Pakistan: Tax Issues Surrounding Corporate Amalgamations, Mergers & Acquisitions*

By Huzaima Bukhari & Dr. Ikramul Haq[1]

Contents

1. INTRODUCTION
2. BACKGROUND
3. COMPARATIVE ANALYSIS

3.1. United Kingdom

3.2. India

• TAX NEUTRALITY
• IMPLICATIONS OF SCHEMES OUTSIDE THE SCOPE OF TAX BENEFITS
• CAPITAL GAINS TAX EXPOSURE
• CONCLUSION

1.   INTRODUCTION

In the era of globalization, cross-border amalgamations, mergers and acquisitions are important for international corporate growth and the integration of worldwide business. However, the pace of such transactions has been at best sluggish in Pakistan, partly because of unfavourable and complicated corporate and tax laws, in addition to the absence of a strong corporate culture.[2] In the last few years, however, policymakers have attempted to catch up with other nations by rationalising tax and corporate laws[3] and providing a swift mechanism for the implementation of any scheme of merger, takeover, demerger, acquisition, arrangement and reconstruction. This scope of this article is limited to important tax implications of such transactions under the Income Tax Ordinance, 2001.

2.   BACKGROUND

There were no specific provisions in the repealed Income Tax Ordinance, 1979 (“repealed Ordinance”) which dealt with tax implications arising from any scheme of amalgamation, merger or acquisition. In addition, there was no available definition of amalgamation and other related expressions in the repealed Ordinance. Tax implications of such transactions were dealt with under general provisions in connection with:

–    implications on the acquiree company;

–    implications on the shareholders of the acquiree company;

–    implications on the acquirer company; and

–    implications on the shareholders of the acquirer company.

In the new Income Tax Ordinance, 2001, the terms used to describe the acquiree and acquirer companies have been changed to “amalgamating” and “amalgamated” companies respectively.

Historically, a tax exemption on the proceeds of the disposal of shares in listed companies was available in Pakistan,[4] and shareholders of the acquirer company did not suffer tax on the acquisitions of shares. Although the taxability of shareholders of listed companies was neutralised by exemption, other incentives were not made available to the companies, such as deduction of merger expenses and the carry forward of losses for merged entities. In the case of non-listed public companies and private companies, there were onerous tax implications for both shareholders and corporate entities involved in any scheme of amalgamation, merger, take-over or even reconstruction.

Under the new Income Tax Ordinance, 2001 (“the Ordinance”) effective from 1 July 2002, a number of specific provisions exist for amalgamating and amalgamated companies. The Government has made efforts to provide incentives to companies by making such transactions tax neutral upon the fulfillment of certain conditions. The incentives are detailed below and have been issued under Circular No. 1 of 2007, Circular No.1 of 2005, Circular No.17 of 2004 and Circular No.7 of 2003 of the Federal Board of Revenue (FBR):[5]

• –        expenses incurred in relation to mergers and amalgamations are deductible;

–    no profit or gain arises on the disposal of assets;

–    the unutilised depreciation of the amalgamating company can be transferred to the amalgamated company; and

–    no restrictions on the transfer or carry forward of losses of the merged entities.

These incentives were originally confined to the amalgamation between banks, financial institutions and insurance companies. The Finance Act of 2005 extended the scope of benefits to all industrial undertakings without business specifications, and permitted one of the merging companies to be a private limited company. In 2007, the incentive was further extended to “companies engaged in the provision of services, not being trading companies”. As Section 2(1A) of the Ordinance (amended as at 30 June 2007), provides the following definition of amalgamation:

“amalgamation” means the merger of one or more banking companies or non-banking financial institutions, or insurance companies or companies owning and managing industrial undertakings or companies engaged in providing services and not being a trading company or companies in either case at least one of them being a public company, or a company incorporated under any law, other than Companies Ordinance, 1984 (XLVII of 1984), for the time being in force, (the company or companies which so merge being referred to as the “amalgamating company” or companies and the company with which they merge or which is formed as a result of merger, as the “amalgamated company”) in such manner that–

• the assets of the amalgamating company or companies immediately before the amalgamation become the assets of the amalgamated company by virtue of the amalgamation, otherwise than by purchase of such assets by the amalgamated company or as a result of distribution of such assets to the amalgamated company after the winding up of the amalgamating company or companies; and
• the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation.”

In addition, the above amendments have been addressed by the FBR in Circular No. 1 of 2005:

“Originally, the term amalgamation was defined under Section 2(1A) as “merger of one or more banking companies or non-banking financial institutions or insurance companies.

The scope of this definition has been extended to the industrial sector as well where amalgamation takes place on or after 1 July 2005.

Furthermore, previously both the merging companies had to be either public companies or companies incorporated under any law other than the Companies Ordinance 1984. This restriction has also been relaxed by allowing one of the merging companies to be a private limited company.”

Based on the above, the FBR reiterates that provision of Finance Act 2005 which widened the scope of incentives with its extension to companies owning and managing industrial undertakings. One of the companies should be a public company, based on the conditions of Sec. 2(1A) of the Ordinace that one company can be a private limited company but at least one should be a public company. The term public company is defined in Sec. 2(47) of the Ordinance as follows:

“public company” means –

(a)   a company in which not less than fifty per cent of the shares are held by the Federal Government or Provincial Government;

(ab)  a company in which not less than fifty per cent of the shares are held by a foreign Government, or a foreign company owned by a foreign Government; 

(b)   a company whose shares were traded on a registered stock exchange in Pakistan at any time in the tax year and which remained listed on that exchange at the end of that year; or

(c)   a unit trust whose units are widely available to the public and any other trust as defined in the Trusts Act, 1882 (II of 1882).”

As evident from Sec. 2(47)(b), any non-listed company (although categorized as a public company under the Companies Ordinance, 1984), is excluded from the definition of a public company for the application of the Income Tax Ordinance, 2001. Therefore, in any scheme of amalgamation under Sec. 2(1A) of the Ordinance, one company should be a listed public company in order to qualify for the following benefits provided in Secs. 20(3) and 57A of the Ordinance:

–    deduction of any expenditure incurred by the amalgamated company on legal and financial advisory services as well as other administrative costs relating to the planning and implementation of the amalgamation;

–    the accumulated business losses of the amalgamating company or companies can be set off or carried forward against the business profits and gains of the amalgamated company and vice versa, for a period of up to 6 tax years, from the year immediately following the tax year in which the loss was first computed; and

–    the unabsorbed deprecation of the amalgamating company or companies can be transferred to the amalgamated company and vice versa.

In order to utilise the above benefits, the amalgamated company must continue the business of the amalgamating company for a minimum period of 5 years from the date of the amalgamation. In addition, the expressions “amalgamated company” or “amalgamating companies” should be interpreted according to Sec. 2(1A) of the Ordinance.

3.   COMPARITIVE ANALYSIS

3.1. United Kingdom

The taxation of mergers and acquisitions are a complex subject the world over. In the process of framing and implementing the new Ordinance, Pakistan has drawn on the UK experience where tax implications of mergers and acquisitions largely result from the purchase of shares rather than purchase of assets. Added to the complexity in any scheme of amalgamation is the group relationship or related party transactions of companies normally entering into such mergers, and the taxability of those transactions. With any acquisitions, a new group may be created or the existing relationship may be changed. These transactions typically fall into the following three main groups:

– advance corporation tax. In this group, the parent-subsidiary relationship exists when a shareholding of more than 50% is involved. The parent company may surrender advance group tax paid to its subsidiaries in order to offset against the composite tax liability;

– group relief. In the case of a 75% shareholding, losses may be transferred by the parent to the subsidiary company. The shares in the subsidiary are held for investment purposes rather than as trading assets; and

– capital gains tax. Applies where the parent holds at least 75% of the shares in the subsidiary, and assets are held and transferred within the group. Capital gains or losses do not arise unless the asset is transferred out of group.

There are similar tax group relationships for value added tax and stamp duty.

The tax implications arising in the UK for the acquiree company, acquirer company and its shareholders can be summarised as follows:

Acquiree

The acquiree entering into the merger is entitled to group relief on the advance payment of corporate tax, on the basis of the relationship between the acquiree and acquirer. On acquisition, the acquiree becomes part of a new tax group and will accordingly receive or surrender the group relief. Profit and loss is apportioned on a time basis between the two notional accounting periods, i.e. before and after the merger. Group relief is available in the notional accounting period where the company is a group member. The continuance of these practices are sanctioned by the Finance Act, 1984. 

In the event that the acquiree is recording a loss on acquisition, the acquirer may be granted tax relief only if the subsequent trade of acquiree reflects a profit. Past losses are not eligible for group relief. Therefore, in order to utilise the carry forward of losses, it is in the interest of the acquirer to turn the acquiree’s business around.

With regards to capital gains tax, assets may be transferred within the group without giving rise to taxation, which has resulted in schemes of tax avoidance, i.e. with the transfer of assets to the subsidiary and subsequent sale of shares of the subsidiary, the purchaser is able to transfer the assets out. This loophole has since been closed.

Shareholders of the acquiree

The disposal of shares in the acquiree is subject to capital gains tax, except in the case of a bona fide reorganization which should satisfy the following conditions: 

–    the shares in one company (Company A) are exchanged for shares or debentures of another company (Company B);

–    the original shareholding in the company is cancelled, and new shares or debentures are issued in proportion to the original shareholding;

–    Company A must hold  more than ¼ of the ordinary share capital of Company B; and

–    the issue of shares must be made by Company A incidental to a general offer to members of Company B, and the objective of the general offer is for Company A to gain control over Company B.

Some reorganisations may involve the transfer of assets below market value from the subsidiary to its parent constituting a deprecation transaction; or the subsidiary may issue substantial dividends to the parent company which can significantly affect the value of the shares in the subsidiary. These manipulations are checked through provisions in the capital gains tax legislation.

Acquirer

With reference to corporation tax, the practice of notional accounting in relation to the acquiree company is acceptable for the acquirer company.  For capital gains tax purposes, a situation may arise where the acquirer sells shares in the acquiree and make a claim for the rollover relief.  In the UK, this relief is available in respect of the sale of chargeable assets to enable the acquisition of <The highlighted section of the sentence has been rephrased, kindly confirm technical accuracy> It is correct.  new assets, for a sum equal to the disposal proceeds. The relief is available only when the old and new assets <are the old and new assets used simultaneously in the business? or both the old and new assets have to be used in the trade? Both are to be used simultaneously> are used in the trade carried out by the company or a member company of the group as a single trade <would it still qualify as a single trade for other member companies of the group? yes>.

Shareholders of the acquirer

The shareholders of acquirer company are not subject to any tax consequences following the merger or takeover by the acquirer company.

The determination of tax obligations in any scheme of amalgamation or merger in Pakistan is primarily modeled on the UK system.

3.2. India

In India, income tax is most vital amongst all tax laws which affect the amalgamation of companies from the perspective of tax savings and accounting treatments. Section 2(1B) of the Indian Income Tax Act, 1961, reproduced below, provides the following definition on amalgamation.

2(1B) “amalgamation”, in relation to companies, means the merger of one or more companies with another company or the merger of two or more companies to form one company (the company or companies which so merge being referred to as the amalgamating company or companies and the company with which they merge or which is formed as a result of the merger, as the amalgamated company) in such a manner that–

1. all the property of the amalgamating company or companies immediately before amalgamation becomes the property of the amalgamated company by virtue of the amalgamation;
2. all the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation;
3. shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by, or by a nominee for, the amalgamated company or its subsidiary) becomes shareholders of the amalgamated company by virtue of the amalgamation,

otherwise than as a result of the acquisition of the property of one company by another company pursuant to the purchase of such property by the other company or as a result of the distribution of such property to the other company after the winding-up of the first-mentioned company.

The definition of term amalgamation in Pakistan under Sec. 2(1A) of the Ordinance is almost pari materia to Sec. (21B) of Indian Income Tax Act, 1961. The purpose and objective behind the tax codes of both India and Pakistan with regards to amalgamations is to encourage corporate growth. The meaning of the term amalgamation includes not only the merger of one or two companies to form one entity but also the merger of one or more companies with another existing company. In India, an amendment to this effect was made in the definition clause via the Finance Act, 1967 with similar provisions in the Gift Tax Act in order to encourage the mergers of uneconomic units with other financially sound units with the objective of increasing efficiency and productivity, and also for removal of certain tax liabilities on amalgamating company and its shareholders. Sec. 72A and Sec. 2(1B) of the Income Tax Act, 1961 is aimed at encouraging the voluntary merger of “sick” units with “healthy” units in order for the implementation of a viable revival scheme. However, no such incentives were provided in Pakistan until 30 June 2007.[6]

In both India and the UK, the legislature does not condone amalgamation as a means to avoid tax and its real aim has been to encourage corporate mergers or amalgamations to promote corporate growth and the industrial development in these countries. Pakistan has followed the same approach by ensuring the benefits of tax neutrality, and corporate mergers are required to fulfill the following conditions:

–    all property belonging to the amalgamating company should be reinvested in the amalgamated company;

–    all liabilities of the amalgamating company should become the liabilities of the amalgamated company;

–    not less than 9/10 of the value of the shares in the amalgamating company, should be translated into the value of the shareholding in the amalgamated company.

All of the above conditions have to be fulfilled in order to qualify as an amalgamation under the Pakistani tax law, and for tax neutrality to apply in respect of gains arising from the disposal of assets.

In the Income Tax Ordinance, 2001, all possible forms of amalgamations, mergers, demergers, reconstructions, takeovers etc. have been covered under Sec. 97 and 97A. Sec. 97 is explored in further detail in Section 4 of this article, while Sec. 97A, effective from 1 July 2007, primarily deals with various forms of corporate arrangements and reconstructions. Thus, with effect from the 2008 tax year, in this respect Pakistani law conforms with international practice which provides for tax neutrality on such transactions.

4.   TAX NEUTRALITY

In the new Ordinance, the legislature originally provided for tax neutrality for the disposal of assets between resident companies wholly-owned by a group of resident[7] companies. The benefit was subsequently extended to non-resident companies following the insertion of clause (62), Part IV of the Second Schedule to the Ordinance.

Section 97 of the Ordinance deals with tax neutrality, and provides for the following:

(1)   where a resident company disposes of an asset to another resident company (hereinafter referred to as the “transferee”), no gain or loss shall be taken to arise on the disposal if the following conditions are satisfied, namely:-

(a)   both companies belong to a wholly-owned group of resident companies at the time of the disposal;

(b)   the transferee must undertake to discharge any liability in respect of the asset acquired;

(c)   any liability in respect of the asset must not exceed the transferor’s cost of the asset at the time of the disposal; and

(d)   the transferee must not be exempt from tax for the tax year in which the disposal takes place.

(2)   Where sub-section (1) applies –

(a)   the asset acquired by the transferee is to be treated as having the same character as it had in the hands of the transferor;

(b)   the transferee’s cost in respect of the acquisition of the asset shall be–

• in the case of a depreciable asset or amortized intangible, the written down value of the asset or intangible immediately before the disposal;
• in the case of stock-in-trade valued at fair market value  or
• in any other case, the transferor’s cost at the time of the disposal;

(c)   if, immediately before the disposal, the transferor has depreciation or amortisation of cost in respect of the asset transferred which have not been set off against the transferor’s income, the amount not set off shall be added to the deductions allowed under those sections to the transferee in the tax year in which the transfer is made; and

(d)   the transferor’s cost in respect of any consideration in kind received for the asset shall be the transferor’s cost of the asset transferred as determined under clause (b), as reduced by the amount of any liability that the transferee has undertaken to discharge in respect of the asset.

(4)   the transferor and transferee companies belong to a wholly-owned group if-

• one company beneficially holds all the issued shares of the other company; or
  • a third company beneficially holds all the issued shares in both companies.

These provisions essentially waived capital gains tax on the disposal of assets between the wholly-owned resident companies up to 29 August 2006. Eligibility for the tax benefit required that both resident companies, one being the transferor and the other being the transferee of assets, belonged to a wholly-owned group of residentcompanies at the time of disposal to avoid taxation. At the time of the merger between Standard Chartered Bank (non-resident entity) and a local resident bank, Union Bank Limited, a relaxation to this rule was granted through the insertion of clause (62), Part IV of the Second Schedule of the Ordinance vide SRO <what does SRO stand for? Statutory Regulatory Order> 885(I)/2002 dated 29 August 2006 which provided for the removal of the restriction of resident companies as well as belonging to a wholly-owned group of resident companies <As stated above, the merger was between a non resident bank and a resident bank. However, the clause (62) appears to apply to resident companies?> In fact, Clause (62) removes the condition of “wholly-owned group of resident companies. Thus a merger was made possible between a resident and non-resident banking companies.

In accordance with Sec. 53(2) of the Ordinance, the Federal Government has discretionary powers to insert exemption clauses in the Second Schedule of the Ordinance. With these powers, the tax benefits were extended to non-resident companies which enabled them to avoid capital gains taxation in the case of mergers (Sec. 97 and clause (62), Part IV of the Second Schedule of the Ordinance). This relaxation of the rule created favourable conditions for non-resident companies to enter into mergers with other resident companies, such as ABN-AMRO Bank NV of the Netherlands (now part of the Royal Bank of Scotland) which acquired 97% of the share capital of a local resident bank, i.e. Prime Commercial Bank Limited which merged into ABN-AMRO Bank (Pakistan) Limited. The above illustrates an example of a non-resident bank merging its business assets in Pakistan with a locally-owned subsidiary without significant tax implications.

In view of the volume of activity surrounding mergers and acquisitions in Pakistan, a need arose for the scope of tax neutrality to be widened and extended to all disposals of assets by virtue of any scheme of arrangement and reconstruction under Secs. 282L,[8] and 284 to 287 of the Companies Ordinance, 1984, and Sec. 48 of the Banking Companies Ordinance, 1962. Thus, Sec. 97A was incorporated in 2007 to facilitate the non-taxation of disposals of assets under any such schemes,  upon the fulfillment of certain conditions. This enactment was aimed at accelerating corporate growth in Pakistan as companies engaged in schemes of arrangement or reconstruction, approved by their respective regulators, will not be subjected to tax under the Ordinance in relation to gains arising out of such transactions. This has been the primary tax incentive provided for the inclusion of sick units or less viable entities into healthy companies for the purpose of achieving higher economic growth, and also signaled the realisation of the part of the authorities that it was essential to incentivise the corporate sector, if higher growth rate is to be attained and sustained.

In Circular No. 1 of 2007, the FBR explained that Sec. 97A would apply to any scheme of arrangement and reconstruction approved on or after 1 July 2007. The salient features of the provision are as follows:

–    no gain or loss arises from the disposal of assets from one company to another under a scheme of arrangement and reconstruction under Secs. 282L, and 284 to 287 of the Companies Ordinance, 1984, and Sec. 48 of the Banking Companies Ordinance, 1962;

–    in cases of disposals of shares issued and vested under a scheme of arrangement and reconstruction, the cost of the shares shall be the cost prior to the operation of the scheme;

–    The scheme should have the approval of:

     –    the High Court;

     –    the State Bank of Pakistan; or

–    the Securities and Exchange Commission of Pakistan, as the case may be.

In light of the recent changes to Secs. 97 and 97A, it can thus be concluded that Pakistani Income Tax Law now provides tax neutrality in cases of amalgamations, mergers, takeovers, reconstructions and rearrangements etc. for both resident and non-resident companies, subject to certain conditions that conform to international practices.

5.   IMPLICATIONS OF SCHEMES OUTSIDE THE SCOPE OF TAX BENEFITS

In schemes of amalgamations,[9] mergers, takeovers, demergers, arrangements and reconstructions which fall outside the ambit of the definition clause (Sec. 2(1A) of the Ordinance) and the neutrality provisions of Sec. 97 and 97A, tax is chargeable under Sec. 37 of the Ordinance. In such situations, no benefits of tax neutrality is available, and Sec. 37 will be applied with Secs. 75, 76 and 77 of the Ordinance. In other words, tax officials will levy tax on capital gains with reference to these sections, if no exemptions are available under the law. The officers will determine the higher of the fair market value of the going concern and the consideration received, and following the deduction of the appropriate costs (Sec. 76), capital gains, if any, will be taxed in the hands of transferor.  Similarly, the disposal of shares not falling under the exemption clause will also be taxed.  There will also be retrieval of depreciation allowed on assets on disposal at the time of merger as provided in section 22(8) of the Ordinance.<Do you mean that depreciation claims previously made will be forfeited? Yes> The value of assets are determined in accordance with Sec. 22(5) of the Ordinance. In simple terms, gains are computed by deducting the written down value (WDV) from the higher of the sale proceeds or fair market value. Amalgamated companies not included in the definition clause (Sec. 2(1A) of the Ordinance) are not accorded benefits stipulated in Secs. 20(3) and 57A of the Ordinance. Expenses incurred on merger or amalgamation will not be deductible, and the losses of amalgamating companies become permanent losses.

6.   CAPITAL GAINS TAX EXPOSURE

For any schemes of amalgamation, mergers or takeovers not covered under the tax neutrality regime discussed above, the main tax liability that arises would be chargeability to capital gains in accordance with Sec. 37 of the Ordinance. The main features of capital gains tax in Pakistan are:

–    gains arising from the disposal of a capital asset by a person in a tax year is chargeable as capital gains tax, other than gains which are exempt from tax;

–    gains are computed by deducting cost incurred from considerations received. If considerations received is below the fair market value, the Commissioner <of Income Tax? Yes> is empowered to make the necessary adjustments; and

–    where the capital asset has been held by a person for more than one year, the taxability of any gains arising on disposal of the asset shall be reduced by 25%; and

–    for capital assets which become the property of the persons under the following conditions, the fair market value of the asset, on the date of its transfer or acquisition by the person is treated as the cost of the asset:   

–    a gift, bequest or will;

     –    succession, inheritance or devolution;

–    distribution of assets on dissolution of an association of persons; or

–    distribution of assets on liquidation of a company.

For the purposes of Sec. 37, capital asset means properties of any kind held by a person, whether or not connected with a business, but excludes the following:

–    any stock-in-trade (not being stocks and shares), consumables or raw materials held for the purposes of business;

–    any property which a person is entitled to a depreciation or amortisation deduction;

–    immovable property; or

–    any movable property held for personal use by a person or any member of the person’s family who is dependent on the person.

According to the application of the provisions in Sec. 37, the amalgamating company as a going concern is treated as a capital asset. The transfer of a going concern in any scheme of amalgamation, merger or acquisition is deemed as a disposal of capital asset at fair market value within the ambit of Sec. 75(1) of the Ordinance. The resultant gain, if any, is taxable in accordance with Sec. 37(2) as follows:

Gain = consideration (not less than fair market value) minus costs (Sec. 76(2))

Sec. 76(2) provides that the cost <do you mean consideration, instead of cost? yes> of an asset is the total consideration paid for the asset, including the fair market value of any consideration in kind determined at the time the asset is acquired. Costs include any incidental expenditure, and other expenditure incurred to alter or improve the asset. It should also be noted that the term “disposal” under Sec. 75 includes most of possible ways of alienation of properties i.e. sale, exchange, transfer, redistribution, redemption, relinquishment, surrender, destruction and expiration. 

There is a wealth of case law in the subcontinent in relation to the sale or transfer of a going concern by way of mergers or amalgamations categorised as movable assets and is thus taxed as capital gains, although part of deal may involve the sale of immovable property, which fall outside the ambit of federal taxation. In the following cases, it was held that the going concerns of any industrial undertakings are not classified as immovable property:

–    ‘capital asset’ will definitely include an ‘undertaking’ <Can you provide a short summary on this? A business as a going concern is considered as sale of the entire whole, undertaking, and therefore, the sale of immovable property and other individual movable assets is not considered in separate terms for the purpose of determining gain and loss in respect of each and individual asset. In this case this principle has been elaborated holding that sale of a running bank constitutes sale of a “capital asset” as a business undertaking> – Indian Bank Ltd. v. CIT [1985] 153 ITR 282 (Mad.); and

–    Running business is a capital asset- a business as a going concern would constitute a capital asset <Can you provide a short summary on this it is same as above. The court held that sale of business as going concern is to be taken a composite sale and not sale of individual assets of the business? – CIT v. F.X. Periera & Sons (Travancore)(P.) Ltd. [1990] 184 ITR 461 (Ker.).

In Premier Automobiles Ltd v Income Tax Officer,[10] the Bombay High Court held that:

“For the purposes of computing assessable profits, one has to go by the provisions of the Income Tax Act. If the income/profit is the long-term capital gain, one has to take original cost with indexation. For short-term capital gain, one has to take the amount shown under the Block of Assets on the first day of the previous year. Lastly, the valuation of assets done by the transferee – PPL <what is PPL? Name of the company Premium Pentium Limited> in this case is not for determining value of individual assets but for allocating the price of various assets in their books of account. Therefore, the sale value assigned by the transferee for the purposes of their books of account cannot constitute the basis for computing income/profits of PPL as above under the Income-tax Act. In the case of sale of business as a whole, there is no allocation of price to any particular assets and, therefore, the computation of capital gains in such a case is done on the business as a whole which business itself is a capital asset”.[11]

Other tax issues relate to the deductibility of expenses, allowances and the depreciation of assets acquired from the amalgamated company. In this regard, the relevant sections are:

–    Sec. 22(5) —  the determination of costs of assets for depreciation purposes, by the amalgamating company;

–    Sec. 23(5)(c) — Non-availability of initial depreciation for plant or machineries acquired from the amalgamating company; and

–    Section 29 & 29A — Non-availability of bad debts acquired from the amalgamating company.

7.   CONCLUSION

It is thus advisable that tax planning aspects are well thought out before any scheme of amalgamation, merger or acquisition is entered into, as they can have substantial tax implications and financial ramifications for corporate entities and their shareholders. In such transactions, the tax obligations of both the transferor and transferee companies and shareholders arise, and for tax efficiency purposes there may be a need to restructure the entire transaction in order to take advantage of tax neutrality provisions. It is also important to note that mergers do not merely involve a simple case of the transfer of shares from one entity to another, or the surrendering of management functions and assets. From a tax perspective, a spectrum of issues arise, and authorities will examine these transactions under various statutory provisions including stringent anti-tax avoidance measures, e.g. sections 59B, 90, 98, 108 and 109 contained in the new Income Tax Law in Pakistan.

In brief, Sec. 59B relates to the denial of group relief, Sec. 90B refers to sham transactions and Sec. 98 involves the prohibition of losses carried forward in the hands of new entity.

Invariably, the Commissioner <of Income Tax? yes> will also examine if the arm’s length principle has been satisfied (Sec. 108) and in cases of deviation, necessary adjustments in allocation of profits and/or determination of allowable expenses will be made (Sec.  109).

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* © Huzaima Bukhari & Dr. Ikramul Haq.

[1] Huzaima Bukhari and Ikramul Haq are Senior Partners at Huzaima & Ikram, a Lahore-based member firm of Taxand.

[2] For details  see, “Tax Reform Agenda: Open Letter to Prime Minister”, Tax Review, Lahore, Pakistan (April 2006).

[3] Sec. 282L and Sec. 284 to 287 of the Companies Ordinance, 1984. See Annex 1 for full text.

[4] In Pakistan, capital gains derived by listed companies are exempt from tax up to 30 June 2008. From 1 January 2008, short term gains (on disposals within one year) derived by banks and financial institutions are taxable at the rate of 35% and long-term  gains are taxed at reduced rate of 10%.

[5] The Federal Board of Revenue is the apex revenue authority for federal taxes in Pakistan, pursuant to the Federal Board of Revenue Act approved by Parliament on 1 July 2007. Prior to this, the FBR operated under as the Central Board of Revenue under the Central Board of Revenue Act, 1924 (since repealed). 

[6] Haq, Dr. Ikramul, “Tax Incentives for Acquiring Sick Units, Business Recorder (www.brecorder.com), 20 & 21 September 2003.

[7] A company is considered as resident in Pakistan under Sec. 83  if “it is incorporated or formed by or under any law in force in Pakistan” or  “the control and management of the affairs is situated wholly in Pakistan at any time in the year.”

[8] See Annex I for the full text of the above laws.

[9] Only the term amalgamation is defined in Sec. 2(1A) of the Income Tax Ordinance, 2001. The definition applies in relation to the carry forward of losses or deductibility of expenses (Sec. 57A and 20(3) respectively). With regards to the tax neutrality of these transactions, Sec. 97 and 97A are provisions which confirm that upon the disposal of assets, a “no gain, no loss” situation arises. Disposalas defined in Sec. 75 of the Ordinance includes any scheme of merger, amalgamation, consolidation, combination, reconstruction, arrangement, acquisition, takeover, restructuring, etc. The meaning of the above expressions are construed within the specific meaning assigned if any, under the relevant corporate laws, or if no specific definitions exist, the generally-accepted meaning. 

[10] 129 TAXMAN 289(2003).

[11] The Court held that with reference to the sale of itemized assets, in addition to the allocation of disposal proceeds to land, buildings, plant and machinery, the assessing officer should take into account other assets in order for the computation of capital gains to be considered as accurate.