Tag Archives: Cross Border M&A

M & A: Different structures and a comparative

Acquisition of an entity can be undertaken in a number of ways such as an asset transfer, stock purchase, share swap, etc. It is critical to have certainty on the mode or structure of acquisition from the initial stage itself since the definitive agreements and the implementation steps for effectuating the acquisition will largely depend on the mode of acquisition. An acquisition transaction can be structured in different ways depending on the objective of the acquiring entity or the buyer. In this article, we have attempted to provide a brief overview and comparative of some of the different structures of acquisition.

Asset Purchase

  • In an asset purchase transaction, the acquiring entity takes over, either all or certain identified assets of the target entity or the seller. The first step in an asset purchase transaction is to determine what the assets and liabilities being taken over would be. Similarly, the definitive agreements should clearly lay down the assets/ liabilities being taken over and those which are not.
  • One of the major advantages of an asset purchase transaction is that the buyer can pick and choose the assets and liabilities which are to be acquired. The buyer may also choose not to take over any liabilities but purchase only the assets.
  • Another important aspect which has to be taken into consideration is with respect to the employees. In an asset transfer transaction, consent of the employees has to be taken if they are part of the acquisition transaction. Compliance to various labour laws has to be met. If the employees are not part of the transaction, then retrenchment compensation under Industrial Disputes Act, 1947 has to be examined. Please see our previous post on Employee Rights in M&A to know more on this.
  • In an asset purchase transaction, tax is calculated basis depreciable assets and non-depreciable assets. Capital gains tax is applicable basis the difference between the cost of acquisition and sale consideration. Depending on the holding period of the asset, either long term capital gains tax or short-term capital gains tax is applicable. In case of depreciable assets, depreciation is allowed as deduction.
  • Stamp duty is levied, in an asset purchase transaction, on the individual assets being transferred. Stamp duty is usually a percentage of the market value of the assets.
  • Losses or any other tax credits cannot be carried forward in an asset purchase transaction, as the target entity itself is not being acquired in this case. After an asset transfer, the shell entity remains and it is often a commercial consideration of whether the promoters of the acquired entity need to compulsorily shut down the shell entity or if it can be used for other business purposes. If the target entity continues to exist, considerations of ongoing business, usage of any remaining intellectual property, etc. become major discussion points between the parties involved.
  • Slump Sale: Slump sale refers to the sale of the entire business of an entity as a going concern without values being assigned to individual assets. As per section 2(42) of the Income Tax Act, 1961, ‘slump sale’ means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales. In case of a slump sale, the seller is liable to pay tax on the profits derived on the transfer at rates based on the period for which the undertaking is held. If the undertaking is held for more than 36 months, the capital gains will be taxed as long-term capital gains and if the undertaking is held for less than 36 months, capital gains will be taxed as short-term capital gains.

Share Purchase

  • Share purchase is a type of acquisition in which the buyer takes over the target entity by purchasing all the shares of such target entity. The entire liability of the seller is taken over by the buyer in such an acquisition.
  • An advantage of structuring an acquisition as a share purchase, is that there would not be any major disturbances caused to the business of the seller since there is no requirement of entering into fresh contracts, licenses, etc. Losses and other tax credits could also be carried forward.
  • If the shares being sold are held for more than 24 months, capital gains will be taxed as long-term capital gain tax. If the shares being sold are held for less than 24 months, the capital gains will be taxed as short-term capital gains tax. Indexation benefits will be as applicable.
  • In the event of transfer or issue of shares to a non-resident, the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 and the pricing guidelines have to be complied with.
  • Determination of fair market value pricing is important in such case, due to the applicability of pricing guidelines (in case of non-resident involvement) and also as per Section 50CA and Section 56(2)(x)(c) of the Income Tax Act, 1961, that provide for deeming provisions and taxation (in the hands of both transferor and transferee) basis full value consideration, in case of transaction price being less than FMV/full consideration.
  • Deferred Consideration: Since in a complete share purchase acquisition, the buyer also takes over the liabilities of the target entity, it is common to have deferred consideration models, in order to set off any future liabilities from the total consideration package. However, in case of such share purchase acquisition coming under the ambit of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, the Reserve Bank of India, vide Notification No. FEMA 3682016-RB, has mandated that not more than 25% of the total consideration can be paid by the buyer on a deferred basis within a period not exceeding 18 months from the date of the transfer agreement. As mentioned in the said Notification, for this purpose, if so agreed between the buyer and the seller, an escrow arrangement may be made between the buyer and the seller for an amount not more than 25% of the total consideration for a period not exceeding 18 months from the date of the transfer agreement, or, if the total consideration is paid by the buyer to the seller, the seller may furnish an indemnity for an amount not more than 25% per cent of the total consideration for a period not exceeding 18 months from the date of the payment of the full consideration.

However, this brings in difficulties in transactions where for commercial reasons, the buyer and the seller may mutually agree to tranche based or deferred consideration, which as per the mentioned Notification, can only done within certain specified parameters.

Share-Swap

  • Another method of structuring an acquisition deal is through a share swap arrangement. In a share swap arrangement, if one entity wants to acquire another entity, instead of cash consideration, the shares of the buyer entity may be exchanged for the shares of the seller entity. An acquisition can be structured such that the entire consideration is through share swap or it can also be partly through share swap and partly through cash consideration.
  • If a foreign entity is involved in a share swap deal, the FDI and ODI Regulations become applicable. One of the most important consideration to be mindful of, is that the FDI regulations states that the price of shares offered should not be less than the fair market value of shares valued by SEBI registered Merchant Banker. Please refer to our previous post on M&A through Share Swap/Stock Swap Arrangements for more details in this regard.
  • The taxation in a share swap transaction works such that the shareholders swapping the shares are subject to taxation, basis the difference between the value of the shares being swapped. The concern here is that the shareholders will have to pay taxes when they have not received any actual cash consideration, but only shares of another entity by exchanging the existing shares they held.

Acqui-hire

  • In an acqui-hire transaction, typically, a relatively bigger entity, acquires the talent pool of a relatively smaller entity and this has gained significant prominence in the early stage ecosystem in India over the last couple of years. An acqui-hire may also be combined with an asset purchase transaction. The consideration in an acqui-hire is usually based on the talent of the employees, seniority, etc.
  • One of the main advantages of an acqui-hire transaction, from the perspective of the buyer, is that the employees already have experience, the buyer need not spend time, effort and energy in training them.
  • Another advantage of an acqui-hire is that the employees are usually subject to non-compete clauses with their employer and therefore, lateral hiring of employees may not be always possible especially when the acquirer is in a competing business as that of the target company. In an acqui-hire, the non-compete clauses would typically get waived.
  • Shares held by the existing investors of the target company and the way it is dealt varies on a case to case basis and it is mostly a function of discussion between the promoters, the existing investors and the potential buyer, given the economic condition and sustainability of the target company, if the acquisition does not go through.
  • Since the main objective of an acqui-hire is to acquire the employees, the employment agreement entered into with the acquired employees becomes very important. Adequate precaution needs to be taken to ensure that all important clauses such as earn out, non-compete, stock options granted to employees, etc. are included in the employment agreement.
  • Some of the consideration points of an acqui-hire deal would be conducting interviews of the employees selected to be acquired, and assess suitability. Also, there is always the possibility of the acquired employees leaving upon the expiry of the earn-out period, which then needs to be structured in a very balanced manner. This requires a very evaluated cost benefit analysis of the earn out versus the minimum time period for which an employee would be required to continue in the purchasing entity.

Cross-Border Merger

  • Cross-border mergers are one of the ways adopted by entities to expand their operations to a foreign country and entering into new markets. A cross-border acquisition means acquisition of one entity by a foreign entity.
  • Cross border mergers in India are mainly dealt with under the Companies Act, 2013 and the Foreign Exchange Management (Cross Border Merger) Regulations, 2018 (“Merger Regulations”). As per the Merger Regulations, the separate approval of RBI is no longer required as long as the cross-border merger is undertaken in accordance with the Merger Regulations.
  • Cross-border merger may be either ‘inbound merger’ or ‘outbound merger’. Inbound merger means a cross-border merger, where the resultant company is an Indian company. An outbound merger means a cross-border merger where the resultant company is a foreign company. A resultant company means an Indian company or a foreign company which takes over the assets and liabilities of the companies involved in the cross-border merger. There are separate set of compliances required for inbound merger and outbound merger under the Merger Regulations. For example, in case of an inbound merger, the compliances with respect to pricing guidelines, sectoral caps, reporting requirements, etc. under the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 ought to be adhered to. Also, subject to the foreign exchange management regulations, the Indian entity is allowed to hold assets in the foreign country. Also, the Merger Regulations give both the Indian entities and foreign entities a time period of 2 years to comply with the foreign exchange management compliances. Please refer to our previous post on Cross-Border Mergers-Key Regulatory Aspects to Consider for further details regarding the regulatory aspects to be considered in case of cross border mergers.
  • One of the major concerns regarding cross-border mergers is with respect to taxation. While an inbound merger, where the resulting entity is an Indian company, is exempt from capital gains tax as per Section 47 (vi) of the Income Tax Act, 1961, there is no such exemption given in case of outbound mergers. Also, in case of outbound mergers, the branch office in India may be considered as a branch office of the foreign entity. In such a scenario, the branch office in India may be considered as a permanent establishment of the foreign entity in India and global income of the foreign entity may become be subject to tax in India.

Disclaimer: Structuring an M&A transaction is complex and requires a case to case evaluation of objectives, consideration, taxation at each stakeholder level, etc. The purpose of this article is to disseminate information only and readers are requested to seek profession advice shall for any individual requirement.

 We do not practice in tax matters. Any reference to tax matters herein is indicative and for reference purpose only.

Cross Border Mergers – Key Regulatory Aspects to Consider

Introduction

Cross-border mergers and acquisitions have rapidly increased reshaping the industrial structure at the international level. A cross-border merger means any merger, amalgamation or arrangement between an Indian company and a Foreign Company[1] in accordance with the Companies Act, 2013 and the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016.

The Ministry of Corporate Affairs notified Section 234 of the Companies Act, 2013 thereby enabling cross-border mergers with effect from 13 April 2017. Thus, it was a matter of time that the Reserve Bank of India notified the regulations in order to operationalize the cross-border merger.

Regulatory Framework

In India, Cross border is majorly regulated under (i) the Companies Act 2013; (ii) SEBI (Substantial Acquisition of Shares and Takeovers) Regulations 2011; (iii) Competition Act 2002; (iv) Insolvency and Bankruptcy Code 2016; (v) Income Tax Act 1961; (vi) The Department of Industrial Policy and Promotion (DIPP); (vii) Transfer of Property Act 1882; (viii) Indian Stamp Act 1899 (ix) Foreign Exchange Management Act 1999 (FEMA) and other allied laws as may applicable based on the merger structure.

The two most relevant regulations under FEMA from a merger & amalgamation perspective are Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (the FDI Regulations) and Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (the ODI Regulations). In addition to this, the Reserve Bank of India (the RBI) has notified Foreign Exchange Management (Cross-Border Merger) Regulations, 2018 (the Cross-Border Regulation) under the Foreign Exchange Management Act, 1999 to include enabling provisions for mergers, demergers, amalgamations and arrangements between Indian companies and foreign companies covering Inbound and Outbound Investments. This is a significant move as there will be a massive surge in the flow of Foreign Direct Investment with the enactment of new laws and tweaking of existing policies.

Inbound & Outbound Merger

Cross-Border Merger could be either Inbound merger or Out-bound Merger. Inbound Merger means a cross-border merger, where the resultant company is an Indian company. An outbound merger means a cross-border merger where the resultant company is a foreign company. A resultant company means an Indian company or a foreign company which takes over the assets and liabilities of the companies involved in the cross-border merger.

Key provisions of the Cross-Border Regulation in case of Inbound Mergers

Issuance of Securities

As a consideration, the Indian company would issue or transfer of securities to the shareholders of transferor entity which may include both persons resident in India and person resident outside India. In case of a person resident outside India, the issuance of securities shall be in accordance with the pricing guidelines, sectoral caps and other applicable guidelines as prescribed under the Cross-Border Regulation. However, if the foreign company is a JV/WOS then it shall comply with the conditions prescribed as specified in Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004. Further, if the inbound merger of the JV/WOS results into an acquisition of the one or more step-down subsidiary of JV/ WOS of the Indian party by the Resultant Indian company, then such acquisition should be in compliance with Regulation 6 and 7 of the ODI Regulations.

Vesting of Assets & Liabilities

  • Any borrowings or guarantees of the transferor company shall become the borrowings or guarantees of the resultant company. A timeline of two years has been provided to conform with the external commercial borrowings compliance. The end use restrictions would not apply in such cases.
  • Any asset acquired by the resultant company can be transferred in any manner as permissible under the Act or regulations. Where such asset is not permitted to be acquired, the resultant company shall sell the same within two years from the date of sanction of order by the National Company Law Tribunal (the NCLT) and the sale proceeds shall be repatriated to India immediately through banking channels. Where any liability outside India is not permitted to be held by the resultant company, the same may be extinguished from the sale proceeds of such overseas assets within the period of two years.
  • The resultant company is permitted to open a bank account in the foreign country’s jurisdiction for overseeing transactions related to the merger for a maximum period of two years from the date of sanction of scheme by the NCLT.

Valuation

The valuation shall be done as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 i.e., by Registered Valuers who are members of recognized professional bodies in the prescribed jurisdictions of the transferee company and such valuation is in accordance with internationally accepted principles on accounting and valuation.

Key provisions of the Cross-Border Regulation in case of Outbound Mergers

Issuance of Securities

(a) As a consideration, the Foreign Company would issue securities to the shareholders of Indian entity which may include both persons resident in India and person resident outside India. In case if shares are being acquired by a person resident in India, then such acquisition shall be subject to the ODI Regulations as prescribed by the RBI.

Vesting of Assets & Liabilities

  • The guarantees or borrowings of the resultant company shall be repaid as per the scheme sanctioned by the NCLT. Further, they should not acquire any liability not in conformity with the Act or regulations as prescribed. A no objection certificate to this effect should be obtained from the lenders in India of the Indian company.
  • Any asset acquired can be transferred in any manner as permissible under the Act or the regulations thereunder. In cases where it cannot be held or acquired by the resultant company, it shall be sold within two years from the date of sanction of the scheme by the NCLT and the sale proceeds shall be repatriated outside India immediately through banking channels. Repayment of Indian liabilities from sale proceeds of such assets or securities within the period of two years shall be permissible.

Opening a Bank Account

The resultant company is permitted to open a Special Non-Resident Rupee Account (SNRR Account) for the purpose of for overseeing transactions related to the merger for a maximum period of two years from the date of sanction of a scheme by the NCLT.

Valuation

The valuation shall be done as per Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules 2016 i.e., by registered valuers who are members of recognized professional bodies in the prescribed jurisdictions of the transferee company and such valuation is in accordance with internationally accepted principles on accounting and valuation.

Other Compliances

  • The resultant company and/or the companies involved in the cross-border merger shall be required to furnish reports as may be prescribed by the RBI, in consultation with the Government of India, from time to time.It is pertinent to note that at the time of sanctioning the merger of a foreign transferor body corporate with an Indian transferee company, the NCLT shall consider the validity of the merger as per the laws of the country in which the foreign body corporate has been incorporated, and any transaction on account of a cross-border merger undertaken in accordance with Cross-Border Merger regulations will be deemed to have prior approval of the RBI.

Conclusion

A range of complex issues must be navigated in an effort to successfully complete cross-border mergers. Each cross-border merger is different and implementation of these issues will greatly depend on the facts, dynamics, scale and geographic scope of both companies. The Cross-Border Regulations being fairly new, a lot of practical issues are yet to be identified and shall be addressed as and when encountered in the due course of time.

Authors: Ms. Ifla. A and Ms. Shruthi Shenoy, associates at NovoJuris Legal.

[1]Section 2(42) of the Companies Act 2013 defines Foreign Company as any company or body corporate incorporated outside India which: (a) has a place of business in India whether by itself or through an agent, physically or through electronic mode; and (b) conducts any business activity in India in any other manner.