Post Merger Integration – Legal

Post Merger Integration – Legal

There are numerous legal compliances, critical in nature, which have to be addressed by the entities transacting acquisition. Depending upon legal intricacies involved in the structuring, there can be various legal implications in the post-acquisition scenario. It could be in form of increased compliance cost or reaping benefits of favorable enactments or even a failure of the entire scheme. A restructuring activity is carried with the vision to create better value for the organization and the people connected with it, in most cases. A single wrong step on the legal ladder can prove disastrous for the whole process. A diligent check of all relevant enactments should be carried to avoid undesired events.

It is proven over a period of time that business restructuring may bring tremendous value to the enterprise, but nothing comes without a price tag. One needs to take care of all legal, financial, human resource and other aspects even small in nature to make it a success. Talking in strict legal context, there are as many as 27 laws which directly hit the acquisition process at one or another stage of it. As every organization would definitely take proper steps to make the legal part sure, the article strives to discuss some of the crucial facets of significant enactment, having a bearing on the post acquisition integration.

Corporate Laws

AS a general perception, the approach to corporate law is more of compliance oriented, to ensure the smooth approval for the merger. But there are provisions in corporate laws which put a check on the organization, in the post-acquisition scenario.

  1. FII limits under merged entities

    Under Regulation 7 of FEMA 2000, once a scheme of merger, demerger or amalgamation has been approved by the court, the transferee company (whether the survivor or a new company) is permitted to issue shares to the shareholders of the transferor company who are persons resident outside India, subject to the condition that the percentage of non-resident holdings in the company does not exceed the limits for which approval has been granted by the RBI or the prescribed sectoral ceiling under the foreign direct investment policy set under the FEMA laws. If the new share allotment exceeds such limits, the company will have to obtain the prior approval of the FIPB and the RBI before issuing shares to the nonresidents.

  2. Competition Act

    The competition Act uses a composite expression – combination to cover different modes, viz. merger, acquisition of shares, assets, acquiring control of an enterprise. The objective of any competition law is to ensure that persons or enterprises obtaining the autonomy through merger or acquisition do not impair the structure of competition.

    What bothers the Post acquisition scenario is a provision of Section 20(1) of the Act, where the CCI (Competition commission of India) can inquire into any combination, so moto or upon receiving information, within one year from when such combination takes effect. The pre-notification option granted to enterprises under Section 6(2) and the power of the CCI to inquire so moto under Section 20 may lead to an anomalous situation, since companies that do not exercise their option under Section 6(2) are not automatically exempt from the investigations of the CCI.

  3. The threshold limits

    Assets of the merged/amalgamated entity more than Rs 1000 Cr. or turnover more than Rs 3000 Cr. (these limits are US$ 500 million and 1500 million in case one of the firms is situated outside India).

    The limits are more than Rs 4000 Cr. or Rs 12000 Cr. and US$ 2 billion and 6 billions in case merged/amalgamated entity belongs to a group in India or outside India respectively

    For e.g. Company “A” acquires company “B.” A and B do not consider their transaction anti-competitive even though they have an asset value and turnover above the prescribed threshold limit. The two companies do not notify the CCI about their merger. The companies invest a large amount on their merger within the first six months. The CCI on receipt of information from a competitor carries out an inquiry and passes a judgment within one year of the merger, that the merger has an adverse effect on competition and should not take effect. In this case, the two merged companies will incur huge losses as a result of the CCI’s order. This inconsistency can be removed by making pre-notification of combinations mandatory for all enterprises that have the prescribed asset value and turnover.

    As the investigation would be pending with CCI in an adverse case, it will create many uncertainties. The uncertainty has several implications, including the following:

    • Perception among customers
    • Uncertainty as regards the ‘identity’ of the enterprise could create reluctance among customers, who could choose to shift to a more ‘stable’ competitor.
    • Strategic and an operational business decision could remain in ‘limbo’.
    • Human resources: This has dimensions relating to alignment of titles, roles, and responsibilities. A long period of uncertainty could seriously dent morale and heighten attrition.
    • Enterprise value(s): As a result of the uncertainty, including the above factors, the market value of both enterprises could be severely dented due to the long period of uncertainty.
  4. Tenancy Act

    In an amalgamation under Section 394 of the Companies Act, 1956, the court has been given vast powers as a result of which the order of the court sanctions the amalgamation results, without further act or deed, in the transfer of the assets and liabilities of the business undertaking being transferred. In other words, the transfer does not require the permission of each of the parties, so long as the prescribed procedure is followed. In this background, the question that arises is that when the tenancy is practically an asset of the company and when land and buildings could be transferred without further act or deed, can tenancy be also so transferred. More importantly, will the landlord’s permission not be required for such transfer.

    The answer is in the negative. The legal requirement of taking the permission of the landlord is necessary to be complied for the transfer to be effective. If the transfer is made without such complying with such legal requirement, the landlord can evict the tenant even if the court had sanctioned the scheme in which it was clearly stated that the tenancy would be transferred along with other assets and liabilities. The reason for this is simply that the court while sanctioning such a transfer of undertaking has no powers to override the provisions of the state laws relating to tenancy.

    It must be said that transfer of tenancy imposes an important hurdle towards post-acquisition integration process. The solution for this, considering that tenancy laws are state laws, is not easy. While much can be said for and against tenancy laws in general, some amendments need be made if restructuring transactions are to be encouraged.

Duties and Taxes

Duties and taxes play a significant role in structuring strategy, as they bear a direct effect on the cash flow and the bottom line of the entity post acquisition.

  1. Indirect Tax

    • Impact on Inputs/Work in progressAs on the appointed date, the transferor company may have credit lying either in stock or in work in progress. Under such circumstances, the credit has to be transferred to the transferee company. However, the credit shall be allowed only if the stock of inputs or work in progress is also transferred along with the factory to the new site of ownership and the inputs on which credit has been availed of are duly accounted for to the satisfaction of the Tax Dept.
    • Carry forward of creditsIt is been stated that the transfer of CENVAT credit shall be allowed only “if the stock of inputs as such are in the process, or the capital goods are also transferred along with the factory to the new site or ownership and the inputs or capital goods on which credit has been availed of.The transferee company is entitled to avail of credit on the inputs which are to be used in the manufacture of the final product after filing a declaration. It is submitted that notwithstanding the changes in ownership the unit remains the same for all practical purpose for compliance with the excise formalities and therefore there is no restriction in availing excess credit.
    • Transfer from Backward area, SEZ, etc.Where any undertaking being the Unit which is entitled to the deduction under THE SPECIAL ECONOMIC ZONES ACT, 2005 is transferred, before the expiry of the period specified, to another undertaking, being the Unit in a scheme of amalgamation or demerger, then no deduction shall be admissible to the amalgamating or the demerged Unit, being the company for the previous year in which the amalgamation or the demerger takes place; the provisions shall, as they would have applied to the amalgamating or the demerged Unit being the company as if the amalgamation or demerger had not taken place, & would be applicable to Amalgamated company.
    • Integrating undertakings/FactoriesWhere the plants/factories of the transacting entities are situated in the same locality where they are attached via bridge or road or any other suitable means, they can be integrated into as one plant. If the output of one factory/plant becomes input for another one, then the transfer of material would fall into the category of captive consumption and such transfer would be exempt from excise duty.
  2. Stamp Duty

    • Dematerialization of shares of Pvt. Ltd companies:Before acquiring a private company, one can get its shares dematerialized with NSDL and CDSL. Where the private company‘s Articles of Association do not contain a provision for dematerialization, it has to be amended accordingly. This would save on the stamp duty on transfer of shares to be paid by the Acquirer Company.
    • No stamp duty for Holding – subsidiary marriage:The Central Government has exempted the payment of stamp duty on instrument evidencing the transfer of property between companies limited by shares as defined in the Indian companies’ act 1913 in a case:
      • Where at least 90% of the issued capital of the transferee company is in the beneficial ownership of the transferor company
      • Where the transfer takes place between a parent company and a subsidiary company one of which is the beneficial owner of not less than 90% of the issued share capital of the other. Or,
      • Where the transfer takes place between two subsidiary companies each of which not less than 90% of the share capital is in the beneficial ownership of a common parent company.

    However, stamp duty being a state subject the above would apply only in those states where the state government follows the above-stated notification of the Central Government otherwise stamp duty would be applicable irrespective of the relation mentioned in the above said notification.

  3. Income Tax

    • Integrate as separate company/SBU/Branch/Subsidiary?While integrating the acquired entity, the legal format to be kept is one of the important issues from tax point of view. There are different implication different formats as follows:
      1. As subsidiary:Where the transferor company is an Indian company and kept as subsidiary, on integration the losses will be allowed to be carried forward and most importantly there will be no stamp duty obligation on transfer of assets.But in case of cross boarder merger, if the acquired company is a foreign company and kept as subsidiary for integration, on integration carry fwd of losses will not be allowed to the Indian transferee company under Indian tax laws
      2. As Branch:Where the transferor company is integrated into a branch, carry forward of losses will be allowed irrespective of whether the transferor company is a foreign company or a domestic company. The effect of Branch’s operations is directly affected in the books of the acquiring company.
    • Allowances
      1. Scientific Research expenditure [Sec 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, the amalgamating company shall not be allowed the R&D expenses, 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.But in case the resulted company has sold or otherwise transferred the R&D asset than the expenditure would not be allowed.
      2. Statutory dues paid after due date [Sec 43B]:It is submitted that the amount paid on account of the statutory dues after the last date of the previous year or the appointed date would be deemed to have been paid on behalf of the amalgamated company and not by the amalgamating company. Even though theoretically this appears to be difficult, the provisions will have to be read in a reasonable manner, as the liability discharged would have to be treated as liability of the amalgamating company, even though as per the scheme, it is acting on behalf of the amalgamated company after the appointed date and it should be allowed.
    • Deductions
      1. Small scale industry issue:In this context, the successor of business will be eligible to get the deduction for the unexpired period. The difficulty is, however, likely to arise in case the deduction is granted u/s. 80-HHA or 80-I/80-IB etc, on the basis of SSI status and if on amalgamation, it ceases to be SSI, then whether the amalgamated company will be able to claim the deduction in view of the specific provisions of sec, 80HHA (3). Deduction u/s. 80-I, cannot be withdrawn even after amalgamation merely because it ceases to be SSI after amalgamation if the deduction is otherwise allowable to the amalgamated company.
      2. Deduction based on undertaking:Another issue in this context that may arise is, whether deduction u/s. 80-IA/80-1B etc. would be of the entire profit of the amalgamated company (including profits of the other units of the amalgamated company) or only on profits of the amalgamating company (which has got merged) by treating it as a separate unit. It is felt that deduction u/s.80-I/80-IA/80-IB which are qua “the undertaking” and not the entire profits of the amalgamated company and therefore, will be restricted to the profits of the eligible unit only.
      3. Tax benefits U/s 80-IA not available to amalgamation or de-merger:The provisions of section 80-IA provide for 100% deduction for ten years in respect of profits and gains of certain undertakings or enterprises engaged in the business of development, operation, and maintenance of infrastructure facility, industrial parks and special economic zones or generation, distribution or transmission of power.Earlier the benefit were available to amalgamation under Sub-section (12) of section 80-IA, but the union Budget 2007-2008 has inserted a new sub-section (12A) in section so that the provisions of sub-section (12) shall not apply to any undertaking or enterprise, which is transferred in a scheme of amalgamation or de-merger.

Post acquisition integration process is a ticklish issue which, most of the time gets well documented at the pre-integration stage but fails miserably at the implementation stage. Companies should be wary of this critical issue and keep their eyes and ears open at every stage of the implementation.

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