LEGISLATION FOR

MEGER AND
ACQUISITION
1
Legislation Dealing Mergers in a
Particular Sector.
Section 48 of the Banking
Companies Ordinance, 1962
282L of Companies Ordinance,
1984
Section 67 to 71 of the Insurance
Ordinance, 2000 and
application to High Court
For Banking Companies.
For N.B.F.Cs
For Insurance Companies.
Specific Laws Dealing Mergers.
Section 287 to 289 read with Section 282L & 284 of the
Companies Ordinance, 1984 applies to mergers involving
companies incorporated under the laws of Pakistan.
Section 2 (1A); 20 (3); 57A, 97; 97A & Clause 62 of Part
IV of Second Schedule to the Income Tax Ordinance,
2001.
Section 11 of Competition Ordinance, 2007.
Legislation on Foreign Investment.
Board of Investment and Foreign Exchange
Regulation contain certain exceptions and
restrictions for non-residents for which general or
special permission is required.*
Section 2 (1A) of the Income Tax Ordinance,
2001
Amalgamation means the merger of one or more
1. banking companies or
2. non-banking financial institutions, or
3. insurance companies, or
4. companies owning and managing industrial undertakings or
5. companies engaged in providing services and not being a trading company or
companies.
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
Section 2 (1A) of the Income Tax Ordinance,
2001
The liabilities of the amalgamating company or companies immediately before
the amalgamation become the liabilities of the amalgamated company by virtue
of the amalgamation
Requisite criterion
One company must be a public company or
A company incorporated under Companies Ordinance,1984 or under any
other law for the time being in force,
Merger/Amalgamation.
From
Members/Shareholders
Point of View
From the Point of View of
Company to be
Merged/Amalgamating.
From the Point of View of
Amalgamated
Company.
From Members/Shareholders Point of View
[S. 2(19)(a)] - Dividend includes
distribution of accumulated profit
entailing release of assets of the
company possessing profit.
[S. 2(19)(c)&(d)] - Distribution on
liquidation or reduction of capital
In merger / amalgamation, no
distribution of accumulated profit takes
place thus no release of asset.
Is exchange of shares treated as Dividend?
Section 37 (5) - Shares are Capital Asset
No Disposal i.e. sale / transfer /
exchange / relinquishment etc. involved.
If exchange / relinquishment is treated as
Disposal even then no gain / loss arises
Taxability regarding exchange of shares?
From the Point of View of Company to be
Merged/Amalgamated.
S 97 & 97A - No gain or loss is taxable
subject to certain conditions.
Amalgamating companies are resident
and belong to wholly owned group.
In case of Section 97 the condition of
both companies to be resident shall not
apply in light of clause 62 of Part IV of
2nd Schedule.
Gain of amalgamating companies are
taxable if the above criteria is not
fulfilled under the Income Tax
Ordinance, 2001
Taxability of gain on transfer of assets and
liabilities?
From Amalgamated Company Point of View.
S 76 - Relating to cost of purchase.
S 98C, concerning succession.
The tax value of assets in the hands of
amalgamating company (immediately
before amalgamation) shall be taken
as the tax value for amalgamated
company
Tax value of assets / liabilities acquired?
From Amalgamated Companys Point of View.
Goodwill an intangible or capital asset
a dilemma?
Treatment of goodwill?
Difference between Tax-value and
Accounting value of assets?
What about goodwill taxation?
From the Amalgamated Companys Point of View.
S 20(3) - Only expenditures incurred
under following heads are tax
deductible
Legal Advisory Services
Financial Advisory Services
Administrative expenses
Planning and Implementation of
amalgamation
What is the treatment of merger related
expenses?
What about carry forward and set-off
of losses sustained by the
amalgamating company ?
S. 57A - In the year of amalgamation only
assessed loss of the amalgamating
companies for the tax year is available
for the set off. The facility to set off
accumulated losses of amalgamating
companies has been taken away from
July 01, 2007.
Tax Consequence in Case of
Acquisitions.
Acquirer point of view
Acquiree point of view
Acquirer Point of View.
In case of non-arms length transaction the fair market
value may be treated as consideration as cost of
acquisition [S. 76 & 78]
Tax treatment for payment of goodwill.
Tax deductibility of consideration paid under restrictive
covenants ?
Acquiree Point of View.
Transfer of assets and liabilities have tax implications
depending on the basis of nature of asset.
Consideration may be taken at higher of the actual selling
price or Fair Market Value [S. 77]
Slump sale principle Applicability ? [S. 77]
Consideration under restrictive covenant whether capital
or revenue?
Role of tax Advisor in Mergers &
Acquisitions.
International mergers and acquisitions require
appropriate planning.
Planning will end after consideration of domestic
laws effect on home country & other country
laws.
Effective consideration will be whether to merge
or acquire.
If to acquire consideration to be given to manner
of acquisition.
To acquire the business as a whole, slump
transaction or through shares or as an asset
purchase.
PAYING FOR
ACQUISITION
Principal Methods of Payment for
Acquisition
Cash in exchange for shares
Share Exchange- A specified number of bidder share in
exchange for each target share
Cash underwritten share offer-Bidders share sold to
investment banker of broker (vendor
placement or to bidder shareholders
(vendor rights)
Loan Stock- Debenture in exchange for share
Convertible loan- at pre-determined exchange rate over
pre-specified time.
Preferred shares- same
Deferred Payment- Part of Consideration subject to
performance.
Factors influencing choice among
financing methods
a. Risk and Valuation Considerations Preferred Payment Method a. Risk and Valuation Considerations Preferred Payment Method
Higher valuation risk to bidder
Target a highly cyclical business
Bidder keen to exploit its high current
share valuation
Bidder already leveraged
bidder prefers shares(Target-cash)
share offer
Share offer
Share offer to reduce financial risk
b. Maximize Tax Benefits Preferred Payment Method
high capital gain tax to target
Bidder can use accumulated tax losses
and investment credits of targets
Bidder can step up target assets value for
depreciation allowance
Exploit additional debt capacity of target
And tax advantage of debt
Target prefers shares
Share offer
Cash
Loan stock or leveraged cash finance
Factors influencing choice among
financing methods
a. Risk and Valuation Considerations Preferred Payment Method a. Corporate Control Considerations Preferred Payment Method
bidder don t wan to dilute control
Target want to maintain control
cash offer
Share exchange or earn-out payment
b. Deal Execution considerations Preferred Payment Method
bidder keen to deter rival bidder
Need for speed in deal execution
Bidders free cash flows and liquidity
high
cash
Cash or leveraged cash offer
Cash
Cash offer
More certain
Value does not depend on post-acquisition
performance
No need for complex difficult to value derivatives
to insure against stock price decline.
Simple to evaluate
Eliminates lemon problem for target shareholders
Clean break for target shareholders
Safeguard against potential rival bidder.
Cash offer-sources
Internal operating cash flows
Cash flow from prior asset disposal
Cash underwritten offer
A pre-bid loan stock issue
Bank credit
Share Exchange
Stock Exchange Ratio determine the exchange of bidders
shares and target shares in a stock for stock exchange.
Exercised where valuation problem are exist.
To avoid problem of uncertainty, bidder may make
Fixed exchange rate offer-Specficied share for share
Fixed value offers- ( floating rate offer) the exchange is
completed at whatever ratio is required to yield the agreed fixed
value.
Enhances target protection
Acquirers is faced with uncertainty about dilution and number of
shares to be issued.
Pricing period, both length and timing is bone of contention of
bidder and target
Share Exchange-Fixed Value offer
Collars-a fixed rate price subject to both floor and a
cap
Floor if bidder price falls below the floor the
fixed rate is adjusted upward
Cap the acquirer may impose an absolute limit on
the additional shares to be issued.
Share Exchange-Walk-away
options and Top up right
M&A agreements may provide for termination for
either party to walk away from deal when price has
fallen (target)or risen (bidder) unacceptably high.
Walk-away option may be exercised with collars
and exercised when the bidder stock price goes
outside the range.
To off-set target walk-away rights, the bidder may
ask for top up rights which allow to increase the
exchange ratio.
Conversion value Rights
CVRs are commitment by the acquirer to pay
additional cash or securities if the share prices of
the combined company does not exceed a specified
level e.g. a year after the acquisition is completed.

CVRs are part of the acquisition currency and are

traded in open market enabling the shareholder to
target to cash out earlier.
Cash underwritten Offer
In cash underwritten offer, the bidder offers stock
exchange to the targets but target shareholders can
sell the received stock to realize cash.
It may be more flexible in that underwriting can be
made conditional upon the bid succeeding.
May be cheaper than right issue of shares as
underwriting expenses are charged for period
underwriting remains open.
Leveraged Cash Financing
Secured Bank Debt-collateral and covenants
Mezzanine Debt-Second ranking loan with no
secondary market-expensive-restrictive conditions
Corporate Bonds-long term-deep global market-
more liquid-more diverse investor base
Bridge Loan-short term loans to be replaced by
high yielding bonds or equity-Need for rating-high
speed cheaper being short term
Leveraged cash Financing-
characteristics
High gearing may sometimes leads to default and
decline
Target assets may be used to finance the acquisition
Related interest payment is tax deductible.
Leveraged Financing-Financing
with Loan Stock
Loan stock is consideration for bid
Shares to target are swapped with debt
A loan stock reduces the risks of information as
symmetry
Loss of control to target shareholders
Financing with Convertibles
Straight preferred or loan stock with an option of
conversion to ordinary shares.
Valuing a convertible is rather complex.
Deferred consideration Financing-
An Earn-out
Both bidders and shareholder of target face
valuation risk in negotiation.
One way of mitigating this risk is to make
consideration contingent upon future performance
of the company under their own management.
Value of such company normally depends upon
human creativity and the flair of one or two
individual e.g. advertising company
An earn-out is the way of retaining the vendors
talent.
Earn-out consideration
Cash paid immediately Rs. 75 million
Discretionary earn-out at end of Ist year
Rs. 20 million
Discretionary earn-out at end of 2
nd
year
Rs. 25 million
Maximum consideration Rs. 120 million
Total consideration if earn out targets missed
Rs. 110 millions
Deferred consideration Financing-
An Earn-out
Advantages Disadvantages
a. For Acquirer
Vendors talent retained
Valuation risk reduced
Buy not and pay later reduces
immediate need for cash
Provide hedge against warranty and
indemnity claims
Conflict of motive between vendor and
buyer
Vendor given autonomy and buyers
integration plan delayed
Vendor after becoming rich may lack
motivation
Management succession after earn-out
may cause problems
b. For Vendor
Increases personal wealth
Career opportunities may be brighter
Buyer can fund future growth of
business.
Loss of control
Pressure for short term results
Culture shock of working in a large
bureaucratic company
Tax Aspects of Acquisition
financing
Objectives:
Structuring acquisition to maximize the tax relie
Enhancing bid price to benefit target shareholders and
success of acquisition
Tax Aspects of Acquisition
financing
Is good will taxable?
Is tax relief available for higher depreciation as a result
of asset set-up
Can pre-acquisition tax losses of target be offset in the
future against bidders or merged companys profits
Can the target be restructured prior to acquisition so as
to reduce capital gains to the target or its shareholders
In the case of cross border acquisition, are dividends
and interest payable to target owners are subject to
withholding or double taxation.
Bidders financial strategy and
acquisition financing
Maintaining reasonable gearing
Credit rating
Ensuring adequacy of lines of credit from banks
Tax impact on cost of capital
Timing of security issue
Earning dilution is share exchange
Boot strapping-applying bidder higher P/E ratio to
target is known as boot strapping. It assumes that
earning growth of target after acquisition match with
that of the bidder. If not, boot strapping will be a short
lived delusion.