Taxation Aspect of Mergers and Amalgamation

by CMA. Sanjay Gupta on 03 May 2011

Under Income Tax Act, 1961 Section 2(1B) of Income Tax Act defines amalgamation as merger of one or more companies with another company or merger of two or more companies to from one company in such a manner that:-

1. 2. 3.

All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation. All the liabilities of the amalgamating company or companies immediately before the amalgamation becomes the liabilities of the amalgamated company by virtue of the amalgamation Shareholders holding at least three-fourths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamated company or its nominee) becomes the shareholders of the amalgamated company by virtue of the amalgamation. (Example: Say, X Ltd merges with Y Ltd in a scheme of amalgamation and immediately before the amalgamation, Y Ltd held 20% of shares in X Ltd, the above mentioned condition will be satisfied if shareholders holding not less than 75% in the value of remaining 80% of shares in X Ltd i.e. 60% thereof, become shareholders in Y Ltd by virtue of amalgamation)

The motive of giving this definition is that the benefits/concession under Income Tax Act, 1961 shall be available to both amalgamating company and amalgamated company only when all the conditions, mentioned in the said section, are satisfied. Amalgamating company means company which is merging and amalgamated company means the company with which it merges or the company which is formed after merger. However, acquisition of property of one company by another is not amalgamation. Income Tax Act defines amalgamation as merger of one or more companies with another company or merger of two or more companies to from one company. Let us take an example of X Ltd and Y Ltd. Here following situations may emerge:(a) X Ltd Merges with Y Ltd. Thus X Ltd goes out of existence. Here X Ltd is Amalgamating Company and Y Ltd is Amalgamated Company. (b) X Ltd and Y Ltd both merges and form a new company say, Z Ltd. Thus both X Ltd and Y Ltd goes out of existence and form a new company Z Ltd. Here X Ltd and Y Ltd are Amalgamated Company and Z Ltd is Amalgamated Company.

Tax Reliefs and Benefits in case of Amalgamation

If an amalgamation takes place within the meaning of section 2(1B) of the Income Tax Act, 1961, the following tax reliefs and benefits shall available:1. Tax Relief to the Amalgamating Company:

o Exemption from Capital Gains Tax [Sec. 47(vi)]: Under section 47(vi) of the Income-tax Act, capital gain arising from the transfer of assets by the amalgamating companies to the Indian Amalgamated Company is exempt from tax as such transfer will not be regarded as a transfer for the purpose of Capital Gain. o Exemption from Capital Gains Tax in case of International Restructuring [Sec. 47(via)]: Under Section 47(via), in case of amalgamation of foreign companies, transfer of shares held in Indian company by amalgamating foreign company to amalgamated foreign company is exempt from tax, if the following two conditions are satisfied: o At least twenty-five per cent of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company, and o Such transfer does not attract tax on capital gains in the country, in which the amalgamating company is incorporated 2. Tax Relief to the shareholders of an Amalgamating Company:

o Exemption from Capital Gains Tax [Sec 47(vii)]: Under section 47(vii) of the Income-tax Act, capital gains arising from the transfer of shares by a shareholder of the amalgamating companies are exempt from tax as such transactions will not be regarded as a transfer for capital gain purpose, if: o The transfer is made in consideration of the allotment to him of shares in the amalgamated company; and o Amalgamated company is an Indian company. 3. Tax Relief to the Amalgamated Company:

o Carry Forward and Set Off of Accumulated loss and unabsorbed depreciation of the amalgamating company [Sec. 72A]: Section 72A of the Income Tax Act, 1961 deals with the mergers of the sick companies with healthy companies and to take advantage of the carry forward of accumulated losses and unabsorbed depreciation of the amalgamating company. But the benefits under this section with respect to unabsorbed depreciation and carry forward losses are available only if the followings conditions are fulfilled:-

o There should be an amalgamation of (a) a company owning an industrial undertaking(Note 1) or ship or a hotel with another company, or (b) a banking company referred in section 5(c) of the Banking Regulation Act, 1949 with a specified bank (Note 2), or (c) one or more public sector company or companies engaged in the business of operation of aircraft with one or more public sector company or companies engaged in similar business. [Note 1. The term Industrial Undertaking shall mean any undertaking engaged in : (i) the manufacture or processing of goods, or (ii) the manufacture of computer software, or (iii) the business of generation or distribution of electricity or any other form of power, or (iv) mining, or (v) the construction of ships, aircrafts or rail systems, or (vi) the business of providing telecommunication services, whether basic or cellular, including radio paging, domestic satellite service, network of trunking, broadband network and internet services. Note 2. Specified bank means the State Bank of India constituted under the State Bank of India Act, 1955 or a subsidiary bank as defined in the State Bank of India (Subsidiary Bank) Act, 1959 or a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertaking) Act, 1970 or under section 3 of the Banking Companies (Acquisition and Transfer of Undertaking) Act, 1980.] o The amalgamated company should be an Indian Company. o The amalgamating company should be engaged in the business, in which the accumulated loss occurred or depreciation remains unabsorbed, for 3 years or more. o The amalgamating company should held continuously as on the date of amalgamation at least three-fourth of the book value of the fixed assets held by it two years prior to the date of amalgamation. o The amalgamated company holds continuously for a minimum period of five years from the date of amalgamation at least three-fourths in the book value of fixed assets of the amalgamating company acquired in a scheme of amalgamation o The amalgamated company continues the business of the amalgamating company for a minimum period of five years from the date of amalgamation. o The amalgamated company fulfils such other conditions as may be prescribed to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purpose. o Expenditure on scientific research [Sec. 35(5)]: When an amalgamating company transfers any asset represented by capital expenditure on the scientific research to the amalgamated Indian company in a scheme of amalgamation provisions of section 35 shall be applicableo Unabsorbed expenditure on scientific research of the amalgamating company will be allowed to be carried forward and set off in the hands of the amalgamated company,

o If such asset ceases to be used in the previous year for scientific research related to the business of amalgamated company and is sold by the amalgamated company the sale price to the extend of cost of asset shall be treated as business income and the excess of sale price over the cost shall be subject to the provisions of capital gain. o Amortization of expenditure in case of Amalgamation [Sec. 35DD]: Under Sec 35DD for expenditure incurred in connection with the amalgamation the assessee shall be allowed a deduction of an amount equal to one-fifth of such expenditure for each of the five successive previous years beginning with the previous year in which the amalgamation takes place. o Treatment of preliminary expenses [Sec. 35D(5)]: When and amalgamating company merges with an amalgamated company under a scheme of amalgamation, the amount of preliminary expenses of the amalgamating company to the extend not yet written off shall be allowed as deduction to the amalgamated company in the same manner as would have been allowed to the amalgamating company. o Expenditure for obtaining a licence to operate telecommunication services [Sec. 35ABB(6)]: Where in a scheme of amalgamation, the amalgamating company sells or otherwise transfer its licence to the amalgamated company (Being an Indian Company), the provisions of Section 35ABB which were applicable to the amalgamating company shall become applicable in the same manner to the amalgamated company, consequently: o The expenditure on acquisition on license, not yet written off, shall be allowed to the amalgamated company in the same number of balance installments. o Where such licence is sold by the amalgamated company, the treatment of the deficiency/surplus will be same as would have been in the case of amalgamating company. o Treatment of capital expenditure on family planning [U/S 36(1)(ix)]: If Asset representing capital expenditure on family planning is transferred by the amalgamating company to the amalgamated company under a scheme of amalgamation, such expenditure shall be allowed as deduction to the amalgamated company in the same manner as would have been allowed to the amalgamating company. o Treatment of bad debts [Sec. 36(1)(vii)]: When due to amalgamation debts of the amalgamating company has been taken over by amalgamated company, and subsequently, such debts turn out to be bad, it shall be allowed as deduction to the amalgamated company.

Corporate Restructuring - A Phenomenon

by CMA. Sanjay Gupta on 08 March 2011
Published in Corporate Law | Comments

Corporate Restructuring means rearranging the business of a company for increasing its efficiency and profitability. It is tool to catapult value to the organization as well as to the investors. It is the fundamental change in a company's business or financial structure with the motive of increasing the company's value to shareholders or creditors.

Restructuring is a method of changing the organizational structure in order to achieve the strategic goals of the organization. Corporate Restructuring is a wide expression and it includes various kinds of tools. Thus, it is the purpose or objective of the organization which will determine the kind of too to be used in corporate restructuring. Hence, corporate restructuring is a comprehensive process by which a company can consolidate its business operations and strengthen its position for achieving its short-term and long-term corporate objectives. Corporate restructuring is vital for survival of a company in competitive environment. EMERGENCE OF CORPORATE RESTRUCTURING IN GLOBAL AND NATIONAL PERSPECTIVE A restructuring wave is sweeping the corporate world. Corporate India is witnessing a restructuring revolution. The somewhat guarded, tentative response of the early years of economic reforms is slowly giving place to more decisive initiatives in corporate restructuring. Consolidation at the group and industry levels through mergers and acquisitions, strategic divestitures to permit sharper focus, strategic alliances and to a lesser extent demergers and spin offs etc; are transforming the ownership profile and competitive structure of the Indian Industry. Takeovers, mergers and acquisition activities continue to accelerate. From banking to oil exploration and telecommunication to power generation, companies are coming together as never before. Not only these new industries like biotechnology have been exploding but also the old industries are being transformed. Corporate restructuring through acquisition, amalgamations, mergers, arrangements and takeovers has become integral to corporate strategy today. In India, the concept has caught like wildfire with a merger or two reported every now and then. The process of restructuring through mergers and amalgamations has been a regular feature in the developed and free economy nations like USA and European countries, more particularly UK, where hundreds of mergers take place every year. Courts too have been sympathetic towards merger, the classic example being the following remarks of Supreme Court in the HLL-TOMCO merger case: In this era of hyper-competitive capitalism and technological change, industrialists have realized that merger/acquisitions are perhaps the best route to reach a size comparable to global companies so as to effectively compete with them. The harsh reality of globalization has dawned that companies which cannot compete globally must sell-out as an inevitable alternative. NEED/PURPOSE OF CORPORATE RESTRUCTURING Following are some of the main purposes of Corporate Restructuring: 1) 2) 3) To expand the business or operations of the company. To carry on the business of the company more economically or more efficiently To focus on core strength

4) 5)

Cost Reduction by deriving the benefits of economies of scale. Obtaining tax advantage by merging a loss making company with a profit making company. 6) To have access to better technology. 7) To improve debt-equity ratio. 8) To have better market share. 9) To overcome significant problems in a company. 10) To become Globally Competitive. 11) To eliminate competition between the companies. 12) In the public interest (by the Central Government in exercise of the powers conferred by section 396).

TOOLS OR STRATEGIES OF CORPORATE RESTRUCTURING Following are some of the important tools or strategies of corporate restructuring discussed in brief just to give a basic idea. Amalgamation The term amalgamation is not defined under Companies Act, 1956. Generally speaking, amalgamation is a legal process by which two or more companies are joined together to form a new entity or one or more companies are to be absorbed or blended with another and as a consequence the amalgamating company loses its existence and its shareholder become the shareholder of the new or amalgamated company. Merger Merger is an arrangement whereby the assets of two or more companies be come vested in or under the control of one company, which may or may not be one of the original two companies, which has as its shareholders, all or substantially all, the shareholders of the two company. Merger is a tool used by companies for the purpose of expanding their operations often aiming at an increase of their long term profitability. It is a combination of two or more business enterprises into a single enterprise. Mergers occur in a consensual (occurring by mutual consent) setting where executives from the target company help those from the purchaser in a due diligence process to ensure that the deal is beneficial to both parties. Mergers can be of three types; namely: a) Horizontal Mergers: A horizontal merger is when two companies competing in the same market merge or join together. This type of merger can either have a very large effect or little to no effect on the market. When two extremely small companies combine, or horizontally merge, the results of the merger are less noticeable. These smaller horizontal mergers are very common. In a large horizontal merger, however, the resulting ripple effects can be felt throughout the market sector and sometimes throughout the

whole economy. b) Vertical Mergers: A merger between two companies producing different goods or services for one specific finished product. By directly merging with suppliers, a company can decrease reliance and increase profitability. An example of a vertical merger is a car manufacturer purchasing a tire company. Vertical Mergers can be in the form of Forward Integration of Business [E.g. A manufacturing company entering in the Direct Marketing Function. which was not its foray in the erstwhile times) or in the form of Backward Integration of Business [E.g. A manufacturing company also focusing on the producing the required raw materials and managing its supply chain activities on its own . which was not its foray earlier]. c) Conglomerates merger: This type of merger involves mergers of corporates in unrelated lines of businesses activity to achieve three objectives; (a). Product Extension (b). Entry into new Geographic Markets (c). Entry into unrelated yet profitable businesses. E.g. most big business houses such as Reliance Industries, Aditya Birla Group, etc. undertake such mergers to expand their businesses. Demerger Demerger means division or separation of different undertakings of a business functioning hitherto under a common corporate umbrella. A scheme of demerger is, in effect, a corporate partition of a company into two undertakings, thereby retaining one undertaking with it and transferring the other undertaking to the resulting company. The resulting company issues its shares at the agreed exchange ratio to the shareholders of the demerged company. The demerger of the Reliance group is by far the biggest corporate restructure story in the private sector. Reverse Merger Reverse merger is an alternative method for private companies to become public, without going through the long and convoluted process of traditional Initial Public Offering. In a reverse merger, a private company acquires a public entity by owning the majority shares of the public entity .The private company takes on the corporate structure of the public entity, with its own company name. Reverse mergers allow a private company to become public without raising capital, which considerably simplifies the process. While conventional IPOs can take months (even over a calendar year) to materialize, reverse mergers can take only a few weeks to complete (in some cases, in as little as 30 days). This saves management a lot of time and energy, ensuring that there is sufficient time devoted to running the company. Slump Sale Slump sale means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In a slump sale, a company sells or disposes off whole or substantially the whole of its undertaking for a lump sum pre determined consideration, called the slump price. In a slump sale, an acquiring company may not be interested in buying the whole company, but only one of its division or a running undertaking on a going concern basis. In simple words, slump sale is

nothing but transfer of a whole or part of business concern as a going concern; lock, stock and barrel. Takeover/Acquisition An acquisition, also known as a takeover, is the buying of one company (the target) by another. An acquisition may be friendly or hostile. In the former case, the companies cooperate in negotiations; in the latter case, the takeover target is unwilling to be bought or the target's board has no prior knowledge of the offer. Acquisition usually refers to a purchase of a smaller firm by a larger one. The objective is to consolidate and acquire large share of the market. Types of Takeover: a) Friendly or Negotiated Takeover: Friendly takeover means takeover of one company by change in its management & control through negotiations between the existing promoters and prospective invester in a friendly manner. Thus it is also called Negotiated Takeover. This kind of takeover is resorted to further some common objectives of both the parties. Generally, friendly takeover takes place as per the provisions of Section 395 of the Companies Act, 1956. b) Bail Out Takeover: Takeover of a financially sick company by a financially rich company as per the provisions of Sick Industrial Companies (Special Provisions) Act, 1985 to bail out the former from losses. c) Hostile takeover: Hostile takeover is a takeover where one company unilaterally pursues the acquisition of shares of another company without being into the knowledge of that other company. The most dominant purpose which has forced most of the companies to resort to this kind of takeover is increase in market share. The hostile takeover takes place as per the provisions of SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 1997. Joint Venture A joint venture (often abbreviated JV) is an entity formed between two or more parties to undertake economic activity together. The parties agree to create a new entity by both contributing equity, and they then share in the revenues, expenses, and control of the enterprise. The venture can be for one specific project only, or a continuing business relationship such as the Sony Ericsson joint venture. This is in contrast to a strategic alliance, which involves no equity stake by the participants, and is a much less rigid arrangement. Strategic alliances An arrangement between two companies who have decided to share resources in a specific project. A strategic alliance is less involved than a joint venture where two companies typically pool resources in creating a separate entity. Disinvestment

Disinvestment can be defined as the action of an organization (or government) selling or liquidating an asset or subsidiary. It is also referred to as divestment or divestiture. It refers to the transfer of the assets/shares/control from the government to the private sector. In general terms Disinvestment(Dis-investment) is simply selling the equity(share) invested by the government in Public Sector Enterprises(PSU).PSUs are enterprises which are either owned completely by the government or whose shares are maximum owned by the government(51% or above).Examples include BHEL,ONGC etc. Buy Back of Shares The buying back of outstanding shares (repurchase) by a company in order to reduce the number of shares on the market. Companies will buyback shares either to increase the value of shares still available (reducing supply), or to eliminate any threats by shareholders who may be looking for a controlling stake. A buyback is a method for company to invest in itself since they can't own themselves. Thus, buybacks reduce the number of shares outstanding on the market which increases the proportion of shares the company owns. To be continued......... Regards CMA. Sanjay Gupta

Merger and Amalgamation - An Overview

by CMA. Sanjay Gupta on 26 April 2011
Published in Corporate Law | Comments

MEANING OF MERGER AND AMALGAMATION As per Companies Act, 1956 The terms merger and amalgamation have not been defined in the Companies Act, 1956 though this voluminous piece of legislation contains more than 50 definitions in Section 2 of the Act. For the purpose of this act the terms Merger and Amalgamation are synonymous. The statutory provisions relating to merger and amalgamation are contained in sections 390 to 396A. As per General Dictionary Meaning According to Oxford Dictionary, the expression merger or amalgamation means combining of two commercial companies into one merging of two or more business concerns into one respectively. Merger is a fusion between two or more enterprises, whereby the identity of one or more is lost and the result is a single enterprise whereas Amalgamation signifies blending of two or more existing undertakings into one undertaking, the blended companies losing their identities and forming themselves into a separate legal identity. There may be amalgamation either by the transfer of two or more undertaking to a new company, or by the transfer of one or more undertaking to an existing company. As per Income Tax Act, 1961

Amalgamation as defined in section 2 (1B) of the Income Tax Act, 1961 means the merger of one or more companies with another company or the merger of two or more companies to form one company in such a manner that the following conditions are satisfied: a) All the property of the amalgamating company or companies immediately before the amalgamation becomes

the property of the amalgamated company by virtue of the amalgamation. b) All the liabilities of the amalgamating company or companies immediately before the amalgamation becomes

the liabilities of the amalgamated company by virtue of the amalgamation c) Shareholders holding at least three-fourths in value of the shares in the amalgamating company or companies

(other than shares already held therein immediately before the amalgamated company or its nominee) becomes the shareholders of the amalgamated company by virtue of the amalgamation.

As Per Accounting Standard

According to the mandatory Accounting Standard 14 (AS-14) issued by the Institute of Chartered Accountants of India (ICAI), amalgamation means an amalgamation pursuant to the provisions of the Companies Act, 1956 or any other statute which may be applicable to companies. Under the said AS-14 the following two methods of amalgamation have been contemplated: 1) Amalgamation in the nature of merger:- Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions:-

a) All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company. b) Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation. c) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares. d) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company. e) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.
2) Amalgamation in the nature of purchase:- Amalgamation in the nature of purchase is an amalgamation

which does not satisfy any one or more of the conditions specified in (1) above

PURPOSE / OBJECTIVES BEHIND MERGER AND AMALGAMATIONS Following are the main reasons for the companies to go for mergers and amalgamation: 1) To achieve economies of Scale: - The combination of two or more companies and their resources

production facilities, marketing outlets, managerial skills, liquidity etc. could be u sed to achieve economies of scale and thus, improve the profitability, and attain synergetic operating economies. It will result in reduction in advertising costs, administration costs and production costs. 2) To reduce the gestation period for new business: - To develop new business will need a gestation period and

might amount to re-investing the wheel. If, however, a company can acquire another company which has a profitable business running and merged with it, it is possible to avoid the initial teething trouble period of a new business and venture into new field with relative ease. 3) To compete globally: - In this era of globalization, unless a company is large in size and capital, it will be very difficult to compete with global companies where the cost of production is lower due to the benefits of economies of scale. In a free competitive world, it is necessary to position oneself in such a manner to compete with the best and prove oneself as better than the others. This could be achieved only by merger and amalgamation of companies in the same line of business and create a niche world market for oneself. 4) To utilize the liquidity available with the company for achieving growth through diversification: -

Finance is a scarce resource. Liquidity can be better used by acquiring competing and complementary businesses. Sometimes mergers take place by a financially strapped company with a financially rich company and thus take advantage of the finance available with the merged company. 5) To acquire and maximize the available managerial skills to increase the profitability: - It is possible that a

company may have expertise and skilled managerial personnel, but for the reasons beyond their control, the company may not be able to compete with another company. In such cases, the other company would benefit by merging with the former company and take full advantage of the available managerial skills and thus, save costs to improve its own profitability and at the same time, the skilled persons are also gainfully employed. 6) To Diversify the risk: - Another reason for merger is to diversify the companys dependence on a number of

segments of the economy. Diversification implies growth through the combination of firms in unrelated businesses. All the businesses go through cycles. So in decline stage the company can find it difficult to sustain itself and therefore looks to diversify into the unrelated area of business. Such diversification helps to open up the avenues of growth. In short - We are all aware of the famous saying: Dont put all your eggs in one basket. When a firm operates in many businesses, the downs in one can be compensated by the ups in another. A good example of an Indian company attempting to diversify and develop a new core is ITC. Among the businesses which ITC has entered in recent years are apparel retailing and branding, ready-to-eat packaged foods, confectionery items, InfoTech, paper and boards, Hotel Chain etc. 7) To avail the taxation advantages under the Income Tax Act, 1961: - Mergers and amalgamation also take

place to avail the taxation benefits available to amalgamating companies (subject to fulfillment of certain conditions) under the Income Tax Act, 1961. These benefits are available mainly by virtue of Sec 72A (Provisions relating to carry forward and set off of accumulated loss and unabsorbed depreciation allowance in amalgamation). Apart from these tax benefits are also available to amalgamating companies and the shareholders of the amalgamated companies. 8) In the Public Interest: - Where the Central Government is satisfied that it is essential in public interest that

two or more companies should amalgamate, it may, by notified order in the Official Gazette, provide for the amalgamation of those companies into a single company. This power is vested in the hands of Central Government under section 396 of the Companies Act, 1956. Earlier Article of this Series--Corporate Restructuring - A Phenomenon To be continued......... Regards CMA. Sanjay Gupta