Lately,
the income tax authorities have been actively objecting to schemes of
arrangement initiated under sections 391 to 394 of the Companies Act, 1956 on
the ground that the schemes are intended to avoid applicable taxes. Such
objections are usually raised when the scheme is presented for sanction of the
High Court. This scenario has been played out last week in a decision
of the Gujarat High Court in Vodafone
Essar Gujarat Limited v. Department of Income Tax.
the income tax authorities have been actively objecting to schemes of
arrangement initiated under sections 391 to 394 of the Companies Act, 1956 on
the ground that the schemes are intended to avoid applicable taxes. Such
objections are usually raised when the scheme is presented for sanction of the
High Court. This scenario has been played out last week in a decision
of the Gujarat High Court in Vodafone
Essar Gujarat Limited v. Department of Income Tax.
The
scheme involved the demerger of the passive infrastructure assets of several
telecom companies into a single transferee company. Both the transferor companies
and the transferee company were part of the same group, with all of them being
wholly owned subsidiaries of one of them. Since the companies were located in
several states, the scheme required the approval of different High Courts.
While the High Courts of Bombay, Calcutta, Madras and Delhi approved the
scheme, a single judge of the Gujarat High Court rejected the scheme on the
ground that the transaction did not fall within the scope of “arrangement”
within the provisions of the Companies Act as the transaction was considered to
be a gift due to the lack of consideration. The court found the existence of a
number of other grounds to reject the scheme, primarily because the transaction
would result in a loss to the revenue.
scheme involved the demerger of the passive infrastructure assets of several
telecom companies into a single transferee company. Both the transferor companies
and the transferee company were part of the same group, with all of them being
wholly owned subsidiaries of one of them. Since the companies were located in
several states, the scheme required the approval of different High Courts.
While the High Courts of Bombay, Calcutta, Madras and Delhi approved the
scheme, a single judge of the Gujarat High Court rejected the scheme on the
ground that the transaction did not fall within the scope of “arrangement”
within the provisions of the Companies Act as the transaction was considered to
be a gift due to the lack of consideration. The court found the existence of a
number of other grounds to reject the scheme, primarily because the transaction
would result in a loss to the revenue.
Although
similar arguments were placed by the income tax authorities before the Delhi
High Court, the scheme was nevertheless sanctioned with powers reserved to the
income tax authorities to determine tax liability on the scheme. We have
previously discussed these contrasting approaches between the Gujarat and Delhi
High Courts in a previous
post.
similar arguments were placed by the income tax authorities before the Delhi
High Court, the scheme was nevertheless sanctioned with powers reserved to the
income tax authorities to determine tax liability on the scheme. We have
previously discussed these contrasting approaches between the Gujarat and Delhi
High Courts in a previous
post.
Unsurprisingly,
the company appealed against the decision of the single judge of the Gujarat
High Court, which was reversed last week by a division bench. After carefully
considering the law pertaining to the ability of the income tax department to
successfully challenge a scheme of arrangement on the ground of tax avoidance,
the court came to its own conclusion on the relevant issues.
the company appealed against the decision of the single judge of the Gujarat
High Court, which was reversed last week by a division bench. After carefully
considering the law pertaining to the ability of the income tax department to
successfully challenge a scheme of arrangement on the ground of tax avoidance,
the court came to its own conclusion on the relevant issues.
First, on the threshold question whether
the income tax authority has the locus
standi to challenge a scheme before the court, there was no doubt about that
because the income tax authority is in the nature of a creditor of the company,
and is entitled to examine the scheme from the purview of any tax liability
arising from that.
the income tax authority has the locus
standi to challenge a scheme before the court, there was no doubt about that
because the income tax authority is in the nature of a creditor of the company,
and is entitled to examine the scheme from the purview of any tax liability
arising from that.
Second, the court’s role in approving a
scheme of arrangement was considered, and that includes an examination of
whether the provisions of the scheme were structured so as to be against public
policy or contrary to the provisions of applicable law.
scheme of arrangement was considered, and that includes an examination of
whether the provisions of the scheme were structured so as to be against public
policy or contrary to the provisions of applicable law.
Third, the expression “arrangement” in
sections 391 to 394 is of wide import, and cannot be interpreted narrowly. In
that sense, it cannot be said that a scheme that is in the nature of a gift
cannot amount to an “arrangement” for the purposes of these provisions.
sections 391 to 394 is of wide import, and cannot be interpreted narrowly. In
that sense, it cannot be said that a scheme that is in the nature of a gift
cannot amount to an “arrangement” for the purposes of these provisions.
Fourth, while examining the scheme, the
court cannot conduct a close examination of its terms such as the nature and
extent of the consideration involved in the transaction, which was among group
companies. As far as the role of the court is concerned, it was observed:
court cannot conduct a close examination of its terms such as the nature and
extent of the consideration involved in the transaction, which was among group
companies. As far as the role of the court is concerned, it was observed:
In
our view, while examining the Scheme each and every objection of a third party
cannot be considered by carrying out microscopic examination. It is also
required to be noted that it is not necessary that consideration is always a
monetary consideration. In such type of cases wherein the reconstruction
involves give and take and mutual/reciprocal promises and obligations, which
can be said to be consideration for each other and it cannot be said that there
is absolutely no consideration so far as Scheme of Arrangement is concerned.
The Court is required to see whether the Scheme in question is for the benefit
of shareholders and whether it is framed with the sole object of avoidance of
the Scheme is avoidance of tax or it is against the public policy. Even
otherwise, when various High Courts have sanctioned the identical Schemes, even
on the principles of parity and judicial comity, in our view, consent is
required to be given to the Scheme in question.
our view, while examining the Scheme each and every objection of a third party
cannot be considered by carrying out microscopic examination. It is also
required to be noted that it is not necessary that consideration is always a
monetary consideration. In such type of cases wherein the reconstruction
involves give and take and mutual/reciprocal promises and obligations, which
can be said to be consideration for each other and it cannot be said that there
is absolutely no consideration so far as Scheme of Arrangement is concerned.
The Court is required to see whether the Scheme in question is for the benefit
of shareholders and whether it is framed with the sole object of avoidance of
the Scheme is avoidance of tax or it is against the public policy. Even
otherwise, when various High Courts have sanctioned the identical Schemes, even
on the principles of parity and judicial comity, in our view, consent is
required to be given to the Scheme in question.
Fifth, the role of the tax authority to
object to the scheme is fairly narrow and courts will generally be slow in
rejecting a scheme on account of issues pertaining to tax. Here, it was
observed:
object to the scheme is fairly narrow and courts will generally be slow in
rejecting a scheme on account of issues pertaining to tax. Here, it was
observed:
… it
is required to be noted that even if the ultimate effect of the Scheme may
result into some tax benefit or even if it is framed with an object of saving
tax or it may result into tax avoidance, it cannot be said that the only object
of the Scheme is tax avoidance. Considering the various clauses of the Scheme
it is not possible for us to come to a conclusion that the Scheme is floated with
the sole object of tax avoidance. In its commercial wisdom if the Company has decided
to have a particular arrangement by which there may be even benefit of saving income-tax
or other taxes, that itself cannot be a ground for coming to the conclusion
that the sole object of framing the Scheme is to defraud the Income Tax
Department or other taxing authorities.
is required to be noted that even if the ultimate effect of the Scheme may
result into some tax benefit or even if it is framed with an object of saving
tax or it may result into tax avoidance, it cannot be said that the only object
of the Scheme is tax avoidance. Considering the various clauses of the Scheme
it is not possible for us to come to a conclusion that the Scheme is floated with
the sole object of tax avoidance. In its commercial wisdom if the Company has decided
to have a particular arrangement by which there may be even benefit of saving income-tax
or other taxes, that itself cannot be a ground for coming to the conclusion
that the sole object of framing the Scheme is to defraud the Income Tax
Department or other taxing authorities.
In sum,
the division bench of the Gujarat High Court appears to have adopted a similar
stance as the other courts that sanctioned the scheme, particularly the Delhi
High Court which considered similar objections from the income tax department.
The ultimate outcome seems to be that while the income tax department may have
limited powers to prevent the implementation of the scheme itself, courts have
generally recognised powers to the department to subsequently open the issue of
taxability of the scheme and the consequences arising from that. Therefore,
from a structuring and implementation standpoint, while companies may now be
able to undertake and successfully proceed with various types of schemes of
arrangement, the impact of taxation may be felt only subsequently when the
department examine the taxation issues.
the division bench of the Gujarat High Court appears to have adopted a similar
stance as the other courts that sanctioned the scheme, particularly the Delhi
High Court which considered similar objections from the income tax department.
The ultimate outcome seems to be that while the income tax department may have
limited powers to prevent the implementation of the scheme itself, courts have
generally recognised powers to the department to subsequently open the issue of
taxability of the scheme and the consequences arising from that. Therefore,
from a structuring and implementation standpoint, while companies may now be
able to undertake and successfully proceed with various types of schemes of
arrangement, the impact of taxation may be felt only subsequently when the
department examine the taxation issues.
There
seems to be a pattern emerging now on cases involving challenges of schemes by
the tax authorities or others (on taxation grounds). A somewhat similar approach
was adopted in two other cases recently,
In
re: AVM Capital Services (P.) Ltd. and In
re Indo Rama Textile Ltd.
seems to be a pattern emerging now on cases involving challenges of schemes by
the tax authorities or others (on taxation grounds). A somewhat similar approach
was adopted in two other cases recently,
In
re: AVM Capital Services (P.) Ltd. and In
re Indo Rama Textile Ltd.
In the AVM Capital case,
a scheme of amalgamation was challenged on the ground that it amounted to avoidance
of capital gains tax, and hence that the scheme ought not to be sanctioned.
However, the Bombay High Court, after extensively considering the case law on
tax avoidance and schemes of arrangement, proceeded to sanction the scheme.
a scheme of amalgamation was challenged on the ground that it amounted to avoidance
of capital gains tax, and hence that the scheme ought not to be sanctioned.
However, the Bombay High Court, after extensively considering the case law on
tax avoidance and schemes of arrangement, proceeded to sanction the scheme.
In the Indo Rama Textile
case, a scheme of demerger was sanctioned by the court although there was no
allocation of common assets and liabilities among the different undertakings.
This was on the ground that the transferred assets and liabilities themselves constituted
an undertaking that is capable of carrying on business in an uninterrupted
manner. In that case, the court clearly stated that a scheme of demerger may be
sanctioned by the court under sections 391 to 394 of the Companies Act although
the scheme may not satisfy the requirements of a qualifying demerger under
section 2(19AA) of the Income Tax Act.