282 votes of the same value were cast for the resolution only
6,046 votes of the same value were cast against the resolution. Of the 1,784
members present in person or by proxy at the meeting, 1,740 shareholders
voted in favour of the resolution while only 24 voted against the resolution
and 20 votes were invalid.
Thus, the resolution approving the scheme of amalgamation was passed by a
majority in number representing two thirds in value of the shareholders
present either in person or by proxy at the meeting as required under section
44A(1) of the Banking Regulation Act, the affidavit added.
The allegation that 65 per cent of the shares were held by a single entity was
totally false. No person holding share in excess of ten per cent of the bank
exercised voting rights in excess of 10 per cent.
With the permission of the RBI, a person could hold more than 10 per cent
of the share of a banking company but the right to exercise vote was
restricted to 10 per cent of the total voting rights.
12
Case Study-5
In a dramatic climax to a bitter takeover battle that laid bare the large role still played by
economic nationalism in Europe, France's largest drug maker, Aventis SA, Sunday
agreed to be swallowed by its smaller rival, Sanofi-Synthelabo SA, for about €55.2
billion, or $65 billion in cash and stock.
Resorting to behind-the-scenes arm-twisting of Sanofi, along with public and private
warnings to back off directed at rival suitor Novartis AG of Switzerland, the French
government succeeded last night in producing what it had long desired: a French national
champion in a strategically important industry, the fast-growing and highly competitive
drug business.
With Aventis succumbing to Sanofi's
sweetened offer, the combination of the two
will form the world's third-largest
pharmaceuticals company, behind Pfizer Inc.
and GlaxoSmithKline PLC, with a market
capitalization of around €90 billion and a
stable of leading drugs such as Sanofi's stroke-
prevention treatment Plavix, sleeping pill
Ambien and cancer therapy Eloxatin. The new
company would also boast Aventis's allergy
pill Allegra, anti-blood-clotting drug Lovenox
and cancer medicine Taxotaere.
Important as its impact will be on the global
pharmaceutical industry, the Aventis drama
will be equally remembered for its political
implications, particularly in the new Europe.
From the start, the battle for Aventis was as
much about France's desire to create a home-
grown national champion in the
pharmaceutical industry as it was about
shareholder value and business sense. The
French government pushed to make Sanofi and
Aventis come together, as it did four years ago
when it backed the all-French mergers that
created Total SA, the world's fourth-largest oil
company, and BNP Paribas SA, the biggest bank among the countries that have adopted
the euro.
Before Sanofi even unveiled its original bid in late January, the French finance minister
called it "positive" because it would enable France to create a "national champion" -- a
NATIONAL CHAMPIONS
Aventis CEO: Igor Landau Headquarters: Strasbourg, France 2003 income: $2.91 billion*
Leading drugs: Allergy pill Allegra, anti-blood-clotting drug Lovenox and cancer medicine Taxotere
Sanofi-Synthelabo CEO: Jean-Francois Dehecq Headquarters: Paris 2003 income: $2.48 billion *Leading drugs: Antistroke medicine Plavix, sleeping pill Ambien and cancer therapy Eloxatin *Figures converted from euros to dollars at current rate. Source: the companies
13
huge company in what the country deems a strategic industry able to compete world-wide
with U.S. giants.
When it became clear that Aventis would fight Sanofi's hostile bid and seek a white-
knight offer from Novartis, French officials placed phone calls to executives at the Swiss
company on at least three occasions warning that Novartis should stay away.
France's intervention in the takeover battle, which runs counter to the free-market
principles espoused by the European Union, comes as the four-decade-old EU is
expanding to include 10 new members, ranging from Malta to Poland. Together with
Germany, France has been the EU's founding father and its biggest advocate. Yet, in
recent years, it has broken the union's economic rules more than once, giving state aid to
ailing French companies, letting its budget deficit grow and thus contravening a pact that
underpins the euro, and getting involved in takeover battles.
Afraid that Aventis, based in Strasbourg, France, would fall into Swiss hands, the French
government had leaned on Sanofi Chief Executive Jean-Francois Dehecq in recent days
to raise Sanofi's bid to improve the chances of an all-French deal.
The higher bid was accepted after Aventis's Chief Executive Igor Landau and Sanofi's
Mr. Dehecq met Friday under pressure from French Finance Minister Nicolas Sarkozy,
according to people familiar with the matter. It was the first time the two men, who have
been waging a war of words for three months, met face to face since Sanofi unleashed its
hostile takeover.
Mr. Landau will resign his executive duties at the company with a golden parachute
valued at €24 million, but may retain a seat on the merged company's board, according to
a person familiar with the arrangement. Mr. Dehecq will become head of the new
company.
The sudden finish to the Aventis takeover battle came after a surprise no-show by Swiss
drug-maker Novartis. Novartis failed to put in a bid for Aventis just a few days after
announcing that it was prepared to enter merger negotiations with France's biggest drug
maker. An Aventis team had been negotiating with Novartis late into Saturday night and
had produced agreements on everything from conditions for the offer and businesses to
be divested, say people familiar with the situation. However, Novartis still had not
broached a possible price at which it would be willing to acquire Aventis, making some
on the Aventis team suspicious that the Swiss company would turn up with a bid.
Novartis said last night it decided to break off merger talks with Aventis and not to
submit a bid because of the "strong intervention of the French government."
While French authorities last night were congratulating Sanofi and Aventis on their
planned marriage, some investors have long thought that France's approach could hurt it
in the long term. France argued that Aventis's vaccines were crucial to its defense against
14
potential bioterrorism -- an argument that the European Commission has said would be
hard to prove and that investors have dismissed as an excuse to mask protectionism.
"I think ultimately the victim is the French economy," says Steven Cohen, chief
investment officer at Kellner DiLeo Cohen & Co., a $500 million New York-based hedge
fund that owns Aventis shares. "There is no better way to discourage investment in your
economy" than to deter foreign companies from bidding for French companies.
Even as Aventis's board was meeting yesterday, French ministers were talking up the
merits of a Sanofi-Aventis tie-up. Speaking on Europe-1 radio, Health Minister Philippe
Douste-Blazy said he was hoping for a "positive response" from the Aventis board,
presented with the opportunity of a hook-up with Sanofi that would be a "very good
thing" for French industry. Any other outcome would leave Sanofi vulnerable to a
takeover, the minister warned. "If it doesn't buy another company, a foreign bidder will
come along," he said.
Under the pact, Sanofi will offer 0.8333 Sanofi share and €20 a share in cash, valuing
Aventis at €69 a share in cash and stock, based on Sanofi's average closing stock
price in the month before rumors of the deal leaked earlier this year, say people
familiar with the situation. However, based on Sanofi's closing stock price Friday of
€55.95, the deal values Aventis at €66.6 a share in cash and stock or a total of about
€53.2 billion. Both values are higher than Sanofi's original offer in January that valued
the company at €60.43 a share in cash and stock. The combined company will have a 17-
member board with nine members from the Sanofi side, including Mr. Dehecq, and eight
from the Aventis side.
The decision to accept the Sanofi offer was not unanimous. Kuwait Petroleum Corp.,
which is Aventis's single largest shareholder, was one of the parties that abstained, say
people familiar with the situation.
The takeover battle for Aventis could burnish the reputation of Novartis chief Daniel
Vasella as a tough pharmaceutical deal-maker who is willing to walk away from
transactions when the apparent price becomes too high.
Still, the outcome leaves Novartis with a dilemma. The company has made no secret of
its desire to grow, especially in the U.S. market, a region where an Aventis acquisition
would have helped significantly. But the potential assets it could acquire now are few and
far between. Novartis has been stymied in its efforts to take over Swiss rival Roche
Holding AG and it is sitting on a large hoard of billions of dollars in cash. Analysts say
reinvesting such cash doesn't always yield the kind of return a fast-growing
pharmaceutical company such as Novartis would like, because of declining productivity
in the drug industry.
Novartis may fall back now on licensing drugs from other companies as part of its
strategy to keep growing
15
Case Study-6
: Ranbaxy Laboratories (Ranbaxy) and Orchid Chemicals & Pharmaceuticals (Orchid)
have announced that they have entered into a business alliance agreement involving
multiple geographies and therapies for both finished dosage formulations and active
pharmaceutical ingredients (APIs). Additionally, this agreement would establish a
framework for enhanced future co-operation between the two companies.
The business alliance between the two comes even as the Ranbaxy Group has stretched
its holding in Orchid to 14.7 per cent through market operations, triggering intense
speculation about a possible takeover attempt on Orchid. With the holding of promoters
in Orchid dropping to 16.2 per cent, the Ranbaxy Group‟s share-buying exercise has only
heightened the possibilities for a takeover.
The drop in equity holding was caused by the sale of 5.6 million shares by a couple of
lenders with whom the promoters had pledged seven million free shares. The promoters
had borrowed about Rs. 80 crore from India Bulls Financial Services and Religare
Enterprises to help them raise their stake in the company from 17 per cent to 24 per cent.
They had bought five million shares from the market during March-April 2007 to raise
their stake.
K. Raghavendra Rao, Managing Director, Orchid, said the talks for a business alliance
with Ranbaxy were on much before the developments on the share front. He expected the
business alliance to fetch `significant revenue for Orchid‟. Mr. Rao told The Hindu that
the alliance would not upset the existing applecart (business). The incremental revenue
would be determined by the product and market configuration of any new business
initiative.
To a question, he said Orchid would continue to drive drug development and make
products. The alliance would leverage the marketing strength of Ranbaxy to push sales
numbers for both, he said. On increased co-operation between the two companies, Mr.
Rao said, “what is known is captured. The template is ready. A super structure can be
built easily, as the framework is already there.” Asked if the alliance with Ranbaxy and
the share buying episode would constrain Orchid, Mr. Rao said, “The management
freedom should continue. It should not be dictated by the shareholders.”
Informed institutional sources said that Orchid promoters were indeed trying to secure
their positions. Mr. Rao, however, has preferred to keep his cards close to his chest. With
institutional holders reportedly not enthusiastic about selling their shares in Orchid,
industry observers felt that the Ranbaxy Group would do nothing hastily.
Driven by a robust growth in emerging markets and North America, Ranbaxy
Laboratories on Tuesday reported a profit after tax of Rs. 153 crore for the first quarter
ended March 31, 2008, a 7.21 per cent growth over the corresponding period last year.
16
“Emerging markets continue to be the major contributor to the company‟s growth,
accounting for around 55 per cent of our total sales, followed by developed markets
which account for 40 per cent,” Ranbaxy Managing Director and CEO Malvinder Mohan
Singh told reporters here.
On the company‟s plans for alliances, Mr. Singh said at present it was negotiating with a
firm for a deal similar to what it has with GlaxoSmithKline. “Initially, it will be with
Ranbaxy but once the demerger takes place it will be transferred (to Ranbaxy Life
Science Research),” Mr. Singh said.
Mr. Singh said Ranbaxy was at present involved in about 19 patents litigations with an
innovator value of $27 billion . Out of these, the company had been able to settle four
that had a value of $8-10 billion.
Case Study-8
Battle lines are being drawn in India‟s pharmaceutical sector. A creeping acquisition has
begun in the shares of Chennai-based Orchid Chemicals & Pharmaceuticals which has
become vulnerable to acquisition after its share price fell steeply last month.
A firm called Solrex Pharmaceutical Co, which market sources say belongs to Ranbaxy
Labs or its founders, has now garnered 9.54% stake in the company.
Orchid founder and managing director Kailasam Raghavendra Rao said he was
determined to retain control over the company and would lean on support from
institutional investors. But his options could be limited, since he owns only 17%. “I have
not started this company to sell out,” an emotional Mr Rao told ET. He will be watched
for his moves in the next few days.
When contacted, Ranbaxy managing director and CEO Malvinder Singh said, “I have no
comment to make.” However, Mr Singh had earlier spoken of consolidation being the
„buzzword‟ in the industry and his company had been on the lookout for strategic stakes
in the domestic market.
Orchid shares were beaten down mercilessly on March 17, when promoter holdings of
about 7.5% were sold by stock dealers who had lent Mr Rao and his family money to
buy those shares. A bearish pressure had caused the price to fall below a predetermined
threshold, invoking margin calls that Mr Rao could not meet.
The Orchid founder incurred a personal loss of Rs 75 crore in the selloff and the shares
lost 40%, though they have recovered ground since then. "I do not know the antecedents
of Solrex and the events of the past few days have been too sudden to say anything. But I
can tell you, I am here to stay,” Mr Rao said.
The buzz about Ranbaxy‟s interest and a block deal of nearly one million shares, or 1.5%
stake in the target firm, caused a spike in Orchid shares which gained 15.5% to close at
17
Rs 207.15 on the BSE. Even after this, the company is trading at a low price-earning
multiple of 7.2 compared with the industry average of 17.23.
Incidentally, the name „Solrex‟ bears a close resemblance to Ranbaxy‟s two business
divisions „Solus‟ and „Rexcel‟, which were created in 2002 as part of the company‟s
restructuring programme. With Ranbaxy refusing to clarify, it was unclear whether
Solrex could be a Ranbaxy unit or a firm floated by its promoters.
Analysts said that it made sense for Ranbaxy to have Orchid in its fold. “What Orchid
brings on the table for Ranbaxy is its market standing in Cephalosporin (both sterile and
oral). Orchid has created many assets in this regard over the past couple of years.
Ranbaxy has products in anti-biotics and Orchid would help consolidate its position in
this regard,” said Angel Broking vice-president (research) Sarabjit Kaur Nangra.
Pharma consultant and industry veteran Ajit Dangi said, “Orchid Chemicals has good
API portfolio and manufacturing facilities. It should be complementary for Ranbaxy to
acquire Orchid and enable the Indian pharma MNC to increase its market share.”
However, another industry expert said that the investment could just be an attractive-
buying opportunity rather than a strategic fit for the company.
Orchid reported Rs 866-crore revenues and a net profit of Rs 169 crore for the nine-
month period ended December 2007. It has a return on capital of about 11% and a market
capitalisation of Rs 1,400 crore.
_____________________________________________________________
___________Merger,acquisition And Corporate Restructuring
Structure
Conceptual framework
History of M&A
Financial framework
Corporate restructuring
Accounting for amalgamation
Tax benefits
Exercise
CONCEPTIONAL FRAMEWORK
18
CONCEPTIONAL
FRAMEWORK
MEANING OF
• MERGERS
• ACQUSITIONS
• AMALAMATIONS
• TAKEOVERS
• ABSORPTIONS
TYPES OF MERGERS
HDFC Bank's merger with Centurion Bank of Punjab and Walt Disney
Company's acquisition of 17.2per cent stake in UTV Software
Communication to increase its stake to 32.10 per cent in the company.
19
In February 2008, as many as 38 cross-border deals were announced with
total value of $2.80 billion, of which 27 were outbound deals with a value of
$2.57 billion.
Diologic Report
Meanwhile, global financial information provider Diologic in its latest report
said that India-targeted M&A volumes reached $11.9 billion through 345
deals so far this year. US was the leading acquiring country with deals worth
1.6 billion dollars, followed by the UK with $904 million and Germany with
USD 584 million.
ADVANTAGES
REDUCTION OF COMPETITION
PUTTING AN END TO PRICE CUTTING
ECONOMIES OF SCALE IN PRODUCTION
RESEACH AND DEVELOPMENT
MARKETING AND MANAGEMENT
VERTICAL MERGER –
FIRMS SUPPLYING RAW MATERIALS MERGE WITH FIRM THAT
SELLS
ADVANTAGE
LOWER BUYING COST OF MATERIAL
LOWER DISTRIBUITION COST
ASSURED SUPPLIES AND MARKET
COST ADVANTAGE
CONGLOMERATE MERGER
UNRELATED INDUSTRIES MERGE
PURPOSE
DIVERSIFICATION OF RISK
Ex:Time warner-(they were into media & movie production) & AOL-
(leading American website)
20
Expansion
Merger and Acquisition
Asset acquisition
Joint ventures
Tender offer
Contraction
1.Spin off-shares in subsidiary distributed to its own shareholders
Kotak Mahendra Capital finance Ltd formed a subsidiary called Kotak
Mahendra Capital Corporation by spinning off its investment division.
2.Split off- A new company is created to takeover an existing division or
unit.
It does not result in any cash inflow to the parent company
HISTORY
The First wave
1897-1904-horizontal Mergers
Monopolistic Market structure
Mega merger between US Steel and Carnegie Steel.It also merged with 785
separate firms-75% of Steel production of US.
More than 3000 companies disappeared.
General Electric,Navistar, Standard Oil, Du-Point, American Tobacco-90%
of market share
Transformation of regional firms into national firms.
Exploited the economies of scale.
Table-1
Year Number of mergers
1897 69
1898 303
1899 1208
1900 340
1904 79
Problems of the first Wave
Financial factors
Fraudulent financing
Stock Market crash in 1904 and Banking panic of 1907
Closure of many banks and formation of Federal Reserve System.
21
Easy finance ends here.
The US President Teodore Roosevelt and President William Taft made a
crack down on Large Monopolies.
As a result: ???? What happened to Standard Oil?
Standard Oil(SO)
Broken in to 30 Companies.
SO of New Jersey named EXXON
SO of New York named MOBIL
SO of California renamed CHEVRON
SO of Indiana renamed AMOCO
The Second Wave
1916-1929
Oligopolies industry structure
Industries like primary metals, petrolium products, food products, chemicals
Outside the previously consolidated heavy manufacturing industries.
Product extension merger like IBM and General Foods
Vertical mergers In the mining and metal industries(1920)
Prominent Corporations
General Motors, IBM, Union Carbide, John DEERE
Between 1926 and 1930- there were 4600 mergers took place
Result of which between 1919 and 1930 12,000 manufacturing ,
mining,public utility and banking firms disappeared.
This period rail transportation, motor vehicle transportation became national
market.
Radios in homes, entertainment enhanced the competition.
Mass merchandising, national brand advertising
Enhance productivity as a part of war effect.
The firms were urged to work together rather than compete
The second wave came to an end when stock market crashed on October
29,1929.
Investment Bankers played in the first two phases of mergers.
The 1940s
The second world war with merger of small firms with larger firms
Motive of tax relief
High estate taxes
There were no increased concentration of wealth
22
Mergers were small.
The third Wave-1965-1969
Merger activity reached its highest level during this period
Booming of economy
Conglomerate merger period-80%
Diversification strategy
It is because of ANTI TRUST enforcement
Federal government adopted a stronger antitrust enforcement both with
horizontal and verticle merger.
1963-1361 mergers; 1970-5152 mergers
Management sciences
Management principles were applied in industries.
Management graduates were employed to manage conglomerate mergers.
There were 6000 mergers which leads to 25000 firms disappeared.
Investment Bankers do not finance most of these mergers
Finance:-????
Finance for mergers
Equity financing
Boom in stock market prices
Many conglomerate merger failed
The Revlon –cosmetic entered into health care and failed and suffered in
cosmetic industry.
The Fourth Wave-1981-1989
Recession in 1974-75
Hostile merger
Take over or targeting on target company‟s board of directors.
If the board accepts, it is considered friendly, and if it opposes it, it is
deemed to be hostile.
The great mergers such as Oil companies-21.6%
Of dollar values of merger and acquisitions
Drugs and medical equipment industries due to deregulation in some
industries
Deregulation of airline industries
23
Investment bankers played an aggressive role.
M&A advisory services became a lucrative source of income for Goldman
Sachs
Innovation in acquisition techniques
The Fifth Wave-1992-till date
Once again increased activity in merger in 1992
Mega mergers
Strategic mergers
Equity based
Deregulations and technological changes
Banking , telecommunications entertainment and media industries
High growth in banking sectors in 1990 as banks grew greater than central
banks.
Banks fund M&A rather than new ventures.
Oligopoly market structure
Competition declined
Very few competitors
Example: Coco-Cola-44.5%,Pepsi-31.4%,Cadbury Schweppes-14.4%
Globalisation
Not confined to US companies
1995-US companies were acquired
1981-2395
1989-2366
1990-2074 companies
2001-7528 companies merged
Major Mergers in the telecom
Acquirer Target
Vodafone Mannes man
MCL worldcom Spirit
Bell atlantic GTE
24
AT&T MeCaw Celluar
SBC Pacific Telesis
Major Mergers in Media and Entertainment sector
AOL Time Warner
VIOCOM CBS
WALT DISNEY CAPITAL ITIES/ABC
AT&T MEDIA ONE
TIME WARNER TURNER BRODCAST
M&A IN INDIA
License era-Unrelated diversification
Conglomerate merger
Friendly take over and hostile bids by buying equity shares
Example: Swaraj paul attempted to raid on Escorts Ltd.and DCM Ltd but
could not succeed.
The Hindujas raided and took over Ashok leyland and Ennore Foundaries.
Chhabria Group acquired stake in Shaw Wallace, Dunlop india and Falcon
Tyres.
Goenka group from culcutta took over Ceat tyres.
The Obroi-Pleasant hotels of Rane group.
1989- Tata Tea acquired 50% of the equity shares of Consolidated Coffee
Ltd from resident shareholders.
Merged to form HCL Ltd??.
HCL
Hindustan Computers, Hindustan Reprographic, Hindustan
Telecommunications and Indian Software Ltd.
Comparative study
US India
Strategic By default(ANZ&
Gains by investment Not benefited by banks
Capital goods Consumer goods
BorrowedEarlier
debt later by equity cash/FDI
Anti trust Act MRTP later The competition
bill 2001
25
FINANCIAL FRAMEWORK
1.IT COVERS THREE INTERRELATEDASPECTS
2.DETERMINING THE FIRM‟S VALUE
3.FINANCING TECHNIQUES IN MERGER
4.CAPITAL BUDGETING
DETERMINIG THE FIRMS VALUE
QUANTITATIVE FACTORS – BASED ON
THE VALUE OF THE ASSETS
BOOK VALUE – OWNERS EQUITY
DEPENDS ON FIXED ASSETS AND WORKING CAPITAL
APPRAISAL VALUE- INDEPENDENT APPRISAL AGENCIES
MARKET VALUE – BASED ON STOCK MARKET QUATATIONS
,BUT CHANCE FOR SPECULATION
EARNING PER SHARE AND P/E RATIO – IMPACT OF EPS AFTER
MERGERTHE EARNINGS OF THE FIRM.
EXERCISE
COMPANY A
NO. OF SHARES 2 LACS
MARKET VALUE PER SHARE RS.25
EPS RS.3.125
COMPANY B
NO. OF SHARES 1 LAC
MARKET VALUE RS.18.75
EPS RS.2.5
CONCLUSIONS
EXCHANGE AT EPS – NO EFFECT ON EPS AFTER MERGER
EXCHANGE MORE THAN EPS RATIO – COMPANY WITH LOWER
EPS GAINS
26
IF LESS THAN EPS RATIO – COMPANY WITH HIGHER EPS BEFORE
MERGER GAINS
PRICE EARNING RATIO APPROACH
MEANING
COMPUTATION :
P/E RATIO = MP/EPS
EPS = EAT/NO. OF EQUITY SHARES
MARKET PRICE = P/E (NO. OF TIMES) * EPS
EXAMPLE
7.58P/E RATIO(TIMES)
18,75,00050,00,000TOTAL MARKET
VALUE (N*MPS) OR
(EAT*P/E RATIO)
18.7525MARKET PRICE PER
SHARE(MPS)
2.53.125EPS
1,00,0002,00,000NO. OF SHARES
2,50,0006,25,000EAT
FIRM BFIRM APRE MERGER
SITUATION
27
7.58P/E RATIO
(ASSUMED TO BE THE
SAME)
21.8253.125*8=25MPS
65,47,50070,00,000TOTAL MARKET VALUE
8,75,000/3,00,000=2.91/8.75/2.8=3.125EPS
2,00,000+1,00,000=3,00,0
00
2.8 lakhsNO. OF SHARES
8,75,0006.25+2.5=8.75EAT(COMBINED FIRM)
1 : 12.5:3.125=.8EXCHANE RATIO/ SWAP
RATIO (ASSUMING)
SITUATION 2SITUATION 1
(BASED ON CURRENT
MARKET PRICE
POST MERGER
CONCLUSION
IF SHARES ARE EXCHANGED BASED ON CURRENT MARKET
PRICE PER SHARE , POST MARKET PRICE SHARE INCREASED AT
HIGHER RATE THAN EXCHANGED BELOW THIS RATIO
Boot strap effect
MARKET VALUE AFTER MERGER = MARKET VALUE BEFORE
MERGER = 68,75,000
NET GAIN = 15,00,000
? IF EXCHANGE RATIO IS 2.5:1 WHO GAINS WHO LOSES
? IF EXCHANGE RATIO IS 1:1 WHO GAINS WHO LOSES
? HOW TO CALCULATE TOLERABLE SHARE EXCHANGE RATIO
28
DETERMINATION OF
TOLERABLE SHARE
EXCHANGE RATIO75,00,000
10,00,000
TOTAL MV
LESS: MINIMUM TO BE GIVEN TO B
1,00,000NO. OF SHARES OF A TO A CO. SHARE
HOLDERS
65,00,000NET BENEFIT TO A
10,00,000/65 = 15,385 SHARESNO. OF EQUTY SHARES TO BE ISSUED
BASED ON DESIRED MARKET PRICE
50,000/15385 = 3.25 SHARES OF FIRM B,
1 SHARE IN FIRM A
1:3.25
TOLERANCE SHARE EXCHANGE
RATIO
65 PER SHAREDESIRED POST MERGER MPS
CONCLUSION
FIRM WITH HIGHER P/E RATIO CAN ACQUIRE FIRM WITH LOWER
P/E RATIO WHICH WILL INVARIABLY INCREASES MARKET
VALUE AFTER MERGER
CAPITAL BUDGETING
THE TARGET FIRM SHOULD BE VALUED BASED ON PV OF
INCREMENTAL CASH INFLOWS
CORPORATE RESTRUCTURING
FINANCIAL RESTRUCTURING
RESTRUCTURING SCHEMES : INTENAL AND EXTERNAL
RESTRUCTURING
DEMERGERS
29
BUYOUTS
ACCOUNTING FOR AMALGAMATION
POOLING INTEREST METHOD
CONDITIONS AS PER AS 14:
ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE
ASSETS OF THE TRANSFREE CO.
AT LEAST 90% OF F.V OF EQUITY SHARE HOLDERS SHOULD BE
SHAREHOLDERS OF NEW CO.
PURCHACE CONSIDERATION TO BE SETTLED BY THE NEW CO.
THE BUSINESS OF NEW CO. SHOULD CONTINUE
NO ADJUSTMENT IS INTENDED TO BE MADE TO BOOK VALUE OF
ASSETS AND LIABILITIES OF TRANSFEROR CO.
OTHER ACCOUNTING TREATMENTS
CROSS HOLDINGS OF SHARES TO BE CANCELLED SUBSIQUENT
TO MERGER
INTER CO. TRANSACTIONS LIKE DEBTORS AND CREDITORS –
SALE OF GOODS FROM ONE CO. TO ANOTHER
SALES TAX PAID ALREADY CAN NOT BE RECOVERED
INCOME TAX RELATED ISSUES FOR AMALGAMATION
CONDITIONS OF AMALGAMATION UNDER INCOME TAX ACT
SEC 2 (1B)
ALL ASSETS AND LIABILITIES OF TRANSFEROR CO. TO BE THE
ASSETS OF THE TRANSFREE CO.
SHARE HOLDERS HOLDING NOT LESS THAN 3/4TH
IN VALUE OF
SHARES OTHER THAN SHARES ALREADY HELD SHOULD
BECOME SHARE HOLDERS OF AMALGAMATED COMPANY
EX. NO. OF SHARES OF Altd CO. 1,00,000
NO. OF SHARES HELD BY Bltd IN Altd IS 20,000
NOMINAL VALUE OF SHARE IS RS.10
ASSUME Altd MERGE WITH Bltd THEN 75% OF 1,00,000- 20,000 =
60,000 TO BE THE SHARE HOLDES OF B CO.
30
NOTE:SHARE HOLDERS MAY BE EQUITY OR PREFERNCE SHARE
HOLDERS
OTHER CONDITIONS
THE AMALGAMATED CO. IS AN INDIAN CO.
EXCEPTION
IF SHARES OF INDIAN CO.HELD BY FOREIGN BEFORE MERGER
AND SUCH FOREIGN CO. TAKEN OVER BY ANOTHER FOREIGN
CO.
ATLEAST 25% OF THE FOREIGN CO. (BEFORE MERGER) TO BE
SHARE HOLDERS OF THE NEW FOREIGN CO.
? WHAT IS THE BENEFIT TO THE AMALGAMATED CO.
AMALGAMATING CO.(OLD CO.)
NO CAPITAL GAIN ON TRANSFER ON CAPITAL ASSETS BY THE
TRANSFEROR CO. UNDER SEC 47(VI) OF I.T ACT
? CAN NEW CO. CARRY FORWAD AND SET OF LOSS AND
DEPRECIATION
SEC 72 A TO BE FULFILLED
ACCUMULATED LOSSES REMAIN UNABSORBED FOR 3 OR MORE
YEARS
75% OF BOOK VALUE TO BE HELD ATLEAST FOR 2 YEARS
BEFORE AMALGAMATION
THE AMALGAMATED CO. CONTINUES TO HOLD 3/4TH
OF BOOK
VALUE ATLEAST FOR 5 YEARS
NEW CO. SHOULD CONTINUE FOR ANOTHER 5 YEARS
NEW CO. SHOULD ACHIEVE ATLEAST 50%OF INSTALLED
CAPACITY BEFORE END OF 5 YEARS AND SHOULD CONTINUE
FOR 5 YEARS
THE NEW AMALGAMATED CO. SHOULD FURNISH TO ASSESSING
OFFICER ABOUT PARTICULARS OF PRODUCTION
BENEFIT
THIS SCHEME IS ALSO APPLICABLE TO BANKING INSTITUTIONS.
31
Conditions in brief
A LTD AMALGAMATES WITH B LTD
AS ON 2007
NO CAPITAL
GAIN TAX &
ACCUMULATED
LOSSES &
UNABSORBED
DEPERICIATION
CAN BE
CARRIED
FORWARD
DOES NOT
ATTRACT
CAPITAL GAIN
FOR A BUT NO
GAIN FOR B
NO BENEFIT
TO A & B
A MERGES WITH
B (A GOES OUT)
SATISFIES
BOTH 2(1B) & 72
A
SATISFIES 2(1B)
BUT DOES NOT
SATISFY 72 A
DOES NOT
SATISFY SEC
2(1B) & 72 A
PARTICULARS
A LTD AMALGAMATES WITH B LTD AS ON 2007
? If b merges with a & b goes out of market who gains under above 3
situations
? If a&b merge with c what are the tax implication under above situations
Assume b is a loss making co.& Have accumulated losses & unabsorbed
depreciation
? If c is not an Indian co.
32
OTHER TAX BENEFITS
Expenditure on amalgamation or de-merger – allowed under sec 35DD both
revenue and capital expenditure allowed
Expenditure on scientific research can be carried forward
Expenditure on acquisition of patent rights copyrights – depreciation can be
provided
Expenditure for obtaining license for tele-communication service can be
written off
Preliminary expenses
Capital expenditure on family planning
Bad debts are allowed
Tax Concession To Share Holders Of Amalgamating Co.
No capital gain tax provided, new co. is an Indian co.& Shareholders are
acquired everything in shares
EXERCISE
4070MARKET PRICE
810P/E RATIO
57EPS
7,50020,000NO. OF SHARES
37,5001,40,000EAT
CO. BCO. APARTICULARS
Co. A is acquiring co. B Exchanging one share for every 1.5 shares of B ltd
& p/e ratio will continue even after merger
33
? Are they better or worse of than they were before in merger
? Determine the range of minimum & maximum ratio between the two firms
? A is an Indian co.
? A is a foreign co.
? A merges with T & formed a new co. AT ltd
? What are the tax planning required before & after merger
Conversion of sole proprietorship into a company By
Prof.Augustin Amaladas
conditions
•All assets and Liabilities of the sole proprietarily concern leading to the
business immediately before the succession shall become the A/L of the
company
•Sole proprietor should hold not less than 50% of the total voting power
in the company
•The sole proprietor should continue for a minimum period of 5 years.
•The sole proprietor should receive the consideration only in the form of
shares in the company
Consequences if not fulfilled
•Withdrawal of exemption U/S 47A(3)
•The capital gain which was not taxed earlier will become taxable in the
hands of the company.
34
Conversion of Firm into a company
•Conditions:
•1. All assets and Liabilities of the firm leading to the business
immediately before the succession shall become the A/L of the company.
•2. All the partners of the firm become the shareholders of the company
in the same proportion of their capital account stood before the
succession.
•3.Every thing should be received in Shares of the company by the
partners.
•4.Not less than 50% of voting power in the company by all the partners
and hold such shareholdings for a period of 5 years from the date of
succession.
Failed to fulfill the conditions
•Withdrawal of exemption U/S 47A(3)
•The capital gain which wad not taxed earlier will become taxable in the
hands of the company
Exercise-1-Case study
•A Ltd. is incorporated on April 1st 2008 which takes over the assets and
liabilities at the agreed valuation of X Co. as follows:
•Plant-2,80,000, House property-10,00,000, stock-60,000, debtors-
70,000,Bank –10,000.
???
•How is it treated as per IT?
•If firm sells the whole business at the agreed value what is the tax
implication?
•Calculate the total consideration the company is willing to give the
partners and also find out the number of shares allotted to each
partner?
•If Shareholder Y transfers his shares to Z on 5th
March 2011 what is
the consequences to the firm and Company and partners(shareholders)?
•How do you compute capital gain tax?
•Suppose the firm has a land worth Rs. 50 crores and sells which
attracts 8 crores Income tax. Is there tax planning to avoid tax liability?
35
Answer
1.Short term capital gain on plant and Machinery as a depreciated
asset=2,00,000
House property – Long term as no depreciation provided use index cost
of acquisition
Stock in trade 60,000-40,000=20,000 is business income.
•If all the conditions fulfilled as per 47(xiii)
•No capital gain tax.However business income arises on stock which
attracts tax as business income and to be paid by the firm.
•Stock is a current asset which is used as a stock in trade does not
amount to capital asset.
•If Y transfers his shares to Z the capital gain earlier exempted will be
taxed as it was originally calculated.Long term capital gain on house
property and short term capital gain on plant and machinery.
Tax Planning:
•If lands worth Rs. 50 crores if transferred to A Ltd. it does not amount
to transfer.
•No capital gain on the firm and the company.
•It is treated just like gift or will and the cost of acquisition will be the
cost of acquisition of firm.
Set off and carry forward of losses of proprietor/Firm
•Un absorbed depreciation and accumulated losses can be carried
forward and can be set off by the company as if it is their losses.
•It should not be speculative business loss.
•If failed to fulfill the conditions such losses set off and un absorbed
depreciation set off are considered as income of the company.
•Any loss can not be carried forward for more than 8 years. How ever if
company acquires firm the company itself can carry forward and set off
such loss for the further period of 8 years.
Case study-2
36
•X and Y are partners; capital ratio is 1:3; Business Loss –10 crores
which remains due to be set off at the end of 7th
year, the firm can carry
forward and set off with in one more year otherwise it will lapse.
•If firm is converted into a company the company can treat such loss as
their loss occurs in the first year. Therefore they can carry forward for
8 more years.
•If Y transfers his shares with in 5 years to Z then the loss set off is
taxed to the company as the shareholder Y fails to fulfill the
requirements as per the law.
_____________________________________________________________
___________
Practicals
DETERMINATION OF VALUE PER SHARE OF XY LIMITED,
ITES DIVISION OF XY
SERVICES XY PRIVATE LIMITEDAND M&A INDIA LIMITED
Determination Date: April 1, 2008- based on the audited
Balance sheet as on 31st March, 2005, 2006 and 2007 except for the ITES
division of XY India Private Limited, where I have relied on the
segment financials provided by the client.
Purpose: The purpose of this Certificate is to estimate the ―fair value‖
of the Equity Shares of the Companies on the determination date
requested.
Dear Sir,
I have prepared, and enclosed herewith, my report on determination of fair
value of equity shares of M/s. XY Limited ITES division of XY Services
India Private Limited and M/s. M&A Ltd. based on the audited balance
sheets of the companies as on 31st March, 2005, 31
st March 2006 and 31
st
37
March, 2007, in case of XY and M&A and based on the segment financials
provided by the company in case of CISIPL. The purpose of the report is to
estimate the “fair value” of the equity shares of the three companies as on 1st
April, 2008.
Estimate of the Fair Value
I have used the Intrinsic Value method, the Capitalisation of Earnings
Method as well as the Profit Earning Capacity Value method to determine
the “fair value per share” of the three companies and the results of my
workings are as under:
Using the Intrinsic Value Method:
The value per share of M/s. Cambridge Solutions Limited is Rs.15.88, that
of the ITES division of XY is Rs. Nil and that of M/s. M&A is Rs. Nil.
Using the Capitalisation of Earnings Method:
The value per share of M/s. XY is Rs.2.74, that of the ITES division of XY
is Rs.11.77 and that of M/s. M&A Limited is Rs. Nil.
Using the Price Earning Capacity Value Method:
The value per share of M/s. XY Limited is Rs.22.05, that of the ITES
division of XY Services India Pvt. Ltd. is Rs.16.76 and that of M/s. M&A is
Rs.Nil.
Based on my findings above, I consider that the fair value per share of XY to
be Rs.13.56, that of the ITES division of XY Services India Private Limited
to be Rs.9.51 and M&A to be Rs. Nil.
However, since XY Limited is a company listed in recognized stock
exchanges in India, it is prudent to consider the market price of the
company‟s share, as on the date of valuation being Rs.125 [average of BSE
and NSE prices as on March 30, 2007, rounded off], as the fair value per
share of XY Limited.
Further, the par value of equity shares of XY India Private Limited of Rs 10
[in respect of 6,285,620 equity shares of Rs 10 each fully paid up] and Rs 5
[in respect of 178,449 equity shares of Rs 5 each fully paid up], is
considered as fair and reasonable.
38
Based on my findings above, I consider an exchange ratio of one equity
share in M/s. XY Limited for every 12.50 equity shares of Rs 10 each
fully paid up and held in M/s. XY Services India Private Limited, to be
fair and reasonable.
Based on my findings above, I consider an exchange ratio of one equity
share in M/s. XY Limited for every 25 equity shares of Rs 5 each fully
paid up and held in M/s. XY Services India Private Limited, to be fair
and reasonable.
Thanking you,
Yours truly,
For A &Co.
CHARTERED ACCOUNTANTS
Enclosed:
a) Summary of the valuation of share of the three companies using the
various methods
b) Calculation of value as per the Net Assets Method
c) Calculation of value as per the Earnings Capitalisation Method of XY
d) Calculation of value as per the Earnings Capitalisation Method of XY
Integrated
e) Calculation of value as per the Earnings Capitalisation Method of
M&A
f) Calculation of value as per Profit Earning Capacity Value Method of
XY
g) Calculation of value as per Profit Earning Capacity Value Method of
XY integrated
h) Calculation of value as per Profit Earning Capacity Value Method of
M&A
i) Average PE Multiple of Software Development Companies
j) Average PE Multiple of IT Enabled Services Companies
k) Report
39
PURPOSE OF THIS REPORT
The report has been prepared for the specific purpose of determining the
“fair value” of the equity shares of XY Limited, ITES division of XY
Services India Private Limited and M&A India Limited. The determination
of fair value is based on the audited financial accounts for the years ended
31st March, 2005, 31
st March, 2006 and 31
st March, 2007 in case of XY and
M&Aand the segment financials provided by the company in case of
XYSIPL.
The determination is on the basis of the intrinsic value per share of the three
companies, the capitalization of earnings method as well as the price
earning capacity value based on the audited balance sheets of the companies
for the immediately previous three years.
APPROACH TO VALUATION
My approach has been to determine an estimate of the fair value per share.
My estimate of value is based on the audited financial accounts of the
companies for the years ended 31st March, 2005, 31
st March, 2006 and 31
st
March 2007.
For the purpose of this valuation I have not included a review, analysis and
interpretation of extent of control associated with the percentage of equity
proposed to be divested, since it is not applicable under the given
circumstances.
40
LIMITING CONDITIONS
This report is based on the historical financial information provided to me. I
have not audited or reviewed the underlying data.
I have no present or contemplated financial interest in the Company or with
any of the members of the management team. My fee, for this valuation, is
based upon my normal hourly billing rates and is in no way contingent upon
the results of my findings. I have no responsibility to update this report for
events and circumstances occurring subsequent to the date of this report.
The report has been prepared for the specific purpose of determining the
“fair value per share” of the companies on the determination date and is not
intended for any other use. Furthermore, no aspect or conclusion of this
report is meant to be construed as legal advice, or any other type of
professional advice or counsel, unless specifically stated to the contrary in
this report.
I have relied on the Audited Financial Accounts and other Financial
Information concerning the value and useful condition, of all equipment, real
estate leases, investments, and any other assets or liabilities except as
specifically stated to the contrary in this report. I have not attempted to
confirm whether or not all assets of the business are free and clear of liens
and encumbrances, or that the business has good title to all assets.
41
Valuation of Shares using the Net Assets Method [Intrinsic Value Method]
Amount in Rupees
Particulars XY Ltd M&A
XY Integrated
services
ASSETS
Fixed Assets (net of accumulated
depreciation)
51,897,165
- 135,893,593
Capital Work-in-Progress
6,368,235
- 58,831,491
Intangible Assets
6,075,480
- 18,618,605
Investments:
- 49,990 Equity Shares in Matrix
One India Ltd
- -
- Other Investments
2,391,268,775
- -
Deferred Tax Asset
30,007,312
- 10,851,163
Current Assets:
Inventory
-
1,221,199 -
Sundry Debtors
1,382,259,872
10,802,715 8,825,698
Cash and bank balances
44,815,501
2,699,359 20,806,119
Loans and advances
643,659,863
1,937,244 82,886,363
42
TOTAL ASSETS
4,556,352,203
16,660,517 336,713,032
LIABILITIES
Secured Loans
930,293,407
- 135,528,456
Unsecured Loans
1,426,500,000
- 35,307,070
Current Liabilities
451,734,802
22,807,106 163,498,859
Provisions
78,578,371
617,695 2,445,411
TOTAL LIABILITIES
2,887,106,580
23,424,801 336,779,796
NET ASSETS
1,669,245,623
(6,764,284) (66,764)
Weighted Average Number of
Equity Shares
105,130,577
50,000 6,374,845
Intrinsic Value per share
15.88
- -
Face Value per share
10.00
10.00 10.00
Notes:
a)
Fixed Assets are considered at
book value.
43
b)
Current Assets are considered to be fully
recoverable at book value.
c)
For the ITES Division of XY Integrated Services India Private Limited, 178,449 shares
of Rs 5 each fully paid
up have been converted into equal number of equity shares of Rs 10 each fully paid up,
on a weighted average basis.
Valuation of Shares of XYLimited using the Earnings Capitalisation Method
Amount in Rupees
Particulars
Year ended
March 31,
2005
Year ended March 31,
2006
Year ended
March 31, 2007
Net Profit before Taxation
79,010,924 73,010,924 (97,468,857)
Add: Adjustment of Extraordinary
Items
- Interest on 5.22% Convertible
Bonds - 4,350,085 88,203,890
Adjusted Net Profit Before Tax
79,010,924 77,361,009 (9,264,967)
Provision for Taxation
27,967,938 (26,959,333) (13,843,682)
44
[including Deferred Tax and Fringe
Benefit Tax]
Adjusted net profit after tax
106,978,862 50,401,676 (23,108,649)
Assigned weights 1 2 3
Product
106,978,862 100,803,352 (69,325,947)
Weighted Average of the adjusted net profit for
three years 23,076,045
Weighted Average Profit capitalised at a
normal earnings of 8% 288,450,556
No of equity shares 105,130,577
Value per share 2.74
Face Value per share 10
Note:
1. The profits exhibit a trend of decrease year on year. Therefore, it is
prudent to assign
a higher weight for the later years.
2. Capitalisation factor of 8% is arrived at considering the return on
Government of
India ["GOI"] securities gross of taxation.
3. Weighted Average of Adjusted Profits is assumed to be the future
annual earnings of
the company, under assumption of going
concern.
45
Valuation of the ITES Division of XY Integrated Services India Private Limited
using the Earnings Capitalisation Method
Amount in Rupees
Particulars Year ended
March 31, 2005
Year ended
March 31, 2006
Year ended March
31, 2007
Net Profit before Taxation (64,512,818) (24,329,324) 44,284,413
Add: Adjustment of Extraordinary Items - - -
Adjusted Net Profit Before Tax (64,512,818) (24,329,324) 44,284,413
Provision for Taxation - (2,412,779) 7,048,765
[including Deferred Tax and Fringe
Benefit Tax]
Adjusted net profit after tax (64,512,818) (26,742,103) 51,333,178
Assigned weights 1 2 3
Product (64,512,818) (53,484,206) 153,999,534
Weighted Average of the adjusted net profit for three
years 6,000,418
Weighted Average Profit capitalised at a normal
earnings of 8% 75,005,229
Weighted Average number of equity shares 6,374,845
Value of ITES Division per share 11.77
Face Value per share 10
46
Note:
1. The profits exhibit a trend of increase year on year. Therefore, it is
prudent to assign
a higher weight for the latest year.
2. Capitalisation factor of 8% is arrived at considering the return on GOI
securities gross
of taxation.
3. Weighted Average of Adjusted Profits is assumed to be the future annual
earnings of
the company, under assumption of going
concern.
4. 178,449 shares of Rs 5 each fully paid up have been converted into equal
number of
equity shares of Rs 10 each fully paid up, on a weighted
average basis.
Valuation of Shares of M&A India Limited using the Earnings Capitalisation Method
Amount in Rupees
Particulars
Year ended
March 31,
2005
Year ended March 31,
2006
Year ended March
31, 2007
Net Profit before Taxation
461,361 2,900,850 (6,228,052)
Add: Adjustment of Extraordinary Items
- - -
Adjusted Net Profit Before Tax
461,361 2,900,850 (6,228,052)
Provision for Taxation
(35,000) (617,695) -
[including Deferred Tax and Fringe
Benefit Tax]
47
Adjusted net profit after tax
426,361 2,283,155 (6,228,052)
Assigned weights
1 2 3
Product
426,361 4,566,310 (18,684,156)
Weighted Average of the adjusted net profit for
three years (2,281,914)
Weighted Average Profit capitalised at a normal
earnings of 8% (28,523,927)
Weighted Average number of equity shares 50,000
Value per share 0
Face Value per share 10
Note:
1. Though the profits do not exhibit any particular trend year on year, for
consistency,
a higher weight has been assigned for the latest year.
2. Capitalisation factor of 8% is arrived at considering the return on GOI
securities gross
of taxation.
3. Weighted Average of Adjusted Profits is assumed to be the future annual
earnings of
the company, under assumption of going
concern.
48
Valuation of Shares of XY Limited
using the Profit Earning Capacity Value Method
Amount in Rupees
Particulars
Year ended
March 31,
2005
Year ended
March 31,
2006
Year ended March 31, 2007
Net Profit before Taxation
79,010,924
73,010,924 (97,468,857)
Add: Adjustment of Extraordinary Items
- Interest on 5.22% Convertible
Bonds -
4,350,085 88,203,890
Adjusted Net Profit Before Tax
79,010,924
77,361,009 (9,264,967)
Provision for Taxation
27,967,938
(26,959,333) (13,843,682)
[including Deferred Tax and Fringe
Benefit Tax]
Adjusted net profit after tax
106,978,862
50,401,676 (23,108,649)
Weighted Average number of equity
shares
28,732,276
30,113,456 105,130,577
Earnings Per Share [EPS]
3.72 1.67 (0.22)
Assigned weights
1 2 3
Product
3.72 3.35 (0.66)
49
Weighted Average of the EPS for three years (a) 1.07
Average PE multiple of Software Development
companies (b) 20.63
on the BSE Index [refer Annexure A]
Value per share based on EPS (a) * (b) 22.05
Face Value per share 10
Note:
1. The profits exhibit a trend of decrease year on year. Therefore, it is
prudent to assign
a higher weight for the later years.
2. Weighted Average of Adjusted Profits is assumed to be the future annual
earnings of
the company, under assumption of going
concern.
Valuation of the ITES Division of XY Integrated Services India Private Limited
using the Profit Earning Capacity Value Method
Amount in Rupees
Particulars
Year ended
March 31,
2005
Year ended March
31, 2006
Year ended
March 31, 2007
Net Profit before Taxation
(64,512,818) (24,329,324) 44,284,413
Add: Adjustment of Extraordinary Items - - -
Adjusted Net Profit Before Tax
(64,512,818) (24,329,324) 44,284,413
Provision for Taxation - (2,412,779) 7,048,765
50
[including Deferred Tax and Fringe
Benefit Tax]
Adjusted net profit after tax
(64,512,818) (26,742,103) 51,333,178
Weighted Average number of equity
shares
6,332,260 6,374,845 6,374,845
Earnings Per Share [EPS]
(10.19) (4.19) 8.05
Assigned weights
1 2 3
Product
(10) (8) 24
Weighted Average of the EPS for three years (a) 0.93
Average PE multiple of ITES companies on the BSE Index [refer
Annexure B] 45.06
Discounted PE multiple@40% (b)
18.03
Value of ITES Division per share based on EPS (a) * (b)
16.76
Face Value per share
10
Note:
1. The profits exhibit a trend of increase year on year. Therefore, it is
prudent to assign
a higher weight for the latest year.
2. Weighted Average of Adjusted Profits is assumed to be the future
annual earnings of
51
the company, under assumption of going
concern.
3. For the years ended March 31, 2007 and March 31, 2006, 178,449
shares of Rs 5 each
fully paid up have been converted into equal number of equity shares
of Rs 10 each
fully paid up, on a weighted average
basis.
Valuation of Shares of M&A India Limited
using the Profit Earning Capacity Value Method
Amount in Rupees
Particulars Year ended
March 31, 2005
Year ended
March 31, 2006
Year ended
March 31, 2007
Net Profit before Taxation 461,361 2,900,850 (6,228,052)
Add: Adjustment of Extraordinary Items - - -
Adjusted Net Profit Before Tax 461,361 2,900,850 (6,228,052)
Provision for Taxation (35,000) (617,695) -
[including Deferred Tax and Fringe
Benefit Tax]
Adjusted net profit after tax 426,361 2,283,155 (6,228,052)
Weighted Average number of equity
shares 50,000 50,000 50,000
Earnings Per Share [EPS] 9 46 (125)
Assigned
weights 1 2 3
Product 9 91 (374)
52
Weighted Average of the EPS for three years (a) 0
Average PE multiple of Software Development companies 20.63
on the BSE Index [refer Annexure A]
Discounted PE multiple@40% (b) 8
Value per share based on EPS (a) * (b) 0
Face Value per share 10
Note: 1. Though the profits do not exhibit any particular trend year on year, for consistency,
a higher weight has been assigned for the latest year.
2. Weighted Average of Adjusted Profits is assumed to be the future annual earnings of
the company, under assumption of going
concern.
Annexure A - List of Software Development companies considered
for computation of PE multiple
Particulars EPS Share price PE multiple
Aztecsoft
4.60
119 25.9
Cranes Software International
5.60
100 17.9
Geometric Software
2.90
103
35.5
GTL Limited
5.90
135
22.9
Helios & Mathers
13.40
125
9.3
53
Intellvisions Software
4.30
147
34.2
Kernex Microsystems
7.60
126
16.6
Megasoft Limited
10.30
120
11.7
Panoramic Universal
7.00
120
17.1
Ramco Systems Limited
(22.1
0)
129 (5.84)
Redington (India) Limited
3.80
140
36.8
Vakrangee Software
5.40
138
25.6
Total 247.6
Average PE Multiple of the Software Development companies 20.63
> The share price is based on the closing share price as on April 9, 2007
> Source: Dalal Street (April 16 - April 29, 2007)
Annexure B - List of IT Enabled Service companies considered for computation of
PE multiple
54
Particulars EPS Share
price PE multiple
Allsec Technologies
14.20
280 19.7
HOV Services
Limited
2.10
186 88.6
Northgate
Technologies
15.30
851 55.6
Spanco Telesystems
12.60
206 16.3
Total 180.3
Average PE Multiple of the IT
Enabled Service companies 45.06
> The share price is based on the closing share price as on April 9, 2007
> Source: Dalal Street (April 16 - April 29, 2007)
Summary of Valuation of Shares of XY Limited,
M&A India Limited
and the ITES Division of Cambridge Integrated
Services India Private Limited
55
Amount in Rupees
Method of Valuation XY
Limited
ITES Division of
XY Integrated
Services India
Private Limited
M&A India
Limited
Value per share under Net
Asset Value Method
15.88 0 0
Value per share under
Earnings Capitalisation
Method
2.74 11.77 0
Value per share under Price
Earning Capacity Value
Method
22.05 16.76 0
Average Value per share
based on the above
methods
13.56 9.51 0
Face Value per share
10.00 10.00 10.00
Market Price per share
(average of BSE and NSE
prices
125.00 NA NA
as on March 30, 2007,
rounded off to the nearest
decimal)
56
57
58
59
60
61
62
63
64
65
66
67
68
69
M&A Regulatory control By
Prof. Augustin Amaladas
Content
•Evolution of Regulatory Control of M&A
•Procedures under the Companies Act, 1956
•The SEBI Takeover Regulation Code, 1997
•The recent changes made by SEBI in the take over Code
•Implications under Income tax Act, 1961.
Evolution of Regulatory Control of M&A
•Every business is targeted.
•MRTP-1969
•Indian firms require consolidation
•Survival and growth
•Preceding to 1991 there were 120 successful mergers and takeovers and
about which failed to succeed.
•HLL-TOMCO merger -SC‘s Judgment.It is the best route to reach a
size comparable to global companies so as to effectively compete with
them.
•
•Compliance under the Companies Act, 1956
•1. Scheme of Amalgamation /Merger
•2. Financial Institutions‘ approval-Debenture holders, Banks, creditors
etc.
•3. Approval of BODs
•4. Intimation to stock exchange-when release to press.
•5. Application to court for direction-U/S 391(1)-A separate application
by TFR and TFREE
•6. Direction by court Directions for Members‘ Meeting.
•7. Draft notices calling for meetings of Members
•8. 21 days clear notices
•9.Advertise for Meeting of members
•10. Confirmation about services of the Notice-Chairman conveys to the
court for the fulfillment of issue of notices and advertised.
70
•No one can acquire individually or along with some one (more than
15% upto 75%) of holding further shares without public
announcement.
•The offer price to be paid in cash/shares of acquirer company.
•Average weekly high and low of the closing prices of the shares of
target price traded during 26 weeks quoted
•or average daily price high and low of closing prices most frequently
traded during two weeks before the public announcement whichever is
higher.
•Minimum 20% of voting capital to be acquired.
•The offer should not be more than 16 days
•11. Holding the meeting and pass with ¾ th majority of the value of
shares.And file such resolution with the Registrar within 30 days of the
resolution
•12. Submission of Chairman‘s Report of the General Meeting to Court
within 7 days.
•13. Joint petition to court within 7 days from the date of his report to
court for approving the scheme.
•14.Issue of Notice to Regional Director‘s Company Law Board u/s 394A
by the Court.
•15. Hearing of petition and confirmation of scheme
•16. Filing of Court‘s order with ROC by both the Companies.
•17. Dissolution of Transferor Company u/s 394(1)(iv) without winding
up.
•18. Transfer of assets and Liabilities U/s 394(2)
•19. Allotment of shares to shareholders of Transferor company
•20. Listing of shares at Stock Exchange-new shares allotted
•21. Court Order to be annexed to Memorandum of Transferee
Company
•22.Prevention of Books and papers of amalgamated Company
•23. Post merger secretarial obligation
The Companies Act 1956-Special provisions-merger/take over
•1. Condition Prohibiting Reconstruction or Amalgamation of Company
(sec.376)
•MOA Or AOA Or resolution prohibiting is void.It is also applicable for
reorganisation
71
Power to compromise or make arrangements with creditors and members
•Compromise either with company and the creditor/members/any class
of them
•The court may order the company to conduct meeting of the
creditors/class of creditors/members/class of members.
•¾ in value of such creditors/members vote for the resolution.It binds
on all creditors/members
Regulatory framework of Takeovers
•As per SEBI (Substantial Acquisition of Shares and takeover)
Regulations
The company which takes over make outside shareholders an
opportunity to exit.
The price will be the price the company which takes over paid to the
sellers or the average price quoted in the market
Disclosure of share holdings
•Any person holding more than shares 5% or 10%, 15% of voting rights
–disclose to SEBI within 2 months and to the company at every stage.
•The company also should disclose to all stock exchanges with in 3
months from the date of notifications.
•A promoter or person controlling company disclose with in 2 months.
•Purchase/ sale of 2% or more-with in 2 days to stock exchange and the
company.
•The company should disclose to all stock exchanges.
•Any person holding 15% -disclose to company within 21 days of the
financial year ending on 31st March.
Capital gains By
Augustin Amaladas.Lourduswamy
M.Com.,AICWA.,B.Ed.,PGDFM
Capital Assets
72
•Any stock-in-trade, consumable stores or raw materials held for the
purpose of his business or profession;
•Personal effects, i.e., movable property (including wearing apparel and
furniture, excluding jewellery), held for personal use by the assessee or
any member of his family dependent on him.
•Agricultural land in India, not being land situated in the following:-
•In any area which is comprised within the jurisdiction of a municipality
(whether known as a municipality, municipal corporation, notified area
committee, town area committee, town committee, or by any other
name) or a cantonment board and, which has a population of not less
than ten thousand according to the last preceding census.
•In any area within such distance, not being more than eight kilometers,
from the local limits of any municipality or cantonment board referred
to in item
Capital assets
• 6.5 per cent Gold Bonds 1977, or 7 per cent Gold Bonds 1980,
National, Defence Gold Bonds, 1980, issued by the Central
Government;
• Special Bearer Bonds, 1991, issued by the Central Government;
• Gold Deposit Bonds issued under the Gold Deposit Scheme, 1999
notified by the Central Government.
•
Computation of Short-term capital gain
1. Find out the full value of consideration
2. Deduct the following:
a. Expenditure incurred
wholly and exclusively
in connection with such
transfer.
b. Cost of acquisition.
c. Cost of improvement
3. From the resulting sum
deduct the exemption provided
by section 54B, 54D and 54G.
4. The balancing amount is the short-term capital gain.
Short term capital gain
73
Computation of Long-term capital gain
•1. Find out the full value of consideration
2. Deduct the following:
a. Expenditure incurred wholly and exclusively in connection with
such transfer
b. Indexed Cost of acquisition
c. Indexed Cost of improvement.
3. From the resulting sum deduct the exemption provided by section 54,
54B, 54D, 54EC,, 54F and 54G, and 54GA.
4. The balancing amount is the long-term capital gain.
How IS long term capital gain taxed?
•Flat rate-20%+Surcharge+Educational cess+ Secondary and higher
education cess.
•Surcharge-10% if net income exceed Rs.10,00,000 for
individual,HUF,AOP,BOI
• Educational cess-3% on tax
• Companies -10% if net income does not exceed 1 crore rupees.
3% educational cess
• For Assesment year 2008-09 secondary and higer education cess-
1% on( tax+surcharge)
Indexed cost of acquisition
•Formula
•Cost *Index of the year of sale/index of the year of acquisition of the
present owner
•cost= cost of acquisition of the present owner or
•Cost of acquisition of the previous owner in case of will or gift
indexed cost of acquisition?
•S 48 defines "indexed cost of acquisition" as the amount, which bears
to the cost of acquisition the same proportion as Cost Inflation Index for
74
the year, in which the asset is transferred, bears to the Cost Inflation
Index for the first year in which the asset was held by the assessee or for
the year beginning on the 1st day of April, 1981, whichever is later.
The Cost Inflation Index, in relation to a previous year, means such
Index as the Central Government may, having regard to 75% of
average rise in the Consumer Price Index for urban non-manual
employees for the immediately preceding previous year to such previous
year, by notification in the Official Gazette.
tax shelter for avoiding capital gains tax?
•The Income Tax Act grants total/partial exemption of capital gains
under Sec.- 54, 54B, 54D, 54EC, 54F, 54G and 54H.
Capital gains exemted U/S 10 1. Capital gain on transfer of US 64[Section 10(36)]- both long term and
short term
•2. Long term capital gain on transfer of BSE-500 Equity
Shares[10(36)]-long term
•3.Compulsory acquisition of urban agriculture land[10(37)]-longterm
and short term.-individual and HUF.
•4. Securities not chargeable to tax if covered under transaction tax-
such as mutual fund equity linked issued by domestic companies.
•5. Capital gain arising in the reconstruction or revival of power
generation business [10(41)]
75
Under S 54 F
•where, in the case of an assessee being an individual or a Hindu
undivided family,
•the capital gain arises from the transfer of any long-term capital asset,
•not being a residential house,
•within a period of one year before
• or two years after the date on which the transfer took place purchased, or
has within a period of three years after that date constructed, a residential
house.
S 54 G Voluntary transfer of industry
•The shifting of such industrial undertaking to any area other than an
urban area, and
• the assessee has, within a period of 1 year ,before
•or 3 years after the date on which the transfer took place, purchased a
new machinery or plant for the purposes of business of the industrial
undertaking
Sec.54GA Shifting from urban to Special Economic Zone
•Industry
•1year before or 3 years after transfer
•New asset can not be transferred with in 3 years.
Amalgamation
•cost of acquisition of the asset shall be deemed to be the cost of
acquisition to him of the shares(s) in the amalgamating company.(old
company )
conversion of bonds or debentures, debenture-stock
•the cost of acquisition of the asset to the assessee shall be deemed to be
that part of the cost of debenture, debenture- stock or deposit
certificates in relation to which such asset is acquired by the assessee.
Demerger
•The cost of acquisition of the shares in the resulting company shall be
the amount which bears to the cost of acquisition of shares, held by the
assessee in the demerged company
Compensation for loss of capital asset(Insurance claim)
•It amounts to extinguishment of right
76
•Sec.45(1A)
•Taxable in the year of compensation
Compensation for revenue asset-stock in trade
•It amounts to revenue receipt u/s-28 from business
•Or income from other sources u/s 56
Buy back of shares
•Sec.46A
•Transfer in the year of buy back
•Capital gain=consideration received minus cost of acquisition(Index if
long term)
Slump sale[50B]
•Assets are not sold individually but collectively
•Capital gain=Sale- Net worth
•Net worth= Assets—liabilities appearing in the books of accounts
•No index
77
Consolidation of business – options
A consolidation of ABC Limited and XYZ Limited can be
achieved either through a slump sale or itemized sale approach, de-
merger process or a merger
•Each of the consolidation approaches have been discussed in some
detail in the subsequent slides and the pros and cons have been outlined
Itemized and slump sale options
Conventional modes
•Sale of assets and liabilities through an itemized sale
•Slump sale of undertaking
Potential shortcomings
•No protection of carried forward tax losses
•Capital gains tax (in the range of 22-34 % on gains) on transfer
•Cash flow impact – movement of cash from one company to another
•No automatic dissolution of the selling company
•Long drawn winding up process of shell company
•Stamp duty at 8-10%* on market value of immovable properties
* On a conservative basis
De-merger (meaning)
•Generally, a de-merger means the splitting up of a company into one or
more companies through a court approved process
•A qualified de-merger is defined under the Income Tax Act, 1961(‗Act‘)
[section 2(19A)]
•The de-merger requires approvals from shareholders, creditors, the
jurisdictional Courts, etc
•Under the Act, de-merger is defined to mean a transfer pursuant to a
scheme of arrangement under sections 391 to 394 of the Companies Act,
1956, by a de-merged company of one or more of its undertakings to
any resulting company in the prescribed manner
78
•If the de-merger complies with the conditions prescribed under section
2(19AA) of the Act, it will result in specific tax benefits to the Group
companies and its shareholders
•For the purpose of the analysis, we have assumed that XYZ Limited
would be de-merged into ABC Limited
•We understand that XYZ Limited has only one undertaking, that is
principally engaged in certain services. In this regard, XYZ Limited
can de-merge its lone undertaking and transfer it to ABC Limited .
•Pursuant to the de-merger XYZ Limited would be a shell company
without any business
•Further, pursuant to the de-merger, a separate winding up process
would be required to wind up XYZ Limited to result in the creation of
only one entity in India
•The de-merger process has been explained later in this presentation.
Essentially the approval of the board of directors, shareholders, High
Court(s) approvals are required.
•Normal time frame 5 to 6 months
De-merger (conditions) •Section 2(19AA) of the Act, prescribes certain conditions, which
necessarily need to be complied with in order for the de-merger to
qualify as such under the Act and only in such circumstances are the
stakeholders eligible for various tax incentives under the Act
•Briefly the conditions prescribed are:
–The Scheme of arrangement to be under section 391to section 394 of the
Companies Act, 1956;
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–The scheme should result in the transfer of one or more undertakings;
–The undertakings to be transferred as a going concern and all property
and liabilities to be transferred;
–The transfer of property and liabilities to be at book value and there
should be no revaluation as such;
–Settlement of consideration by issue of shares to the shareholders of the
de-merged company on proportionate basis. Composite consideration
through a mix of equity and cash is not possible;
–Shareholders holding at least 75% in value to become shareholders in
the new resulting company.
•The de-merger should result in a transfer of one or more undertakings
•Explanation 1 to section 2(19AA) of the Act, defines an undertaking to
include:
–any part of an undertaking;
–a unit or division of an undertaking; or
–a business activity taken as a whole
but does not include individual assets or liabilities or any combination
thereof, not constituting a
business activity
•The underlying condition is that an ‗undertaking‘ should constitute a
separate business activity and should not merely represent assets or
property
•The other possible tests which would go on to substantiate a separate
undertaking are:
–Independent and distinct business
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–separate revenue stream
–Independence in terms of capital employed, assets, customer base,
employees, etc
–Continuation of business of the undertakings after de-merger
•The going concern condition contemplates that the company will
operate indefinitely and will not go out of business or liquidate its assets
• The going concern assumption assumes:-
–That the company does not have neither the intention nor the necessity
of liquidation or of curtailing materially the scale of business and
intends to continue its business for the foreseeable future
–Indicators like loss of key management personnel without replacement,
loss of major market or contract raises questions regarding the going
concern assumption being not valid
•Hence, it is necessary that all assets, liabilities, contracts and employees
relating to the services business of XYZ Limited should be transferred
to the resulting company (ABC Limited ) so that the going concern
condition is satisfied
•
•Liabilities include:-
–the liabilities which arise out of the activities or operations of the
undertaking
–the specific loans or borrowings (including debentures) raised, incurred
and utilised solely for the activities or operations of the undertaking
–general or multipurpose borrowings to the extent of :
total of such borrowing X value of the assets transferred in a
de-merger
total value of the assets of such de-
merged company
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•Properties include:-
–All immovable and movable assets which arise out of the activities or
operations of the undertaking
–All intangible assets which have been developed out of the functioning
of the undertaking
•Section 72A(4) of the Act provides that in the event of a de-merger, the
business loss and unabsorbed depreciation of the de-merged company to
the extent it relates to the undertaking being de-merged is deemed to be
the business loss and unabsorbed depreciation of the resulting company
and is permitted to be carried forward and set-off in the hands of
resulting Co
•In case where such loss or unabsorbed depreciation is directly relatable
to the undertaking transferred to the resulting company, the same shall
be allowed to be carried forward and set off in the hands of the resulting
company
•However where such loss or unabsorbed depreciation is not directly
relatable to the undertaking transferred, the same shall be apportioned
in the hands of de-merged and resulting company in the same
proportion in which the assets of the undertaking have retained by the
de-merged company and transferred to the resulting company.
•Practical challenges exist in determining the quantum of loss in cases
where there is more than one undertaking in the de-merged entity
•We understand that XYZ Limited has carry forward tax losses.
•In case of de-merger the benefit of carry forward is available to an
‗undertaking‘ in general and not restricted to industrial undertaking.
The term ‗undertaking‘ is wider than the term industrial undertaking.
As advised in slide 14, the business of XYZ Limited would qualify as
undertaking. Hence, the business loss or unabsorbed depreciation of
the de-merged company (XYZ Limited ), would be eligible for carry
forward in the hands of the resulting company (ABC Limited )
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Merger (meaning)
•A merger involves the union of 2 or more legal entities into 1 legal
entity accompanied by pooling of all financial and other resources of the
entities
•A qualified merger is defined under section 2(1B) of the Act
•Under the Act, amalgamation and merger are similar concepts
•Section 2(1B) of the Act defines amalgamation to mean merger of one
or more companies with another company or the merger of two or more
companies to form one new company
•Further, section 2(1B) prescribes the following conditions for a
qualified merger
–All properties to be transferred to the merged company
–All liabilities to be transferred to the merged company
–At least 3/4th in value of shareholders of the merging Co should be
shareholders in the merged Co
•The above conditions are cumulative and would need to be satisfied to
ensure that the amalgamation qualifies as a tax qualified merger
•The legal consolidation can be achieved through a Scheme of merger
under section 391-394 of Companies Act, 1956. The merger requires
approvals from shareholders, creditors, company law authorities and
the jurisdictional Courts
•Discharge of purchase consideration by way of issue of shares by
transferee company (ABC Limited ) to the shareholders of the
transferor company (XYZ Limited ). In addition, cash consideration
could also possibly be structured
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•Automatic dissolution of the transferor company (XYZ Limited ) and
hence separate winding up process is not necessary
•Time frame 5 to 6 months
•Section 72A(1) of the Act provides that in case of amalgamation of a
company owning an industrial undertaking with another company, the
business loss and unabsorbed depreciation of the amalgamating
company (XYZ Limited ) is permitted to be carried forward and set-off
in the hands of amalgamated company (ABC Limited ) subject to
fulfillment of certain conditions
•Conditions to be fulfilled by amalgamating company (XYZ Limited ):
–It qualifies as an industrial undertaking
–Has been engaged in the business for at least three years during which
the accumulated loss has occurred or the unabsorbed depreciation has
accumulated
–Has held continuously as on the date of the amalgamation at least
three-fourths of the book value of fixed assets held by it two years prior
to the date of amalgamation
Merger (tax implications)
Carry forward of losses
•Conditions to be fulfilled by amalgamated company (ABC Limited ):
–Holds at least 3/4th
of the book value of the fixed assets of the
amalgamating company (ABC Limited ) for a minimum period of five
years from the date of amalgamation
–The amalgamated company (ABC Limited ) continues the business of
the amalgamating company (XYZ Limited ) for a minimum period of
five years from the date of amalgamation
–It achieves a certain minimum level of production of installed capacity
of the amalgamating company. However, considering the fact that XYZ
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Limited is engaged in certain services, this condition should not per-se
be applicable
•In case the any of the above conditions are not fulfilled in subsequent
years the amount of loss or unabsorbed depreciation set off would be
taxable in the hands of amalgamated depreciation (ABC Limited ) in
the year in which the applicable condition is breached
•Further it should be noted that benefit of carry forward of losses is
available only to a company owning an industrial undertaking or a ship or
a hotel
•Industrial undertaking is defined in section 72A(7) of the Act to mean
an undertaking engaged in one of the following:-
–The manufacture or processing of goods
–The manufacture of computer software
–The business of generation or distribution of electricity or any other
form of power
–The business of providing telecommunication services
–The construction of ships, aircraft or rail systems
–Mining
•The above definition of the term industrial undertaking is exhaustive
and any other industry not falling within the above definition would not
qualify as industrial undertaking
•Hence any other entity not engaged in the businesses that have been
specifically covered in section 72A(7) of the Act and which merges into
another company would not be entitled to the benefit of carry forward
of business loss and unabsorbed depreciation
•We understand that XYZ Limited is engaged in the business of certain
services
•We also understand that such services would not fall within any of the
clauses of the definition of the term industrial undertaking
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•XYZ Limited hence may not qualify as a company owning an
industrial undertaking and hence upon merger may not be able to carry
forward business losses and depreciation if a merger option is pursued
Stamp duty implications
on de-merger and merger
•We have not been provided with the financial statements of XYZ
Limited and ABC Limited . We also have not been provided with the
value of immovable property.
•Therefore, we are unable to quantity potential stamp duty liabilities
and the purpose of this section is to address the concept and broad
principles
•Stamp duty is payable in the state in which the registered office (RO) of
the de-merged or amalgamating company is situated or where the
immovable property is located
•We understand that XYZ Limited has its registered office in Mumbai,
Maharashtra. Further, XYZ Limited has operations in Calcutta (West
Bengal) and Bangalore
•In such a case, the de-merger or merger of XYZ Limited with ABC
Limited could trigger stamp duty levies in Mumbai, the state where the
registered office is located and in West Bengal and Karnataka, the
states where immovable property (if any) is located. Practically the
stamp duty is payable at the rate of the state which imposes the
maximum stamp duty and although stamp duty is payable in the other
states credits may possibly be obtained. The exact mechanics would
need to be checked by a lawyer
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Stamp duty implications
Maharashtra Stamp Act provisions
•The Maharashtra Stamp Act has specific entries prescribing stamp
duty rates applicable in merger and de-merger situations
•The applicable stamp duty levy is 10% of the market value of shares
issued or allotted on merger or de-merger and the amount of
consideration payable as such
•However the above rate is restricted to higher of the following limits:
–5 percent of the market value of the immovable property of the selling
Co located in Maharashtra; or
–0.7 percent of the market value of the shares issued or allotted plus
amount of consideration paid.
•Where no property is situated in Maharashtra, stamp duty in
Maharashtra is payable on 0.7 percent of the consideration paid on de-
merger or merger
Stamp duty implications
Karnataka Stamp Act provisions
•The Karnataka Stamp Act also has specific entries prescribing stamp
duty rates applicable in merger and de-merger situations
•The stamp duty payable in Karnataka is computed based on the lower
of the following limits:
–7 percent of the market value of the immovable property or 0.7 percent
of the value of shares, whichever is higher; or
–10 percent of the value of the shares
Stamp duty implications
West Bengal Stamp Act provisions
•West Bengal does not have a separate state duty legislation and hence
one would need to resort to the provisions of the Indian Stamp Act. The
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West Bengal State Government has however issued time to time
notifications amending the provisions of the Indian Stamp Act as
applicable specifically to the State of West Bengal
•The Indian Stamp Act provides for stamp duty on conveyance as
defined in section 2(10)
•As per the Indian Stamp Act, the term ‗conveyance‘ has been defined to
include a sale or conveyance and every instrument by which property,
whether movable or immovable, is transferred and which is otherwise
not specifically provided for by Schedule I A
•The West Bengal State Government in the context of conveyance has
notified that the term conveyance would include any court decree
providing for amalgamation, merger, reconstruction or de-merger of
companies
•The West Bengal State Government has also notified that the
applicable stamp duty levy is 8% on market value of property
transferred in the case of a conveyance
Stamp duty implications
Haryana Stamp Act provisions
•Since XYZ Limited does not have any presence in Haryana, the
provisions as applicable to stamp duty in the state of Haryana should
per se not apply. The Haryana Stamp Act provisions would assume
importance in case ABC Limited is the selling Co
•Haryana does not have a separate state duty legislation and hence one
would need to resort to the provisions of the Indian Stamp Act
•As per the Indian Stamp Act, stamp duty is payable at 8% on the
market value of the immovable property. However, there is no specific
notification on whether stamp duty is payable on merger or
amalgamation
•In the absence of a specific entry, Indian Courts have been divided on
the applicability of stamp duty on de-merger and merger transactions
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•While the Calcutta High Court has held that stamp duty is not payable
in a merger or de-merger transaction, the Bombay High Court has
ruled to the contrary. The conservative view here is that stamp duty is
payable even in the case where there are no specific entries supporting
the levy and is liable at the rate as applicable to conveyance
Stamp duty implications
Stamp duty on issue of shares
•As per the Indian Stamp Act, issue of shares would be subject to stamp
duty at 0.1% of the value of shares issued
•Issue of shares by XYZ Limited to the shareholders of ABC Limited
would be subject to stamp duty at 0.1% of the value of shares issued Stamp duty implications (summary)
•If ABC Limited merges or de-merges its business into XYZ Limited , it
is possible that stamp duty is payable in the states of Maharashtra, West
Bengal and Karnataka
•All of the above states have provided guidance on the quantum of
stamp duty payable in the case of a merger or de-merger process and
the stamp duty payable would need to be computed based on the highest
levy prescribed
•The broad stamp duty as applicable to the subject transaction can be
computed on the basis of the net book values as reflected in the latest
financial statements, which will determine the shares to be issued to the
shareholders of XYZ Limited . The market values of immovable
properties are also required to compute the stamp duty amounts
•Considering that XYZ Limited is a services company, it is unlikely that
there would be significant ownership of immovable assets and hence the
stamp duty costs may not be large
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•The issue of shares by XYZ Limited to the shareholders of ABC
Limited would be subject to stamp duty at 0.1% of the value of shares
issued
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DDee--mmeerrggeerr aanndd mmeerrggeerr pprroocceessss •Board approval of the transferor and transferee company
•Preparation of a de-merger or merger scheme (―scheme‖) and
valuation
•Application to the High Court for directions to convene / dispense with
meetings
•Convening of Meetings (if ordered by the Court) and submission of the
chairman‘s report
•Petition to the High Court
•Implementation of the Scheme
De-merger and merger process
The scheme should inter-alia contain the following matters:-
•Definitions
–Transferor Company (XYZ Limited ) & Transferee Company (ABC
Limited )
–Effective date of Transfer – Appointed Date
–Undertakings to be transferred pursuant to the scheme
•Contracts, agreements, pending suits, charges and guarantees of
Transferor Co
•Transfer of employees of Transferor Co to Transferee Co
–On same terms and conditions as applicable in the transferor co
–Without any break or interruption in their services
–Transfer of balances held in provident funds, etc to respective funds of
transferee co
De-merger and merger process
•Interim period related issues
–Functioning of the transferor company and transferee co until such
time Court approvals are obtained
–Issue of further shares in the transferor company and transferee
company until such time the Court approvals are obtained and rights of
the existing shareholders to participate
•Payment of consideration by the transferee company to shareholders of
the transferor Company
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–Record date i.e. cut off date on which the shareholders in the transferor
Co would be issued shares in the transferee Co
–Exchange ratio and treatment of fractional shares and rights of the new
shareholders
•Accounting Treatment in accordance with the applicable Indian
accounting standard
•Conditions precedent and expenses of the scheme
–Obtaining various approvals such as labour law approvals, creditor
approvals, etc
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De-merger and merger process - valuation
•The valuation could be a subjective process since this could depend on
the valuation methodology followed by the respective Valuer
•There are several recognized valuation approaches including Net Asset
Value, Profit Earning Capacity Value, Market Value, Discounted Cash
Flow, Hybrid Methods, etc
•The appropriateness of Method could depend on several methods
including purpose of valuation, the size of stake being valued, nature of
entity, etc
•In the instant case, since the transfer of the undertakings is between
related entities, it may be appropriate to transfer at book values.
Further, since the transfer is between related entities, valuation may not
be a critical factor. Given, the fact pattern, the Court may even
dispense with the requirement to obtain a separate valuation for this
purpose
De-merger and merger process - Board of Directors approval
•It is necessary to obtain the approval of Board of Directors of both the
transferor company (XYZ Limited ) as well as the transferee company
(ABC Limited )
–To approve the Scheme and adopt and / or recommend exchange ratio
–Authorize any director / company secretary / officer to implement the
scheme
–Authorize any director / company secretary / officer to execute / sign
necessary documents
•The object clause in the memorandum of association of XYZ Limited
to provide for de-merger and merger; else the object clause would need
to be altered
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De-merger and merger process - High Court application
•Each company has to make an application to the jurisdictional High
Court:-
–High Court under whose jurisdiction the registered office of the
company is situated
–We understand that in the instant case, registered office of XYZ
Limited and ABC Limited is located in different states
–Hence, separate application to the jurisdictional High Court i.e. Courts
in Haryana and Mumbai will have to be filed
–The possibility of shifting one of the registered offices to one state can
also be evaluated to avoid the requirement to obtain two High Court
approvals
–Petition should contain the de-merger / merger scheme highlighting key
features of the scheme
•Application seeking directions to convene meeting of shareholders and /
or creditors
–Application to be made in Form 33 along with Affidavit in Form 34
De-merger and merger process - High Court application
•The Court will order that meetings of all stakeholders i.e. the
shareholders and creditors (including banks and financial institutions)
be called for and their approval be taken to the scheme, necessary
provisions are made to safeguard interests of the dissenting parties
•The direction as to meetings – order in Form 35 shall be issued by the
High Court
–Determination of classes of creditors / members whose meetings are
required to be held
–Fixing time, place and quorum for each meeting
–Appointing chairman for the meeting
–Particulars of notice to be given for each meeting
–Directions as to advertisements to be released in newspapers and
government gazette
–Format of the report of the chairman of each meeting
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De-merger and merger process - stakeholder meetings
•The meetings are to be convened as per directions of the Court
–Chairman appointed by the Court to preside over the meeting
–Voting at the meeting to be taken by poll only
•The scheme is to be approved by special majority - Section 391(2) of
the Co Act
–Majority in number - 51% of the members / creditors present should
vote in favor of the scheme
–3/4th in value - The above majority shareholders should be holding
75% shares in value terms
•Chairman to report (in Form 39) result of the meetings to the Court
–Report to be submitted within 7 days of the meeting
De-merger and merger process - stakeholder meetings
•Notice of the meetings – Typical requirements
–At least 21 days‘ clear notice
–To be sent under Certificate of Posting
–To be sent along with Explanatory Statement, Scheme and Proxy Form
•Explanatory Statement under Section 393
–Salient features of the Scheme, its purpose, effect and implications
–Disclosure of material interests of the directors in the Scheme
•Publishing of advertisements – at least 21 days before the meeting
–In one vernacular and one English newspaper
•Notices, Explanatory Statements and advertisements to be approved by
the High Court
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De-merger and merger process - stakeholder meetings
•In the case of each meeting, chairman to file an affidavit:-
–To the effect that all the formalities relating to convening of meeting
have been complied with as per the Court‘s directions and this report
has to be filed at least 7 days before the meeting
–Financials statements, valuation report, proxy register, etc to be made
available for inspection by shareholders or creditors as required
•Other arrangements to be made for the meetings include:-
–Identify two scrutinizers for the meeting
–Shareholders‘ Register and list of Creditors along with their
outstanding dues
–Speech of the Chairman
–Ballot Papers and Ballot Box required for consent of the scheme
De-merger and merger process - High Court
petition •Once the stakeholder meetings are held, a petition in Form 40 must be
filed with the jurisdictional High Court(s) (Mumbai and Haryana)
seeking approval of the Scheme
–To be presented within 7 days of filing the Chairman‘s report
•Admission of the Petition
–The Court to fix a date of final hearing for consideration of the petition
•Notice of Petition and date of final hearing to be given to the Central
Government i.e. Regional Director and Company Law Board and to
newspapers and Government Gazette
De-merger and merger process - High Court
petition •Prior to filing the High Court petition with the jurisdictional High
Court(s), an advocate is required to file an affidavit of compliance at
least 7 days before the date of final hearing
•The jurisdictional High Court(s) will consider the following factors
while hearing the Petition - Court‘s function, power and discretion
–Ensure compliance with requisite statutory procedure
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–Approval of all the stake holders
–Whether scheme not in violation of any provision of law and not
contrary to public policy
–Whether the scheme is against public interest
–Completeness and workability of the Scheme
•Order of the Petition (Form 41) will be issued after the petition
De-merger and merger process – other investment
approvals •Under Indian foreign direct investment and exchange control
legislation, an Indian Co can pursuant to a merger or de-merger issue
shares under the automatic route i.e. without the requirement to obtain
specific approvals subject to the satisfaction of certain conditions:-
–The foreign shareholding does not exceed the applicable sectoral caps
as permitted
–The transferor and transferee co shall not engage in plantation or real
estate business
–The transferee co files a return in the prescribed form to the Reserve
Bank of India outlining the details of the de-merger and merger and the
details of the shares issued
•It is also important that the shares issued by the transferee co complies
with applicable valuation norms. Here, the shares need to be valued on
the basis of the average of Net Asset Value or the Price Earning
Capacity Method as discounted by an appropriate variable
•It is our understanding that the investment in XYZ Limited n entities
have been under the automatic route where no specific investment
approvals have been obtained. Upon merger or de-merger the
applicable conditions outlined above are likely to be satisfied and no
separate investment approval should be required, subject to certain
reporting formalities
De-merger - notices to regulatory authorities
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•We would like to bring out that if a de-merger is implemented, XYZ
Limited would be a shell company pursuant to the de-merger
•The Courts in India prior to approving the scheme would issue notices
to various regulatory authorities to provide comments, if any, on the
proposed scheme
•It is possible here that the Indian tax office may challenge the de-
merger scheme and contest that a de-merger was the preferred option
(vis-à-vis amalgamation) only so that the resulting entity could obtain
tax concessions through carry forward of business losses and
unabsorbed depreciation
•If the de-merger is the preferred consolidation approach, this issue
would need to be debated further and addressed
De-merger and merger process - implementation
of the Scheme •Upon obtaining the order of the High Court(s), the order must be filed
with appropriate RoC
–As per Section 394(3), within 30 days of the date of receiving certified
copy of the order
–RoC acknowledgement to be filed with the High Court for form /
decree
•Other steps to be taken
–Payment of stamp duty on the Order
–Allotment of shares pursuant to the Scheme
–Appending the Order of the High Court to Memorandum
–Preservation of Books of Accounts of Transferor Co (Section 396A)
•The de-merger and merger is effective from the date the form / decree
passed by the High Court and unless the appointed date is changed by
the High Court(s), the de-merger and merger takes effect from the
appointed date as selected by the company
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SSppeecciiffiicc QQuueerriieess--11 •
•The transfer of shares pursuant to a de-merger or merger process
would not impact the ability to carry forward business losses, subject to
other conditions being satisfied
•Here, in the case of merger, since the amalgamating company (XYZ
Limited ) may not qualify as an industrial undertaking the ability to
carry forward losses may be impacted
•We understand that one of the possible options the ABC group is
creating a holding – subsidiary structure through one Indian company
acquiring the shares of the other operating entity. Once the structure is
in place the entities will be merged or de-merged
•This kind of merger or de-merger in certain states could reduce the
stamp duty impact since on merger the shares are cancelled and hence
the computational mechanism fails
Specific Queries-2
•However, section 79 of the Act places a restriction on carry forward
and set off of business losses if in a closely held company shares
carrying voting power are transferred beyond a specified percentage
(49%). In view of the restriction contained in section 79 of the Act,
there is a possible exposure that XYZ Limited could lose the benefit of
carry forward and set off of business losses in the capacity of a
subsidiary company of ABC Limited
•The risk is mitigated to the extent that the ultimate shareholders
remain common since shares continue to be held within the ABC Group
i.e. commonality of ultimate shareholders of ABC Limited and XYZ
Limited are common. A few tax commentaries also support this view.
This is however a contentious issue and will be contested by the revenue
authorities particularly at lower levels
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•Further, please note that this section does not apply to unabsorbed
depreciation and there would be no exposure in terms of carry forward
and set off of the same
•Under Indian tax law, we would also like to bring out that each entity is
a separate legal entity and losses of one company cannot be set off
against profits of the other
Specific Queries
•Transfer of shares by shareholders of XYZ Limited pursuant to a de-
merger or merger process would not attract capital gains tax
•Generally, a transfer of shares in an unlisted Indian company other
than through a de-merger or merger is subject to capital gains tax
•The all inclusive tax rate on sale of equity shares is 22.66 percent in case
the gain is long term i.e. held for more than a 1 year period and 33.99
percent if short term i.e. under 1 year
Specific Queries-3
•Transfer of capital assets by ABC Limited to XYZ Limited pursuant
to a merger or de-merger process would not be subject to capital gains
tax
•Generally, a transfer of a business or assets at profit is subject to
capital gains tax. The all inclusive tax rate is 22.44 percent in case the
gain is long term i.e. held for more than a 3 year period and 33.66
percent if short term i.e. held under a 3 year time period
Specific Queries-4
•The Indian company law and Indian tax laws specifically provide for a
merger of two Indian companies by following the specified court
approval process, as detailed earlier
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•It would not make any difference if the two Indian entities are parent /
subsidiary or sister companies and these companies can be merged as
well
•In certain states, the merger of a subsidiary into a parent may go to
mitigate stamp duty costs, however, in the instant case if the Indian
entities are structured as parent / subsidiaries structure, the benefit of
carry forward of business losses of the amalgamating company may
need to be evaluated further if such a structure is adopted (section 79)
•Further, in the case of the present fact pattern, the merger of two
companies into a new company may not achieve additional efficiencies
since this may result in the payment of stamp duty for both entities vis-
à-vis if one entity were to merge into the other
Specific Queries-5
•In both a de-merger or merger, stamp duty would be payable. Stamp
duty is typically levied on the value of shares or immovable property, as
illustrated earlier
•In an itemized or slump sale option, stamp duty is payable on the value
of immovable assets transferred. Further, in an itemized sale, a VAT or
sales tax may be applicable at 12.5% on the value of movable assets
•We could help with quantifying the stamp duty and VAT implication
under various options identified, once we are provided with a copy of
the financial statements and the values of immovable property held by
the Indian operating companies
•The stamp duty is payable on market value of the immovable property
could typically range between 8 to 10 percent
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CCoonncclluussiioonn aanndd wwaayy ffoorrwwaarrdd
•Review the potential consolidation options at length after a review of
the financial statements and the value of immovable property to
determine the most suitable option
–Determine the entity which needs to be merge or de-merge with the
other
–Determine if both entities should merge or de-merge into a new entity
–Determine slump sale and itemized sale options further, if necessary
–Participate in lawyer discussions to take forward the Court process, etc
•Assist with quantifying the stamp duty and other costs associated with
each option to determine the most feasible option
•Assist with identifying other business and commercial issues, which
may be relevant to the subject consolidation
•Assist with implementing the preferred consolidation option
Case Study
When Carly Fiorina was appointed CEO of Hewlett-Packard in 1999, it
marked many firsts: the first outsider, the first woman, the first non-
engineer, and the youngest person ever to head HP in its 60-year history. Her
mandate from the board: “totally recreate and reinvent HP according to the
original HP Way.” In many people‟s eyes, she accomplished this,
transforming the company from a slow, risk-averse country club into a
battle-ready competitor in the „new economy‟. Others believe she destroyed
the very heart and soul of a company that was founded on ideals worthy of a
Frank Capra movie.
In this case, Professor Randel Carlock, Berghmans Lhoist Chaired Professor
in Entrepreneurial Leadership and Elizabeth Florent-Treacy, Senior
Research Associate, detail the merger, the bitter and very public battle with
the Hewlett and Packard families, and the larger issues of corporate
governance, the relationship between boards and management, and the role
of families that have both financial and emotional stakes in a company.
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This EFMD 2004 Case Competition winner begins with Fiorina‟s arrival in
1999 at an embattled HP, losing market share and pride to the likes of IBM
and Dell. She was to be the saviour, the one to bring HP back to the glory
days under its cherished and now deceased founders, William Hewlett and
David Packard. After a brief honeymoon, Fiorina shakes things up with talks
of a merger with Compaq, launching an ugly battle with the Hewlett and
Packard heirs, which seems to catch her completely by surprise.
At stake is the soul of a company that many revere as an icon among
technology firms in America. Bill Gates hadn‟t even been born when the two
founders started tinkering together in a garage in Palo Alto, California. Not
long after founding the company, the two draft "The Seven Principles of the
HP Way". Included among them are the mandates to “Recognize that profit
is the best measure of a company‟s contribution to society and the ultimate
source of corporate strength,” “Demonstrate good citizenship by making
contributions to the community,” and “Maintain an organizational
environment that fasters individual motivation, initiative and creativity.”
Now, six decades later, Walter Hewlett, an HP board member, votes “Yes”
to the merger but immediately starts a campaign to stop it. With the support
of other family members and the Packard Family Foundation, which in total
own 18% of HP shares, the normally reserved Hewlett leads a fight that
nearly puts an end to the highly publicized merger. In the end Fiorina wins,
after receiving last-minute support from Deutsche Bank. What‟s left over,
say Carlock and Florent, are a series of difficult questions.
Perhaps all would have proceeded smoothly if Fiorina had considered the
concerns of the families before proceeding. They did, after-all, have large
financial and emotional stakes in the company. And what lessons can be
learned about corporate governance? Walter Hewlett says he has learned a
lot, telling an audience at a speaking engagement that the board and
management should have separate counsel during mergers to ensure
unbiased advice and fair representation of shareholders views. In addition,
the case asks students to explore the challenge of leadership when
attempting to regenerate a highly regarded corporation and the significance
of corporate culture in organizational transitions.
Click on 'Carly Fiorina and HP' below to read Randel Carlock's analysis of
Fiorina's recent dismissal from HP.
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Case Study-1
Tata pleases, Ford 'disappoints' British workers' union
Wed, Mar 26 2008 06:38 PM
London, March 26 (IANS) The head of Britain's largest workers union
Wednesday reiterated his support for Tata's acquisition of the luxury car
brands Jaguar and Land Rover, but said he was disappointed by seller Ford's
failure to retain a stake.
'If Jaguar and Land Rover had to be sold, then Tata was the best option,' said
Tony Woodley, joint general secretary of Unite, as Ford announced the sale
of the two British iconic cars to Tata Motors Ltd.
The deal, announced Wednesday, already has the union's seal of approval,
after it secured Tata's assurance that it will not shed jobs at the three Jaguar
and Land Rover factories at Solihull, Castle Bromwich and Halewood and
would continue to source Ford-made engine and components from its
factories in Bridgend and Dagenham.
'We would have much preferred Ford to keep the companies in the family,
so to speak, especially with Land Rover being so profitable,' Woodley said.
'But with the commitments Tata have given to the future of Jaguar-Land
Rover and the long-term supply agreements for components, especially
engines from Bridgend and Dagenham, we're obviously pleased they are in
the game.'
However, Woodley added that there was disappointment that Ford had
decided against taking a stake in the new future.
'That is a big disappointment,' he said.
According to sources in Unite, union officials would have liked to see Ford
take a minority stake, as it did while selling off the luxury car Aston Martin
to two Kuwaiti investment companies last year. Ford retained a $77 million
stake in Aston Martin.
This, the union officials feel, would have helped to 'lock in' long-term
commitments made as part of the agreement signed Wednesday between
Tata and Ford.
The nervousness may be explained by the fact up to 40,000 jobs were at
stake at a time of a global economic slowdown.
'On the positive side, Tata has not only given us a long-term commitment,
but they are an industrial company as well,' Unite's Andrew Dodgson told
IANS.
'Tata recognise the iconic brand value of Jaguar-Land Rover - that they are
British-engineered and British-made cars and so it is important to keep them
in Britain,' he added.
104
Ford acquired Jaguar for $2.5 bn in 1989 and Land Rover for $2.75 bn in
2000 but put them on the market last year after posting losses of $12.6 bn in
2006 - the heaviest in its 103-year history.
Tata was named by Ford as the preferred bidders in January as it beat off
competition from fellow-Indian carmaker Mahindra and Mahindra and
American buy-up specialist One Equity.
While the three Jaguar and Land Rover factories in Britain employ some
16,000 people, the number swells to between 30,000 and 40,000 when
ancillaries are taken into account, according to Dodgson.
Case Study-2
May 2007, India's Ministry of Civil Aviation announced that Air India
Limited (AI), India's national flag carrier and Indian Airlines Limited (IA),
the government owned domestic airline, would merge with effect from July
15, 2007. The new airline formed by the merger was to be called 'Air India,'
and would operate in both the domestic and international sectors. The
proposal to merge AI and IA had been first mooted in the 1990s. In February
1999, a Parliamentary Standing Committee on Transport and Tourism had
recommended the merger of AI and IA in its report on the 'Functioning of
Air India'.
However, the process had formally been initiated only in September 2006,
when the Indian government assigned the duty of preparing the roadmap for
the merger to Accenture Inc., a management consulting, technology services
and outsourcing company. After being endorsed at various levels of the
administrative hierarchy, the plan for the merger was finally approved by the
Union Cabinet in March 2007.
A new company called the National Aviation Company of India Ltd.
(NACIL) was incorporated on March 30, 2007 under Sections 391 and 394
of the Indian Companies Act, 1956 to facilitate the merger. Under the terms
of the merger, all the undertakings, properties, and liabilities of AI and IA
were to be transferred to NACIL.
The AI-IA merger was expected to create one of the biggest airlines in the
world in terms of the fleet size. As of May 2007, the two airlines had a
combined fleet of 122 aircraft and 34,000 employees including 1,315 pilots.
The combined fleet size placed the merged entity among the top 10 airlines
in Asia, and the top 30 in the world. It would also be India's first airline with
more than 100 aircraft.
105
The motives for the merger were widely discussed in the media. India was
the fastest growing aviation market in the world, ahead of China, Indonesia
and Thailand, as of early 2007. The number of people traveling by air had
been increasing rapidly in the country. The main reason for this was thought
to be the advent of low cost airlines like Air Deccan and SpiceJet in the
country in 2003-2004, which brought air travel within reach of India's large
middle class. The entry of a number of new airlines had intensified the
competition in the aviation sector by 2004.
Mumbai: Merger of national carriers Air India and Indian Airlines has been
challenged in the Bombay High Court on the ground that it defies
Parliament‟s intent to keep international and domestic carriers separate.
The petition filed by Air India Cabin Crew Association (AICCA) also
questions the Constitutional validity of section 620 of Companies Act,
which empowers government to exempt any government company from
provisions of the Act.
Air India Limited and Indian Airlines Limited were created by a
Parliamentary statute, and, therefore, without the Parliament‟s nod they
cannot be amalgamated, the petition contended.
AICCA claims to the “sole recognised trade union” in Air India Limited, and
has 1,800 members. The petition is expected to come up for hearing in the
first week of December.
The merger (amalgamation) of AI and IA was sanctioned by the Ministry of
Corporate Affairs on 22 August this year. The move was aimed at bringing
about more efficiency and better utilisation of resources. A new company
called National Aviation Company of India was created to replace them.
However, AICCA contends that in sanctioning the amalgamation,
Parliament was bypassed.
Tracing the history of the national carriers, it points out that in 1953, eight
private airlines were nationalised under Air Corporations Act, which created
AI and IA. Further, in 1994, Air Corporations (Transfer of Undertakings and
Repeal Act) Act was passed, which converted AI and IA into Air India
Limited and Indian Airlines Limited, respectively.
Case Study-3
Second largest Bank in India is now formally in place . RBI has given
approval for the reverse merger of ICICI Ltd with its banking arm ICICI
Bank. ICICI Bank with Rs 1 lakh crore asset base bank is second only to
State Bank of India, which is well over Rs 3 lakh crore in size. RBI also
cleared the merger of two ICICI subsidiaries, ICICI Personal Financial
Services and ICICI Capital Services with ICICI Bank.
106
The merger is effective from the appointed dated of March 30, 02, and the
swap ratio has been fixed at two ICICI shares for one ICICI Bank share.
Reserve Bank, approval is subject to the following conditions:
(i) Compliance with Reserve Requirements
The ICICI Bank Ltd. would comply with the Cash Reserve Requirements
(under Section 42 of the Reserve Bank of India Act, 1934) and Statutory
Liquidity Reserve Requirements (under Section 24 of the Banking
Regulation Act, 1949) as applicable to banks on the net demand and time
liabilities of the bank, inclusive of the liabilities pertaining to ICICI Ltd.
from the date of merger. Consequently, ICICI Bank Ltd. would have to
comply with the CRR/SLR computed accordingly and with reference to the
position of Net Demand and Time Liabilities as required under existing
instructions.
(ii) Other Prudential Norms
ICICI Bank Ltd. will continue to comply with all prudential requirements,
guidelines and other instructions as applicable to banks concerning capital
adequacy, asset classification, income recognition and provisioning, issued
by the Reserve Bank from time to time on the entire portfolio of assets and
liabilities of the bank after the merger.
(iii) Conditions relating to Swap Ratio
As the proposed merger is between a banking company and a financial
institution, all matters connected with shareholding including the swap ratio,
will be governed by the provisions of Companies Act, 1956, as provided. In
case of any disputes, the legal provisions in the Companies Act and the
decision of the Courts would apply.
(iv) Appointment of Directors
The bank should ensure compliance with Section 20 of the Banking
Regulation Act, 1949, concerning granting of loans to the companies in
which directors of such companies are also directors. In respect of loans
granted by ICICI Ltd. to companies having common directors, while it will
107
not be legally necessary for ICICI Bank Ltd. to recall the loans already
granted to such companies after the merger, it will not be open to the bank to
grant any fresh loans and advances to such companies after merger. The
prohibition will include any renewal or enhancement of existing loan
facilities. The restriction contained in Section 20 of the Act ibid, does not
make any distinction between professional directors and other directors and
would apply to all directors.
(v) Priority Sector Lending
Considering that the advances of ICICI Ltd. were not subject to the
requirement applicable to banks in respect of priority sector lending, the
bank would, after merger, maintain an additional 10 per cent over and above
the requirement of 40 per cent, i.e., a total of 50 per cent of the net bank
credit on the residual portion of the bank's advances. This additional 10 per
cent by way of priority sector advances will apply until such time as the
aggregate priority sector advances reaches a level of 40 per cent of the total
net bank credit of the bank. The Reserve Bank‟s existing instructions on sub-
targets under priority sector lending and eligibility of certain types of
investments/funds for reckoning as priority sector advances would apply to
the bank.
(vi) Equity Exposure Ceiling of 5%
The investments of ICICI Ltd. acquired by way of project finance as on the
date of merger would be kept outside the exposure ceiling of 5 per cent of
advances towards exposure to equity and equity linked instruments for a
period of five years since these investments need to be continued to avoid
any adverse effect on the viability or expansion of the project. The bank
should, however, mark to market the above instruments and provide for any
loss in their value in the manner prescribed for the investments of the bank.
Any incremental accretion to the above project-finance category of equity
investment will be reckoned within the 5 per cent ceiling for equity exposure
for the bank.
(vii) Investments in Other Companies
The bank should ensure that its investments in any of the companies in
which ICICI Ltd. had investments prior to the merger are in compliance with
Section 19 (2) of Banking Regulation Act, 1949, prohibiting holding of
108
equity in excess of 30 per cent of the paid-up share capital of the company
concerned or 30 per cent of its own paid-up share capital and reserves,
whichever is less.
(viii) Subsidiaries
(a) While taking over the subsidiaries of ICICI Ltd. after merger, the bank
should ensure that the activities of the subsidiaries comply with the
requirements of permissible activities to be undertaken by a bank under
Section 6 of the Banking Regulation Act, 1949 and Section 19 (1) of the Act
ibid.
(b) The take over of certain subsidiaries presently owned by ICICI Ltd. by
ICICI Bank Ltd. will be subject to approval, if necessary, by other regulatory
agencies, viz., IRDA, SEBI, NHB, etc.
(ix) Preference Share Capital
Section 12 of the Banking Regulation Act, 1949 requires that capital of a
banking company shall consist of ordinary shares only (except preference
share issued before 1944). The inclusion of preference share capital of Rs.
350 crore (350 shares of Rs.1 crore each issued by ICICI Ltd. prior to
merger), in the capital structure of the bank after merger is, therefore, subject
to the exemption from the application of the above provision of Banking
Regulation Act, 1949, granted by the Central Government in terms of
Section 53 of the Act ibid for a period of five years.
x) Valuation and Certification of the Assets of ICICI Ltd
ICICI Bank Ltd. should ensure that fair valuation of the assets of the ICICI
Ltd. is carried out by the statutory auditors to its satisfaction and that
required provisioning requirements are duly carried out in the books of
ICICI Ltd. before the accounts are merged. Certificates from statutory
auditors should be obtained in this regard and kept on record.
109
National Aviation Company of India Ltd, the new entity formed after the
merger of Indian and Air India, today moved the Supreme Court seeking
consolidation of the cases challenging the merger of the two state carriers.
Case Study-4
Merger of Lord Krishna Bank with Centurion Bank legal'
K. C. Gopakumar
Counter affidavit filed against challenging the merger
All shareholders who wanted to exercise their vote were able to vote
without obstruction at the AGM'
Sec. 237 of Companies Act applicable only to companies other than
banking companies'
Kochi: There is absolutely no basis or ground to appoint any inspector to
investigate the affairs relating to the scheme of amalgamation of Lord
Krishna Bank with the Centurion Bank of Punjab, according to
B.Swaminathan, managing director and chief executive officer of the bank.
In a counter-affidavit filed in the High Court, he said section 237 of the
Companies Act was applicable only to companies other than banking
companies. Banking companies were controlled, supervised and inspected
by experts of the Reserve Bank of India (RBI), which could not be done by
inspectors to be appointed by the Central Government under section 237 of
the Companies Act.
The affidavit was filed in response to a writ petition filed before the Kerala
High Court by Umesh Kumar Pai, a minority shareholder, challenging the
merger and seeking to appoint inspectors to investigate the amalgamation
scheme.
The affidavit said no provision of the Companies Act could be invoked to
challenge the amalgamation proceedings initiated under section 44A of the
Banking Regulation Act. In fact, section 44A had overriding effect over
section 237 or any other provisions of the Companies Act.
The affidavit further said resolutions were moved one by one and
arrangements were made for members/proxies to exercise their votes. The
allegations that there was obstruction at the venue of the AGM were
baseless.
All the shareholders or proxies who wanted to exercise their votes were able
to vote without any obstruction. The allegation that there was no discussion
was false. The chairman of the meeting had invited shareholders for
discussion.
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A resolution for the approval of the scheme of amalgamation was passed
with the requisite majority in accordance with the provisions of section 44A
of the Banking Regulation Act.
While 5,63,65,282 votes of the same value were cast for the resolution only
6,046 votes of the same value were cast against the resolution. Of the 1,784
members present in person or by proxy at the meeting, 1,740 shareholders
voted in favour of the resolution while only 24 voted against the resolution
and 20 votes were invalid.
Thus, the resolution approving the scheme of amalgamation was passed by a
majority in number representing two thirds in value of the shareholders
present either in person or by proxy at the meeting as required under section
44A(1) of the Banking Regulation Act, the affidavit added.
The allegation that 65 per cent of the shares were held by a single entity was
totally false. No person holding share in excess of ten per cent of the bank
exercised voting rights in excess of 10 per cent.
With the permission of the RBI, a person could hold more than 10 per cent
of the share of a banking company but the right to exercise vote was
restricted to 10 per cent of the total voting rights.
Case Study-5
In a dramatic climax to a bitter takeover battle that laid bare the large role still played by
economic nationalism in Europe, France's largest drug maker, Aventis SA, Sunday
agreed to be swallowed by its smaller rival, Sanofi-Synthelabo SA, for about €55.2
billion, or $65 billion in cash and stock.
Resorting to behind-the-scenes arm-twisting of Sanofi, along with public and private
warnings to back off directed at rival suitor Novartis AG of Switzerland, the French
government succeeded last night in producing what it had long desired: a French national
champion in a strategically important industry, the fast-growing and highly competitive
drug business.
111
With Aventis succumbing to Sanofi's
sweetened offer, the combination of the two
will form the world's third-largest
pharmaceuticals company, behind Pfizer Inc.
and GlaxoSmithKline PLC, with a market
capitalization of around €90 billion and a
stable of leading drugs such as Sanofi's stroke-
prevention treatment Plavix, sleeping pill
Ambien and cancer therapy Eloxatin. The new
company would also boast Aventis's allergy
pill Allegra, anti-blood-clotting drug Lovenox
and cancer medicine Taxotaere.
Important as its impact will be on the global
pharmaceutical industry, the Aventis drama
will be equally remembered for its political
implications, particularly in the new Europe.
From the start, the battle for Aventis was as
much about France's desire to create a home-
grown national champion in the
pharmaceutical industry as it was about
shareholder value and business sense. The
French government pushed to make Sanofi and
Aventis come together, as it did four years ago
when it backed the all-French mergers that
created Total SA, the world's fourth-largest oil
company, and BNP Paribas SA, the biggest bank among the countries that have adopted
the euro.
Before Sanofi even unveiled its original bid in late January, the French finance minister
called it "positive" because it would enable France to create a "national champion" -- a
huge company in what the country deems a strategic industry able to compete world-wide
with U.S. giants.
When it became clear that Aventis would fight Sanofi's hostile bid and seek a white-
knight offer from Novartis, French officials placed phone calls to executives at the Swiss
company on at least three occasions warning that Novartis should stay away.
France's intervention in the takeover battle, which runs counter to the free-market
principles espoused by the European Union, comes as the four-decade-old EU is
expanding to include 10 new members, ranging from Malta to Poland. Together with
Germany, France has been the EU's founding father and its biggest advocate. Yet, in
recent years, it has broken the union's economic rules more than once, giving state aid to
ailing French companies, letting its budget deficit grow and thus contravening a pact that
underpins the euro, and getting involved in takeover battles.
NATIONAL CHAMPIONS
Aventis CEO: Igor Landau Headquarters: Strasbourg, France 2003 income: $2.91 billion*
Leading drugs: Allergy pill Allegra, anti-blood-clotting drug Lovenox and cancer medicine Taxotere
Sanofi-Synthelabo CEO: Jean-Francois Dehecq Headquarters: Paris 2003 income: $2.48 billion *Leading drugs: Antistroke medicine Plavix, sleeping pill Ambien and cancer therapy Eloxatin *Figures converted from euros to dollars at current rate. Source: the companies
112
Afraid that Aventis, based in Strasbourg, France, would fall into Swiss hands, the French
government had leaned on Sanofi Chief Executive Jean-Francois Dehecq in recent days
to raise Sanofi's bid to improve the chances of an all-French deal.
The higher bid was accepted after Aventis's Chief Executive Igor Landau and Sanofi's
Mr. Dehecq met Friday under pressure from French Finance Minister Nicolas Sarkozy,
according to people familiar with the matter. It was the first time the two men, who have
been waging a war of words for three months, met face to face since Sanofi unleashed its
hostile takeover.
Mr. Landau will resign his executive duties at the company with a golden parachute
valued at €24 million, but may retain a seat on the merged company's board, according to
a person familiar with the arrangement. Mr. Dehecq will become head of the new
company.
The sudden finish to the Aventis takeover battle came after a surprise no-show by Swiss
drug-maker Novartis. Novartis failed to put in a bid for Aventis just a few days after
announcing that it was prepared to enter merger negotiations with France's biggest drug
maker. An Aventis team had been negotiating with Novartis late into Saturday night and
had produced agreements on everything from conditions for the offer and businesses to
be divested, say people familiar with the situation. However, Novartis still had not
broached a possible price at which it would be willing to acquire Aventis, making some
on the Aventis team suspicious that the Swiss company would turn up with a bid.
Novartis said last night it decided to break off merger talks with Aventis and not to
submit a bid because of the "strong intervention of the French government."
While French authorities last night were congratulating Sanofi and Aventis on their
planned marriage, some investors have long thought that France's approach could hurt it
in the long term. France argued that Aventis's vaccines were crucial to its defense against
potential bioterrorism -- an argument that the European Commission has said would be
hard to prove and that investors have dismissed as an excuse to mask protectionism.
"I think ultimately the victim is the French economy," says Steven Cohen, chief
investment officer at Kellner DiLeo Cohen & Co., a $500 million New York-based hedge
fund that owns Aventis shares. "There is no better way to discourage investment in your
economy" than to deter foreign companies from bidding for French companies.
Even as Aventis's board was meeting yesterday, French ministers were talking up the
merits of a Sanofi-Aventis tie-up. Speaking on Europe-1 radio, Health Minister Philippe
Douste-Blazy said he was hoping for a "positive response" from the Aventis board,
presented with the opportunity of a hook-up with Sanofi that would be a "very good
thing" for French industry. Any other outcome would leave Sanofi vulnerable to a
takeover, the minister warned. "If it doesn't buy another company, a foreign bidder will
come along," he said.
113
Under the pact, Sanofi will offer 0.8333 Sanofi share and €20 a share in cash, valuing
Aventis at €69 a share in cash and stock, based on Sanofi's average closing stock
price in the month before rumors of the deal leaked earlier this year, say people
familiar with the situation. However, based on Sanofi's closing stock price Friday of
€55.95, the deal values Aventis at €66.6 a share in cash and stock or a total of about
€53.2 billion. Both values are higher than Sanofi's original offer in January that valued
the company at €60.43 a share in cash and stock. The combined company will have a 17-
member board with nine members from the Sanofi side, including Mr. Dehecq, and eight
from the Aventis side.
The decision to accept the Sanofi offer was not unanimous. Kuwait Petroleum Corp.,
which is Aventis's single largest shareholder, was one of the parties that abstained, say
people familiar with the situation.
The takeover battle for Aventis could burnish the reputation of Novartis chief Daniel
Vasella as a tough pharmaceutical deal-maker who is willing to walk away from
transactions when the apparent price becomes too high.
Still, the outcome leaves Novartis with a dilemma. The company has made no secret of
its desire to grow, especially in the U.S. market, a region where an Aventis acquisition
would have helped significantly. But the potential assets it could acquire now are few and
far between. Novartis has been stymied in its efforts to take over Swiss rival Roche
Holding AG and it is sitting on a large hoard of billions of dollars in cash. Analysts say
reinvesting such cash doesn't always yield the kind of return a fast-growing
pharmaceutical company such as Novartis would like, because of declining productivity
in the drug industry.
Novartis may fall back now on licensing drugs from other companies as part of its
strategy to keep growing
Case Study-6
: Ranbaxy Laboratories (Ranbaxy) and Orchid Chemicals & Pharmaceuticals (Orchid)
have announced that they have entered into a business alliance agreement involving
multiple geographies and therapies for both finished dosage formulations and active
pharmaceutical ingredients (APIs). Additionally, this agreement would establish a
framework for enhanced future co-operation between the two companies.
The business alliance between the two comes even as the Ranbaxy Group has stretched
its holding in Orchid to 14.7 per cent through market operations, triggering intense
speculation about a possible takeover attempt on Orchid. With the holding of promoters
in Orchid dropping to 16.2 per cent, the Ranbaxy Group‟s share-buying exercise has only
heightened the possibilities for a takeover.
The drop in equity holding was caused by the sale of 5.6 million shares by a couple of
lenders with whom the promoters had pledged seven million free shares. The promoters
114
had borrowed about Rs. 80 crore from India Bulls Financial Services and Religare
Enterprises to help them raise their stake in the company from 17 per cent to 24 per cent.
They had bought five million shares from the market during March-April 2007 to raise
their stake.
K. Raghavendra Rao, Managing Director, Orchid, said the talks for a business alliance
with Ranbaxy were on much before the developments on the share front. He expected the
business alliance to fetch `significant revenue for Orchid‟. Mr. Rao told The Hindu that
the alliance would not upset the existing applecart (business). The incremental revenue
would be determined by the product and market configuration of any new business
initiative.
To a question, he said Orchid would continue to drive drug development and make
products. The alliance would leverage the marketing strength of Ranbaxy to push sales
numbers for both, he said. On increased co-operation between the two companies, Mr.
Rao said, “what is known is captured. The template is ready. A super structure can be
built easily, as the framework is already there.” Asked if the alliance with Ranbaxy and
the share buying episode would constrain Orchid, Mr. Rao said, “The management
freedom should continue. It should not be dictated by the shareholders.”
Informed institutional sources said that Orchid promoters were indeed trying to secure
their positions. Mr. Rao, however, has preferred to keep his cards close to his chest. With
institutional holders reportedly not enthusiastic about selling their shares in Orchid,
industry observers felt that the Ranbaxy Group would do nothing hastily.
Driven by a robust growth in emerging markets and North America, Ranbaxy
Laboratories on Tuesday reported a profit after tax of Rs. 153 crore for the first quarter
ended March 31, 2008, a 7.21 per cent growth over the corresponding period last year.
“Emerging markets continue to be the major contributor to the company‟s growth,
accounting for around 55 per cent of our total sales, followed by developed markets
which account for 40 per cent,” Ranbaxy Managing Director and CEO Malvinder Mohan
Singh told reporters here.
On the company‟s plans for alliances, Mr. Singh said at present it was negotiating with a
firm for a deal similar to what it has with GlaxoSmithKline. “Initially, it will be with
Ranbaxy but once the demerger takes place it will be transferred (to Ranbaxy Life
Science Research),” Mr. Singh said.
Mr. Singh said Ranbaxy was at present involved in about 19 patents litigations with an
innovator value of $27 billion . Out of these, the company had been able to settle four
that had a value of $8-10 billion.
Case Study-8
115
Battle lines are being drawn in India‟s pharmaceutical sector. A creeping acquisition has
begun in the shares of Chennai-based Orchid Chemicals & Pharmaceuticals which has
become vulnerable to acquisition after its share price fell steeply last month.
A firm called Solrex Pharmaceutical Co, which market sources say belongs to Ranbaxy
Labs or its founders, has now garnered 9.54% stake in the company.
Orchid founder and managing director Kailasam Raghavendra Rao said he was
determined to retain control over the company and would lean on support from
institutional investors. But his options could be limited, since he owns only 17%. “I have
not started this company to sell out,” an emotional Mr Rao told ET. He will be watched
for his moves in the next few days.
When contacted, Ranbaxy managing director and CEO Malvinder Singh said, “I have no
comment to make.” However, Mr Singh had earlier spoken of consolidation being the
„buzzword‟ in the industry and his company had been on the lookout for strategic stakes
in the domestic market.
Orchid shares were beaten down mercilessly on March 17, when promoter holdings of
about 7.5% were sold by stock dealers who had lent Mr Rao and his family money to
buy those shares. A bearish pressure had caused the price to fall below a predetermined
threshold, invoking margin calls that Mr Rao could not meet.
The Orchid founder incurred a personal loss of Rs 75 crore in the selloff and the shares
lost 40%, though they have recovered ground since then. "I do not know the antecedents
of Solrex and the events of the past few days have been too sudden to say anything. But I
can tell you, I am here to stay,” Mr Rao said.
The buzz about Ranbaxy‟s interest and a block deal of nearly one million shares, or 1.5%
stake in the target firm, caused a spike in Orchid shares which gained 15.5% to close at
Rs 207.15 on the BSE. Even after this, the company is trading at a low price-earning
multiple of 7.2 compared with the industry average of 17.23.
Incidentally, the name „Solrex‟ bears a close resemblance to Ranbaxy‟s two business
divisions „Solus‟ and „Rexcel‟, which were created in 2002 as part of the company‟s
restructuring programme. With Ranbaxy refusing to clarify, it was unclear whether
Solrex could be a Ranbaxy unit or a firm floated by its promoters.
Analysts said that it made sense for Ranbaxy to have Orchid in its fold. “What Orchid
brings on the table for Ranbaxy is its market standing in Cephalosporin (both sterile and
oral). Orchid has created many assets in this regard over the past couple of years.
Ranbaxy has products in anti-biotics and Orchid would help consolidate its position in
this regard,” said Angel Broking vice-president (research) Sarabjit Kaur Nangra.
Pharma consultant and industry veteran Ajit Dangi said, “Orchid Chemicals has good
API portfolio and manufacturing facilities. It should be complementary for Ranbaxy to
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acquire Orchid and enable the Indian pharma MNC to increase its market share.”
However, another industry expert said that the investment could just be an attractive-
buying opportunity rather than a strategic fit for the company.
Orchid reported Rs 866-crore revenues and a net profit of Rs 169 crore for the nine-
month period ended December 2007. It has a return on capital of about 11% and a market
capitalisation of Rs 1,400 crore.
Successful management post merger/acquisition
To integrate companies following a merger, arguably the most important
challenges involve the top of the organization� appointing the right top
team, structuring it appropriately, defining its agenda, and building the trust
that enables its members to work well together. Executives who fail to
overcome these challenges are responsible for the ego clashes and politics
that are often the root cause of spectacular failed mergers.
Unfortunately, recent thinking about change management no longer
emphasizes the pivotal role of the top team. The consensus on how to
manage change has shifted to a dispersed approach because too many
initiatives designed to cascade down the hierarchy have delivered
disappointing results. The usual interpretation is that top-down change fails
because at every step messages get diluted, so that each succeeding one
seems less compelling and less authentic.
While this may be true in certain circumstances, a merger requires direction
from the top because that is the only way to initiate change throughout an
organization. The change required to integrate companies cannot be driven
from an entrepreneurial business unit, an innovative functional unit, or the
front line. Too much coordinated, programmatic change must be achieved in
too short a time for such approaches to succeed. The spirit of the project is
determined at the top, where the conditions are set for the whole integration
effort.
But the top team must do more than just talk about the new company, adopt
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its language and trappings, and act according to its norms. The team must
become the new company in the full sense (see sidebar, "Who's on the top
team?"). Its messages, processes, and targets must deeply incorporate the
aspirations of the new company in a way that is visible
There is a wealth of both anecdotal and theoretical evidence that cultural
differences can, and frequently do, disrupt the attempted integrational
benefits sought in mergers and acquisitions. However as Associate Professor
of Organisational Behaviour Günter Stahl and co-author Andreas Voigt
investigate in depth, empirical research on the performance impact of
cultural differences in M&A has generally offered mixed results.
Some studies have found national and/or organisational cultural differences
to be negatively related to M&A performance measures. Yet others have
disclosed either a positive relationship, or largely found cultural differences
to be undemonstrably related to such performance. Stahl and Voigt offer
several explanations for the generally inconsistent findings of prior research
on the effect of cultural differences in this area, and develop a model that
synthesises their current understanding of the fundamental role of culture in
M&A.
The authors provide a review of previous studies that have examined the
impact of cultural differences on three types of M&A outcome measures:
accounting-based performance measures, stock market returns, and socio-
cultural integration outcomes. "While theoretical models of the role of
culture in M&A emphasise the 'dark side' of cultural diversity," the authors
posit, "empirical research indicates that cultural differences, under some
conditions, may be an asset rather than a liability in M&A."
Their accumulation of research evidence points to an interesting tendency:
"Cultural differences may actually have a positive effect on aspects of the
socio-cultural integration process, such as the cultural sensitivity and
tolerance exhibited by the acquiring firm managers". In contrast,
"(organisational) cultural differences were generally found to have a
negative impact in domestic settings".
In the authors' estimation, such findings support the conclusion that national
cultural differences are very often more prominent than organisational ones.
This serves to increase managers' awareness of the significance of cultural
factors in the post-merger/acquisition integration process. This may in many
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instances lead to more culturally sensitive integration management.
However, Stahl and Voigt concede that the studies included in their
literature review tend to differ widely in terms of sample characteristics;
geographical areas covered; methodologies used; dimensions of cultural
differences examined, etc., thereby making firm conclusions about the
verifiable impact of such differences problematic.
The authors offer both tentative explanations and an integrative model in an
effort partially to remedy these defects. These include analyses of:
- How the impact of cultural differences depends on the outcome variable
being examined.
- How cultural issues cannot realistically be viewed in isolation from other
variables.
- The ongoing, positive shift in focus from the initial conditioning factors to
the integration process involved in M&A activities.
The concept of "culture" as both a multi-level construct and an emergent
process.
In an effort to offer a more integrative framework than provided in existing
research on this topic, the authors present a model synthesising theoretical
perspectives and empirical findings. This helps to account for some of the
complexity underlying the culture-performance relationship in M&A, and
should help in guiding future research by delineating the main mechanisms
through which cultural differences may affect M&A performance.
Stahl and Voigt conclude that the relationship between cultural differences
and M&A outcomes is more complex than previously appreciated. They
summarise their findings by stating that "whether cultural differences have a
positive or a negative impact ... or any impact at all, depends on the
performance measures examined, and ... on the nature and extent of cultural
differences, the integration approach taken, the interventions chosen to
manage cultural differences, and a variety of other factors. Rather than
asking if cultural differences have a performance impact in M&A, future
research endeavours should focus on how cultural differences affect the
integration process."
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Effects: At first, the sight of so many take over battles raging across the
corporate arena leads to loads of excitement. But perhaps it is also necessary
to take a long view. According to business analyst, three issues have to be
considered with a cool head. First, will industry become more efficient after
the current round of consolidation is through? Second, will share holders
benefit when their companies are bought and sold? Third, will we see the
emergence of new monopolies as the small fry are eaten up by the big fish?
The answer seems quite clear. Research the world over shows that although
every take over does not necessarily lead to better use of companies' assets,
in general, mergers (or even the threat of a take over) force companies to
become more lean and mean as far as investors go, the new take over
regulations have ensured that the old-style cosy deals that leave ordinary
investors out in the cold are no longer possible: just look at the number of
open offers in the market today. And monopoly? That's a real threat. The
country badly needs anti-trust legislations to protect consumers from the
monopolies that could emerge once the current round of corporate
consolidation is over.
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