Over the past few months, M&A and private equity players have been bustling with activity and picking up pace after the recent downturn. With the cloud of the new tax legislation – Direct Taxes Code Bill (DTC) dangling over their futuristic plans, M&A deal makers and private equity houses were adopting a cautious approach.
On 30 August 2010, the Government of India laid out the roadmap by placing a revised version of the DTC before the Parliament. The cloud of DTC has drifted away by one more year as it is expected to be implemented with effect from 1 April 2012, providing an opportunity to the investors to gear up for it and to chart out their future action plan. The Government has built the bridge for transition from the archaic tax law to a well thought DTC.
The Government has executed a couple of clean strikes in the field of current tax regime for M&A players and PE houses:
Strike 1: Ever since the Vodafone deal in 2007, the Government has been intending to clamp down on similar rampant deals. The Government has loaded it’s armory by proposing to bring to tax indirect transfers of assets by overseas assets albeit this is based on a brightline test based on valuation of Indian assets.
Strike 2: Private Equity funds set up abroad and making investments into India through intermediary holding companies (such as Mauritius, Cyprus, etc.) could be subjected to detailed scrutiny under the General Anti Avoidance Regulations (GAAR) regime which has also been introduced in the DTC. Adequate substance would have to be built into intermediary holding companies to safeguard the adverse effect under GAAR.
GAAR empowers the tax authorities to declare certain arrangements as impermissible avoidance arrangements. It is also proposed that detailed guidelines would be introduced to ensure the intended applicability of GAAR. Further, minimum threshold limits for applicability of GAAR would be notified in due course.
In the light of the limitation of benefit clause (laying down substance requirements) as per the India Singapore Tax Treaty, overseas investors could possibly explore Singapore as an intermediate jurisdiction as a measure to withstand attempts by the tax authorities to initiate GAAR.
Here’s a brief synopsis at some other key proposals which would impact M&A and PE investors
DTC v/s Tax Treaty – The cheering factor – After much deliberations and representations, the Government has retained the mechanism, wherein, the tax payer has an option to be governed by the provisions of the Act or the relevant Tax Treaty, whichever are more beneficial. This will substantially restore the Treaty benefit and is a welcome proposal.
Corporate tax rates –Portfolio Companies
There has been a marginal reduction in corporate tax in the case of portfolio companies in India from 33.99% to 30% for Indian Companies as compared to the rate under Income tax Act, 1961 (the Act).
Further, the proposal of computing Minimum Alternate Tax (MAT) as a specified percentage of “gross assets” (i.e. investment linked levy – as was provided in the earlier draft of the DTC) has been done away with. The rate of MAT is proposed to be increased to 20% from the existing 18% as per the current provisions of the Act.
This proposal has provided relief to a large number of Private Equity investors from their portfolio companies perspective. However, MAT credit appears to be omitted from the list of grandfathering provisions.
Capital Gains on Sale of Equity Shares – A good move
Capital gains arising on sale of equity shares of a listed company or units of an equity oriented fund (held for more than 1 year) would continue to remain exempt from tax (subject to levy of Securities Transaction Tax (STT)). Similarly, where aforesaid shares are held for upto 1 year, a deduction of 50% of the capital gains would be available and the balance gains would be subject to tax at applicable tax rates (subject to levy of STT). The earlier draft of DTC proposed to tax the gains at applicable tax rates and did not provide for such deductions. This should provide some impetus to PIPE deals in India.
Capital Gains on Slump Sale
Gains arising on slump sale would continue to be characterized under the head ‘capital gains’ instead of ‘business income’ as provided in the earlier draft of the DTC. This is certainly a major relief. Further, capital gains on slump sale would be subject to maximum marginal rate of tax, hence in such a case, the concessional rate on long term capital gains currently applicable would no longer apply.
Certain proposals introduced in the earlier draft of the DTC continue as follows:
Business reorganizations, where one of the parties is a non-resident in India, would not be subject to the tax exemption. Accordingly, cross border mergers and demergers would have India tax implications.
Under the DTC, carry forward of losses of the demerged unit would be available upon satisfaction of the business continuity test as opposed to a free carry forward of losses which is available under the existing law.
In case of ‘slump sale’ the tax liability would depend upon the definition of ‘net worth’ which has not been prescribed so far. Further, there is no specific definition for the term ‘undertaking’ for slump sale purpose.
The Government has put its best foot forward by extending the time limit for the implementation of DTC by one year, which could open up avenues for further deliberations and discussions. It has also been pro active in seeking and inviting public comments and has implemented a number of suggestions of public by amending certain provisions in DTC. By retaining / introducing a few worthy provisions, it has also judiciously tried to carry out a balancing act between a simple tax regime for public at large and at the same time casting a net on unfair tax practices. While it is worth appreciating the efforts on the part of the Government, there are certain key areas in the DTC which still need to be addressed. One needs to wait and watch for the impact and the effect of the DTC provisions once it is implemented.
(Anil Talreja , Tax Partner and Neha Rupani, Deputy Manager are from Deloitte Haskins & Sells. Views expressed are personal.)