TAXATION IN DOMESTIC M A s

2. INTERNATIONAL PERSPECTIVE � POST 2000 In the context of September 11th, 2001 incident, all acquisition activities, primarily hostile ones came down initially. It is believed that the reduction of bids occurred because of public perception that such takeovers would be taking advantage of a national tragedy. However, significant increase in acquisition activities in the recent past.

3. INTERNATIONAL PERSPECTIVE Most hostile activity involved distressed telecom and technology companies. Example : COMCASTS 72 Billion Dollars unsolicited acquisition of A T & T broadband, Northrop Grummam Corps 6 Billion Dollars unsolicited bid for TRW. Given current economic landscape and continued stock market turbulence, the outlook reflects an increase in acquisition activities especially in industries undergoing consolidation including banking, financial services, energy and utilities. This also presents a unique opportunity for potential acquirers and increased risks for vulnerable companies attempting to remain independent.

4. INTERNATIONAL PERSPECTIVE In the past takeovers were generally leveraged financial acquisitions, designed to breakup or restructure target companies and were practiced by Corporate LBO raiders such as Carl ICAHN. The main catalyst & driver behind the increase in M & A activities has been weakness of the US economy since this provides ample opportunity for leading companies to purchase valuable assets at a substantial discount especially of technology and telecom business.

5. INTERNATIONAL PERSPECTIVE Anti takeover strategies including poison pills make M & A prohibitively expensive e.g. flooding target stocks for purchase at a significant discount by existing stock holders of the target company rather than the hostile bidder. This can deter and give the targets both time to find strategic holders and provide negotiating leverage. Therefore, poison pills use increased in the past. Companies using such poison pills include Yahoo, Gateway, Palm etc.

6. INTERNATIONAL PERSPECTIVE Cross Border Mergers from Indian Corporate Law viewpoint, permit the merger of a foreign company into a domestic Indian Company. Jurisdictions such as Mauritius, UAE, British Virgin Islands and Jersey allow cross border mergers into an Indian Company.The merger is a tax neutral transaction in India (subject to specified conditions) and therefore in many instances this route is followed for acquisitions and profit repatriation.

9. 2. AMORTISING INTANGIBLES In the US goodwill may be amortized over 15 year period. In France it is not allowed to be amortized. In Germany amortization of intangible includes goodwill provided it is acquired. UK�s tax regime provided for amortizing intangible property covering patent, trademark and other intellectual properties and goodwill. It also provided that no stamp duty would be charged on goodwill. In the Netherlands any goodwill included in the acquisition price of shares can not be amortized. However, it can become tax deductible only if the acquisition takes place as an asset deal when it can be amortized generally over a period of 5 years.

14. DEFINITIONS IN INCOME TAX ACT Mergers and amalgamation are defined in section 2(1B) and Demergers are defined under section 2(19AA). In both thee definitions, it is mentioned that all the properties and liabilities are transferred. This really restricts the tax benefits in the event of non-compliance with this 100% stipulation. In today�s liberalized era, it is noticed in a large number of cases only those assets and liabilities relatable to the undertaking which are mutually agreed upon between the parties should be transferred and not all assets and liabilities. Moreover, it may be noted that provisions of section 72A states that at least 3/4th in book value of fixed assets of the amalgamating company is held by the amalgamated company for a period of five years.

15. DEFINITIONS IN INCOME TAX ACT Amalgamation provisions only apply to companies. The Demerger definition also applies only to companies in the context of demerger of undertakings. In other words, the non-corporate sector is excluded from the purview of any tax concession. (However, section 72A now provides for business loss/unabsorbed depreciation adjustment in cases of reorganization of business whereby a firm or a proprietary concern is succeeded by a company or a private company/unlisted public company is succeeded by a limited liability partnership).

16. DEFINITIONS IN INCOME TAX ACT The abovementioned definition also stipulates that shareholders holding not less than 3/4th in the value of the shares in the amalgamating company or demerged company become shareholders of the amalgamated company or resulting company. This 75% stipulation is highly restrictive since a subsidiary may be formed even with over 50% shareholding control. Therefore, at least 50% norm should be provided for in the Income Tax Law. In fact, the SEBI norms regarding acquisition and open offer stipulates far lower percentages.

17. DEFINITIONS IN INCOME TAX ACT The abovementioned definition also has an exception para �Otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first mentioned company�. This is a very vague provision since it appears to have been inserted as a measure of abundant caution so as to exclude specially a case of a pure �buy� transaction of any asset or property.

18. CAPITAL LOSSES There is no provision for carry forward of losses on capital gains. It may be noted that the Kelkar Committee in its report has suggested that �since capital gain represents accumulation of income over a period of time, these can be illusory and therefore the cost of asset adjusted over the period of holding for inflation.� As such the long term capital gains thereafter, is a real gain to be taxed at normal rates. This in turn implies that loss should also be treated at an equal footing and allowed to be adjusted subsequently. Also, it may be noted that under section 72, carry forward business losses are not allowed to be adjusted with the year�s capital gains. Thus in the case of the sick units being merged etc., if any assets/shares are sold before the takeover the capital gains tax is to be paid inspite of carrying forward huge losses. This is however permitted under the DTC � ref clause 64.

19. OTHER PROVISIONS Under section 43B, statutory and other liabilities are taxable only on payment basis. However, in the event of an amalgamation or demerger, the law is not clear on the applicability of this section although there does not appear to be any dispute. Clarification is required in respect of tax concession being available where consideration is partly paid by way of issue of shares and partly by way of cash payments or other instruments.

20. OTHER PROVISIONS Under section 79, it is provided that where a change in shareholding has taken place in the case of a company not being a company in which the public are substantially interested the loss carry forward benefit shall not be available. It also provides for exception in the case of change in shareholding of an Indian Company which is a subsidiary or a foreign company. As a result of amalgamation or demerger of the foreign company subject to the condition that 51% shareholders of the amalgamating or demerged foreign company continue to be shareholders of the amalgamated or the resulting foreign company. However, this benefit is not extended to domestic companies.

21. OTHER PROVISIONS Section 10A provide for tax exemptions to 100% export oriented undertakings in Free Trade Zones or Software Technology Park or Special Economic Zone. Similar tax benefits are also available under section 10B to newly established 100% export oriented undertakings. In the event of a merger or demerger, the benefits are available. Thus, the tax benefit is given for merger/demergers on the lines of the existing section 80IB etc. whereby the benefit is continued in the hands of the amalgamated/resultant company

22. OTHER PROVISIONS Section 80IA provides for deduction for infrastructure development like power etc. sub-section (12) specifically provides the benefit to be carried forward in the even of a merger or demerger. A similar provision exists in section 80IB (for specific industrial undertakings e.g. industries in backward districts). Similar provision also exist under section 35A, 35AB, 35D, 35DDA, 35E etc. Such provision should have been replicated in various other sections like 43B, 74 and 115JAA.

23. Carry forward of Business Losses Section 72A is the most important section under the Income Tax Law which provides for carry forward and set off of accumulated loss and unabsorbed loss and unabsorbed depreciation in amalgamation or demerger. This section provides that in the event of amalgamation. The amalgamated company should also have been engaged in the business in which the accumulated loss/depreciation has occurred, for 3 or more years and has held continuously at least 3/4th of the book value of fixed assets 2 years prior to the date of amalgamation. The amalgamated company holds continuously for a minimum period of 5 years at least 3/4ths in the book value of fixed assets of the amalgamating company. These clauses are somewhat restrictive in nature since it insists on a very high percentage of the fixed assets being continued to be used and needs to be relooked at.

25. The benefits under section 72A are restricted only to manufacturing companies including software companies and power. However, in today�s world the service sector has emerged as an important player and all services should also be covered including financial services. It may be noted that in recent Budgets, the benefit was extended to newer section like telecom which is a good beginning and should be extended further. Section 50B provides for computation of capital gains in the case of slump sale. Under sub-section (2), the net worth of the undertaking is taken to be the cost of acquisition and cost of improvement and no indexation benefit is available. If the undertaking owned and held by the assessee for not more than 36 months, it will be treated as short term capital gain, otherwise it will be long term capital gains.

26. OTHER PROVISIONS Under section 115JAA, MAT paid is allowed to be carried forward for set off for a period of 10 years. However, no such benefit is available in the event of a merger or demerger. Section 80HHC : This benefit is no longer applicable. Earlier, as per the decision of the Supreme Court in the case of Shirke Construction [291 ITR 38], the computation for manufactured/processed exports was to be done after adjustment of carry forward business losses and unabsorbed depreciation.

27. In this era of increased M & A activity, repeated acquisitions are expected to be a common feature. However, section 72A does not deal with the subject and leaves the same to interpretations and disputes. It is suggested that there should be a very clear provision for allowing the benefits.

28. OTHER ISSUES Bad Debts : Disputes may arise in respect of allowability of bad debts written off by amalgamated / resultant company for debts etc. taken over from the predecessor. In this context, reference may be made to the decision in CIT v. Veerabhadra Rao etc. [155 ITR 152] in which the Hon�ble Supreme Court held that the successor assessee would be entitled to write off.

29. OTHER ISSUES Depreciation : The various aspects of tax depreciation is provided for under section 43(6). These are drafted in a fairly elaborate way but interpretation issues may arise. Example : in explanation 2B the term �books of account� has been mistakenly used. However, the basic principle is that it is supposed to be tax neutral. The main problem which can arise with regard to determination of the written down value of each asset for the undertaking transferred.

30. OTHER ISSUES MAT : Book Losses of amalgamating company could be reduced in computing book profit of merged company under MAT provisions (Ref. recent decision of ITAT Lucknow in the case of Kothari Products Ltd.) Stamp Duty : In India stamp duty is imposed on transfer of undertakings by various State Governments which is currently very high. It ranges appoximately between 5% and 10%. It may be noted that in China Stamp Duty is only 0.05%.

31. ADVANCE TAX / TDS/DDT Since the High Court orders under S. 391 to394 of the Co.�s Act come very late and apply very retrospectively, the amalgamating company operates independently for the time period after the effective date and before the court order. During this time period, it may have to pay TDS for transactions between the two companies and also pay DDT (to the other company) and advance tax. However, currently no proper provision exists for giving full credit for the same in the hands of the amalgamated/resultant company it is suggested that proper prov. should be inserted under Chapter XVII for giving full credit for such advance tax/TDS/DDT (recently Chennai ITAT in case of TVS Motors has upheld DDT adjustments after effective date).

32. Administrative Issues in Taxation On the administrative side, various operating problems are faced by Corporates in the event of mergers/demergers. For example transfer of files of the amalgamating company to the jurisdiction of the amalgamated company is a serious problem in the absence of specific directions from the authorities. This is applicable for all matters related to income tax assessments and appeals.

33. DTC Under the DTC, amalgamations and demergers include only re-organizations between residents, meaning thereby that merger of a non-resident with a resident shall not be tax neutral. This needs a fresh look since it shuts the door on a preferred mode of acquiring foreign companies and repatriating funds. Recently, Indian Tax Authorities have disputed transactions involving share transfers by a non-resident to another non-resident, when such a transfer involves a change in the ultimate shareholding of an Indian Company. M & A transactions involving such transfer of shares outside India alongwith a bundle of assets e.g. rights to do business, licenses etc. are currently being subjected to detail scrutiny all over the country.

34. CAPITAL GAINS - DTC There are no provisions in the Income Tax Act for capital gains tax in case of indirect transfer of shares. Even under the DTC, �income deemed to accrue in India� remain unchanged {clause 5(1) of DTC is similar to section 9(1)}. The DTC however stipulates that for computing income of a non-resident, in respect of a transfer outside India of shares / interest in a foreign company, it shall be deemed to accrue in India, if at any time in twelve months preceeding the transfer, the fair market value of assets in India, owned, directly or indirectly by the foreign company represent at least 50% of fair market value of all assets owned by the company.

35. CONTROLLED FOREIGN COMPANY (CFC) The DTC proposes to introduce CFC Rules, a specific Anti-avoidance measure. This has implication for M & A structuring in India through holding companies abroad. These exist in many developed countries. USA introduced CFC in 1962 followed by Germany in 1972 (Brazil 2001, China 2009). CFC is a legal entity / company that exists in one jurisdiction and is owned / controlled by taxpayers in another jurisdiction (India). Aimed primarily to stop shifting / deferral of passive income.

36. CONTROLLED FOREIGN COMPANY (CFC) Passive Income means income derived by holding assets e.g. dividends, interest, royalties, etc. CFC under DTC is defined as a foreign company which is : - resident of territory with lower rate of tax (less than 50% of Indian Tax computed as per code) ; Shares are not traded in stock exchange ; One or more residents in India exercise control over the company ; Is not engaged in any active trade or business ; Specified income exceeds Rs.25 lakhs ;

37. CONTROLLED FOREIGN COMPANY (CFC) Active trade / business means : Active participation through employees in the economic life of resident state ; Less than 50% of income is passive income like dividends, interest, capital gains, house property income, royalty etc. ; Taxation of pro-rata income attributable to CFC as per specified formula ; CFC shares liable to Wealth Tax ; Subsequent distribution of dividends by CFC not taxable ; CFC rules apply to all resident shareholders / assesees not withstanding tax treaties ;

38. CFC � SOME ISSUES FOR M & A THROUGH SPV ABROAD Applicability in case of multi-tier structures (i.e. for step down CFC) Applicability to downstream investment to subsidiaries of overseas operating companies ; Applicability to non-corporate overseas entities ; Meaning of Dominant Influence/Decisive Influence/Directly or Indirectly ; Measuring lower rate of taxation could result in complexities (each CFC to be subject to separate computation as per DTC) ; Availability of credit for foreign taxes paid by CFC ; Set-off between profits and losses between different CFCs ; Gains on sale of CFC�s shares to be taxed without offsetting past year�s taxes paid due to CFC ; Double Taxation on account of applicability of Transfer Pricing and CFC provisions ; Wealth Tax Guidelines for valuing CFC shares (to be notified) ;

39. TAX RESIDENCY Tax Residency for foreign companies under DTC widened : based on POEM (Place of Effective Management) ; Foreign company resident in India if POEM is in India at anytime in the financial year ; POEM means : Place where the BOD of the company or its Executive Directors make their decisions ; or In case where the BOD routinely approve the commercial and strategic decisions made by the Executive Directors or Officers, the place where such Executive Directors or Officer perform their functions ;

40. TAX RESIDENCY Overseas Subsidiaries of Indian Companies could be impacted if POEM of such subsidiary is in India ; Income of such subsidiary will be taxable at 30% ; Dividend declared by such subsidiary will be subject to DDT at 15% ; Expression at �any time� is very wide ; even one meeting could result in tax residency (requires clarification) ; Clarity required also on several terms like officers, routinely, commercial and strategic decisions etc. ; Availability of tax credits where passive income is actually distributed needs clarification ; Issues of multiple POEMs in India and abroad in case of conducting Board Meetings in multiple jurisdictions and also having key operating officials doing managerial / strategic decision making in such jurisdictions. Huge complexities could arise ;

41. BRANCH PROFITS TAX (BPT) Additional BPT proposed to be levied @ 15% on income of foreign companies ; Applicable to income of foreign companies ; - attributable directly or indirectly to PE in India ; or - from an immovable property in India - corresponds to DDT on Indian companies Not linked to repatriation of income ; Overrides Tax Treaty Provisions

42. GENERAL ANTI AVOIDANCE RULE (GAAR) GAAR applies both to residents and non-residents ; Onus on tax payer to prove that obtaining tax benefit not the main purpose of arrangement ; Power to invoke GAAR bestowed only upon CIT :- - CIT to issue directions to the AO for making adjustments ; - Directions binding on the AO ; GAAR not to be invoked for every arrangement involving tax mitigation ; CBDT to issue guidelines providing circumstances under which GAAR may be invoked Threshold limit of tax avoidance to be provided for invoking GAAR GAAR to override provisions of Tax Treaties ; DRP route to be available for resolving disputes

43. TREATY OVERRIDE Position under the Act continues : - Domestic law to apply only if more beneficial than the treaty ; However, limited treaty override in cases where : - GAAR invoked, or - CFC triggered, or - BPT levied

44. OTHER IMPLICATIONS OF DTC Pursuant to Demergers, the DTC specifically provides for issue of equity shares to the shareholders of the demerged company as against the Income Tax Act where the nature of shares was not specified. Resulting companies have been issuing mezzanine instruments e.g. preference shares, convertible debentures etc.to the shareholders of the resulting company to plan tax efficient exits, avoiding dilution of control and facilitating future repatriation of funds. Such mechanisms, used in group re-structuring earlier may not be feasible in future. DTC provides for liberalized regime for carry forward losses as against the current law, which provides for various conditions like continuity in business for at least 3 years, nature of business etc..