Breaking Down the Taxation Angle in Your M&A Deal

Tax implications of mergers and acquisitions (M&A)  in India can significantly impact the final outcome of  the deal. 

Understanding these is essential so that your potential gains do not turn into unforeseen tax burdens. Explore with experts this complex landscape. 

Legal Framework Governing Mergers and Acquisitions (M&A) in India

In India, mergers and acquisitions are governed by a multitude of laws and regulations. Before we delve into the tax implications of mergers and acquisitions, here’s a quick look at the legal framework: 

Companies Act, 2013

• Cornerstone for M&A activities in India, ensuring transparency and fairness in mergers, demergers, and amalgamations.
• Sections 230-240 cover approvals, valuation requirements, and protection of minority shareholders.

Securities and Exchange Board of India (SEBI) Regulations

• Oversees transparency and investor protection during M&A involving listed companies.
• Takeover code provides guidelines to ensure fair practices during takeovers, disclosures, and delisting to safeguard shareholder interests.

Competition Act, 2002

• Regulates combinations that may adversely affect competition in India. 
• The Competition Commission of India (CCI) assesses M&A transactions to prevent monopolistic practices.

Income Tax Act, 1961

• Governs tax implications of M&A, including exemptions under Section 47 and benefits under Section 72A for loss carryforwards.
• Imposes capital gains tax on the transfer of shares and assets unless exemptions apply.

Foreign Exchange Management Act (FEMA), 1999

• Regulates foreign investments and currency transactions in cross-border M&A deals.
• Approval from the Reserve Bank of India may be required for certain transactions

Insolvency and Bankruptcy Code (IBC), 2016

• Allows companies in financial distress to be acquired through insolvency resolution processes.
• Ensures fair valuations and creditor protection during restructuring or liquidation.

Stamp Duty Laws

• State-specific laws impose stamp duties on the transfer of assets and property during M&A transactions.
• Rates may vary across states, which can influence transaction costs significantly.

Industry-Specific Regulations

• Certain industries like banking, telecommunications, and insurance require additional approvals from sector-specific regulators.
• These include RBI for banks, TRAI for telecom, and IRDAI for insurance firms.

Must Know Tax Implications of Mergers and Acquisitions in India 

The taxa implications of mergers and acquisitions are complex and can significantly impact the financial outcomes for both companies and shareholders. 

Here’s a look at the taxes applicable on mergers and acquisitions in India:

Direct Tax Implications

For Companies 

• Capital Gains Tax: Companies transferring assets during mergers may incur capital gains tax, except when such transfer is covered under Section 47 of the Income Tax Act. 
• Carry Forward of Losses: Section 72A permits an amalgamated company to carry forward and set off accumulated losses and unabsorbed depreciation from the amalgamating company, provided certain conditions are satisfied.
• Depreciation Benefits: The merged or acquiring company can claim depreciation on the transferred assets based on the ratio of number of days for which assets were used by both the companies.

For Shareholders

• Tax Neutrality (in the hands of the shareholder):  Shareholders do not have to pay capital gains tax when they exchange their shares for shares in the new or merged company. This is allowed when the merger meets certain conditions – 
  • Shareholders of the merging company must receive shares in the new or merged company in exchange for their original shares.
  • Transaction qualifies as an amalgamation i.e. two or more companies combine to form a new entity.
  • Resulting or amalgamated company must be an Indian company.
  • Shareholders retain a continuing interest in the new entity, typically through the shares received.

• Capital Gains Tax: Shareholders exchanging shares during mergers are taxed on the profit earned unless the transaction qualifies for any conditions under Section 47.
• Cost of Acquisition: The cost of shares in the merged entity is calculated based on the indexed cost of acquisition of the original company.
• Holding Period: The holding period of shares in the merged entity includes the period of holding shares in the original company. This affects eligibility for long-term capital gains tax benefits.

Indirect Tax Implications

Goods and Services Tax (GST) 

Generally, GST does not apply to share transfers; however, if assets are transferred as part of an M&A transaction, GST may be applicable depending on the nature of those assets.

• Slump Sale vs Itemized Sale: GST applies to itemized transfers of goods and services but does not apply to slump sales (sale of a business as a going concern).
• Input Tax Credit (ITC): Unutilized ITC in the merging company may be transferred to the merged company, provided conditions under GST rules are satisfied.
• Tax Liability on Services: Any service provided during M&A, such as consultancy or legal services, is subject to GST at applicable rates.

Stamp Duty 

Stamp duty is applicable on the transfer of shares and immovable property during M&A transactions. The rates vary by state and type of asset being transferred. 

Registration Charges 

Movable and immovable property transferred during M&A must be registered, and charges apply as per the local registrar’s office.

The charges depend on the property’s market value, increasing the overall transaction cost.

Tax Deduction at Source (TDS)

Payments made during acquisitions, such as purchase consideration, consultancy fees, or legal charges, may attract TDS under various provisions of the Income Tax Act.

Also Read:

Tax-saving strategies through mergers and acquisitions

Specific Taxation Considerations for Cross-Border M&A Transactions

In cross-border M&A transactions, taxation implications vary due to differences in tax laws between countries. 

Such transactions are governed by the Income Tax Act, 1961, Foreign Exchange Management Act (FEMA), and Double Taxation Avoidance Agreements (DTAA). Here’s a look at these: 

Capital Gains Tax

It is applicable when a capital asset is transferred, including assets held by non-residents if they are situated in India. The nature of the asset and the residency status of the parties involved will determine the tax implications.

• Certain conditions are available under Section 47, such as transfers during an amalgamation where the resulting company is an Indian entity.
• Transfers of shares of an Indian company by a foreign company to another foreign company under a scheme of amalgamation, provided specific conditions are met.

Double Tax Avoidance Agreements (DTAAs)

India has entered into DTAAs with many countries to prevent double taxation on income, including capital gains. 

Its applicability depends on the tax residency of the entities involved in the merger and acquisition which further influences where capital gains will be taxed.

For instance, Non-residents must provide a Tax Residency Certificate (TRC) to claim benefits under DTAA.

Withholding Taxes & TDS

Payments made to non-residents, such as consideration for shares or dividends, are subject to withholding tax under Section 195 of the Income Tax Act.

The DTAA agreements with the foreign countries can impact and lower the withholding tax.

For non-residents there is a possibility of applying for a lower TDS certificate to avoid excessive deductions.

Transfer Pricing

Transactions between related parties across borders must comply with transfer pricing regulations. 

This is done to ensure that they are conducted at arm’s length, which can affect tax liabilities.

Tax Related Compliance Requirements During M&As

Pre Merger 

• Tax Due Diligence – Assess tax liabilities, pending disputes, and compliance history to avoid surprises.
• Transaction Structuring – Optimize the deal to minimize tax liabilities, leveraging exemptions.
• Regulatory Approvals – Obtain clearance certificates (Section 281) and approvals from NCLT, SEBI, and RBI for compliance.
• Valuation and Tax Certificates – Conduct asset valuation and secure tax certifications for transfer pricing and withholding taxes.
• GST Compliance – Update GST registrations, verify unused Input Tax Credit (ITC), and assess reverse charge liabilities.

Post-Merger

• Tax Filings – File revised returns, update TDS records, and report new transfer pricing arrangements.
• Loss Set-Off Claims – Apply to carry forward losses and unabsorbed depreciation under Section 72A.
• GST and Indirect Taxes – Transfer ITC using Form ITC-02, update registrations, and pay applicable GST on asset transfers.
• Documentation– Maintain legal agreements, valuation reports, and updated tax audit records.
• Stamp Duty and Registration – Pay applicable stamp duties and register transferred properties as per state laws.
• Cross-Border Compliance – Deduct taxes for payments to non-residents (Section 195), comply with DTAA, and report transactions under FEMA.

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Frequently Asked Questions

1. What are the tax implications of merger and acquisition?, 

M&A transactions in India attract capital gains tax, stamp duty, registration charges, and GST on certain services. Companies can benefit from tax exemptions under Section 47 and carry forward losses under Section 72A if conditions are met.

2. Do foreign companies face additional compliance requirements in Indian M&A?

Yes, foreign companies must comply with FEMA regulations, submit reports to RBI, and ensure withholding tax compliance under Section 195. They can also benefit from DTAA provisions to avoid double taxation.

3. What is the role of GST in M&A transactions?

GST generally does not apply to the transfer of businesses as a going concern. However, it applies to services such as legal consultancy, due diligence, and valuation.

4. What are the indirect tax implications of M&A?

In addition to GST and stamp duty, companies involved in cross-border M&A must consider withholding taxes on payments made to non-residents and comply with transfer pricing regulations for transactions between related parties.

5. What should companies do to ensure compliance during M&A?

Companies should conduct thorough due diligence, prepare necessary documentation, obtain regulatory approvals, and consult with tax advisors to navigate the complexities of tax compliance effectively during M&A transactions.