The State Bank Governor, Dr Shamshad Akhtar, has advised the textile industry to consolidate itself through mergers as larger companies are more likely to survive in a competitive world..

The textile industry is unable to compete in the international market despite availability of cotton locally because of high cost of production due critical shortage of energy, rising costs of utility services and other inputs and a poor law and order situation.

Apart from the adverse economical and political factors, the textile sector is also responsible for the existing situation. Many textile companies under different names are in fact, owned and controlled by a few groups of industrialists. These smaller units lose the benefit of scale and suffer from inefficiencies. But smaller units help to avoid taxes and avail bank loans.. Consequently most of textile units - particularly the listed companies--, are not showing profits.

With a view to encourage mergers and acquisitions in textile industry, the Planning Commission had recently recommended a 15 per cent tax credit to the profit-making companies which acquire loss-making or smaller units. It had also recommended that the profit-making company should be allowed to declare losses of acquired smaller or loss-making unit in its accounts. Though the government approved these recommendations, they failed to materialise. However, the government has provided tax incentives for mergers and acquisition of a small/loss making company in the Income Tax Ordinance 2001 (Ordinance).

Many textile tycoons are not aware that the Ordinance has made very simple procedures for consolidation through mergers and acquisitions, that is coupled with the tax incentives. It is different from the scheme of amalgamation under the Companies Ordinance 1984 which involves a cumbersome exercise.

To encourage corporatisation and consolidation of small companies or loss making units, the government has provided several options in the Ordinance. It has provisions for conversion of sole proprietorship and partnership or association of person (AOP) into a company. It has also provided for a small company to merge into large company or a group of companies. Sections 95 and 96 of the Ordinance provide for a resident individual and AOP to convert themselves into a company by transferring their assets and liabilities to a resident company in consideration of shares of the new company. Thereby, they will become shareholder of new company.

Similarly, Sec 97 provides for merger and acquisition in case both the companies, transfer and transferee firms belong to a wholly-owned group of companies, they may be acquired or merged into other company simply by transfer or disposal of an asset and liability to another company.

Incentives for mergers: It would be assumed that there no gain or loss that has arisen on disposals of their business assets. The company acquiring a small or loss making will be entitled to claim in the tax year in which the transfer of the company is made, the unabsorbed depreciation, initial allowance or amortization in respect of the assets transferred/disposed of to it which have not been set off against the transferor’s business income

By virtue of a new section 97A introduced in the Ordinance through the Finance Act 2007, no loss or gain shall be assumed to arise on disposal of assets from one company to other company under a Scheme of Arrangement and Reconstruction u/s 284-287 of the Companies Ordinance 1984 or u/s 48 of the Banking Companies Ordinance 1962, approved by the High Court, State Bank of Pakistan or the Securities and Exchange Commission of Pakistan, as the case may be.

Thus maximum tax incentives are offered to encourage industrial consolidation and to develop a strong corporate sector to meet the international challenges. It has widened the concept of amalgamation 2(1A)

Under the merger of one or more banking companies or non-banking financial institutions were initially allowed to derive benefits of amalgamation, but it has been widened. The benefit of merger has been extended to insurance companies and industrial undertakings and service sector too It allows the major tax incentive to the amalgamated company to set off or carried forward the accumulated losses of the amalgamating company for a period of six tax years against it business profit. The Income Tax Appellate Tribunal has approved to set-off and carrying forward of the assessed losses of amalgamating company, in the case of M/s Ellahi spinning ad Weaving Mills Ltd and Taj Textile Mills Ltd. These tax benefits are subject to certain conditions specified in the said sections.

The government has done its bit to protect the industrial sector from tough international competitions. It is now for the industry to realise that it needs consolidation to be competitive in the world markets by creating economies of scale.

In spite of substantial investment under BMR over the past few years for its higher value addition to meet increase competition in the international market in the post quota regime, the textile sector seems to be struggling to face this challenge as is apparent from sluggish exports and liquidity crisis. It requires support from the government for lowering cost of production as quickly as possible.

The corporate governance is a major problem in the textile sector. The textile industry enjoys so many tax incentives, (most of them are exporters), falls under the presumptive tax regime. They are subject to tax at lower than normal tax rates but declaration of profit by them has always been is debatable.

Over 30 per cent of listed companies on Karachi Stock Exchange are from the textile sector; 85 cent of them have been denied a reasonable return to their shareholders at least for last three years or more. The price earning ratio of 65 per cent of them is negative. The regulators are lenient and flexible towards them. They do not resort to the legal provisions available to them under Companies Ordinance 1984 and the Listing Regulations against the defaulting company in respect of non-payment of dividend.

In addition to stated modes for consolidation, the Ordinance has also provision for group taxation whereby 100 per cent owned group companies are taxed as a single fiscal unit if group companies select to be taxed as such. Moreover, the Ordinance also allows a holding company, listed on stock exchange, owning and managing an industrial undertaking to claim losses incurred by its subsidiary company. These are attractive incentives package offered to the industry under the tax statute to encourage efficient and profit making companies to acquire loss making firms and derive advantage of set-off their losses against their profit.