I. INTRODUCTION

Mergers and acquisitions are an important tool of economic development and every effort should be made to incentivise the merger process in the country. Fiscal statutes form an important means of economic development by providing benefits to the concerned businesses. Large scale mergers are occurring at a fast pace within and outside the country. In this regard the income tax legislation in India is quite development oriented for domestic companies going in for merger or amalgamation and acquisition. In India, the Income Tax Act, 1961 is the primary legislation dealing with taxability of income arising in the hands of an individual or business entity. An important question that arises here is: What are the benefits available under the Income Tax Act, 1961, to companies going in for merger or acquisition. These benefits are available in the form of allowable deductions from the income in the hands of an individual or companies. They apply equally to companies going in for merger or acquisition in India. The focus of the present paper is to highlight the deductions available to companies going in for mergers. A firm can achieve growth in several ways. It can grow internally or externally. Internal Growth can be achieved if a firm expands its existing activities by up scaling capacities or establishing new firm with fresh investments in existing product markets. Where a firm grows internally, it can face problems with regard to the size of the existing market or product, no growth potential in future or government restriction on capacity enhancement. The income tax legislation acts as an aid to external growth by providing deductions under its provisions. Fiscal statutes are a significant source of economic development and create space for growth of industrial activities within the country. Therefore a legal metamorphosis occurs when a merger takes place. The Income Ta Act, 1961 contains special provisions so as to minimize the ambiguities in ascertaining the tax liabilities of the merged entity. In India, the primary fiscal legislation dealing with mergers is concerned solely with the amalgamation o companies and des not refer to amalgamation between other forms of legal entities like  partnership firms or sole proprietorship. The following type of mergers are envisaged: merger of one or more company with some other company and the merger of to or more companies form a new company.

 

Though the income tax deductions stand discontinued at any time, but being part of legislations point towards their recurring nature and availability at any time for a company.[1]   

 

2. TAX BENEFITS OR ASPECTS OF AMALGAMATION UNDER THE INCOME TAX ACT, 1961:

 

2.1 DEFINITION OF AMALGAMATION UNDER THE INCOME TAX ACT, 1961:

Section 2(1B) of the Income Tax Act, 1961 defines the term “amalgamation” as follows :

 

“amalgamation”, in relation to companies, means the merger of one or more companies with another company or the merger of two or more company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that

 

(i)     all the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation ;

(ii)   all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation;

(iii)  shareholders holding not less than 14(three-fourths) in value of the shares in the amalgamating company or companies (there than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) become shareholders of the amalgamated company by virtue of the amalgamation,

 

otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding up of the first-mentioned company.”[2]

 

It will be noticed that the definition uses the expression “amalgamating company” and “amalgamated company” to refer to the expressions “transferor company” and “transferee company” respectively.[3] An important issue that arises in the case of amalgamation is that of capital gains arising from the transfer of shares or any kind of capital gains arising with respect to taxation of the capital gains.[4] However the company may also stand to lose in cases of amalgamation as mergers in the Indian context are viewed as a tax planning measure.[5] The deductibility has to be seen in the hands of the transferee company.[6]

 

To constitute “amalgamation” under the Income Tax Act, there must be satisfied the three conditions specified clauses(i) , (ii) and (ii) of the definition.

 

2.2 THE FOLLOWING BENEFITS OR PROVISIONS ARE THERE IN THE INCOME TAX ACT, 1961 FOR CASES OF AMALGAMATION OF COMPANIES:

 

·       2.2.1 INVESTMENT ALLOWANCE:

Investment allowance in the Act has been inserted in place of Development Rebate. The purpose of this allowance is to provide for deduction on any purchases made in the form of ship, aircraft, machinery, plant. The rate of investment allowance is 25% of the actual cost of the ship, aircraft, machinery or plant. Therefore it could be termed as a deduction on the investment made by the person which is allowed to him at the time of calculation of his taxable income. The section provides for exemption from application of the provision in certain cases mentioned in the Section itself. Sub section (2) of the section assumes importance in light of the fact that it provides for the meaning to be given to the words ship, aircraft and plant and machinery by stating their purposes or the object with which it is to be used. For example, clause (b) of sub section (2) provides for the purposes of installation of plant or machinery which may be generation of electricity or distribution of the same, in a small scale industrial undertaking for the manufacture of any article, for the purposes of business of construction, manufacture or production of any article. Sub section (5) of the section provides for disallowance of the investment allowance in certain circumstances.[7] The purpose of creation of an investment allowance is the creation of a reserve called the Investment Allowance Reserved Account for the purposes of acquiring new ship or aircraft or machinery and plant, and for other purposes of business of the undertaking except for distribution of dividends, profits or remittances outside India as profits. Sub section (6) stipulates conditions to be followed in case of an amalgamation and the amalgamated company is supposed to take over the mantle of the maintenance and creation of the reserve for the aforesaid utilization in the business.  

 

The term manufacture in the provision is to be understood in the manner concerning production of articles for use from raw or prepared materials by giving such materials new forms, qualities or combinations whether by hand, labour or machines and if the change made in the article results in a new and different article then it would amount to manufacturing activity.

 

CURRENT STATUS OF THE BENEFIT: Notification dated 19 March 1990 was issued to discontinue investment allowance from the assessment year 1991-92.

 

·       2.2.2. DEVELOPMENT REBATE:

This rebate is granted at varying rates, in respect of ships, machinery and plant provided:

I the machinery or plant is not an office appliance, or a road transport vehicle.

II it is not installed in any office premises.

III the asset is new.

IV it is owned by the assessee.

V it is wholly used for the purposes of the assessee’s business.

VI the particulars prescribed for the purpose of depreciation allowance have been furnished.

VII a development rebate reserve is created and the asset is not transferred for eight years as provided in s34(3).

 

Sub section (3) provides for cases in which amalgamation of companies occurs and it says that the amalgamated company shall continue to fulfill the conditions mentioned in sub section (3) of section 34 in respect of the reserve created by the amalgamating company and in respect of the period within which the ship, machinery or plant shall not be sold or otherwise transferred and accordingly provides for any default. The same sub section provides for the balance amount of the development rebate to be allowed to the amalgamated company or the new entity.

 

The section further provides for the fulfillment of certain conditions for the allowance of development rebate which says that development rebate shall be allowed in respect of a ship, machinery or plant installed on or after 1 Jan 1958, s34(3) enacts that development rebate should be allowed only if the following conditions are fulfilled which are as follows:

(i)    An amount equal to 75% of the development rebate to be actually allowed should be debited to the P&L A/c and should be credited to a reserve account. The reserve so created is utilized for a period of eight years.

(ii)  For distribution by way of dividends or profits.

(iii) For remittance outside India as profits.

(iv) For any other purpose which is not a purpose of the business of the undertaking.

 

The clause requires to maintain a reserve of the value of 75% of the development rebate actually allowed.

 

CASE OF AMALGAMATION: The right to development rebate would be lost even if a transfer of the asset is affected within eight years merely as a step in business reorganization or expansion. Only in two cases of business reorganization is the bar against transfer of assets removed ie: when the two companies amalgamate and when a firm is succeeded by a company. But this benefit is available only when the amalgamation takes place as per the conditions laid down in s 2(1B) of the Income Tax Act, 1961.

 

CURRENT STATUS OF DEVELOPMENT REBATE: The development rebate has been discontinued from 31 May 1977 and at present stands discontinued.

 

 

 

·       2.2.3.DEVELOPMENT ALLOWANCE:

Under section 33 A, an assessee who is carrying on the business of growing and manufacturing tea in India is entitled to a deduction while  computing his profits by way of development allowance with reference to the actual cost of planting tea bushes.  Here the actual cost planting comprises the cost of planting and replanting and the cost of upkeep thereof, for the previous year in which the land has been prepared for planting and the three succeeding years.[8] This benefit of deduction is available under the current legal provision to companies carrying on similar kind of business and going in for amalgamation. The section is applicable to an assessee carrying on the business of growing and manufacturing tea in India. The allowance is available only if the assessee grows and manufactures tea in the country. Allowance is granted under this section at the following rates:

I.      50% of the actual cost of planting tea bushes, where such tea bushes are planted on a land and not planted with any other tea bushes planted earlier (such cost being incurred between 1 Apr 1965 and 31 Mar 1990).

II.    30% of the actual cost of planting tea bushes where tea bushes are planted in replacement of tea bushes that have died or have become permanently useless on any land already planted (such cost being incurred between 1 Apr 1965 and 31 Mar 1970).

 

 

Sub section (5) provides that all the conditions relating to creation and maintenance of reserve and sale and otherwise transfer of the land should be fulfilled by the amalgamated company just as they would have been fulfilled by the amalgamating company.

 

·       2.2.4. EXPENDITURE INCURRED ON SCIENTIFIC RESEARCH:

According to section 35(5), where, in a scheme of amalgamation, the amalgamating company sells or otherwise transfers to the amalgamated company (being an Indian company) any asset representing expenditure of a capital nature on scientific research[9] - 

(i)    the amalgamating company shall  not be allowed the deduction under clause (ii) or clause (iii) of sub-section (2); and

(ii)  the provisions of this section shall, as far as may be, apply to the amalgamated company as they would have applied to the amalgamating company if the latter had not so sold or otherwise transferred the asset

 

The Madras High Court held in Tamil Nadu Civil Supplies Corporation Ltd v CIT[10] that, after the Research Centre was taken over by the assessee, entire actual expenditure incurred by assessee was allowable, therefore, the Tribunal was not justified in allowing proportionate expenditure. The research, for the purposes of the present section, need not necessarily be related to present manufacturing activity. It was held in CIT v National Rayon Corporation Ltd.[11] that, ‘the expression “related to business” does not mean related to present manufacturing activities of the assessee. In this case assess was all along using imported wood pulp for the manufacture of rayon incurred expenditure on research for making pulp out of bamboo since it proposed to set up a plant for making bamboo pulp.  The expenditure on such research could not be disallowed because it did not relate to the present manufacturing activity of the assessee.

 

2.2.5. EXPENDITURE ON ACQUISITION OF PATENT RIGHTS OR COPYRIGHTS:

Section 35 A of the Income Tax Act deals with expenditure on acquisition of patent rights or copyrights.  According to its sub-section (1), in respect of any expenditure of a capital nature incurred after the 28^th day of February, 1966 but before the 1^st day of April, 1998, on the acquisition of patent rights or copyrights, used for the purposes of the business, there shall, be allowed for each of the relevant previous year, a deduction equal to the appropriate fraction of the amount of such expenditure. Sub-section (6) of this section provides that, where, in a  scheme of amalgamation, the amalgamating company sells or otherwise transfers the rights to the amalgamated company (being an Indian company),

 

(i)    the provisions of sub-sections (3) and (4) shall not apply in the case of the amalgamating company ; and

(ii)  the provisions of this section shall, as for as may be, apply to the amalgamated company as they would have applied to the amalgamating company if the latter had not so sold or otherwise transferred the rights.

Sub-section (6) was inserted in section 35(A) by the Finance (No.2) Act, 1967, to provide deduction to amalgamated companies.  The scope of its insertion is elaborated in the following extract of the circular No 5-P, dated 9.10.1997, which read as under:

 

“Where the amalgamating company sell or otherwise transfers to the amalgamated company (being an Indian Company) any capital assets used by it for scientific research related to its business or any capital asset of the nature of patent right or copyrights or any capital assets used for promoting family planning amount its employee, the amalgamated company will be entitled to amortize the capital cost of such assets against its profits under the relevant provision of the Income Tax Act, viz., sections 35, 35A and 36 (1) (ix), in the same manner and to the same extent as the amalgamating company would have been, if it had not sold or transferred the asset to the  amalgamating company will not be entitled to any of the terminal benefits under the provisions of section 35, 35 A and 36 9i) (ix).”[12]

 

Where an assessee has purchased patent rights or copyrights, he is entitled to a deduction under section 35 A for a period of 14 years in equal installments.  If during such period the assessee merges with another company, the amalgamated company would then have the right to claim the unexpired installment as a deduction from its total income.  However, where the whole or any part of the right are sold by the amalgamated company after amalgamation and the sale proceeds exceeds the amount of the cost of acquisition of the asset which remains unallowed as deduction, the excess amount would be chargeable to income-tax in the hands of  the amalgamated company.  If the sale price even exceeds the cost of acquisition, the difference between such price and the cost would be the capital gains which would be taxed in the hands of the amalgamated company.

 

2.2.6. AMORTISATION OF CERTAIN PRELIMINARY EXPENSES:

Section 35D of the Income Tax Act deals with amortization of certain preliminary expenses.  According to its sub-section (1), where an assessee being an Indian Company or a person (other than a company) who is resident in India, incurs, after the 31^st day of March, 1970, any expenditure specified in sub-section (2)

(i)    before the commencement of his business, or

(ii)  after the  commencement of his business, in connection with the extension of his industrial undertaking or in connection with his setting up a new industrial unit,

 

the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation. The section grants deduction in respect of expenditure which may otherwise be disallowed as an expenditure of a capital nature. This implies that expenses of a capital nature which are generally disallowable as deductions at the time of calculation of taxable income, may be allowed by virtue of this section of the Act. The expenditure may be incurred in respect of any of the following:

(i)    preparation of feasibility report.

(ii)  preparation of project report.

(iii) conducting  market survey or any other survey necessary for the business of the assessee.

(iv) engineering services relating to the business of the assessee.

(v)  legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee.

(vi) where the assessee is a company, also expenditure, by way of legal charges for drafting the Memorandum and Articles of Association of the company.

(vii)        On printing of the Memorandum and Articles of Association.

(viii)       By way of fees for registering the company under the provisions of the Companies Act, 1956.

(ix) in connection with the issue, for public subscription, of shares in or debentures of the company, being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus.

(x)  such other items of expenditure (not being expenditure eligible for any allowance or deduction under any other provision of this Act) as may be prescribed.

 

 

Section 35D is an enabling provision which enables an assessee to amortize w.e.f. assessment year 1999-2000 its  preliminary expenses incurred after 31.3.1998 by an Indian Company or a person resident in India.  The expenses can be amortized in five equal installments for five successive previous years i.e one fifth of the expenditure shall be allowed as deduction, for a period of five successive previous years. And the aggregate amount of the preliminary expense incurred after 31.3.98 should not exceed 5% of the cost of project and in case of a company as its option, 5% of the capital employed.  However, if it exceeds 5% then the expenditure shall be limited to 5% of the cost of project. This certainly depends on a case to case basis.[13] 

 

2.2.7. AMORTISATION OF EXPENDITURE IN CASE OF AMALGAMATION OR DEMERGER:

Section 35DD has been inserted in the Income Tax Act w.e.f 1 April, 2000 by the Finance Act, 1999 to provide for amortization of expenditure in case of amalgamation and demerger. It provides that, where an assessee, being an Indian company, incurs any expenditure, on or after the 1^st day of April, 1999, wholly and exclusively for the purposes of amalgamation or demerger of an undertaking , the assessee shall be allowed a deduction of an amount equal to one-fifth of such expenditure for each of the five successive previous years beginning with the  previous year in which the amalgamation or demerger takes place. However, no deduction shall be allowed in respect of the expenditure mentioned in sub-section (1) under any other provision of this Act. According to sub-section (1) of section 35DD, any expenditure incurred in connection with amalgamation or demerger of any undertaking is allowable in five equal installments over a period of five years beginning with the year of amalgamation or demerger.  However, following conditions need to be fulfilled:

(i)  The entity making the expenditure shall be an Indian company

(ii) The expenditure shall be incurred on or after 1-4-1999.

 

Further, no deduction shall be allowed under any other provisions of the Act, as per sub-section (2) of section 35DD.

 

2.2.8. SPECIAL PROVISION FOR COMPUTATION OF COST OF ACQUISITION OF CERTAIN ASSETS:

Section 43C of the Income Tax Act provides that, where an asset, which become the property of an amalgamated company under a scheme of amalgamation, is sold after the 29^th February, 1998, be the amalgamated company as stock-in-trade of the business carried on by it, the cost of acquisition of that asset to the amalgamated company in computing the profits and gains from the sale such asset be the cost of acquisition of that asset to the amalgamating company, as increased by the cost, if and, of any improvement made to it and the expenditure, if any, incurred, wholly and exclusively in connection with such transfer by the amalgamating company. This means that in case where an amalgamation occurs, the cost of an asset to be ascertained for the purposes of taxing the gains or profits made from the sale of such asset, is to be taken at the same value which might have been incurred by the amalgamating company and any expenditure made by the amalgamated company on the asset should be taken into consideration while providing for deduction to the amalgamated company.

 

 

 

2.2.9. CARRY FORWARD AND SET OFF OF ACCUMULATED LOSS AND UNABSORBED DEPRECIATION ALLOWANCE IN AMALGAMATION:

This section constitutes an exception to the general rule that the unabsorbed depreciation allowance of the previous owner of a business cannot be carried forward and set off by the successor and that a business loss can be carried forward and set off the business profits of a subsequent year only by the assessee who has incurred the loss. Where a company owning an industrial undertaking, ship, hotel or a banking company merges into another company this section permits set off if certain conditions are fulfilled. Theses conditions are as follows:

(i)    The amalgamated company shall continuously hold at least three fourths in value of the assets of the amalgamating company for a minimum period of five years from the date of amalgamation.

(ii)  The amalgamated company shall continue the business of the amalgamating company for at least five years from the date of amalgamation.

(iii) It should fulfill other conditions notified by the Central Government to ensure the revival of the business of the amalgamating company or to ensure that the amalgamation is for genuine business purpose.

 

After the amendment made by the Finance Act of 2003 with effect from 1 Apr 2004, two further conditions need to be fulfilled which are as:[14]

(i)    it should have been engaged in the business for at least three years during which the accumulated loss ha occurred or the unabsorbed depreciation had accumulated.

(ii)  It should have continuously held on the date of amalgamation at least three fourths of the book value of the fixed assets, which it held two years prior to the date of amalgamation.

 

Under the old provisions, in a case of amalgamation, shareholders holding not less than nine-tenths in value of shares in the amalgamating company were required to become shareholders of the amalgamated company.  This condition has been relaxed.  After the Amendment vide Finance Act, 1999, shareholders holding tree-fourths in value of the share shall be required to become shareholders of the amalgamated company. The provisions of section 72A of the Income-Tax Act, 1961, have been on the statute book since 1977.  The main object of enacting this provision was to encourage merger of sick companies with profitable ones.  Unfortunately, this provision has not served its purpose in view of the vague and onerous conditions, subject of litigation. 

 

From the provision of erstwhile section 72A, it may be seen that there were number of conditions including satisfaction of the Government, on the recommendation of the specified authority, laid down for such amalgamation. Besides, the amalgamated company was required to submit proposed scheme of amalgamation to the specified authority and thereupon, such an authority would make a recommendation to the Central Government, in that behalf. All these conditions have omitted, after the amendment of section 72A, vide Finance Act, 1999, with effect from 1^st April 2000.

 

Sub-section (1) of section 72A provides that, where there has been an amalgamation of a company owning an industrial undertaking or a ship with another company, then, notwithstanding anything contained in any other provision of this Act, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the loss or, as the case may be, allowance for depreciation company for the previous year in which the amalgamation was effected, and other provisions of this Act relating to set-off carry forward of loss and allowance for depreciation shall apply accordingly.

 

4. CONCLUSION:

From the aforementioned it could be seen that the following tax benefits pertain to the transferor company by virtue of the specific provisions of the Income Tax Act, 1961 after an amalgamation:[15]

(i)    Investment Allowance-  under Section 32A(6)

(ii)  Development Rebate- under Section 33(3)

(iii) Development allowance- under Section 33A(5)

(iv)  Scientific research expenditure- under Section 35(5)

(v)  Expenditure on acquisition of patent rights or copyrights- under Section 35A(6)

(vi) Amortization of certain preliminary expenses- under Section 35D(5)

(vii)        Deduction for expenditure on prospecting, etc. for minerals- under Section 35E(7)