Mergers and Acquisitions (M&A) are a prominent feature of the wide-reaching market. The tax framework for business restructuring in India consists of numerous concessions to provide the tax-neutrality for specified reorganisations, acquisitions etc.
Tax has always been a key factor in governing and guiding the shape of M&A and over time various provisions have been inserted in tax laws wherein tax neutrality was introduced for mergers and demergers, respectively.
While these provisions have been amended over a period to deal with the changing environment, assessee behaviour etc. certain legacy provisions may be relooked at by Finance Minister Nirmala Sitharaman during the upcoming budget considering the matured tax administration set up in the country.
1. A new tax law to deal with tax losses
- Section 71, 72 and 74 restricts the set-off of losses under capital gain against other income and long-term capital losses against short term capital losses. These restrictions were imposed to prevent tax avoidance by creating artificial losses. However, due to a robust tax administration and evolving technologies, these provisions merit reconsideration.
- Section 72A provides the benefit of tax losses of an amalgamating company (owning an industrial undertaking, hotel etc.) to the amalgamated company. Hence, there are various companies in the services sector (e.g., IT, hospitals including e-commerce companies) that are prevented from the benefit of this section. Hence, it is time to extend the benefit of this section to other sectors as well.
- Section 79 provides for lapse of tax losses on change in voting power beyond 49%. While some relaxation has been provided to eligible start-up u/s 80-IAC, they are quite restrictive. The objective of this section was to prevent the trading of tax losses. With the introduction of General Anti Avoidance Rules (GAAR), this window is no longer available to the assessee. Accordingly, the government may consider relaxing the applicability of this section to give a big boost to fundraising plans and M&A activities.
2. Tax neutrality provisions for various restructuring requires overhauling
- Section 2(1B) provides tax neutrality only for mergers of companies and does not cover mergers of LLPs. The business format of LLPs combining the flexibility of a partnership firm and company has increased global competitiveness. Amidst the surge in LLPs in the Indian market, there is undue hardship for LLPs looking at restructuring their business. Hence, this section should be amended to cover LLPs as well.
- Similarly, the shareholders of an amalgamating company are granted tax neutrality on transfer of their shares in a merger only if the amalgamated company (transferee company) is an Indian company. After globalisation and liberalising investment policies, Indian companies/individuals are investing overseas. However, any restructuring by overseas companies leading to a transfer of shareholding of Indian shareholders is subject to tax in India, which needs to be tax neutral.
- The tax neutrality for the transfer of capital assets between parent and wholly-owned subsidiary, conversion of firm/sole proprietorship to company or company to LLP is withdrawn on breaching certain notified conditions within a period of 5/8 years. This period is quite long and doesn't seem justifiable in the current competitive environment. Further, relaxation should also be provided if the transferee/transferor company ceases to exist due to a merger etc.
- While cross border merger is permitted in Indian regulation, the merger of an Indian company with a foreign company has not seen light in the absence of tax neutrality for Indian companies and their shareholders. It is imperative to amend the tax laws to provide tax neutrality/deferment till the monetisation of shares of a foreign company which will also pave the way for overseas listing through SPACs.
The issues discussed above are a few instances where there exists a scope of liberalisation in the tax laws which may boost the Indian economy. With the growing Indian economy, M&A activity is an ongoing phenomenon, and the domestic tax laws must stay relevant especially considering the developments around GAAR and BEPS globally.
(The author is Associate Partner - M&A Tax and Regulatory Services, BDO India.)