Cross Border Mergers: The Five-Year Wait Is Over...Maybe...
RBI finally notifies cross border merger regulations, but is that enough?
Cross border mergers no longer require the Reserve Bank of India’s prior approval. Starting April 20, inbound and outbound mergers will receive automatic clearance provided they satisfy conditions set out in new regulations issued by the RBI last week.
It’s taken five years for cross border mergers to go from being on paper to reality. The earlier companies law, Companies Act, 1956, did not permit an Indian company to merge with a foreign company though the reverse was allowed. That changed, conceptually, in 2013 when the new companies law was legislated. But the specific provision permitting cross border mergers was notified only last year. Yet such mergers required prior RBI consent until The Foreign Exchange Management (Cross Border Merger) Regulations, 2018 were issued last week.
The basic theme of these regulations is that companies cannot use the merger process to circumvent any requirements of the Foreign Exchange Management Act, Vivek Gupta, partner and national M&A head at KPMG told BloombergQuint. FEMA regulates the manner in which foreign exchange enters and leaves India.
For instance, the new regulations specify that:
For inbound mergers - where a foreign company merges into an Indian company, the resulting company is permitted to own and acquire assets outside India but only in accordance with existing FEMA regulations - such as the overseas direct investment regulations that set out investment limits and investment routes available to an Indian resident for investing offshore.
For outbound mergers - where an Indian company merges into a foreign entity, the Indian resident who becomes a shareholder of the resulting foreign company can acquire shares or other securities pursuant to such merger only if permitted under the Liberalised Remittance Scheme. The scheme caps a resident’s foreign investment to $250,000 per annum. Any merger consideration received by the Indian shareholder that exceeds this limit will not be permitted without specific RBI approval.
For both inbound and outbound mergers - the resulting companies will get a two-year period to regularise compliance with the existing FEMA framework. This means that if, for instance, the resulting company after the merger is not permitted to hold certain securities, assets or liabilities under the existing laws, the company will get two years to sell or dispose such assets or liabilities so that it complies with the FEMA laws.
That’s a smart way to do that in the sense that you must provide some sort of transition system otherwise in facts and circumstances of any such merger there will always be items which will trip us somewhere or the other. At the same time the government could not have taken a view that you can do through a merger or through a scheme of arrangement something that is otherwise not permitted under FEMA.Vivek Gupta, National M&A Head, KPMG
Compliance Conflicts
Despite the grant of a transition period, certain compliances with FEMA regulations could likely be onerous and even a deal deterrent, said a lawyer.
For instance, when an Indian company merges with a foreign company the Indian office of the resulting company may be considered a branch office under FEMA. As per RBI regulations, a branch office can undertake limited activities. It cannot, for instance, engage in any manufacturing activity.
Mehul Shah, partner at Khaitan & Co, said such challenges will need addressing.
We expect to see necessary amendments to the regulations – especially branch office regulations. There would also in all likelihood be amendments to the ODI regulations, FDI policy and perhaps the Companies Act as well.Mehul Shah, Partner, Khaitan & Co
But Gupta is not counting on any RBI-led relaxations. For instance, he said, it is unlikely that the regulator will make any concession to an Indian shareholder in a post-merger foreign company to hold shares or securities in violation of existing RBI regulations.
The government has said, fine, you can do an outbound merger – the resulting foreign entity, after assimilating the Indian company which has merged into it, can issue shares to the shareholders of the Indian company but you must comply with one of these (LRS, ODI, ODA) routes for such issuance to be an eligible issuance under FEMA.Vivek Gupta, National M&A Head, KPMG
Tax Hurdles
According to experts, the biggest hurdle cross border mergers are likely to run into is tax. Currently, a merger or amalgamation where the resulting company is an Indian company is exempted from capital gains tax under the Income Tax Act. But a similar benefit is not available for situations where an Indian company merges with a foreign company, possibly because such a transaction was not permitted earlier.
Another potential tax issue for outbound mergers is that operations of the resulting foreign company in India, through a branch or otherwise, could amount to the company having a “permanent establishment” under Indian tax laws. In which case profits of the company from its operation in India could be taxed at 40 percent.
Unless the present tax regime is amended and liberalised to extend tax benefits to outbound mergers, experts say that this could affect the popularity of these provisions, despite the latest regulations.
For overseas outbound mergers to take off in a meaningful fashion tax laws will need to change and some of the restrictions on Indian holding of foreign securities will also need to change, said Gupta, adding that these are very fundamental changes to India’s capital controlled FEMA regulatory framework.