Chapter 13 Cross Border Mergers – Corporate Restructuring Insolvency Liquidation & Winding Up Notes is designed strictly as per the latest syllabus and exam pattern.
Cross Border Mergers – Corporate Restructuring Insolvency Liquidation & Winding Up Study Material
Question 1.
GKL Ltd., an Indian company intends to amalgamate with PS International Ltd., a foreign company. Examine the legal provisions that have to be complied with for such an amalgamation. (June 2019, 5 marks)
Answer:
‘Outbound merger’ means a cross border merger where the resultant company is a foreign company. In terms of the Foreign Exchange Management (Cross Border Merger) Regulations, 2018, GKL Ltd. and PS International Ltd. have to take care of the following provisions in this regard:
(i) A person resident in India may acquire or hold securities of the resultant company in accordance with the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004.
(ii) A resident individual may acquire securities outside India provided that the fair market value of such securities is within the limits prescribed under the Liberalized Remittance Scheme laid down in the Act or rules or regulations framed thereunder.
(iii) An office in India for the Indian company, pursuant to sanction of the Scheme of cross border merger, may be deemed to be a branch office in India of the resultant company in accordance with the Foreign Exchange Management (Establishment in India of a branch office or a liaison office or a project office or any other place of business) Regulations, 2016. Accordingly, the resultant company may undertake any transaction as permitted to a branch office under the aforesaid Regulations.
(iv) The guarantees or outstanding borrowings of the Indian company which become the liabilities of the resultant company shall be repaid as per the Scheme sanctioned by the National Company Law Tribunal (NCLT) in terms of the companies (Compromises, Arrangements and Amalgamations) Rules, 2016.
The resultant company shall not acquire any liability payable towards a lender in India in Rupees which is not in conformity with the FEMA or rules or regulations framed thereunder. A no-objection certificate to this effect should be obtained from the lenders in India of the Indian company.
(v) The resultant company may acquire and hold any asset in India which a foreign company is permitted to acquire under the provisions of the Foreign Exchange Management Act, 1999, rules or regulations framed thereunder. Such assets can be transferred in any manner for undertaking a transaction permissible under the said Act or rules or regulations thereunder.
(vi) Where the asset or security in India cannot be acquired or held by the resultant company under the Foreign Exchange Management Act, 1999, rules or regulations made thereunder, the resultant company shall sell such asset or security within a period of two years from the date of sanction of the Scheme by NCLT and the sale proceeds shall be repatriated outside India immediately through banking channels. Repayment of Indian liabilities from sale proceeds of such assets or securities within the period of two years shall be permissible.
(vii) The resultant company may open a Special Non-Resident Rupee Account (SNRR Account) in accordance with the Foreign Exchange Management (Deposit) Regulations, 2016 for the purpose of putting through transactions under these regulations. The account shall run for a maximum period of two years from the date of sanction of the Scheme by NCLT.
Question 2.
“Cross Border Mergers not only bring benefits but also assume risks”. Briefly comment with specific provision under Companies Act, 2013. (June 2019, 3 marks)
Answer:
As per Section 234(1) of the Companies Act, 2013, the provisions of cross border merger are subject to every other law specifically providing for any restriction.
A company may merge with a foreign company incorporated in any of the jurisdictions specified in Annexure B under Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 after obtaining prior approval of the Reserve Bank of India and after complying with provisions of Sections 230 to 232 of the Companies Act, 2013 and these rules. It is to be ensured that while entering into an outbound merger, it is with a company from one of the specified jurisdictions.
Some of the risks associated with cross border mergers are:
- Taxation: Despite Double Tax Avoidance Agreements, the tax implications in the host countries may prove to be complex and tedious. This may increase the costs as a local professional is required to be hired.
- Regulatory landscape: The laws and regulations in the host country would be different and may be difficult to comply. An unsuitable regulatory landscape may pose risks to a cross border merger.
- Political scenario: It is essential to assess the political situation of the country before one enters into a merger with an entity belonging to that country. Unstable political situation may lead to difficulties in carrying out business.
- Valuation: Valuation is one factor which changes with countries due to changes in exchange rate, stock market transactions and other macroeconomic developments.
Question 3.
Differentiate between Inbound merger and Outbound merger. What are the laws governing Cross border mergers in India? (Dec 2019, 5 marks)
Answer:
An inbound merger is one where a foreign company merges with an Indian company resulting in an Indian company being formed. An outbound merger is one where an Indian company merges with a foreign company resulting in a foreign company being formed.
The following Acts/laws govern Cross border mergers in India:
- Companies Act, 2013
- SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011
- Foreign Exchange Management (Cross Border Merger) Regulations, 2018
- Competition Act, 2002
- Insolvency and Bankruptcy Code, 2016
- Income Tax Act, 1961
- Department for Promotion of Industry and Internal Trade (DPIIT)
Cross Border Mergers Notes
Cross-border mergers
A cross border merger refers to any merger, amalgamation or arrangement between an Indian company and foreign company in accordance with Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 notified under the Companies Act, 2013.
Inbound Merger
An Inboynd merger is one where a foreign company merges with an Indian company resulting in an Indian company being formed.
Outbound Mergers
An outbound merger is one where an Indian company merges with a foreign company resulting in a foreign company being formed.
Section 234 of Companies Act, 2013
Foreign company, may with the prior approval of the Reserve Bank of India, merge into a company registered under this Act or vice versa and the terms and conditions of the scheme of merger may provide, among other things, for the payment of consideration to the shareholders of the merging company in cash, or in Depository Receipts, or partly in cash and partly in Depository Receipts, as the case may be, as per the scheme to be drawn up for the purpose.
Section 234 of the Companies Act, 2013 which was notified in December, 2017 has made provisions for both in bound and outbound mergers.
Rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016
The Companies Amalgamation Rules permit foreign companies to merge with an Indian company subject to obtaining prior approval of Reserve Bank of India and after complying with the provisions of sections 230 to 232 of the Act and the Rules.
The Companies Amalgamation Rules, 2017 also mandates that the valuation should be conducted by valuers who are members of a recognised professional body and in accordance with the internationally accepted principles.
Benefits of entering into a cross border merger
- Diversification: A merger often leads to product diversification, whereas a cross border in addition to offering diversification of products also leads to geographical diversification.
- Achieving cost effectiveness: When a company seeks to enter new markets, it takes some resources and money to build capacity. Having an existing infrastructure and resources in the new market helps in achieving cost effectiveness.
- Technological advancement: Mergers enable both the parties to use each other’s intellectual properties hence enhancing technical know-how.
- Distribution: Cross border mergers help in creating a large distribution network transcending boundary
Risks associated with cross border mergers
- Despite Double Tax Avoidance Agreements, the tax implications in the host countries may prove to be complex and tedious. This may increase costs as a local professional is required to be hired.
- Regulatory landscape: The laws and regulations in the host country would be different and may be difficult to comply. An unusable regulatory landscape may pose risks to a cross border merger.
- Political scenario: It is essential to assess the political situation of the country before one enters into a merger with an entity belonging to that country. Unstable politics may-lead to difficulties in carrying out business.
Valuation of Cross Border Firm
The DCF (Discounted Cash Flow) approach to valuation calculates the value of the enterprise as the present value of alt future tree cash flows less the cash flows due to creditors and minority shareholders.
- The P/E ratio is an indication of what the market is willing to pay for a currency unit of earnings. It is also an indication of how secure the markets perception is about the future earnings of the firm and its riskiness.
- The market-to-book ratio (M/B) is a method of valuing a firm on the basis of what the market believes the firm is worth over and above its capital, its original capital investment, and subsequent retained earnings.
Taxation of mergers and acquisitions in India in Cross Border Merger
When the undertaking is acquired via slump sale where the particular picking up of assets by the buyer is not possible, some of the tax benefits/deductions of the undertaking are made available to the buyer.
No GST is applicable to a slump sale, i.e., wherein all the assets, rights, property and liabilities are transferred to the transferee. On the other hand, in a situation where particular assets are bought, the GST rate pertaining to the asset is applicable.
When the acquisition is via sale of shares, Securities Transition Tax (STT) is payable by both the buyer and when the shares are sold through a recognized stock exchange, STT is imposed on purchases and sales of equity shares listed on a recognized stock exchange in India at 0.1 percent based on the purchase or sale price.
Where a foreign company transfers shares of a foreign company to another company and the value of the shares is derived substantially from assets situated in India, then capital gains derived on the transfer are subject to income tax in India.
If the foreign company is the parent company and the subsidiary is in India then the merger of the foreign company with another foreign company makes the newly created company, the owner of the Indian company provided that 25% of the shareholders of the amalgamating company remain the shareholders of the amalgamated company as well. Such a situation warrants for tax exemptions.
Regulatory aspects in Cross Border Merger
The Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside lndia)Regulations, 2000 (the FDI Regulations) and Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004 (the ODI Regulations) are extremely important pieces of legislation for allowing foreign investment in India and hence prove to be pertinent to cross border mergers as well.
In addition to this, the Reserve Bank of India (the RBI) has notified Foreign Exchange Management(Cross-Border Merger) Regulations, 2018 (the Cross-Border Regulation) under the Foreign Exchange Management Act, 1999. These Regulations specifically deal with cross border mergers and contain provisions pertaining to mergers, demergers, amalgamations and arrangements between Indian companies and foreign companies.
FDI Regulations: Cross border mergers essentially lead to inflow of foreign direct investment in the country and hence would be required to comply with the same. The two routes through which foreign investors may enter the country are government approval and automatic route.
Takeover Code: These are applicable if the merger is happening with a listed company in India. If voting rights or control over the company is acquired then these regulations get triggered.
Competition aspects in Cross Border Merger
- The Competition Commission of India (CCI) regulates the mergers in order to prevent the nse of monopolistic mergers.
- The CCI has to assess and inquire into any merger which may have an adverse impact on the healthy competition in the market.
- If the merged enterprise created post a cross-border merger possesses assets worth more than $500 million, or turnover more than $1500 million; or the group to which the merged enterprise belongs possesses assets worth more than $2 billion, or turnover more than $6 billion then the competition commission is required to examine such combination.
Accounting aspects in Cross Border Merger
In merger accounting, all the assets and liabilities of the transferor are consolidated at their existing book values. Under acquisition accounting, the consideration is allocated among the assets and liabilities acquired(on a fair value basis). Therefore, acquisition accounting may give rise to goodwill, which is normally amortized over 5 years.
Post-merger performance evaluation
The following parameters may be used to assess the post-merger performance:
Returns: A comparative analysis of the returns being generated by the entity pre and post-merger should be carried out. If the merged entity is earning significantly higher returns than the merger is deemed successful. Cash flow and operational efficiency: If post-merger the cash flow significantly increases and this increased cash flow is put to use to obtain operational efficiency, this too shows that the newly created entity is performing well.
Stock market reaction: If the stock market reaction to the announcement of merger is positive then the merger appears to be a positive step.
Practicalities which need to be kept in mind while entering cross border mergers
- Conduct due diligence on the other firm
- Conduct a risk-benefit analysis before entering into the merger
- Valuation of both the firms is essential so as to predict the competition law treatment of the merger
- Make sure that when you enter into an outbound merger it is with a company from one of the prescribed jurisdictions
- Have an in-depth analysis of the host country’s regulatory and political landscape ready before you take the decision of the merger