Historically, Companies Act, 1956 (‘the 1956 Act’) permitted merger of a foreign company with an Indian company (colloquially also referred to as inbound merger).  However, reverse merger of an Indian company with a foreign company (referred to as outbound merger), was prohibited. 

Companies Act, 2013 (‘the 2013 Act’) which replaced the 1956 Act, recognised outbound mergers for the first time in the Indian history. When the draft provisions of the 2013 Act were released, a wave of positive economic sentiment was witnessed. India was addressing to globalised business needs of the modern world and paving way for a larger merger and acquisition landscape.

Another noteworthy modification by the 2013 Act was that, since December 2016 the power to sanction all scheme matters of Compromise, Arrangements and Amalgamations was granted to a quasi-jurisdictional body, the National Company Law Tribunal (‘NCLT’) and correspondingly the powers of the Jurisdictional High Court were revoked.

Though NCLT has been the approving body for domestic mergers since December 2016, section 234 of the 2013 Act governing cross border mergers had not been notified.  This led to a temporary lull in law where neither the Jurisdictional High Court nor the NCLT could approve cross border mergers.

Notification from the Ministry of Corporate Affairs (‘MCA’) on 13 April 2017, finally permitting cross border merger (ie section 234 of the 2013 Act), eased this anxiety.  As per the notification, cross border mergers (both inbound and outbound) will need RBI approval in addition to approval of the NCLT.

Since there were no provisions under the current FEMA law which provided a mechanism to facilitate RBI approval on cross border mergers, a consequential FEMA notification was expected.  On 26 April 2017, the RBI released draft guidelines for cross border mergers which were open for public comments until 9 May 2017.

Primarily the essence of the RBI guidelines is that a merger route cannot be a mode in which companies may be able to seek exemptions from current FEMA guidelines (such as Foreign Direct Investment (FDI), External Commercial Borrowing (ECB), Liberalised Remittance Scheme (LRS) or the Overseas Direct Investment (ODI). For instance, in cases of inbound mergers, issue of shares to non-resident should be in compliance with FDI guidelines  

Given this, it appears that mergers of large conglomerates with their foreign parent companies still does not seem to be possible under the guidelines.

Obviously India opening its doors to outbound merger is a welcome change sending a positive message to external investors about the Indian economy. The idea that an Indian company will be permitted to merge with a company incorporated in Mauritius, USA, UK, the Netherlands, Singapore, UAE, France etc, is certainly very promising. There are several developed countries around the world which still do not permit outbound mergers and India taking such a step is noteworthy.

However, there appears to be few inconsistencies between the notification released by the MCA and the draft RBI guidelines.  As per the MCA notification, a company cannot file an application for cross border mergers unless the same has been pre-approved by the RBI.  Contrary to the MCA notification, the draft RBI guidelines seek to mention that if the cross border merger is in compliance with the said regulations, the RBI approval is deemed.  The two provisions need to be aligned on this aspect.  However, if there does exist a requirement of pre-approval, then one may argue, that the process of undertaking inbound merger has been made stringent under the 2013 Act in comparison to the 1956 Act. For instance, hitherto under the 1956 Act, no requirement to obtain pre-approval of the RBI existed. Such obligations cast on RBI to pre-approve all inbound mergers may increase the timeline for merger completion substantially, since the RBI approval process and the NCLT process cannot be undertaken simultaneously.

Certain economies around the world approve mergers within a month of furnishing the application and requisite documents. Requirement of RBI pre-approval coupled with the erstwhile requirement of approval from regulatory bodies (such as Regional Director, Registrar of Companies, Tax Authorities, Industry administrator) could imply that an inbound merger process may take as long as 8-12 months to complete.

Another disconnect between the two guidelines is that, the draft RBI guidelines state that in order for India to perform a cross border merger (whether inbound or outbound) the jurisdiction of the foreign company should be permitted as per the jurisdictions referred to in the MCA notification, however, the MCA notification does not provide any such restriction.  As per the MCA notification, the restriction of the jurisdiction only applies to outbound mergers. Changes to make the two guidelines (FEMA and Companies Law) consistent can be expected.

One of the biggest uncertainty surrounding outbound merger is its resultant tax consequence, and makes one question if despite its enactment, can outbound mergers be undertaken only on paper? The current income-tax provisions provides tax neutrality to all mergers (the merging companies and the shareholders) as far as the merged entity remains an Indian company.  However, in case of outbound merger, the Indian entity will lose its legal existence and the merged entity will be a foreign company – currently, no neutrality is available for such a scenario.  Hence, visibility of tax consequence on outbound merger is vital.

Whether the tax administration will make outbound mergers tax neutral is another question. For example: outbound mergers of cash rich entities may pave way for remittance of cash out of India in a tax neutral manner, which would otherwise suffer repatriation tax (in form of dividend distribution tax or buy back tax) hence leading to substantial loss of tax revenue for the Government in case outbound mergers are actually made tax neutral.  It will be interesting to watch, perhaps in the Budget of 2018 or sooner, as to how taxability of outbound mergers will surface.

There could be several practical challenges as well, such as: how will the merged foreign entity carry out its business post an outbound merger (in cases where the merging India company has a business presence in India); or how will the merged foreign company operate its bank account in India (which were originally owned by the amalgamating Indian company). Also, will the employees of the Indian company be relocated to outside India post-merger, if not could there be potential Permanent Establishment risk for the merged foreign companies?

With unanswered questions such as these, despite its enactment, substantial amount of traction may not be expected to witness in the mergers and acquisitions market with respect to outbound mergers. Considering such ambiguities and uncertainties, it will be definitely be interesting to watch which company actually opts to undertake a cross border merger. As it appears, this is only a welcome move for realignment of several holding companies/ non-operating companies.

(Bhavin Parekh, Senior Tax Professional, EY, also contributed to the article)

(Views expressed are their personal)