Taxation in case of Mergers & Acquisitions

An M&A transaction can be structured as a purchase of shares, purchase of assets, or a scheme of amalgamation. The tax impact differs for each structure because the tax authorities treat the consideration received by the target’s shareholders either as a capital receipt or as a deemed dividend.

For the purpose of the NISM exam, the Income Tax Act distinguishes between cash consideration (direct monetary payment) and share consideration (exchange of shares of the acquiring company). The holding period of the original shares, the nature of the transaction, and any exemptions under the Companies Act all influence the rate of tax that applies.

Why this matters: A candidate must quickly decide whether a transaction triggers short‑term capital gains (STCG), long‑term capital gains (LTCG), or is exempt. Mistakes in this classification lead to loss of marks in scenario‑based questions.

• Cash vs. share consideration determines the tax base.
• Holding period decides STCG/LTCG rates.

When shareholders receive cash for their shares, the transaction is treated as a sale under the Income Tax Act. The capital gain is the difference between the cash received (sale consideration) and the cost of acquisition, adjusted for any expenses incurred during the sale.

If the shares were held for more than 12 months, the gain is classified as LTCG and taxed at 10% (plus applicable surcharge and cess) on the amount exceeding INR 1 lakh. If the holding period is 12 months or less, the gain is STCG and taxed at the individual’s applicable slab rate or at 15% for listed securities.

Exam relevance: NISM questions often provide the purchase price, holding period and cash proceeds. Candidates must compute the gain, apply the correct rate, and remember the INR 1 lakh exemption for LTCG on listed equity.

• Cash receipt = taxable event.
• Holding period determines rate.

When shares of the acquiring company are issued as consideration, the target shareholder’s cost of acquisition is transferred to the new shares on a proportionate basis. The cost is apportioned according to the market value of the shares received at the date of acquisition.

The holding period of the original shares is also carried forward to the new shares. Consequently, if the original shares were held long‑term, the subsequent gain on the new shares will be taxed as LTCG, and vice‑versa.

Why this is tested: Many exam scenarios involve a mix of cash and share consideration. Candidates must allocate the original cost between cash and shares, compute the gain on each portion, and apply the appropriate tax rate.

• Cost base is split proportionally.
• Holding period is preserved.

For shareholders of the target company, the receipt of consideration is either a capital receipt or a deemed dividend. If the consideration is purely cash or shares and the transaction qualifies as a genuine sale, it is a capital receipt. However, when the acquiring company distributes shares without adequate consideration, the tax authorities may treat part of it as a deemed dividend, taxable at the shareholder’s slab rate.

Another nuance is the treatment of goodwill. If goodwill is part of the purchase price, it is included in the sale consideration and therefore in the capital gains computation. The cost of goodwill, if any, can be amortised by the acquirer but does not affect the target’s tax liability.

Exam tip: Look for wording such as “consideration is wholly in cash” or “share swap under a scheme of amalgamation”. The former triggers capital gains; the latter may be exempt.

• Deemed dividend arises when consideration is insufficient.
• Goodwill is part of the capital base.

The acquiring company can claim tax deductions on expenses incurred for the acquisition, such as professional fees, stamp duty and underwriting charges. These expenses are capitalised and amortised over the useful life of the acquired assets, reducing taxable income in subsequent years.

If the acquisition involves a scheme of amalgamation that satisfies Section 47 of the Income Tax Act, the transfer of assets and liabilities is tax‑free. The acquirer inherits the cost of acquisition and holding period of the target’s assets, which can be advantageous for future capital gains planning.

Why this matters for NISM: Questions may ask which costs are deductible immediately versus amortised, or whether a particular amalgamation qualifies for exemption. Remember that only a genuine scheme of amalgamation (court‑approved, shareholder‑approved) enjoys the tax‑free benefit.

• Acquisition expenses → capitalised & amortised.
• Section 47 amalgamation → tax‑free transfer.

A scheme of amalgamation under the Companies Act, 2013, when approved by the National Company Law Tribunal (NCLT) and the shareholders, can be treated as a tax‑free transfer under Section 47 of the Income Tax Act, provided certain conditions are met – such as continuity of business and no cash consideration exceeding the fair market value.

The key conditions are: (i) the transfer must be made in accordance with the Companies Act; (ii) the scheme must be approved by the shareholders of both companies; (iii) the transfer must be for consideration that is not in cash or is only a token amount; and (iv) the assets and liabilities are transferred as a going concern.

Exam relevance: NISM questions may present a scenario of a merger and ask whether the transaction is taxable. Remember the four conditions; if any is missing, the exemption does not apply and capital gains tax is triggered.

• Section 47 exemption → only for genuine amalgamation.
• Cash consideration above FMV → tax liability arises.