Mergers & Amalgamations

Mergers & Amalgamations - Procedural Aspects

Mergers and acquisitions have become a symbol of the new economic world. Almost every day one reads of a new merger or acquisition doing the rounds of the corporate circles. It also brings with it complex issues relating to laws and regulations impacting such M & A decisions. In today's business scenario, all companies are possible targets for acquisitions or mergers. As a result a knowledge of the laws relating to them is extremely useful. At the same time they are critical to the health of the businesses and thereby the shareholders. Hence this subject is assuming greater importance in today's business world. The author has attempted to bring out the fundamental issues under the companies Act, 1956 and the implications under the Income tax Act, 1961.

1. INTRODUCTION AND BACKGROUND

1.1 Reasons for merger/amalgamation There is not one single reason for a merger but a multitude of reasons, namely (i) Synergy in operating economies: When two or more undertakings combine their resources and efforts they may with combined efforts produce better results than two separate undertakings because of the savings in operating costs viz. Combined sales offices, staff, staff facilities, plant management etc. Synergy is also possible in areas of production, finance, technology etc. (ii) Taxation advantages: Mergers take place to have benefits of tax laws and company having accumulated losses may merge with profit earning company that will shield the income from taxation. Section 72A of the Income Tax Act provides this incentive. (iii) Other advantages: Growth Diversification Production capacity reduction Operating efficiencies Procurement of supplies Financial Strength (because of larger size of merged assets)

One significant cost disadvantage could be the implication of Stamp Duty which is applicable on transfer of assets from one owner to another. In some states the rate of duty is significant and hence may to some extent neutrilise the cost advantage of savings in tax 1.2 Evolution in India Compelled by the present economic scenario and market trends, corporate restructuring through mergers, amalgamations, takeovers and acquisitions, has emerged as the best form of survival and growth. The opening up of the Indian economy and the government's decision to disinvest, has made corporate restructuring more relevant today. In the last few years, India has followed the worldwide trends in consolidation amongst companies through mergers and acquisitions. Companies are being taken over, units are being hived off, joint ventures tantamount to acquisitions are being made and so on. It may be

reasonably be stated that the quantum of mergers and acquisitions in the last few years must be more than the corresponding quantum in the four and a half decades post independence. Supreme Court of India in the landmark judgement of HLL-TOMCO merger has said that "in this era of hypercompetitive capitalism and technological change, industrialists have realised that mergers/acquisitions are perhaps the best route to reach a size comparable to global companies so as to effectively compete with them. The harsh reality of globalisation has dawned that companies which cannot compete globally must sell out as an inevitable alternative".

2. SCOPE AND OBJECTIVE OF THIS ARTICLE

The objective and scope of this article is to make an overview of the procedural aspects under the Indian Companies Act, 1956 of effecting mergers and the corresponding Income Tax implications arising therein. An attempt has been made to state the regulatory framework in as simple language as possible.

3. PROCEDURE UNDER THE COMPANIES ACT, 1956

(i) Scheme of Amalgamation/Merger: The Scheme of amalgamation/merger should be prepared by the companies which have arrived at a consensus to merge. (ii) Approval of Board of Directors for the scheme: Respective Board of Directors of transferor and transferee companies are required to approve the scheme of amalgamation/ merger. (iii) Approval of the scheme by financial institutions banks/trustees for debenture holders: The Board of Directors should in-fact approve the scheme only after it has been cleared by the financial institutions/banks which have granted loans to these companies or the debenture trustees to void any major change in the meeting of creditors to the convened at the instance of the company courts under section 391 of the Companies Act, 1956. (iv) Intimation to stock exchange about proposed amalgamation/ merger: Listing agreements entered into between company and stock exchange require the company to communicate price-sensitive information to the stock exchange immediately and simultaneously when released to press and other electronic media on conclusion of Board meeting according approval to the scheme (v) Application to Court for directions: The next step is to make an application under section 391(1) of the Companies Act to the High Court having jurisdiction over the Registered office of the company, for an order calling a meeting of its members. The transferor company and the transferee company should make separate applications to the High Court. (vi) High Court directions for members' meeting: Upon the hearing of the summons, the High Court shall give directions fixing the date, time and venue and quorum for the members' meeting and appoint and Advocate Chairman to preside over the meeting and submit a report to the Court. (vii) Approval of Registrar of High Court to notice for calling the meeting of members: Pursuant to the directions of the court, the transferor as well as the transferee companies shall submit for approval to the Registrar of the respective High Courts the draft notices calling the meetings of the members together with a scheme of arrangements and explanations, statement under section 393 of the Companies Act and form of proxy to be sent to members alongwith the said notice (viii) Despatch of notices to members/shareholders: Once the notice has been signed by the chairman of the forthcoming meeting as aforesaid it could be despatched to the members under certificate of posting at least 21 days before the date of the meeting.

(ix) Advertisement of the notice of member meeting: The court may direct the issuance of notice of the meeting of these shareholders by advertisement. (x) Confirmation about service of the notice: Ensure that at lease one week before the date for the meeting the Chairman appointed for the meetings files an Affidavit to the court about the service of notices to the shareholders that the directions regarding the issue of notices and advertisement have been duly compiled with. (xi) Holding the shareholders general meeting and passing the resolutions: The general meeting should be held on the appointed date. The amalgamation/merger scheme should be approved by the members by a majority in number of members present in person or on proxy and voting o the resolution and this majority must represent at least 3/4ths in value of the shares held by the members who vote in the poll. (xii) Filing of resolutions of general meetings with Registrar of Companies: Once the shareholders' general meetings approves the amalgamation/merger scheme by a majority in number of members holding not less that 3/4ths in value of the equity shares, the scheme is binding on all the members of the company. A copy of the resolution passed by the shareholders approving the scheme of amalgamation/ merger should be filed with the Registrar of Companies within 30 days from the date of passing the resolution. (xiii) Submission of report of the chairman of the general meeting to court: The chairman of the general meeting of shareholders is required to submit to the Court within 7 days from the date of the meetings a report setting out therein the number of persons who attend either personally or by proxy, and the percentage of shareholders who voted in favour of the scheme as well as the resolution passed by the meeting. (xiv) Submission of joint petition to court for sanctioning the scheme: Within 7 days from date on which the chairman has submitted his report about the result of the meeting to the court, both the companies should make a joint petition to the High Court for approving the scheme of amalgamation/ merger. (xv) Issue of notice to Regional Director's Company Law Board under section 394A: On receipt of the petition for amalgamation/ merger under section 391 the court will give notice of the petition to the Regional Director, Company Law Board and will take into consideration the representations, if any, made by him (xvi) Hearing of petition and confirmation of scheme: Having taken up the petition by the Court for hearing it will hear the objections first and if there is no objection to the amalgamation/merger scheme from Regional Director or from any other person who is entitled to oppose the scheme, the Court may pass an order approving the scheme of amalgamation/merger. (xvii) Filing of Courts order with ROC by both the Companies: Both the transferor and transferee companies should obtain the Court's order sanctioning the scheme of amalgamation/ merger and file the same with ROC with their respective jurisdiction as required vide section 394(3) of the within 30 days after the date of the Courts order. (xviii) Dissolution of transferor company: Section 394(1)(iv) vests powers in the High Court, either by order sanctioning the scheme or by a subsequent order of dissolution, without winding up, of any transferor company provided the official liquidation has, on scrutiny of the books and papers of the company, made a report to the Court that the affairs of the company have not been conducted in a manner prejudicial to the interests of its members or to public interest. (xix) Transfer of assets and liabilities: Section 394(2) vests power in the High Court to order for the transfer of any property or liabilities from transferor company to transferee company (xx) Allotment of shares to shareholders of transferor company: Pursuant to the

sanctioned scheme of amalgamation/ merger, the shareholders of the transferor company are entitled to get shares in the transferee company in the exchange ratio provided under the said scheme. (xxi) Listing of shares at stock exchange: After the amalgamation/merger is effected, the company which takes over the assets and liabilities of the transferor company should apply to the Stock Exchanges where its securities are listed, for listing the new shares allotted to the shareholders of the transferor company. (xxii) Court order to be annexed to memorandum of transferee company: It is the mandatory requirement vide section 391(4) that after the certified copy of the Court's order sanctioning the scheme of amalgamation/ merger is filed with the Registrar, it should be annexed to every copy of the Memorandum issued by the transferee company. (xxiii) Preservation of books and papers of amalgamated company: Section 396A of the Act requires that the books and papers of the amalgamated company should be preserved and not be disposed of without prior permission of the Central Government. (xxiv) Post merger secretarial obligation: There are various formalities to be compiled with after amalgamation of the companies is given effect to and allotment of shares to the shareholders of the transferor company is over. These formalities include filing of returns with Registrar of Companies, transfer of investments of transferor company in the name of the transferee, intimating banks and financial institutions, creditors and debtors about the transfer of the transferor company's assets and liabilities in the name of the transferee company.

4. IMPLICATIONS UNDER THE INCOME TAX ACT, 1961

4.1 Definition of amalgamation According to section 2(1B) of the Income-tax Act, 1961 (hereinafter referred to as the Act), 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 1. All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of amalgamation 2. All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of amalgamation 3. Shareholders holding not less than 3/4th in value of the shares in amalgamating company or companies (other than shares held therein immediately before the amalgamation 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 distribution of such property to the other company after the winding up of first mentioned company. 4.2 Tax Concessions If any amalgamation takes place within the meaning of section 2(1B) of the Act, the following tax concession shall be available 1. Tax concession to amalgamating company 2. Tax concession to shareholders of the amalgamating company 3. Tax concession to amalgamated company

(i) Tax Concession to Amalgamating company: Capital Gains tax not attracted : According to section 47(vi) where there is a transfer of any capital asset in the scheme of amalgamation, by an amalgamating company to the amalgamated company, such transfer will not be regarded as a transfer for the purpose of capital gain provided the amalgamated company, to whom such assets have been transferred, is an Indian company (ii) Tax concessions to the shareholders of an amalgamating company section 47(vii): Where as shareholder of an amalgamating company transfers his shares, in a scheme or amalgamation, such transaction will not be regards as a transfer for capital gain purposes, if following conditions are satisfied The transfer of shares 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

Cost of acquisition such shares of the amalgamated company are later on transferred The cost of acquisition of such shares of the amalgamated company shall be the cost or acquisition of the shares in the amalgamating company. Further, for computing the period of holding of such shares, the period for which such shares were held in the amalgamating company shall also be included (iii) Tax concessions to the amalgamated company: The amalgamated company shall be eligible for tax concessions only if the following two conditions are satisfied The amalgamation satisfies all the three conditions laid down in section 2(1B) and The amalgamated company is an Indian company

If the above conditions are satisfied the amalgamated company shall be eligible for following tax concessions (a) Expenditure on Scientific Research Section 35(5): Where an amalgamating company transfers any asset represented by capital expenditure on the scientific research to the amalgamated Indian company in a scheme of amalgamation, the provisions of section 35 which were applicable to the amalgamating company shall become applicable to the amalgamated company consequently Unabsorbed capital expenditure on scientific research of the amalgamating company will be allowed to be carried forward and set off in the hands of the amalgamated company If such asset ceases to be used in a previous year for scientific research related to the business of amalgamated company and is sold by the amalgamated company without having being used for other purposes, the sales price, to the extent of the cost of the asset shall be treated as business income other amalgamated company. The excess of the sale price over the cost of the asset shall be subject to the provisions of the capital gains

(b) Expenditure on acquisition of patent rights or copy rights Section 35A(6): Where the patent or copyrights acquired by the amalgamating company is transferred to any amalgamated Indian company, the provisions of section 35A which were applicable to the amalgamating company shall become applicable in the same manner to the amalgamated company consequently The expenditure on patents copyrights not yet written off shall be allowed to the amalgamated company in the same number or balance instalments Where such rights are later on sold by the amalgamated company, the treatment of the deficiency/surplus will be same as would have been in the case of the amalgamating company

However, if such expenditure is incurred by the amalgamting company after 31-3-1998, deduction under section 35A is not allowed, as such expenditure will be eligibel for depreciation as intangible asset. In this case, provisions of depreciation shall aplly (c) Expenditure of know-how Section 35AB(3): With effect from assessment year 2000-01, where there is a transfer of an undertaking under a scheme of amalgamation, the amalgamated company shall be entitled to claim deduction under section 35AB in respect of such undertaking to the same extent and in respect of the residual period as it would have bee allowable to the amalgamating company, had amalgamation not taken place. However, if such expenditure is incurred by the amalgamating company after 31--31998, deduction under section 35AB is not allowed, as such expenditure will be eligible for depreciation as intangible asset. In this case provisions of depreciation shall apply (d) Treatment of preliminary expenses Section 35D(5): Where an amalgamating company merges in a scheme of amalgamation with the amalgamated company, the amount of preliminary expenses of the amalgamating company, which are not yet written off, shall be allowed as deduction to the amalgamated company in the same matter as would have been allowed to the amalgamating company. (e) Amortisation of expenditure in case of amalgamation 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 amalgamation or demerger takes place. (f) Treatment of capital expenditure on family planning Section 36(1)(ix): Where the asset representing the capital expenditure on family planning is transferred by the amalgamating company to the Indian amalgamated company, in a scheme of amalgamation, the provisions of section 36(a)(ix) to the amalgamating company shall become applicable in the same manner, the amalgamated company. Consequently Such transfer shall not be regarded as transfer bythe amagamating company The capital expenditure on family planning not yet written off shall be allowable to the amalgamated company in the same number of balance instalments Where such assets are sold by amalgamated company, the treatment of the deficiency/surplus will be same as would have been in the case of amalgamating company

(g) Treatment of bad debts Section 36(1)(vii): Where due to amalgamation, the debts of amalgamating company have been taken over by the amalgamated company and subsequently such debt or part of the debt becomes bad, such bad debt will be allowed a deduction to the amalgamated company (h) Deduction available under section 80-1A or 801B: Where an undertaking which is entitled to deduction under section 801A/80-1B is transferred in the scheme of amalgamation before the expiry of the period of deduction under section 80-1A or 80-1B then No deduction under section 80-1A or 80-1B shall be available to the amalgamating company for the previous year in which amalgamation takes place and The provisions of section 80-1A or 80-1B shall apply to the amalgamated company in such manner in which they would have applied to the amalgamating company

(i) Carry forward and set off of business losses and unabsorbed depreciation of the amalgamating company: Under the new provisions of Section 72A of the Act, the amalgamated company is entitled to carry forward the unabsorbed depreciation and brought forward loss of the amalgamating company provided the following conditions are fulfilled

The amalgamation should be of a company owning an industrial undertaking or ship The amalgamated company holds at least 3/4th of the book value of fixed assets of the amalgamating company for a continuous period of 5 years from the date of amalgamation The amalgamated company continuous the business of the amalgamating company for period of 5 years from the date of amalgamation The amalgamated company fulfills such other conditions, as may be prescribed to ensure that revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purposes

It may be noted that in case of amalgamation, the amalgamated company gets a fresh lease of 8 years to carry forward and set off the brought forward loss and unabsorbed depreciation for the amalgamating company.