India Budget 2020: Incurring revenue losses is no longer restricted to the long gestation infrastructure sectors and is the norm in most new age sectors such as ecommerce and digital companies.
Budget 2020 expectations: Deal activity in a particular year may not necessarily act as the barometer of the health of the economy; however, it is still the convention to use M&A figures and deal values as supplementary evidence for the same. In line with the economic slowdown in 2019, the M&A activity also saw a downward trend as compared to 2018. The Finance Minister has her hands full in terms of budget expectations from her in 2020 and the thrust is primarily on the twin objectives of increasing investment and consumption. Both Indian and foreign players (whether existing or new entrants) have their own share of skepticism while evaluating greenfield investments. Thus, brownfield investments in the form of acquisitions, joint ventures and collaborations need a push. While availability of cheap external debt and regulatory factors are two critical factors which go into the making of a robust M&A environment; it is also pertinent to draw attention to certain key tax aspects which could go a long way in improving the ease of deal making in India.
Incurring revenue losses is no longer restricted to the long gestation infrastructure sectors and is the norm in most new age sectors such as ecommerce and digital companies. The Income Tax Act, 1961 (the Act) prohibits carry forward of losses where there is a change in shareholding beyond 49 per cent. Thus, the new buyer is deprived of the past losses of the target. Though the government’s steps for relaxing this provision for recognised start-ups and companies under Insolvency and Bankruptcy Code (IBC) is much appreciated, it may now be the time to re-think the utility of the provision and whether the purpose of avoiding trading in losses can be achieved through the General Anti-Avoidance Rules (GAAR) under the Act instead of a complete restriction on carry forward of losses in case of a change in control.
The services sector now commands about 54 per cent 1  share in the Gross Domestic Product (GDP) of India. Even with a lion’s share in GDP contribution, companies of this sector involved in mergers and acquisition are deprived of the benefit of carry forward of losses (including depreciation) owing to archaic provisions of the Act which restrict carry forward of such losses to companies operating in manufacturing, power, banks etc. as per Section 72A of the Act. A re-look at this provision is long overdue and with the online space at the cusp of a mega consolidation, this relief may just be the icing on the cake.
Tax deductibility of investment cost is typically of prime concern to a buyer in an M&A deal. The Apex Court of India has ruled that goodwill arising pursuant to a merger is eligible for claim of tax depreciation. However, the Indian tax department has been litigating the claim for depreciation on goodwill at various forums adding to the woes of the corporates – a certainty on this aspect would indeed be welcome.
Deal consideration typically has an element of deferred or contingent payment and the position on taxability of such payment creates immense ambiguity. While judicial precedents have laid out the principles of upfront taxation of such receipts, the lack of a definite quantum (since the future consideration is based on a range of external factors) and the lack of a mechanism to revise the income tax return post the time limit poses practical challenges in adopting this route. Add to this the treatment of indemnity payouts and receipts and there are enough complications to keep everyone busy. To further confound matters we have the complex capital gains tax regime in India especially to the extent it relates to capital gains tax on shares which involves differing tax rates, complex rules for calculating period of holding, indexation formulae and challenges in computing the base cost of 1 April 2001. Grandfathering of cost with reference to the 31 January 2018 market price was well intentioned at the time of introducing the new 10 per cent tax on listed securities, however it has come with its own share of ambiguities in cases of bonus issues, merger/demerger of the listed company, stock splits, etc. While the tax ordinance has substantially reduced corporate tax rates, an anomaly now exists in the law whereby tax rates for short term and long-term capital gains are higher than the tax on manufacturing income of newly set-up companies. This goes against the basic tenet of tax laws where capital appreciation is typically taxed at a lower rate than ordinary income.
Boosting consumption and market sentiment by lowering personal tax rates and increasing government spending is likely to be the focus of the government in the annual budget 2020 and hence, it may be wishful thinking to expect an immediate redressal of the above matters which are more fundamental in nature. An overhaul of the tax law by way of the Direct Tax Code, if implemented, would provide a once in a lifetime opportunity where tax provisions can be aligned with the macro-economic objective of projecting India as a mega deal market.
( A version of this article appeared in The Financial Express on February 1, 2020)