Fema to apply to reverse overseas M&As, says RBI

Clarifies stand to corporate affairs ministry.

The Reserve Bank of India has said Indian companies merging with overseas firms will continue to be treated as entities resident in the country under the Foreign Exchange Management Act (Fema).

There is no provision for such a merger under the current Companies Act. But a Bill to amend the Act tabled in the Budget session of Parliament proposes to allow Indian companies to merge with overseas companies, under section 205, a move that could introduce greater flexibility in cross-border merger and acquisitions (M&As).

The amendment to allow Indian companies to merge with foreign companies was first suggested in 2005 by an expert committee on company law chaired by Tata Sons Director J J Irani. If this amendment goes through, it will meet a key demand of many multinationals investing in India.

Under Fema, an entity resident in India will be treated on a par with a person resident in India, who is defined as somebody who has stayed in the country for more than 240 days.

In its feedback to the Ministry of Corporate Affairs a couple of weeks ago, the central bank said the Indian entity, after its merger with the foreign company, will operate as its branch in India, and therefore has to comply with all provisions of Fema for inward remittance of funds, investments by the foreign company through its Indian entity in any Indian ventures, dividend payment besides repatriation of profit to the foreign company.

The central bank has also clarified that payment by the foreign company to shareholders of listed Indian companies being merged can be made in the form of cash, shares or Indian Depository Receipts (IDRs) issued by the overseas companies.

In this case, RBI has clarified that Fema will have to amended suitably. Besides, IDRs in their existing form do not have voting rights and the law has to be changed to incorporate this change. This will be important if the merger involves allotting voting rights to Indian shareholders or some sort of management control.

Sources familiar with the developments said, "Currently there is no provision in Fema for share transfer by a foreign company beyond 5 per cent in a company based in India”.

The Central Board of Direct Taxes (CBDT) is also working on its views on the tax implications, the sources said.

A tax official said even if the Indian company ceases to exist in India, it will continue to operate as a branch or Indian office of the foreign company and will be taxed in the same way as any Indian branch of foreign company gets taxed on the basis of being a permanent establishment.

A permanent establishment is a concept that allows Indian tax authorities to derive taxes from local offices of a foreign company on the basis that income is accruing from operations in India.

Legal experts said the merger of an Indian company with a foreign one can help structure M&A deals in many ways. For example, if an overseas company has acquired another foreign company that has a subsidiary in India, the new provision will allow the acquirer to merge the Indian operations with it, instead of retaining it as a separate entity.