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Mergers & amalgamations: Practical issues in Cenvat
May, 13th 2013

The general philosophy in tax is that a merger or demerger, acquisition or sale should be tax neutral, as far as possible. This is particularly true in case of indirect tax, which is supposed to be a tax collected from the customer, not imposed on the business.

To this end we have rule 10 of the Cenvat credit rules, which is intended to facilitate a seamless transfer of Cenvat credit from the person selling the business to the acquirer. Rule 10 provides that in case of transfer of business due to sale, amalgamation, lease, etc, the accumulated Cenvat credit would also be transferred to the extent unutilised. The words used in rule 10 are that the person transferring the business 'shall be allowed to transfer the Cenvat credit lying unutilised in his accounts to such transferred, sold, merged, leased or amalgamated business'.

This is intended to be a facilitative provision, not a punitive one or an anti-abuse provision. However, there is a potential problem with this particular provision. In order to understand the issue, one has to understand these transactions in terms of how they typically take place. Typically, the parties involved file a scheme of arrangement with a court, which details what business will be transferred from which date, etc.

The court hears the proposed scheme and provides its approval to the scheme, provided it is satisfied that the interests of all parties have been reasonably taken care of by the specifics of the scheme. The court order is filed with the registrar of companies, at which point it is effective. At this point one realises the complications in rule 10 mentioned above.

Typically, the effective date of the scheme is in the past. Depending on the specifics of the time taken to negotiate the scheme, the time taken for the court approval process, etc, the effective date may be at least 3-4 months earlier. This applies equally for a sale or lease of a business, which does not require a court approval. As an illustration, let us assume that a sale of a business took six months to negotiate and was signed on September 30 of a particular year. Let us also assume that the effective date of the transfer of the business was March 31 of the same year, ie, six months earlier. This would not at all be an unusual fact pattern. In this situation, the business would belong to the new owner from April 1. However, this would not be known until September 30 that year - 6 months later.

Normally, the old owner would have some Cenvat credit in his books that was unutilised as on March 31. (This would usually relate to capital goods purchased in the previous year, where the Cenvat credit rules permit credit to be taken over two years.) Usually, such credit would be utilised for the service tax or excise payment for April. However, in September the business is sold as of March 31. Rule 10 provides that the unutilised Cenvat credit is 'allowed' to be transferred to the new owner.

In a more mature jurisdiction, this would not create a problem. The provision would be interpreted liberally and the fact that the unutilised Cenvat credit on March 31 was used up in the month of April would be interpreted as that on the day of the transaction being implemented (September 30) there was no unutilised Cenvat credit that had to be transferred. At this point at least, the tax authorities in India have a more confrontational culture with the assessee. Therefore, such a benign interpretation is unlikely to be taken. It is more likely that the authorities would treat the old owner as having used Cenvat credit that was transferred to the new owner by virtue of rule 10.

The old owner of the business would be treated as having paid tax short. This would be particularly true in some businesses where the transferred business had significant assets (which generated unutilised Cenvat credit each year) but insignificant revenues, because the part of the business that was sold did not have revenues. An example of this would be if a captive power plant was spun off as a separate business, where prior to being spun off, it was captive to a manufacturing operation.

The solution is that rule 10 should be redrafted appropriately so that the transfer of Cenvat credit should be something that is exercised by both - the buyer and seller of the business - as a matter of choice.

Considering that rule 10 is an enabling provision, this should not be too difficult a suggestion to the authorities.

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