Tax and legal due diligence of target company is key
October, 10th 2006
Any M&A in India has to be carefully planned and executed, cutting through a wide spectrum of tax and regulatory issues.
When companies go through M&A (merger and acquisition) deals what are the key tax issues that arise? How far do tax laws and other laws encourage or constrict M&A, inbound and outbound? For starters, inbound deals have a foreign buyer and an Indian target, while outbound deals are the opposite.
"Inbound acquisitions have recently become the flavour of the season with a good number of deals ringing the bells of some of the finest Indian fast-growing corporates," says Mr Girish Vanvari, Executive Director - M&A Tax, KPMG, India.
He cites as examples: Heidelberg's purchase of 51 per cent stake in Mysore Cements, EDS Corp's acquisition of 52 per cent stake of MphasiS BFL, Kohlberg Kravis Roberts (KKR) buying up Indian software unit Flextronics, and Holcim taking up stake in Gujarat Ambuja Cement.
"These transactions require a lot of structuring such that they are tax-efficient, compliant with SEBI (Securities and Exchange Board of India), FDI (Foreign Direct Investment) regulations and so forth," points out Mr Vanvari. "The Heidelberg's acquisition in the BIFR-reported (Board of Industrial and Financial Reconstruction) Mysore Cements triggered off the SEBI takeover code. Heidelberg compulsorily made an open offer for 22.15 per cent stake at a price higher than their acquisition price," he recounts.
"The acquisition of 51 per cent stake was made on a preferential basis subject to the approval of the shareholders in their extraordinary general meeting." Thus, corporate law provisions come in to full play in deals involving companies.
What about the EDS Corp deal? "This merger is subject to the approval of the Bombay and Karnataka High Courts. Also required are sanctions of the stock exchanges, shareholders, creditors, and regulatory authorities," explains Mr Vanvari.
"Tax neutrality of this merger will be on the compliance with the `amalgamation' conditions laid down under Section 2(1B) of the Income-Tax Act, 1961." In contrast, KKR's acquisition of 85 per cent of Flextronics did not trigger the takeover code, distinguishes Mr Vanvari. Because "the Indian entity had applied for voluntary delisting and been delisted from BSE and NSE in 2005."
Not all proposals sail through, as for example the US glassmaker Guardian Industries' idea to set up a separate wholly owned glass venture in the country.
"It ran into rough weather with the FIPB (Foreign Investment Promotion Board) since the company already had a joint venture partner in India, and its partner would not grant a no-objection certificate to Guardian," narrates Mr Vanvari.
"Any M&A in India has to be carefully planned and executed, cutting through a wide spectrum of tax and regulatory issues such as exchange control, income-tax, capital market regulations and so forth," he opines.
"From tax perspective it would be important to structure these transactions into the country in a tax efficient manner, taking into account manner of funding, and choice of the holding company jurisdiction."
Recently we have had many outbound acquisitions. Such as: Patni's acquisition of the US-based Cymbal Corporation for about $68 million; Dr Reddy's acquisition of Betapharm in Germany for $570 million, and Terapia in Romania for $324 million; Suzlon's acquisition of Eve Holding in Belgium for $526 million; Aban Loyd's acquisition of Sinvest ASA in Norway for $445 million; and Matrix Labs acquiring Docpharma in Belgium for $320 million. And the deal meter keeps ticking!
"Outbound acquisitions are guided not only by the tax laws of the foreign companies but also the political relationships, free trade agreements (FTAs) and double taxation avoidance agreements (DTAAs or tax treaties) between these countries," says Mr Vanvari. "Deal structuring from tax perspective has become one of the most important factors for structuring transactions in the recent times such that the transaction is tax neutral or has minimum tax outflow."
It should enthuse professionals that a lot of tax planning is possible because good tax treaties are in place with many countries.
Yet, areas that need appropriate attention, according to Mr Vanvari, are: `substance' test, tax outflow, capital gains, dividend, interest and royalty, withholding taxes and elimination of double taxation.
"Tax, legal and financial due diligence of the target company is of utmost importance," he alerts.
For, such an exercise can result in `a good understanding of the laws governing the target company,' so that you can structure the transactions appropriately.