TAX BENEFITS IN THE CASE OF AMALGAMATION !

An in-depth look at the IT act and it's significance in times of a merger.

1.1. By way of Absorption : Under the Income Tax Act, the concept of the transferor company losing its identity in the case of an amalgamation by way of absorption, has a great significance. In this case, the corporate personality of the transferor company ceases to exist immediately upon completion of amalgamation. This results in the loss of benefit by way of carry forwa

rd of loss1, only the person the legal entity which has sustained the loss - can carry forward the loss. In other words, the right to carry forward the loss is directly attached to the assessee and neither to the business nor the undertaking. Thus, if a sick company merges with a healthy company, the losses will not automatically flow to the healthy company. The healthy company can avail the benefits of the losses of the sick company only by obtaining the Government's approval under Sec. 72A of the I.T. Act. The losses of the sick company become a capital loss and the benefit of right to carry forward is lost to the sick company when it merges with a healthy company, as the legal entity ceases to exist consequent to the amalgamation. 1.2. Tax consequences when Companies merge with a new company : Sometimes, the business of existing Companies is restructured by merging existing Companies with a newly incorporated company. By properly structuring the capital of the new company, the desired capital gearing is achieved after taking into account the fresh shares to be issued to the shareholders of the other company. If all the Companies are unlisted in any stock exchange, then there will not be any impediment in adopting this plan. There are also examples where listed Companies were merged with unlisted Companies to achieve the same objective. Whatever may be the motive (from business point of view), the tax consequences in the case of both the merging company and the merged company remains the same and there is no special tax advantage. As far as the merging Companies are concerned, if they were incurring losses the carry- forward benefits would not be available to the new company. At the same time, the new company would also not get any special advantage as it is only taking over the businesses of the existing company. 2.3. Implications of Sec. 79 of the I.T. Act when there is a change in the shareholding : Under Sec. 79 of the Income Tax Act, if there is a change in the shareholding of a company in which the public are not substantially interested, any loss incurred prior to the previous year in which the change has occurred will not be allowed to be carried forward and set-off unless shares constituting more than 51 percent. of the voting power were beneficially held by persons who beneficially held shares on the last day of the year or years in which the loss was incurred. There has been vehement criticism on this Sec. and it has been pointed out by all that this Sec. comes in the way of rehabilitating sick private Companies even though there are many entrepreneurs willing to take up the challenge. Keeping the criticism aside, let us analyse the position of a sick private limited company being amalgamated with another company (whether private or public). If this definition2  is satisfied, then because of the change in the share-holding of more than 51 percent., Sec. 79 will get attracted, denying in the process the night to carry forward and set-off the losses incurred in the previous years. This is a paradox and it is hoped that the Government will scrap Sec. 79 altogether. Needless to say, it has been clarified by various judgments that the loss referred in this Sec. represents only the business loss and not any unabsorbed depreciation. Tax planners merging listed company with unlisted Companies or merging two unlisted Companies should keep this point in mind. 2. Capital Gains & Amalgamation 3.1. Specific exemptions contained in Sec. 47 with respect to amalgamation : Is there any capital gain incidence at the time of amalgamation? Under the provisions of the Income Tax Act, a capital gain will arise when a capital asset is 'transferred'. The word 'transfer'3  means the sale, exchange, or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law. Shri Nani Palkhiwala in his own style rules out the incidence of capital gains tax in the following manner : "Where company A amalgamates with and merges into company B and the shareholders of company B in their own right and not as nominees of company A question arises whether those share-holders reliable to tax under the head 'Capital Gains'. It is clear that such amalgamation does not involve any exchange either within the legal meaning of the term. Whereas the allotment of shares by company B to the shareholders of company A does not involve a transfer of the assets by either of the two parties to the other. The allotment of shares by the company cannot be regarded as a transfer of property by that company".4 The merger does not involve 'relinquishment of the asset' because relinquishment postulates the contained existence of the asset over which the rights of its holder are relinquished or surrendered, whereas upon amalgamation the shares in company A cease to exist.5 2.2. Is capital gains exemption available to the shareholder if he gets shares and bonds in exchange of shares? With the new types of financial instruments being invented and used commonly by all, there arises a doubt as to whether in an amalgamation Scheme if shares are exchanged for shares and bonds in the amalgamated company, the exemption will be available or whether there be any capital gains incidence? Mr. N. A Palkhiwala, the learned author feels that the exemption will continue to apply.6 2.2.1. C.I.T. v. Master Raghuveer Trust :Facts of the case are very interesting a7nd relevant in this context. The assessee Trust held shares in S Bank which was amalgamated with the Industrial Credit and Development Syndicate (I.C.D.S.) after the nationalisation of Banks in 1969 as per the Scheme approved by the High Court under Sec. 394 of the Companies Act. Consequently, the assessee received equity shares, advance call deposit certificates, debentures and redeemable bonds in lieu of the shares held by the assessee in S. Ltd. For the assessment year 1974-1975, the assessee claimed exemption of the capital gains realised from the said Scheme of amalgamation, inter alia, on the ground that there was no transfer involved as required under Sec. 2(47). (Judgment) The Court held that : "Even if it was assumed that in the process of amalgamation of Companies, there would be transfer of assets of the amalgamating company to the amalgamated company inasmuch as there would be extinguishment of rights in the shares held by the assessee in the amalgamating company, there was no consideration for such extinguishment which would be paid to the assessee. In the first place, the assessee was not an eo nomine party to the amalgamation or to any transaction by which its assets were transferred to the I.C.D.S. Secondly, by the process of amalgamation, the shares held by the assessee in S. Ltd., had become useless or valueless and S. Ltd., was struck off from the register as required under Sec. 394(1)(iv) of the Companies Act. And thirdly, the assessee, as a member of the amalgamating company, S. Ltd., was entitled to some shares, bonds, etc., from the I . C . D . S . This was neither in satisfaction of its rights nor as a consideration for the transfer. The allotment of shares, etc., to the assessee could not, therefore, be considered as a transfer for consideration within the meaning of Sec. 2(47). The Special Leave Petition filed by the Income-tax Department in this case was rejected by the Supreme Court.8 There was a contrary decision rendered by the Gujarat High Court in C.I. T. v. Goutham Sarabhai T r u s t . 9 The same High Court again reconsidered the matter in C.I.T. v. Leena Sarabhai,10 and after examination, decided the case in favour of the assessee by holding that there is no transfer as defined under Sec. 2(47) when the assessee receives shares and bonds in exchange of shares because of amalgamation. Thus, it is evident that even in a typical case where shares and bonds (including convertible) are allotted in exchange of shares, there is no capital gains liability. The idea can be properly used for structuring the capital gearing of the amalgamated company in the post-merger

scenario.

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<EM>1. As under the provisions of the I.T.

A2.&nbsp;As per cSec. 2(IB), the dt efinition of am.algamation will be satisfied only if shareholders holding not less than nine-tenths in value of the amalgamating company become shareholders in the amalgamated company by virtue of amalgamation.

3.&nbsp;As defined under Sec. 2(47) of I.T. Act

4.&nbsp;The Law &amp; Practice of Income Tax Act, pages 771 to 773

5.&nbsp;The amalgamation does not involve extinguishment&nbsp; of the asset viz. shares in company A ; but the better view is that it does not involve 'extinguishment of rights therein'.

6.&nbsp;Under Sec. 47(vii) 7.&nbsp;151 ITR 368

8.&nbsp;See 187 ITR Statute 45

9.&nbsp;173 ITR 216

10.&nbsp;81 Taxman 29</EM>