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Presented By CA Swatantra Singh, B.Com , FCA, MBA Email ID: singh.swatantra@gmail.com New Delhi , 9811322785 , www.caindelhiindia.com, www.carajput.com.
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Presented By CA Swatantra Singh, B.Com , FCA, MBA Email ID: singh.swatantra@gmail.com New Delhi , 9811322785, www.caindelhiindia.com, www.carajput.com
Mergers & Acquisitions Current Scenario and Way Ahead
Precedents • Takeover of Ashok leyland by Hindujas • Chabbria group took over Falcon tyres • Ceat tyres taken over by Goenkas • Pepsi & Coke taking over Parle and Indian soft drink companies • Take over of Tetley by Tata Tea. • Grasim acquired UltraTech through a Swap • Tata Motors’ acquisition of Daewoo • Jindal Vijaynagar steel merged Euro Iron & steel, Euro energy and JSW Power • ITC, Somani group through BIFR. • Recently Vijay Malaya took over Shaw Wallace
Why M & A • Horizontal growth for enlarged markets & optimum utilization • Vertical combination to economize cost and reduce tax burden • Diversification of Business • Combination of management, financial and human resources. Synergies • Improve dividend yield, earnings, book value of entities and cash flow of the entities. • Attraction to foreign investors • Financial Restructuring and • Tax Planning
Terminologies • Blending of two or more existing undertakings: “Amalgamation” • Sale of business - As a going concern – “Slump Sale” - Individual assets - “Itemised sale” • Merger / Amalgamation of existing business – “Merger” • Sell to a subsidiary – “Subsidiarisation” • Demerger • Secondary market / negotiated purchase of shares – “Share Purchase” • Issue of fresh shares (preferential issue) – “Fresh Issue”.
Current Scenario • Revival in deal activity in the country • More than double the transactions in first five months as compared to same period last year • Rebound linked to recovery of Indian and global economy • Active sectors – Telecom, Pharma, Cement, FMCG 6
…Mergers & Acquisitions… Top 5 M&A Deals - 2009 Top 5 M&A Deals - 2008 8
…Private Equity… Top 5 PE Deals - 2009 Top 5 PE Deals - 2008 12
Positive Trends… • Market in favour of consolidation • Higher degree of homogeneity across markets due to globalization – Marginal costs of set up in new markets • Brand identity recognizable across markets • Market dynamics favour fewer players – economies of size and scale • Recent examples – Bharti – Zain, GTL Tower deal 15
…Positive Trends… • Flexibility and pragmatism demonstrated by Indian Promoters • Promoters recognise strengths and weaknesses and willing to adapt • No stigma attached to alienation of stake in companies • Ability to gauge time to encash vs carry on • Recent examples – Ranbaxy, Piramal, Wockhardt, Tata Docomo 16
…Positive Trends… • Availability of credible information • Reliable standards of accounting – transition to IFRS • Higher levels of transparency and corporate governance • Breadth and depth in the financial sector • Increase in number of players in the financial intermediary market • Emergence of investor classes with different risk appetites • Angel investors, VC, PE, FIIs, Domestic cos, Foreign cos, Retail investors 17
…Positive Trends • Certainty in regulatory framework • Clarity in tax provisions relating to slump sale • Incorporation of M&A provisions in direct and indirect taxes 18
Roadblocks… • Positive trends yet to achieve full potential • Greater flexibility to be shown by Indian promoters • Need for consolidation not fully recognized • Grey areas in regulatory framework • Lack of clarity on stamp duty liability • 80IA provisions not conducive to mergers and acquisitions 19
…Roadblocks… • Restrictive foreign exchange controls and listing norms • Direct listing of Indian shares on foreign exchanges not allowed • Indian companies not allowed to merge with foreign companies • Foreigners individually not permitted to invest in Indian shares • Restricts usage of Indian shares as currency for deals • Increasing protectionism • Governments keen on retaining national identity of iconic companies • Increasing use of capital controls to regulate flow of foreign capital 20
…Roadblocks • Accounting for M&A under IFRS • Appointed date of merger vs actual date of merger • Purchase method of accounting – valuation of intangibles and off balance sheet items and residuary goodwill • Marked departure from Indian GAAP – no comparability pre and post IFRS • Capital Reserve vs Credit to P&L A/c – MAT impact • Demergers to be treated as non-cash dividend – change in accounting for transferor • IFRS to apply to top 50 companies – different norms applicable to different companies at same time 21
Wishlist… • Certain shortcomings in IFRS to be addressed • Few norms contribute to volatility and subjectivity in fin statements • Accounting for FCCBs • Lease Equalization vs Inflation • Fair degree of subjectivity in fair valuation norms 22
…Wishlist… • Regulations to encourage cross border M&A • Indian companies to be allowed to merge with foreign companies • Capital controls to be lifted on the Indian rupee • Listing on foreign exchanges to be allowed and vice versa • Permit accounting and reporting in functional currency 23
…Wishlist… • Rationalization of tax provisions • Tax liability only on encashment - not on exchange or conversion • Tax benefits to continue in case of mergers • Clarity on treatment of depreciation post transaction • Introduction of group relief • Introduction of anti-abuse provisions like CFC and thin capitalization rules • As opposed to current anti-abuse norms prescribed in DTC 24
…Wishlist • Better protection of minority rights in corporate law • Strengthen norms on independent directors and corp governance • Suitable amendments in listing agreement • Provisions to eliminate conflicts of interest in cases where management also holds majority shares 25
Corporate Restructuring -- Necessity • Companies worldwide are refocusing, downsizing andmerging to become globally competitive. • Developing core competence for global / domestic competition, technological development through collaboration and joint venture • Divesting non profitable business
Restructuring Restructuring Stock sale Mergers/ Amalgamation Demerger / Spin off Subsidiary Sale as a going concern- Slump sale Itemized sale
Amalgamation Shareholder X Shareholder Y Shareholders X & Y Company X Ltd.. Company Y Ltd.. Company XY Ltd. Cement Unit Cement Unit Cement Unit • Merger of one or more company into another or merger of companies to form another company provided • 75% in value of the shareholders of amalgamating company must become shareholders of the amalgamated company (Sec 2(1B)) • Amalgamation - Direct tax neutralized • No income to amalgamating company/shareholders on the transfer of business undertaking/receipt of income. (Sec 47(vi)) • Depreciation to amalgamated company on the basis of tax w.d.v in the hands of the amalgamating company (Explanation 7 to Sec 43) • Accumulated losses and unabsorbed depreciation of amalgamating company can be carried forward by the amalgamated company if specified conditions are fulfilled. (Sec 72A)
Tax Consequences On Companies • Income/ Loss transferred w.e.f Appointed date • Capital Gains: • To Transferor NIL • To Shareholders NIL • Depreciation basis for: • Transferee Existing w.d.v • Transferor Remaining w.d.v • Quantum Prorated
Tax Consequences…..Contd • Tax incentives of undertaking Continue • Subsequent Expenditure Allowed • Holding Period benefit • For Asset Transferred Continue 1/4/81 Option • For resulting shares Continue • B/f - carried forward • Depreciation Allowed • Loss Allowed • Cessation of liability Taxed • Expenses on process Deductible
Amalgamation.. .Issues • ¾ shareholding criteria to be applied in respect of shares held as on Appointed date or Effective date? • 43B payment by amalgamated Company • Credit in respect of MAT paid by amalgamating Company • Depreciation on cost or WDV 43(1) vs 43(6) • Whether succession to business • Transaction between holding & subsidiary in the intervening period • Dividend distribution tax paid
Tax implications……c/f and set off of losses u/s 72A • Conditions prescribed: For Amalgamating Co. • Has been engaged in business in which accumulated losses occurred/depreciation remained unabsorbed for 3 or more years • Has held continuously as on date of Amalgamation 3/4 of book value of fixed assets held by it 2 years prior to date of Amalgamation • For Amalgamated Co: • Holds continuously for 5 years 3/4 of book value of fixed assets of Amalgamating co. • Continues business of Amalgamating co. for 5 years • Fulfill conditions prescribed under Rule 9C
Tax implications……conditions under Rule 9C in case of Amalgamation Conditions prescribed under Rule 9C • Amalgamated Co. to achieve production level of 50% of installed capacity of undertaking of Amalgamating Co. before end of 4 yrs & continue to achieve it till the end of 5 yrs • Amalgamated Co. to furnish a CA report to AO in Form No. 62 along with ROI for AY in which above condition is satisfied and for subsequent AY falling within 5 yr period
Demerger... Public - 60% Promoter - 40% Public - 60% Promoter - 40% Company(DC) Company (DC) Company(RC) Cement Unit Cement Unit Steel Unit Steel Unit • Transfer of business undertaking as a going concern by one company (DC) to another company (RC) pursuant to a court Scheme subject to fulfillment of following conditions (Section 2(19AA)) • All properties and liabilities of the business undertaking are transferred at book values; • Shares of the RC are issued to the shareholders of the DC on a proportionate basis; • Shareholders holding not less than 75% in value of the shares of the DC become shareholders of the RC;
Demerger ... • Demerger - Direct tax neutral for company/shareholder. • No income to DC on transfer of undertaking (Section 47(vib)) • No income to shareholder on receipt of shares in RC (Section 47(vid)) • Proportionate depreciation in the year of demerger. Depreciation to RC on the basis of tax W.D.V. in the hands of DC.[explanation to Section 43(1)] • Accumulated business losses and unabsorbed depreciation (Section 72A):- • directly relatable to the demerged undertaking - allowed to be carried forward by RC • not directly relatable to the demerged undertaking - to be apportioned in the ratio of assets transferred to RC and assets retained by DC • Demerged business undertaking eligible for most tax exemption - benefits available even as part of RC (deduction u/s 80IA, 80IB available for unexpired period to resulting Co.)
Demerger.. .Issues • ¾ shareholding criteria to be applied in respect of shares held as on Appointed date or Effective date? • Transactions between holding & subsidiary Company during ‘Appointed date’ & ‘Effective date’? • Dividend declared - DDT • 43B payment by resulting Company • Whether succession to business • What happens if conditions for demerger are not satisfied
Demerger.. .Tax consequences if conditions of demerger not satisfied • Capital gain to transferor / shareholder • Deemed dividend to shareholder – dividend distribution tax • Section 72A not applicable • Depreciation to transferee on consideration paid • Cost of shares issued to shareholders of demerging company
Subsidiary Promoter - 40% Public - 60% Promoter - 40% Public - 60% Company X Ltd.. Company X Ltd. Cement Unit Cement Unit Steel Unit New Company Y Ltd.. Steel Unit • Transfer of undertaking to WOS for a consideration • Direct Tax - Transaction is tax neutral subject to a lock-in period. (Section 47A ) • No capital gains to the holding company (Section 47(iv)) • Depreciation to subsidiary on the basis of the written down value • for the holding company (Explanation 6 to section 43) • Two layers of Dividend distribution tax
Slump Sale Promoter - 40% Public - 60% Promoter - 40% Public - 60% Y Ltd.. Company X Ltd.. Company X Ltd.. Cement Unit Steel Unit Cement Unit Steel Unit • Transfer of business undertaking as a going concern for lump sum consideration without values being assigned to individual assets and liabilities.(Section 2(42C) • Transferor Company • Transferor Company liable to short/long term capital gains (holding period 36 months)(Section 50B) • Capital gains computed by deducting ‘net worth’ from the sale consideration • Step up of Depreciation - possible as transferee entitled to depreciation on the cost of assets.(Section 32 & 72) – Valuation of assets required
Slump sale.. .Issues • Contingent consideration – tax implications to purchaser/seller • Negative net worth – capital gain? • Depreciation to purchaser on cost – impact of 5th proviso to section 32 • Tax liabilities of predecessor – Sec 170 • Approval u/s 281 – practical difficulty
Stock Sale • Liable to long term capital gains depending on the period of holding (holding period 12 months) • In case of shares listed on a recognised stock exchange in India • Subject to securities transaction tax instead of Capital gains tax • Deduction under section 88E of STT available if income under ‘PGBP' includes any income from taxable securities transactions
Stock Sale.. .Issues • Interest deduction of acquisition cost • Tax liabilities of predecessor – Sec 170 • Approval u/s 281 – practical difficulty s
Itemized Sale • Sale on the basis of value being assigned to a separate item. • Transferor liable to short/long term capital gains depending on the nature of asset & period of holding • Depreciable asset-Short term capital gain • Non depreciable assets • For stock-Long term if held for a period > 12 months • For others-Long term if held > 36 months • Depreciation to transferee on cost – opportunity to claim step up depreciation
Itemized sale.. .Issues • 47A – No step up when holding Co. pays tax • Tax liabilities of predecessor – Sec 170 • Approval u/s 281 – practical difficulty
Considerations • Legal Aspects: • Companies Act, 1956 • MRTP Act • Industrial Development & regulation Act • Sick Industrial (special provisions) Act • SEBI Regulations • Finance Aspect: • Synergy • Valuation of firm – DCF / APV • Taxation Aspect: I.T.Act, 1961 • Accounting Aspect: AS 14 • Procedural Aspects – Scheme of Amalgamation
Legal Aspects I • Companies Act, 1956: Sections 391 to 396 • An application to be made to the court along with scheme of amalgamation, company’s final accounts. • Court has powers to supervise and modify the structuring of the scheme. Court can order a meeting of shareholders, members as it deems fit. • If a ¾ majority of such a meeting consents and the scheme is sanctioned by court, file it with registrar. • Court can order for merger of 2 cos. In public interest • In case of court merger, the transferor co. will be dissolved without winding up whereas in acquisition, the transferor co. continues to exist. • MRTP Now Competition Act: • Power retained with the government to order discontinue or restructuring of such combination agreement as would obtain dominant position.
legal Aspects II • Industrial (Development And Regulation Act): • High court can order to appoint anyone to takeover the management of the entity for running or restarting. • License of the amalgamating co. shall automatically be transferred to amalgamated co. • Sick Industrial (Special Provisions) Act: • Not applicable to non-industrial co.and small scale or ancillary undertaking. • Section 18 empowers BIFR to sanction the merger of a sick co. with another co. & vice versa considering the employee’s views. • SEBI: • Regulation 3 of SEBI regulations provides for the non applicability of takeover provisions to Amalgamations effected u/s 391 to 394 of companies act and Sick Industrial units u/s 18
Finance Aspect… Returns>cost • Synergy is the economic value of benefits arising out of Amalgamation. Synergy = VAB –(VA + VB)Hence, it signify the difference between combined value and individual values of entities. • Synergy can be a vital but a sole determinant of Amalgamation. Post merger integration, managerial talent can result in abnormal returns. • Valuation of the transferor entity can be done by DCF Methodology i.e. discounting the estimated future cash flows of entity (less) value of debt and other obligations as estimated. • An alternative approach to value target co. can be APV: • Value the company as if it were financed entirely with equity. • Estimate the value of financing side effects like tax shields etc • Add the two to arrive at APV.
Taxation Matters • Transferor Company can claim Capital gains exemption u/s 47(vi) • WDV of depreciable assets of transferor co. as on the appointed day to be added to the respective block of transferor co. Other Assets can be taken at actual cost – Expl (2) to Section 43(6)( C). • Depreciation claim to be split up between both cos. as per number of days • Only accumulated business loss & unabsorbed depreciation can be transferred. Capital loss to lapse. Transferee co. should be an Industrial undertaking, Shipping Company, Hotel or a Bank to claim benefits. • Tax benefits u/s 10A,10B,80IA,80IB shall be available continuously. • Amalgamation expenses can be claimed as deduction equally over 5 years period. • No transfer for shareholders of transferor Co. hence no tax liability. Period for which shares are held in transferor co. to be considered for indexation.