Budget 2022 – ‘Expectations for Corporate Restructuring’

Suvira Agarwal,
Surabhi Singhal
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The Indian Economy is anticipated to grow at  more  than  9%  growth  rate in the current year and the Budget slated to be announced on 1stFebruary, 2022 will set the tone for developments for the domestic economy.

With a surge in the M&A deals and investments, the experts anticipate  a strong recovery of the economy in the coming months. The successful IPOs in the recent months is indicative of the growth impulse which is igniting the Indian financial sector. As more and more companies are going for IPO or a private fund raise from the financial and strategic investors, various groups are resorting to group restructuring exercises to put the house in order and ready for fund raise through  consolidation of multiple entities, winding up non operative entities, delinking of non-core assets, etc.

However, there are various challenges and ambiguities in the current tax regime which act as an impediment to such restructuring transactions and arrangements. The investors and corporates have high expectations from the finance ministry to provide clarity on some of these aspects which would facilitate and boost the economic activity in the country.

Some of these key expectations relating to the Corporate restructuring transactions and arrangements are as below:

  • Relaxation of section 56(2)(viib) provisions – The provisions of this section basically aim at taxing the share premium received by a closely held company, from  any  domestic investor,  which is in excess of the fair market value      of the shares. However, while the objective of these provisions was to discourage the potential money laundering activities through investment at unjustifiable share valuations, these provisions at times create  challenges  for  genuine  investments or for private companies which are in need of investments for growth and expansion especially in the  given  times.  Accordingly, rationalisation of the said provisions is  of reasonable importance to boost the investment activities. For instance, appropriate  relaxations  for  investment  in  loss- making entities which is duly supported by the appropriate business projections or relaxation for investment in companies under resolution process can be introduced to enable such companies to raise the requisite funds required for business revival.
  • Relaxation of Section 56(2)(x) provisions –In these unprecedented times, the valuations of businesses have significantly diminished resulting in lower valuation of the  shares of the companies and sometimes, the fair value (i.e. actually realisable value) of such shares is even lower than the prescribed fair market value ((i.e. adjusted book value as prescribed in Rule 11UA). Accordingly, there are undue  hardships faced by the Acquirers  /  Investors  in  cases  where  the fair value is genuinely below the prescribed fair market  value. Accordingly, appropriate relaxation or  exemptions  may  be introduced from applicability of provisions of Section 56(2) (x) where the lower fair value of shares (i.e. lower than prescribed FMV) is justified through an independent valuation report basis the exit or liquidation valuation of the companies.
  • Applicability of Section 72A benefit to service sector companies – Service sector viz. hotels, restaurants, transport services are the worst hit sectors by the COVID-19 pandemic. Currently, the provisions of section 72A dealing with carry forward and set off of tax losses pursuant to merger transactions are not applicable on the service sector companies. To promote the growth, enable sustenance and facilitate restructuring transactions in the service sector, it is imperative that the Ministry should consider extending the benefits of section 72A to service sector companies as well.
  • Conversion of Firm / LLP into Company form– As a small or a medium scale promoter driven business grows, the need for introduction of an investor or requirement of an increased capital base arises and often the partnership firms resort to conversion into companies for facilitating  fund  raising. However, there are various  aspects  on  which  there  is  no clarity available under the current tax regime. For instance, whether such conversion would be exempt in the hands of the partners as well, what would be the cost of acquisition and period of holding of shares of the successor company in the hands of the partners should there be a transfer of shares by the partners in future. Further, there is no clarity on how the capital gains tax shall be  computed  for  the  successor companies where the conditions prescribed for the tax neutral conversion are not met or breached subsequent to conversion. Hence, it is recommended that clarity on these aspects is provided.
  • Merger / consolidation of two or more LLPs - While the LLP Act permits merger of two or  more  LLPs  through  the  NCLT approval process, there is no specific provision on taxability of such mergers under the Income tax  Act,  1961. There are no exemption provisions for merger of LLPs similar to the provisions available for tax neutrality  of  amalgamation and demerger of companies. There is no clarity on tax implications in the hands of the Transferor and the Transferee LLP and their partners respectively as well as no clarity on the carry forward of losses of the LLP in case of amalgamation of LLPs. Introduction of similar provisions for LLPs is required in order to give LLPs a level playing field along with companies.
  • Cross border restructuring – Under the existing global economic scenarios, the MNCs have been finding it difficult to sustain their business operations in the overseas jurisdictions and accordingly, the corporate groups are increasingly resorting to winding up their business operations in the unviable jurisdictions. The Indian corporate as well as foreign exchange regulations currently permit both inbound and outbound merger transactions between the Indian and foreign companies. However, while the Income tax provisions exempt the inbound merger transactions from capital gains tax subject to compliance with prescribed conditions, there is no similar exemption available for outbound merger transactions. Hence, introduction of such exemption would act as a big trigger for the foreign investment in India, which is the economic requirement at the moment.

Other than the above, there are various other key aspects where clarity or relaxation should be provided under the current tax regime such as carry forward of losses in case of group  restructuring  schemes  / exercises where the ultimate  ownership  remains  the  same,  relaxation  of exemption conditions for various forms of restructuring such as conversion  of  firm  into  LLP,  rationalisation  of  TDS/  TCS  provisions  etc. While the corporate taxpayers would indeed have a long wish list  to  meet, it is anticipated that the Budget 2022 will be a growth-oriented budget which would boost the economic activity and steer the economy towards a higher growth path.