Mergers, demergers and other forms of
corporate restructuring are usually effected through a scheme of arrangement
that not only requires the approval of different classes of shareholders and
creditors, but also the sanction of the relevant court of law. The provisions
of the Companies Act, 1956, specifically sections 391 to 394, contain an
elaborate framework to give effect to such schemes of arrangement. This
framework has functioned quite well, and it has been used extensively by the
corporate sector in India. Although many other countries in the Commonwealth
too have similar provisions in their corporate statutes that deal with schemes
of arrangement, a broad survey of corporate law in various countries would
suggest that the utilization of these legal provisions in India to effect
M&A transactions far exceeds that in those other jurisdictions. The Indian
courts too have played a pioneering role in developing the jurisprudence on
schemes of arrangement, by clearly laying down the parameters within which such
schemes of arrangement may be initiated, approved by classes of shareholders
and creditors and then accorded the sanction of the court.
corporate restructuring are usually effected through a scheme of arrangement
that not only requires the approval of different classes of shareholders and
creditors, but also the sanction of the relevant court of law. The provisions
of the Companies Act, 1956, specifically sections 391 to 394, contain an
elaborate framework to give effect to such schemes of arrangement. This
framework has functioned quite well, and it has been used extensively by the
corporate sector in India. Although many other countries in the Commonwealth
too have similar provisions in their corporate statutes that deal with schemes
of arrangement, a broad survey of corporate law in various countries would
suggest that the utilization of these legal provisions in India to effect
M&A transactions far exceeds that in those other jurisdictions. The Indian
courts too have played a pioneering role in developing the jurisprudence on
schemes of arrangement, by clearly laying down the parameters within which such
schemes of arrangement may be initiated, approved by classes of shareholders
and creditors and then accorded the sanction of the court.
One of the specific requirements of a scheme
of arrangement is that under section 394A of the Companies Act, 1956, the court
shall take into account any representations made by the Central Government
before passing any order. This power of the Central Government is exercised by
the Regional Director, Ministry of Corporate Affairs.
of arrangement is that under section 394A of the Companies Act, 1956, the court
shall take into account any representations made by the Central Government
before passing any order. This power of the Central Government is exercised by
the Regional Director, Ministry of Corporate Affairs.
The precise role of the Regional Director in
making representations, particularly on matters pertaining to income tax, came
up before the consideration of the Bombay High Court in Casby CFS Pvt. Ltd., with
the judgment
being rendered on March 19, 2015. The judgment gives rise to a number of issues
pertaining to schemes of arrangement in general, and hence requires discussion.
making representations, particularly on matters pertaining to income tax, came
up before the consideration of the Bombay High Court in Casby CFS Pvt. Ltd., with
the judgment
being rendered on March 19, 2015. The judgment gives rise to a number of issues
pertaining to schemes of arrangement in general, and hence requires discussion.
Brief Facts
The scheme involved an amalgamation of Casby CFS
Private Limited (the transferor) into Casby Logistics Private Limited (the
transferee). Upon filing of the scheme before the court and during its
consideration by the court, the Regional Director filed objections on several
issues, which were followed up by objections from the Income Tax Department.
More specifically, the scheme carried a retrospective appointed date of April
1, 2008. The issue in question was whether the transferor was a subsidiary of
the transferee as on that date.
Private Limited (the transferor) into Casby Logistics Private Limited (the
transferee). Upon filing of the scheme before the court and during its
consideration by the court, the Regional Director filed objections on several
issues, which were followed up by objections from the Income Tax Department.
More specifically, the scheme carried a retrospective appointed date of April
1, 2008. The issue in question was whether the transferor was a subsidiary of
the transferee as on that date.
The companies suggested that such a parent-subsidiary
relationship existed as on that date because certain individuals were holding
shares in the transferor as nominees of the transferee. On the other hand, the
Regional Director disputed the existence of such a nominee relationship between
the transferee and those individuals. In essence, the existence and
establishment of the nominee relationship was crucial to determine whether the
transferor was a subsidiary of the transferee. The Regional Director alleged
that not only were relevant facts suppressed by the companies, but also that
the scheme and the retrospective appointed date were devised so as to engineer
tax benefits that otherwise did not exist. In otherwise, it was alleged that
the scheme was motivated for the purpose of obtaining undue tax advantages. All
of these were countered by the companies.
relationship existed as on that date because certain individuals were holding
shares in the transferor as nominees of the transferee. On the other hand, the
Regional Director disputed the existence of such a nominee relationship between
the transferee and those individuals. In essence, the existence and
establishment of the nominee relationship was crucial to determine whether the
transferor was a subsidiary of the transferee. The Regional Director alleged
that not only were relevant facts suppressed by the companies, but also that
the scheme and the retrospective appointed date were devised so as to engineer
tax benefits that otherwise did not exist. In otherwise, it was alleged that
the scheme was motivated for the purpose of obtaining undue tax advantages. All
of these were countered by the companies.
After considering all the factual allegations as well
as legal arguments, a single judge of the Bombay High Court allowed the scheme
to stand (with suitable modifications), but imposed costs on the companies.
as legal arguments, a single judge of the Bombay High Court allowed the scheme
to stand (with suitable modifications), but imposed costs on the companies.
In this post, I discuss some of the rulings of the
court on key legal issues and their implications on M&A practice involving
schemes of arrangement.
court on key legal issues and their implications on M&A practice involving
schemes of arrangement.
Role of the
Regional Director
Regional Director
One of the contentious issues raised before the Court
related to the role of the Regional Director, and particularly whether he was
entitled to raise objections pertaining to income tax. Moreover, the objections
of the income tax authorities were raised belatedly. In addressing this issue,
the court first considered the role of the Regional Director generally:
related to the role of the Regional Director, and particularly whether he was
entitled to raise objections pertaining to income tax. Moreover, the objections
of the income tax authorities were raised belatedly. In addressing this issue,
the court first considered the role of the Regional Director generally:
31. Further, the right/duty of the Regional Director
to make a representation and offer his comments in respect of a scheme has
received statutory recognition in Sections 394 and 394A of the Act. Both these
provisions postulate that the Regional Director is required to examine the
scheme and offer his comments and views thereon, which are required to be
considered by the Court. It is therefore clear that the legislature intended
that the Regional Director will examine a scheme from all aspects and place his
observations and views before the Court and the Court will consider the same
before sanctioning the scheme. It is obvious that the Regional Director, while
making his observations and comments is entitled to consider the scheme from
all aspects and is not restricted in any manner. He is entitled to consider the
effect and implications of the scheme on any law and place his views before the
Court if he finds that the scheme violates any law or prejudicial to public
interest or to the interests of the shareholders of the company or companies
involved. In fact, it is the duty and obligation of the Regional Director to
consider every scheme in the aforesaid manner and place his views and
observations before the Court. To hold otherwise would be to defeat the
intention of the legislature as reflected in Sections 394 and 394A of the Act.
to make a representation and offer his comments in respect of a scheme has
received statutory recognition in Sections 394 and 394A of the Act. Both these
provisions postulate that the Regional Director is required to examine the
scheme and offer his comments and views thereon, which are required to be
considered by the Court. It is therefore clear that the legislature intended
that the Regional Director will examine a scheme from all aspects and place his
observations and views before the Court and the Court will consider the same
before sanctioning the scheme. It is obvious that the Regional Director, while
making his observations and comments is entitled to consider the scheme from
all aspects and is not restricted in any manner. He is entitled to consider the
effect and implications of the scheme on any law and place his views before the
Court if he finds that the scheme violates any law or prejudicial to public
interest or to the interests of the shareholders of the company or companies
involved. In fact, it is the duty and obligation of the Regional Director to
consider every scheme in the aforesaid manner and place his views and
observations before the Court. To hold otherwise would be to defeat the
intention of the legislature as reflected in Sections 394 and 394A of the Act.
The more detailed legal issue pertained to the interpretation
of the Ministry of Corporate Affairs’ (MCA) Circular
of January 15, 2014 (previously discussed here).
According to this Circular, the Regional Director is required to invite
comments from the Income Tax Department within 15 days of receipt of notice
before filing his response to the Court. If the Income Tax Department does not
respond within the said 15-day period, then it is to be presumed that the
Income Tax Department has no objection to the scheme. In the present case, the Income
Tax Department failed to respond within the stipulated time-period, and hence
the question was whether the Court can entertain the Department’s objections
made belatedly.
of the Ministry of Corporate Affairs’ (MCA) Circular
of January 15, 2014 (previously discussed here).
According to this Circular, the Regional Director is required to invite
comments from the Income Tax Department within 15 days of receipt of notice
before filing his response to the Court. If the Income Tax Department does not
respond within the said 15-day period, then it is to be presumed that the
Income Tax Department has no objection to the scheme. In the present case, the Income
Tax Department failed to respond within the stipulated time-period, and hence
the question was whether the Court can entertain the Department’s objections
made belatedly.
On this issue, the Bombay High Court refused to be
drawn into the technicality of the Circular. It found that the provision of the
Companies Act conferring powers on the Regional Director were wider than those
specified in the Circular. Hence, “a circular cannot fetter or restrict the
rights of the Regional Director conferred and imposed on him by statute. The
Circular must yield to the statutory provisions and cannot be construed to
override the statutory provisions.” On this basis, the Court concluded that it
was entitled to take on board the objections raised by the Income Tax Authorities
as represented before it by the Regional Director.
drawn into the technicality of the Circular. It found that the provision of the
Companies Act conferring powers on the Regional Director were wider than those
specified in the Circular. Hence, “a circular cannot fetter or restrict the
rights of the Regional Director conferred and imposed on him by statute. The
Circular must yield to the statutory provisions and cannot be construed to
override the statutory provisions.” On this basis, the Court concluded that it
was entitled to take on board the objections raised by the Income Tax Authorities
as represented before it by the Regional Director.
Appointed Date
It is quite customary in schemes of arrangement to
assign a retrospective appointed date to which the scheme would relate back.
This is primary to indicate that the financial statements of the companies
involved would disclose the effect of the transaction from the appointed date.
However, in this case, the validity of choosing an appointed date of April 1,
2008 was challenged. Not only was this a retrospective appointed date, but it
also related back a number of years. This was because the income tax returns of
the two companies involved would have to be amended from the appointed date so
as to give effect to the scheme.
assign a retrospective appointed date to which the scheme would relate back.
This is primary to indicate that the financial statements of the companies
involved would disclose the effect of the transaction from the appointed date.
However, in this case, the validity of choosing an appointed date of April 1,
2008 was challenged. Not only was this a retrospective appointed date, but it
also related back a number of years. This was because the income tax returns of
the two companies involved would have to be amended from the appointed date so
as to give effect to the scheme.
Specifically, the choice of appointed date was
challenged on the ground that it contravened section 139(5) of the Income Tax
Act. Under that provision a revised income tax return can be filed only if the
conditions stipulated therein are satisfied, i.e. (i) that the assessee
discovers any omission or wrong statement in the income tax return already
filed, and (ii) the revised return is filed before the expiry of one year from
the end of the relevant assessment year or before the completion of the
assessment, whichever is earlier. In the present case, it appears these
conditions were not satisfied. The question therefore is whether the use of the
appointed date mechanism amounts to circumvention of section 139(5).
challenged on the ground that it contravened section 139(5) of the Income Tax
Act. Under that provision a revised income tax return can be filed only if the
conditions stipulated therein are satisfied, i.e. (i) that the assessee
discovers any omission or wrong statement in the income tax return already
filed, and (ii) the revised return is filed before the expiry of one year from
the end of the relevant assessment year or before the completion of the
assessment, whichever is earlier. In the present case, it appears these
conditions were not satisfied. The question therefore is whether the use of the
appointed date mechanism amounts to circumvention of section 139(5).
On this issue, the Court decided as follows:
50. … Prima facie, I am satisfied that there
is some substance in the contentions of the Regional Director. It is clear from
the various decisions cited by the Regional Director that revised income tax
returns can be filed only if the conditions prescribed by Section 139(5) are
satisfied. It would appear that by virtue of the retrospective appointed date,
the Petitioners may file revised income tax returns with effect from 1st April
2008 without satisfying the conditions. … Accordingly, in my view it would be better
to leave it to the Income Tax Department to decide whether the revised income
tax returns, if filed, would be valid or would be violative of Section 139(5)
of the Income Tax Act.
is some substance in the contentions of the Regional Director. It is clear from
the various decisions cited by the Regional Director that revised income tax
returns can be filed only if the conditions prescribed by Section 139(5) are
satisfied. It would appear that by virtue of the retrospective appointed date,
the Petitioners may file revised income tax returns with effect from 1st April
2008 without satisfying the conditions. … Accordingly, in my view it would be better
to leave it to the Income Tax Department to decide whether the revised income
tax returns, if filed, would be valid or would be violative of Section 139(5)
of the Income Tax Act.
51. … In the circumstances, in my view, it
would be proper to direct that the Income Tax Department shall not be bound by
the appointed date fixed under the scheme while carrying out pending and/or
future assessments of the Transferor and Transferee companies whether on the
basis of the income tax returns already filed or revised returns, if any, that
may be filed or otherwise and shall carry out such assessments without being
influenced by the observations made herein.
would be proper to direct that the Income Tax Department shall not be bound by
the appointed date fixed under the scheme while carrying out pending and/or
future assessments of the Transferor and Transferee companies whether on the
basis of the income tax returns already filed or revised returns, if any, that
may be filed or otherwise and shall carry out such assessments without being
influenced by the observations made herein.
Although the Court left the issue somewhat open-ended,
the observation clearly put paid to the use of the “appointed date” mechanisms
by raising some doubts regarding its use.
the observation clearly put paid to the use of the “appointed date” mechanisms
by raising some doubts regarding its use.
Role of the
Court in a Scheme of Arrangement
Court in a Scheme of Arrangement
This issue has been expounded quite clearly in two
landmark decisions of the Supreme Court, Miheer Mafatlal[1] and Hindustan Lever[2], which have acquired the
status of jurisprudential folklore in M&A. However, the precise role of the
courts was again raised in the present case wherein the Bombay High Court
adopted the following view:
landmark decisions of the Supreme Court, Miheer Mafatlal[1] and Hindustan Lever[2], which have acquired the
status of jurisprudential folklore in M&A. However, the precise role of the
courts was again raised in the present case wherein the Bombay High Court
adopted the following view:
30. … It is an undisputed proposition that the court can interfere
with the decision/commercial wisdom of the shareholders if the Court is
satisfied that the scheme has been framed with the intention of contravening
the provisions of any law. It is also well settled that the Court can interfere
with the decision/commercial wisdom of the shareholders if the Court is
satisfied that the scheme as framed in fact contravenes the provisions of any
law, albeit unintentionally. There can be again no disagreement on the issue
that the shareholders of companies are free to choose any date as an appointed
date in their commercial wisdom. However, if the Regional Director nurtures any
doubt qua any of the clauses in the scheme, including the date chosen as the
appointed date, and finds that the same is contrary to law or apprehends that
on the strength of such a clause contained in the scheme, the Company, after
obtaining sanction from the Court, may use or misuse the same for contravention
of any law including the provisions of the Income Tax, he is entitled to voice
his doubt/apprehension before the Court, at the time the Court considers the
grant of sanction to the scheme and it is always open to the Court to consider the
doubt/apprehension expressed by the Regional Director and pass necessary orders
either rejecting the scheme or sanctioning the same with/or without necessary
clarification. I also do not agree with the argument advanced by the Petitioners
that the Regional Director cannot object to the scheme on the ground that the
same violates the provisions of the Income Tax Act and it is only the Income Tax
Authorities who may raise an objection and that too only within the specified
period stipulated in the circular dated 15th January 2014. Since this Court is
required to ensure that a scheme of amalgamation does not contravene any
provision of law, in my view, the Regional Director is not only entitled to but
is duty bound to bring to the attention of the Court any provision in the
scheme which may contravene/circumvent the provisions of any law including the
law pertaining to Income Tax. This is to ensure that a company does not obtain
sanction of a scheme and thereafter use the same as a shield to protect itself
from the consequences arising out of the contravention of provisions of law.
with the decision/commercial wisdom of the shareholders if the Court is
satisfied that the scheme has been framed with the intention of contravening
the provisions of any law. It is also well settled that the Court can interfere
with the decision/commercial wisdom of the shareholders if the Court is
satisfied that the scheme as framed in fact contravenes the provisions of any
law, albeit unintentionally. There can be again no disagreement on the issue
that the shareholders of companies are free to choose any date as an appointed
date in their commercial wisdom. However, if the Regional Director nurtures any
doubt qua any of the clauses in the scheme, including the date chosen as the
appointed date, and finds that the same is contrary to law or apprehends that
on the strength of such a clause contained in the scheme, the Company, after
obtaining sanction from the Court, may use or misuse the same for contravention
of any law including the provisions of the Income Tax, he is entitled to voice
his doubt/apprehension before the Court, at the time the Court considers the
grant of sanction to the scheme and it is always open to the Court to consider the
doubt/apprehension expressed by the Regional Director and pass necessary orders
either rejecting the scheme or sanctioning the same with/or without necessary
clarification. I also do not agree with the argument advanced by the Petitioners
that the Regional Director cannot object to the scheme on the ground that the
same violates the provisions of the Income Tax Act and it is only the Income Tax
Authorities who may raise an objection and that too only within the specified
period stipulated in the circular dated 15th January 2014. Since this Court is
required to ensure that a scheme of amalgamation does not contravene any
provision of law, in my view, the Regional Director is not only entitled to but
is duty bound to bring to the attention of the Court any provision in the
scheme which may contravene/circumvent the provisions of any law including the
law pertaining to Income Tax. This is to ensure that a company does not obtain
sanction of a scheme and thereafter use the same as a shield to protect itself
from the consequences arising out of the contravention of provisions of law.
Thus, the Court is
clear in its jurisdiction to ensure that the scheme is not in contravention of
any law, and more specifically, the Income Tax Act.
clear in its jurisdiction to ensure that the scheme is not in contravention of
any law, and more specifically, the Income Tax Act.
Finally, the Court
also made some observations regarding non-disclosure by the companies.
also made some observations regarding non-disclosure by the companies.
Despite raising a
number of issues and expressing strong views on matters relating to the scheme,
the Court nevertheless sanctioned the scheme based on the facts of the case.
However, this was subject to deletion of clause 6.2.1 of the scheme relating to
filing of revised tax returns. Moreover, the Court left it open to the Income
Tax Department determine the tax liability of the companies without being
influenced by the judgment. In doing so, it was clarified that the Department
would not be bound by the appointed date of April 1, 2008.
number of issues and expressing strong views on matters relating to the scheme,
the Court nevertheless sanctioned the scheme based on the facts of the case.
However, this was subject to deletion of clause 6.2.1 of the scheme relating to
filing of revised tax returns. Moreover, the Court left it open to the Income
Tax Department determine the tax liability of the companies without being
influenced by the judgment. In doing so, it was clarified that the Department
would not be bound by the appointed date of April 1, 2008.
Analysis
Although there are
number of decisions of Indian courts relating to schemes of arrangements, in
the last few years there has been greater uncertainty in dealing with
objections to scheme on grounds of taxation. Schemes have previously been
rejected (but some upheld on appeal). The contribution of the Bombay High Court
in this case has been the attempt to introduce some level of clarity. At the
same time, the effect of this judgment leaves several issues open for debate.
number of decisions of Indian courts relating to schemes of arrangements, in
the last few years there has been greater uncertainty in dealing with
objections to scheme on grounds of taxation. Schemes have previously been
rejected (but some upheld on appeal). The contribution of the Bombay High Court
in this case has been the attempt to introduce some level of clarity. At the
same time, the effect of this judgment leaves several issues open for debate.
First, although the
MCA circular of January 14, 2014 was intend to bring about clarity to
objections on taxation grounds, that has been effectively disregarded by the Court.
This may require the MCA to reexamine the process for objecting to schemes. If
the Regional Director or the Income Tax Departments are allowed to raise
objections belatedly, that will make the process for sanctioning the scheme
uncertain and inefficient.
MCA circular of January 14, 2014 was intend to bring about clarity to
objections on taxation grounds, that has been effectively disregarded by the Court.
This may require the MCA to reexamine the process for objecting to schemes. If
the Regional Director or the Income Tax Departments are allowed to raise
objections belatedly, that will make the process for sanctioning the scheme
uncertain and inefficient.
Second, the
judgment seems to question the fundamental premise and very purpose of “appointed
date” in a scheme. While the concept has been used in the past with judicial
blessing, the present judgment raises some issues regarding its viability,
especially when tax filings are to be revised. Although the Court’s
observations towards such an appointed date mechanism have been rather
negative, it did not decide on the merits of the issue by leaving it open for examination
by the Income Tax Department.
judgment seems to question the fundamental premise and very purpose of “appointed
date” in a scheme. While the concept has been used in the past with judicial
blessing, the present judgment raises some issues regarding its viability,
especially when tax filings are to be revised. Although the Court’s
observations towards such an appointed date mechanism have been rather
negative, it did not decide on the merits of the issue by leaving it open for examination
by the Income Tax Department.
Finally, there is
yet some room for debate regarding the role of the court in a scheme of arrangement,
particularly on tax matters. Arguably, the Bombay High Court has assumed a more
interventionist role in the scheme, and more so than set forth by the Supreme
Court in its landmark judgments.
yet some room for debate regarding the role of the court in a scheme of arrangement,
particularly on tax matters. Arguably, the Bombay High Court has assumed a more
interventionist role in the scheme, and more so than set forth by the Supreme
Court in its landmark judgments.
In all, the
judgment epitomizes some of the complexities that may arise in implementing schemes
of arrangement in India. Although efforts are being made constantly by the
legislature and the executive arms of the government to streamline the process,
several questions remain.
judgment epitomizes some of the complexities that may arise in implementing schemes
of arrangement in India. Although efforts are being made constantly by the
legislature and the executive arms of the government to streamline the process,
several questions remain.
(I would like to
acknowledge a reader who brought this judgment to our attention)
acknowledge a reader who brought this judgment to our attention)
