Decoding the big takeaways of the new cross-border mergers framework
L to R: Tejasvini Shirodkar, Pearl Boga and Karen Issac

The erstwhile Companies Act, 1956 only permitted inbound mergers, or mergers of foreign companies with Indian companies. However, it was silent on outbound mergers, or those of domestic companies with foreign firms.

To be in pace with the rapid economic development in India, the Ministry of Corporate Affairs realised the need for implementing appropriate provisions governing cross-border mergers, especially outbound mergers, and came out with an amendment to the Companies Act, 2013 by notifying Section 234 of the Act. The ministry also brought into force the Companies (Compromises, Arrangements and Amalgamations) Amendment Rules, 2017, for regulating the cross-border mergers framework from 13 April 2017.

Subsequently, on 26 April 2017, the Reserve Bank of India (RBI) issued draft regulations to govern cross-border mergers and invited suggestions to implement such regulations. Upon receiving objections and suggestions, the RBI after due scrutiny notified the Foreign Exchange Management (Cross Border Merger) Regulations, 2018.

Significance of the merger regulations

The regulations have created a promising path for the Indian market with international business. The erstwhile regulations in relation to outbound mergers required the merging business entities to seek prior approval from the RBI. However, the new regulations ensured deemed RBI approval for entities involved in outbound mergers.

As such, the new regulations have resulted in reduction of uncertainty by providing a statutory platform for Indian entities and simplifying business in India. This would pave a way for increase in foreign direct investment in the country by way of collaboration with foreign operations by Indian entities operating abroad.

The major advantage for entities involved in cross-border mergers is to consolidate ownership and control, and diversify their business. Such a transaction would also help a company internally by way of restructuring and consolidation of holdings.

Further, this would provide Indian companies quicker access to foreign markets through a ready base for conducting business in the host country of the foreign entity. This would include access to the customer base of the foreign entity and also through sharing of technology and know-how through collaboration and ownership of intellectual property.

Challenges merging entities may face under the new framework

The provisions of the erstwhile Companies Act, 1956 permitted a foreign company to transfer their undertaking to an Indian company and included restructuring and arrangements of any nature. However, the current Act limits this to only include mergers and amalgamations, without any mention of “demergers”. As such, the Act is not very clear about the possibility of an Indian company demerging its business undertaking to a foreign company or vice versa.

The new merger regulations mention that for the purpose of outbound mergers, the foreign company should be incorporated in a jurisdiction specified in Annexure B to the Amendment Rules. Thus, the merger regulations restrict the scope of outbound mergers to limited territories and the same is not applicable globally.

Further, the Act is silent on the outcome of any divergence between the merger regulations, including the Act, and the laws of the resultant foreign company in case of outbound mergers, such as compliance with Indian overseas direct investment and liberalised remittance scheme regulations.

Similarly, in case of inbound mergers, it may not be possible for the resultant Indian company to comply with all provisions governing foreign regulations, including those related to external commercial borrowing regulations.

Ideally, branch offices in their own jurisdiction would be governed by the prevalent domestic laws applicable to such branch offices. However, under the merger regulations, a branch office pursuant to a cross-border merger shall be deemed to be a branch office of the resultant company.

Therefore, an Indian branch will be governed by the FEMA (establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016, and can only carry out certain permitted activities. The overseas branch can undertake transactions permitted under the FEMA (Foreign Currency Account by a person resident in India) Regulations, 2015.

As per the merger regulations, any transfer of assets acquired by a foreign company must be in compliance with the Foreign Exchange Management Act and rules thereunder (FEMA). The foreign company may acquire and hold assets in India which a foreign company is permitted to acquire under FEMA. If any foreign entity is barred under the provisions of FEMA to acquire and hold any asset to be transferred pursuant to the outbound merger, then such resultant entity would have to sell such asset within two years from the date of sanction of the merger and the sale proceeds shall be repatriated outside India within such time period.

Another major hurdle faced by the merger regulations is the implication of income tax. The Income Tax Act, 1961, has yet not been amended to be in line with the amended Companies Act and the merger regulations.

As per Section 47 (vi) of the Income Tax Act, in a scheme of amalgamation, any transfer of capital assets by a transferor company shall be exempt where the resultant company is an Indian company.

Similarly, as per Section 47(vii) of the Income Tax Act, in a scheme of amalgamation, any transfer of a capital asset by a shareholder in consideration for the issue of shares in the resulting company shall be exempt.

However such exemption is available only to inbound mergers and not outbound mergers, because to avail the exemption the resultant entity must be an Indian entity. This would prove to be burdensome for taxpayers opting for outbound mergers.

Understanding the framework for issuance of shares in cross-border transactions

The merger regulations clearly mention that the merging entities will have to adhere to the foreign exchange regulations in case of cross-border mergers. The two main regulations governing the issuance of shares of the resultant entity pursuant to a cross-border merger are Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 and Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.

Thus, in addition to compliance with the Act, Amendment Rules and merger regulations, the merging and resultant entities will be required to comply with the aforementioned regulations as well.

Opportunities presented by the framework to the IBC process

The array of bidders would widen as foreign investors will now be able to take part in insolvency proceedings. This can be beneficial as it would allow for better pricing decisions regarding the assets to be sold. But, strict adherence to the timeline prescribed under the Insolvency and Bankruptcy Code will be imperative in attracting foreign bidders.

Conclusion

Despite numerous challenges faced by the merger regulations, it is indeed a breakthrough of the current regime on cross-border mergers. These regulations have given a widespread platform for cross-border market internationally and increased opportunities for Indian players to now merge foreign companies and expand business globally.

However, it is imperative that the RBI lays down a detailed regulatory and procedural framework with additional emphasis on the eligibility standard and factors to be considered in case of cross-border mergers.

Further, the central government could also consider amending the Income Tax Act to include outbound mergers within the exemption list provided under Section 47.

Tejasvini Shirodkar is a partner, Pearl Boga is a senior associate and Karen Issac is an associate at law firm Rajani Associates.

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