Incorporation
The transfer of a business as a
contribution-in-kind to the capital of a company is treated as a
sale, and the gain thereon (i.e., the difference between the value of
the shares or cash receivable and value of the business transferred)
I subject tot ax as capital gains in the assessment of the transfer
or. The unabsorbed loses and depreciation of the transferor are not
carried over the transferee. (However, there is no tax on capital
gains in the case of certain amalgamations and transfers between a
holding company and its 100 percent subsidiary - see below.)
Merger or amalgamation
No capital gains are computed for a transferor
company or its sharer holders on the transfer of a business under a
scheme of amalgamation, provided the following conditions are
satisfied.
1. All assets of the amalgamating company are
transferred to the amalgamated company.
2. All liabilities of the amalgamating company are transferred to the
amalgamated company.
3. Ninety percent of the shareholders of the amalgamating company
become shareholders in the amalgamated company.
4. The amalgamated company is an Indian company.
Where the above conditions are fulfilled, the
unabsorbed losses and depreciation of the amalgamating company can be
carried over by the amalgamated company if the scheme is approved by
the prescribed authority.
Where the merger or amalgamation does not
fulfill the above conditions, the general rule mentioned under
"Incorporation" above applies. In such a case, if the value
of the shares in the transferee company distributed to a shareholder
of the transferor company, the excess is subject to tax in the
shareholder's hands as capital gains.
Transfer abroad of shares in an Indian company
by one nonresident to another is taxable event in India. However, the
transfer of such shares by one foreign company to another in a scheme
of amalgamation is exempt from capital gains tax if specified
conditions are satisfied.
Reorganization
No capital gain is computed on the transfer of
assets to or from a wholly owned subsidiary, provided this
relationship continues for at least eight years and the transferee
company is an Indian company (unless capital assets taken over are
converted into inventory within eight years of transfer). Subject to
this and the exemption for amalgamations fulfilling specified
conditions mentioned above, all other reorganizations, e.g.,
spin-offs of divisions, mergers not satisfying the specified
conditions, result in taxable capital gains both at the corporate
level for transfer of business or assets and at the shareholder level
if shares are exchanged. However, a mere stock split or stock
consolidation is not regarded as disposition for tax purposes.
Instead, the total cost of the shares previously held is simply
allocated over the larger or smaller number of shares received.
Liquidation
A company continues to be liable to tax on
profits and capital gains arising after commencement of liquidation
until the liquidation is finally terminated with distribution of all
assets. Expenses incurred after the company has ceased business are
generally not deductible.
Distribution to shareholders is treated as a
dividend to the extent of accumulated profits. The balance of the
distribution is regarded as a return of capital and taken into
account in computing capital gains on the shares held.
Asset acquisition
In an asset acquisition at arm's length, the
cost of the purchased assets in the hands of the purchaser is
equivalent to the total amount paid (except an amalgamation in which
the conditions mentioned earlier are satisfied or a transfer between
a holding company and its wholly owned subsidiary, provided in
either case the transferee is an Indian company). However, the
purchaser cannot amortize the cost of goodwill. If the company's
acquired through a purchase of assets rather than shares, the
unabsorbed losses, depreciation, etc., of the company cannot be
carried forward by the purchaser. The company whose assets are
acquired recognizes a gain or loss depending on the nature of assets
(i.e, capital gain or loss where the asset transferred is a current
asset). Capital gains are recognized on the transfer of goodwill.
A significant point the seller must keep in
mind is the recapture of certain capital allowances allowed earlier
if the capital assets are transferred within eight years of
acquisition. Also important is the high stamp duty on the transfer
of immovable property. Depending on the facts, interest on
borrowings for acquisition or on the unpaid purchase price of assets
is generally deductible where the business is carried on.
Share acquisition
In a share acquisition, the selling shareholder
is taxed on capital gains on the shares transferred. The price paid
constitutes the purchase price of the shares in the hands of the
purchaser. There is no step-up in the value of the company's assets
upon the change of control to reflect the purchase price. The
unabsorbed losses, depreciation and capital allowances of the
company continue to be carried forward up their normal statutory
limits because its corporate existence is unaffected. Interest on
borrowings to acquire shares is deductible from dividends income,
except that tax is withheld on the basis of gross dividends in the
case of foreign companies.
Buyer and seller
Foreign investment in India is possible only
with the permission of the Reserve Bank of India. While foreign
buyers may be permitted to participate in the share capital of an
Indian company up to a specified extent, they are not normally
permitted to make a straight purchaser of assets of an Indian
business that would make it virtually a branch.
He acquisition and sale of shares in an Indian
company have tax implications already explained, but the transfer of
shares abroad of a foreign company that holds shares in an Indian
company is not a taxable event in India. However, an Indian company
with foreign holdings may acquire assets or shares, and the
consequences indicated earlier will follow.
While the relative considerations of the buyer
and seller will depend on the facts of each case, the buyer would
weight the possibility of increasing the asset base through asset
acquisition against high stamp duty, loss of unabsorbed losses and
depreciation, and recapture of past capital allowances. The seller
would try to maximize capital gains and might prefer to avoid all
corporate involvement. On balance, acquisition of shares is more
common.
See Appendix XIV for other points that should
be considered by investors, their legal counsel and their
accountants before acquiring a business enterprise in India.
General Section
