Budget 2022: Need to include tax exemptions for cross-border mergers

The Indian regulatory landscape is coming of age to appreciate and facilitate the unlocking of potential of Indian entrepreneurship. One of the key improvements here has been a specified framework for outbound merger, i.e., merger of an Indian company with a foreign company. Several laws, including corporate law, FEMA and SEBI laws, have been upgraded to implement this unique transaction.

While merger into an Indian company is exempted from income tax--subject to certain conditions--no such exemption is accorded to an outbound merger where the amalgamated company is a foreign company. It needs to be appreciated that certain situations--especially in terms of raising capital, synergising operations--merit a more intimate transaction like a merger. Therefore, the government/finance ministry should seriously consider giving tax exemption to outbound mergers as well. Of course, adequate safeguards may be provided for to ensure retention of talent and capital in India.

Another step which will further boost marketability and value unlocking of Indian companies is giving capital tax exemption on Indian shares listed overseas. Currently, such benefit is accorded only to foreigners under the ADR/GDR route.

On similar lines, share-swap with a foreign company--read special purpose acquisition vehicle--to facilitate indirect listing of Indian shares abroad should also be granted tax exemption. Thus, when Indian promoters, employees, shareholders of the Indian company transfer the Indian company’s shares to receive shares of the foreign-listed company in a cashless manner designed to facilitate overseas listing of Indian shares, no capital gains tax should be triggered.

The law provides exemption when a foreign amalgamating company transfers its stake in an Indian company, when it merges with another foreign company. Further, the law grants a similar exemption at an indirect level, where the foreign amalgamating company owns foreign shares which derive substantial from Indian assets.

However, there is no express exemption at the shareholder level of such amalgamating companies. Thus, taxability remains unclear for the shareholder of the amalgamating company, who transfers the amalgamating company’s shares and receives the amalgamated company’s shares under a foreign amalgamation. As the intent is to accord tax-neutrality to such foreign restructuring, the government/finance ministry should eliminate this ambiguity at the shareholder level.

Closer home as well, a key demand of local players is parity of treatment of past tax losses in a pure domestic merger. Currently, as per section 79 of the Income Tax Act 1961, past tax losses of a closely held company lapse if the voting power of the company changes beyond 49 percent. However, change in voting power due to merger of the foreign parent company with another company is exempted from the rigours of this provision. Domestic merger on the other hand continues to result in lapsing of the ability to set-off and carry forward past losses.

Indian economy is at such a stage where business models should be allowed to pivot often to hit the sweet spot of addressing /creating customer needs and unlocking the potential of capital for investors. Several times, this can be only addressed by merging companies. Merging a loss-making and capital starved start-up with a well capitalised company can often provide another chance to pivot/improvise its business model and provide cash, which is after all the oxygen of such businesses. It would indeed be pragmatic to allow such utilisation of losses even in case of merger of such a start-up with another company including in case of service sector, giving its increasing prominence in India’s GDP as against restricting the benefit of losses to certain specified industries such as manufacturing, ship, hotel etc.

This is another long-standing issue regarding share-sale transactions. Fundamentally, capital gains tax applies on transfer of a capital asset. However, where some part of the consideration is contingent upon factors like the target’s future performance, etc, taxing such consideration upfront can lead to absurd consequences when such consideration does not materialise at all in future. The government should allow to offer such contingent amount to capital gains tax in the year of its crystallisation. Alternatively, taxpayers should be allowed to revise returns of the year of transfer in future in case there is any downward adjustment to the contingent consideration.

In a fast-changing world order, India should strive to attain and retain a pole positionqua talent and capital. Several of the above measures will give Indian entrepreneurs the unfettered wings to aim for the sky and take India towards the ambitious GDP target of $5 trillion.