Carve-out in India 24 August 2022
2 Agenda Overview of carve-out and market trends Alternative options for carve-outs and analyses of each option + case studies Key consideration from tax perspective and latest tax amendments Questions and Answers
3 Carve out – objectives and market trends
and objectives
De-risk / focus on core unit transformationBusinessmodel requirementsRegulatory considerationsESGMonetisation / fund raising Carve-out represent an opportunity to focus on core assets, improve the overall value (“shrink to grow”). Carve-outs require considerable planning and careful execution to navigate the risks to seller, buyer, and the carve-out entity inter alia from perspective of business objectives, regulatory compliances and tax impact.
Rationale of carve-outs
Market trends | Divestitures on the rise ! Based on Deloitte’s 2022 Future of M&A Trends Survey polled 1,300 executives at corporations and private equity investor (PEI) firms to glean insights about current deal activity and expectations for the next 12 months Our global survey across leading business executives indicate that ~89 % organization (surveyed) are either undergoing a carveout and have been part of one in the last 12 months ! Has your organization engaged in any divestitures in the past 12 months? YesNo, but we are considering it now… No, and we are not considering it 11% 32% 57% Which of the following transactions are you most interested in exploring currently? 45% 35% 19% 38% 35% 27% (StrategicAlternativesAlliance,JV,SPACs) Acquistions 2019Divestitures2021 Interest in divestitures climbed 800 bps in 2021
6 Carve out options and analyses
7 Alternative options for carve-outs Carve-out options Demerger Slump sale Itemized sale Share sale
8 Options | Demerger Demerger KeyFrameworkconsiderations Demergers are tax neutral subject to certain conditions as prescribed under the ITA as below All properties and liabilities of the demerged undertaking become the properties of Resultant company − Consideration is discharged by issue of shares to the shareholders of demerged company on proportionate basis − Shareholders holding 75% or more in value of shares in demerged company become shareholders of resultant company the transfer of the undertaking is on a going concern basis Timelines and approvals • Approval from NCLT is required • Timelines 10 12 months Tax neutrality conditions • Test of undertaking satisfied? • No GST implications should apply • Carry forward & set off of losses/ unabsorbed depreciation relatable to demerged undertaking to the transferee • Stamp duty to be paid on scheme depending on value of shares issued and market value of immovableDemergerpropertyinvolves carving out an undertaking of the Seller/ Demerged company to the Buyer / Resultant company that entails: − transfer of assets and liabilities of the undertaking from the Demerged company to the Resultant company − the consideration is discharged by the Resultant company by issuance of shares to the shareholders of the Demerged company
9 Options | Slump sale Slump sale Key Frameworkconsiderations • Slump sale is subject to capital gains tax • Tax rate depends on the period of holding of the undertaking • Holding period of at least 36 months would qualify for a 20% tax rate and less than 36 months would be taxed at the applicable rates of 22% to 30% (excluding surcharge and cess) Timelines and approvals • No court approval required - can be achieved through shareholder resolution and business transfer agreement. Alternatively, slump sale through court scheme may also be carried-out • Timelines 2-3 months Tax provisions • Test of undertaking satisfied? • No GST on slump sale • Stamp duty is applicable on slump sale depending on the state in which the undertaking is situated. • Losses relating to the undertaking do not get transferred to the acquirer • Slump sale is a sale of one or more undertaking(s) for a lump sum consideration, without assigning values to individual assets or liabilities. • Business to be transferred as a going concern basis
10 Options | Itemised sale Itemised sale KeyFrameworkconsiderations • Capital gains tax payable • Gains arising on sale of capital assets taxed as long/ short term capital gains depending on period of holding of respective assets • Gains on sale of depreciable assets treated as short term capital gains taxable at 22%-30% (excluding surcharge and cess) Timelines and approvals • No court approval required - can be achieved through shareholder resolution and transfer agreement • Timelines – 2-3 months Tax provisions • Stamp duty is applicable on sale of assets depending on the state in which the assets are situated • GST applicable on assets transferred • Transfer of business where consideration is identified against each asset/ liability‘cherry picking approach’ • Consideration identifiable with individual assets • No sale of ‘undertaking’ • No requirement to continue/undertake business
11 Options | Share sale Share sale Framework • Gains arising on sale of shares taxed as long/ short term capital gains depending on period of holding of shares • Tax rate on sale of unlisted shares held for less than 24 months (short term) is 40% for non residents and 10% (excluding surcharge and cess) if held for more than 24 months (long term). • For resident company, the tax rate is 20% for long term gains and 22%-30% for short term gains (excluding surcharge and cess) in relation to sale of unlisted shares Key considerations • Deemed gift tax provisions for acquisition below tax FMV • In case of sellers from Singapore / Mauritius – treaty benefits to be evaluated / insurance to be taken • Pricing guidelines under FEMA • Indirect transfer tax implications to be evaluated on sale by non-residents • Surcharge on LTCGs reduced to 15% for individuals from 1 4 2022 (earlier the peak of surcharge on capital gains was 37%). • Stamp duty applicable at 0.015% + state level stamp duty payable on SPA. Tax provisions • Acquisition of (whole or part of) the stake in target company through purchase of shares
12 Case study 1 Agreed consideration Y LtdX Ltd Sale of hotel business Existing Structure Y LtdX Ltd BusinessHotel Resulting Structure BusinessHotel • X Ltd sold its hotel business to Y Ltd for an agreed consideration • The Business inter alia includes land, building, furniture, equipment's, license for lodging and boarding etc. • However, certain liabilities in relation to the undertaking were not transferred as part of the transaction Facts • Whether non transfer of liabilities will vitiate the “undertaking” argument for slump sale purposes? Key considerations
13 Case study 2 Issued share to shareholders of A Ltd B LtdA Ltd Existing Structure B LtdA Ltd Resulting Structure • A Ltd has two business units: manufacturing unit and investment unit (which includes investments held in equity shares, mutual funds, etc.) • A Ltd proposes to demerge its investment unit to B Ltd and in consideration B Ltd to issue shares to the shareholders of A Ltd Facts • Whether “investment unit” qualifies as undertaking for purposes of demerger? Key considerations Unit 1 Unit 2 Transfer of investment unit Unit 1 Unit 2
14 Key tax considerations + latest amendments
Other key tax and regulatory considerations Commercial rationale for carve-out ? To establish main purpose is not for tax benefit Sectoralapprovalauthority Taxability of consideration?contingentSuccession and section 281 risk on buyer Allocation and transfer of debt
Recent key tax amendments | Impact on carve-outs ConsiderationsImplicationsamendmentsTax/ • Depreciation claim on goodwill recognized by buyer on carve-out will no longer be available • Possibility onintangiblesrecognizingofotherbybuyerfuturepurchase? Goodwill not an intangible asset for tax depreciation Capital gains tax shall arise on transfer of undertaking by way of slump exchange or any other means Slump sale to include slump exchange
Recent key tax amendments | Impact on carve-outs Tax amendments Implications Considerations/ • Whether shares / securities will be construed as “goods” for purposes of the section? • Applicability on sale of “undertaking”? TDS/TCS at 0.1 percent purchase/saleon of goods • Sale value to be higher of FMV1 (i.e., value of net assets of the undertaking) or FMV2 (i.e., value of monetary and consideration)non-monetaryFMVasperRule11UAEtobeobtainedtodeterminesale consideration for slumppurposessale
18 Question and Answers
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