Use of Tax Credits in Mergers and Acquisitions With Examples

Written By – PKC Desk, Edited By – Vijay, Reviewed By – Aakash

Use of tax credits in mergers and acquisitions (M&A) can significantly impact the post-transaction financial health and tax liabilities of the entities involved.

Explore with us a list of tax credits for M&A in India and the use of these credits in different scenarios using examples.

Types of Tax Credits Relevant to M&A in India

Here’s a quick list of tax credits for M&A in India:

Minimum Alternate Tax (MAT) Credits

MAT is a provision that ensures companies pay at least a minimum amount of tax, even if they have significant deductions or exemptions.

Companies that pay MAT can generate MAT credits, which can be carried forward and utilized against future regular tax liabilities.

It is the difference between MAT paid and the regular tax liability. It can be carried forward for up to 15 years.

In M&A transactions, the surviving or amalgamated entity may inherit and utilize MAT credits of the merging company, provided the merger complies with all tax laws.

Unabsorbed Business Losses and Depreciation

Unabsorbed business losses and depreciation can be carried forward to offset future taxable income.

In the context of M&As, the acquiring company can utilize these losses and depreciation from the target company against its income, potentially reducing overall tax liability.

The treatment of unabsorbed losses depends on compliance with provisions under the Income Tax Act, including maintaining continuity of ownership and business operations.

Input Tax Credits under GST

GST-registered entities are eligible to claim input tax credits (ITC) on taxes paid for goods or services used in the course of business.

ITC accumulated by the merging entity can be transferred to the amalgamated entity under GST law. The process involves filing GST Form ITC-02 with proper documentation to transfer unutilized ITC.

Ensure compliance with GST laws during the transaction to avoid disallowance of credits.

Research & Development Credits

Companies engaged in R&D activities can claim tax deductions and credits subject to conditions as specified under Section 35 of Income Tax Act,1961.

Relevance to M&A:

If the merging entity has unclaimed R&D tax benefits, these can be carried forward and utilized by the amalgamated entity.

To leverage this credit, the R&D activities and assets must be continued post-merger. This is especially relevant for M&A transactions in technology, pharmaceuticals, and other innovation-driven sectors.

Foreign Tax Credits (FTCs)

FTCs allow companies to claim credits for taxes paid in foreign jurisdictions under India’s Double Taxation Avoidance Agreements (DTAAs).

In cross-border M&A transactions, the surviving entity may inherit FTCs from the merged company.

This helps reduce the overall tax burden on global income and ensures compliance with international tax treaties.

Tax Deducted at Source (TDS) and Advance Tax Credits

In a merger, TDS and advance tax credits of the merging company can be transferred to the amalgamated entity.

These credits can reduce the tax payable by the surviving entity post-merger, leading to better cash flow management.

Use of Tax Credits in Mergers and Acquisitions Examples

EXAMPLE 1: ACQUISITION
Company A, a big tech firm, decides to acquire Company B, a smaller software firm. The acquisition is structured as a stock purchase.

EXAMPLE 2: MERGER
Company X (profitable) manufacturing firm merges with Company Y (loss-making). The merger is structured as an amalgamation.

Utilizing Tax Credits in Different M&A Scenarios

In mergers and acquisitions (M&A), tax credits can be a strategic tool for optimizing the financial outcomes of the transaction. Here’s how tax credits are utilized in different M&A scenarios:

Amalgamation

Amalgamation involves the merger of one or more companies into another, to form a new entity.

MAT credits of the amalgamating company can be carried forward to the amalgamated company if the transaction meets the conditions specified under Section 115JB.
Under Section 72A of the Income Tax Act, unabsorbed business losses and depreciation can be transferred to the amalgamated entity, provided the amalgamation is approved and certain conditions are met (e.g., maintaining 75% shareholding for five years).
GST ITC from the merging company can be transferred by filing GST Form ITC-02, ensuring compliance with GST rules.

Demerger

A demerger involves the separation of a division or unit of a company into a new or existing company.

MAT credits remain with the demerged company and are not typically transferred to the resulting company.
Unabsorbed business losses and depreciation can be apportioned between the demerged and resulting companies based on the value of assets transferred, subject to compliance with Section 72A.
GST credits can be allocated to the resulting entity based on the proportion of transferred business.

Acquisition of a Business

In a business acquisition, one company acquires the business undertaking of another company without merging the legal entities.

MAT credits are not transferable in an asset purchase transaction, as the acquiring entity does not inherit the legal identity of the seller.
Unabsorbed losses and depreciation cannot be transferred unless the transaction qualifies as a slump sale and meets specific conditions.
Input tax credits related to the transferred business may be claimed by the acquirer, provided the sale is structured properly and GST rules are adhered to.

Slump Sale

A slump sale involves the transfer of a business undertaking as a going concern for a lump sum consideration without assigning individual values to assets and liabilities.

MAT credits are not transferred in a slump sale, as the acquiring entity does not inherit the seller’s legal identity.
The acquiring entity cannot claim the seller’s unabsorbed business losses and depreciation.
The buyer can claim ITC for GST paid on the acquisition of the business, provided the transaction complies with GST regulations.

Cross-Border M&A

Cross-border M&A involves the acquisition or merger of a company in a foreign jurisdiction.

FTC can be utilized to avoid double taxation on foreign income by claiming credits for taxes paid in the foreign jurisdiction under applicable DTAAs.
MAT credits are only applicable to Indian entities and cannot be transferred across borders.
Losses from foreign subsidiaries cannot be transferred to the Indian parent company under Indian tax laws.

Challenges and Risk Mitigating Strategies for Use of Tax Credits in Mergers and Acquisitions in India

Challenges

Tax credits are subject to strict regulations. Non-compliance can result in denial of credits or penalties.
Insufficient due diligence may uncover ineligible or expired credits, leading to financial risks.
Poorly structured deals can cause loss of credits, especially MAT credits and unabsorbed losses.
International transactions may involve complex withholding taxes and compliance with DTAAs.
Disputes over valuations can impact tax credit utilization and overall deal feasibility.

Risk Mitigation Strategies

Conduct thorough tax due diligence to identify all eligible tax credits and potential risks before finalizing the transaction.
Consult experienced tax professionals like PKC Management Consulting to ensure compliance with applicable laws and to structure transactions optimally for credit utilization.
Maintain detailed records of all tax payments, filings, and credit-related transactions to defend claims during audits.
Design M&A transactions to maximize the transfer and utilization of tax credits while meeting legal requirements.
Monitor changes in tax policies and adapt strategies accordingly to avoid losing eligible credits.
Create a clear plan to harmonize accounting practices and utilize credits effectively.

Frequently Asked Questions

What are tax credits in M&A?

They refer to reductions in tax liabilities that companies can utilize during and after a merger or acquisition. These credits can come from various sources, such as MAT) credits, unabsorbed business losses, input tax credits, and foreign tax credits.

How do tax credits impact the valuation of a target company?

Tax credits can enhance the valuation of a target company by providing future tax savings. Buyers often consider the availability of these credits when assessing the overall financial health and attractiveness of an acquisition.

How do cross-border M&A transactions affect tax credit utilization?

They can introduce complexities such as withholding taxes and compliance with Double Taxation Avoidance Agreements (DTAAs). Understanding these factors is essential for optimizing tax credit utilization and minimizing liabilities.

What are some common challenges in utilizing tax credits during M&A?

Common challenges include navigating complex regulatory frameworks, discrepancies in valuations, implications of transaction structures, and integration issues post-merger that may complicate the effective use of tax credits.

How can companies mitigate risks associated with tax credit utilization?

Companies can mitigate risks by conducting thorough due diligence, engaging experienced tax advisors, carefully structuring transactions, planning for integration, and staying informed about regulatory changes.