Mergers and Acquisitions

New India is clearly the fastest-growing economy in the world. To maintain this status, two elements are critical: robust capital flows from domestic corporates, multinationals, and financial sponsors, and a push for mergers and acquisitions (M&A) and other value creation activities. This Budget, the first one in the third term of the government, thus carries great expectations from investors and India Inc. Here are seven predictions on what one could potentially see in the current Budget from an M&A standpoint. Valuation Rules for Listed Company Transactions: Listed company transactions in India today face a peculiar and unique problem. Valuation rules enshrined in the anti-abuse provision contained in section 56 of the Income Tax Act can be misinterpreted, leading to unintended consequences. Even bona fide trades between unrelated parties at prices discovered transparently and commercially negotiated could still be subject to artificial pricing norms, exposing the transaction to ordinary income taxes in the hands of the buyer. In the current markets, one would expect a host of listed company transactions, and the government would likely want to resolve this issue. Rationalization of Capital Gains Tax Rates: There has been discussion around the various different tax rates applicable to capital gains in different situations. In the context of the current active transactions market, taxability of capital gains has assumed greater relevance. One may expect some rationalization of the rates and holding periods for transactions that give rise to capital gains taxes. Deferral of Taxes on Share Swaps: Deferral of taxes on share swaps has been a long-standing point of conversation. The logic is simple – a share swap in certain situations largely achieves the same result as a merger. If a merger is accorded tax deferral, then it stands to reason that, subject to prescribed anti-abuse conditions, which could include non-monetization covenants, the same treatment be accorded to swap transactions. This would also make our law consistent with the tax provisions applicable in other markets such as the US. Financing of M&A Activity: Financing of M&A activity in India is more difficult owing to legal restrictions. This places Indian acquirers at a competitive disadvantage relative to their foreign peers while bidding for assets. While this is not an issue to be centrally addressed by the Budget, a directional policy indication on this count would be useful in bolstering the confidence of the markets and leveling the playing field for domestic acquirers. Reconsidering Tax Distinctions Between Industrial and Non-Industrial Companies: In today’s value creation cycle, the historical distinction that the tax law makes between an industrial and a non-industrial company merits reconsideration. There are benefits, for example, consolidation of losses in a merger scenario, available to companies carrying on manufacturing or industrial activities but not typically to most classes of services or non-industrial companies. At a time when significant value in the economy is being generated from non-industrial companies, the time to reconsider this distinction is perhaps with the current Budget. Taxation Regime for Deal Structures: M&A transactions in India, particularly at the current valuation levels, have started employing tools used globally to bridge valuation gaps. These include earn-outs, deferred considerations, and contingent payments. Aligning tax laws to these deal realities by providing a clear taxation regime is something the government can achieve without losing tax revenue – this will go a long way in clearing the path for such transactions to occur seamlessly. Clean-ups in the Tax Law: Provisions involving overseas mergers of companies that hold Indian assets are already accorded tax neutrality. These provisions need certain “clean-up” clarifications to make them workable. Likewise, Indian holding companies of overseas subsidiaries will benefit from some clarificatory amendments for restructuring of such overseas subsidiaries. This government has shown responsiveness to valid asks around the theme of clarifications and clean-ups, and one would expect these to be carried in the current Budget.