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A: Due to unawareness of the real legal nature of the concept of amalgamation, the tax authorities tend to imply that the set of tax implications attributed to a sale of a business is also applicable to the process of amalgamation.
Due to this unfortunate situation, there is uncertainty prevailing on the tax implications on amalgamations. This uncertainty acts as a barrier for smooth amalgamations. The Companies Act of 2007 has provided for Court free amalgamation. Takeovers and amalgamation of companies are part of a vibrant economy hence any barriers should be eliminated.
Sri Lanka tax statutes do not contain a single provision with regard to consequences of amalgamation apart from the two amendments introduced to the Inland Revenue Act and Value Added Tax Act in 2014 only for the Central Bank’s scheme of consolidation of the finance companies. Hence tax implications should be ascertained in the context of the existing general tax rules.
Provisions of the Companies Act and decided case law in other countries with regard to the nature of amalgamation point out to the fact that in an amalgamation there is no legal transfer or disposal and the amalgamating company continues in the form of the amalgamated company and this does not trigger any tax incidences in the Sri Lankan context.
Q: What is the difference between an amalgamation and a sale of business from a legal point?
A: A sale of business is where a company disposes its assets and liabilities or you may call it as a ‘transfer of a going concern’. Here an income tax exposure may arise on account of depreciable capital assets, VAT on the supply, stamp duty on transfer of immovable property, etc.
An amalgamation is simply a fusion, union or blending of companies. This mechanism is provided for in the Companies Act itself. The effect of certificate of amalgamation is set out at Section 245 of the Companies Act. In an amalgamation instruments such as deed of conveyances, assignments of mortgages, assignments of leases, guarantees, contracts are not executed separately. However in the case of sale of business to give effect to such sale additional instruments must be executed. Sometimes these additional instruments may attract taxes.
Q: In a nutshell, what is the legal nature of an amalgamation?
A: Well an amalgamation is where two or more companies amalgamate and continue as one company. Provisions in relation to amalgamation are couched in Sections 239 – 245 of the Companies Act No. 7 of 2007.
The legal nature of amalgamation is such that the amalgamated company succeeds to all the property, rights, powers, privileges, liabilities and obligations of each of the amalgamating companies. Furthermore, even pending proceedings by or against an amalgamating company could be continued against the amalgamated company. Any conviction, ruling, judgment in favour or against the amalgamating company could be enforced by or against the amalgamated company. Therefore if we take an example, the amalgamated company would be responsible, post amalgamation for an Assessment raised in the name of the amalgamating company. Hence it creates a no loss situation for the Inland Revenue Department, because it can actually recover any outstanding taxes of the amalgamating company from the amalgamated company.
The law is clear, the amalgamated company succeeds to all the rights of the amalgamating companies, and it continues as one company. Hence there is no situation of a transfer or disposal which may give arise to taxes. There are many case laws decided in foreign jurisdictions which support this. Hence no additional taxes should arise in the case of an amalgamation in the Sri Lankan context.
Q: You mentioned decided cases in other countries have clearly established the legal nature of amalgamations. What are they?
A: In the case of Soniawear Vs Central Electricity Board, Supreme Court of Mauritius held that amalgamating company and the amalgamated company are one and the same. Hence the Judge explicitly stated that there is continuity without any indication of assignment or sale or transfer for value.
In issuing this judgment the Supreme Court of Mauritius has referred to few other cases which are also vital to understand the legal nature of amalgamation such as the case decided in New Zealand Court of Appeal Carter Holt Harvey Ltd. v McKernan, another New Zealand Supreme Court case decided in 2008, Elders New Zealand Ltd. v PGG Wrightson Ltd. and a Canadian case of the Queen v Black and Decker Manufacturing Company Ltd.
In those cases, principles such as in an amalgamation there is no disposition or legal transfer to the amalgamated company, amalgamating company continues in the shoes of the amalgamated company were established. Also, the concept that there no new or old company in an amalgamation, the amalgamated company continues to be liable for the liabilities of the amalgamated company were also pointed out.
Q: So you mean to say that the amalgamated company is responsible for the amalgamating company’s liabilities as well. Is that correct?
A: Of course, as I mentioned earlier as per Section 245 (f) (g) and (h) the legal effect of amalgamation is such that the amalgamated company succeeds to all the liabilities of the amalgamating companies. Even pending Court proceedings can be continued in the name of the amalgamated company. Any rulings, judgments in favour or against the amalgamating companies can be forced by or against the amalgamated company. In the Canadian case of Black & Decker it was decided that the amalgamated corporation remain liable to prosecution for offences committed prior to the amalgamation by the amalgamating company. Likewise the amalgamated company would continue to be liable for all the tax liabilities of the amalgamating companies.
Q: You spoke of rights, obligations, etc. What are rights?
A: A company could derive rights in many ways but broadly there are two categories, contractual rights and statutory rights. Rights a company derives from a contract falls into the first category. The right company had to enforce the personal guarantee given by Mckernan under the contract of guarantee in the case of Carter Holt decided by the New Zealand court is a good example. In addition a company would have derived statutory tax rights whilst carrying on business.
For example, if a company has acquired capital assets for use in the business it derives the statutory right to claim an allowance for depreciation under s.25 of the Inland Revenue Act. As the legal nature of amalgamation is that the amalgamating company continues in the form of amalgamated company and all the rights of the amalgamating company flows to the amalgamated company. The right to claim unutilised or unabsorbed allowance for depreciation also flows to the amalgamated company for the remaining period provided assets continue to be used in the business.
In the same manner all other tax rights of an amalgamating company flow to the amalgamated company.
Q: Are there any other tax rights? Please elaborate.
A: Under Sec. 136 and 137 of the Inland Revenue Act, a company derives the right to claim credit for withholding tax and notional tax credits. The right to claim these tax credits flow to the amalgamated company pursuant to an amalgamation.
Under Sec. 200 of the Inland Revenue Act and Sec. 58 of the VAT Act, if an amalgamating company has a right for income tax or VAT refunds, such refunds would be due to the amalgamated company after the amalgamation as the right for tax refunds of the amalgamating company would flow to amalgamated company.
Under Sec. 22 of the VAT Act if an amalgamating company has a right for claiming input tax, the same right would accrue to the amalgamated company.
Under Section 3 of the ESC Act, if the amalgamating company has any brought forward ESC, it could claim it against its income tax payments. This same right will flow to the amalgamated company.
Q: Why is that when a company sells capital assets there will be income tax payable but not in an amalgamation?
A: When a company sells or disposes capital assets in terms of Section 25(3) of the Inland Revenue Act, any sale proceeds on the sale of capital assets on which depreciation allowance has been claimed in full or in part is deemed to be a receipt from business and is chargeable to income tax. “Disposal” in terms of Section 25(7) includes sale, exchange or other transfer and cessation of the use of such assets.
An amalgamation is where by operation of law, assets and the liabilities contractual rights and obligations of amalgamating companies continues in the amalgamated company. As decided in the case of Elders New Zealand Ltd. v PGG Wrightson Ltd., the assets and the liabilities of the amalgamating company continues in the amalgamated company, hence ‘no disposition or transfer to the amalgamated company’. Hence Section 25(3) read in conjunction with Section 25(7) cannot be applied at a time of a disposal. By now it should be clear that amalgamation does not trigger a disposal neither a transfer hence Section 25(3) cannot be applied in an amalgamation.
Q: You are also of the view that an amalgamation does not trigger VAT. Can you explain this? Does an amalgamation in New Zealand attract VAT?
A: Yes and no! There are two specific provisions dealing with Good and Services Tax (GST) consequences pertaining to amalgamations in the GST Act of New Zealand. The Act creates an artificial or a deemed supply to charge GST when the amalgamating company is registered for GST but the amalgamated company is not. Here we have to understand why such a deemed supply is created by law to charge GST. The amalgamating company since GST registered would have claimed input credit for its supplies purchased and pursuant to amalgamation if the amalgamated company is not registered for GST there would not be any output tax. This would result in loss of revenue to the State.
The correct amount of GST or Value Added Tax (VAT) due to the state is ensured by the output tax minus input tax mechanism. If there is a break in the mechanism due to amalgamation there will be a loss of revenue to the state. To prevent this and restore the output tax minus input tax mechanism the law creates a deemed supply and charges output VAT on an amalgamation in this circumstances.
But the status is different if the amalgamating company is not registered for GST. Since no input GST has been claimed, if the company enters an amalgamation, no GST is charged in the process irrespective of the GST status of the amalgamated company.
Sri Lankan VAT Act has a lacuna as it has not addressed the VAT treatment on amalgamation. Ideally two provisions similar to New Zealand must be introduced. In the absence of an artificial or deemed supply similar to New Zealand being introduced it may not be possible to charge VAT on an amalgamation. Due to the legal nature of an amalgamation there is no ‘supply’ in the process for VAT to arise.
The supply of connotes the existence of a supplier and recipient and consideration. In an amalgamation, the amalgamating company continues in the form of the amalgamated company. There is no transfer or disposition as pronounced in decided case law by the Supreme Court of New Zealand and other countries. The amalgamation does not fall within the definition of the ‘supply of goods’ given the VAT Act. There is no passing of exclusive ownership of goods from one company to another.
Q: What about Nation Building Tax (NBT) implications on an amalgamation?
A: NBT is not applicable. NBT charge is on turnover derived by manufacturers, importers, service providers and whole sale and retail sale. The legal nature of amalgamation does not trigger chargeability to NBT.
Q: Would there be stamp duty payable all over again with regard to share portfolio (investment in shares reflected in the balance sheet of amalgamating company) due to the amalgamation?
A: Well, the simple answer is no! If I may explain the reason, there is no transfer, assignment or new issuance of shares involved with regard to the investment in share portfolio reflected in the balance sheet of the amalgamating company. All that happening is a name change of the same shareholder (from the name of the amalgamating company to the name of the amalgamated company).
I would like to draw an analogy from the case of Mauritius Supreme Court case of Soniawear Ltd. v Central Electricity Board 2013 SCJ 42 where the contention of the Central Electricity Board that the amalgamated company should open a new account under the amalgamated company was rejected by the Supreme Court. The amalgamated company’s request to the Central Electricity Board that the name of the account held by the amalgamating company be changed to the amalgamated company was upheld by the court.
The Stamp Duty Special Provisions Act imposes stamp duty only on share certificates issued on transfer, assignment or new issuance of shares. Hence irrespective whether the subject shares are listed (where Central Depository System has a role to play) there should not be stamp duty on this incidence.
Q: What are your thoughts on resolving this issue with regard to the true tax effect of amalgamation?
A: The exact nature of an amalgamation is not known to many including Government agencies. This leads to much hardship and injustice to companies seeking to amalgamate and continue as a single entity. The Inland Revenue Department, Registrar General of Lands, Central Depository System (stock exchange) Registrar General of Motor Vehicles, the Board of Investment, institutions providing utilities such as water, electricity and banks, etc., all have a role to play with regard to an amalgamation.
To my mind, there are two ways in which the matter could be resolved. An amalgamated company should apply to Courts, either under the established appellate procedure or by way of a Writ, for the matter to be resolved.
The alternate and the more practical way of resolving the matter would be for the Attorney General to study the matter and provide an opinion as to the consequence of an amalgamation including all the tax issues. After all, the Attorney General is the lawyer of all the Government agencies. For this purpose a Government institution must refer the matter to the Attorney General, maybe by the Commissioner General of Inland Revenue or even it could be Central Bank in the context of the consolidation of the financial institutions. Yes I think a direction from the Attorney General to all the Government agencies would be the best way of resolving the issue.
