Companies Act 2013: M&A norms need some tweaking
Partner & National Leader (Transaction Tax), EY
Senior Tax Professional, EY
Indian corporate law has undergone a radical change with the introduction of the Companies Act, 2013, (the Act). On the M&A front, the Act aims to open up new, simple avenues for domestic and cross-border M&As and make Indian organisations more attractive to investors. However, as with any evolving law, there remain few areas where there is scope for clarity and improvement.
In the past, Indian promoters have used the route of issuing treasury stocks to consolidate their holdings in companies to raise funds and to control voting rights. In a typical case, shares of subsidiary companies would be transferred to trusts and shares of holding companies would be issued to trust pursuant to the mergers of subsidiaries with holding companies, instead of cancelling such shares. The Act now restricts a transferee company from holding such treasury shares.
These provisions, though intended to reduce the scope of unconventional/ambiguous practices, would hamper M&A deals where synergistic benefits is the key driver and the acquirer would want to merge the companies; but due to accounting standard adherence, the merger may lead to goodwill impairment. The goodwill amortisation could impact the earnings and also limit the distributable profits of the companies. Further, it is unclear how treasury stock holdings already existing will be treated going forward.
The ministry of corporate affairs (MCA) could consider curbing voting rights instead of placing an outright prohibition on treasury shares and introduce grandfathering provisions for existing trust structures.
The draft rules released by the MCA clarify that the term ‘demerger’ means transfer of undertaking(s) in the manner, and subject to conditions, provided under section 2(19AA) of the Income Tax Act, 1961 (I-T Act). This could prohibit any hive off that is not in compliance with the I-T Act provisions.
Tax consequences of any arrangement should not be the criteria for legal permissibility. This new requirement could hamper the flexibility of companies to arrange affairs in efficient way. Moreover, the draft rules are not entirely in line with the I-T Act provisions with respect to demergers and one hopes that this inconsistency is addressed in due course.
Cross border mergers
The Act proposes to allow both—inbound and outbound cross-border mergers between Indian and foreign companies incorporated in jurisdictions to be notified by the government.
Enabling of cross-border mergers is expected to provide benefits such as helping Indian companies in migrating of holding structure overseas, facilitating overseas listing of Indian entities and providing exit routes to investors in overseas jurisdictions.
However, currently, the I-T Act does not provide for tax-neutrality for outbound mergers. The debate on whether outbound mergers should be taxable or not is an interesting one, since in some mergers, companies may be moving some value outside India. Similarly, the impact of payment of cash or depository receipts on the tax neutrality of the amalgamations will need deep analysis.
A key aspect will be notification of the “specified jurisdictions” for cross-border mergers and the amendment of Exchange Control Regulations. This may restrict the scope of outbound mergers as well as inbound ones, which are currently allowed from any jurisdiction that allows cross-border mergers under its domestic laws. Moreover, the requirement of approval from RBI is expected to play a major role in such cross-border mergers.
In addition, while the new legislation does specifically permit outbound mergers, there is no corresponding provision enabling cross-border demerger. It is hoped that suitable amendments are made before notifying these provisions so as to enable all forms of internationally recognised cross-border restructuring.
Merger of listed companies with unlisted ones
The Act provides an option to a transferee company to remain unlisted if shareholders of transferor company are given an exit opportunity by making provisions for payment of the value of the shares and other benefits, based on a pre-determined price formula or after a valuation report is produced (subject to a floor value prescribed by Sebi).
It will also be interesting to see the interplay between Sebi’s delisting regulations and these provisions, especially in light of the requirements of delisting regulations, where minority shareholders effectively determine their own exit price.
One would expect the provisions between Sebi and MCA to be aligned.
National Company Law Tribunal (NCLT)
Under the Act, NCLT will assume the jurisdiction of High Courts in context of restructuring schemes. However, there is no clarity on the timing of constitution of NCLT. We need to wait and watch how this transpires in the coming days.
It remains to be seen how the NCLT orders are acceptable to various authorities (for instance, other regulatory or government bodies) and stakeholders (for instance, lessors) for smooth implementation of merger/demerger schemes. A High Court order sanctioning such scheme was very effective during the implementation of such schemes. Practical difficulties are expected in implementation of provisions relating to restructuring till these issues are clarified.
Overall, the new law certainly can be expected to have far-reaching positive impact on M&A in India. Provisions such as fast track mergers, increase in threshold limit for shareholder/creditor objections, enabling of outbound mergers would be welcomed by India business. However, to serve its intended purpose, corporate organisations in India would expect that MCA introduces lucidity through finalised rules and wherever needed, amendments to sections and at the same time, other regulators modify their relevant laws and regulations to synchronise with the Act.