The successful acquisition of Corus by the Tatas has raised expectations of similar deals by Indian corporate houses. The Finance Minister, Mr P. Chidambaram, has promised all help to the Tatas in their new venture in London. Financial analysts have pointed out how several Indian companies pursued several global deals only to lose out in the end, generally because of the price factor. Videocon's bid for South Korean electronics major Daewoo Electronics and UB's bid for the Scotch giant Whyte and Mackay fell through because the asset prices demanded by the foreign target groups were 15 per cent higher than what the Indian companies offered. The head of the mergers and acquisitions (M&A) division of an international consulting firm observed:

"When companies get into high-profile acquisitions, a lot depends on how you back up the deal process. Besides the obvious pack of how much you can cough up, experience in closing cross-border deals also makes a difference."

Fiscal incentives

Indian companies have gained a reputation for turning around loss-making global operations. This has been made possible by, among other things, fiscal incentives provided by way of amendment to the income-tax law. New provisions were incorporated in the law for demerger, which is relatively a new phenomenon in the Indian corporate sector.

The Companies Act does not have specific provisions governing demergers. Transactions of this nature are covered through schemes of compromise or arrangement under Sections 391 to 394 of the Companies Act and these are sanctioned by the High Court.

Section 2(19AAA) of the Income-Tax Act, 1961 defines the term "demerger". After laying down several conditions for qualifying as demerger for claiming tax concessions, the definition clause makes the availability of concessions subject to the fulfilment of the conditions notified by the Central Government under Section 72A(5). Provisions are there in Section 47 for exemption from capital gains tax for demergers. Tax exemptions are provided to a foreign shareholder for transfer of shares of an Indian company pursuant to a merger or demerger (Section 47 (via).) To get the benefit of this exemption, at least 25 per cent of the shareholders of the amalgamating foreign company should continue to remain with the shareholders of the amalgamated foreign company.

There is the further requirement that the transfer should not attract capital gains tax in the country of incorporation. This was the decision of the Authority for Advance Ruling (1994 In Re 240 ITR 518). Now the question arises, what happens in the converse case. Transfer of shares in a foreign company by the Indian shareholder consequent to a foreign merger or restructuring should also be eligible to get similar exemption from capital gains tax. There is no provision in Section 47 in this regard to promote tax neutrality for Indian shareholders. This requires immediate attention.

Restrictive definition

The restrictive definition of demerger in the Indian law creates problems in the practical world. Indian law requires that all assets and liabilities relating to the undertaking be transferred at book value. Tax consultancy firms point out that there can be exceptional cases where, due to various laws or contractual obligations, it may not be possible to transfer all assets and liabilities. Nor will it always be possible to transfer at book value. Such exceptional cases should also be taken care of by fine-tuning Section 47 to promote tax neutrality. A proviso can always be added that the sole objective of demerger should not be tax avoidance.

Section 79 is yet another provision which has to be looked into while working out cross-border transactions. Carry forward of losses and their set off is not allowed under the Section in the case of a closely-held company, unless on the last day of the previous year the shares of the company carrying not less than 51 per cent of the voting power are beneficially held by the same persons as on the last day of the previous year in which the loss was incurred.

This requirement of Section 79 will not apply in cases where the shareholding changes in an Indian subsidiary on account of merger or demerger of a foreign company. It is necessary that this relaxation be provided to Indian holding companies too. Section 79 should be made applicable to all cases of mergers and demergers.

The definition of the term `industrial undertaking' and the `specified banking company' in Section 72A need to be changed. In this era of globalisation, where the service sector accounts for 50 per cent of GDP, it is unrealistic to limit fiscal concessions merely to the manufacturing sector, specified banking companies or telecom services and shut out other important sectors. After all, fiscal concessions will enable Indian companies have better bargaining power in cross-border deals. The tax cost is a vital element in all such deals.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)