In today's time business restructuring is imperative to the growth of any business as it provides benefits such as operational synergies, cost optimization, facilitate innovation in business process, improvement in EPS, efficient utilization of excess cash, identification of apt form of entity for doing businesses, etc. Restructuring is required in every spectrum of business cycle from inception to winding up and the law should provide such provisions for business reorganization so that it do not result in high tax cost of restructuring or involve impairment of tax attributes.
As the industry is eagerly waiting for Union Budget 2017, we list down expectations which are imperative from business restructuring perspective:
• Applicability of grandfathering provided under treaty on shares received on conversion of convertibles/merger etc.
Recently, Government of India has signed protocol for amendment of tax treaties entered with other countries viz. Mauritius, Cyprus and Singapore.
Under these amended treaties, grandfathering has been provided for investments made before April 2017. Question on whether shares issued after April 2017 pursuant to demerger, merger and in lieu of convertible instruments will be governed by these grandfathering provisions remain unanswered. Appropriate clarity on this aspect needs to be provided.
• Tax neutrality on amalgamation of Limited Liability Companies (LLPs)
Current tax regime has specific provisions for tax neutrality of amalgamation and demerger of companies subject to fulfilment of specified conditions.
With the advent of more flexible forms of entity structures in India like LLPs, there is a necessity to align the benefits of tax neutrality on restructuring viz. amalgamation/demerger available to companies to LLPs as well and thus, specific provisions with respect to tax neutrality of the same are required to be introduced.
• Protection to losses in case of business restructuring of Parent Co.
Section 79 of the Income-tax Act, 1961 (the Act)impairs ability of closely held companies to carry-forward and set off of losses in case of change in shareholding by more than 49 percent.
However, the above restriction does not apply in case where there is a change in shareholding of an Indian company by more than 49% as result of amalgamation/demerger of two foreign companies provided at least 51% of the shareholders of the amalgamating foreign company continue to be the shareholders of the amalgamated foreign company.
However, similar benefit is not provided in case of amalgamation/demerger of two Indian companies involving change in shareholding of more than 49% of another Indian company. This effects restructuring of Indian companies even though it is necessitated by commercial reasons.
• Outbound merger: Tax neutrality
Current tax regime provides tax neutrality on transfer of a capital asset being shares of an Indian company by the amalgamating foreign company (F Co1) to amalgamated foreign company (F Co2) provided at least 25% of the shareholders of F Co1 continue to remain shareholders of F Co2 and such transfer does not attract capital gains tax in country where amalgamating company is incorporated.
However, presently there is no provision that provides tax neutrality to an Indian Hold Co on merger of its foreign subsidiary with another foreign company and hence, Indian Hold Co is subject to tax on such amalgamation even if such amalgamation is exempt in foreign jurisdiction.
As Indian businesses are going global, inclusion of such a provision in the Act would entail ease of doing business for India companies investing abroad and restructuring of overseas operations.
• Clarification with respect to buy back tax
♦ Applicability of buy back tax in case of secondary purchase
Under Section 115QA of the Act, buy back tax (BBT) is levied on domestic companies @ 20% (excluding applicable surcharge and cess) of distributed income. Recently, buy back rules were also released to reduce ambiguity on the subject.
However, one aspect that warrants more clarification is BBT on secondary market deals. The current Act do not recognize the secondary transactions between investors in unlisted companies and thus, leads to double taxation. This happens because buy back law do not recognize step-up price in secondary deals. Each time the shares exchange hands in the secondary market, their step-up price would be ignored in such computation and would result in double taxation on the same amount, once as capital gains, and thereafter, as BBT.
This aspect in the Income Tax Law has existed since the introduction of BBT in India.
♦ Taxability on redemption of redeemable preference shares & capital reduction
The Act does not provide a specific mechanism for taxability on redemption of redeemable preference shares.
Buy back by domestic companies is subject to buy back tax (BBT) @ 20% (excluding applicable surcharge and cess) of distributed income. Further, "buy back" is defined to mean purchase by a company of its own shares in accordance with the provisions of any law for the time being in force relating to companies
There is an ambiguity whether redemption of preference shares will be subject to BBT in the hands of the company or would amount to 'transfer' of a capital asset in the hands of shareholder. Further, whether the amount received on such redemption can be construed as 'deemed dividend' under section 2(22)(d) of the Act.
Similarly, post introduction of BBT there is no clarity on whether capital reduction under section 66 of the Companies Act, 2013 will be taxed as buy back in the hands of company. It is expected that clarity in this regard is provided.
Real Estate Investment Trust (REIT) and Infrastructure Investment Trusts (InvIT) are alternate investment vehicles for investment in the infrastructure and real estate sectors. As these platforms are gaining importance, it becomes pertinent that law should entail relevant provisions to line up with the REIT and InvIT regulations.
♦ DDT exemption under two tier structure for REIT/InvIT
Under the prevailing provisions, Dividend Distribution Tax (DDT) is not applicable on distribution of dividend by SPV to REIT. Also, onward receipt of dividend by unit holders is exempt from DDT.
SEBI has recently permitted two tier SPV structure i.e. investment in SPV through another SPV by REIT/InvIT subject to fulfilment of specified conditions.
DDT provisions require amendment on account of DDT exemption under such two tier structure to promote alternate investment vehicles like REIT/InvIT.
♦ Exemption on interest received from LLP by REIT/InvIT
Under REIT regulations, SPV can be LLP or company. However, the Act provides for exemption on interest received by REIT from SPV being an Indian company. Therefore, interest received by REIT from LLP will attract tax in the hands of REIT/InvIT.
Definition of SPV needs to be amended to include LLPs to extend such benefit to SPV set up as LLP.
♦ Lapse of losses on account of change in shareholding on transfer of shares by Sponsor to REIT/InvIT
If moreop than 49% of the voting shares of the closely held SPV are transferred by Sponsor of REIT/InvIT in exchange of units of REIT, the ability to carry forward losses of SPV gets impaired and therefore will upsurge the tax load on SPVs.
Accordingly, it is provided that losses of SPV should not lapse on transfer of shares of SPV by Sponsor to REIT.
• Tax on conversion of convertible preference shares
The Act exempts capital gains on conversion of bonds, debentures, debenture-stock or deposit certificates into shares or debentures of the company. Further, cost of such convertible security becomes the cost of converted shares or debentures.
However, the Act does not provide any exemption on conversion of preference shares into equity shares.
Therefore relevant provisions may be amended/inserted to provide tax neutrality on conversion of preference shares to equity shares to provide certainty and clarity.
• Corresponding amendment in the Act on notification of provisions for compromise/arrangement of Companies Act, 2013
In December 2016, sections with respect to scheme of arrangement under Companies Act 2013 have been notified. Requisite changes are required to be made under the Act to align it with new provisions of the Companies Act, 2013 such as in provision like demerger where demerger is defined as "demerger in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manner that….."