Promoting mergers and divisions in companies and partnerships can be an important policy tool.
From KS Mehta
Union Trade Minister Piyush Goyal initiated the production-based incentive system to attract investment. Finance Minister Nirmala Sitharaman brought in the credit facility and equity systems while MSME Minister Nitin Gadkari liberalized MSME policy and increased sales to Rs.250 billion plus unlimited exports. However, PSB’s NPA level is predicted to be 17%. Therefore, the FM needs to develop a strategy for (i) the growth of healthy industries as well as (ii) the revitalization of weak industries.
These latest guidelines can resuscitate animal spirits to achieve the dual goals of growth and resuscitation when certain supportive measures are taken in tax, corporate, LLP, and partnership law – all in the FM realm. Tax law for business combinations has existed since 1961; The Demerger Act came in the 1990s (this author had a small role in it). This accelerated the split and restructuring of companies, resulting in higher sales and taxes than the undivided company before.
Promoting mergers and divisions in companies and partnerships can be an important policy tool. While there are corporate and tax laws for mergers / divisions, there are none for partnerships or LLPs. Existing tax laws should be liberalized to allow the issuance of a mixture of shares or preference shares plus debt against the current requirement of only interests in mergers / divisions. The requirement that 75% of the old shareholders will become shareholders of the merged company should be reduced to 51% in the case of mergers and to 75% in the case of a 100% split. Even if 25% of shareholders disagree, they can be paid out. Tax laws require a 100% share issue in the event of a split.
A specialized court (NCLT) approves merger / demerger plans. A registered expert report is mandatory for all companies. In listed companies, the stock exchange and Sebi also carry out an audit. A NOC from the tax authorities is also required. Therefore checks and balances are already in place.
A clarifying change to the definition of a split is required. An income tax is levied on five heads – salary, property, corporate capital gains, and other sources. A company that is primarily investing that generates capital gains but does not generate business income still earns income and pays dividends and taxes on a regular basis. However, the tax authorities do not classify it as a “company” and therefore keep it out of the definition of Section 2 (19AA). However, if you split the investment division, there is no tax exemption. When A-Limited built its Rs 1,000 investment division to generate capital gains, the ITO believed that investing is not a business and therefore cannot be tax-free if it is split up. Any income-generating split should be viewed as a Company for Section 2 (19AA). In common parlance, investing is business.
Many companies have invested in subsidiaries that have to grow faster due to a spin-off and at the same time have to protect the interests of the shareholders and supporters of the holding company in the event of a split.
The takeover of sick companies by efficiently run companies is an alternative turnaround strategy. If the sick company is not listed on the stock exchanges or is no longer listed due to a change in ownership, the target company loses its right to carry forward its business loss. This attracts taxes on future profits much faster while the old liabilities have to be paid off. Internal funding available for resuscitation has been exhausted. The recovery period and costs become longer. Section 79 should be deleted.
In many situations, tax laws do not allow for losses from merging companies to be offset, although this does actually turn the trend. For example, if a loss-making engineering firm merges with a tractor company in the manufacture of car seats at a loss, it will lose its tax losses and unabsorbed depreciation if the unit does not reach production of car seats with a capacity of at least 50% within three years.
It cannot use these facilities to manufacture components and must continue the loss-making business of making car seats. Another absurd requirement is that the merged company must have 75% of the same old equipment for five years. How then can such a unit adopt new technologies or diversify production? The prerequisite is that 50% of the former workforce is employed.
The law only allows some manufacturing industries and only some services such as telecommunications, hotels, etc. to carry losses forward in a merger. The service sector accounts for over 60% of GDP but is largely excluded from this exemption, although it is a high level of employment for the investment generator. Think about the above measures for at least five years and evaluate their effectiveness.
MSMEs work mainly as partnerships. While the LLP law provides for a reorganization, merger or split of LLPs per se, there is no such law for partnerships. The government should put in place a law for the merger of companies and LLP with listed or unlisted companies for fast growth / liquidation. Currently, company law requires a law firm to register as a single company. then merge for tax reasons after a five-year waiting period. That’s absurd.
Two / three companies or LLPs should be merged directly into one operating company or registered as one company. Size and speed are crucial. Likewise, the law to split a division of one or more companies or LLP as allowed for a company should be allowed. Have the company’s regional director embark on a quick process so equity investments can flow in faster.
The LLP Act has established procedures for such matters. This should be extended to partnerships under this Act, but power should be delegated to RD or a specialized NCLT bank.
Inexplicably, the LLP law only allows a merger with an unlisted company. This should be extended to listed companies, including through a split. All tax laws relating to mergers and divisions should be extended to partnership companies and LLPs.
An acquisition finance program should be launched that allows healthy borrowers to obtain special loans with an overall moratorium of up to five years on acquisition or amalgamation with weak borrowers. When a business is successful by converting it into a business, capital gains are exempt and losses can be carried forward under certain conditions. This should also be allowed when a department of a company is transferred.
There are operational problems with such a succession through a company transfer agreement compared to a merger / split due to a court order that is binding on all. Such reorganized companies will race for growth.
The author is managing partner, SS Kothari Mehta & Co.
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