For India, 2021 was a record year in merger and acquisition (M&A) activity and initial public offerings (IPOs), as private equity and venture capital took centre stage in both the businesses.
The country even witnessed successful implementation of the largest special purpose acquisition company (SPAC) deal.
For the coming year, the government will do well if it can plug the unintended tax leakages, reduce the compliance burden and adopt a more deal and business friendly approach. There are also avenues to extend the tax incentives to newly introduced business possibilities at a cross-border level.
We have highlighted some of the key areas that need attention with some being a recurring ask over the years.
Deferred consideration and earn-outs are a valuable deal making tool in bridging the gap between valuation of a business perceived by a seller and a purchaser.
Indian law seeks to tax the deferred consideration and earn-outs upfront in the year of transfer of the business even though there is no assurance of the consideration being received in later years. The issue gets further problematic as the sellers have a limited window to revise their tax returns and cannot seek a refund of tax where they do not end up making the expected returns in later years. While there are practical work arounds, the exercise ends up being time consuming and often complex.
The solution is rather simple; tax the consideration when it is actually accrued and received. We could have a win-win for both the taxpayers and the revenue.
Secondly, it is common for shares of two entities to be swapped either as part of group restructuring exercise; a part-cash and part-equity deal in M&A; or externalisation of Indian shareholding to attract foreign investments including a SPAC.
Currently, swap of shares results in tax leakage for both the parties and that too without getting any liquidity. Such tax cost is a deterrent to the structure, where cash liquidity is not available to meet the tax costs.
It would greatly help commercial reorganization and help raise funds if the tax on swaps could be deferred to a liquidity event. This could be achieved by making such swaps tax neutral and keeping the base cost at par with original investment resulting in gains since inception being taxable at a liquidity event.
There will not be any tax loss to the revenue since entire gains would be taxed when the taxpayer actually earns the money. However, there will be delay in tax collection compared to current position. Having said that, facilitating business growth and raising of further capital would only increase the over all tax collections in time. Similar deferral of taxes, on swap, is also provided by UK, Canada, Australia, etc.
Also, currently an offshore merger i.e., merger of two foreign entities is exempt from Indian tax even where shares of Indian entities are being transferred as a result. However, there may be unintended tax cost for shareholders of the foreign merging entity, where such merging entity derives substantial value from Indian shares. It would be helpful to extend the tax neutrality to the shareholders of the merging entity as well.
Provisions around tax collection at source (TCS) and tax deduction at source (TDS), at the rate of 0.1%, were made applicable to sale and purchase of “goods”.
It appears that revenue wanted to play the big brother and have all transactions in goods reported. There was some uncertainty initially around whether such provisions were applicable to shares i.e., whether shares were also “goods”.
A clarification from the government, exempting listed securities from such provisions, implied that in principle, shares were covered and the transaction of unlisted shares would continue to be subject to such TDS / TCS.
An exemption was also provided to foreign buyer entities from withholding tax where the foreign entity did not have a taxable presence in India. However, a mirror exemption was not provided for foreign seller entities from TCS requirements. Overall, such TDS / TCS provisions at 0.1%, that do not even result in any material tax collection for the Indian government, have unnecessarily increased the compliance burden and have complicated the deal making process.
Finally, foreign entities may have to delay the transaction in some cases just to procure tax registrations such as PAN / TAN that are needed in the first place to carry out such TDS / TCS obligations. It would do much good if the government exempts all securities from such compliance burden.
These are some of the changes that would aid in deal making and at the same time only help increase the overall tax collections by enhancing business activity. After all, laws are made for businesses and not the other way around.
Indruj Singh Rai (Partner) and Aditya Comar (Associate),Khaitan& Cocan be reached at indruj.rai@khaitanco.com and aditya.comar@khaitanco.com
