Comprehensive Guide to Tax Implications in Mergers, Acquisitions, and Business Purchases under the Income Tax Act, 1961

Corporate restructuring through mergers, acquisitions, and business purchases is a vital tool for achieving strategic objectives such as market expansion, operational efficiency, and financial optimization. However, these transactions carry significant tax implications under the Income Tax Act, 1961, requiring meticulous planning and compliance.

Detailed Understanding of  mergers, acquisitions and business purchases mentioned below: 

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1. Tax Treatment of Amalgamation

Definition and Key Conditions (Section 2(1B))

Amalgamation, as per the Act, involves the merger of one or more companies into another or the combination of two or more companies to form a new entity. The key conditions include:

1. Transfer of Assets and Liabilities: All properties and liabilities of the amalgamating company(ies) become those of the amalgamated company.
2. Shareholding Continuity: Shareholders holding at least 75% of the value of shares in the amalgamating company become shareholders of the amalgamated company.

Tax Implications for the Amalgamated Company

(i) Carry Forward and Set-Off of Losses (Section 72A)

The amalgamated company can carry forward and set off accumulated losses and unabsorbed depreciation of the amalgamating company if:

• The amalgamating company is an industrial undertaking, ship-building company, or hotel.
• The amalgamation is undertaken to revive the amalgamating company’s business.
• The amalgamated company continues the business and retains at least 75% of the book value of fixed assets for five years.
• Compliance with prescribed conditions under Rule 9C is ensured.

(ii) Tax Neutrality (Section 47(vii))

Transfers of assets during an amalgamation are exempt from capital gains tax if the amalgamation satisfies the criteria under Section 2(1B).

(iii) Deduction of Amalgamation Expenses (Section 35DD)

Expenditure incurred wholly and exclusively for amalgamation is eligible for deduction over five successive years in equal installments.

Tax Implications for Shareholders (Section 47(vii))

• No capital gains tax is levied on shareholders for exchanging their shares in the amalgamating company for shares in the amalgamated company, provided the amalgamation meets the criteria of Section 2(1B).

Case Law References

1. Marshall Sons & Co. (India) Ltd. v. ITO (1997): The Supreme Court held that an amalgamating company ceases to exist upon amalgamation, transferring all liabilities to the amalgamated company.
2. CIT v. Rasiklal Maneklal (HUF) (1989): Highlighted that shareholders are not liable for capital gains tax if they receive shares in the amalgamated company.

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2. Tax Treatment of Demerger

Definition and Key Conditions (Section 2(19AA))

A demerger refers to the transfer of one or more undertakings of a company into another company, meeting the following criteria:

1. Transfer at Book Value: All properties and liabilities of the demerged undertaking must be transferred at book value.
2. Shareholding Proportionality: Shareholders of the demerged company must receive shares in the resulting company proportional to their existing shareholding.

Tax Implications for the Resulting Company

(i) Carry Forward of Losses (Section 72A(4))

Accumulated losses and unabsorbed depreciation of the demerged undertaking are transferred to the resulting company in proportion to the value of the assets transferred.

(ii) Tax Neutrality (Section 47(v))

The transfer of assets from the demerged company to the resulting company is exempt from capital gains tax if the demerger satisfies the conditions of Section 2(19AA).

Tax Implications for Shareholders

• Shareholders of the demerged company are not taxed on the receipt of shares in the resulting company if the conditions under Section 2(19AA) are met.

Case Law References

1. Vodafone Idea Merger (2020): The Supreme Court clarified that tax neutrality in mergers and demergers requires adherence to the statutory definitions and conditions under Section 2(19AA).

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3. Tax Implications in Business Purchase Transactions

(A) Asset Purchase

• Capital Gains Tax for Sellers (Section 45): Gains are classified as short-term or long-term based on the holding period.
  • Short-Term Gains: Taxed at applicable slab rates (up to 30%).
  • Long-Term Gains: Taxed at 20% with indexation benefits.
• Depreciation for Buyers (Section 32): Buyers can claim depreciation on acquired assets, with the purchase price allocated to individual assets.

(B) Slump Sale (Section 50B)

• Definition: Transfer of a business undertaking as a whole for a lump sum consideration, without valuing individual assets.
• Capital Gains Tax: Gains are computed as the difference between the sale consideration and net worth.
  • Long-Term Gains: Taxed at 20%.
  • Short-Term Gains: Taxed at slab rates.

(C) Share Purchase

• Capital Gains Tax for Sellers (Section 45):
  • Listed Shares: Long-term gains taxed at 10% beyond ₹1 lakh; short-term gains taxed at 15%.
  • Unlisted Shares: Long-term gains taxed at 20% with indexation; short-term at slab rates.
• No Depreciation for Buyers: Buyers cannot claim depreciation on acquired shares.

Case Law References

1. CIT v. Artex Manufacturing Co. (1997): Clarified the taxability of business transfer considerations.
2. Premier Automobiles Ltd. v. ITO (2003): Defined tax implications of slump sales.

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4. TDS Obligations in Mergers and Acquisitions

• Section 194Q: Buyers must deduct TDS at 0.1% on purchases exceeding ₹50 lakh in a financial year.
• Section 195: In cross-border transactions, TDS is applicable at rates specified in DTAA agreements.

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5. Indirect Tax Implications

• Goods and Services Tax (GST): Asset transfers may attract GST unless classified as a “going concern,” which is exempt under GST law.

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6. Compliance and Reporting Obligations

• Form Filing: Entities must file Forms No. 62 and 63 under Section 72A for amalgamations and demergers.
• Valuation Reports: Necessary to substantiate transaction values for tax purposes.

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Summary

Mergers, acquisitions, and business purchases involve complex tax implications requiring compliance with multiple provisions under the Income Tax Act, 1961. Strategic tax planning and professional advice can optimize tax benefits and ensure legal adherence.