Union Budget 2021: The budget must allow mobility of accumulated tax losses upon merger for services companies. It must also consider permitting mergers of limited liability partnerships
By Vaibhav Gupta & Samudra Acharyya
As the countdown begins to what has been termed a ‘once in a century’ Budget, all eyes will be on the finance minister to flick the magic wand and provide a much-needed impetus to the economy. With the government taking several measures throughout the year to navigate the tough Covid-times, the Budget to be announced on February 1 is indeed special. There are a lot of expectations—from reduction of personal taxes, an introduction of Covid cess to corporates being given further tax benefits. With quite a bit of inherent pain amongst corporates due to the Covid-induced stress, the next couple of years are likely to witness heightened merger and acquisition (M&A) activity involving business and group restructuring, divestments, consolidations and fundraising.
It may be prudent for the Budget to realistically consider changes in the tax provisions to provide a better playing field for corporate M&A activity. One of the significant changes which should be considered is the mobility of accumulated tax losses on mergers. While the current section 72A permits migration of tax losses on the merger of companies owning an industrial undertaking, services companies are largely kept outside the ambit of this provision. As India has transformed into a service economy over the last few years, it is only logical to enable services companies to preserve their losses in the event of an amalgamation. Equally important is the aspect of permitting mergers of limited liability partnerships (LLP). Admittedly, the LLP law was meant to enable the service sector and professionals to have their liability limited unlike in a traditional partnership model. While under the old company law, the merger of a partnership firm into a company was possible, the new company law places restrictions on the same. We saw the NCLAT reject the merger of an LLP, which was approved by the Chennai NCLT, a couple of years ago. While the merger of foreign LLPs is permitted, there is no reason why a level ground should not be provided to Indian LLPs. Mergers of LLPs, both with a company and with another LLP, should also be made tax-neutral, similar to mergers between companies.
In order to enable companies to raise overseas capital, a few changes are indeed necessary. Outbound mergers should be provided tax neutrality. This can, of course, be subject to conditions around change in majority shareholding and control. The 2013 Companies Act permitted outbound mergers; however, the absence of tax neutrality has perhaps not generated enough interest in this space. Direct overseas listing has been much awaited in India. While we hear that the regulations will be introduced soon, it is imperative that taxes on the sale of shares listed outside India are brought on a par with India-listed securities. Our focus should be to encourage the inflow of overseas capital in India through the direct listing route.
Provisions around deemed minimum consideration on transfer of shares and immovable property coupled with a deemed gift under Section 56 have generated enough controversy. Time and again, representations have been made to the finance ministry to consider relaxations in these norms in view of actual market prices being lower than the government-mandated valuation guidelines. While a tolerance limit of 10% exists for immovable property, it may be relevant to consider increasing the said limits, since prices of real estate have significantly dipped in the last year. Also, a similar benefit should be extended to Rule 11UA for valuation of the shares that derive value from underlying immovable property.
With a view to enable tax-efficient internal group restructurings, exemption from the applicability of Section 50CA and Section 56 should be considered on the transfer of shares within group companies. While exemptions exist for transactions between holding companies and wholly-owned subsidiaries, the benefits of the exemption should be expanded to cover all subsidiaries. Restrictions under Section 47A can also be similarly expanded. In the same vein, continuity of losses on the transfer of shares between group companies should be considered.
The 2020 Budget removed dividend distribution taxes, making dividends fully taxable in the hands of the shareholders. Buybacks by companies are still taxable in the hands of the companies as a distribution tax. It is only logical that taxation of the buyback is also brought in line with dividend as a tax on the shareholders. This move will allow public shareholders of listed companies to avail the 10% capital gains tax rate applicable for listed shares. Similarly, non-resident shareholders will get access to treaty benefits and a 10% domestic tax rate. Another anomaly in buyback tax is that while buyback entails the cancellation of shares, the actual cost of such shares acquired in the secondary market by the shareholders, along with any indexation benefits thereon, is not available as a set-off.
The Finance Act 2018 made the sale of listed shares taxable for the shareholders. A grandfathering provision was brought in to exempt gains up to the fair market value till January 2018. A number of issues and clarifications in these provisions are desired, particularly around the availability of the grandfathering benefits in a merger or any other tax-neutral mode of transfer, where the period of holding is preserved under law.
As India Inc hopefully prepares for an action-packed year on M&A and restructurings, some of these changes would go a long way in facilitating transactions, the economic benefits of which might far exceed any tax costs to the exchequer.
Gupta is partner and Acharyya is principal, Dhruva Advisors Views are personal