Merger & Acquisition Tax And Regulatory Updates

Taxation Updates

From the Judiciary

Ahmedabad ITAT: Sec. 56(2)(viib) held not applicable to issue of shares on amalgamation

Citation: M/s. Ozone India Ltd. (I.T.A. Nos. 2081/Ahd/2018)

M/s. Kalavir Estate Pvt. Ltd. (KEPL) amalgamated with Ozone India Ltd. (the assessee) under a scheme of amalgamation approved by the High Court of Gujarat effective from 1 April 2012. Pursuant to the amalgamation, the assessee took over all the assets and liabilities of the KEPL (net assets were worth ~INR 540 million). In consideration, the assessee issued 300 shares for each share held by the shareholders of KEPL, amounting to INR 150 million.

The excess of net assets over consideration was credited to capital reserve by the assessee. The tax authorities considered the same as income liable to tax under Section 56(2) (viib) of the Act being excess of the consideration received on the issue of shares in the course of amalgamation.

The ITAT ruled out the applicability of Section 56(2)(viib) in transactions like amalgamations observing as under:

• The intent of the provision was to deter the generation and use of unaccounted money.
• The Budget Memorandum to Finance Bill, 2012 and CBDT Circular 3/2012 indicates that the legislative intent was to cover the cases of the closely held company who receive a disproportionate amount on the issue of shares which over and above the face value of the share by way of share-premium.
• In the scheme of amalgamation, consideration is paid by the amalgamated company in the form of issue of share capital rather than consideration being received by the assessee as understood by the tax authorities. The persons to whom shares have been allotted have not paid anything for the allotment of shares. The shares have been allotted in consideration of their shareholding in the amalgamating company.
• The SC ruling in Mother India Refrigeration has held that deeming fictions are limited to the underlying purpose and cannot be extended beyond their legitimate field.
• In cases of amalgamation, there is a tripartite agreement between the amalgamated co., amalgamating co and shareholders of amalgamating co. and such agreements are not contemplated in the deeming clause in question;

In view of the above, the Ahmedabad ITAT held that issue of shares at face value by amalgamated co. to shareholders of amalgamating co. in pursuance to the scheme of amalgamation does not fall under Section 56(2)(viib) of the ITA;

Our Comments

The ruling clearly reflects the unintended ambiguity caused by the provision and thus unsettling the settled. Deeming fiction must be construed strictly and cannot be extended beyond its purpose/intent.

Mumbai ITAT - Section 56(2) (viib) held not to be applicable on advance received, should apply at the time of allotment of shares

Citation: Impact Retail Tech Fund Pvt. Ltd [TS-258-ITAT-2021(Mum)]

Impact Retail Tech Fund Pvt. Ltd. (assessee) revalued its investment in its wholly-owned subsidiary on account of the huge losses incurred by the subsidiary in its business. The assessee created a provision of INR 2.8379 billion on revaluation and its net worth became negative. In order to improve the financial position of the assessee and the subsidiary, the holding company of the assessee provided financial assistance of INR 1.5926 billion in the form of a loan to the assessee in A.Y. 2012-13. During the year,i.e., A.Y. 2013-14, the assessee re-classified the said loan as an advance towards share capital and received a further advance towards share capital of INR 1.54 billion. The AO invoked the provisions of Section 56(2)(viib) and held that the advance received by the assessee was in excess of the fair market value of the shares as on the date of receipt of advance.

The Tribunal ruled out the applicability of Section 56(2)(viib) by observing as under:

• While it is agreed that no prudent investor will invest more than fair market value, but a prudent businessman will invest in order to safeguard the investment in the subsidiary or revive it.
• The intent behind introducing the provision by the legislature is to curb the practice of generation and circulation of unaccounted money. In the current case, no such event is brought on record.
• Receipt of advances is a liability and will never take the character of the ownership until it is converted into share capital. The event of allotment will change the color of funds received by the assessee from liability to ownership. Thus, the provisions of Section 56(2)(viib) are attracted only in the year of allotment of shares, i.e., subsequent year.
• If Revenue’s contention is accepted, any fund received by the sick or capital eroded subsidiary companies which will be more than the fair market price of the shares, for expansion or revival, shall attract the deeming provisions of section 56(2) (viib). The intent of the legislature does not appear to tax such legitimate investments.

Our Comments

A landmark decision by the Mumbai Tribunal holding that Section 56(2) (viib) has limited applicability to cases of money laundering of unaccounted income. The Tribunal has reiterated the principle that deeming fictions should not be extended beyond their legitimate field.

Madras High Court: Allows depreciation on non-compete fees taken over in the course of amalgamation, deletes addition made u/s. 28 of reserve arising on amalgamation

Citation: Areva T & D India Ltd [TS- 231-HC-2021(MAD)]

Areva T&D India Ltd (assessee) had taken over businesses of three sister concerns under a scheme of amalgamation. The assessee credited the excess of net asset value over the purchase consideration paid to the amalgamating companies to its general reserve. The AO treated such excess as business income of the assessee taxable under Section 28(1)(iv) of the Act.

Furthermore, the AO also disallowed the claim of depreciation on 'non compete fee,' which was claimed by the assessee on an asset taken over from one of its sister concerns in the course of amalgamation. The AO rejected the claim holding that the same was not a business or commercial right under Section 32 of the Act.

On appeal, the CIT(A) and ITAT ruled in favor of the assessee. Aggrieved, the Revenue appealed before the HC, which dismissed Revenue’s appeal, with key observations and findings as under:

Addition w.r.t excess of net asset value over consideration, credited to reserves:

• The Supreme Court, in the case of Mahindra & Mahindra (404 ITR 1) held that for applicability of Section 28(1)(iv) the income must arise from the business or profession. The assessee was not in the business of amalgamation, hence, Section 28(iv) cannot be made applicable.
• Furthermore, the coordinate bench in the case of Stads Limited (373 ITR 313) had held that provisions of Section 28(1)(iv) make it clear that the amount reflected in the balance sheet as amalgamation reserve under the head 'reserves and surplus' could not be treated as a benefit or perquisite.
• The Revenue’s reliance on the case of Aries Advertising (125 Taxman 969) was distinguished on facts as in the said case, the amounts, which were transferred to the company represented various credits and deposits and remained outstanding for a long time for recovery and unclaimed. The amounts were then transferred to the general reserve. Whereas in the present case, the amount transferred to general reserve is the excess of net book value over purchase consideration.
• The HC thus ruled in favor of the assessee.

In context of depreciation on noncompete fee:

• The Revenue placed reliance on the case of Sharp Business System (27 taxmann.com 50), where the Delhi HC had laid that the rights contemplated in Section 32 of the Act require an element of exclusivity whereby the owner has an advantage against the world at large. It was observed that the coordinate bench in the case of Asianet Communications (257 Taxman 473), after considering the said ruling, categorically expressed disagreement with the reasoning provided by the Hon’ble division bench in the case of Sharp Business Systems, holding that the test laid down by the Apex Court in the case of Empire Jute was not fulfilled.
• It was also observed that in the past years, the AO and CIT(A) allowed depreciation to the assessee’s sister concern on the non-compete fee. Therefore, it was held that the AO was bound to be consistent with the earlier approach, and depreciation shall be allowed.
• In the present appeal, the Tribunal had granted the relief placing reliance on the jurisdiction HC ruling in the case of Pentasoft Technologies (41 taxmann.com 120), holding that non-compete fee is in the nature of a commercial right.
• It was also held that the case of Sharp Business System was distinguishable on facts and hence the Tribunal rightly allowed the reliance to the assessee.

Our Comments

The decision retouches upon the highly litigated issue of depreciation on non-compete fees and reapproves of the deductibility. The tax authorities’ approach for taxing the excess of the net book value of assets over consideration as business income is clearly a case of unwarranted litigation!

Mumbai ITAT grants stay on furnishing securities worth 20% of the demand raised by tax authorities by invoking deemed dividend provisions on the demerger leg of the composite scheme of arrangement

Citiation: Grasim Industries Limited [TS-253-ITAT-2021(Mum)]

The assessee, Grasim Industries Ltd., had entered into a composite scheme of arrangement facilitating its merger of Aditya Birla Nuvo Ltd (ABNL), and thereafter, the demerger of the financial services business into Aditya Birla Capital Limited (ABCL). The NCLT approved this composite scheme of arrangement. Prior to this merger, ABCL was a subsidiary of ABNL, but as ABNL itself merged into the assessee company, ABCL became a subsidiary of the assessee company. The AO observed that the demerger is not in accordance with Section 2(19AA) and held that ABCL merely transferred INR 920 million shares to the assessee under the guise of consideration for the combination of assets and liabilities with a net book value of INR 17.21 billion. He held that the consideration paid is taxable as deemed dividend and the assessee had a liability to discharge Dividend Distribution Tax (DDT). While the assessee’s case is pending before the Tribunal, it filed an appeal before the Tribunal for seeking a stay on recovery proceedings.

Considering that such a huge cash outgo can cripple the business in the current pandemic situation, the Tribunal directed the assessee to submit securities worth 20% of the demand of INR 37.8634 billion as determined by the CIT(A). The Tribunal, going a step ahead, has recorded the below critical issues to be considered while deciding the matter:

• It cannot be concluded that the demerger scheme does not constitute, directly or indirectly, distribution by a company of accumulated profits, and if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company.
• A call will also have to be taken whether the shares allotted to the assessee’s shareholders must come ‘out of’ the accumulated profits, or as long as the distribution is ‘of’ accumulated profits directly or indirectly, the foundational requirements of Section 2(22)(a) will suffice.
• Whether it can be open to the Income Tax authorities to rewrite the demerger scheme approved by the NCLT- particularly when the income tax authorities did not question the same when they were provided of an opportunity to object to the same.

Our Comments

While the ITAT has granted the stay on demand against the deposition of securities by the assessee, the true fate of the case is the most awaited. It needs to be seen how the courts view the term ‘business activity’ or ‘undertaking’ in the context of demerger transactions that enjoy tax neutrality.

Regulatory Updates

Company Law Corner

The Ministry of Corporate Affairs (MCA)’s, circular on clarification for spending CSR funds for setting up makeshift hospitals and temporary COVID-19 care facilities

MCA vide Circular No. 05/2021 dated 22 April 2021 has clarified that spending of CSR funds for ‘setting up makeshift hospitals and temporary COVID-19 Care facilities‘ is an eligible CSR activity under item nos. (i) and (xii) of Schedule VII of the Companies Act 2013 relating to healthcare promotion, including preventive healthcare and, disaster management respectively.

Our Comments

The clarification would pave the way in augmenting resources in the prevailing COVID-19 situation.

MCA issues the Companies (Accounts) Amendment Rules, 2021 and the Companies (Accounts) Second Amendment Rules, 2021 and Companies (Audit and Auditors) Amendment Rules, 2021 and The Companies (Audit and Auditors) Second Amendment Rules, 2021

The MCA, vide a notification dated 1 April 2021, has made a further amendment to The Companies (Accounts) Rules, 2014, regarding the exercise of the powers conferred by Section 134 read with Section 469 of Companies Act, 2013. These new rules may be called the Companies (Accounts) Second Amendment Rules, 2021.

As per the Amendment, the MCA has now deferred the implementation of mandatory use of accounting software featuring the capability of an audit trail to Financial Year commencing from 1 April 2022, i.e., (Beginning from Financial Year 2022-23). Previously, the implementation of such accounting software was mandatory from Financial Year 2021-22. The above amendment shall come into force with effect from 1 April 2021.

In line with the above, MCA also vide its notifications dated 24 March 2021 has inter alia prescribed use of software directing mandatory use of audit trails and made the same applicable with effect from 1 April 2021. Now vide notification dated 1 April 2021, prescribed the Companies (Audit and Auditors) Second Amendment Rules, 2021 has deferred use of software for audit trails which shall now be applicable from 1 April 2022.

Our Comments

The deferment of the date of implementation gives sufficient time to corporates to be ready for proposed changes, especially in view of the COVID-19 situation.

External Commercial Borrowings (ECB)

External Commercial Borrowings (ECB) Policy – Relaxation in the period of parking of unutilized ECB proceeds in term deposits

RBI vide Circular No. RBI/2021-22/16 dated 7 April 2021 has allowed unutilized ECB proceeds drawn down on or before 1 March 2020 to be parked in term deposits with AD Category-I banks in India prospectively for an additional period up to 1 March 2022.

Our Comments

ECB borrowers are allowed to park ECB proceeds in term deposits with AD Category-I banks in India for a maximum period of 12 months cumulatively. Based on requests from stakeholders, including industry associations, and to provide relief to the ECB borrowers affected by the COVID-19 pandemic, RBI relaxed the above stipulation as a one-time measure for ECB proceeds drawn down on or before 1 March 2020, for an additional period up to 1 March 2022.

Securities Law And Compliances Corner

Amendment in Securities and Exchange Board of India Act, 1992 (SEBI Act)

The SEBI Act has been amended on 1 April 2021 in light of the Finance Act, 2021. The Board has inserted Section 12(1C) in the SEBI Act, making it compulsory to obtain registration by every person who acts as a sponsor or cause to be sponsor or cause to be carried on the activity of an alternative investment fund or a business trust as defined in clause (13A) of Section 2 of the ITA, 1961.

A sponsor is a person(s) who set up the Alternative Investment Fund(AIF) and includes promoter in case of a company and designated partner in case of a limited liability partnership.

Our Comments

The said amendment would increase the control on such sponsors who intend to carry on the business of AIF, Real Estate Investments Trusts or Infrastructure Investment Trusts without obtaining appropriate registration certificates.

Amendments in Securities Contracts (Regulation) Act, 1956

To bring it in consonance with the amendments advised in the Finance Act, 2021 the SEBI has brought the following amendments in the Securities Contracts (Regulation) Act, 1956 (The Act) w.e.f. 1 April 2021:

• Insertion of the definition of ‘Pooled Investment Vehicle’(PIV) under Section 2 (da);
• modification of the definition of ‘securities’ under Section 2 (h)(i);
• insertion of ‘units or any other instrument issued by any pooled investment vehicle’ as Section 2 (h) (ida);
• insertion of special provisions related to pooled investment vehicle as Section 30B

Special provisions related to PIV have also been prescribed under Section 30B of the Act, which entails the management of the PIV. The provisions inter alia consist of the below:

PIV eligible to borrow and issue debt securities

PIV constituted as a trust or otherwise and registered with SEBI shall be eligible to borrow and issue debt securities in the manner and extent as specified under the SEBI regulations.

PIV to be permitted to provide security interest to lenders

PIVs shall be permitted to provide security interest to lenders in terms of the facility documents entered into by such PIVs.

Lenders' right to recover any amount from trustees acting on behalf of pooled investment vehicles

In case of default, the lender shall recover the defaulted amount and enforce security interest, if any, against the trust assets, by initiating proceedings against the trustee acting on behalf of such PIV, provided the trustees shall not be personally liable, and his assets shall not be utilized towards the recovery of such debt.

Our Comments

With the above amendments PIV will not fall in the definition of ‘securities’ and be construed accordingly under various statutes, including ITA.

Regulatory reporting by AIFs

As per paragraph 3.2 of Circular No. CIR/IMD/DF/10/2013 dated 29 July 2013, and in terms of AIF Regulations, the AIFs are required to submit periodic reports to SEBI relating to their activities.

In order to simplify the reporting requirements, SEBI vide its circular no. SEBI/HO/IMD/IMD-I/DOF6/ CIR/2021/549 dated 7 April 2021 has advised that all AIFs shall submit a report on their activity as an AIF to SEBI on a quarterly basis within 10 calendar days from the end of each quarter in the revised formats. Further, Category III AIFs shall also submit a report on leverage undertaken on a quarterly basis in the revised formats. All this reporting shall be done online through SEBI intermediary portal and would come into force with immediate effect.

The said Circular has also made certain modifications to paragraph 3 of Circular No. CIR/IMD/DF/16/2014 dated 18 July 2014. As per the changes, SEBI has inter alia advised that any changes in terms of private placement memorandum and the fund/scheme documents shall be intimated to investors and SEBI on a consolidated basis within one month of the end of each financial year. These modified reporting requirements shall be applicable from the quarter ending December 2021.

Our Comments

SEBI, based on consultation with various stakeholders and recommendation of the Alternative Investment Policy Advisory Committee, has taken efforts to assuage the existing regulatory reporting requirements of the AIFs.

SEBI Circular on relaxations relating to procedural matters – Issues and Listing

SEBI vide Circular no. SEBI/HO/CFD/ DIL2/CIR/P/2021/552 on 22 April 2021 has extended the relaxations granted vide Circular No. SEBI/HO/ CFD/DIL2/CIR/P/2020/78 dated 6 May 2020 (Primary Circular). In the primary Circular, SEBI had granted a one-time relaxation from strict enforcement of certain SEBI regulations, including (Issue of Capital and Disclosure Requirements) Regulations, 2018, pertaining to Rights Issue opening. The relaxation mentioned in point no. in point (iv) of aforesaid Circular, providing that an application to rights issue can be made by in addition to ASBA facility having regard to difficulties faced due to COVID-19 and lockdown measure, has been extended up to 30 September 2021.

Our Comments

SEBI has been receiving requests from various market participants for relaxation from the clause that the application for a rights issue shall be made only through the Applications Supported by Blocked Amount (ASBA) facility. SEBI, therefore, understanding the difficulties being faced by the applicants, had granted the above relaxation in May 2020 for rights issues opening up to 31 July, and later extended the relaxation for rights issues opening up to 31 December 2020, 31 March 2021 and now up to 30 September 2021.

SEBI Circular for relaxation from compliance with certain provisions in light of the COVID-19 pandemic

SEBI vide circulars dated 29 April 2021 has relaxed certain timelines under SEBI (Listing Obligations Disclosure Requirements) Regulations, 2015 (Regulations) considering the surge in COVID-19 cases and lockdown measures. The below table prescribes revised timelines as under:

Furthermore, listed entities are permitted to use digital signature certifications for authentication/certification of filings/submissions made to the stock exchanges under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 for all filings until 31 December 2021.

Our Comments

The relaxation comes at the right time and responds to the needs of the present situation of increasing COVID-19 cases and lockdown measures.