India

India is the great big oasis most multinational corporations are looking to as they consolidate their position in Indian companies. This was evident during the past year where foreign players accounted for approximately 35% of the value of Indian acquisitions. The telecoms sector dominated the M&A scene accounting for 24% of all deals done last year. The Batata-BPL telecom deal ($662 million) represented 10% of all deals done during 2001. The following pie chart gives an industry-wise break up of deals done in 2001:

Source: CII (WR) Newsletter, Article by India Advisory Partners

It is true that an M&A deal requires active management of desired business synergies, market prospects, price, structure, negotiations and human resources. However, before considering an M&A the acquirer would need to consider the legal and tax aspects of the deal.

DUE DILIGENCE

Once the acquirer has identified the target, the next step would be for it to conduct legal, financial and business due diligence on it. The main reasons for conducting due diligence are to identify the benefits, and importantly, the risks of the proposed acquisition. The consequences of neglecting to identify the risks can be quite dangerous not only in consummating the deal but could also lead to the acceptance of a price by the acquirer that is out of line with the actual level of the overall risk.

An important aspect of the due diligence, especially where the target is engaged in the information technology or pharmaceutical sector, is the examining of the target's intellectual property (IP). In such cases, much of the deal value may constitute the amount payable for the IP. In addition, searches with respect to immovable property owned by the target can be undertaken only if the company itself provides required information as in India, records are maintained in local land registries and not in central databases.

TAKEOVER CODE

In India, the Takeover Code has a big impact on the acquisition of shareholding and control over a listed company. According to the Securities and Exchange Board of India (SEBI) ex-chairman, D R Mehta, who recently completed his term at SEBI, nearly 1,400 companies have taken advantage of the provisions of the SEBI Takeover Code and about 350 companies have made tender offers to the public.

Under the Takeover Code, an acquirer would be required to make a tender offer for a minimum of 20% of the total shareholding of the target company, if such acquirer (together with persons acting in concert with it), buys (either directly or indirectly):

• shares carrying voting rights of 15% or more of the target; or
• control over the target.

It is important to note certain exceptions to the tender offer provisions of the Takeover Code, some of which are as follows:

Preferential allotment of shares by the target company in favour of the acquirer, through the passing of the required resolution by the target's shareholders, is exempt from the tender offer provisions of the Takeover Code, subject to certain conditions being fulfilled. This provision of the Takeover Code is to be amended, however, to make the tender offer provisions applicable to preferential allotments resulting in a change in control.

Inter se transfer of shares between existing promoters of a company subject to certain conditions being fulfilled.

RECENT AMENDMENTS TO THE TAKEOVER CODE

Public Sector Undertaking (PSU) disinvestments

The SEBI amended the Takeover Code in September 2001. The amendment bars any public announcement for a competitive bid after an acquirer has already made the initial public announcement for the acquisition of shares of the PSU after entering into an agreement with the central government for acquisition of shares or voting rights or control of a PSU.

The SEBI decided in January 2002 that the reference date for calculation of an offer price in the case of frequently traded PSU shares shall be the date preceding that when the central government opens the financial bids, instead of the date when central government, after receiving cabinet approval, announces the name of the successful bidder. This would enable bidders to take into account the price of the shares and also minimize the occasional possibility of unsuccessful bidders manipulating the market price.

Changes to 'creeping acquisition' route

To permit those acquirers who already hold a substantial shareholding in the target company to increase it, the Takeover Code permits a creeping acquisition of not more than 5% of the shareholding or voting rights in any given period of 12 months. This has been increased to 10% by an amendment made in October 2001.

RECENT TAKEOVER CODE CASES

In the case of Kiron Margadarsi Financiers (KMF) vs Adjudicating Officer, SEBI, the issue to be considered was whether the pledge of shares by the promoters of a company in favour of KMF in excess of the tender offer trigger limits amounted to an acquisition of shares under the Takeover Code, thereby requiring KMF to make a tender offer.

It was held that the acquisition of shares by KMF would not attract the tender offer provisions of the Takeover Code. This is because the shares were not registered in KMF's name but only held by it physically. Also the voting rights in respect of the shares remained with the promoters. Hence acquisition of custody over shares pursuant to a pledge, in itself does not attract the tender offer provisions of the Takeover Code, unless voting rights are conferred along with it by virtue of such a pledge.

In another interesting decision, the Securities Appellate Tribunal in the case of Modipon Ltd. vs SEBI held that Modipon, although being a "promoter" of Modi Rubber MRL, cannot be regarded as "a person deemed to be acting in concert" with the acquirers and hence Modipon should be allowed to participate in the tender offer made by the acquirers.

PRIVATIZATION AND DISINVESTMENTS

The privatization process in India has received a boost with 51% of Bharat Aluminium Company (Balco) being acquired by Sterlite Industries from the central government. This disinvestment deal could take place only after the Supreme Court of India (SC) decision on the matter. In this case, the valuation was a contentious issue with the government facing criticism from various quarters, the argument being that tribal land was given to a private company thereby flouting constitutional and statutory provisions. The SC stated that the lease was validly given to Balco a number of years ago, and therefore it was not open to the state to challenge the correctness of its own action. The SC decided in this case that the divestment by the central government in favour of the highest bidder (Sterlite Industries Limited) for a consideration of approximately Rs5.51 billion was transparent. Importantly, the SC has stated in its judgment that the courts should keep away from economic policy matters. It further restricted its power of judicial review in economic policies and said it would interfere only if the policy was contrary to the Constitution of India or any other law.

This judgment has eased the legal hurdles in the path of the disinvestments and privatization of PSUs.

The disinvestment process of CMC has been successfully completed and the disinvestments process of several others are in the pipeline. The Cabinet Committee on Disinvestment has also cleared strategies for sale of government equity in VSNL, IBP, Shipping Corporation of India and Hindustan Copper.

PROPOSED COMPETITION LAW

India lacks an effective competition and antitrust policy. However, based on the recommendations of the SVS Raghavan Committee, appointed by the Indian government, the government introduced the Competition Bill, 2001,in the Indian parliament in August 2001.

The Bill seeks to repeal the existing Monopolies and Restrictive Trade Practices Act, 1969 (MRTP). It also seeks to set up a competition commission of India, a regulatory body which will look to prevent transactions which have an "appreciable adverse effect" on competition, and protect the interests of the consumers.

The term "appreciable adverse effect" has not been defined under the Bill. However, the section of the Bill relating to combinations, provides that the commission shall look at certain factors, such as actual or potential level of competition through imports in the market, extent of barriers to entry to the market, extent of effective competition likely to sustain a market in determining whether a combination is or is likely to have an appreciable adverse effect on competition.

It is expected that the Bill will soon be legislation.

EXCHANGE CONTROLS

Foreign investment in Indian companies is governed by the provisions of the Foreign Exchange Management Act, 1999 (FEMA) and its regulations came into effect in June 2000. FEMA has replaced the Foreign Exchange Regulation Act, 1973 (FERA) which was a draconian legislation. Contravention of the provisions of the FEMA attracts monetary penalty unlike contravention of the provisions of FERA which attracted criminal prosecution in certain cases.

Non-Indian resident acquiring shares of a company in India

Secondary purchases of shares of an Indian company by a foreign investor (including non-resident Indians (NRIs)), from Indian residents would require the prior approval of the Foreign Investment Promotion Board (FIPB). Additionally, Reserve Bank of India (RBI) approval would also be required. The RBI regulates the price at which the transfer takes place. Although not prescribed, the price is generally – where the Indian company is listed in India – pegged at a price which is not lower than the market price of the shares as quoted on the relevant stock exchange. If the company is unlisted, then the RBI arrives at the minimum price which is the average of the aggregate of share price based on (i) net asset value per share; and (ii) profit earning capacity value per share.

Transfer of shares by a person resident outside India (who is not an NRI or an overseas corporate body held to the extent of at least 60% by NRIs) to another non-resident does not require the prior approval of the FIPB in certain cases. The transferee however, would need this approval if it has a previous venture or tie-up in India in the same or allied field – unless it is in the IT sector in which case no prior approval is required.

Transfer of shares from a person resident outside India to an Indian resident would require the prior approval of the RBI. The RBI regulates the price at which such transfers take place and will generally approve a price which is not higher than that arrived at by following the prescribed method of valuation.

Indian companies going global

There are special circumstances under which an Indian company is allowed to make an investment in a foreign company, (unless it is in the real estate or banking business) without the prior approval of the RBI. Some routes available to an Indian company intending to invest in / acquire a foreign company are set out below:

• Direct investment by an Indian company in a joint venture or wholly owned subsidiary outside India by utilizing the proceeds in its Exchange Earners' Foreign Currency account.
• Acquisition of a foreign company by drawing foreign exchange from an authorized bank in India not exceeding 50% of the net worth of the Indian company.
• Acquisition under the equity share swap route after receiving required approval.
• Utilizing the proceeds of its American Depositary Receipt (ADR)/ Global Depositary Receipt (GDR) issue proceeds for the acquisition of the foreign company.
• Acquisition of a foreign company using the ADR/GDR share swap route, subject to certain conditions.

MERGERS IN INDIA

With the reverse merger of ICICI with ICICI Bank being announced, it is expected that many more mega restructuring deals in the banking industry, particularly with reference to development financial institutions, will take place. Both ICICI and ICICI Bank are listed on the NYSE as well as in India.

For the purposes of the Companies Act, the terms merger and amalgamation are used synonymously. The procedure to be followed in a merger of two or more Indian companies, or a foreign company into an Indian company, is covered in sections 391-394 of the Companies Act.

An important part of a merger is the drafting of the scheme of amalgamation which includes detailed information on all involved companies and the share exchange ratio. Every amalgamation, except one involving a sick industrial company, also requires the sanction of the High Court which has jurisdiction over the state where the registered office of a company is.

An amalgamation is effective only when a copy of the High Court order is filed with the Registrar of Companies. The date on which this filing is made is termed as the effective date of the merger. On this date the transferor company is dissolved and soon after the shareholders company are allotted shares of the transferee company.

REVERSE / FORWARD TRIANGULAR MERGERS IN THE US AND THE INDIAN IMPACT

During the past year several reverse / forward triangular mergers were completed in the US. Some of these were in the IT sector where the US target would have a wholly owned Indian subsidiary. Most Indian subsidiaries would have 100% Export Oriented Units (EOUs) or units organized in Software Technology Parks (STPs) or in Special Economic Zones (SEZs). In such cases, apart from the legal due diligence which would need to be undertaken on the Indian subsidiary, there are certain other Indian legal aspects which would need to be considered.

For instance, under Indian tax laws, a change in the beneficial holding of more than 49% of the voting power of an Indian company that has EOUs or units organised in STPs or SEZs would result in the Indian company losing the 10-year tax holiday from the year in which the change takes place.

The other issue that would need to be dealt with is the Indian exchange control implications of the assumption of stock options which could be associated with such acquisitions.

BUYBACK OF SHARES

Some company promoters see the depressed market conditions as a ripe time for them to consolidate their position in their respective companies through the buyback route. The interesting part is that there is no out-flow of personal funds as buybacks are funded by the companies themselves.

Last year, the Companies Act was amended to allow companies to make a new issue of shares after six months of a buyback instead of two years. It also permits Indian companies to buy back up to 10% of their shares with the approval of the board of directors instead of shareholders' approval. For an Indian company to buy back more than 10% of its shares, shareholders' approval would be required. It must be noted that the debt equity ratio after the buyback needs to be maintained at 2:1.

STAMP DUTY

Transfer of shares of Indian companies attract stamp duty at the rate of 0.5% of the consideration paid. This may be borne by either the transferor or the transferee. Traditionally, it is paid by the transferee.

PROPOSED LABOUR REFORMS

Recently, the Group of Ministers (GOM) finalized the proposed amendments to Indian labour laws. Set out below are some of the proposed amendments:

Establishments employing less than 1,000 workers (currently 100 workers) will not require prior permission of the government before layoffs, retrenchment or closure.

The GOM has also recommended that no employer can retrench or layoff staff unless the staff have been paid at the time of retrenchment or layoff a compensation equivalent to 45 days (it is currently 15 days) of average pay for every completed year of continuous service or any part thereof in excess of six months.

TAXATION

A crucial part of any M&A transaction is the tax on the shareholders and the companies. The Indian Income-tax Act, 1961 (ITA) is the central taxing statute. There are no state level income taxes. Indian companies are taxed at the rate of 35% on their net profits. Dividend paid by an Indian company is exempt in the hands of shareholders (including foreign shareholders). However, an additional income tax (referred to as dividend distribution tax) of 10% is payable by Indian companies at the time of declaration, distribution or payment of dividend. All the rates mentioned above are exclusive of surcharge.

Non-Indian companies looking to acquire Indian companies could structure their acquisition of the shares of the target company through Mauritius, thereby benefiting from the favourable provisions of the double-taxation avoidance agreement between India and Mauritius. Under the treaty, capital gains earned by a Mauritius tax resident company on divestments made from Indian companies are not taxed in India if the Mauritius company does not have a permanent establishment in India.

In India M&As can be structured in different ways. Some of these methods and the tax implications are discussed below.

A merger/ amalgamation between two or more Indian companies is tax exempt in India if certain prescribed conditions stipulated in the ITA are complied with. One of these conditions is that shareholders holding not less than 75% in value or voting power in the amalgamating company should become shareholders of the amalgamated company.

In an asset acquisition, where only certain assets are purchased from the target company, the gains realized by the target from sale of assets will be subject to tax in India.

When an entire unit or undertaking is sold as a going concern for a lump sum consideration, without values being assigned to the individual assets and liabilities, the sale is described as slump sale as opposed to sale or acquisition of assets. The ITA provides that profits derived by a company from a slump sale will be regarded as long-term capital gains if the undertaking is owned and held by the selling company for a period of more than three years, otherwise the gains will be regarded as short-term capital gains. The gains will be computed as a difference between the sales consideration and net worth of the undertaking from the date of the transfer.

When the shares of a company are acquired by an entity from its existing shareholder, the seller will be subject to capital gains tax on gains realized by it from the transfer. The gains will be computed as a difference between the sales consideration and cost of acquisition of the shares. If the shares are held for a period of more than 12 months, the gains realized from the sale of the shares will be regarded as long-term capital gains, otherwise it will be regarded as short-term capital gains.

CONCLUSION

The current low equity valuations have prompted a surge in M&A activity. While there is a feel-good factor associated with a completed M&A deal, it is imperative that the parties involved ensure that the implementation is undertaken with a similar amount of scrutiny and due diligence. In the absence of this it is unlikely that the objectives for which the transaction was undertaken will be fulfilled.

On the reforms front, it is expected that the Budget 2002-03 will facilitate India's spree of corporate restructuring and consolidation by simplifying existing norms pertaining to M&As. The provisions of the Companies Act are to be amended so as to permit corporate mergers, demergers and consolidation without the need to approach the Indian courts. As per the present law, the laborious and time-consuming court route has to be adopted.

Nishith Desai Associates
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Nariman Point
Mumbai 400 021
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