Cross-Border Merger Framework in India: Limited Efficacy?

On April 13, 2017, the Ministry of Corporate Affairs (“MCA”) notified Section 234 of the Companies Act, 2013, as amended (the “Companies Act”) and Rule 25A of the Companies (Compromises, Arrangements, and Amalgamations) Rules, 2016, as amended (the “Companies Merger Rules”) to allow the merger and amalgamation of a foreign company with and into an Indian company.

Furthermore, on March 20, 2018, the Reserve Bank of India (“RBI”) published the Foreign Exchange Management (Cross Border Merger) Regulations, 2018, as amended (“FEMA Merger Regulations”) to address the inadequacies in the current framework in terms of foreign exchange.

The Companies Act’s Key Provisions

Prior to 2013, the Companies Act, 1956, as amended (“Erstwhile Act”) prohibited the merger or amalgamation of an Indian business with a foreign corporation. The former Act defined “transferee company” as only firms formed in India, and cross-border mergers were limited to mergers of foreign corporations with and into Indian companies (section 394 of the Firms Act, 1956). Section 234 of the Companies Act, however, removes this prohibition, making Chapter XV (Compromise, Arrangement, and Amalgamations) applicable to all cross-border mergers. As a result, Section 234 of the Companies Act, read in conjunction with Rule 25A of the Companies Merger Rules, establishes the foundation for cross-border mergers in India.

In accordance with such provisions, the concerned company must seek prior approval from the RBI for any merger or amalgamation with a foreign or Indian company, as applicable, and file an application with the National Company Law Tribunal (“NCLT”) in accordance with sections 230 to 232 of the Companies Act and rule 25A of the Companies Merger Rules.

The merger scheme may provide for payment of consideration to the merging company’s shareholders in cash, depository receipts, or a combination of cash and depository receipts and must meet the requirements of sections 230 to 232 of the Companies Act, including approval from shareholders, creditors, and tax authorities, among others. However, the scope of an Indian business’s merger with a foreign firm is limited to the jurisdictions listed in the Company Merger Rules.

FEMA Merger Regulations’ Key Provisions

A cross-border merger is defined as “any merger, amalgamation, or arrangement between an Indian company and a foreign company in accordance with the Companies (Compromises, Arrangements, and Amalgamation) Rules, 2016 notified under the Companies Act, 2013.” Cross-border mergers are further categorised by the legislation as:

• inbound mergers, in which the resultant firm is an Indian company, and
• outbound mergers, in which the resultant company is a foreign company or business.

Any merger carried out in accordance with the FEMA Merger Regulations will be deemed to have received prior RBI approval for the purposes of Rule 25A of the Companies Merger Rules, provided the following conditions are met:

Securities Transactions

In the event of an inbound merger:

• The resulting business may transfer its securities to a person residing outside of India in accordance with the terms of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside of India) Regulations, 2017, as amended (“FEMA 20-R”). The Foreign Exchange Management (Non-debt Instruments) Rules, 2019, the Foreign Exchange Management (Debt Instruments) Regulations, 2019, and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 took effect on October 17, 2019; and
• If the merger includes a foreign firm, extra compliance with the Foreign Exchange Management (Transfer or Issue of any Foreign Security) Regulations, 2004, as amended (“TIFS Regulations”) is necessary.

Furthermore, in the event of an outbound merger, a resident individual may acquire or hold securities in the resulting company within the limits of the liberalised remittance scheme established by the Foreign Exchange Management Act, 1992, as amended, and the regulations issued thereunder (“FEMA”) (see regulations 5(1) and 5(2) of the FEMA Merger Regulations).

Borrowings and guarantees.

The borrowings and guarantees of the foreign firm from overseas sources vest with the resulting company following an inward merger, and such an entity is expected to assure compliance with FEMA within two years. During this period, no remittances from India are authorized for the repayment of the responsibility, and the requirement about end use is not applied.

Asset Acquisition and Transfer

The resulting corporation may buy and hold assets outside of India or within India, as approved by the FEMA, and transfer them as permitted by the FEMA. Any asset or security of the resulting firm that violates the FEMA must be liquidated within two years after the scheme’s approval by the NCLT, and the revenues must be remitted beyond India or to India, as appropriate.

Bank Account

The resulting firm of an inbound merger may keep an overseas bank account for transactions related to the cross-border merger for a maximum of two years after the plan is approved by the NCLT.

In the event of an outbound merger, the resulting business may create a Special Non-Resident Rupee Account for a comparable duration under the Foreign Exchange Management (Deposit) Regulations, 2016.

Implications for Taxation

The Income-tax Act, 1961 (“the IT Act”), provides exemptions for tax neutrality in mergers only if the transferee firm is an Indian corporation. Such exclusions are not available in the case of a merger between an Indian and a foreign corporation. As a result, if an Indian firm merges with a foreign corporation, the Indian company and its stockholders may be taxed.

Section 72A of the IT Act allows for the carryforward and setoff of cumulative tax business losses and unabsorbed depreciation, provided the merger meets specific circumstances. According to Section 72A, such a benefit is not accessible in the event of outbound mergers.

Inference

The existing legal framework’s ease of outbound mergers has broadened the scope of cross-border mergers in India. However, in practice, the framework for cross-border mergers in India remains ineffective. So far, such a structure has mostly been used in the context of a merger of fully owned foreign subsidiaries with and into an Indian holding company, or vice versa. This appears to be due to several factors, including:

(a) the nature of the conditions for deemed RBI approval under the FEMA Merger Regulation;

(b) a lack of clarity regarding demergers; and

(c) the absence of tax benefits.