Changing the game

The new regulations on cross border mergers have changed several things and brought in fresh challenges. This article is an in-depth analysis of what these regulations entail.

Since the new government came into power in May 2014 with its vision to make India globally competitive and contributing a larger chunk to international trade, the country has witnessed numerous reforms such as ease in Foreign Direct Investment (FDI) norms to attract foreign investment, promoting Make in India, introduction of GST to streamline the indirect taxes regime, etc. Further, owing to the benefits of cross border transactions in promoting trade and economy, viz., consolidation and pooling of assets and resources, simplification of structure, listing or fund raising, etc., the last couple of years have seen multiple enactments in the Indian regulatory ecosystem by the government in order to accelerate cross border transactions. These new enactments have paved the way for cross border mergers and is undoubtedly a remarkable step by the Indian Government in putting together a framework for reorganisations, consolidations, etc., and facilitating globalisation by giving an opportunity to Indian companies to expand globally. 
Although the merger of foreign companies into Indian companies (i.e. inbound merger) was permitted under the erstwhile Companies Act, 1956, there was no corresponding provision in the Companies Act, 2013, for cross-border mergers until recently, before section 234 came into force.
On 13 April, 2017, the Ministry of Corporate Affairs (MCA) has notified section 234 of the Companies Act, 2013, giving legal recognition to merger and amalgamation of an Indian company with a foreign company (or vice versa), provided prior approval from the Reserve Bank of India (RBI) is obtained. This is different from the erstwhile Companies Act, 1956, where no such condition of obtaining RBI approval was specifically provided. Further, unlike the past, where mergers were generally implemented with consideration in the form of shares, section 234 allows, amongst other things, the payment of consideration in the form of cash or depository receipts or both.
To operationalize the above notified section, the MCA further notified the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2017 introducing Rule 25A to the erstwhile Companies (Compromises, Arrangements and Amalgamations) Rules, 2016.
Rule 25A specifies certain conditions, which are required to be mandatorily fulfilled in cross border mergers, 
▪ The Indian company could merge only with foreign company incorporated in a permitted jurisdiction;
▪ Prior approval of the RBI is obtained for the merger;
▪ The transferee company to ensure valuation is conducted as per internationally accepted principles by valuers who are members of a recognised professional body in its jurisdiction. In this regard, a declaration by the transferee company is required to be attached with the application made to the RBI to obtain its approval for the merger;
▪ Cross border mergers should comply with the provisions of section 230 to 232 of the Companies Act, i.e., making an application to the Tribunal, convening a meeting of creditors/ shareholders, intimating various regulatory authorities, etc.
Further, it has been specifically provided that any amendment in this rule may only be made after consultation with the RBI.
As mentioned earlier, under the erstwhile Companies Act there was no clarity on whether RBI approval was required for cross border mergers; however, both section 234 and the corresponding Rule 25A of the Companies Act, require RBI approval before implementing a cross border merger. Therefore, RBI approval is mandatory for all types of cross border mergers under the new Companies Act, which was proving to be an onerous requirement in a cross border transaction. To streamline the procedure for cross border mergers, make it time efficient and provide a regulatory framework for obtaining the RBI’s approval, the RBI on 20 March, 2018, notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018. These regulations provide that a cross border merger shall be deemed to be approved by the RBI if it is in accordance with the said regulations.
These regulations cover both inbound and outbound mergers. An inbound cross border merger refers to any merger, amalgamation or arrangement between an Indian Company and a Foreign Company where the resultant company is an Indian Company, whereas in an outbound cross border merger, the resultant company is a Foreign Company.
In Inbound mergers, the issuance or transfer of security to a person resident outside India by the resultant Indian Company should be in accordance with pricing guidelines, entry routes, sectoral caps and reporting requirements, etc., as laid down in the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017.
Further, any guarantees or borrowing of the foreign company, which as a result of the merger, became the borrowing of the Indian company, should confirm to the External Commercial Borrowing (ECB) or Trade Credit norms or any other Indian foreign exchange regulations as applicable, within two years.
The resulting Indian company may acquire and hold any asset outside India, which it is permitted to acquire under the relevant provisions of the Indian foreign exchange regulations. Where any asset or security outside India is not permitted to be acquired or held, the Indian company shall sell such asset or security within two years from the date of sanction of the Scheme by the NCLT.
In case any liability outside India is not permitted to be held by the Indian company, the same would need to be settled within two years, first using the sale proceeds of foreign assets that an Indian company is not permitted to hold and the balance, if any, may be paid off by the resulting Indian Company.
In Outbound mergers, a person resident in India may acquire or hold securities of the resultant Foreign Company in accordance with the Foreign Exchange Management (Transfer or issue of any Foreign Security) Regulations, 2004 (ODI Regulations). In case the shareholder of the merging Indian company is a resident individual, the fair market value of foreign securities needs to be within the limits prescribed under the Liberalised Remittance Scheme (LRS).
The guarantees or outstanding borrowings of the Indian company, which become the liabilities of the resultant foreign company, need to be repaid as per the Scheme sanctioned by the NCLT. 
Further, the resultant Foreign Company may hold or transfer any asset or security subject to the provisions of the relevant Indian foreign exchange regulations. Where the asset or security in India cannot be acquired or held by the resultant company under the relevant regulations, the resultant Foreign Company shall sell such asset or security within a period of two years from the date of sanction of the Scheme by the NCLT.
These regulations provide that the valuation of the Indian company and the foreign company shall be done in accordance with the aforementioned Rule 25A. Further, as already stated, any cross border merger undertaken in accordance with these regulations shall be deemed to have prior approval of the RBI and no separate approval is required, thus, saving substantial time and effort in completing the cross border merger transaction.
Cross border mergers - Taxation
Presently, under the Indian tax regime, only inbound mergers are tax neutral. The Indian taxation regime provides a tax neutral status to merging companies, provided all the assets and liabilities are transferred and the shareholders holding 75% value of shares in the merging company become shareholders in the Indian transferee company. Further, tax exemption is also extended to shareholders of the merging company if the consideration is discharged only in shares and the transferee company is an Indian company.
However, if any of the above conditions for tax exemption is not fulfilled, in case of an overseas merging company, which does not have any assets situated in India; there may be no tax implications in India in the hands of overseas merging company. Similarly, in the hands of shareholders, there may be no capital gains implications on extinguishment of shares of the merging foreign company in India, unless the shareholders are Indian tax residents or such shares derive their value substantially from assets in India (resulting in the trigger of indirect transfer provisions under the Indian tax laws)
In the case of outbound mergers, although the relevant provisions have now been notified under the Companies Act and the Indian exchange control regulations, giving it a go-ahead from the regulatory perspective, the corresponding tax provisions for outbound mergers are still awaited. However, considering that the essence of the existing tax neutrality provisions of mergers/ transfers under the current Indian tax regime is that the surviving/ recipient entity should be an Indian company (which is evident from certain exemptions provided under the Income-tax Act in relation to amalgamations, transaction between holding company and subsidiary company where the exemption is only available provided the recipient company is an Indian company), any tax exemption for outbound mergers (similar to inbound merger) may not be forthcoming. However, considering the pace of cross border transactions, its need and importance for the Indian economy, and for outbound mergers to be a successful proposition, it is imperative that the government introduce some tax relaxations. Having said that, it will be worthwhile to see how the Indian tax authorities respond to the expectations.
Some key challenges
While the introduction of cross border regulations by the RBI in relation to cross border mergers seems to be the last brick in the wall for the implementation of cross border mergers, certain questions and open issues still hover and remain unanswered, requiring clarifications from the authorities. 
Some practical issues are as follows:
1. Cross border demerger: While section 394 of the erstwhile Companies Act applies to both mergers and demergers, section 234 of the Companies Act, 2013, only refers to mergers and amalgamations with no explicit mention of demergers. Thus, with a literal interpretation, one may take a view that cross border demerger may not be allowed under the new law.
2. No fast track cross border merger: While section 234 provides that the provisions of the entire Chapter XV (Compromises, Arrangements and Amalgamations) of the Act shall apply to cross border mergers as well, Rule 25A requires the compliance of only sections 230 to 232 for cross border mergers and mandates approaching the jurisdictional Tribunal for approval. Thus, it appears that section 233, which provides a fast track window for the merger of certain companies without approaching the NCLT may not be available to cross border mergers.
3. Taxation of outbound mergers: As discussed above, unlike inbound mergers, the current Indian tax regime does not provide any tax exemption to outbound mergers. Consequently, the capital gains from these mergers may result in tax liabilities in the hands of the merging Indian company as well as shareholders of the merging company. This lack of tax neutrality makes the outbound mergers a less attractive option at present.
These are some practical difficulties in the implementation of cross border mergers and clarity by the regulators on the above issues will be a major step in settling many arguments and may open new avenues for Indian companies, as we witness the future of cross border transactions in India in the era of globalisation.
About the author: 
Amit Bahl, Partner – M&A Tax, PwC India
Raashi Agarwal, Manager and  Shubham Aggarwal, Associate – M&A Tax, PwC India also contributed to this article.
(Disclaimer: Views of the author are personal) 

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