Transaction Expenses In M&A Deals

Welcome to the May edition of Beyond Headlines!

Mergers and acquisitions (M&A) continue to be a key strategic tool for businesses across sectors — enabling growth, unlocking synergies, scaling operations and facilitating exit opportunities. Alongside these transactions come a range of deal-related expenses: legal fees, tax and regulatory advisory, investment banker's fees, and other professional costs.

In this edition, we explore how these costs are treated from an Income-tax, GST, and regulatory perspective — for the entities, acquirers and sellers

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Transactions costs incurred by a Seller

Sellers are typically taxed on sale of their investments under the head 'Capital gains'. The Income-tax Act allows a deduction for expenses incurred 'wholly and exclusively' and 'in connection with the transfer' of capital assets such as shares, or a business undertaking.

Over time, various judicial precedents have interpreted this phrase. Some key interpretations include:

• The phrase 'in connection with the transfer' is broader than 'for the transfer'. If the payment is necessary to complete the transfer, it qualifies for deduction.¹
• The word 'wholly' refers to the quantum of expenditure and word 'exclusively' refers to the motive, objective and purpose of the expenditure. A practical and pragmatic view should be taken to tax the real income.²
• The expression 'in connection with such transfer' has a wide ambit and allows deduction of expenses closely linked to the transaction.³

Applying these principles, costs such as lawyer's fees, investment banker's fees, tax advisors' fees, etc. are generally viewed as closely linked to the transfer and therefore deductible.

That said, documentation is critical. Sellers must be able to substantiate actual incurrence and payment of expenses, particularly when multiple promoters are involved and each seeks to claim a proportionate share.

At times transaction expenses could also be used as a tool for utilising excess cash in a company. This approach could bring certain efficiencies – subject to commercial drivers. However, challenges arise where shareholders sell their shares, but the company bears the transaction expenses. Tax authorities may question whether the expense represents a deemed dividend paid by the Company to its shareholders.

Transaction costs incurred by an acquirer

An acquirer may also incur costs in the form of feasibility studies, due diligence, legal and tax advisory, and investment banking support. While these costs are clearly incurred in the course of business, tax authorities may argue that such expenditure relates to the acquisition of assets. Therefore, these costs are not allowed as regular business expense. These costs can be included as cost of the investment itself.

Madras HC⁴ held that legal and professional fees incurred for acquiring shares of a French company were allowable as business expenditure. The Court observed that the expansion of global operations is a valid commercial objective, and such costs fall within the ambit of 'commercial expediency' – a principle that supports that all expenditures a prudent businessman incurs for the purpose of business are allowed.

In cases involving amalgamation or demerger, the Income-tax Act, 1961 specifically provides that transaction expenses are allowed equally over a period of 5 years beginning with the year in which the amalgamation or demerger takes place.

GST and FEMA Considerations

GST: Transaction related professional services provided by Indian service providers are generally subject to 18% GST. While businesses can claim Input tax credit, individual shareholders without GST registration bear this as an additional cost.

FEMA: If individual shareholders obtain services from overseas professionals, the maximum limit of USD 250,000 per financial year under the Liberalised Remittance Scheme shall apply. Further, such remittance shall also attract 20% TCS. These constraints do not apply when remittance is made by a company.

FINAL THOUGHTS

M&A-related expenses often sit at the intersection of business strategy and tax complexity. Both companies and promoters should be mindful of how these costs are treated under various statutes — Income-tax, GST, transfer pricing, and FEMA — to avoid additional tax exposure and ensure cost efficiency.

We have also seen recent instances of tax authorities issuing notices directly to professionals and advisors, requesting details of their scope of work and fees — as part of validating whether the expense claimed by acquirer or Seller is indeed eligible for deduction.

Early planning and clear documentation of transaction costs are key to achieving both tax and regulatory alignment.

Footnotes

1. [1991] 190 ITR 56

2. [2018] 404 ITR 136

3. [2011] 46 SOT 19

4. [276] Taxman 141

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.