Tax Aspect

8/8/2019 Tax Aspect

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Tax aspects of M&A

Amalgamation for the purposes of income tax isrecognized only if the conditions given under Section2(1B) of the Income Tax Act, 1961 (ITA) are fulfilled.The term µamalgamation¶ is defined in sec.2(IB) of theIncome Tax, 1961 which says:-

µAmalgamation¶, in relation to companies, means themerger of one or more companies with another company or the merger of two or more companies toform one company in such a manner that:

1. All the properties/liabilities of the amalgamatingcompany immediately before the amalgamation should become the property/liabilities of the amalgamatedcompany by virtue of the amalgamation;

thethe

8/8/2019 Tax Aspect


Tax aspects of M&A

2. Shareholders holding not less than three-fourths in

value of the shares in the amalgamating company (other

than already held by the amalgamated company or by its

nominee) become shareholders of the amalgamatedcompany by virtue of the amalgamation.

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Under certain conditions, tax benefits may tur n outto be the underlying motive for a mer ger. Theseconditions relate to the tax laws allowing set off andcarry forwar d of losses.

It may be beneficial to mer ge a firm saddled with

lar ge tax carry forwar d losses with a firm havingsufficient current ear nings.

The ar gument is that this tax loss carry forwar d willreduce the taxable income of the newly mer gedfirm, with its obvious impact on the reduction of taxliability.

The mer ged firm is taxed as if the two firms(acquiring and tar get) had always been together.

In operational terms the losses of tar get firm will beallowed to be set off against the profits of theacquiring firm.

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Firm A acquires Firm T. As of date Firm Thas accumulated losses of Rs. 1000 lakh.Firm A is a well managed company with agood profit recor d. The projected profitsbefore taxes, of firm A, for the next 3 years

are given below:(in lakhs)

Year 1 Rs. 350

Year 2 Rs. 500

Year 3 Rs. 700

Assuming corporate tax rate of 35 per centand discount rate of 12 per cent, determinethe present value of tax gains likely to accrueon account of merger to A.

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Particulars Year I Year II Year III

(a)Profit before tax Rs. 350 l Rs. 500 l Rs.700 l

(b)Less: Ad justmentagainst loss of firm T/

Reduction in taxable

income

350 500 150

(c)Reduction in tax

payment (b x 0.35)

122.5 175 52.5

(d)Multiply by PV factor

at 12%

0.893 0.797 0.712

(e)Total PV of tax

shield is Rs.286.24

lakh (c x pv factor)

109.39 139.47 37.38

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Tax Concessions to Amalgamated Company

The following are the major tax benefits available tothe amalgamated company.

Carry Forward & Set off of Business losses &Unabsorbed Depreciation (Sec 72A) providedfollowing conditions fulfilled:

a). The amalgamated company continuously holdsfor a minimum period of 5 years, from the date of amalgamation at least three-fourths of the abovevalue of fixed assets of the amalgamating company,acquired in the scheme of amalgamation.

b). The amalgamated company continues thebusiness of the amalgamating company for aminimum period of 5 years from the date of amalgamation.

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c). The amalgamated company fulfils such other conditions as may be prescribed to ensure therevival of the business of amalgamating company or to ensure that the amalgamation is for genuine

business purposes.d). The amalgamation should be of a companyowning an industrial undertaking or ship. Industrialundertaking, in this context, means an undertakingthat is engaged in:

The manufacture or processing of goods; or The manufacture of computer software; or

The business of generation or distribution of electricity or any other form of power; or

The business of providing telecommunication services,whether basic or cellular, including radio paging, domesticsatellite service, network of trunking, broadband networkand inter net services; or Mining or

The construction of ships, aircrafts or rail system

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In case where any of the aboveconditions (i-iv) are not complied with,the set off of loss or allowance of

depreciation made in any previousyear in the books of amalgamatedcompany would be deemed to beincome of the amalgamated companyand char geable to tax for the year inwhich such conditions are notcomplied with.

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Expenditure on Scientific Research: Where anamalgamating company transfers any assetrepresented by capital expenditure on scientific

research to the amalgamated Indian company,unabsorbed capital expenditure in the books of the amalgamating company would be eligible tobe carried forwar d and set off in the hands of amalgamated company.

Expenditure on Acquisition of Patent Rights or Copy Rights: The expenditure on patents &

copyrights not yet written off in the books of amalgamating company would be allowed to bewritten off in the same number of balanceinstallments.

Where such rights are later on sold by theamalgamated company, the profit/loss on suchsales would be treated in the hands of theamalgamated company, in the same manner as itwould have been allowed to be treated by theamalgamating company.

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In case such expenditure has been incurred by theamalgamating company after March 31, 1998, suchan expenditure would be eligible for depreciation, asintangible asset and provision of depreciation wouldapply.

Expenditure on Know-how : Regar ding theexpenditure on know-how, the amalgamated

company would be entitled to claim deduction withrespect to the transferred undertaking, to the sameextent and for the same residual period as otherwisewould have been allowed to the amalgamatingcompany, had such amalgamation not taken place.

Like patent rights, In case such expenditure hasbeen incurred by the amalgamating company after March 31, 1998, such an expenditure would beeligible for depreciation, as intangible asset andprovision of depreciation would apply.

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Expenditure for obtaining License to operateTelecommunication Services: When theamalgamating company transfers license to theIndian amalgamated company, the expenditure onacquisition of license, not yet written off, is allowedto the amalgamated company in the same number of balance installments. When such license is soldby the amalgamated company, the treatment of surplus/deficiency would be the same as wouldhave been in the case of amalgamating company.

Preliminary Expenses: Deduction of preliminaryexpenses (to the extent not amortized) would bemade in the books of the amalgamated companyin the same manner as would have been allowedto the amalgamating company.

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Expenditure on Prospecting of certainMinerals: Where an amalgamating companymer ges with the amalgamated company, the

amount of expenditure on prospecting, etc, of certain minerals of the amalgamating companythat are not yet written off, would be allowed asdeduction to the amalgamated company in thesame manner as would have been allowed to theamalgamating company.

Capital Expenditure on Family Planning: Thecapital expenditure on family planning not yetwritten off would be allowed to the amalgamatedcompany in the same number of balanceinstallments.

Bad Debts: When the debts of amalgamatingcompany have been taken over by theamalgamated company and subsequently suchdebt or part of debt becomes bad, they would beallowed as a deduction to the amalgamatedcompany in the same manner as would have beenallowed to the amalgamating company.

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In brief, the Income Tax Act for all types of businessreorganizations/ amalgamations/ mergers has becomefully tax neutral. Virtually all fiscal concessions/

incentives/ deductions (in respect of fixed assets,capital expenditures, intangible assets, deferred revenueexpenditure and so on) that would otherwise have beenavailable to the amalgamating company are madeavailable to the amalgamated company as well.

In other words, the unwritten off amount, with respect toall these items, is treated in the hands of theamalgamated company in the same manner as wouldhave been treated by the amalgamating company. Thus,the amalgamated company is not put to anydisadvantage as far as the income tax concessions andincentives are concerned. The present generous/

favorable fiscal provisions are indicative/reflective of Government policy to facilitate, promote and createopportunities for more amalgamations and mergers.

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Tax Concessions to Amalgamating

Company

Free of Capital Gains Tax: Accor ding to Section47(vi), where there is transfer of any capital assetby an amalgamating company, such transfer willnot be considered as a transfer for purpose of

capital gain.Free of Gift-Tax: Accor ding to Section 45 (b) of the Gift Tax Act, where there is a transfer of anyasset by an Indian amalgamating company, gifttax will not be attracted.

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Tax Concessions to Shareholders

of an Amalgamating Company

Accor ding to Section 47 (vii), where a shareholder of an Indian amalgamating company transfers hisshares, such transaction will be disregar ded for capital gain purposes, provided the transfer of

shares is made in consideration of the allotment of any share to him or shares in the amalgamatedcompany.

Further, for computing the period of holding of such shares, the period for which such shares

were held in the amalgamating company wouldalso be included so that the shareholders of theamalgamating company are not put indisadvantage.

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Tax Aspects Related to

Demergers

Under sections 391 to 394 of the Companies, a

demerger means the transfer by the demerged company, of

one or more of its undertakings to any resulting company.

Tax concessions to Resulting Company1. Carry Forward & Set off Losses & Unabsorbed

Depreciation of the Demerged Company: The

accumulated loss & unabsorbed depreciation µin a

demerger¶ should be allowed to be carried forward by the

resulting company, if these are directly related to the

undertaking proposed to be transferred.

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Tax Aspects Related to

Demergers2. Expenditure on Acquisition of Patent Rights orCopyrights: where the patent or copyrights acquired by thedemerged company is transferred to the resulting Indiancompany, the expenditure on patents or copyrights notwritten off would be allowed to be written off in the handsof the resulting company in the same number of balanceinstallments.

3. Expenditure on know how.

4.Expenditure for obtaining license to operatetelecommunication Services.

5. Expenditure on Prospecting of certain Minerals

6. Bad Debts

Tax Aspect

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