Key tax aspects to consider when contemplating M&A

In these testing times, when organic growth is getting difficult, companies are resorting to inorganic business growth including through acquisitions. This has resulted in an upsurge in structuring and restructuring of the companies by way of merger, demerger, takeovers, etc. For a smooth inorganic expansion and value creation, companies will need to be aware of certain tax issues.

Statutory conditions

The term “merger” is not defined in the Companies Act, 1956, or the Income Tax Act, 1961 (ITA). The term amalgamation, which is akin to the term merger, is defined in section 2(1B) of the ITA. Amalgamation refers to the merger of companies under sections 391 to 394 of the Companies Act which satisfies the following conditions, thereby making it tax neutral: (a) all property and liabilities of the amalgamating company becomes the property and liabilities of the amalgamated company; (b) shareholders holding not less than three-fourths in value of the shares in the amalgamating company become shareholders of the amalgamated company by virtue of the amalgamation.

As the shareholders of the amalgamating company must become shareholders of the amalgamated company by virtue of the amalgamation, consideration should be by way of issue of shares by the amalgamated company. This condition would not be satisfied if the shareholders are already shareholders of the amalgamated company and no fresh shares are issued. Payment by other modes, such as debt instruments, may not satisfy this condition. If the conditions prescribed for amalgamation are not satisfied, then the fair value of the shares issued by the amalgamated company will be treated as consideration for the purpose of computing capital gains in the hands of the shareholders.

Pranay Bhatia is a partner and Janhavi Sharma is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.