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Business Restructuring –Tax and Legal Aspects

December 30, 2010Alok MundraDirector - M&A Tax

© 2010 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 2

Agenda

SLUMP SALE

MERGER

DEMERGER

CAPITAL REDUCTION

LEGAL ASPECTS


SLUMP SALE

MERGER

DEMERGER

CAPITAL REDUCTION

LEGAL ASPECTS


Section 2(1B) defines “Amalgamation”

“Amalgamation”, in relation to companies, means the merger of one or more companies with another company or

the merger of two or more companies to form one company (the company or companies which so merge being

referred to as the amalgamating company or companies and the company with which they merge or which is formed as

a result of the merger, as the amalgamated company) in such a manner that—

(i) all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation ;

(ii) all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation ;

(iii) shareholders holding not less than [three-fourths] in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the

amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the

amalgamation,

otherwise than as a result of the acquisition of the property of one company by another company pursuant to the

purchase of such property by the other company or as a result of the distribution of such property to the other company

after the winding up of the first mentioned company

If all the above conditions are fulfilled, then…


If all the conditions fulfilled…

•

Transfer of capital asset by an amalgamating to the amalgamated company if amalgamated company is an Indian company…………………….Section 47(vi)

•

Transfer of shares held in an Indian company on amalgamation of a foreign company into another foreign company

•

At least 25% of the shareholders of the amalgamating foreign company continue to remain shareholders of the amalgamated foreign company; and

•

Such transfer does not attract tax on capital gains in the country in which the amalgamating foreign company is

incorporated…………………………………… Section 47(via)

•

Transfer by a shareholder of a capital asset being a share or shares held by him in the amalgamating company, if—

•

the transfer is made in consideration of the allotment to him of

any share or shares in the amalgamated company, and

•

the amalgamated company is an Indian company; ……………………………………

Section 47(vii)

Conditions similar to Clause 314 (16) of the DTC; additionally amalgamation to be in accordance with the Companies Act

Then following will not be considered as “transfer” and hence will not be subject to capital gains


“Cost of Acquisition” and “Period of Holding” of Shares received upon Amalgamation

What will be the cost of acquisition of shares of amalgamated company in the hands of shareholder of amalgamating company

•

Where the capital asset being a share or shares in an amalgamated company which is an Indian company became the property of the assessee in consideration of a transfer referred to in clause (vii) of section 47, the cost of acquisition of the asset shall be deemed to be the cost of acquisition to him of the share or shares in the amalgamating company……Section 49

?

? What will be the period of holding of shares of amalgamated company in the hands of shareholder of amalgamating company

•

In the case of share or shares in an Indian company, which becomes the property of the assessee in consideration of a transfer referred to in clause (vii) of section 47, there shall be included the period for which the share or shares in the amalgamating company were held by the assessee…..Section 2(42A)


Benefit of carry forward of “accumulated losses” and “unabsorbed depreciation”

Where there has been an amalgamation of •

Company owning an industrial undertaking, a ship, or a hotel; or

•

Banking company; or

•

Public sector engaged in the operations of aircrafts business

then, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the

loss or, as the case may be, allowance for unabsorbed depreciation of the amalgamated company for the previous

year in which the amalgamation was effected, and other provisions of this Act relating to set off and carry forward of

loss and allowance for depreciation shall apply accordingly

Industrial Undertaking for this purpose means any undertaking which is engaged in -•

Manufacture or processing of goods; or

•

Manufacture of computer software; or

•

Business of generation or distribution of electricity or any other form of power; or

•

Telecommunication services; or

•

Mining; or

•

Construction of ships, aircrafts or rail systems

DTC does not provide for ‘industrial undertaking’


Benefit of carry forward of “accumulated losses” and “unabsorbed depreciation”Conditions to be satisfied for carry forward of accumulated losses and unabsorbed depreciation

By Amalgamating Company

•

Engaged in the business in which the accumulated loss has occurred and depreciation remains unabsorbed for 3 or more

years

•

Held 3/4th of the book value of fixed asset for 2 years prior to

the date of amalgamation

By Amalgamated Company

•

Holds 3/4th of the book value of fixed asset for 5 years from date of amalgamation

•

Continues business of amalgamating company for at least 5 years from the date of amalgamation

•

To achieve production of at least 50% of the installed capacity of the undertaking before the end of 4 years from the date of

amalgamation and to maintain the said minimum level till the end

of 5 years from the date of amalgamation (Rule 9C)

Whether fresh lease of life available in case of amalgamation?

Clause 64 of the DTC – however, test of continuity (Clause 314(260) of the DTC) to be satisfied – to hold 3/4th of the book value of fixed assets and continuity of business


Other Relevant Provisions

•

Aggregate deduction, in respect of depreciation tangible and intangible assets to the

amalgamated company shall not exceed in any previous year the deduction calculated at the

prescribed rates as if the amalgamation had not taken place;

•

And such deduction shall be apportioned between the amalgamating

company and the

amalgamated company in the ratio of the number of days for which

the assets were used by

them

•

Where an assessee, being an Indian company, incurs any expenditure, on or after the 1st

day of April, 1999, wholly and exclusively for the purposes of amalgamation or demerger of

an undertaking, the assessee shall be allowed a deduction of an amount equal to one-fifth of

such expenditure for each of the five successive previous years beginning with the previous

year in which the amalgamation takes place

Depreciation calculation in the

hands of Amalgamated

Company

(Section 32)


hands of Amalgamated

Company

(Section 32)

Amortization of expenditure in case

of amalgamation

(Section 35DD)


of amalgamation

(Section 35DD)


Case Study 1 – Merger of wholly owned subsidiary into holding and shares are not issued...will it be tax neutral Amalgamation?

Whether merger of wholly owned subsidiary into holding

company where shares are not issued will be a tax

neutral event?

shareholders holding not less than [three-fourths] in value

of the shares in the amalgamating company or companies

(other than shares already held therein immediately

before the amalgamation by, or by a nominee for, the

amalgamated company or its subsidiary) become

shareholders of the amalgamated company by virtue of the

amalgamation

Company A

Company B

100%Merger

?


Case Study 2 – Whether “transfer” of asset under the scheme of merger is subject to deemed dividend tax?

Whether transfer of capital asset on merger of Company

B into Company A results in distribution of dividend by

the subsidiary company to its shareholder under Section

2(22)(a) or Section 2(22)(c)?

−

Section 2(22)(a) is attracted in case of distribution

entails release of an asset

−

Section 2(22)(c) is attracted in case of liquidation

Company A

Company B

100%Merger

?


Case Study 3 – Merger of two loss making companies…..

•

Co A, a closely held company, proposes to merge

into Co B

•

Loss in FY 2005-06

•

Co B has losses of Rs. 10 crores

Company A

Company B

Merge

Loss Rs. 10 crores

Loss = Rs. 5 crores

Which Section to apply – Section 72A or Section 79?


SLUMP SALE

MERGER

DEMERGER

CAPITAL REDUCTION

LEGAL ASPECTS


Section 2(19AA) defines “Demerger”

““Demerger”, in relation to companies, means the transfer pursuant to a Scheme of Arrangement under sections 391 to 394 of the Companies Act, 1956, by a demerged company of its one or more undertakings to any resulting company in such a manner that—

(i) all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;

(ii) all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;

(iii) the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;

(iv) the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;

(v) the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger, otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company;

(vi) the transfer of the undertaking is on a going concern basis;

(vii) the demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf.


Section 2(19AA) - Demerger

Explanation 1 – For the purpose of this clause, “undertaking” shall include any part of an undertaking, or a unit or

division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any

combination thereof not constituting a business activity

DTC; only equity shares can be issued as a consideration,individual assets or liabilities or any combination thereof which constitutes a business

activity would be regarded as an undertaking


Section 2(19AA) – Demerger

Explanation 2.—For the purposes of this clause, the liabilities referred to in sub-clause (ii), shall include—

(a) the liabilities which arise out of the activities or operations of the undertaking;

(b) the specific loans or borrowings (including debentures) raised, incurred and utilised solely for the activities or operations of

the undertaking; and

(c) in cases, other than those referred to in clause (a) or clause (b), so much of the amounts of general or multipurpose

borrowings, if any, of the demerged company as stand in the same

proportion which the value of the assets transferred in a

demerger bears to the total value of the assets of such demerged

company immediately before the demerger.

Explanation 3.—For determining the value of the property referred to in sub-clause (iii), any change in the value of assets

consequent to their revaluation shall be ignored.

Explanation 4.—For the purposes of this clause, the splitting up or the reconstruction of any authority or a body

constituted or established under a Central, State or Provincial Act, or a local authority or a public sector company, into

separate authorities or bodies or local authorities or companies, as the case may be, shall be deemed to be a demerger if

such split up or reconstruction fulfils [such conditions as may be notified in the Official Gazette, by the Central

Government];


If conditions mentioned in Sec.2(19AA) are fulfilled…

Then following will not be considered as “transfer” and hence will not be subject to capital gains

•

Transfer of capital asset by a demerged company to the resulting

company if the resulting company is an Indian company…………………….Section 47(vib)

•

Transfer of shares held in an Indian company by the demerged foreign company to the resulting foreign company

•

At least 75% of the shareholders of the demerged foreign company

continue to remain shareholders of the resulting foreign company; and

•

Such transfer does not attract tax on capital gains in the country in which the demerged foreign company is

incorporated…………………………………… Section 47(vic)

•

On transfer or issue of shares by the resulting company, in a scheme of demerger to the shareholders of the demerged company, if the transfer or issue is made in consideration of demerger of the undertaking -

Section 47(vid)

Similar provisions under Clause 47(1) of DTC


“Cost of Acquisition” and “Period of Holding” of Shares received upon Demerger

What will be the cost of acquisition of shares of resulting company in the hands of shareholder of demerged company

•

Cost of acquisition of shares in resulting company = Cost of acquisition of shares held in the demerged company X Net book value of the assets transferred in the demerger

______________________________________________________________________________________Net worth of the demerged company immediately before such demerger

•

Cost of acquisition of shares in demerged company =Original cost of acquisition of shares in the demerged company Less Cost of acquisition of shares in the resulting company as calculated above ……Section 49(2C) and (2D)

?

? What will be the period of holding of shares of resulting company in the hands of shareholder of demerged company

•

In the case of share or shares in an Indian company, which becomes the property of the assessee in consideration of a demerger, there shall be included the period for which the share

or shares in the demerged company were held by the assessee…..Section 2(42A)


Other Relevant Provisions

•

Aggregate deduction, in respect of depreciation tangible and intangible assets to the

demerged company and resulting company shall not exceed in any previous year the

deduction calculated at the prescribed rates as if the demerger had not taken place;

•

And such deduction shall be apportioned between the demerged company and the resulting

company in the ratio of the number of days for which the assets were used by them

•

WDV of the assets in the hands of the demerged company


hands of Demerged Company

(Section 32)


hands of Demerged Company

(Section 32)

WDV in the hands of Resulting Company

(Section 43(6))

WDV in the hands of Resulting Company

(Section 43(6))


of demerger

(Section 35DD)


of demerger

(Section 35DD)

•

Where an assessee, being an Indian company, incurs any expenditure, on or after the 1st

day of April, 1999, wholly and exclusively for the purposes of amalgamation or demerger of

an undertaking, the assessee shall be allowed a deduction of an amount equal to one-fifth of

such expenditure for each of the five successive previous years beginning with the previous

year in which the demerger takes place


ALLOWABILITY

•

Loss and unabsorbed depreciation directly relatable to the demerged undertaking

•

In case loss and unabsorbed depreciation is not directly relatable to the demerged undertaking, loss and

unabsorbed depreciation to be apportioned in the ratio of assets

retained and assets transferred

•

No other conditions as those mentioned for amalgamation needs to

be satisfied

Whether fresh lease of life available in case of demerger ?

Benefit of carry forward of “accumulated losses” and “unabsorbed depreciation” in case of Demerger


Case Study 4 – Transfer of subsidiary’s shares to the shareholders under scheme of arrangement…….whether covered u/s. 47(vid)?

•

Co A, a listed company, demerges its business into Co B

•

Shares issued by Co B to the shareholders of Co A

•

By virtue of the demerger, Co B to also list its shares

•

As a part of the Scheme of Arrangement, Co B proposes to transfer its shares held in Co C, its subsidiary, to the

shareholders of Co A

•

Whether transfer of shares of Co C covered under section 47(vid)?

Company A Company B

Company C

Demerger

100%

Shareholders Issue of shares


Case study 5 – Issue of shares by Resulting Company….

•

D Co, a listed company, demerges its business into R Co

•

R Co. issues shares to the shareholders of D Co.

•

Further, D Co. also demerges certain undertaking to W Co., wholly owned subsidiary of R Co.

•

Pursuant to this demerger, R Co. issues shares to the shareholders of D Co.

•

Definition of resulting company under Section 2(41A) includes its subsidiary company

D Co R Co.

W Co.Demerger

100%

Shareholders Issue of shares

Demerger


Case study 6 – Demerger of a division……

•

ABC Ltd demerged Division X into XYZ Ltd

•

Consideration has been discharged by issue of shares to the

shareholders of ABC Ltd.

•

Scheme of Arrangement provides for transfer of assets of the

demerged undertaking at its fair values

ABC Ltd.

Division X Division Y

XYZ Ltd.

Demerger

Shareholders

Whether the transfer qualifies as demerger?

If yes, is the demerger tax neutral?

Further, Can there be any capital gains tax liability in the hands of the ABC Ltd or its

shareholders?


DEMERGER

MERGER

SLUMP SALE

CAPITAL REDUCTION

LEGAL ASPECTS


Section 2(42C) - Slump Sale

•

Section 2(42C) of the IT Act defines :

‘Slump Sale’ as the transfer of one or more undertakings as a result of the sale for a lump sum

consideration without values being assigned to the individual assets and liabilities in such sales.

•

The term ‘Undertaking’

shall have same meaning as assigned in the definition of ‘Demerger’.

•

It shall include:

-

any part of an undertaking; or

-

a unit or division of an undertaking; or

-

a business activity taken as a whole

but does not include individual assets or liabilities or any combination thereof not constituting a business

activity.

Determination of value of asset for the purpose of stamp duty shall not be regarded as assignment of values to individual assets – explanation to Sec 2(42C)


Slump Sale – Tax implications

In the hands of Seller

•

Consideration less ‘cost of acquisition’

would be Capital Gains in hands of Seller

–Cost of acquisition = ‘Tax net worth’

of the undertaking –

Section 50B(2) of the IT Act

-

Net Worth = Aggregate value of total assets less aggregate value

of total liabilities

-

Depreciable assets –

Income tax WDV of the block of assets –

Section 43(6)(c)(i)(C)

-

For other assets –

book value

•

If undertaking held for more than 3 years, gain would be LTCG and in other cases as STCG

•

Chartered Accountants report in Form 3CEA needs to be obtained for the valuation of net worth

•

Possible to claim exemptions against long term capital gain u/s

54EC, 54ED and 54F of the IT Act.

Indexation benefit not available and revaluation of assets, if any to be ignored


Slump Sale – Tax Implications

In the hands of Buyer

•

Allocation of cost among the assets acquired

-

No methodology prescribed

•

Assets (tangible and intangibles) acquired could be recorded at their fair values (As per AS 10)

- Backed by an independent valuation report which allocates purchase consideration to various assets / liabilities

- Balance purchase consideration, if any, attributable to goodwill

Can values be assigned to intangibles to claim tax depreciation over it ?


Slump Sale – As per Direct Tax Code 2010

•

Slump sale has been defined (under clause 314 (234) of DTC 2010)

as to mean:

“The sale of any undertaking or division of a business for a lump-sum consideration without values being

assigned to the individual assets and liabilities in such sale……..”

–

The above definition includes division of a business which is not covered in the Act.

•

Slump sale will be taxed under the head “capital gains”

–

similar to the existing provisions of the IT Act as against the business income proposed in the earlier draft of DTC issued

in August 2009.

•

Capital gains on slump sale taxable at 30% in all the cases.

“Net worth” and “ Undertaking in relation to slump sale” not defined in the DTC 2010


Going Concern Requirements

•

Normally, litigation in slump sale transaction arises on two components-

-

What quantifies as Undertaking for the purpose of Section 2(42C)

-

If consideration is not lumpsum and determined on the basis of individual values of assets / liabilities,

Definition of “Undertaking“ is wide enough to include even a business activity which in normal parlance may not resemble an “Undertaking”

Transfer to be regarded as slump sale even if certain assets are not transferred provided it does not impair the operation/ continuity of the business transferred


DEMERGER

MERGER

CAPITAL REDUCTION

SLUMP SALE

LEGAL ASPECTS


Deemed Dividend

In the hands of Shareholders –

Deemed Dividend and Capital gain tax implications

Section 2(22) “Dividend”

includes:-

(a) any distribution by a company of accumulated profits, whether capitalised or not, if such distribution

entails the release by the company to its shareholders of all or any part of assets of the company;

(b)…………

(c)………….

(d) Any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the

company possesses the accumulated profits which arose after the end of the previous year ending next

before the 1st day of April 1933, whether such accumulated profits have been capitalised or not;

(e)………….


Transfer

Section 2(47) “transfer”, in relation to a capital asset, includes,-

(i)

the sale, exchange or relinquishment of the asset; or

(ii)

the extinguishment of any rights therein; or

(iii)

…………………….

(iv)

……………………….


Issues for consideration

Return of capital – whether ‘accumulated profits’ for the purpose of deemed dividend ?

The expression used in section 2(22) of the IT Act is ‘accumulated profits, whether capitalised or not’.

The legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which are also capable of being capitalised.

This would clearly exclude return of part of a capital of the company, as the same cannot be regarded as profit capable of being capitalised.

(CIT v. Urmila Ramesh [1998] 96 Taxman 533 (SC))

Share Premium – whether ‘accumulated profits’ for the purpose of deemed dividend ?

The amount of premium is neither 'profit' nor 'gain' of the company, it is capital receipt for company.

This amount cannot be credited in the profit and loss account of the company.

It is in nature of shareholders funds. Therefore, share premium

account cannot be included in 'accumulated profits' of the company.

Any question as to "whether capitalized or not" cannot be raised for share premium as only profits can be kept as revenue reserve or they can be capitalized and transferred to capital reserve.


DEMERGER

MERGER

LEGAL ASPECTS

SLUMP SALE

CAPITAL REDUCTION


Restructuring – Approval of High Court

•

Merger

–

Combination of two or more companies

•

Spin off

–

Hiving off of one or more undertaking into a separate company

•

Buyback not covered by Section 77A of Companies Act

•

Issuance of debenture out of accumulated profit

•

Any other arrangement contemplated with shareholders /creditors

•

Repayment of capital through capital reduction or adjusting accumulated losses


Approval of High Court - Process

•

Determination of swap ratio

•

Preparation of arrangement /amalgamation scheme

•

Board Approval

•

Filing of the Scheme with stock exchanges in case of listed companies

•

Application to the High Court for directions to convene / dispense with meetings

•

Convening of Meetings (if ordered by the Court)–

Submission of the chairman’s report

•

Petition to the High Court

•

Obtaining approval of the RoC, Regional Director and Official Liquidator (for merger)

•

Hearing at the High Court and order of the High Court

•

Filing of the High Court Order with ROC and appropriate authorities to give effect to the SchemeEntire process takes about 4-6 months


Thank YouThank You

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