Revamping direct tax law can usher in positive changes for M&As
The expectation is that India’s new direct tax code will be in sync with the economic conditions of the country
The current regulatory environment is dynamic, and changing constantly at a rapid pace to propel India Inc., with ease of doing business being the sole motto. In the quest to improve its global ranking in ease of doing business, one such action taken is that of constituting a task force for redrafting the almost 60-year-old direct tax law.
The expectation is that the new direct taxes code will be in sync with the economic conditions of the country, prevailing international best practices, the ease in carrying out business, reduction in avenues of litigation and, above all, be a less cumbersome tax system.
Over the last couple of years, the approach has been of substance over form, and aligning ourselves to international best practices, including base erosion and profit shifting (BEPS), exchange of information and country-by-country reporting.
Even in these turbulent times of global trade wars, rising oil prices and a weakening currency, global CEOs are positive of investing in India and considering it one of the focused markets. Therefore, a revamp of the direct tax law provides a unique opportunity to usher in clear positive changes from a mergers and acquisitions (M&A) perspective, as well. If the following could be considered, it will be a welcome change:
Deferred considerations and earn-outs
In many M&A deals there is the concept of earn-outs and deferred considerations. The purpose of these, among other things, is to ensure that sellers have skin in the game, milestones of future profitability are achieved and that there are no unpleasant surprises in the form of a significant claim. Some advanced countries, such as the US, have provisions in tax laws with regards to taxability of such aspects. Similarly, the proposed new tax code could provide for taxing the same in the year of accrual, as additional income, giving the same treatment as to the original income earned.
Over a period we have seen that acquisitions are funded through leverage. Post-acquisition, organizations look at avenues to ensure that debt is serviced from the business/entity acquired. Currently, advanced countries such as China, Japan, the UK and the US, etc., have provisions related to debt push down, especially in relation to deduction of interest incurred for acquisitions, subject to certain conditions. Similar provisions in the new tax code will give an impetus to deals, as well as flow of foreign investments into India.
Uniform conditions for reorganization
Currently in India, businesses are carried out through various forms of entities—from sole proprietorships and partnership firms, to LLPs and companies. Currently, only mergers and demergers among companies are tax-neutral (including loss roll-over), subject to fulfilling certain conditions. It would be prudent to ensure uniform conditions for tax neutrality (including losses roll-over), for mergers, demergers, and reorganizations of companies, LLPs and firms.
Eased terms for carrying forward losses
Currently, there is significant litigation and debate around carry forward of losses in cases of share acquisitions. If we have to match with global standards, such as those in the US, UK, Germany, etc., it would be worthwhile to legislate that even if there is a change in the shareholding pattern, and the business remains the same, then losses be allowed to be carried forward and set off against profits.
Deductions on goodwill in acquisitions
In many business acquisitions, there is always an element of goodwill which is paid by the acquirer to the seller. It would be prudent that the acquirer be permitted to claim deduction on such goodwill. In the US, Japan and Germany, etc., acquirers can claim deduction on goodwill paid for acquisition of the business. Such a provision in the new tax code will make claims less ambiguous and reduce litigation.
Tax neutrality for outbound mergers
India is one of the very few countries, globally, to have a regime of outbound mergers. However, under the current tax law, there is no provision to deal with neutrality of outbound mergers. Keeping in line with its tax themes of a business-friendly environment, the new tax code should align outbound mergers with domestic mergers, as tax neutral, subject to certain conditions.
While there has been a significant change in the overall respect for India across the globe, the journey has just begun. The expectation for change will always keep mounting and such initiatives will ensure that we are walking alongside global leaders. As Mahatma Gandhi once said: “Be the change that you want to see in the world.” This is an opportunity for India to unlearn, learn and relearn. As India is likely to become a hotbed of M&A activity, the M&A aspects of the new tax code would generate immense interest among Indians, as well as globally.
Amrish Shah is a partner with Deloitte India and Parthiv Kamdar is a director with Deloitte Haskins and Sells LLP .