- The term “merger” finds substantial mention in the Companies Act,2013 (CA13) as well as 1956(CA56), the Income Tax Act, 1961(IT Act) and various regulations of Securities and Exchange Board of India(SEBI), none of them have clearly laid down an exhaustive and absolute definition of merger. However, the framework of merger laid down in these legislations connotes that merger is the blending of two or more companies into one.
- It is an amalgamation where all properties and liabilities of transferor are merged with the properties and liabilities of the transferee company. In essence, it is a merger of assets and liabilities of two or more companies. The IT Act defines an amalgamation as the merger of one or more companies with another or the merger of two or more companies to form a new company.
- All assets and liabilities of the amalgamating companies become assets and liabilities of the amalgamated company. The shareholders with at least nine-tenths in value of the shares in the amalgamating company (or companies) become shareholders of the amalgamated company. All assets, liabilities and the stock of one company stand transferred to Transferee Company in consideration of payment in the form of:
- Equity shares in the transferee company,
- Debentures in the transferee company,
- Cash, or
- A mix of the above mode
- An ‘acquisition’ or ‘takeover’ is the purchase by one person, of controlling interest in the share capital, or all or considerably all of the assets and/or liabilities, of the target. A takeover may be friendly or hostile and may be effected through agreements between the offeror and the majority shareholders, purchase of shares from the open market, or by making an offer for acquisition of the target’s shares to the entire body of shareholders.
- Acquisitions may be by way of acquisition of shares of the target, or acquisition of assets and liabilities of the target.
Forms and Types of Merger
- Merger through Absorption:- An absorption is a combination of two or more companies into an ‘existing company’. All companies except one lose their identity in such a merger.
- Merger through Consolidation:- A consolidation is a combination of two or more companies into a ‘new company’. In this form of merger, all companies are legally dissolved and a new entity is created. Here, the acquired company transfers its assets, liabilities and shares to the acquiring company for cash or share exchange.
- Horizontal merger: – Is a combination of two or more firms in the same area of business.
- Vertical merger: – Is a combination of two or more firms involved in different stages of production or distribution of the same product.
- Conglomerate merger: – Is a combination of firms engaged in completely different lines of business activity.
- Acquisition refers to the process of acquiring a company at a price called the acquisition price or acquisition premium. The price is paid in terms of cash or acquiring company’s shares or both.
There are two types of business acquisitions, friendly acquisition and hostile acquisition.
- In a friendly acquisition, a company invites other companies to acquire its business.
- In a hostile acquisition, the company does not want to sell its business. However, the other company determined to acquire the business takes the aggressive route of buying the equity shares of the target company from its existing shareholders.
- Amalgamation is an arrangement where two or more companies strengthen their business to form a new firm, or become a subsidiary of any one of the company. The terms amalgamation and merger are used interchangeably but there is a slight difference.
- Merger is the integration of two or more companies into a single company where the identity of some of the companies gets dissolved. Whereas, amalgamation involves dissolving the entities of amalgamating companies and forming a new company having a separate legal entity.
Types of Amalgamation
- There are two types of amalgamations.
- The first one is similar to a merger where all the assets and liabilities and shareholders’ of the amalgamating companies are combined together. The accounting treatment is done using the pooling of interests method. It involves laying down a standard accounting policy for all the companies and then adding their relevant accounting figures like capital reserve, machinery, etc. to arrive at revised figures.
- The second type of amalgamation involves acquisition of one company by another company. In this, the shareholders of the acquired company may not have the same equity rights as earlier, or the business of the acquired company may be discontinued which is similar to the purchase of a business. The accounting treatment is done using a purchase method. It involves recording assets and liabilities at their existing values or revaluating them on the basis of their fair values at the time of amalgamation.
- Joint venture is a contractual arrangement between two or more parties who agree to come together for the purpose of undertaking a business project. All the parties contribute capital and share profits and losses in a decided ratio. Joint ventures are a type of partnership that is always executed through a written contract known as a joint venture agreement (JVA).
- The contracts registered under JVA are legally binding on the parties. Furthermore, they are temporary in nature because they are implemented for a definite period of time to attain a specific goal. The contract automatically dissolves after the expiry of the decided time period.
- Where the business of an entity comprises two well defined ‘undertakings’, it is possible to split up the entity into two entities. Generally, shareholders of the original entity would be issued shares of the new entity. Where a demerger is completed through a court process and fulfills certain conditions prescribed under the Tax Act, it will not result in capital gains for the seller (section 2(19AA) of the Tax Act) or sales tax liability. In addition, tax losses of a demerged company responsive to the demerged ‘undertaking’ can be carried forward and balance the profits of the resulting company, subject to fulfillment of certain conditions.
Regulatory framework governing M&A transactions Company law
- An acquisition of shares is acceptable with prior approval of the audit committee and board of directors. Share sale between related parties may also require prior shareholders’ approval. Earlier mergers or demergers were largely governed by sections 391-394 of the Companies Act, 1956.
- Recently, with effect from 15 December 2016, sections 230-240 of the Companies Act, 2013, were notified(except Section 234 of Companies Act, 2013), following to which all the Schemes of Arrangement now require approval of the National Company Law Tribunal (NCLT) as against the High Court earlier.
- As per the procedures, any scheme is first approved by the audit committee, the board of directors, stock exchanges (if shares are listed) and then by the shareholders/creditors of the company with a requisite majority (i.e. majority in number and 3/4th in value of shareholders/creditors voting in person, by proxy or by postal ballot).
- NCLT gives its final approval to the scheme after considering the observations of the Regional Director, Registrar of Companies, Official Liquidator, income tax authorities, other regulatory authorities (RBI, stock exchanges, SEBI, Competition Commission of India [CCI], etc.) and any other objections filed by any other stakeholder interested in or affected by the scheme.
Income-tax Act, 1961
- Implications under the Income Tax Act, 1961 Tax implications can be understood from the following three perspectives:
- Tax concessions to the Amalgamated (Buyer) Company. If the amalgamating company has incurred any expenditure eligible for deduction under sections 35(5), 35A(6),35AB(3), 35ABB, 35D, 35DD, 35DDA, 35E and/or 36(1)(ix), prior to its amalgamation with the amalgamated company as per section 2(1B) of the Act and if the amalgamated company is an Indian company, then the benefit of the aforesaid sections shall be available to the amalgamated company, in the manner it would be available to the amalgamating company had there been no amalgamation. Also under section 72A of the Act, the amalgamated company is entitled to carry forward the unabsorbed depreciation and unabsorbed accumulated business losses of the amalgamating company provided certain conditions are fulfilled.
- Tax concessions to the Amalgamating (Seller) Company.Any transfer of capital assets, in the scheme of amalgamation, by an amalgamating company to an Indian amalgamated company is not treated as transfer under section 47(vi) of the Act and so no capital gain tax is attracted in the hands of the amalgamating company.
- Tax concessions to the shareholders of an Amalgamating Company. When the shareholder of an amalgamating company transfers shares held by him in the amalgamating company in consideration of allotment of shares in amalgamated company in the scheme of amalgamation, then such transfer of shares in not considered as transfer under section 47(vii) of the Act and consequently no capital gain is attracted in the hands of the shareholder of amalgamating company. Where an Indian target entity is sought to be acquired by a foreign entity, it may be noted that the corporate laws permit only domestic companies to be amalgamated. So the foreign acquirer have to create a local special purpose vehicle (SPV) in India to give effect the amalgamation with the Indian company and more over the SPV avails the tax benefits on amalgamation under the Act since the same are subject to the amalgamated company being an Indian company.
- In the case of foreign companies holding shares of Indian companies, on amalgamation or de-merger of the foreign company with another foreign company, the transfer of shares would enjoy exemption from capital gains tax, subject to the following conditions:
- At least 25% shareholders of the amalgamating foreign company 75% of shareholders of the de- merged company continue to remain share holders of the amalgamated foreign company/resulting foreign company and
- Such transfer does not attract tax on capital gains in the country of incorporation of the amalgamated/resulting company. Amalgamation when effective: – Date of amalgamation. Every scheme of amalgamation provides for a transfer date from which the amalgamation is effective i.e., the Appointed Date‘. The effective date‘ is the date when the amalgamation actually takes place after obtaining the jurisdictional Court Approval and furnishing of the relevant documents with the Registrar of Companies. The effective date thus differs from the appointed date.
- Tax Implications on Mergers and Acquisitions Mergers and acquisitions (M&As)
- Tax Implications on Mergers and Acquisitions Mergers and acquisitions are an accepted strategy for corporate growth. While they may create value, mitigate agency problems associated with a firm’s free cash flow, enhance the firm’s market power, or help utilize tax credits.
- The tax impact of properly structuring the disposition and acquisition of a company can have a very material impact on the economics of the transaction to both parties. , there are numerous tax planning opportunities that allow each party to obtain its specific tax and economic objectives without harming the other party.
- Any acquisition of shares of more than 25% of a listed company by an acquirer would trigger an open offer to the public shareholders. Any merger or demerger involving a listed company would require prior approval of the stock exchanges and SEBI before approaching NCLT.
- Further, under the Takeover Code, a merger or demerger of a listed company usually does not trigger an open offer to the public shareholders.
Foreign Exchange Regulations
- Foreign exchange regulations Sale of equity shares involving residents and nonresidents is permissible subject to RBI pricing guidelines and permissible sectoral caps.
- A merger/demerger involving any issuance of shares to non-resident shareholders of the transferor company does not require prior RBI/government approval provided that the transferee company does not exceed the foreign exchange sectoral caps and the merger/demerger is approved by the Indian courts.
- Issuance of any instrument other than equity shares/compulsorily convertible preference shares/ compulsorily convertible debentures to the non-resident would require prior RBI approval as they are considered as debt.
- Where an acquisition relates to a sector where foreign investment is restricted and therefore needs prior regulatory approval from the central government, the waiting period for such approvals can range from six to eight weeks. The central government has delegated authority to the Foreign Investment Promotion Board (FIPB) under the support of the Ministry of Finance to grant such approvals on its behalf. In practice, delays are not uncommon and the definitive timing to obtain FIPB approval is hard to predict.
- Foreign investment in the insurance sector is restricted to 49 per cent of the share capital of the Indian insurance company. In addition, the Indian insurance company is required to obtain a license from the Insurance Regulatory and Development Authority and adhere to several reporting, solvency and accounting requirements.
- Tax residency certificate
- Non-resident taxpayers are mandatorily required to furnish a tax residency certificate along with the prescribed information such as status of the taxpayer, country of incorporation, tax identification number, etc, for claiming the benefit of an applicable tax treaty.
- Withholding tax
- Where the payee is a non-resident or a foreign company, there is a legal obligation on the payer (whether resident or non-resident) to deduct tax at source when making any remittance to the former, if such payment constitutes income which is chargeable to tax under the Tax Act read with the applicable tax treaty.
Any acquisition requires prior approval of CCI if such acquisition exceeds certain financial thresholds and is not within a common group. While evaluating an acquisition, CCI would mainly scrutinize if the acquisition would lead to a dominant market position, resulting in an adverse effect on competition in the concerned sector.
- The Indian Stamp Act, 1899, provides for stamp duty on transfer/issue of shares at the rate of 0.25%. In case the shares are to be withdrawn, there would be no stamp duty on transfer of shares.
- Conveyance of business under a business transfer agreement in the case of a slump sale is charged to stamp duty at the same rate as in the case of conveyance of assets. Typically, a scheme of merger/demerger is charged to stamp duty at a concessional rate as compared to conveyance of assets. The exact rate levied depends upon the specific entry under the respective state laws.
The basic regulatory framework governing labour and employee benefits in a business combination
- Among the key issues which an investing company is confronted with, is the tangle of labour and employment laws in India which govern employee rights. Provisions for termination of employment are contained in the Industrial Disputes Act, Shops & Establishment Act of the State in which the establishment is located, Standing Orders Act, and the Service Contracts of employees.
- Restructuring which involves merger of one unit with another where the original unit loses its identity or becomes part of another entity, or one unit acquires another but the existing unit retains its status as an entity, are all events which lead to change of owner for the employees, or reallocating (transfer) employees between the existing and acquired units, or termination of employment contract, and designing settlement packages, or even re-writing employment agreements require to be within the permissible limits under the local laws.
- Divestment of a Unit or Undertaking.
- Divestment of a Unit or Undertaking is when a running business undertaking is acquired by another company and the ownership of the business changes from the old company to a new company. This leads to a sale of assets and purchase by a new company with or without the employees (assuming these to be “workman”) of the transferred undertaking.
- Where such workmen are not taken over by the new buyer, the old company may continue their service contracts but any redeployment of roles and terms would require consent to be obtained in terms of the ID Act, notices to be given regarding changes in their terms, etc. On the other hand, if the workmen are transferred to the buyer entity, this involves a change of ownership and a new employer for such workers.
- As judicial norms go, the Supreme Court in India has held that the old employer has to obtain the consent of the affected workers even if there is no change in their terms of service and they are transferred on no less favourable terms. More significantly, the employee transfer would have to be accompanied by an agreement between the transferor (seller) and the transferee (buyer) under which the seniority or period of service may have to be taken over by the buyer so that there is no interruption of employment for purpose of social security benefits.
- This will also involve transfer of gratuity funds to the buyer entity and transfer of provident fund accounts of the employees to the new entity. If the workers do not wish to move over, and the existing employer does not wish to retain them then the workers have to be “retrenched” as redundant under the ID Act and have to be paid compensation, given notice of termination with reason recorded therein, and all their termination benefits have to be paid under appropriate settlement agreements.
- There may also be a situation where the transfer of undertaking may involve transfer of workmen on terms less favourable. In this case the workmen who agree to resign from the old employer (seller), and accept to move to the new employer (buyer), would have to be paid retrenchment compensation as provided under the ID Act, and if they have done five years of continuous employment in the seller company, they would have to be paid their gratuity benefits, though the provident fund accounts and balances would have to be transferred to the new employer (buyer).
- Here a note of caution needs to be sounded for the benefit of the buyer/new employer, as the courts have held that the doctrine of continuing employer mandates that the new employer must take over the service seniority of the employees. Thus, new employers must undertake due diligence to ensure that the appropriate deductions of statutory contributions were made by the old employer and only then take over the accounts. In most cases of mergers (involving sale or transfer of shares), the courts now insist that the buyer would incur the social security obligations as a successor employer.
- Determination of the status of employees
- There are a number of statutory and judicially defined criteria that have to be applied to the employment agreements or appointment letters to determine the exact status in each case.
- Both the ID Act and the S & E Act of the State concerned provide for notices, grounds of termination simpliciter where permitted, though in most cases only ‘with cause’ termination are permitted. Then, depending upon the industry and strength of the total numbers employed, there are legal requirements of giving simple notice to the government or applying for prior permission to the government in case of large undertakings in certain industrial establishments.
- Under the ID Act, the procedure to be followed depends on a case to case fact situation of the industry, whether it is in the service sector or in the manufacturing sector. Where the employees are external resources or “consultants” who were hired for providing services as independent contractors, the procedural requirements and legal conditions for termination are different from those mandated for “workmen”. If these resources have to be terminated as surplus or redundant, their settlement packages, and payment of statutory benefits, if applicable, hinge on the determination of their status.
Bankruptcy under Mergers and Acquisitions
- Under Indian law, a company is regarded to be ‘potentially sick’ where accumulated losses at the end of a financial year have dissolved 50 per cent of its net worth during the immediately preceding four financial years.
- The board of directors of a ‘potentially sick’ company can make a reference to the Board for Industrial and Financial Reconstruction (BIFR) within 60 days from the date of finalisation of the audited accounts for the financial year with reference to which ‘sickness’ can be attained.
- Foreign investors are permitted to invest in ‘sick’ units, provided that prior approval of the BIFR is obtained. While acquiring assets from a company in the BIFR, it is very important to ensure that no proceedings are pending against any order by the BIFR that could possibly delay title to the assets.
- Under section 531A of the Companies Act, 1956 (corresponding provision section 329 under the Act is not yet notified), any transaction relating to property of the company concluded within one year prior to the commencement of its winding-up, other than in the ordinary course of business or in good faith for valuable consideration, is invalid.
- Additionally, transactions with creditors preceding six months prior to the commencement of a winding-up can be challenged as a fraudulent preference.
Anti-Corruption Laws and Sanctions for Business Mergers and Acquisitions
- Indian Government has passed the following Laws and Acts against corruption:
- Indian Penal Code, 1860
- (IPC), Prevention of Corruption Act, 1988 (POCA),
- Prevention of Money Laundering Act, 2002 (PMLA) and
- Foreign exchange laws and regulations.
- India is also a signatory to the United Nations Convention against Corruption and has ratified the same.