Mergers & Acquisitions Introduction

Merger Definition
A merger may be defined as an arrangement whereby the assets of two companies become vested in or under the control of one company, which has as its shareholders, all or substantially all the shareholders of the two companies. In a merger, one of the two existing companies may form a new company and merge their identities into the new company by transferring their business and undertakings including all other assets and liabilities to the new company

Amalgamation
When two or more companies merge together to form a new company, the process is known as amalgamation. Although the terms merger and amalgamation appear synonymous there is a difference between the two. All amalgamations are necessarily mergers, all mergers may not necessarily be amalgamations.

Kinds of Mergers
Cogeneric mergers: These mergers happen between companies that operate within the same industry Horizontal mergers: These mergers are between companies in the same business activity Vertical mergers: These mergers are between two or more companies which are engaged in a different functions within the same industry

Kind of mergers
Conglomerate mergers: Mergers between companies that belong to different industries Upstream merger: Merger in which the subsidiary is merged with the parent company Down-stream merger: Merger in which a parent is merged with its subsidiary Reverse Merger: Merger in which a company with a sound financial track record amalgamates with a loss making or less profitable company

Takeover
Takeover is a strategy of acquiring control over the management of another company either directly by acquiring shares of the company that carry voting rights or indirectly by participating in the management.

Takeover
Where the shares of the company as closely held by a small number of shareholders, a takeover might be affected by an agreement with the shareholders. Where the share of a company are widely held by the general public it involves the process as set out in the SEBI guidelines called Substantial Acquisition of Shares and Takeovers Regulation,1997

Kinds of Takeovers
Friendly Takeover- Takeover with the consent of the target company achieved through negotiations between the management Hostile Takeover- Where a company silently and unilaterally pursues efforts to gain control against the wishes of the existing mangement, such an attempt is considered hostile. Example: LN Mittal group acquired control of Arcelor

Kinds of takeovers
Bailout takeover: Takeover of a financially weak company by a financially stable company to bailout the former is known as bailout takeover. In the Indian context the financial institution appraises the financially weak company which is not a sick industrial company, and draws up a rehabilitation plan on the principle of protection of interests of the minority shareholders, good management, effective revival and transparency.

Kind of takeovers
Leveraged buyout: This form of takeover is defined as acquisition of stock or assets of a company by an acquirer, in a manner that the consideration is financed largely by borrowing (i.e. debt funding) and a small component of equity. The acquirer forms a shell company to act as a legal entity making the acquisition. The LBO differs from a normal acquisition on two grounds: A Large fraction of the acquisition is debt financed The shares of the target company are not publicly traded

Kind of takeovers
Management buyout: Acquisition of a company by its management is referred to as MBO. In this form the management will buy out all or most of the shareholders

Economic Aspects of M&A

Shareholders wealth enhancing shareholders value Synergy --- Synergy signifies an improvement in the performance Market Share- the merged entity could get a substantial market share e.g. coke buying the THUMS UP Core competence Mergers enhance the core competence of a company that already has expertise in a business domain

Economic Aspects of M&A

Diversification: Merger gives a tool for the company to diversify into new business area Increased debt capacity: A merged company would have a higher capacity to absorb debt

Definition of Merger as per Company Law

Section 390 of the Companies Act defines the term arrangement to include re-organisation of share capital of a company by the consolidation of shares of different classes, or by the division of shares into shares of different classes or by both these methods

Broad procedure to be followed for sanction of an amalgamation

Stage 1- Drafting the scheme and obtaining boards approval The scheme incorporates the following: Transfer of assets and liabilities Transfer of employees, legal proceedings, contracts, permits, licences etc of the transferor company to the transferee company Appointed date of transfer of assets and laibilities Consideration for the amalgamation and manner of discharge

Broad procedure to be followed for sanction of an amalgamation

Stage 1: Method of accounting Dissolution of the transferor company

Broad procedure to be followed for sanction of an amalgamation

Stage 2 In the case of listed companies after board of approval, the scheme needs to be approved by the Stock Exchange where the shares of the companies concerned are listed Clause 24(f) of listing agreement with BSE/NSE

Broad procedure to be followed for sanction of an amalgamation

Stage 3 Application to be filed in the High Court seeking directions to convene the meeting of shareholders and creditors to obtain consent, for approval of scheme of amalgamation

Broad procedure to be followed for sanction of an amalgamation

Stage 4. Meeting of shareholders and creditors and filing of petitions--- The scheme would have to be approved by three-fourths in value of the shareholders and creditors present and voting at such meetings.
In case of amalgamation of a wholly owned subsidiary into its parent, the Bombay High court observed that the parent need not file a petition for sanction-Mahaamba Investments v IDI Limited (2001)

Broad procedure to be followed for sanction of an amalgamation

Stage V- Approvals from regional director and official liquidator Notice needs to be given to the Central Government and to the official liquidator attached to the High Court to obtain their approval to the scheme of amalgamation

Broad procedure to be followed for sanction of an amalgamation

Stage VI Approval from the High Court After considering all the relevant and circumstances, the High Court may sanction the scheme of amalgamation with or without modifications as it deems fit.

Accounting aspect of Mergers

AS 14 deals with the accounting for amalgamations and the treatment of any resultant goodwill or reserves. AS 14 classifies amalgamation into two broad categories: 1. Amalgamation in the nature of merger 2. Amalgamation in the nature of purchase

Amalgamation in the nature if merger

All the following conditions have to be satisfied: All the assets and liabilities of the transferor company become after amalgamation the assets and liabilities of the transferee company Shareholders holding not less than 90% of the equity shares become equity shareholders of the transferee company The consideration is wholly discharged by the issue of equity shares of the transferee company The assets and liabilities of the transferor company are recorded at their book value in the transferee company

Amalgamation in the nature of merger

A very important aspect of the amalgamation in the nature of merger is that any difference between the amount of share capital issued and the amount of share capital of the transferor company has to be as premium and adjusted in the capital reserve (not free for distribution as dividend)

Examples
Two very good examples of pooling of interest are: Amalgamation of I-Ven Interactive Limited with Infomedia 18 Limited (effective date August 25, 2009) Amalgamation of Aptech Software Limited with Aptech Limited(Appointed date being April 1, 2009)

Amalgamation in the nature of Purchase

Under this method the assets that are acquired are recorded by the transferee company either at their existing carrying values or the fair values. It has been observed that value could be assigned to assets/liabilities which are not recorded in the books of the transferor company if they are identifiable

Amalgamation in the nature of Purchase

The normal accounting rules of purchase are applicable to this method and hence reserves, other than the reserves that are required by law do not appear in the books of the transferee company. Any consideration paid over and above the value of the assets/liabilities is considered as goodwill. In case of a deficit the difference is considered as capital reserve

Amortisation of Goodwill
AS 14 as it stands requires goodwill to be amortised AS 28 requires that the goodwill be tested for impairment

Important Dates in Mergers

Appointed Date: This is the date stated in the scheme as a date appointed by the parties to the amalgamation concerned. Sec. 391 of the Companies Act Effective Date: This is the date on which the order of the high court approving the scheme is filed with the registrar of companies

Disclosure requirements
AS 14 requires the following disclosures for all amalgamations to be made in the financial statements: Names and general nature of business of the amalgamating companies Effective date of amalgamation for accounting purposes Method of accounting used to reflect the amalgamation Particulars of the scheme sanctioned under a statute

Disclosure requirements
If the amalgamation is under the pooling of interest method
Description and number of shares issued, together with the swap ratio; and Amount of any difference between the consideration and the value of net identifiable assets acquired and the treatment thereof

If the amalgamation is under the purchase method

Consideration for amalgamation an d a description of the consideration payable and ; Amount of any difference between the consideration and the value of net identifiable assets acquired and the treatment thereof including the period of amortisation of any goodwill arising on amalgamation

Regulatory aspect

SEBI Regulations
SEBI regulations are applicable when the following conditions are satisfied: A listed company is amalgamating with another listed company An unlisted company is amalgamating with a listed company A listed company is amalgamating with an unlisted company

Listing Agreement
All amalgamations involving listed companies require in-principle approval of stock exchange. Listing agreement of stock exchanges require all listed companies to file any scheme of arrangement proposed to be filed before any Court or Tribunal under s. 391, 394 and 101 of the Companies Act, with the stock exchange at least a month before it is presented to the Court or Tribunal Auditors certificate: The above filing with the exchange has to be accompanied by the auditors certificate that states that the accounting treatment in the scheme of amalgamation is in compliance with all Accounting Standards

Explanatory statement to Shareholders

The listing agreement requires that an Explanatory statement be sent to the shareholders giving the following details: Pre and post amalgamation capital structure and shareholding pattern; Fairness opinion obtained from an independent merchant banker on valuation of assets/shares done by the valuer for the company

Listing of an unlisted company without an IPO

This situation arises when a listed company gets merged into an unlisted company: The shares for which the company seeks listing must have been allotted to the holders of securities of the listed company pursuant to the scheme sanctioned by the relevant High Court The terms of their listing should be governed by the Scheme and must not issue any shares not covered under the scheme Atleast 25% of its fully diluted, paid-up share capital should be issued to the public shareholders in the listed company

Listing of an unlisted company without an IPO

Lock-in requirements: The increased promoters stake in the listed company has to be locked-in as follows: 25% of increase in promoters stake for 3 years; or Entire increase in the promoters stake for one year

Shares issued by the unlisted company in lieu of the locked-in shares of the listed company must be subject to lock-in for the remaining period

Listing of an unlisted company without an IPO

In a case where the unlisted company has a paid-up share capital that is more than that required for incorporation purposes, the promoters shares shall be locked in to the extent of 20% of the post merger paid-up capital of the resulting company, for 3 years from the date of listing; Further, the balance of the entire pre-merger capital of the unlisted company shall be locked-in for a period of 3 years from the date of listing;

Exemption from open offer requirements

An acquirer who acquires shares or voting rights in a listed company in excess of the specified limits under the Securities and Exchange Board of India Regulations, 2011 needs to make an open offer of at least 26% to the public shareholders. Exemption provided : 1. Court order in pursuant of a scheme 2. Arrangement not directly involving the target company as a transferor or a transferee, under a scheme such that :
a) The component of cash and cash equivalent in the consideration paid being less than twenty five percent and b) Persons directly or indirectly holding at least thirty three percent of the voting rights in the combined entity are the same as the persons who held the entire voting rights before the implementation of the scheme

Income Tax Implications

Definition of tax-neutral amalgamation under the Income Tax Act

All properties of the transferor company become the properties of the transferee company; All liabilities of the transferor company become the liabilities of the transferee company; Shareholders holding 75% or more in value of the shares in the transferor company (excluding shares already held immediately before the amalgamation by the transferor company or its subsidiaries or its nominees) become shareholders of the transferee company The above must be achieved by virtue of the merger and not by way of purchase of properties by one company from another or by way of distribution of properties pursuant to the winding up of a company concerned

What is a tax neutral amalgamation

All properties of the transferor company become the properties of the transferee company All liabilities of the transferor company become the liabilities of the transferee company Shareholders holding 75% or more in value of the shares in the transferor company (excluding shares already held immediately before the amalgamation by the transferor company or its subsidiaries or its nominees) become shareholders of the transferee company, and; The above must be achieved by way of merger and not by purchase

ILLUSTRATION: Scenario 1
Pre-amalgamation structure Mr A and (60%) Mr B(40%) are shareholders in AB Ltd. Mr C (50%) and Mr D (50%) are shareholders in CD Ltd.

AB Ltd. Is merged in CD Ltd. , the share holding pattern now is

Mr A (30%), Mr B(20%), Mr C (25%), Mr D(25%)

The above amalgamation would qualify as amalgamation under the ACT but if the Mr B had received cash instead of shares and thus only 60% of the AB Ltd. shareholders would be merged, the merger would not qualify as an amalgamtion under the act

Capital Gains on Transfer

Section 47(vi)
The act specifically provides under sec. 47(vi) that any transfer of capital assets in a scheme of amalgamation would be regarded as exempt transfer and accordingly would not attract capital gains.

The CBDT has also clarified vide its circular no 5P(LXXVI-63) of 1967 dated October 9, 1967 that where a company transfers its assets pursuant a amalgamation, such transfer will not be regarded as distribution of accumulated profits

Implications for shareholders of the amalgamating company

Amount (Rs)

Year 1. Mr A purchased 100 shares of A Ltd for Rs 20.

Year 5: A Ltd. Amalgamates with B Ltd. The share swap ratio is for one share of A Ltd. the shareholder will get 10 shares of B Ltd.

2000

Year 5: Fair value of 1 share of B Ltd. Is Rs 5

Year 5: Mr A receives 1000 shares of B Ltd. Hence he will get shares that are worth Gain on receipt of shares of B Ltd on amalgamation 5000 3000

Tax Implication
Section 47(vii) of the Income Tax Act provides that any transfer of shares in a transferor company by the shareholders in an amalgamation would not be liable to capital gains tax if: 1. The shareholders of the transferor company receive shares in the transferee company in consideration of such transfer and 2. The transferee company is an INDIAN company The Gujarat High Court has held in the case of CIT vs Gautam Sarabhai Trust that such exemption will only be applicable if the shareholders receive shares otherwise the above capital gain exemption would not apply

Tax Implication to the transferee company

1. Actual cost of assets, depreciation, WDV in respect of capital assets transferred 2. Tax holiday benefits 3. Allowability of amalgamation expenses 4. Carry forward of losses of transferor company 5. Continuity of certain deduction of certain specific expenses incurred by transferor company

Actual cost of assets, depreciation, WDV in respect of capital assets transferred

-When a capital asset is transferred by a transferor company to a transferee company pursuant to an amalgamation, the latter being an Indian company, the actual cost of the transferred asset to the transferee company should be the same as it would have been to the transferor company, if the amalgamation had not taken place Pursuant to amalgamation, where a block of assets is transferred by transferor company to transferee company, then, the opening written down value of the block of assets transferred by the transferor company is regarded as the WDV of the block for the transferee company

Actual cost of assets, depreciation, WDV in respect of capital assets transferred

The tax depreciation is calculated differently for the year in which the amalgamation takes place. The aggregate annual depreciation in respect of depreciable assets which are transferred by a transferor company to the transferee company is required to be apportioned between the amalgamating and amalgamated company in the ratio of the number of days of usage of those assets by the respective companies

Tax Holiday benefits

All Tax holidays benefits other than the tax holiday enjoyed under Sec.80 IA of the Income Tax Act will be treated as follows: No tax holiday deduction will be allowed to the transferor company in the year of amalgamation The amalgamated company would be entitled to the tax holiday for the unexpired period, as if the amalgamation had not taken place

Tax Holiday benefits under 80 IA

Circular No 3 dated March 12, 2008 of CBDT has made the following clear: Any Tax Holiday enjoyed under sec. 80-IA will not be enjoyed by the amalgamated company if such amalagamation/de-merger has happened after 31/3/2007. There was a special subsection (12) added to the section 80-IA.

Amalgamation Expenses
Under section 35DD of the Act: The transferee company is allowed a deduction of 1/5th of the expenses incurred wholly and exclusively for the purpose of the Scheme over a period of five successive years beginning from the year in which the amalgamation takes place

Amalgamation Expenses
Under section 35DD of the Act: The transferee company is allowed a deduction of 1/5th of the expenses incurred wholly and exclusively for the purpose of the Scheme over a period of five successive years beginning from the year in which the amalgamation takes place

Carry forward of losses

Section 72A, 72AA and 72AB of the Act provides that accumulated losses of the transferor company would be deemed to be those of the transferee company provided : 1. The transferor company has been engaged in the business in which the accumulated losses occurred or depreciation remains unabsorbed, for 3 or more years 2. The transferor company has held continuosly as on the date of amalgamation at least 75% of the book value of the fixed assets held by it 2 years prior to the date of amalgamation 3. The transferee company continues to hold 75% of the book value of the fixed assets for at least 5 years 4. The transferee company carries on the business of the amalgamating company for at least 5 years 5. The transferee company should achieve the level of production of at least 50% of the installed capacity before the end of the 4 years from the date of amalgamation and continue to maintain this level of production till the end of 5 years from the date of amalgamation

Preliminary Expenses
The Act provides that if an Indian Company having an unamortised preliminary expenditure is amalgamated with another Indian company before the expiry of five years of the amortisation period, the unamortised preliminary expenses can be claimed by the transferee company for the unexpired period.

Capital Expenditure for obtaining licence to operate telecommunication services

The capital expenditure incurred by the transferor company for obtaining a telecommunications licence and for which payment has been actually made. Where in a scheme of amalgamation any such licence is transferred by the transferor company to the transferee company the expense is not allowed as a deduction for the transferor company but allowed for the transferee company as if the amalgamation did not take place

Expenditure on prospecting for minerals or development of mines

Expenditure incurred for prospecting minerals or development of mines is deductible in ten equal installments in respect of any expenditure incurred after March 31, 1970. Such expenditure is not allowed as a deduction for the transferor company in the year the amalgamation takes place, but allowed to the transferee company from the previous year the amalgamation takes place as if the amalgamation has never taken place.

ILLUSTRATION
Consider the amalgamation of AB Ltd. and CD Ltd. Both the companies have accumulated losses 100 crore and 200 crore respectively, the fair values of the companies are Rs 5,100 crore and Rs. 4,900 crore respectively. The shares are alloted in the ratio of the valuation that they have arrived at. There could three scenarios that could happen

ILLUSTRATION: Scenario 1
Pre-amalgamation structure

Shareholder of AB Ltd 100%

Shareholder of CD Ltd 100%

100 cr. loss

200 cr. loss

AB Ltd. Is merged in CD Ltd. , the share holding pattern now is

Shareholders of AB Ltd. get 51% and CD Ltd. get 49%

Because CD Ltd. Shareholding has been reduced to 49% the 300 crore setoff of losses WILL NOT BE AVAILABLE FOR CARRY FORWARD, BUT THE LOSSES OF AB LTD.OF A 100 CRORE IS AVAILABLE FOR SET-OFF

ILLUSTRATION: Scenario 2
Pre-amalgamation structure

Shareholder of AB Ltd 100%

Shareholder of CD Ltd 100%

100 cr. loss

200 cr. loss

CD Ltd. Is merged in AB Ltd. , the share holding pattern now is

Shareholders of AB Ltd. get 51% and CD Ltd. get 49%

In this scenario since CD has merged with AB Ltd. The 51% shareholding of AB Ltd. Continue to be 51% and hence the losses of AB and also of CD would not lapse

ILLUSTRATION: Scenario 3
Pre-amalgamation structure

Shareholder of AB Ltd 100%

Shareholder of CD Ltd 100%

100 cr. loss AB and CD both merge into a new company called ABCD

200 cr. loss

Shareholders of AB Ltd. get 51% and CD Ltd. get 49%

In this scenario the losses of both AB and CD would continue to be allowed to be carried forward and set-off against future profits

Stamp Duty(Not in detail)

State Andhra Pradesh Gujurat Stamp Duty on amalgamation 2% of the market value of the property Maximum of 10 crores 1% of the market value of the shares issued or allotted OR 1% of the immovable property of the transferor company situated in the state of gujurat Whichever is higher 2% of the market value of the property of the transferor company located in karnataka OR 1% of the aggregate market value of shares issued or allotted Whichever is higher 7% of the market value of immovable property transferred which is located in MP OR 0.7% of the aggregate market value of the shares issued

Karnataka

Madhya Pradesh

Stamp Duty (not in detail)

State Maharashtra Stamp Duty on amalgamation Maximum of 25 crore 10% of the market value of shares transferred or issued The amount of duty shall not exceed: (i) 5% of the true market value of the immovable property located within the State of Maharashtra OR (ii) 0.7% of the aggregate of the market value of the shares issued or allotted in exchange Whichever is higher 4% of the market value of the property transferred which was located in Rajasthan 8% of the aggregate market value of the shares issued or allotted in exchange or otherwise

Rajasthan West Bengal

Tamil Nadu

2% of the market value of the immovable property of the transferor company loacted in the state OR 0.6% of the market value of the shares Whichever is higher