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Mergers and amalgamations meant to avoid tax to face more scrutiny
April, 15th 2014

The Central Board of Direct Taxes (CBDT) and the ministry of corporate affairs (MCA) are getting their act together to ensure a strict vigil over mergers and amalgamations (M&A) to safeguard tax revenues.

M&A deals involving the proposed merger of a loss-making company into a profit-making entity to set off the loss and, thereby, reduce the tax liability of the corporate group, are likely to come under the glare of the regulators.

Through internal memos', both the CBDT and the MCA have geared up to strengthen the implementation of the existing regulations. In the administrative process outlined by the regulators in their internal memos, the MCA will ensure that the Income Tax (I-T) authorities are informed of proposed M&A transactions within 15 days of receiving intimation from companies. If the I-T authorities find that the proposed M&A transaction is structured in a manner that it would be 'prejudicial to the interest of the revenue and thereby not in public interest', it will report its objection. The MCA will include this objection in the report filed by it with the jurisdictional high court.

"Companies would be well advised to have a clear commercial rationale for their proposed restructuring schemes of merger or demerger. Schemes driven solely by tax objectives could be subject to far greater scrutiny and companies may need to be prepared to demonstrate the primary purpose of the scheme and be prepared for the consequential implementation delays," says Pranav Sayta, partner, EY.

A terse instruction issued by the CBDT in its memo dated April 11, addressed to all chief commissions, calls upon I-T officials to respond to the MCA immediately on being notified of an M&A transaction.

The memo stems from an M&A transaction where the scheme of amalgamation was designed to be effective from retrospective dates and not from the date of approval by the high court. This restructuring with retrospective effect facilitated set-off of losses of some companies against the profits of other companies in the corporate group. The CBDT, in its memo, refers to the 'adverse impact on public revenue' (tax collection) of the M&A transaction.

I-T authorities were not informed by the MCA about this particular transaction. Later, an intervention application filed by the I-T authorities opposing the M&A scheme, was shot down by the high court on the ground that the I-T department did not have a 'locus standi' in the matter. Only the MCA was authorized to file its report opposing the M&A before the high court.

While the CBDT's memo does not name the parties in the M&A transaction, according to sources close to the developments, it relates to the Sesa-Sterlite restructuring after which the company claimed a tax refund of Rs 1,500 crore. According to earlier news reports, the Supreme Court last November held that an appeal opposing the merger can be heard only if the MCA files a special leave petition.

The CBDT, in its memo, emphasizes that it is important to revert immediately to the MCA on being informed of an M&A transaction. "This is the only opportunity with the I-T department to object to the amalgamation scheme if the same is found prejudicial to the interest of the revenue."

On its part, the MCA had in January issued an internal memo on the same subject, calling upon all its Regional Directors to ensure that within 15 days of receiving a notice of the proposed M&A from the companies, they must inform the I-T authorities and seek their specific comments. Only then should they file their report with the high court concerned.

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