Budget 2024 Expectations: Mergers and acquisitions

Vivek Gupta, Partner, Deloitte India

Current environment

• Significant global challenges that defined 2023—high interest rates, macroeconomic uncertainty, regulatory scrutiny and geopolitical risks—will persist in 2024.
• With a strong domestic economy as a backdrop, Indian companies may see M&A as a crucial strategy to help them manage business uncertainty, integrate supply chains and strengthen their market positions.
• While Indian business houses are adopting a cautious approach, they are also gauging for momentous M&A activities, post the general elections. As a result, M&A activities are expected to bounce back soon, thereby creating enormous opportunities for the Indian economy to flourish.
• Considering the above scenario, we have captured the following expectations for the upcoming budget that will help increase M&A activities in the near future.

Expectations

Ask #1: Ensure outbound mergers to be tax neutral

• The Companies Act, 2013, permits the merger of an Indian company into a foreign company, subject to certain conditions.
• An Indian company’s merger with another Indian company is tax neutral if the prescribed conditions are satisfied. However, no specific exemption is provided under the Income-tax Act, 1961 for the merger of an Indian company with a foreign company.
• To encourage cross-border M&A, tax exemption should be provided on the merger of an Indian company with a foreign company by adding a specific clause in Section 47.

Ask #2: Extend the transition of losses from amalgamating a “non-industrial undertaking” company to an amalgamated company

• Under the existing provisions in Section 72A, the benefit of carry forward of losses and unabsorbed depreciation is, inter alia, allowed in cases of amalgamation of a company owning an “industrial undertaking”.
• The provision was incorporated when India was a capital-intensive country. The country is moving from a capital-intensive to capital-light model; the services industry is also growing and contributing to the economy.
• To encourage rapid consolidation and growth, and make India competitive in the services sector, the benefit under Section 72A (to carry forward losses and depreciation on amalgamation) should be extended to service industries amongst others.

Ask #3: Provide exemption to foreign shareholders in case of mergers and demergers

• In case of merger of the foreign company (Co A) deriving substantial value from India, [which holds the Indian company (Co B)], with another foreign company (Co C), Section 47(via) provides that transfer of shares of an Indian company (Co B) transferred in a foreign amalgamation would not be regarded as a transfer, provided certain conditions are met.
• In case of merger of the foreign company (Co A) deriving substantial value from India, (which holds another foreign company (Co B) deriving substantial value from India), with another foreign company (Co C), Section 47(viab) provides that transfer of shares of a foreign company (Co B) that derives value substantially from assets located in India, in an amalgamation, would not be regarded as a transfer, provided certain conditions are met.
• The above sections seem to indicate that the exemption is provided only to the amalgamating foreign company and not to its shareholders.
• Specific provisions, such as Section 47(vii), should be incorporated in the Act to provide relief to the shareholders of the amalgamating foreign company (shareholders of Co A). The provision exempts shareholders in a domestic amalgamation.
• A similar issue emerges for demergers. In the absence of exclusion from compliance with the Indian company law requirements in Section 47(vid), the benefit of shareholder exemption is not available to shareholders of the foreign demerging company in an overseas demerger. This has the effect of imposing a tax liability on the shareholders of the foreign demerging company and hence, against the principle of enabling tax neutrality for overseas demergers.
• A proviso [as provided in Section 47(vid) and 47(vid)] should be incorporated in Section 47(vid) to provide an exemption to the shareholders of the foreign demerged company despite the demerger not complying with the relevant Indian company law provisions.

Ask #4: Provide exemption to the Indian holding company on an overseas merger of two foreign subsidiaries

• An overseas merger between two foreign subsidiaries of an Indian holding company is undertaken for reasons, such as consolidation, value creation and regulatory hurdles. While the value is retained within the group on such overseas merger, there could be tax implications in India for the common Indian holding company whose shares in amalgamating foreign company are transferred pursuant to overseas merger with another foreign subsidiary company.
• There should be tax exemption for such Indian holding company in case of transfer of shares of the amalgamating company in exchange for amalgamated company shares pursuant to the merger of its foreign subsidiaries.

Ask #5: Enforce complete tax-neutrality on mergers and demergers

• Section 56(2)(viib) seeks to tax a company (other than a company in which the public are substantially interested) on issue of shares for a consideration higher than the prescribed FMV.
• While there is a specific exemption from applicability of section 56(2)(x) to the shareholders on receipt of shares on tax neutral transactions, such as mergers/demergers, no specific exemption is available u/s 56(2)(viib) for a company issuing shares.
• To provide tax neutrality for mergers/demerger transactions with respect to shares issued by the amalgamated/resulting company, an exemption should also be provided under section 56(2)(viib) for the issuance of shares for qualify mergers/demerges.

Ask #6: Rationalise taxation of contingent consideration

• India is an attractive market for international investors. With a focus on balancing profitable exits and correct valuations, most private equity players plan to introduce a combination of clauses in the shareholders agreement. This includes consideration payable in a contingent manner based on certain performance milestones that the promoters achieved.
• In essence, such clauses incentivise promoters for their better performance after the deal.
• There is no clarity on whether such contingent consideration is to be taxed in the year of transfer or receipt, after the consideration crystallises. It may be clarified by an explanation or clarificatory provision to Section 45 (in case of a contingent consideration) that the contingent portion should be chargeable to tax as capital gains in the year in which it is crystallised, irrespective of the year in which the transfer takes place (in line with the accrual concept - refer to Section 5 of the Act).

Ask #7: Relaxation in deemed taxation provisions

• Section 56(2)(x) seeks to tax the receipt of specified assets if the consideration paid for acquiring such assets is less than the fair value determined per the prescribed formula.
• However, this provision leads to tax exposure in genuine transactions conducted by listed entities where the mode of valuation adopted is in line with SEBI provisions or Indian transfer pricing guidelines or the transaction is entered into at arm’s length by related parties.
• In such scenarios, flexibility for determining the fair market value in line with existing regulatory provisions may be added for genuine transactions for listed entities.