Laying down the vision for a $5 trillion economy, Union finance minister Nirmala Sitharaman announced several proposals in the Budget this year, aimed at growth in domestic manufacturing, agriculture, boosting innovation and entrepreneurship and attracting foreign capital.
Liberalisation in the foreign direct investment (FDI) ceilings in the aviation, media and insurance sectors is a welcome move, which will help in raising the much-required growth capital in these businesses. While the fine print of the policy is awaited, it will be interesting to see whether the relaxation in the norms is extended to strategic players also, particularly in sectors such as aviation, where FDI restrictions for strategic buyers have impacted merger and acquisition (M&A) activity in the past.
For real estate investment trusts (REITs) and infrastructure investment trusts (InvITs), the announcement to permit the issuance of listed debt securities to foreign portfolio investors is positive as it seeks to widen investor participation in these vehicles. What remains to be seen is the road map for relaxing some of the other issues, such as taxes and stamp duty on transfer of real assets to REITs and InvITs, which are potential deterrents for a seamless emergence of these platforms.
The other big announcement from a regulatory perspective is the increase in the minimum public shareholding from 25% to 35% for listed Indian companies. While the minister has only stated that the government will urge the capital market regulator Securities and Exchange Board of India (SEBI) to look into this -- if implemented, the move will drive significant activity in capital markets, with promoters having to dilute their ownership through offer for sale (OFS) and qualified institutional placement (QIP), etc. Such a policy change will be critical for many companies, particularly listed Indian subsidiaries of multinationals where the promoter shareholding is almost 75%.
On the tax front, this Budget has some important proposals that are likely to impact M&As and corporate structures. One of the most far-reaching announcements on the increase in surcharge for a specified category of assessees earning taxable income more than Rs 2 crore, while possibly intended for individual taxpayers, has also impacted institutional taxpayers structured as trusts. For many venture capital (VC) and private equity (PE) funds, this amendment will reduce internal rates of return (IRRs). The impact of this change will be crucial on exit transactions, which have already been concluded and taxes have been withheld or paid in this financial year. While the government has announced that it will consider relaxations from these rules for foreign portfolio investors, it remains to be seen how that will be done.
In the recent past, the government has made great strides in incentivising startups by providing clarifications on certain issues, which were haunting the Indian startup industry. The startups will no longer be subject to scrutiny for valuation of share premiums subject to requisite information being provided and, in cases of pending assessments, the tax officer will not be allowed to make further enquiries without approval of a supervisory officer.
In addition to the current regime, capital-raises from Category-II alternative investment funds (AIFs) will no longer be subject to provisions of Section 56(2)(viib), popularly called the angel tax. The government’s resolve to address these angel tax issues should have a very positive impact on fundraising activity for these new-age companies, which require capital to innovate constantly and, hence, a favourable tax climate for such capital-raises should enable them to concentrate on business, innovation and entrepreneurship.
The other important announcement for small and mid-sized businesses has been the increase in the limit for a reduced corporate tax rate of 25% to Rs 400 crore of revenues during the financial year 2017-18. While this is a welcome move, the clarification on whether the rate applies to new businesses incorporated as companies has not yet come.
Another significant change announced is to subject buybacks by listed companies to the buyback distribution tax of 20%, plus the applicable surcharge and cess. While the buyback by a listed company was until now subject to a 10% tax in the hands of the shareholders on the gains received, with the amendment, buybacks by listed and unlisted companies have now been brought on a par.
If one were to look at the amendment brought in last year on capital gains on the sale of listed shares by shareholders where a grandfathering of the market price of the shares on January 31, 2018, was available as a cost, going forward, in the case of a buyback, such grandfathering is no longer available. It will now be an interesting analysis on the profit distribution strategies that listed companies will adopt, as there are clear tax-related issues that merit consideration on whether the profits are distributed as dividend or by way of a buyback offer.
Conceptually, for a tax-neutral demerger, the resulting company must record the value of business acquired on demerger at book values whereas Indian Accounting Standard (Ind-AS) requires a business combination between unrelated parties to be recorded at fair values. This mismatch between taxation laws and accounting concepts has now been cleared: The tax law has been harmonised with Ind-AS with effect from April 1, 2020. This is a welcome clarification, which will enable transaction activity of business hive-offs with far more clarity on the tax aspects.
Lastly, the Finance Bill also provides for some exceptions to be provided for the anti-abuse provisions relating to the transfer of unlisted shares and receipt of property without adequate consideration. Provisions of Section 56(2)(x) and Section 50CA, which provide for these deeming laws, have been a cause of concern in genuine dealmaking activity. While the details on these exceptions are awaited, one hopes that some of the genuine situations which lead to hardship for taxpayers will be dealt with.
Summing it up, from an M&A activity perspective, the Budget focuses on facilitating transactions, relaxing the foreign investment climate across sectors and encouraging innovation and entrepreneurial activity. The government has indicated its commitment to resolve the few irritant issues that may have been unintended, which will possibly pave the way for a favourable tax and policy climate for transaction activity in the country.
Vaibhav Gupta is partner and Jagrit Khanna is senior associate at Dhruva Advisors LLP. Views are personal.