OPTING FOR RIGHT BUSINESS ACQUISITION DEALS : AN ANALYTICAL COMPARISON

 

By Nirmal Behera

Madhusudan Law College, Cuttack, India

Email- nirmalbhr6@gmail.com

Linkedin- www.linkedin.com/in/nirmal30

 

ABSTRACT- This Article goes through various aspects of business deals for the acquisition of undertakings and of business entities. Also, an effort has been made hereunder to establish a clear distinction among different kinds of business acquisition processes. The author seeks to explain, the manner and implications of such business acquisition deals. It will help the reader to get an over-all idea of the reasons behind such business deals and to conclude the pros and cons of all kinds of business acquisition mechanisms. This article also has elaboration on the tax implications and the computation aspect of such taxation, according to Income Tax Act, 1961 for methods of business sales, such as slump sale and asset sale.

 

INTRODUCTION-

 

Acquisitions and Transfers of Businesses and of undertakings are common in Business World. “As in Ocean, Big Fish Consumes the Small Fishes to Survive and Compete with other Big Fishes”, in a similar manner, Big Conglomerates and Business entities take over small businesses for expansion of their business. It may be a part of the strategic investment or a scheme of restructuring, using as an instrument, the take-over or acquisitions takes place. Many times companies sell part of their business division to other business entities or to their own subsidiaries in order to optimize returns and bring more administrative efficiency. A transfer of business or undertaking is different from that of a transfer of asset. In an asset sale, individual values are assigned to each asset of an undertaking. The buyer gets to buy only specific assets of a business undertaking and not the business itself. In a transfer of business undertaking, the buyer gets to buy the whole business along with its assets and liabilities. In a business transfer, the buyer may acquire the entity along with the business setup as well.

 

There are two famous ways to transfer business undertakings, is Slump sale and Share sale. Unlike Business transfers through Amalgamation or Demerger which are Court driven process, Slump sale and Asset sale are not court driven and are inter-party transactions out of the Courtroom.

 

DIFFERENCE BETWEEN SLUMP SALE AND SHARE SALE-

 

 A slump sale is a transfer of one or more business for a lump-sum consideration without values being assigned to the individual assets and liabilities [S. 2(42-C) of Income Tax Act, 1961]. Share sale may involve the transfer of the ownership or voting power of the company itself. The buyer of shares owns the company, which owns the trade and assets of the business. As the shares in a company represent its underlying value of assets and liabilities, that is transferred as well.

 

Both the slump sale and share sale attract capital gains to the seller. An Acquirer may opt for a slump sale to expand its own business without acquiring the business entity housing the business. The operations of the business acquired are carried out even after the sale but under the ownership of the acquirer. In slump sale, the acquirer only acquires a particular processing unit of a business and not the entity itself. But in the case of share sale or purchase, the acquirer gets the voting rights and ownership of a business entity, depending on the percentage of shares are acquired. Usually, when the target company has an established base of loyal customers and a good market trust, the acquirer company opts for share purchase in that target company.

 

 

AMALGAMATION AND DEMERGER-

 

Amalgamation of companies’ means merger of one or more companies into another company, or merger of two or more companies into one new company. The merger of one or more companies into an already existing company is known as a merger by absorption. The companies which merge are called amalgamating companies. The company with which they merge is called the amalgamated company. All the property and liabilities of the amalgamating companies become the property and liabilities of the amalgamated company in the amalgamation. Also, the shareholders holding not less than three-fourths the value of shares in the amalgamating companies become the shareholders of the amalgamated company[S.2(1B) of ITA].

 

Demerger in contrary to amalgamation, is the process of separating a business of a company from its parent company. The resulting company from the demerged company is known as the resultant company. Demerger also involves the transfer of a business undertaking, by a company to another company as a going concern. S.2(19AA) of the ITA defines demerger as a transfer in pursuant to a scheme of arrangement under S.391 to 394 of the Companies Act, 1956 by a demerged company in a manner, all the property and liabilities of the demerged company becomes the property and liabilities of the resultant company, immediately before the demerger by virtue of demerger. The undertaking transferred by the demerged company should be transferred at valued in its books of account. The resulting company issues its shares to the shareholders of the demerged company in consideration of the demerger, on a proportionate basis. Also, the shareholders holding not less than three-fourths the value of shares in the demerged company become the shareholders of the resulting company by virtue of demerger.

 

Both the amalgamation and demerger are court-driven processes and are tax neutral if satisfies the condition under section 47 of the Income Tax Act, 1961. A scheme of amalgamation or merger is opted to reduce the administrative burden and compliance burden. Big companies having a lot of subsidiaries incorporated as different companies might face difficulties to manage all the administration in an integrated manner and looking after compliance issues. Restructuring through a scheme of amalgamation helps companies to check all such issues.

 

Companies sometimes opt for demerger to provide more focus, or say distinct focus, to a specific business under the group. Many times the parent companies, due to administrative and marketing issues, are unable to get the maximum output from a division of their business. In such a case, in order to optimize the returns from a specific business and maximize the efficiency, they opt for a demerger.

 

MANNER OF UNDERTAKING-

a)      Asset sale and Slump sale- Both of the sales are undertaken by an agreement called as Business Transfer Agreement (BTA).

b)      Share sale- A Share Purchase Agreement lists out the value of shares and the terms and conditions of acquisitions.

c)      According to the Companies Act, 2013 a scheme of amalgamation or a demerger requires to pass the Board meeting and then an application to the National Company Law Tribunal in the relevant jurisdiction under section 230 of the Act. Also consent of 75 percent of the secured creditors in value is required.

 

TAX IMPLICATIONS-

 

To compute and assess the tax implications, it is necessary to find the sale consideration of the capital asset sold and the cost of acquisition of that asset. The Income Tax Act, 1961 has provided several provisions to compute the capital gains subjecting the total gain to all necessary deductions and expenditures and to arrive at the net worth of an asset or assets.

 

 An Asset sale shall attract profit under the head of capital gains and depending on the period of holding, it will be charged under long-term or short-term capital gains. If the asset has been held for more than the period of 36 months, the profit of sale will be deemed as long-term capital gains and if has been held for a period of fewer than 36 months, the profit will be deemed as short-term capital gains. In the case of depreciable assets, the deductions will be allowed from the profit. The profit will be computed as the difference between the cost of acquisition of the assets and the sale consideration. Stamp duty payable for an asset purchase agreement is state-specific. However, in certain circumstances, the transfer of assets by a company to its shareholders is not regarded as a transfer. Section 46 of ITA reads that, if the assets of a company are distributed to its shareholders on its liquidation, such distribution shall not be regarded as transfer by the company and the company in such case cannot be said to have made capital gains. However, if a shareholder on liquidation of the company receives any money or other assets from the company, he shall be chargeable to income tax under the head of capital gains.

 

 In the case of C.I.T. v. R.R. Amin, where a shareholder receives money representing his share on the final distribution of the net assets of a foreign company which was not covered by the definition of the company as given in section 2(17), it was held by the Supreme Court that, the amount received by the assessee in respect of the share in access of the cost of acquisition of those shares constituted profit or gains. But there was no transfer contemplated by the law to attract the levy of tax on capital gains. The shareholder received that money in satisfaction of the right which belonged to him by virtue of him holding the shares and not by operation of any transaction(A.I.R., 1977).

 

A Slump sale, through Business Transfer Agreement (BTA), shall attract capital gains. Depending on the period of holding, that is more than 36 months or less, the capital gain shall be termed as long-term or short-term capital gain respectively. Section 50B of the ITA provides for a special provision for the computation of capital gains in case of slump sale. It explains that the net worth of such undertaking shall be the net value of the total assets of that undertaking or division as appears in the book of account. Any revaluation of such assets shall be excluded. For depreciable assets, the written down value for such assets would be taken into account, instead of the book value of such assets. Written down value reflects the present worth of an asset. In case the net worth of any asset comes out to be negative, the cost of acquisition shall be considered NIL.

 

Any profit or gain by the sale of Shares is considered as capital gain and is taxable under the head of capital gain tax by the Income Tax Act, 1961.  Capital gains on the transfer of listed shares, if held for more than 12 months are taxed as long-term capital gains. Capital gains realized on the transfer of the shares if held for 12 months or less are taxed as short-term capital gains. The capital asset pertaining to securities or shares is also known as a financial asset. The cost of acquisition of such financial assets shall be computed under section 55(2) of the ITA. It states that the cost paid for acquiring any shares in a company shall be the cost of acquisition of that share. In case the financial asset or shares allotted to the assessee without any payment and on the basis of holding any other financial asset shall be taken to be nil.

 

Profits earned by Mergers or Demergers are tax neutral if the conditions under section 47 of the ITA are satisfied. Section 47 states the conditions for a transaction not to be regarded as a transfer and the gains arising from such transfers are not taxed under the head of capital gain. S.47(6) reads that, any transfer, in a scheme of amalgamation, of a capital asset by the amalgamation company to the amalgamated company is not regarded as a transfer if the amalgamated company is an Indian company. Any transfer through a scheme of amalgamation, of capital the asset being a share or shares held in an Indian company, by the amalgamating foreign company to the amalgamated foreign company is not regarded as transfer, if a minimum of 25% of the shareholders of the amalgamating foreign company continues to remain, shareholders of the amalgamated foreign company and such transfer does not attract tax on capital gains in the company in which the amalgamating company is incorporated.

 

PARTY TO PARTY DIRECT SALE VS SCHEME OF AMALGAMATION AND DEMERGER-

 

The major difference between a party to party direct sale of assets or undertakings and acquisition through a court-driven scheme of amalgamation and demerger is that of tax implication and stamp duties. The Court or NCLT driven process of merger and demerger process is tax neutral and involves less risk, as the whole process and implementation of the scheme are supervised by the court itself. On the downside, it takes much more time than the direct slump sale process. On the other hand, the direct party to party deal gives quick results to the consideration of both the entities but involves significant tax implications under the capital gain head of ITA. The slump sale kind of deal might involve potential risks for unsecured creditors and minority investors. Unless proper due diligence is followed in negotiations and regulatory aspects have been taken proper care of, the party to party sale of business undertakings involves the potential risk of litigation in the future. Companies in mutual consent, who want to do away with the complex aspect of the court-driven process and technical roadblocks may opt for slump sale in order to achieve fast expansion and business goals at the expense of hefty taxation and potential future risk.

 

 

 

A.I.R. 1977. C.I.T. v. R.R. Amin. s.l. : S.C., 1977.

taxxmann.com 102. 2012. DCIT V. Summit Securities Ltd. 2012.