Taking the right route to cross-border mergers

The new law, which lists out requirements, should ensure smooth implementation

In a significant move, the Indian Government opened the doors to cross-border mergers by notifying section 234 of the Companies Act, 2013 and related rules, on April 13, 2017.

Prior to this move, company law permitted a foreign company to merge with an Indian company, but not the other way round. Remember that it was always possible for companies to acquire each other’s shares (whether inbound or outbound), but this section permits companies to dissolve into each other and become one single legal entity.

Moving on to actual provisions, the new law provides that cross-border mergers need to follow the NCLT supervised process and seek prior approval of the RBI.

In addition to the payment of consideration by issuance of shares, the provisions permit payment of consideration by way of cash or depository receipts or a combination thereof. For out-bound mergers, the rules require that the foreign company should be from notified jurisdictions (a fairly wide list including Singapore and Mauritius) and the application be accompanied by a report of a recognised valuer in the foreign country.

So far so good — now, let’s delve into some of the ancillary domains of the Indian legal framework to explore whether the implementation path is a smooth one or a post-monsoon dirt track.

To provide a better perspective, consider two scenarios for an Indian company wanting to merge with a foreign company — on one hand, consider a small holding company and on the other, imagine a listed FMCG company with a dozen manufacturing locations, distribution outlets and a few thousand shareholders/employees.

The cross-border merger provisions apply equally to both — with these scenarios in mind, let’s consider some of the key regulatory provisions.

Tax

First up, note that Indian tax laws bestow neutrality on mergers so long as the merged/surviving company is an Indian company. However, similar tax benefits for out-bound mergers do not exist, limiting its attractiveness as an effective restructuring tool.

Companies contemplating out-bound mergers would need to evaluate the risk of constituting a ‘permanent establishment’ in India owing to Indian operations/assets, thereby leading to taxation at a higher rate.

Similarly, consider the impact of indirect tax laws (including impending GST) to post-merger Indian operations of a foreign company, availability of credits/related compliances.

From a process perspective, given that schemes of merger require prior approval of tax authorities in India, it is not clear what position they will take on an outbound merger — how will pre-existing tax proceedings continue, what taxes should be recovered at exit and what tests should be applied before issuing a no-objection certificate.

It will be important to lay down clear rules and procedures, so that the merger process doesn’t hit a road block due to absence of a tax approval or uncertainty of an unknown tax bill manifesting itself in future.

Exchange control

In a welcome sign that regulators are moving in a coordinated fashion, the RBI issued draft guidelines to address exchange control issues impacting cross border mergers. The draft guidelines are forward-looking in their approach, as they provide for a “deemed approval” mechanism for both in-bound and out-bound mergers, subject to conditions.

Guidelines also lay down what is permissible and what is not, including holding of assets, compliance with ECB guidelines, filings, etc. We will need to wait till mid-May or so for final guidelines to be released post inputs from stakeholders. Meanwhile, the existing in-bound merger applications are likely to remain on hold.

Other factors

Apart from the above regulations, companies considering outbound cross-border mergers would also need to consider several other factors — how will it affect interests of creditors (banks), will existing licences require modification, SEBI ensuring protection of public shareholders, accounting/reporting matters, permission of CCI and a host of operational guidelines at a local, state and central level. As regards companies engaged in sensitive sectors (insurance, defence, broadcasting etc.), sectoral regulators will provide their own perspective.

Overall, one would feel that the MCA’s move to permit cross-border mergers is a laudable one and a definite step in the right direction; this will provide a welcome boost to companies wishing to migrate ownership to international jurisdictions, raise capital and provide liquidity as also open up exciting possibilities for cross-border alliances. To make this a reality, the RBI has also swiftly moved into action and it is likely additional changes will be made to necessary regulations to ensure smooth implementation.

The writer is Partner, M&A, BMR Advisors

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