Tax Issues in M A PDF

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Tax Issues in M&A

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August 2016
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Tax Issue in M&A Trasactions
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Legal & Tax Issues
Contents
1. TAX CONSIDERATIONS ON M&A TRANSACTIONS 01
I. Introduction 01
II. Merger 01
III. Demerger 02
IV. Share Sale 04
V. Slump Sale 05
VI. Asset Sale 07
2. CROSS BORDER TAX ISSUES 10

I. Introduction 10
II. Claiming Treaty Benefit: Requirements and Procedure 10
III. Withholding Tax Obligations 11
IV. Structuring Investments into India – Suitable Holding Company Jurisdictions 12
V. Tax as a Representative Taxpayer/Assessee 14
VI. Provisions for Cross-border Mergers 14
VII. Tax Indemnities on
Transfer 15
3. PREVAILING AMBIGUITIES IN INDIRECT TRANSFER PROVISIONS 16
I. Introduction 16
II. Uncertainty and Subsequent Changes after the 2012 Amendment 16
III. Prevailing Issues 17
IV. Current Situation with Respect to Taxation of Indirect Transfers 18
4. CAPITAL GAINS TAXATION: TIMING AND VALUATION 20
I. Event of Taxation 20
II. Computation of Capital Gains 20
5. TAXATION OF EARN-OUT ARRANGEMENTS 22
I. Introduction 22
II. Issues in the Tax
Treatment of Earn-outs 22
III. Earn-outs in Employment Agreements 22
IV. Earn-outs as Purchase Consideration 23
V. When will an Earn-out be Taxed? 23
VI. Conclusion 24
6. CARRY FORWARD OF LOSSES IN CASE OF M&A TRANSACTIONS 25
I. Introduction 25
II. Mergers 25
III. De-mergers 26
IV. Section 79 of the ITA 27
7. MERGERS AND ACQUISITIONS - ESOP / EMPLOYEE TAXATION 29
I. Introduction 29
II. Taxation of Employees 29
III. M&A Involving Transfer of Employees from One Corporate Entity to Another 30


Legal & Tax Issues
IV. Extinguishment of ESOPs in Transferor Entity 30

V. Grant of ESOP in Transferee Entity 30
VI. Transition Payments 30
VII. M&A not Involving Transfer of Employees from One Corporate Entity to Another 31
VIII. Conclusion 31
8. DRAFTING TAX REPRESENTATIONS AND TAXATION OF

INDEMNITY PAYMENTS 32
I. Introduction 32
II. Tax & Business Representations 32
III. Tax Indemnity 33
9. MERGERS AND ACQUISITIONS – NON-COMPETE AND

DEPRECIATION – TAX ISSUES 35
I. Introduction 35
I. Taxation of Non-compete Receipts 35
III. Taxation of Non-compete Expenditure 36
IV. Conclusion 38
10. ANTI-ABUSE RULES TO BE CONSIDERED IN AN M&A TRANSACTION 39
I. Introduction 39
II. Successor Liability Concerns 39
III. Domestic Transfer Pricing Rules 39
IV. Anti-Abuse Rules under DTAAs 40
V. The General Anti-Avoidance Rule 40


Legal & Tax Issues
1. Tax Considerations on M&A Transactions

and requires the approval of the High Court.
I. Introduction In order for a merger to be tax neutral, it must
satisfy specific criteria and qualify as an Amalgama-
The Indian Income Tax Act, 1961 (“ITA”) contains tion under the ITA. These criteria are in addition
several provisions that deal with the taxation of to the requirements under the Companies Act.
different categories of mergers and acquisitions. Hence, an Amalgamation must necessarily be con-
In the Indian context, M&As can be structured ducted under a scheme of arrangement approved
in different ways and the tax implications vary by the High Court.
based on the structure that has been adopted for
The ITA defines an Amalgamation as the merger
a particular acquisition. The methods in which
of one or more companies with another company
an acquisition can be undertaken are:
or the merger of two or more companies to form a new
1. Merger: This entails a court approved process company. For the purpose of the ITA, the merging
whereby one or more companies merge with company is referred to as the “amalgamating company”
another company or two or more companies and the company into which it merges or which is
merge together to form one company; formed as the result of merger is referred to as the
“amalgamated company”. An Amalgamation must
2. Demerger: This entails a court approved process
satisfy the following criteria:
whereby the business / undertaking of one
company is demerged into a resulting company; 1. All the properties and liabilities of the
amalgamating company must become the
3. Share Purchase: This envisages the purchase of
properties and liabilities of the amalgamated
the shares of the target company by an acquirer;
company by virtue of the Amalgamation; and
4. Slump Sale: A slump sale is a sale of a business

2. Shareholders holding at least 3/4th in value of
/ undertaking by a seller as a going concern to an
the shares in the amalgamating company (not
acquirer, without specific values being assigned
including shares held by a nominee or a subsidi-
to individual assets;
ary of the amalgamated company) become share-
holders of the amalgamated company by virtue
5. Asset Sale: An asset sale is another method of
of the Amalgamation.
transfer of business, whereby individual assets /
liabilities are cherry picked by an acquirer.
It is only when a merger satisfies all the above
conditions, that the merger will be considered
In the sections that follow, we have provided further
as an Amalgamation for the purposes of the ITA.
insights into each of the specific methods of acquisi-
Where a merger qualifies as an Amalgamation,
tions.
subject to fulfilling certain additional criteria,
the Amalgamation may be regarded as tax neutral
II. Merger and exempt from capital gains tax in the hands of
the amalgamating company and also in the hands
A merger of companies is typically conducted of the shareholders of the amalgamating company
through a scheme of arrangement under Sections (discussed below). In certain circumstances,
391-3941 of the Indian Companies Act, 1956,
1. Corresponding to Sections 230 to 232 of the Companies Act,

2013. However, these sections are yet to be notified.
1
the amalgamated company may also be permitted For such shareholders, the cost of acquisition
to carry forward and set off the losses of the of shares of the amalgamated company will be
amalgamating company against its own profits.2 deemed as the cost at which the shares of
the amalgamating company were acquired
In the context of a merger/Amalgamation, Section 47
by the shareholder.
of the ITA specifically exempts the following trans-
fers from liability to capital gains tax.
III. Demerger
1. Transfer of capital assets by an amalgamating
company to the amalgamated company if the
A demerger is a form of restructuring whereby one
amalgamated company is an Indian company.
or more business undertakings5 of a company
are transferred either to a newly formed company
2. Transfer of shares in an Indian company by
or to an existing company and the remainder of the
an amalgamating foreign company to the amal-
company’s undertaking continues to be vested in the
gamated foreign company if both the criteria
first company. The consideration for such transfer
below are satisfied:
will flow into the hands of the shareholders of the
§§At least 25% of the shareholders of the amalgamat- demerged undertaking either through issue of shares
ing company continue to remain shareholders or other instruments (for it to qualify as a tax neutral
of the amalgamated company. Hence, sharehold- demerger) or by way of cash.
ers of amalgamating company holding 3/4th
A demerger must also be conducted through
in value of shares who become shareholders
a scheme of arrangement under the Companies Act
of the amalgamated company must constitute
with the approval of the High Court. The ITA defines
at least 25% of the total number of sharehold-
a demerger under Section 2(19AA) as a transfer
ers of the amalgamated company.
pursuant to a scheme of arrangement under Sections
§§Such transfer does not attract capital gains tax 391-394 of the Companies Act, 1956, by a “demerged
in the amalgamating company’s country of company”, of one or more of its undertakings
incorporation. to a “resulting company” and it should satisfy
the following criteria:
3. Transfer of shares in a foreign company
in an amalgamation between two foreign 1. All the properties and liabilities of the under-
companies, where such transfer results taking immediately before the demerger must
in an indirect transfer of Indian shares.3 become the property or liability of the resulting
The criteria to be satisfied to avail this company by virtue of the demerger.
exemption are the same as above.
2. The properties and liabilities must be transferred
4. Transfer of shares by the shareholders of the at book value.
amalgamating company in consideration for
3. In consideration of the demerger, the resulting
allotment of shares in amalgamated company
company must issue its shares to the sharehold-
is not regarded as transfer for capital gains
purpose. This exemption is available if the
amalgamated company is an Indian company.4 the definition of “transfer” under Section 2(47) of the ITA, but
has been specifically exempted from capital gains by virtue of
Section 47(vii) of the ITA. As an inference from this judgment, it
may be said that if a merger does not qualify for such exemption,
2. Please refer to Section VI for further details on carry forward of then shareholders of the amalgamating company who receive
losses in a M&A context. shares in the amalgamated company may be liable for capital
3. Please refer to Section III of this paper for more details on the gains tax as their shares in the amalgamating company may be
provisions relating to indirect transfers. deemed to have been ‘transferred’.
4. The Supreme Court has held in CIT v. Grace Collis and Ors. [2001] 5. The ITA defines an ‘undertaking’ to include an undertaking, or a
248 ITR 323 (SC) that such transfer of shares constitutes “extin- unit or a division an undertaking or business activity taken as a
guishments of rights” in a capital asset and hence falls within whole.
2 © Nishith Desai Associates 2016

Legal & Tax Issues
ers of the demerged company on a proportionate of Indian shares.6 The conditions to be satisfied
basis (except where the resulting company itself to avail this exemption are the same as above.
is a shareholder of the demerged company).
4. Transfer or issue of shares by resulting company
4. Shareholders holding at least 3/4th in value to shareholders of the demerged company
of shares in the demerged company become in consideration of demerger of the undertaking.
shareholders of the resulting company by virtue
Indirect Taxes: There is no VAT incidence upon
of the demerger. Shares in demerged company
transfer of properties and liabilities under
already held by the resulting company or its
an amalgamation or a demerger.
nominee or subsidiary are not considered
in calculating 3/4th in value.
Stamp Duty: Stamp duty on transfer of assets
is governed by the relevant state Stamp Act. In terms
5. The transfer of the undertaking must be on
of stamp duty, though the state laws provide for rates
a going concern basis.
of stamp duty to be paid on various instruments,
6. The demerger must be subject to any additional it is observed that generally there is no specific entry
conditions as notified by the Central Govern- for a High Court order sanctioning the scheme of
ment under Section 72A(5) of the ITA. amalgamation or demerger, in the absence of which
High Courts have taken the view that the High Court
If all the above criteria are satisfied, the demerger
order involving the transfer between two juristic
will be considered as tax neutral and exempt from
persons of certain movable and immovable property,
capital gains tax.
is a ‘conveyance’ and should therefore be chargeable
to stamp duty under that head, and the scheme of
Under Section 47 of the ITA, the following transfers
arrangement itself is an ‘instrument’ under which
relating to demerger do not attract capital gains
the going concern is transferred. This position has
tax liability:
been consolidated by the Supreme Court in Hindustan
1. Transfer of assets in a scheme of demerger from Lever and Anr. v. State of Maharashtra and Anr.7
the demerged company to the resulting company,
The Bombay High Court8 has held that a scheme
if the resulting company is an Indian company.
of arrangement entails transfer of a going concern,
2. Transfer of shares in an Indian company by and not of assets and liabilities separately. As a going
a demerged foreign company to a resulting concern, the value of the property transferred under
foreign company if both the conditions below a scheme of arrangementis reflected from the shares
are satisfied: allotted to the shareholders of the transferor company
under the scheme. Accordingly, under the Bombay
§§ Shareholders holding at least 3/4th in value Stamp Act, 1958 (applicable in the state of Maharash-
of the shares of the demerged company
tra), stamp duty payable on conveyance relating to
continue to remain shareholders of the
amalgamation of companies is 10% of the aggregate
resulting company; and
of the market value of the shares issued or allotted
in exchange or otherwise and the amount for consid-
§§ Such transfer does not attract capital gains
eration paid for such demerger, provided that it shall
tax in the country of incorporation of the
not exceed (i) 5% of the total true market value of the
demerged company.
immovable property located within the state of Maha-
3. Transfer of a capital asset being shares
in a foreign company by the demerged foreign
6. Please refer to Section III of this paper for more details on indi-
company to the resulting foreign company, rect transfer provisions.
where such transfer results in an indirect transfer 7. (2004) 9 SCC 438

8. Li Taka Pharmaceuticals Ltd. And Anr. v. State of Maharashtra and
Ors., AIR 1997 Bom 7
3
rashtra and as transferred by the transferor company transaction has taken place on the floor of the
to the resulting company; or (ii) 0.7% of the aggregate stock exchange or by way of a private arrange-
of the market value of the shares issued or allotted ment, and (iv) whether theseller is a resident
and the amount of consideration paid for the or a non-resident. Further, in respect of
demerger, whichever is higher. a cross-border share sale, the relevant Double
Taxation Avoidance Agreement (“DTAA”)
would determine whether capital gains are taxa-
IV. Share Sale ble in India or in the other country.9
One of the most commonly resorted to methods The general rule is that short term gains arise
of acquisition is share acquisition, which involves from the transfer of a capital asset which is held
the acquisition of the shares of the company for less than 3 year, while long term gains arise
in which the target business is vested. The entire if the capital asset is held for more than 3 years.
company is sold lock, stock and barrel. The major tax However, for all listed securities to qualify
implications of share acquisition are (i) liability to as long term capital gains, a holding period of
a tax on the capital gains, if any, and (ii) liability only 12 months is applicable. As per the Finance
under Section 56(2)(viia) of the ITA. Act, 2016, unlisted securities of both private and
public companies will also qualify as long term
i. Capital Gains: if the shares qualify as capital
capital assets if held for 24 months. The table
assets under Section 2(14) of the ITA, gains aris-
below sets out the capital gains tax rates for
ing upon the transfer of shares would attract
different forms of share sales: 10
a capital gains tax liability. The taxable rate
in India would depend on (i) whether the capital
gains are long term capital gains or short term
capital gains, (ii) whether the target company
is a public listed company, public unlisted com-
pany or a private company, (iii) whether the
9. Please refer to Section IV of this paper for more details on capital

gains tax implications, including the applicable rates of capital
gains tax.
10. These rates are exclusive of surcharge and cess. Cess at the rate of 3%
is applicable on tax and surcharge amount. Surcharge on the tax amount is applica-
ble at the following rates:
Individuals having income more than INR 10 12%

million
Domestic companies with income between 7%

INR 10 million and INR 100 million
Domestic companies with income more than 12%

INR 100 million
Foreign companies with income between INR 2%

10 million and INR 100 million
Foreign companies with income more than 5%

INR 100 million

Legal & Tax Issues
Short Term Capital Gains Long Term Capital Gains

Resident Non-resident Resident Non-resident
Individual / Com- Individuals Companies Individual / Individu- Companies
panies Companies als
Listed equity shares sold 15% 15% 15% Nil Nil Nil
on the floor of the stock
exchange*
Listed equity shares sold Individual – slab 30% 40% 20% 10%** 10%**
off the floor of the stock rate
exchange
Company -30%
Unlisted securities or shares Individual – slab 30% 40% 20% 10%** 10%**
of a private company 11 rate Company -30%
*Provided Securities Transaction Tax has been paid. Indirect Taxes: VAT is not applicable on sale of
shares.
**This beneficial rate is applicable if the inflation
Stamp Duty: Stamp duty levied on transfer of
indexation is not claimed.12
shares is 0.25% of the consideration paid for
ii. Section 56: Where a firm or a company acquires the transfer of shares under the provisions of the
shares of a company at a price which is less than Indian Stamp Act, 1899.14
the fair market value of the shares by an amount
exceeding Rs.50,000, the acquirer is taxable on
the amount of such undervaluation, and the rate
V. Slump Sale
of tax is the normal corporate tax rate of 30% 13
(excluding surcharge and cess) in the case of an A ‘slump sale’ is defined under the ITA as the sale
Indian company and 40% (excluding surcharge of any undertaking(s) for a lump sum consideration,
and cess) in the case of a foreign company. If the without assigning values to individual assets
acquirer is a firm, it would be taxable at 30%. or liabilities.15 ‘Undertaking’ has been defined to
This tax implication does not arise where either include an undertaking, or a unit or a division of
the acquirer or the target is a listed company. an undertaking or business activity taken as a whole.
However, undertaking does not mean a combination
Securities Transaction Tax (“STT”): If the sale of
of individual assets which would not constitute
shares takes place on the floor of a recognized stock
a business activity in itself.16
exchange in India, STT is levied on the turnover
from share sale. In the case of intraday sales, STT
The ITA expounds on the taxation of a slump sale.
at the rate of 0.025% is payable by the seller, while
The ITA states that the gains arising from a slump
in the case of delivery based sales, STT at the rate
sale shall be subject to capital gains tax in the hands
of 0.10% is payable by the buyer and the seller.
of the transferor in the year of the transfer.17 In case
the transferor held the undertaking for a period of 36
(thirty six) months or more, it would be taxable as
11. The Finance Act, 2016 has extended the beneficial rate of 10%
long term capital gains, otherwise it would be short
on
12. Indexation of gains is provided for under the second proviso to term capital gains. The amount subject to capital
Section 48 of the ITA. Such indexation is permitted with regard gains shall be the consideration for the slump sale
to long term capital gains in order to account for inflation.
13. In 2015, the Government had proposed a gradual reduction in
less the ‘net worth’ of the undertaking, which has
the domestic corporate tax rate from 30% to 25% over a period been defined to mean the aggregate value of assets
of four years. The Finance Act, 2016 has taken the first steps in
this direction by providing that new manufacturing entities
set up in India are entitled to a lower rate of 25% (excluding 14. Article 62 of Schedule 1
surcharge and cess) if they meet certain criteria. Furthermore, 15. Section 2(42C) of the ITA
the domestic corporate tax rate has also been lowered to 29%
for domestic companies whose turnover in FY 2014-15 did not 16. Explanation 1 to Section 2 (19AA)
exceed INR 5 crores (approx. USD 800K) 17. Section 50B of the ITA
5
of the undertaking / division less the value of liabilities assets are transferred. The Punjab and Haryana High
of the undertaking / division.18 The value of the assets Court has held that it is not essential that all assets
and liabilities to be considered for the computation are transferred for a transaction to qualify as a slump
is the depreciated book value of such assets or liabilities, sale. Even if some assets of the transferor are retained by
with certain exceptions. it, and not transferred to the transferee, the transaction
may still retain the characteristic of a slump sale. How-
What constitutes ‘slump sale’?
ever, for it to be considered a slump sale, it is essential
that the assets (along with the liabilities) being trans-
Indian courts have evolved certain principles underly-
ferred are an undertaking in itself, and can function
ing ‘slump sale’ under the ITA.
‘without any interruption’.22 This understanding of the
term ‘undertaking’ is equally applicable to demergers.
A. Continuity of Business
The Bombay High Court while dealing with the concept D. Exchange not a Slump Sale
of ‘slump sale’ generally clarified that one of the prin-
The Bombay High Court has held that for any transac-
ciple tests for determination of whether a transaction
tion to be considered as ‘slump sale’, an essential element
would be a ‘slump sale’ is whether there is continuity
is that the transfer of the undertaking must be for cash
of business.19 Thus, the concept of ‘going concern’
consideration. In the case in hand, the High Court, while
is one of the most important conditions to be satisfied
referring to an earlier judgment of the Supreme Court
when analyzing whether a transaction can be regarded
held that a transfer of an undertaking in exchange for
as a slump sale. The same view has also been upheld
shares/ bonds of the transferee entity would not consti-
by the Punjab and Haryana High Court.20
tute a ‘sale’ and accordingly, it would not be taxed
as a slump sale under section 50B of the ITA.23
B. Transfer of Liabilities
The continuity of business also assumes that E. Long Term Capital Gains
all assets and liabilities of the concerned undertaking
Another important aspect of a slump sale is that the gains
are transferred under the sale. This view has been
arising from the sale of an undertaking (if any) shall be
upheld by the Supreme Court, whereby it held that
computed as long term capital gains, if the undertaking
an ‘undertaking’ was a part of an undertaking/ unit/
as a whole has been held for a period of 36 months,
business when taken as a whole.21 Additionally,
irrespective of the fact that some of the assets may have
the ‘net worth’ of the undertaking being transferred
been held for a period of less than 36 months.
considers the book value of the liabilities to be reduced
from the aggregate amount of assets of the undertaking,
The substance, not the form of a slump sale transaction
emphasizing the requirement of transferring liabilities.
is to be examined. In cases where the entire undertaking
has been transferred under different agreements,
C. Transfer of all Assets the Income Tax Appellate Tribunal (“ITAT”), Mumbai
has held that the same would constitute a slump sale.24
While an essential element of a ‘slump sale’ is that the
assets and liabilities of the undertaking are transferred Indirect Tax: There should be no VAT on sale of the
to ensure continuity of business, for a transaction to be business as a slump sale. This is because what is being
characterized as a ‘slump sale’, it is not essential that all sold is the undertaking or the business on a slump sale
22. Premier Automobiles Ltd. vs. Income Tax Officer and Anr. [2003] 264 ITR
18. Explanation 1 to Section 50B of the ITA 193 (Bom) as approved in Commissioner of Income Tax vs. Max India
19. Premier Automobiles Ltd. vs. Income Tax Officer and Anr. [2003] 264 ITR Ltd. [2009] 319 ITR 68 (P&H)
193 (Bom) 23. Bharat Bijlee Limited v. The Addl. CIT (ITA No. 2153 of 2011)
20. Commissioner of Income Tax vs. Max India Ltd. [2009] 319 ITR 68 (P&H) 24. Mahindra Engineering & Chemical Products Ltd. vs. ITO (TS-253-
21. R.C. Cooper vs. Union of India AIR 1970 SC 564 ITAI-2012 (Mum)

Legal & Tax Issues
basis, and ‘business’ per se does not qualify under the gains arising from such transfer are taxed only
definition of ‘good’. Since a business cannot qualify as short-term capital gains irrespective of the period
as a ‘good’, there should be no incidence of VAT of holding of the asset. The capital gains form transfer
on the transfer of business on a slump sale basis. of depreciable assets are determined as the difference,
if any, between the sale consideration from the trans-
Stamp Duty: Please refer to the below section on
fer of the concerned assets, together with the trans-
“Asset Sale”
fer of any other asset within that block in the same
financial year, and the aggregate of (i)expenditure
VI. Asset Sale incurred in connection with such transfer, (ii) depre-
ciated value of the concerned block of assets at the
beginning of the financial year, and (iii) actual cost of
As compared to slump sale discussed above, an asset
any asset acquired during that year and forming part
sale is an itemized sale of the assets of company
of that block.
or a piece meal sale of the assets of the company.
In an itemized sale of assets, for determining taxabil-
If the sale consideration does not exceed the aggre-
ity of capital gains, a distinction is drawn between
gate of the above values, then there is no capital gains
depreciable and non-depreciable assets.
which are said to arise from the sale of the asset even
if the sale consideration exceeds its cost of acquisition.
A. Non-depreciable Assets In such a situation the sale consideration is adjusted
within the block and the value of the block is reduced
On sale of all assets not being depreciable assets,
by the amount of sale consideration of the asset.
capital gains are calculated as per Sections 45
and 48 of the ITA, i.e., the amount by which the The main features of an asset sale would be best
sale consideration of the asset exceeds its cost of understood in contrast to the sale of an undertaking
acquisition. Each asset is assigned a value, and the under a slump sale.
consideration for such asset is also determined.
The gains from the sale of each asset is determined
1. While in case of a slump sale, each asset is
and the transferor is liable to capital gains tax on
assigned a value for the purposes of only stamp
the gains (if any) from the sale of each asset.
duty, etc., in case of an asset sale, each asset is
Further, whether the sale would result in short term
considered as a separate sale and hence values
or long term capital gains would need to be analyzed
are assigned to each asset. The ITAT, Hyderabad,
individually depending on the holding period for each
quoting multiple judgments from the Supreme
asset by the transferor. Accordingly, it may be possible
Court, has held that what is important for
that certain assets result in short term capital gains,
a transaction to be an itemized sale is that each
while some result in a long term capital gain,
asset be assigned a value for the purpose of the
despite being sold as part of the same transaction.
transaction.26 The ITAT went on to state that
the mere fact that values had been assigned to
B. Depreciable Assets individual assets would not necessarily mean that
the transaction is an itemized asset sale, but that
When an asset forms a part of a block of assets 25
it could still be regarded as a slump sale. What is
on which depreciation is allowed as deduction under
essential is that the values have been assigned for
the ITA at the rate applicable on the block, the capital
the purpose of the sale of the assets.
25. “block of assets” is defined in Section 2(11) of the ITA as a group

of assets falling within a class of assets in respect of which the
same percentage of depreciation is prescribed. Such block of
assets may comprise of (a) tangible assets such as buildings,
machinery, plant or furniture; (b) intangible assets such as know- 26. Coromandel Fertilisers Limited vs. Dy. Commissioner Of Income-Tax
how, patents copyrights etc. 2004 90 ITD 344 Hyd
7
2. As the name suggests, an asset sale does not include However, since the stamp duty is payable on the instru-
the transfer of liabilities of the transferor company. ment for transfer, no stamp duty is payable if there is
In some cases, all the assets of a business may be no instrument effecting the transfer. For instance,
transferred, which may be required to operate the if the movable tangible assets are delivered by way of
business going forward, without transferring any physical delivery and the buyer merely acknowledges
liabilities. In such cases while the transferred assets receipt of such assets by way of a ‘delivery note’,
operate as a going concern, the transaction is then no stamp duty is payable on such acknowledge-
an asset sale, since the liabilities are not transferred. ment or receipt of assets. As regards movable assets that
are intangible in nature, such as goodwill, stamp duty
Indirect Tax: VAT could be applicable depending on
at the rate of 3% will need to be paid on the instrument
the nature of asset sold, and could be as high as 13.5%.
conveying such intangible assets. If the intangible asset
like goodwill is transferred by way of an instrument,
Stamp Duty: Stamp duty payable on transfer of assets,
such as the business transfer agreement or the asset
whether in case of an itemized sale or slump sale,
purchase agreement, then the business transfer agree-
is governed by the provisions of the relevant stamp act
ment or the asset purchase agreement will need to be
where the document of instrument of transfer
stamped to the extent of at least 3% of the value of the
is executed / produced. For instance, in Maharashtra,
goodwill. If there are other assets that are being con-
the stamp duty payable on conveyance of immovable
veyed by way of the business transfer agreement or the
property and movable property is 5% and 3%,
asset purchase agreement, then such instruments should
respectively, of the consideration paid therefor.
be stamped to such appropriate value as may be required
under the relevant stamp act. The applicable rates of
stamp duty will vary on a state wise basis.
Below is a comparison between the various methods of

acquisition as discussed above
Slump Sale Share Sale Asset Sale Amalgamation Demerger

Definition Transfer of an Acquisition in whole The sale of the whole Merging of one Transfer of undertaking
undertaking / busi- or part of the share- or part of the assets company into another of company to another
ness for a lump holding of a company of the target to the ac- company or merging of company under a court
sum consideration from the existing quirer with individual two or more companies approved process in
on a going concern shareholders. Unless values assigned for to form a new company compliance with Section
basis without specifically agreed each asset. under a court approved 391 to 394 of the Com-
values being to, the seller has no process in compliance panies Act, 1956.
assigned to the continuing interest with Section 391 to
individual assets in, or obligation with 394 of the Companies
and liabilities in respect to, the assets, Act, 1956.
such sale. liabilities or opera-
tions of the business
Court Not required Not required Not required Required Required
Approval
Transfer All Assets + Liabil- All Assets + Liabilities Such assets/liabilities All Assets + Liabilities All Assets + Liabilities
ities pertaining to pertaining to the that the parties may of the Amalgamating relatable to the under-
the undertaking company determine Company taking being transferred

Legal & Tax Issues
Capital Capital gains Capital gains In case of depreciable No capital gains tax No capital gains tax lia-
Gains realized on the realized on the assets, capital gains liability if it is a tax bility if it is a tax neutral
transfer of the transfer of listed computed on a block neutral amalgamation, demerger, and if the
undertaking, if shares, if held of asset basis and and if the transaction is transaction is covered
held for: for more than 12 the value over and covered under Section under Section 47 of ITA.
months is taxed above the aggregate 47 of ITA.
more than 36
§§ as long term of the written down
months, are capital gains. value of the block of
taxed as long Capital gains assets and expen-
term capital realized on the diture incurred in
gains. transfer of the relation to the transfer
shares, if held will be treated as the
if held for less
§§ for 12 months or capital gains and sub-
than 36 months less is taxed as ject to tax as short
are taxed as short term capital term capital gains.
short term gains.
capital gains. In other cases, capital
As per the Fi- gains tax payable by
For the purpose of nance Act, 2016, the seller will depend
computing capital the holding pe- on the period that the
gains, the cost of riod for unlisted seller has held each
acquisition would shares has been of the assets that are
be the ‘net worth’ reduced from 36 transferred.
of the undertaking months to 24
on the date of the months.
transfer (Section
50B of the ITA)
Carry No carry forward Carry forward of No Carry forward of Carry forward of losses Carry forward of losses if
forward of losses losses if change losses if conditions under conditions under Section
of losses in shareholding Section 72A of ITA are 72A of ITA are satisfied.
does not exceed satisfied.
49%
Value Value Added Tax Value Added Tax Value Added Tax ap- Value Added Tax not Value Added Tax not
Added not applicable not applicable plicable which usually applicable applicable
Tax ranges between 0%
- 13.5% depending on
the nature of goods.
Stamp Rate of stamp duty 0.25% of the sale Rate of stamp duty Rate of stamp duty pay- Rate of stamp duty
Duty payable on the consideration payable on the asset able on amalgamation payable on demerger is
slump sale is state purchase agreement is state specific state specific
specific is state specific
9
2. Cross Border Tax Issues
I. Introduction II. Claiming Treaty Benefit:

Tax issues arise in cross border deals when two different
Requirements and
jurisdictions seek to tax the same sum of money Procedure
or income or the same legal person thereby resulting
in double-taxation. Many countries are aware that double Under Section 90(2) of the ITA, if the non-resident
taxation acts as a disincentive for engaging in any cross is resident in a country with which India has a DTAA,
border trade or activity. Therefore with the primary view he would be taxable according to the provisions of the
to encourage mutual cooperation, trade and investment, DTAA or the ITA, whichever is more beneficial to him.
the countries enter into bilateral Double Taxation
Relief under the DTAA should normally be available
Avoidance Agreements (“DTAA”) to limit their taxing
as long as the non-resident is resident and a separate
jurisdictions voluntarily through self-restraint.
legal person liable to tax under the laws of the relevant
The availability of such benefits and the ultimate tax country and liable to tax under its laws. Sections 90(4)
liability often drives or breaks cross border transactions. and 90(5) require a non-resident claiming treaty relief to:
Particularly in the Indian context, where the tax
i. Furnish a valid Tax Residency Certificate (“TRC”)
administration is perceived to be aggressive and the
issued by the government of its home country;
laws uncertain, any protection offered by a treaty
jurisdiction is important. It is important for the buyer
ii. Provide certain additional information, as may be
in the context of whether there is any withholding
prescribed from time to time, in Form 10F.
obligation while making a remittance to the seller.
At present, the following details are required to be pro-
India is currently going through an overhaul of
vided by a non-resident claiming relief under a DTAA:
the existing investment climate as it is has recently
amended the India-Mauritius DTAA and has prom- i. Status of the claimant i.e., individual, company, firm etc.;
ised to bring the DTAAs with Singapore, Cyprus and
ii. Nationality
Netherlands in line with the amended India-Mauritius
DTAA. Together, these jurisdictions represent almost
iii. Claimant’s tax identification number in the country of
all the investment that has been made into India.
residence and in case there is no such number, a unique
This is in addition to the fact that the General
number on the basis of which the claimant is identified
Anti-Avoidance Rules (“GAAR”) is also set to be effec-
by the Government of the country of which he claims
tive from 1st April 2017, the same date when the India
to be a resident;
– Mauritius DTAA shall stand amended.
iv. Period for which the residential status, as mentioned
It is expected that the current status quo will remain till
in the TRC, is applicable; and
1st April 2017. It is also expected that if the DTAAs are
amended, then they will be suitable protected from the v. Claimant’s address outside India, during the period for
implementation of the uncertain and widely discretion- which the TRC is applicable.
ary GAAR provisions. The positions explained below
Typically, a non-resident claiming relief under a DTAA
must be re-verified when there is a substantial change
is required to furnish an income tax return to the tax
in the laws or the DTAAs.
authorities, where he would be required

Legal & Tax Issues
to quote his Permanent Account Number (“PAN”), India levies a tax on capital gains arising from the
which is a tax identification number issued by the transfer of an asset located in India.29 In the case
Indian taxauthorities. of capital gains arising from the transfer
of shares of an Indian company, the tax on such
gains is typically eliminated through the use
III. Withholding Tax of structures involving a Mauritian or Singaporean
Obligations holding company, since under the DTAAs in place
between India and the aforementioned countries,
subject to certain criteria being fulfilled (e.g., absence
Under Section 195 of the ITA, any person making
of a permanent establishment in India) only the
a payment of a sum to a non-resident that is chargea-
country of residence of the transferor is entitled
ble to tax under the ITA (read with relevant provi-
to levy a tax on capital gains arising from the transfer
sions of the applicable DTAA) would be required
of shares of an Indian company, and importantly,
to withhold tax on such sum at the appropriate
these countries do not tax capital gains.30
rate. Such withholding is required to be made either
at the time of payment or at the time of credit of
In the context of the India-Mauritius DTAA,
income to the account of the non-resident. However,
the Central Board of Direct Taxes (“CBDT”) has issued
if the amount paid is not taxable in India, there is
Circular 682 of 1994 which states that “any resident
no requirement to withhold tax on such payments.27
of Mauritius deriving income from alienation of shares of
However, if the amount paid has an element of
Indian companies will be liable to capital gains tax only
income that is taxable in India, then even a non-resi-
in Mauritius as per Mauritius tax law and will not have
dent who making such remittance is obligated
and capital gains liability in India”. The CBDT also issued
to withhold as per the ITA.
Circular 789 of 2000 which states that: “Wherever
a Certificate of Residence is issued by the Mauritian
India levies withholding tax on certain types of pas-
Authorities, such Certificate will constitute sufficient evidence
sive income (e.g. interest, royalties etc.). India does
for accepting the status of residence as well as beneficial
not levy a withholding tax on dividends, since a Divi-
ownership for applying the DTAA accordingly”.
dend Distribution Tax (“DDT”) is paid by the distrib-
uting company.28
29. India also levies a tax on the gains arising on the transfer of
The normal withholding tax rate on royalties shares or an interest in a foreign company, if the share or
interest derives its value substantially from assets (tangible or
and fees for technical services is 10%, and lower intangible) located in India. This tax on indirect transfers of In-
rates may apply if provided for in a tax treaty. dian assets is dealt with in more detail in the section on Indirect
Transfer Tax.
30. In certain scenarios, eligibility to claim relief under a DTAA
The normal withholding tax rate on interest is 40%. may be conditional upon the satisfactions of certain “sub-
However, more beneficial rates (ranging from 5% stance” requirements. For example, the India-Singapore DTAA
incorporates a “Limitation on Benefits” clause, which requires
– 20%) of withholding are available to non-resident a Singapore resident company to demonstrate the following,
before it can claim benefits under the DTAA:
creditors depending on the nature of the security
involved, the status of the non-resident creditor etc. i. The primary purpose of its incorporation in Singapore should
not be to take advantage of the treaty benefits.
ii. It should not be a shell / conduit company and it must have

bona fide business activities.
27. GE India Technology Centre Ltd. v. CIT, [2010] 327 ITR 456; Voda-
fone International Holdings BV v. Union of India, [2012] 341 ITR 1 iii. It will be deemed not to be a conduit company if:
(SC)
28. The Finance Act, 2016 has proposed the introduction of a tax at a) Its total annual expenditure on operations in Singapore is at
the rate of 10% on dividends in excess of INR 1 million (approx. least S$200,000 during 2 years prior to share transfer, or
USD 15,000) declared by a domestic company and received by a
resident individual, LLP or partnership firm. This is in addition b) It is listed on a stock exchange in Singapore.
to the DDT paid by the distributing company. It is expected that
the introduction of this tax,, will affect the ability of non-resi- The India-Mauritius DTAA contains no such clause at present,
dents to claim foreign tax credit in their home jurisdictions on but the Indian and Mauritian Governments are in negotiations
DDT paid by the distributing company. to introduce a “Limitation on Benefits”.
11
Despite this, the Mauritius route has been the sub- A. Tax Identification Number for
ject of much litigation. However, the Supreme Court Non-Residents
has held 31 that relief under the DTAA cannot be
denied as long as the Mauritius investor is a valid Section 206AA of the ITA, provides that where
company in existence having a TRC issued by the any person fails to provide his Permanent Account
Mauritius Revenue Authority. The above proposi- Number (“PAN”) to the person responsible for
tion has been followed in number of other cases,32 deducting tax at source, the latter shall be required
most recently in Serco BPO (P) Ltd. v. AAR.33 to deduct tax at the rate of 20%, or the maximum
applicable rate chargeable under the ITA, whichever
In the event relief under the relevant DTAA is not
is higher. Whether this provision would be
available, a non-resident would be taxed on capital
applicable to a non-resident claiming treaty benefit
gains at the rate of 15% for short term capital gains on
has been the subject of much litigation, with the
sale of listed shares on the stock exchange (subject to
courts holding both for and against the proposition.34
STT) or 40% for other short term gains. Long term cap-
In the Finance Act, 2016, the Government has
ital gains arising from sale of listed shares on the stock
proposed permitting non-residents to furnish
exchange are exempt (but subject to STT) or taxed
alternative documents such as a tax identification
at 10% if sold outside the stock exchange.
number issued by their country of residence.
This measure, if implemented, effective from June
The capital gains tax for non-residents on transfer
1, 2016, will ensure that the needless incremental
of unlisted securities is 10% for non-residents
burden borne by non-residents who are doing
without indexation benefit. However, this benefit
business with India is avoided.
was typically only applicable effectively for unlisted
shares of a public company, and not a private
company. The Finance Act, 2016 has recently
IV. Structuring Invest-
extended the reduced tax rate of 10% (without
indexation benefit) w.e.f. April 1, 2017 to transfer ments into India –
of shares of ‘a company not being a company in
which the public is substantially interested’, thereby
Suitable Holding
extending it to shares of private companies. Capital Company Jurisdictions
gains arising from the transfer of any other asset
are taxed at the rate of 20%. In light of a non-resident’s ability to claim benefits
under an applicable DTAA, we have highlighted
some of the more beneficial jurisdictions though
which investments into India are often structured.
Of course, the requirement to demonstrate commer-
cial substance is ever present.
31. GE India Technology Centre Ltd. v. CIT, [2010] 327 ITR 456; Voda-
fone International Holdings BV v. Union of India, [2012] 341 ITR 1
(SC)
32. In re, E*Trade Mauritius Limited, [2010] 324 ITR 1 (AAR); Dynamic
India Fund I, AAR 1016/2010 dated July 19, 2012; DDIT v. Saras-
wati Holdings Corporation, [2009] 111 TTJ 334; DB Swirn Mauritius
Trading, [2011] 333 ITR 32 (AAR); In re, Ardex Investments Mauritius Ltd.,
34. DDIT v. Serum Institute of India Ltd, MANU/IP/0145/2015, de-
[2012] 340 ITR 272 (AAR); In re, SmithKline Beecham Port Louis Ltd., [2012]
cided on 30.03.2015 by the Income Tax Appellate Tribunal, Pune
3408 ITR 56; In re, Castleton Investment Ltd. [2012] 348 ITR 537; Moody’s
and reiterated in DDIT v. Infosys BPO, MANU/IL/0278/2015,
Analytics Inc., [2012] 348 ITR 205; In re, DLJMB Mauritius Co., [1997] 228
dated 29.06.2015 and further affirmed in Wipro v. ITO, MANU/
ITR 268; Zaheer Mauritius v. DIT, [2014] 270 CTR (Del) 244
IL/0042/2016, dated 12.02.2016, by the Income Tax Appellate
33. C Writ Petition No. 11307 of 2014 (O&M) Tribunal, Bangalore.

Legal & Tax Issues
MAURITIUS CYPRUS SINGAPORE NETHERLANDS

Capital gains tax Mauritius residents not Cypriot residents not Singapore residents not Dutch residents not
on sale of Indian taxed. No local tax in taxed.** No local tax in taxed till 1st April, 2017. taxed if sale made to
securities Mauritius on capital gains Cyprus on capital gains. Exemption subject to non-resident. Exemption
till 1st April, 2017. The Indian / Cyprus gov- satisfaction of certain for sale made to resident
ernment have recently ‘substance’ criteria and only if Dutch shareholder
After 1st, April 2017: been in discussions and expenditure test by the holds lesser than 10%
have announced that resident in Singapore. No shareholding in Indian
i. No tax on capital gains the Cyprus treaty will be local tax in Singapore company. Local Dutch
on investments made amended on the lines of on capital gains (unless participation exemption
before 1st April, 2017. the Mauritius treaty. characterized as busi- available in certain
ness income). circumstances.
ii. 50% of applicable
Indian tax rate on After 1st April, 2017,
investments made from expected to be in line with
1st April 2017 to 1st Mauritius DTAA (without
April 2019, subject to the benefit of grandfa-
anti-abuse or limitation thering)
of benefits provisions.
iii. Full rate of Indian tax

for investments made
after 1st April 2019.
Tax on Indian company subject Indian company subject Indian company subject Indian company subject
dividends to DDT at the rate of 15% to DDT at the rate of 15% to DDT at the rate of 15% to DDT at the rate of
(exclusive of surcharge (exclusive of surcharge (exclusive of surcharge 15% (exclusive of sur-
and cess) on a gross and cess) on a gross and cess) on a gross charge and cess) on a
basis. basis. basis. gross basis.
Withholding tax No relief. Taxed as per 10%** 15% till 1st April, 2015. 10%
on outbound Indian domestic law till
interest 1st April, 2017.
After 1st April, 2017, tax
After 1st April, 2017, tax on interest payments
on interest payments from from India expected to
India capped at a flat rate be capped at a flat rate
of 7.5% of 7.5%
Withholding tax 15% (for royalties). FTS36 15%** 10% 10%

on outbound may be potentially exempt
royalties35 and in India till 1st April, 2017.
fees for techni-
cal services After 1st April, 2017, FTS
is capped at 10% of the
gross amount.
Other The treaty has been Cyprus economic crisis Treaty has to be re-nego- To consider anti-abuse
comments amended and the amend- and financial situation tiated due to changes in rules introduced in con-
ed protocol will take effect to be taken into consid- Mauritius DTAA. Uncer- nection with certain pas-
from 1st April, 2017 eration. tainty remains as to sive holding structures.
final terms of the DTAA,
DTAA has been re-nego- although it is expected to DTAA may be re-negotiat-
tiated and it is amended be in line with Mauritius ed in the near future to
in line with the Mauritius DTAA. do away with exemption
treaty. on capital gains tax.
35. Finance Act, 2015 proposes to reduce the withholding tax rate
applicable in case of royalty and FTS to offshore entities to 10%
(on a gross basis).
36. Fees for Technical Services
13
**Following the blacklisting of Cyprus by the Indian tax a. A person employed by or on behalf of the non-
authorities in 2013, payments made to entities incorporated resident; or
in Cyprus are subject to a withholding tax at the rate of 30%
b. A person has any business connection with the
or such higher rate as may be applicable. Please note that the
non-resident; or
Indian government is currently re-assessing the blacklisting.
c. A person from or through whom the non-resident
V. Tax as a Representative receives income directly or indirectly; or
Taxpayer/Assessee d. A trustee of the non-resident;
In this context, the term ‘business connection’ mean

In a cross-border transaction where due to a merger
a continuing business relationship carried on by
or an acquisition capital gains arises, even though the
non-resident with a person that yields profits or gains
person ultimately liable for tax on such capital gains
through some activity in India.
is the seller, the person responsible for making the
payment may also be treated as a representative assesse In the landmark ruling by the Supreme Court of India
of the seller. This requirement is independent of the in the Vodafone International Holdings BV v. Union of
requirement of the buyer to deduct tax at source (‘TDS’), India37, the Court noted that the representative assessee
or the withholding tax obligations of the buyer. provisions cannot be invoked to tax the buyer entity
when there is not transfer of a capital asset. Therefore,
Where any final tax liability falls on a non-resident,
the representative assesse provisions may only be used
particularly a foreign company, and the tax authorities
if there is income chargeable to tax in India.
are of the opinion that it may be difficult to recover
tax liable from such non-resident during the final
assessment proceedings may, even at the stage of VI. Provisions for
deduction of TDS, proceed to recover such amounts
from an agent of the non-resident by treating the
Cross-border Mergers
agent as a representative taxpayer/assessee.
The merger of two foreign companies involving the
The power to treat an agent of the non-resident as transfer of shares of an Indian company, is normally tax
a representative taxpayer and recover amounts due from exempt provided that the merger satisfies the criteria for
the non-resident from the representative taxpayer is not an Amalgamation set out in Section I and, (i) at least 25%
limited only to TDS proceedings alone and recoveries can of the shareholders of the merging company remain
be made even for liabilities due after the final assessment shareholders in the merged company , and (ii) such
is completed. It is also legal for the tax authorities to transfer does not attract capital gains tax in the country
proceed against both the non-resident and their agent in which the merging company is incorporated.
simultaneously so long as the recovery is made only
The demerger involving the transfer of shares of
from either one of them. The representative assesse
an Indian company by a demerged foreign company
has in turn the right to recover such amounts paid by
to the resulting foreign company are also tax exempt pro-
it on behalf of the non-resident from the non-resident.
vided that (i) the shareholders holding not less than 3/4
The following persons may be held to be of the shares in the demerged foreign company remain
a representative assesse of a non-resident: shareholders in the resulting company and (ii) such
transfer does not attract capital gains in the country
in which the demerged foreign company is located.
As mentioned in Section I, the merger of an Indian
37. Vodafone International Holdings BV v. Union of India (2012)6SCC613

Legal & Tax Issues
company with a foreign company is also tax exempt, and litigation costs. The tax indemnity is normally
provided the resulting company is an Indian company. negotiated for a period of 7 years, since the tax
authorities are empowered to reopen past assessments
if not more than 6 years have elapsed from the end
VII. Tax Indemnities on of the relevant assessment year.
Transfer It is also possible for investors to resort to tax insurance
to reduce the risk involved if ultimately any tax is liable
Tax indemnities are a critical aspect of negotiating
to be paid. It is advisable to pre-empt any litigation
M&A deals. It has been discussed in greater detail
or adverse orders by the tax authorities and approach
in the Section VIII of this paper.
the Authority for Advance Rulings instead at the
earliest possible stage. The rulings of the Authority
Given the adversarial nature of India’s tax regime,
for Advance Rulings are binding on both the taxpayer
from a commercial stand point it becomes essential
and tax authorities, which may provide a well needed
to negotiate suitable tax indemnity agreements to
measure of certainty in respect of the transaction.
cover not only the actual tax that may become payable
but provide for the costs associated with prolonged
litigation such as interest, penalties, advisory
15
3. Prevailing Ambiguities in Indirect Transfer

Provisions
Further, the provision was made applicable with
I. Introduction retrospective effect as the explanation stated that such
assets “shall always be deemed to have been situated in India”.
Through the Finance Act, 2012, the Indian legislature
had introduced “indirect transfer provisions”.
These provisions require that gains arising from the II. Uncertainty and Subse-
transfer of shares of a company incorporated outside
India would be taxable in India if such shares substan-
quent Changes after the
tially derive their value from assets located in India. 2012 Amendment
The introduction of these provisions in the ITA has
The introduction of the provisions with retrospective
been widely debated by various participants of the
effect caused wide spread concern. Further, the situation
Indian economy. The provisions were introduced
was exacerbated due to the fact that there was no clarity
as a knee-jerk reaction to the Supreme Court’s decision
around the term “substantially” that was the basis of
in the Vodafone International Holdings B.V. v. Union
determining the scope of the 2012 Amendment.
of India & Ors.38 As is well recorded, the Vodafone case
involved a contention by the Indian revenue authorities The situation had already led to litigation with the
that the acquisition of an entity located in the Cayman Delhi High Court weighing in on the issue in the case
Islands by Vodafone’s Dutch subsidiary involved of DIT v. Copal Research Mauritius Limited, Moody’s
an indirect transfer of underlying assets situated in India. Analytics, USA & Ors. .41 In its decision, the High Court
Consequently, the revenue authorities claimed that had stated that the term “substantially” as used in
the gains arising on the transfer were liable to capital explanation 5 to Section 9(1)(i) should be interpreted
gains tax in India. The Supreme Court ruled in favour of to mean “principally”, “mainly” or at least “majority”.
Vodafone stating that the impugned provision39 did not Consequently, it concluded that the indirect transfer
cover such transactions within its scope. tax provisions shall apply when the overseas company
derives at least 50% of its value from Indian assets.
Consequently in 2012, the Indian legislature amended
Section 9(1)(i) of ITA by adding an additional As a response to the prevailing uncertainty, through the
explanation40 clarifying that an offshore capital Finance Act, 2015 (“2015 Act”), the Indian Government
asset would be considered to have a situs in India if it introduced the following additional provisions to
substantially derives its value (directly or indirectly) clarify the position on indirect transfers:-
from assets situated in India (“2012 Amendment”).
A. Threshold Test for

Substantiality and Valuation
38. [2012] 34 ITR 1 (SC)
The 2015 Act provided that the share or interest of
39. Section 9(1)(i), the ITA. The provision deals with “Income deemed
to accrue or arise in India” a foreign company or entity shall be deemed to derive
40. Explanation 5 to Section 9(1)(i) states as follows: its value substantially from the assets (whether tangible
“Explanation 5.-For the removal of doubts, it is hereby clarified that or intangible) located in India, if on the specified date,
an asset or a capital asset being any share or interest in a company or the value of Indian assets (i) exceeds the amount of INR
entity registered or incorporated outside India shall be deemed to be
and shall always be deemed to have been situated in India, if the share
or interest derives, directly or indirectly, its value substantially from
the assets located in India.” 41. [2015] 371 ITR 114(Delhi)

Legal & Tax Issues
10 crores (INR 100 million); and (ii) represents share capital in the foreign company or entity
directly holding the Indian assets (“Holding Co”).
at least 50% (fifty percent) of the value of all the assets
owned by the company or entity. The value of the assets
ii. In case the transfer is of shares or interest in
shall be the Fair Market Value (“FMV”) of such asset,
a foreign entity which does not hold the Indian
without reduction of liabilities, if any, in respect of the
assets directly, then the exemption shall be
asset. However, the manner of determination of the
available to the transferor if it along with related
FMV of the assets was not prescribed in the 2015 Act
parties does not hold (i) the right of management
and was to be subsequently provided for in the rules.
or control in relation to such company or the entity;
Very recently, the draft rules released earlier this year
and (ii) any rights in such company which would
have been finalized.
entitle it to either exercise control or management
of the Holding Co or entitle it to voting power
B. Date for Determining Valuation exceeding 5% in the Holding Co.
Further the 2015 Act stated that typically, the end of the iii. In case of business reorganization in the form of
accounting period preceding the date of transfer shall be demergers and amalgamation, exemptions have
the specified date of valuation. However, in a situation been provided. The conditions for availing these
when the book value of the assets on the date of transfer exemptions are similar to the exemptions that
exceeds by at least 15%, the book value of the assets are provided under the ITA to transactions of
as on the last balance sheet date preceding the date a similar nature.
of transfer, then the specified date shall be the date
of transfer. However, this results in ambiguity especially
in cases where intangibles are being transferred.
III. Prevailing Issues
C. Apportionment of Gains A. Concerns for Multi-layered

Structures
The 2015 Act introduced explanation 7 to Section 9(1)(i)
which stated that the gains arising on transfer of The presence of indirect transfer tax provisions raises
a share or interest deriving, directly or indirectly, critical concerns for an organization which seeks
its value substantially from assets located in India will to take exposure to an Indian entity through
be taxed on a proportional basis based on the assets an intermediary holding vehicle. Not only at the time
located in India vis-à-vis global assets. However, of exit, but there is also a risk of taxation when cash
it did not provide for determination of proportionality is up-streamed by way of redemption of shares of the
and the same are proposed to be provided subsequently holding company that are held by the parent company.
by a separate set of rules.
While the Central Board of Direct Taxes (“CBDT’)
has released a circular42 that has clarified that
D. Exemptions a distribution of dividends by an offshore company
with underlying Indian assets would not result in a tax
The 2015 Act also stated that the provisions shall not be
liability under Section 9(1)(i) read with Explanation 5.
applicable in the following circumstances:-
The operative portion of the 2015 Circular states
as follows:-
i. Where the transferor of shares of or interest in
a foreign entity, along with its related parties does
not hold (i) the right of control or management;
“Declaration of dividend by such a foreign company out-
and (ii) the voting power or share capital or interest
side India does not have the effect of transfer of any under-
exceeding 5% of the total voting power or total
42. Circular no.4 of 2015
17
lying assets located in India. It is therefore, clarified that Further, the Court also took the following points into
the dividends declared and paid by a foreign company consideration:-
outside India in respect of shares which derive their value
i. The minority shareholders of SPV had no evident
substantially from assets in India would not be deemed
extraordinary control of the SPV
to be income accruing or arising in India by virtue of pro-
visions of Explanation 5 to Section 9(1)(i) of the Act.”
ii. The SPV continued exist post sale of shares by its
shareholders.
iii. The SPV was conceptualized in accordance with

However, there is lack of certainty over distributions
the group’s established business practices and
that arise out of redemption of shares made out of
organization structure.
accumulated profits of the holding vehicle to the parent
company. While a view may be taken that redemptions
Lastly, another issue, that arises in such
should not be scrutinized under explanation 5 of
a scenario is that the existence of indirect provisions
section 9(1)(i) of the ITA due to that fact that Section
may lead to multiple incidences of taxation i.e. every
2(22) of the ITA (which defines the term “dividend”)
instance of indirect transfer shall create a taxable
includes distributions by way of any “capital reduction”
transaction in India. Therefore, in a situation where
and provides that “dividend” includes any distribution
there are multiple levels of transactions, the indirect
to its shareholders by a company on the reduction of
transfer provisions may lead to an absurd consequence
its capital, to the extent to which the company
of the liability being imposed each time by the Indian
possesses accumulated profits, whether the such
revenue authorities.
accumulated profits have been capitalized or not.
However, this position suffers from ambiguity due to
the fact Section 46A of the ITA treats purchase of its
B. Availability of Tax Credits
own shares by an Indian company to be a transaction
In respect of taxes paid due to the indirect transfer
that is subject to capital gains and does not consider
provisions, credit for such payment may not be available
such purchases to be a form of dividend distribution.
if the jurisdiction of the assesse does not recognize such
payment for credit against a capital gains liability that
Further, Indian revenue authorities have also raised
arises out of a direct transfer of assets.
issues around commercial substance in interpreting
issues of indirect transfers. For instance, the authority
of advanced rulings while dealing with an application
IV. Current Situation with
filed by Sanofi Pasteur Holdings SA 43, held that a French
special purpose vehicle (‘SPV’) to be a colorable device Respect to Taxation of
which was set up to avoid Indian tax and capital gains
arising from a transaction in India. However,
Indirect Transfers
in the instance of Sanofi the Andhra Pradesh High
In 2014, the finance minister had announced in his
Court held that it would be incorrect to label the SPV
budget speech that a high level committee would be
as a colorable device as the eventual demand raised
constituted which would oversee any fresh case where
by Indianauthorities was lower than the demand from
the assessing officer proposes to assess or reassess
the French revenue authorities.
income in respect of indirect transfers by applying the
2012 Amendment.
43. Sanofi Pasteur SA v. Department of Revenue [2013] 30 taxmann 222

Legal & Tax Issues
In his recent budget speech on February 29, 2016, While it remains to be seen whether the DTDRS will
the finance minister has further stated that this find traction amongst the affected entities, the lack of
committee will now be chaired by the revenue secretary rules concerning apportionment of income attributable
and consist of chairman of CBDT and an external expert. to Indian assets and determination of fair market value
continue to affect operations for structures which fall
Further, in order to give an opportunity to the past cases
within the scope of these provisions.
which were ongoing under Section 9(1)(i) of the ITA,
the finance minister has proposed a one-time scheme Recently, the Indian revenue authorities have issued
of dispute resolution in the form of Direct Tax Dispute rules that prescribe fair market value computation
Resolution Scheme (“DTDRS”) , under which, subject methods and reporting requirements for indirect trans-
to the taxpayer agreeing to withdraw any pending case fer provisions. The objective behind the rules is to
in any court, tribunal, arbitration, mediation under any provide clarity on these teething issues and shed light
Bilateral Investment Protection Agreement (“BIPA”), on the circumstances where such provisions would be
the dispute can be settled by paying the tax arrears applicable. The rules are unclear on various issues such
alone in which case the liability concerning the interest as what constitutes “control” over an entity and provide
and penalty shall be waived. for overzealous reporting requirements and to that
extent it may take time for a final determination of how
the rules will actually be applied in practice.
19
4. Capital Gains Taxation: Timing and Valuation

are subject to capital gains tax to the extent of the
I. Event of Taxation difference. However, in all instances the right to capital
gains must accrue or arise before the gains can be taxed.
The ITA defines ‘income’ to include ‘capital gains’
and prescribes a set of rules for taxing such capital
gains. Pursuant to Section 45 of the ITA capital gains
II. Computation of Capital
tax is levied on the gains or profits arising from the Gains
transfer of a ‘capital asset’. A ‘capital asset’ has been
broadly defined under the ITA as including property
Section 48 of the ITA provides that capital gains are
of any kind (including the shares or good will of
computed by deducting the following from the full
a company) held by a tax payer other than those
value of consideration:
assets held as stock in trade, certain personal effects,
agricultural land, and certain bonds. i. cost of acquisition of the capital asset;
As per Section 45, capital gains tax must be assessed ii. any cost of improvement of the capital asset; and
at the time of transfer of the capital asset, and not
iii. expenditure incurred wholly and exclusively for
necessarily at the time when consideration is received
such transfer.
by the transferor or the date of the agreement to transfer.
In other words, a tax payer is required to pay capital
I` t is now settled law that the term “full value of
gains tax with respect to the year his right to receive
consideration” means the entire consideration received
payment accrues, even if such payment is deferred
by the tax payer, whether or not such amount is the
in whole or in part..
market value of the capital asset transferred. For example,
where Company A offers its own shares as consideration
Further, Section 195 of the ITA requires tax to be
for the shares of Company B, using the relevant market
withheld on any sum paid to a non-resident for which tax
value as the basis for calculating the exchange ratio,
is chargeable under the ITA.44 India levies capital gains
the full value of consideration in the hands of Company
tax on gains arising from the transfer of shares located
B will be the market value of Company A’s shares
in India or deriving their value substantially from assets
(and not par value) as the market value was the
(tangible or intangible) located in India.45 Tax is required
consideration actually received.
to be withheld at the applicable rates for such transfers
to non-residents at the time of payment or credit of such
Further, the cost of acquisition includes the entire
income into the account of the non-resident seller.
amount paid for the asset regardless of whether such
It is also important to note that such withholding is
payment is made in installments over a period of time.
required to be made on the whole consideration amount
However, the Supreme Court in its landmark decision
and not just the gains arising from the transfer. Further,
in the case of CIT, Bangalore v B C Srinivasa Shetty46 laid
certain capital receipts that do not involve any element of
down the principle that cost of acquisition should be
profit or gain are also taxed. For example notional gains
capable of being ascertained in order for the machinery
from the purchase of shares by a company (other than
provided in Section 48 of the ITA to apply. If such cost is
a company held by the government or a listed company)
not ascertainable, no capital gains tax would arise.
for a value less than the fair market value of the shares,
44. Withholding requirements under Section 195 of the ITA are dis-
cussed in more detail in section II.
45. Tax on indirect transfers of Indian assets is discussed in more detail
in the section III. 46. 1981 AIR 972

Legal & Tax Issues
While the judgment was geared at providing clarity The ITA also provides additional deeming provisions
to tax payers, it resulted in a significant loss of revenue whereby the cost of acquisition may be deemed to be
for the Income Tax Department on transfers of certain an amount other than the actual cost. For example,
capital assets like goodwill, intellectual property Section 50C provides that in the event that the actual
rights, and securities issued to shareholders without consideration received for the sale of land or building
consideration. In order to address this situation, is less than the amount determined by government
the Government inserted Section 55(2)(a) and 55(2) authorities for stamp duty valuation (ready reckoner
(aa) w.e.f. April 1, 1995 which provides that the deemed value), then the amount determined by the government
acquisition cost of various financial and self-generated authorities is deemed to be the cost of acquisition.
assets (ie. bonus shares, rights issues, good will, etc.) Further, Section 50D provides that in the event that
for which acquisition cost cannot be determined the consideration received for a capital asset, other
is to be nil. Section 55(3) further states that where than land or building, is not ascertainable or cannot be
the cost for which the previous owner acquired the determined, then the cost of acquisition for the transfer
asset cannot be ascertained, the fair market value of the is deemed to be the fair market value of the asset on the
asset at the time of the previous owner’s acquisition date of transfer.
should be considered.
21
5. Taxation of Earn-out Arrangements
I. Introduction II. Issues in the Tax

It is increasingly common for M&A transactions
Treatment of Earn-outs
to include a deferred contingent payment to the sellers
The tax treatment of earn-outs requires in-depth analysis
as part of the consideration when the buyer and seller
using basic principles of income tax law. Various
cannot agree on the value of a target company.
fundamental questions need to be answered such as-
This type of payment, or “earn-out” is contingent
upon the happening of certain events or the achieving
§§Is the earn-out contingent upon the Promoter’s
of pre-set targets such as meeting a post-transaction
continued employment by the buyer or only the
earnings goal. Earn-out arrangements are particularly
achievement of business targets?
helpful when the target company is an early-stage
or high-growth company where value would be better §§In case of the former, is an earn-out only an
represented by future performance as against historic incentive compensation making it Salary Income for
performance. With the Government’s encouragement the purposes of Section 17 of the ITA?
of start-ups in India, and the steady rise in M&A
activity in the country, it is important to understand §§In case of the latter, is an earn-out an additional
purchase price, i.e. a part of the full consideration
the tax treatment of such earn-out arrangements.
making it a Capital Gain taxable in accordance with
Business and valuation models containing an earn- Section 45 of the ITA?
out arrangement are prevalent in international M&A
practice with investors seeking recourse to the same §§Considering that in case of an earn-out arrangement
the amount payable is unascertainable at the time of
in cases where promoter involvement is sought to be
transfer,
retained throughout the transition period or even to
when should it be taxed?
motivate the seller to keep customers and increase
productivity even after the acquisition. However, in India,
such arrangements are largely used in domestic deals
III. Earn-outs in
since an acquisition of shares by a foreign acquirer from
a resident seller for a deferred consideration requires prior Employment
approval from the RBI which in practice is not granted
very often. Although there are various methods of
Agreements
structuring such arrangements, this restriction has made
Earn-out arrangements are often contained
deferred consideration and earn-out covenants difficult
in employment agreements between the company
to negotiate and implement in cross-border M&A.
and the Promoter. The Authority for Advance Rulings
(“AAR”) in Anurag Jain, In re47, subsequently affirmed
by the Madras High Court48, was examining one such
arrangement and found that the contingent payments
contemplated in a business transfer agreement had
a real nexus with the employment agreement and were
in the nature of incentive remuneration for achieving
a prescribed target. The AAR found that such
47. In re Anurag Jain, 277 ITR 1 (Authority for Advance Rulings).

48. In re Anurag Jain, 308 ITR 302 (Madras High Court).

Legal & Tax Issues
contingent payments fell squarely under Section 17(3) Delhi High Court in Ajay Guliya v. Asst. Commissioner of
(ii) and could therefore be categorized as Salary Income. Income Tax. 50 The court, citing Ashokbhai Chimanbhai,51
found that a conjoint reading of Section 45 and Section
48 of the ITA indicates that the full value of consideration
IV. Earn-outs as Purchase received or accruing in any year as a result of transfer
Consideration of the capital asset shall be taxed in the year in which
transfer takes place irrespective of the year of accrual
or receipt. The court also took into account that there was
On the other hand, when an earn-out arrangement is
no material on the record suggesting that the title to the
not disguised as remuneration, it is to be considered
shares would revert to the seller if the entire consideration
as part of the full value of consideration receivable.
or part is not paid. Therefore, the true nature of the
The AAR in Moody’s Analytics Inc, USA, In re 49 found
transaction was determinable at the point of transfer
that since an earn-out consideration is a part of the sale
and the adoption of a deferred payment mechanism
consideration, it will form part of the capital gains
would not detract from the chargeability of the shares
and the rules of taxing capital gains would be applicable.
when sold. Consequently, the income would be accrued
At the same time, if consideration structured at the time of transfer of the shares, and the whole sale
as an earn-out is not determinable at the time of transfer, consideration would be subject to capital gains tax.
the fair market value of the shares on the date of
A contrary position has been adopted recently by the
transfer shall be considered the full value consideration
Bombay High Court in CIT v Hemal Raju Shete .52
for the purposes of the ITA.
In this case, deferred consideration was payable to
the Respondent-taxpayer over a period of four years
V. When will an Earn-out and the agreement was clear in providing that the
be Taxed? deferred consideration to be received in the four years

would be dependent upon the profits made by the
company concerned in each of the years. The Hon’ble
Besides issues arising out of ambiguity in the
High Court, relying on the Supreme Court decisions
characterization of such income, the taxation of earn-
in Morvi Industries 53 and ED Sasson & Co.54 found that
outs also sees challenges such as the year of taxability
the amount sought to be taxed was the maximum
of the income or even the quantification of the deferred
amount receivable by the Respondent-taxpayer and
payment and consequent revisions to the purchase
not an assured consideration to be received. Therefore
price. In other words, in case earn-out payments are
the amount sought to be taxed did not meet the test
not made in the future due to nderperformance of the
of accrual i.e. whether there is a right to receive the
company, the capital loss so generated creates no tax
amount though later and whether such right is legally
benefit for the seller since the capital gain is deemed
enforceable. The Court held that the whole amount
to accrue in the year of transfer of shareholding.
cannot be said to have accrued to the Respondent-
taxpayer as it was not certain if he would be entitled
The question whether the entire sale proceeds including
to the maximum amount and therefore could not be
the contingent consideration receivable in three
taxed in the assessment year of transfer.
succeeding years was to be considered for the purpose
of levy of capital gains was placed before the
50. Ashok Guliya v. Asst Comr of Income Tax, ITA 423/2012 (Delhi
High Court).
51. CIT v Ashokbhai Chimanbhai, 56 ITR 42 (Supreme Court of India).
52. CIT v Hemal Raju Shete, ITA 2438/2013 (Bombay High Court).
49. In re Moody’s Analytics Inc, USA, AAR/AAR No. 1186 -1187 -1188of 53. Morvi Industries Ltd. v. CIT, 82 ITR 835 (Supreme Court of India).
2011/2011 (31 July 2012, Authority for Advance Rulings). 54. ED Sassoon & Co v. CIT, 26 ITR 27 (Supreme Court of India).
23
VI. Conclusion consideration linked to the underperformance of the

business. The Union Budget 2016-2017, for the first time
since the 2012 Finance Bill provided the Government
As it currently stands, the Indian tax regime places
with an opportunity to create clarity with regards the
potential liability to pay tax for the entire consideration
taxation of such earn-out arrangements. However,
on the sellers. This often leads to a tax outflow for
no such provisioning is found in the Finance Act 2016.
the seller which is disproportionate to cash inflow.
Furthermore, the tax regime provides no mechanism
for recovery of tax paid in the event of reduced

Legal & Tax Issues
6. Carry Forward of Losses in case of M&A

Transactions
years from the date of amalgamation;
I. Introduction
§§ the amalgamating company should have been
The general rule is that the unabsorbed depreciation55 engaged in the business for at least
allowance of the previous owner of a business cannot 3 years during which the accumulated loss had
be carried forward and set off by the successor, occurred or the unabsorbed depreciation had
and a business loss can be carried forward and set off accumulated;
against the business profits of a subsequent year only
by the taxpayer who has incurred the loss. However, §§ the amalgamating company should have
continuously held on the date of amalgamation,
certain provisions of the ITA provide exceptions
at least 3/4ths of the book value of the fixed asset,
to this rule in case of certain M&A transactions
which it had held 2 years prior to the date of
or business reorganizations. This section shall examine
amalgamation; and
such provisions.
§§ any other conditions which may be prescribed

II. Mergers by the Central Government to ensure the revival
of the business of the amalgamating company
or to ensure that the amalgamation is for genuine
Section 72A of the ITA provides that in case of the
business purpose.
amalgamation of a company owning an “industrial
undertaking” with another company, the amalgamated
The Central Government has exercised the power
company will be allowed to carry forward and set-off
vested in it under Section 72A(2)(b)(iii) to prescribe the
the accumulated loss56 and unabsorbed depreciation
below two conditions under Rule 9C of the Income Tax
of the amalgamated company against its profits,
Rules, 1962 (“Rules”):
if the following conditions 57 are fulfilled:
§§The amalgamated company shall achieve the level
§§ the amalgamated company shall continuously hold of production of at least 50% of the installed capacity
at least 3/4ths in value of the assets of the amalgamat-
of the industrial undertaking of the amalgamating
ing company for a minimum period of 5 years from
company before the end of 4 years from the date of
the date of amalgamation;
amalgamation and shall continue to maintain this
minimum level of production till the end of 5 years
§§ the amalgamated company shall continue the busi-
from the date of amalgamation.58
ness of the amalgamating company for at least 5
It is open to the amalgamated company to make

55. “Unabsorbed depreciation” means so much of the allowance for an application to the Central Government for relaxation
depreciation of the amalgamating company or demerged company,
as the case may be, which remains to be allowed and which would
of the above conditions relating to the requisite level of
have been allowed to such company, as the case may be, under the production and/or the aforesaid period of 4 years having
provisions of the ITA, if the amalgamation or demerger had not
taken place. regard to the genuine efforts by the amalgamated com-
56. “Accumulated loss” means so much of the loss of the amalgamating pany to attain the prescribed level of production and the
company or the demerged company, as the case may be, under the
head “Profits and gains of business or profession” (not being a loss
attendant circumstances preventing the same.
sustained in a speculation business) which such company would
have been entitled to carry forward and set off under the provisions 58. In Bayer Material Science P. Ltd. v. ACIT (2013) 142 ITD 22 (Mum)
of Section 72 of the ITA if the amalgamation or demerger had not (Trib), it was held that it was not open to the AO to raise an objec-
taken place. tion as to the non-compliance of Rule 9C(a) before completion of
57. Prescribed under Section 72A(2) of the ITA. the fourth year from the date of amalgamation.
25
§§ the amalgamated company shall furnish to the Further, carrying forward and setting off of losses
Assessing Officer a certificate in the prescribed under Section 72A is fraught with practical difficulties
form, duly verified by an accountant, with such as obtaining the sanction of the competent
reference to the books of account and other court for the proposed scheme of amalgamation.
documents showing particulars of production, This can be a time consuming process, especially if the
along with the return of income for the amalgamated and amalgamating companies are in dif-
assessment year relevant to the previous year ferent states, in which case the application for grant of
during which the prescribed level of production approval will be required to be filed in the competent
is achieved and for subsequent assessment years court of both states. The above conditions pertaining
relevant to the previous years falling within to continuation of business and holding of assets post
5 years from the date of amalgamation. the amalgamation (including the conditions pre-
scribed by the Central Government under Rule 9C
If case of non-compliance of any of the above con-
of the Rules) also add to challenges faced by the amal-
ditions, any set-off of loss or allowance of deprecia-
gamated company which faces the risk of having to
tion availed by the amalgamated company in any
pay tax on the amount of loss or depreciation already
previous year would be treated as the income of the
set-off or allowed, in addition to the disallowance of
amalgamated company for the year in which the
the carry forward of the balance of the loss or deprecia-
non-compliance occurs.59 For these losses to be eli-
tion in case of any non-compliance.
gible for carry forward and set-off, the undertaking
must qualify as an “industrial undertaking” which has
been defined under Section 72A(7)(aa) as “any under- III. De-mergers
taking which is engaged in the manufacture or process-
ing of goods, manufacture of computer software, business Section 72A(4) of the ITA provides that in case of
of generation or distribution of electricity or any other a demerger, the accumulated losses and unabsorbed
form of power, business of providing telecommunication depreciation directly relatable to the undertaking
services, mining, and the construction of ships, aircraft that is being transferred under the demerger,
or rail systems”. Thus, any business or undertaking shall be allowed to be carried forward in the hands
which does not fall under this definition of “indus- of the resulting company.
trial undertaking”, such as an undertaking providing
If the loss or unabsorbed depreciation cannot be
services either in the information technology sector
directly attributed to the said undertaking, the same
or other service sectors, is not eligible for the carry
shall be apportioned between the demerged and
forward of losses.
resulting company in the same ratio in which the
Since, the definition of “accumulates losses” only assets of the undertaking have been retained by the
covers losses under the head “Profits and gains of demerging company and transferred to the resulting
business or profession” or business losses, the benefit company and shall be allowed to be carried forward
of carry forward and set off of any capital loss of the and set off in the hands of the demerged company
amalgamating company against the profits of the and the resulting company, as the case may be.
amalgamated company is not available under this
There is no requirement to comply with the condi-
section.
tions prescribed with regard to amalgamations to
avail of the benefit provided under Section 72A(4).
59. Section 72A(3) of the ITA.

Legal & Tax Issues
IV. Section 79 of the ITA The provisos to this section clarify that this section
is not applicable where:
In addition to the above, even if the above conditions

§§A change in the voting power takes place
are not complied with, Section 79 of the ITA provides
as a result of:
that accumulated business losses of a company
may still be carried forward to the next financial »» the death of a shareholder; or
year pursuant to a change in shareholding on the
fulfilment of the following conditions:
»» a gift of shares by a shareholder to a relative.
§§There is a change in the shareholding

§§ the company is a company in which public
of an Indian subsidiary of a foreign holding
are not substantially interested;60 and
company on account of the amalgamation
§§51% of voting shares held by the previous share- or demerger of the foreign holding company,
holder (prior to change in shareholding) are provided that 51% of the shareholders of the
continued to be held “beneficially” by the same amalgamating or demerged foreign company
shareholder. continue to be the shareholders of the
amalgamated or resulting foreign company.
The basic intent of the section is to suppress the
mischief of taxpayers acquiring control over Since the proviso is restricted to amalgamation
a company which has incurred losses only to and demerger, in case of a substantial change in the
reduce their tax liability.61 This application of this shareholding pattern of an Indian subsidiary due to
section is irrespective of the mode through which the sale of its shares by its foreign parent, the carry
the change in shareholding is effected. Hence, forward of losses may not be allowed under Sec-
in addition to amalgamations and demergers, tion 79, even if the shares are sold to another group
Section 79 also applies in case of a share sale. company.63 While structuring the reorganization of
Section 79 is of particular significance to foreign a foreign company which has an Indian subsidiary
investors looking to make Foreign Direct Invest- (including purely offshore transactions), it is impor-
ments (“FDI”) into start-ups which have been incor- tant to evaluate the applicability of this section,
porated as private limited companies, as a signifi- along with any indirect tax implications that may
cant distortion of the shareholding pattern of the arise from such a restructuring.
Indian company during various rounds of funding,
It is pertinent to note that no requirement as to the
results in inability to carry forward and set off the
minimum percentage of shareholding that these
losses incurred against future profits. This adds to
51% shareholders of the amalgamating company
the risk faced by the promoters and investors of
should hold in the amalgamated company, or the
start-ups, and a carve-out from Section 79 has often
time period for which such shareholders are required
been requested in order to promote FDI into India.62
to continue holding shares in the amalgamated
company has been specified.
There have been divergent judicial pronouncements

regarding the import of the words “beneficially held”
which are used in Section 79, and this ambiguity
60. Section 2(18) of the ITA defines the term “company in which assumes particular significance in the context of
the public are substantially interested”. Any company such
as closely held company, which has not been included under intra-group restructuring undertaken through
Section 2(18) should be a company in which the public are not
M&A transactions.
substantially interested.
61. CIT v. Italindia Cotton Co. P. Ltd. (174 ITR 160)
62. Untangle Tax Issues For E-commerce Sector, available at http://
businessworld.in/article/Untangle-Tax-Issues-For-E-commerce-
Sector/02-03-2016-91604/ 63. YUM Restaurants (India) Pvt. Ltd. v. ITO ITA No. 349/2015.
27
In CIT v. Amco Power Systems Ltd.,64 the Karna- However, the Delhi High Court in the case of YUM
taka High Court took the view that the language Restaurants (India) Pvt. Ltd. v. ITO 68 and the Mumbai
employed under Section 79(a) states that 51% of the Tribunal in the case of Just Lifestyle v. DCIT 69 have
voting power should be beneficially owned by the taken a contrary view on this issue. These judgments
same person (before and after change in sharehold- are based on the view that since a company is a sepa-
ing), and that the section does not require that 51% rate legal entity, the parent company and its share-
of shares should be held by the same person. It was holders should be viewed as distinct and separate
accepted that shareholding pattern is different from persons. The Mumbai Tribunal has also sought
the voting power of a company and a reduction to limit the scope of the judgment in Select Holiday,
in the shareholding had not led to a change on the basis that in Select Holiday the change
in the voting power.65 in shareholding was on account of a merger,
which is akin to the death of a shareholder.
In CIT v. Select Holiday Resorts 66, the Delhi High
Court examined the applicability of section 79
to a reverse merger situation and held that since the
shareholders of the parent company had always
beneficially held the shares of the taxpayer, a reverse
merger of the holding company into the taxpayer
does not result in any prohibition on the carry
forward and setting off of loss against the future
profits of the amalgamated company.67
64. CIT v. Amco Power Systems Ltd. [2015] 62 taxmann.com 350

(Karnataka)
65. On the basis that the board of the subsidiary was controlled and
managed by its 100% parent, even after a change in sharehold-
ing, the Karnataka High Court held Section 79 to be applicable.
66. CIT v. Select Holiday Resorts [2013] 35 taxmann.com 368 (Delhi)
67. In this case, 98% of the taxpayer’s shares were held by a holding
company, which was further held by 4 family members. Conse-
quent to the merger of the holding company into taxpayer, the
resulting company was wholly held by the 4 family members.
The 4 family members exercised control and management over 68. Supra note 8. The transfer of shares of the taxpayer by one
the taxpayer before the merger, and on the resulting company intermediate holding company to another intermediate holding
post the merger. The Delhi High Court held that since the share- company which was also held by the same global holding com-
holders beneficially entitled to 98% of the shares of the taxpayer pany was held to disallow the carry forward and set off of losses
continued to be the same, there should be no prohibition on the of the taxpayer.
carry forward and setting off of loss. 69. Just Lifestyle v. DCIT ITA No.2638/Mum/2012

Legal & Tax Issues
7. Mergers and Acquisitions - ESOP / Employee

taxation
marginal rate of 30% (excluding surcharge and
I. Introduction cess). Such taxes are required to be withheld by the
employer. If there are any non-monetary incentives
M&A’s often involve transfer of employees.
/ perquisites, taxes with respect to such incentives
When employees are transferred, there are several
/ perquisites are also required to be withheld they
considerations involved: (a) whether the transfer of
could be withheld from the monetary payments
employees is to be effected as part of the acquisition
(if sufficient) or the employee could be asked to pay
or whether it should be by way of resignation and
the equivalent amount to the employer. Alterna-
re-hire; (b) whether the stock / similar incentives
tively, at the option of the employer, they could be
granted to the employees are proposed to be
borne by the employer wholly / partially.
continued and if not, how are the employees
proposed to be compensation for termination of such Having said that, taxation of perquisites like
incentives; (c) how to incentive employees to continue employee stock option plan (“ESOPs”) are not trig-
their employment post acquisition; (d) what are the gered till they are contingent in nature. ESOPs
withholding tax obligations of the transferor and are an option given to employees to purchase the
transferee entities; etc. These aspects need to analyzed stock of the employer / parent company of the
on a case-to-case basis in light of commercial, strategic, employer for nil consideration or for a considera-
legal, regulatory and tax implications involved. This tion which is significantly less than the fair mar-
article focusses on some of the key implications ket value of such stock. The ability to exercise such
from a tax perspective, particularly, withholding tax option is subject to satisfaction of conditions pre-
obligations of the transferor and transferee entity. scribed by the entity issuing ESOPs. Generally, one
of the conditions include continuation in employ-
Tax implications could differ depending on the
ment for a certain number of years, which is called
manner in which M&A is structured. In case of M&A
the vesting period. When the option is exercised
by way of merger, demerger, slump sale, asset sale,
(after completion of the vesting period), the issue
etc., employees are transferred from one corporate
of stock is subject to tax (as salary income) on the
entity to another. In case of transfer of shares, there
difference between the fair market value of the
is no change in the corporate entity by whom the
stock and the exercise price (if any) payable by
employees are engaged. However, there is change
the employee at the time of exercise of ESOPs.
in control / management governing the corporate
The employer is required to withhold the tax so
entity involved.
payable. Therefore, liquidity may become a matter
of concern as salary and other monetary incentives
II. Taxation of Employees relating to the employee (which are generally pay-
able on a month-on-month basis) may not be suffi-
cient for withholding taxes.
Before delving into taxation in case of M&A,
we outline below basic principles relating
It may be noted that non-fulfilment of withholding
to taxation of employees.
tax obligations by the employer could lead to
liability for the withholding tax amount, interest
Normally, employment income, including salary
at 12% per annum and penalty up to 100% of
and perquisites (both monetary and non-monetary)
the tax amount.
of resident employees are subject to tax in the hands
of the employee as salary income at the maximum
29
III. M&A Involving However, in the context of M&A, termination /

forfeiture of ESOPs granted by the transferor entity
Transfer of Employees without a cash payout / in lieu of receiving ESOPs
from One Corporate of the transferee entity should not be taxable as

capital gains for the following reasons: (a) stock
Entity to Another options merely confer contingent rights and
therefore, there should be no ‘capital asset’ being
In such cases, taxation of the employee and transferred; (b) the monetary value of stock options
withholding tax obligations of the employer would are not determinable and therefore, as per the
depend on how various employee incentives, ruling of the Supreme Court in the landmark case
including ESOPs are proposed to be transitioned of B.C. Srinivasa Setty 70, capital gains should not
and / or changed. be levied when the computation mechanism fails;
(c) relinquishment and extinguishment apply only
In case of employee incentives not connected
to circumstances where the rights of the person
with stock or in case of cash incentives which are
holding the ‘capital asset’ come to an end without
connected with stock merely for quantification
extinguishment of the ‘capital asset’ itself.
purposes (for example, stock appreciation rights,
where employees may be paid a certain multiple However, if the termination / forfeiture of ESOPs
of the appreciation in stock value on monthly / granted by the transferor entity is made for cash pay-
quarterly / yearly basis), they may be modified / out, such payout will be taxable as salary income in the
terminated as part of the terms of the M&A. hands of the employee and consequently, subject to
Such modification / termination may / may not withholding tax in the hands of the transferor entity.
involve payment to employees in lieu of the
modification / termination. If any payments
are involved, the transferor or transferee entity,
V. Grant of ESOP in
whichever is responsible for making such payments Transferee Entity
would have to withhold tax from such payments.
There should be no tax liability at the time of grant

In case of ESOPs, depending on the terms of the
of ESOPs as stock options merely confer contingent
M&A agreed between the transferor and the
rights. It is only upon the exercise of stock options
transferee entities, ESOPs granted to employees by
by the employees (after the completion of the vesting
the transferor entity may either be terminated with
period) that tax liability should arise in India.
or without a cash payout / ESOPs may be granted by
At the time of such exercise, the transferee entity
the transferee entity on similar / different terms and
shall be required to withhold applicable tax.
with / without recognition for the period of service
rendered as an employee of the transferor entity.
VI. Transition Payments

IV. Extinguishment of
If any payments are due and payable to employees
ESOPs in Transferor by the transferor entity, but are paid by the transferee
Entity entity post acquisition, the payment should normally

not be liable to TDS in the hands of the transferee
entity, particularly if: (i) there are no agreements
Gains arising from the transfer of a ‘capital asset’ are
between the transferor entity, the transferee entity
taxable as capital gains. ‘Transfer’ of capital assets
and the employees or other evidence reflecting
includes exchange or relinquishment of the capital
assets and extinguishment of rights therein.
70. (1981) 128 ITR 294 (SC)

Legal & Tax Issues
an understanding that the transferee entity is making

VIII. Conclusion
such payment to the employees on behalf of the
transferor entity; and (ii) the transferee entity makes
In light of potential consequences of non-fulfilment
such payment without being under an obligation
of withholding tax obligations, it becomes important
contractually/ otherwise to do so. As held by the High
to carefully evaluate all monetary and non-monetary
Court of Andhra Pradesh in the case of V.R. Ganti 71,
incentives of employees both before and after the
“[t]he answer to such questions would depend upon
acquisition, along with modifications pursuant to
whether the amount was paid by the employer or the
the acquisition. Further, acquisition documentation
former employer to the employee qua employee for
should be robust, with possible non-compliance
something done as employee or in his capacity other
by the transferor / transferee factored in, along with
than that of an employee”. However, if there is some
indemnities / other clauses to address potential
contractual/ other obligation on account of which
future risks.
such payment is made by the transferee entity on
behalf of the transferor entity, the payment would be
liable to TDS in the hands of the transferee entity
at the time of payment.
VII. M&A not Involving

Transfer of Employees
from One Corporate
Entity to Another
Acquisition by way of transfer of shares do not
involve any change in the corporate entity which
engages employees. However, there is change
in control / management governing the corporate
entity involved. In these cases, there are generally
no extinction / change in employee incentives,
including ESOPs. However, if ESOPs are granted by
the parent entity and if the share transfer involves
change in the parent entity of the target company,
the considerations outlined above in case of transfers
of employees from one corporate entity to another
would become relevant vis-à-vis such ESOPs.
71. [1995] 82 Taxman 37 (AP)
31
8. Drafting Tax Representations and Taxation

of Indemnity Payments
I. Introduction II. Tax & Business

Is the key to any document just getting all that the cli-
Representations
ent wants? It’s not. While having all the commercials
As discussed above, in offshore M&A deals where
that have been agreed to between the parties in place
the underlying asset which is the subject matter of
is important, it is equally important that the client’s
the sale is Indian shares, tax representations become
rights and obligations are safeguarded. Foreseeing
crucial. Only on the basis of these representations
the future and analyzing various permutations and
will the buyer be able to ascertain whether it should
combinations that could arise in the future and then
withhold any taxes while paying the consideration
providing sufficient protection to the clients in such
to the seller.
situations is not only important but also necessary.
Usually, in offshore M&A deals, the seller will take

In case of an international M&A transaction,
benefit of the DTAA such that there is no withhold-
tax representations and indemnity payments are of
ing requirement and the buyer can make payment of
key importance. Let’s take the example of a share sale
the consideration amount in full to the seller. In such
of an Indian company which is taking place between
a situation, some representations that become abso-
two non-residents. This means that shares of an Indian
lutely non-negotiable are:
company held by a non-resident are being sold to
another non-resident. In such a case, from an Indian
Residency: The seller should represent that
tax perspective, there is a capital gains tax implication
it is a taxable person under laws of the foreign coun-
for the non-resident seller in India. However, if the
try in which it is a resident and is eligible to claim
seller is resident in a favorable tax treaty jurisdiction
benefits of the relevant DTAA. It is not a resident of
with India, it should be possible for it to avail the ben-
India and will not become a resident of India in the
efit of the tax treaty with India and end up paying no
year the sale of shares takes place, it does not have
taxes at all on the share sale. Thus, there should be no
a permanent establishment in India, its place of effec-
withholding tax obligation on the buyer by virtue of
tive management is not in India and it does not have
no tax being payable on the transaction. However,
a business connection in India as defined under the
on what basis can the buyer decide to not withhold
ITA. If the seller is a resident of India or has
any taxes from the payment consideration for the
a permanent establishment in India, the benefit of
share purchase. This is where tax representations
the DTAA may not be available to the seller and
become important – it is based on those representa-
hence there should be a requirement to withhold
tions that the buyer decides not to withhold any taxes.
taxes by the buyer while paying the consideration
However, this does not preclude the tax department
to the seller. Hence, all the above representations are
in India to issue notices to the buyer for not withhold-
a must-have for the buyer to not withhold any taxes
ing taxes. In such a case, a tax indemnity becomes
from the consideration amount.
important as the payment that the buyer may be
required to make to the Indian tax department should Tax Residency Certificate: The seller should repre-
be indemnified by the seller as the seller is the one sent that it is holding a valid Tax Residency Certifi-
who has the final liability to pay tax in India. cate (“TRC”) and shall continue to hold a valid TRC
at the time of the sale of the shares. Having a TRC
is mandatory requirement for availing benefit of the

Legal & Tax Issues
treaty, without which treaty benefits may be denied. will all laws in India should also be taken from the
Practically, this factor becomes very important from seller. Further, the seller should also provide for rep-
a timeline perspective, as authorities in respective resentation in respect of organization and authority
countries may take a certain period of time (which such as it is duly organized and validly existing
could be anywhere between a few days to a few in the jurisdiction of incorporation, the seller was
months) to issue a TRC. The TRC should contain a non-resident at the time of acquisition of the shares
all the information that has been prescribed under which are being sold.
the Income Tax Rules, 1962 (“ITA Rules”).72 To the
extent certain details are not present in the TRC,
the seller should then issue a Form 10F specifying
III. Tax Indemnity
those details to the buyer.
Typically, indemnities are provided for a breach of
Board meetings and Board of Directors: The seller any of the representations and warranties that the
should provide representations stating that it is parties make in the agreement. The affected party
controlled and managed by its board of directors, (commonly referred to as the “Indemnified Party”)
all meetings of the board of directors of the seller are in such a case claims indemnity for losses that it had
held and chaired outside of India. Further, the key to incur due to such a breach which then becomes
management decisions that are necessary for conduct payable by the other party (commonly referred to
of business of the seller are taken by its Board of as the “Indemnifying Party”). The process for
Directors. This representation is an extension of the claiming indemnity is laid out under the indemnity
residency representation. This is because if the board provisions in the document which need to be
of the company is taking decisions sitting in India, followed. However, when it comes to tax indemnities,
it could result in the seller company being resident one needs to go one step further. This is because of the
in India and hence treaty benefits may not be risk of a demand being raised by the tax authorities
applicable. Consequently, the buyer should be for not withholding taxes from the consideration
withholding taxes from the payment consideration. amount that was paid to the seller. In such situations,
it is important that the buyer is well protected as it
Tax proceedings: The seller should represent that
was because of the representations that were made by
all taxes payable by it in India have been discharged
the seller that the buyer did not withhold any taxes.
and no proceedings are pending against it in India.
Accordingly, in such circumstances, it is the buyer
who will receive the demand notice from the tax
Tax Returns: All non-residents claiming treaty relief
authorities for non-payment of taxes.
should file tax returns in India and the seller should
provide a representation to that extent.
While the buyer will always want to get the most
from the indemnity provisions, it is important from
Capital asset: the seller should represent that the
the seller’s side that the liability is limited to the
shares are held by it as a capital asset and not as
extent necessary. While we all agree that if taxes
stock-in-trade. If they are capital asset, the gains
are payable, it is the liability of the seller but that does
should be considered to be capital gains where as
not mean that the seller provides for an unlimited lia-
in case they are held as stock, it should be business
bility to the buyer in the indemnity provisions.
income for the seller and accordingly subject to dif-
What needs to be understood is that the tax is appli-
ferent tax consequences.
cable only on the capital gains amount and not on
Certain other representations such as title to the the consideration amount that is paid. Therefore,
shares, shares are free from all encumbrances, the seller should limit its indemnity payment to
the shares were acquired by the seller in compliance such amount. However, for assessment proceedings
to begin in India, it can take up to 2 years after the
return of income is filed and if at that time
72. Rule 21AB of the ITA Rules
33
a demand is raised, there may be interest and penalty From a buyer’s perspective, in case a demand notice
also that may be applied on the tax demand by the is received and assessment proceedings are initiated,
income tax authorities. While there cannot be the indemnity provisions should provide that the
an absolute estimation of this this, what can be taken indemnity will continue to remain in force till such
into account is total tax payable plus interest at the time that a final non-appealable order has been
rate of 12% per annum along with penalties which received or indemnity amount has been paid by the
can be capped at 100% of the tax amount. Another seller, and the seven year limitation should not apply.
way of limiting the liability is providing for liability However, from a seller’s perspective, it is important
up to the amount of consideration paid. This limit that a carve out is made in the clause stating that in
would subsume the interest and penalty amount also. the event of a favorable decision being obtained and
no appeal has been filed in respect of such decision
The next important aspect to be considered is
or a non-appealable order has been received the
the time limit for which the indemnity provisions
indemnity provisions will automatically fall away.
will remain applicable. While there is no timeline
prescribed under law for withholding obligations, The next point for consideration is how the
indemnity provisions are usually negotiated to indemnity payment should be treated in the books
remain in force for a period of 7 years from the date of the buyer once the seller pays such amount.
on which the transaction takes place. The 7 year While there is limited jurisprudence on this point,
period is provided for keeping in mind that the recently, the Authority for Advance Rulings in the
revenue department in Indian has the power under case of In Re: Aberdeen Claims Administration Inc.
the ITA to re-open assessment proceedings up to held that payments received out of a contractual
a maximum period of 6 years [from the year in settlement should be considered to be capital
which assessment is made]. The additional one receipts and should not be taxable in the hands of
year is because the return of income in which the the receiver. Applying the same principle, in case of
transaction will be disclosed is the next financial year an indemnity payment under a contract,
after the transaction has taken place i.e. for there should be no tax in the hands of the receiver
a transaction that takes place in December 2015, of such payment considering that the indemnity
the return of income will be filed in the next financial amounts should not be regarded as payments in lieu
year i.e. 2016-17. Therefore the additional one year of loss of business or revenue.
is added to the 6 year period.

Legal & Tax Issues
9. Mergers and Acquisitions – Non-compete

and Depreciation – Tax Issues
I. Introduction II. Taxation of Non-

In M&A transactions, it is frequently seen that
compete Receipts
parties enter into non-compete agreements or insert
The ITA provides that sums received, or receivable,
non-compete clauses in transaction documentation
under an agreement for not carrying out any activity
whereby non-compete rights are transferred. A non-
in relation to any business 73; or for not sharing any
compete right encompasses a right under which one
know-how, patent, copyright, trade-mark, licence,
person is prohibited from competing in business
franchise or any other business or commercial right
with another person for a stipulated period. It would
of a similar nature or information or technique likely
be the right of the latter person to carry on a business
to assist in the manufacture or processing of goods
in competition but for such agreement of non-
or provision of services shall be income chargeable
compete. Therefore the right acquired under
to income tax under the head “Profits and gains
a non-compete agreement is a right for which
of business or profession”. The ITA provides for
a valuable consideration is paid. Generally, non-
exceptions for receipts on account of transfer of the
compete fee is paid for a definite period. The idea
right to manufacture, produce or process any article
is to see to it that the business of the acquirer of
or thing or right to carry on business chargeable
the non-compete right is put on a firm footing, by
under the head of “Capital gains” as well as for sums
avoiding competition, thus enabling such business
received as compensation from the multilateral fund
to sustain later on.
of the Montreal Protocol on Substances that Deplete
In order to determine the taxability of transactions the Ozone Layer. However, save for these limited
involving non-compete provisions, there are several exceptions, receipts under non-compete agreements
considerations involved: (a) what would be the tax / clauses, including under most M&A transaction
treatment in the hands of the person receiving a sum, documents, would be chargeable to income tax
in cash or in kind, to refrain from competing in busi- under the head of “Profits and gains of business
ness (b) what would be the treatment of expenditure or profession”.74
incurred in the acquisition of a non-compete right;
The relevant portions of Section 28(va) are repro-
(c) what would be the tax implications in case the
duced hereinbelow:
expenditure incurred on a non-compete right is char-
acterized as revenue expenditure; (d) what would be
the implications in case the expenditure incurred
on a non-compete right is characterized as capital “28. The following income shall be chargeable to
expenditure; etc. These aspects need to analyzed income-tax under the head “Profits and gains of busi-
on a case-to-case basis in light of commercial, strate- ness or profession”,—
gic, legal, regulatory and tax implications involved. …..
This article focuses on some of the key implications (va) any sum, whether received or receivable, in cash or
from a tax perspective. kind, under an agreement for—
73. The Finance Bill, 2016, as passed by the Lok Sabha seeks to
expand the scope by including any agreement for not carrying
out any activity in relation to profession as well.
74. Section 28(va) of the ITA.
35
a. not carrying out any activity in relation to any ture made on revenue account. 75
business; or
Conversely, courts have commonly held non-com-
b. not sharing any know-how, patent, copyright, pete expenditure as having been made on capital
trade-mark, licence, franchise or any other business account when the advantage that accrues is akin
or commercial right of similar nature or informa- to that provided by a capital asset. For example,
tion or technique likely to assist in the manufacture a non-compete arrangement for a substantial period
or processing of goods or provision for services: of time, especially with a person who could other-
……” wise have provided substantial competition to the
acquirer of the non-compete right, has been held
to be capital expenditure.76
III. Taxation of Non- Therefore, the determination of whether

compete Expenditure a particular non-compete expenditure is to be treated
as revenue or capital is a fact-specific determination
dependent on the commercials of the transaction,
The more contentious issues regarding non-compete
with particular focus on the advantage that accrues
fees revolve around their treatment when a person
pursuant to the non-compete right.
incurs expenditure in acquiring non-compete
rights. The first stage of analysis would involve
ascertainment as to whether such expenditure B. Non-compete Expenditure as
is to be regarded as expenditure on the capital Revenue Expenditure
account or expenditure on the revenue account.
In case expenditure incurred on the acquisition of
A. Non-compete Expenditure – a non-compete right is characterized as revenue

expenditure, then as per Section 37 of the ITA,
Revenue or Capital? such expenditure which is wholly and exclusively
used for the purposes of the business or profession
There is no single criterion or test to determine
shall be allowed in computing the income chargea-
whether a particular expenditure is to be
ble under the head of “Profits and gains of business
characterized as having been made on the revenue
or profession”. Therefore, the taxable income will be
account or the capital account. Such a determination
reduced by the amount of such expenditure.
would be dependent on the nature of the transaction,
looking at the aim and object of expenditure and the
commercial necessities of making such expenditure. C. Non-compete Expenditure as
If the advantage accruing pursuant to the expend-
Capital Expenditure
iture consists merely in enabling the management
In case expenditure incurred on the acquisition of
and conduct of the business, while leaving the fixed
a non-compete right is characterized as capital
capital untouched, it would be taken to having been
expenditure, the main question that arises is whether
made on the revenue account. For example, in the
such non-compete right can be regarded as a capital
context of an amalgamation, non-compete fees paid
asset on which depreciation can be claimed under
to a high ranking official of the amalgamating com-
Section 32 of the ITA. The relevant portions of Sec-
panies, who had full knowledge of the entire opera-
tion 32 are reproduced hereinbelow:
tions, has been held to be a commercial decision in
respect of performing of the business of the amalga-
75. Carborandum Universal Ltd. vs. Jt. CIT, Tax Case (Appeal) No.
mated company, and therefore held to be expendi- 244 of 2006, 1997-1998, decided on 10.09.2012 (High Court of
Madras).
76. Sharp Business System vs. The Commissioner of Income Tax –
III, [2012] 211 TAXMAN 576 (Delhi) (High Court of Delhi).

Legal & Tax Issues
The most controversial aspect with regard to

non-compete right which has been characterized
“32. (1) In respect of depreciation of—
as a capital asset is whether it can be regarded
as a business or commercial right of a similar nature
i. buildings, machinery, plant or furniture, being tan-
as know-how, patents, copyrights etc. such that
gible assets;
it is eligible for depreciation in terms of Section 32
ii. know-how, patents, copyrights, trade marks, licences, of the ITA.
franchises or any other business or commercial
In the case of Sharp Business System vs. The Com-
rights of similar nature, being intangible assets
missioner of Income Tax-III 77, the Delhi High Court,
acquired on or after the 1st day of April, 1998,
while looking at a standalone non-compete arrange-
owned, wholly or partly, by the assessee and used for ment held that a non-compete right cannot be said to
the purposes of the business or profession, the follow- be of the same nature as know-how, patent,
ing deductions shall be allowed…. copyright etc. and hence, no depreciation under Sec-
tion 32 can be claimed on the amount incurred in
…..
acquisition of such a right.
iii. in the case of any block of assets, such percentage on

In contrast, in the case of Pentasoft Technologies Ltd. vs.
the written down value thereof as may be prescribed
The Deputy Commissioner of Income Tax78,
the Madras High Court, while considering
…..
a composite agreement for the transfer of software
Provided also that the aggregate deduction, in respect and training divisions of a business to the assesse,
of depreciation of buildings, machinery, plant or furni- including copyrights, trademarks, and non-compete
ture, being tangible assets or know-how, patents, cop- rights, observed that the non-compete clause in the
yrights, trademarks, licences, franchises or any other agreement must be read as a supporting clause to
business or commercial rights of similar nature, being the transfer of copy rights and patents. Therefore,
intangible assets allowable to the predecessor and the the Court herein, while taking the non-compete
successor in the case of succession referred to in clause right to be a commercial right similar in nature to
(xiii), clause (xiiib) and clause (xiv) of section 47 or patents, copyrights etc., held that such non-compete
section 170 or to the amalgamating company and the right is eligible for depreciation in terms of Section
amalgamated company in the case of amalgamation, 32(1)(ii) of the ITA.
or to the demerged company and the resulting com-
Thereafter, in the case of Commissioner of Income Tax,
pany in the case of demerger, as the case may be,
Bangalore vs. Ingersoll Rand International Ind. Ltd.79 ,
shall not exceed in any previous year the deduction cal-
the Karnataka High Court, while contemplating
culated at the prescribed rates as if the succession
a business transfer agreement keeping in mind the
or the amalgamation or the demerger, as the case may
decisions in Sharp and Pentasoft cited hereinabove,
be, had not taken place, and such deduction shall be
took forward the logic employed by the Madras High
apportioned between the predecessor and the successor,
Court in Pentasoft, held a non-compete right to be
or the amalgamating company and the amalgamated
eligible for depreciation in terms of Section 32(1)(ii)
company, or the demerged company and the resulting
of the ITA by virtue of it being a commercial right
company, as the case may be, in the ratio of the number
similar in nature to patents, copyrights etc.
of days for which the assets were used by them.”
However, while the Madras High Court in Pentasoft
made the determination of the non-compete right
Currently, for the intangible assets, the rate of depre-
ciation prescribed under the Income Tax Rules, 1962 77. [2012] 211 TAXMAN 576 (Delhi).
is 25% on the written down value of the assets. 78. [2014] 222 TAXMAN 209 (Mad).
79. [2014] 48 taxmann.com 349 (Karnataka).
37
as an intangible asset of a similar nature as know-

IV. Conclusion
how, patents etc. dependent on it being a part of
a composite agreement involving the transfer of
The taxation of receipts in pursuance of non-com-
such intangible assets as well, the Karnataka High
pete agreements / clauses is covered under Section
Court here has not made that distinction. Follow-
28(va) of the ITA save for certain exceptions men-
ing the logic of the Karnataka High Court, it would
tioned therein.
appear that a non-compete right, once determined
to be a capital asset, would be eligible for deprecia- However, the situation is not as clear with respect
tion in terms of Section 32(1)(ii) of the ITA even if to expenditure incurred on the acquisition of
it were to be transferred as a standalone right. a non-compete right. The first step to be taken
is ascertain whether such expenditure needs to be
In the case of most M&A transactions, non-compete
characterized as revenue expenditure or capital
rights would form part of a gamut of rights being
expenditure. If treated as revenue expenditure,
transferred, which would typically involve intangi-
then such expenditure is allowable in the computa-
ble assets such as know-how, patents etc. Therefore,
tion of total income under the ITA. If treated
employing the reasoning applied by the Madras
as capital expenditure, there remains a grey area
High Court in Pentasoft and the Karnataka High
as to whether non-compete rights can be treated
Court in Ingersoll Rand, it seems reasonable that such
as capital assets eligible for depreciation (thereby
non-compete rights as acquired under the M&A
reducing the taxable income) or as capital assets not
transaction documents, should be treated as capital
eligible for depreciation. As elucidated above,
assets eligible for depreciation in terms of Section 32
there is a variance of opinion on this issue among
of the ITA (assuming other requirements under the
the different High Courts in India.
ITA are met).
In order for non-compete rights to be treated
However, as elucidated hereinabove, there is
as capital assets eligible for depreciation, it would be
a dichotomy in the approach of different High
preferable to structure M&A transaction documents
Courts to the treatment of non-compete rights with
in a manner such that the non-compete rights
respect to eligibility for depreciation in terms of
are transferred as part of a composite agreement
Section 32 of the ITA, with the Madras High Court
wherein other assets, especially intangible assets such
position in Pentasoft being towards the middle end
as know-how, patents etc. are also transferred.
of the spectrum, the ends of which are occupied by
Such structuring would strengthen the case for the
the positions taken by the Delhi High Court in Sharp
non-compete right to be treated as a capital asset
and by the Karnataka High Court in Ingersoll Rand.80
eligible to depreciation in terms of Section 32
of the ITA.
80. Further, another point to be noted is that Section 28(va)(a) spe-

cifically provides for non-compete receipts and Section 28(va)
(b) specifically provides for receipts on account of non-sharing
of intangible assets such as know-how, patents etc. However,
such wording as found in Section 28(va)(a) is not to be found
in Section 32(1)(ii), although it contains wording similar to
Section 28(va)(b) with respect to intangible assets. However, the
Madras and Karnataka High Courts have read in the concept of
non-compete rights as intangible assets of a similar nature such
as know-how, patents etc. in the cases cited hereinabove.

Legal & Tax Issues
10. Anti-Abuse Rules to be Considered in an

M&A Transaction
transfer of assets during the pendency of income
I. Introduction tax assessment proceedings shall be void as against
any claim on such assets in respect of any income
Several specific and general anti-abuse rules have
tax / interest / penalties payable by the transferor.
been proposed and / or enacted by India to check tax
Therefore, if any tax litigations are pending against
avoidance in domestic as well as cross-border trans-
the business or any portion thereof, the requirement
actions. The effect of these measures may vary from
to obtain a no-objection certificate (“NoC”) from the
re-characterization of income earned in a transaction
income tax authorities may need to be evaluated by
to having the transaction rendered void against
the parties to the transaction keeping in mind the
a claim by the income tax authorities. Therefore,
timelines involved and the consequences of Section
the following key anti-abuse rules may need to be
281 of the ITA being invoked against the transaction.
borne in mind by companies looking to engage
in M&A transactions in India. Mergers, on the other hand, are currently court-
driven procedures in India. At present, companies
are required to approach the jurisdictional High
II. Successor Liability Courts in order to seek approval for a merger. Consid-
Concerns ering that such High Courts seek the approval of the
income tax authorities and other regulatory authori-
ties before approving the merger, a specific NoC need
As a general rule, where a business is succeeded by
not be sought by the parties to the transaction in the
any other entity (whether by slump sale or itemized
case of a merger. However, being a court-driven pro-
sale), which subsequently continues to carry on that
cess, it may take anywhere between 6 months
business, the predecessor is assessed for the income
to a year to obtain approval from the jurisdictional
of financial years prior to the date of succession
High Courts in respect of a merger.
and the successor is assessed on the income of the
financial years after the date of succession. In the
It is to be noted that with the notification of such
case of a “slump sale” or the transfer of a business
provisions under the Companies Act, 2013 that
undertaking (comprising such combination of
relate to the National Company Law Tribunal
assets and liabilities that is capable of being run
(“NCLT”) merger petitions (including for cross
independently for a foreseeable future), the successor
border mergers) will need to be filed before the NCLT
may also be liable for the historical indirect tax
rather than the jurisdictional High Courts. However,
liabilities (customs, excise and service tax) in respect
the requirement to notify the income tax authorities
of the financial year in which the succession took
of the merger shall remain even under the proposed
place up to the date of such succession as well as the
new rules governing mergers in India.
financial year immediately preceding that year in the
event that the predecessor cannot be found or where
the predecessor has been assessed but the tax cannot III. Domestic Transfer
be recovered from him.
Pricing Rules
As a measure to check the possibility of assets
and / or liabilities of a business being transferred by Where a private company (or public unlisted com-
a taxpayer with the intention to defraud the revenue pany or other such company which is not defined
authorities, Section 281 of the ITA states that any as a “company in which the public are substantially
39
interested”) receives shares of a private company Further, even the erstwhile Article 13 of the
(or public unlisted company or other such company India-Singapore DTAA which afforded capital
which is not defined as a “company in which gains benefits to Indian investments until the
the public are substantially interested”): renegotiation of the India-Mauritius DTAA81
denied such benefits to Singapore resident
i. Without consideration, where the aggregate fair
companies which did not meet the prescribed
market value of the shares exceeds INR 50,000
threshold of total annual expenditure on operations.
(USD 748.5); or
While the India-Mauritius DTAA has recently been
ii. For a consideration that is less than the aggregate
renegotiated to remove the capital gains benefit
fair market value of the shares by INR 50,000
available under the erstwhile Article 13 of the DTAA
(USD 748.5);
with effect from financial year 2017-18, the benefit
of a 50% reduction in the domestic tax rate applica-
The difference between the fair market value of the
ble to capital gains from transfer of shares is availa-
shares and the consideration paid by the private
ble during a two year transition period from April
company or public unlisted company for the receipt
01, 2017 to March 31, 2019. However, this benefit is
of the shares shall be taxed as ‘other income’,
available only to such Mauritius residents which are
at the rate of 30% (exclusive of surcharge and cess)
(a) not shell/conduit companies and (b) satisfy the
in the case of domestic companies; and at the rate of
main purpose and bona fide business test.
40%(exclusive of surcharge and cess) in the case of
non-resident companies.
A Mauritius resident may be deemed to be
a shell/conduit company if its total expenditure on
Likewise, where a private company (or public
operations in Mauritius is less than INR 2,700,000
unlisted company or other such company which is
(approximately USD 40,000) in the 12 months
not defined as a “company in which the public are
immediately preceding the alienation of shares.
substantially interested”) receives from an Indian
resident any consideration for issue for shares that
exceeds the face value of such shares, the difference
V. The General Anti-Avoid-
between the consideration received by the private
company and the fair market value of the shares ance Rule
shall be taxed as ‘other income’ except in certain
The General Anti-Avoidance Rule (“GAAR”),
specified circumstances.
contained in Chapter X-A of the ITA authorizes the
income tax authorities to tax ‘impermissible avoid-
IV. Anti-Abuse Rules ance arrangements’ i.e., arrangements where the
under DTAAs main purpose is to obtain a tax benefit; and which:
a. create rights or obligations which are not ordi-

Where parties to a transaction are relying on benefits narily created between persons dealing at arm’s
under a DTAA that India may have signed with length,
another jurisdiction, such parties should consider
b. result directly or indirectly in the misuse
whether benefits under the DTAA may be denied on
or abuse of the provisions of the ITA,
the ground of substance requirements. For instance,
the limitation on benefits (“LoB”) clause under
c. lack commercial substance or are deemed to
the India-Luxembourg DTAA permits the benefits
lack commercial substance, in whole or in part,
under the DTAA to be overridden by domestic-anti-
or
avoidance rules.
81. Benefits under the India-Singapore DTAA were coterminous

with those under the India-Mauritius DTAA.

Legal & Tax Issues
d. are entered into or carried out by means or in GAAR, it would be advisable that the commercial
a manner that is not ordinarily employed for rationale behind each step in the corporate arrange-
bona fide purposes. ment should also be adequately documented.
While applying GAAR, tax authorities may disre- Some examples illustrating the applicability of the
gard entities in a structure, deny benefits available GAAR to various corporate situations have been
under the DTAA, reallocate income and expenditure outlined below.
between parties to the arrangement, alter the tax
Illustrations:
residence of such entities and the legal situs of assets
involved, treat debt as equity and vice versa.
Illustration 1
Under the Indian Income Tax Rules (“ITR”) special

Facts: A Foreign Investor which is in the activity
exemptions from the GAAR is available in certain
of investing in various markets has a Holding Com-
circumstances including:
pany (“Hold Co”) set up in another foreign jurisdic-
tion whose treaty with India provides certain specific
a. where the tax benefit arising to all parties to
benefits in relation to capital gains. Hold Co.
the arrangement does not exceed a sum of INR
also has investments in various other jurisdictions,
30 million (approximately USD 450,000) in the
apart from India. The Foreign Investor carries out
relevant financial year;
research with respect to the investments that it can
b. where investments are made prior to April 1, make and provides this research to the Holding Com-
2017; and pany who then decides to make an investment.
Hold Co. also obtains various services from third
c. for non-residents directly or indirectly invest-
parties such as lawyers, accountants, consultants
ing in offshore derivative instruments (such as
to assist in evaluation of investment opportunities.
participatory notes issued by Foreign Portfolio
Hold Co. has a Board of Directors that meets in that
Investors (“FPIs”) / Foreign Institutional Inves-
country and reviews all the activities and reports to
tors (“FIIs”)). However, FPIs/ FIIs claiming ben-
undertake the investment. It however has limited
efits under a DTAA may be scrutinized under
manpower which is used for the research activity.
the GAAR.
Hold Co. sells shares it holds in the Indian compa-
nies but by virtue of the treaty the capital gains is
It is also important to note that even if certain
taxable in the country in Hold Co. is set up and there
prior investments are grandfathered, any corporate
being no capital gains in that country, the capital
arrangement may become subject to scrutiny under
gains so earned by Hold Co. is not subject to tax.
the GAAR on its implementation starting April 1,
2017. Therefore, in light of the
Foreign Investor Foreign Country
Hold Co
A B C
India
41
Issue: Whether making investment in India through inputs. If the Court has already provided approval
the Hold Co can be considered to be an ‘impermissi- for the amalgamation, it is presumed that the Court
ble avoidance arrangement’? has already gone into the bona fides of the transaction.
In such situation, the provisions relating to GAAR
Interpretation 1: Hold Co. has investments in vari-
can no longer be applied to treat the transaction
ous jurisdictions and it can be seen that it is actively
as an impermissible avoidance arrangement’.
engaged in making the investment decisions. Hold
Co. is also following the laws relating to commercial Interpretation 2: Even if the Court has sanctioned the
substance as provided for in the country in which amalgamation, it would be permissible for the tax
it has been set up. It cannot be said that the Hold Co authorities to examine whether the main purpose
lacks commercial substance and the main purpose of the transaction is only to obtain a tax benefit.
for making the investment in to India is to obtain If for example, it is established that there is no other
a tax benefit. The arrangement hence cannot be con- purpose to undertake the transaction other than to
sidered to be an ‘impermissible avoidance arrange- obtain the benefit of losses, the arrangement should
ment’ and hence GAAR should not be applicable. be considered to be an ‘impermissible avoidance
arrangement’ and hence GAAR should be applicable.
Interpretation 2: Hold Co. does not have any signif-
icant manpower or other activities that it can be Illustration 3
shown to have undertaken. Further, there are no
Facts: Foreign direct investment is made by X Co,
reasons set out as to why the Hold Co. is has been set
a resident of a treaty country for tax purposes,
up in such treaty jurisdictions have favorable capital
in India Co., an unrelated company incorporated
gains tax treaty benefit with India. In the absence of
in India through the use of Compulsorily
such conditions being met, the GAAR may still be
Convertible Debentures (“CCDs”), which are debt-
invoked in this case.
like in character under conversion to equity. Such
CCDs entail an annual coupon payment of 14%.
Illustration 2
Redemption of the CCDs or sale of the CCDs to Y Co.,
a country resident in Y, may be considered to be the
Facts: F is a loss making company which merger into
transfer of a capital asset.
a profit making company resulting in offsetting of
profits, lower profits and lower tax liability of the
merged company. The conditions under section 72A
of the ITA are otherwise fulfilled.
Loss making Co
Merger
Profit making Co
Issue: Will the losses be disallowed under the

GAAR?
The relevant treaty provides that (a) transfer of
shares may be taxable in the source country; and
Interpretation 1: The amalgamation of the companies
(b) transfer of any other assets (not specified in the
is done under a Court approved process. As part of
capital gains provisions) shall only be taxable in the
the merger, the Court has provided an opportunity
country of residence.
for the tax authorities to be represented and provide

Legal & Tax Issues
Given that CCDs should not be considered ‘shares’ Further, where the X Co. is carrying out substantial
as per the relevant paragraphs of the relevant treaty, business activities and is also following the laws
the capital gains arising from the sale or redemption relating to commercial substance as provided for
of the CCDs should not be subject to tax in India in the country of residence, it cannot be said that the
under the relevant treaty. However, expenditure X Co lacks commercial substance and that the main
incurred towards the payment of interest or redemp- purpose for making the investment in to India is to
tion premium on the CCDs may be claimed obtain a tax benefit. Therefore, benefits under the
as expenditure by the India Co. relevant treaty should be available in respect of the
capital gains from the transfer of CCDs.
Issue: Whether the benefits under the treaty will be
available to India Co. on application of the GAAR?
Whether deductions claimed in respect of expendi-
ture incurred on the payment of interest will be disal-
lowed by the Indian tax authorities under the GAAR?
Sale of CCDs to
Y Co.
X Co. Y Co.
Redemption Regular coupon pay-

of CCDs by ments
India Co.
Foreign Country
CCDs India
India Co.
Interpretation: An evaluation of whether India Co.

should have raised funds through equity instead of
as a loan should generally be left to commercial judg-
ment and GAAR should not be attracted in this case.
Further, the coupon payments are being made regu-
larly and on an arm’s length basis. Therefore, to the
extent that commercial rationale has been supplied
for the use of CCDs rather than equity, the expend-
iture incurred in respect on interest payments /
redemption premium should not be disallowed
under the GAAR.
43
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Legal & Tax Issues
Research @ NDA
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research by Nishith M. Desai on the taxation of cross-border transactions. The research book written by him
provided the foundation for our international tax practice. Since then, we have relied upon research to be the
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M U M BA I S I L I C O N VA L L E Y BA N G A LO RE S I N G A P O RE M U M BA I B KC NEW DELHI MUNICH N E W YO RK

Tax Issues in M&A

© Copyright 2016 Nishith Desai Associates www.nishithdesai.com

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

2. CROSS BORDER TAX ISSUES 10

3. PREVAILING AMBIGUITIES IN INDIRECT TRANSFER PROVISIONS 16

4. CAPITAL GAINS TAXATION: TIMING AND VALUATION 20

5. TAXATION OF EARN-OUT ARRANGEMENTS 22

6. CARRY FORWARD OF LOSSES IN CASE OF M&A TRANSACTIONS 25

7. MERGERS AND ACQUISITIONS - ESOP / EMPLOYEE TAXATION 29

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

IV. Extinguishment of ESOPs in Transferor Entity 30

8. DRAFTING TAX REPRESENTATIONS AND TAXATION OF

9. MERGERS AND ACQUISITIONS – NON-COMPETE AND

10. ANTI-ABUSE RULES TO BE CONSIDERED IN AN M&A TRANSACTION 39

© Nishith Desai Associates 2016

© Nishith Desai Associates 2016

1. Tax Considerations on M&A Transactions

4. Slump Sale: A slump sale is a sale of a business

1. Corresponding to Sections 230 to 232 of the Companies Act,

2 © Nishith Desai Associates 2016

where such transfer results in an indirect transfer 7. (2004) 9 SCC 438

9. Please refer to Section IV of this paper for more details on capital

Individuals having income more than INR 10 12%

Domestic companies with income between 7%

Domestic companies with income more than 12%

Foreign companies with income between INR 2%

Foreign companies with income more than 5%

4 © Nishith Desai Associates 2016

Short Term Capital Gains Long Term Capital Gains

6 © Nishith Desai Associates 2016

25. “block of assets” is defined in Section 2(11) of the ITA as a group

Below is a comparison between the various methods of

Slump Sale Share Sale Asset Sale Amalgamation Demerger

8 © Nishith Desai Associates 2016

2. Cross Border Tax Issues

I. Introduction II. Claiming Treaty Benefit:

10 © Nishith Desai Associates 2016

ii. It should not be a shell / conduit company and it must have

12 © Nishith Desai Associates 2016

MAURITIUS CYPRUS SINGAPORE NETHERLANDS

iii. Full rate of Indian tax

Withholding tax 15% (for royalties). FTS36 15%** 10% 10%

c. A person from or through whom the non-resident

V. Tax as a Representative receives income directly or indirectly; or

Taxpayer/Assessee d. A trustee of the non-resident;

In this context, the term ‘business connection’ mean

37. Vodafone International Holdings BV v. Union of India (2012)6SCC613

14 © Nishith Desai Associates 2016

3. Prevailing Ambiguities in Indirect Transfer

A. Threshold Test for

16 © Nishith Desai Associates 2016

C. Apportionment of Gains A. Concerns for Multi-layered

42. Circular no.4 of 2015