Want to know how M&A can turn your tax burden into a tax break? Explore with us the tax saving strategies through merger and acquisitions.
We take you through the basics of tax implications of mergers and acquisitions and how you can use it for saving more of your money.
Taxes Applicable on Mergers & Acquisitions in India
When companies go through mergers or acquisitions in India, they are subject to many kinds of taxes. Let’s briefly take a look at them:
Capital Gains Tax
It is levied when there is a sale of capital assets (like shares or property). In an M&A transaction, shareholders or companies may have to pay capital gains tax depending on whether the asset has appreciated.
There are two types of capital gains:
- Short-Term Capital Gains (STCG): If the asset is held for less than 12 months, the gains are considered short-term and taxed at higher rates.
- Long-Term Capital Gains (LTCG): If the asset is held for more than 12 months, the gains are taxed at a lower rate.
Goods and Services Tax (GST)
In an asset purchase deal where specific assets like machinery, property, etc., are sold, GST might be applicable on the value of those assets.
If a business is sold as a whole, operational business), there is no GST on the transaction.
Stamp Duty:
Stamp duty is a tax paid on the legal documents that transfer property or shares during an M&A transaction. The amount can vary depending on the state in which the transaction happens.
In some cases, structuring the deal as a demerger or amalgamation can help reduce stamp duty costs.
Securities Transaction Tax (STT)
This tax is levied on the purchase or sale of securities (like shares) on the stock exchange.
In the case of acquisitions involving listed companies, where shares are bought or sold, STT applies to the transaction.
Tax Deducted at Source (TDS)
In some M&A transactions, particularly those involving the purchase of immovable property, the buyer may need to deduct tax at source (TDS) while making the payment.
This ensures that the seller’s tax liability is partly covered upfront.
Transfer Pricing
In international M&A, transfer pricing regulations apply.
The buyer must ensure compliance with these rules when dealing with related parties to avoid disputes with tax authorities.
Tax Saving Strategies Through Mergers & Acquisitions
M&As allow businesses not only a way to grow and restructure but also opportunities to save taxes. Here are some key tax-saving strategies for M&A:
Carry Forward and Set Off of Losses
This is one of the biggest tax benefits from M&A provisioned under Section 72A of the Income Tax Act.
It allows the company that survives after a merger to carry forward the accumulated losses and unabsorbed depreciation of the acquired company.
This means that if a company being merged has recorded losses in previous years, the acquiring company can use those losses to reduce its own tax in the future.
Claim Capital Gains Tax Exemptions
Certain types of M&A transactions, such as amalgamations and demergers, may qualify for exemptions under Section 47 of the Income Tax Act.
This means that no capital gains tax is levied on the transfer of assets during these transactions, provided they meet certain specific conditions.
Avoid GST on Business Transfers
When companies merge, they often transfer assets like property, machinery, or entire business units. If structured correctly, this can help avoid the payment of GST.
If the business is transferred as a whole, the transaction can be exempt from GST, leading to significant tax savings.
Choose the Right M&A Structure for Tax Efficiency
The choice between asset sales, share purchases, or mergers can have different tax implications as we discuss ahead.
By choosing the structure that fits their tax planning goals, businesses can optimize their tax liability.
Consult with Tax Experts
Onboard tax professionals from reputed firms like PKC Management Consulting who have experience in handling these issues.
With their expertise, they will be able to handle complex regulations and ensure compliance while maximizing potential tax benefits from M&A transactions
Minimize Stamp Duty
Stamp duty is a tax paid on the transfer of assets or shares during an M&A deal. The amount of stamp duty can be reduced by selecting the right structure for the deal.
Stamp duty rates differ between states in India. Companies can structure the transaction to minimize this tax based on favorable state laws.
Cross-Border Tax Benefits
In international M&A deals, companies can take advantage of tax treaties like DTAA between India and other countries to avoid double taxation.
Proper structuring of cross-border deals and transfer pricing can help minimize tax exposure.
Increase Depreciation Claims
Acquiring assets through M&A allows the acquiring company to claim depreciation on newly acquired assets, which can lower taxable income.
The cost of these assets can be stepped up to their fair market value at the time of acquisition.
M&A Structures: Their Types & Tax Saving Benefits
Mergers and acquisitions can be structured in various ways, each with distinct tax implications that can lead to significant tax savings.
Let’s take a look at each type:
Amalgamation/ Merger
Here, two companies combine to form a single entity. The merging company ceases to exist, and its assets and liabilities are transferred to the surviving company.
Tax Saving Benefits:
- If the merger meets specific conditions as per the Income Tax Act, like all shareholders receiving shares in the new entity, no capital gains tax is levied on the shareholders or the company.
- The amalgamated company may carry forward and set off losses and unabsorbed depreciation from the amalgamating company against its profits, reducing overall tax liability.
- The transfer of assets in a merger is exempt from Goods and Services Tax (GST) if the business is transferred as a whole.
- Structuring the transaction within specific states with favorable stamp duty laws can help reduce this burden.
Demerger
It is the separation of a business from the parent company to form a new, independent entity. The new entity operates separately, and shareholders receive shares in both companies.
Tax Saving Benefits:
- Shareholders receive shares in the new entity without incurring capital gains tax at the time of demerger.
- A demerger that complies with Indian tax regulations is tax-neutral, meaning no capital gains tax is imposed on either the parent company or the shareholders for the transfer of shares.
- Similar to mergers, the losses and unabsorbed depreciation of the demerged division can be carried forward to the resulting entity, leading to significant tax savings.
- Stamp duty is levied on the transfer of property and assets. However, some states offer lower rates or exemptions for demerger transactions.
Share Purchase
In a share purchase, the acquiring company buys the shares of the target company. The target company continues to exist as a separate entity, but the ownership changes.
Tax Saving Benefits:
- Although capital gains tax exemptions are not available here, it allows for strategic planning regarding the timing and pricing of share transfers to minimize tax liabilities.
- GST is not applicable on the transfer of shares, as shares are considered “securities” under the GST Act, and securities transactions are exempt from GST under Section 8 of the CGST Act. This is a significant advantage as it reduces indirect tax liability for the transaction.
- If shares of a listed company are transferred, there is no stamp duty on the transaction.
Asset Purchase
In an asset purchase, one company acquires specific assets (like property, machinery, or intellectual property) from another company. The liabilities may or may not be transferred.
Tax Saving Benefits:
- The acquiring company can claim depreciation on the acquired assets, which can reduce taxable profits in subsequent years.
- The selling company is liable for capital gains tax on the sale of assets. However, the buyer can negotiate a lower price to factor in these tax costs.
- GST may apply to the transfer of specific assets, like machinery or goods. However, if the entire business is transferred, GST may not be applicable, as discussed ahead.
Slump Sale
In a slump sale, a business or an undertaking is sold for a lump sum amount without assigning individual values to the assets or liabilities.
Tax Saving Benefits:
- The selling company incurs capital gains tax based on how long it is held.
- Similar to asset sales, if the slump sale qualifies as a sale of a going concern, it is exempt from GST, making it a tax-efficient structure.
(The sale must involve the transfer of the entire business (or a significant portion of it) as a going concern, which includes both assets and liabilities.
The business must be operational at the time of the sale, with the intention that the business will continue to operate after the transaction.)
- The acquiring company can claim depreciation on the assets acquired, leading to future tax savings.
Frequently Asked Questions
- What is the tax benefit of merger & acquisition?
Certain mergers and acquisitions in India are generally tax-neutral, meaning no capital gains tax is incurred. Additionally, the acquiring company can utilize the tax losses of the acquired company, and shareholders may not face capital gains tax when exchanging shares.
- How is a merger treated for tax purposes?
Mergers are treated as tax-neutral transactions, exempting both companies from capital gains tax on asset transfers. Shareholders also do not incur capital gains tax when receiving shares in the new entity, provided certain conditions are met.
- How can companies ensure they maximize their tax benefits in M&A?
To maximize benefits, companies must know all liabilities and exemptions before finalizing deals. Monitoring changes in regulations for effective planning is also essential.
