08 October 2018

Amalgamation – Action in concert for tax benefit?

The High Court of Gujarat observed in Wood Polymer [ See End Note 1] "and the court would not lend its assistance to defeat public interest, namely, tax provision.” A recent order of National Company Law Tribunal (NCLT) refusing to accord sanction to amalgamation scheme has raised certain interesting yet important questions.

The phrase ‘likely to be affected’ means a person may or may not suffer injury or damage though there is a fair chance that he may come to some detriment. This would be the common understanding of the phrase. Of course, since this phrase is part of Section 230(5) of the Companies Act, 2013 applying mutatis mutandis to Section 232 which deals with merger and amalgamation of companies, it assumes significance since income tax authorities are specifically mentioned as one of the parties to whom notice of amalgamation is to be given providing them an opportunity to make representation.

Under the Companies Act, of 1956, notice was to be issued to the Central Government and the interests or concerns of the tax department were highlighted either by the government or at time by shareholders objecting to the scheme and so on. With the Act of 2013 in place, the income tax department no longer needs to implead itself, to prove locus standi as a creditor or interested party to object to the possible revenue leakage in the proposed transaction [ See End Note 2].


Amalgamations – Concessions under IT Act

Some of the benefits which are envisaged for transactions of amalgamation and merger are that the transfer of shares by an amalgamating company by a shareholder would not be considered a transfer for purpose of capital gains, subject to certain conditions. The Income Tax Act (the Act) also provides for carry forward of losses and depreciation by the amalgamated company (subject to conditions). These provisions were enacted to incentivize reconstruction or revival of sick or loss-making companies so that the public and stakeholders like workmen are not adversely affected by closure of industrial units. The Act defines amalgamation and also states that the property of the amalgamating company should become the property of the amalgamated company otherwise than as a result of purchase.


NCLT Order

In a recent case before NCLT [See End Note 3] (Ajanta Pharma), the income tax department objected to the scheme of amalgamation proposed by the petitioner/applicant companies which had common shareholders stating that the main purpose of the amalgamation was avoidance of tax and that it amounted to abuse of the provisions of the Act. The NCLT declined to sanction the scheme stating that tax concerns must be addressed prior to approaching the NLCT for sanction.

The fact that the amalgamating company undertook to pay applicable taxes was not accepted to be a sufficient redressal of the concerns of the tax authorities. The NCLT also held that the scheme was not in public interest since it would benefit only the four common shareholders who were members of the promoter family who would receive shares valued at about Rs. 1477 crores whereas the investment was only about Rs. 48 crores. It was of the view that the scheme did not confer any benefit to the thousands of other shareholders who had consented to the scheme.


Precedents distinguished

The transaction in question may be described as quite commonplace, in which an investment company wherein members of the promoter group are shareholders, was sought to be amalgamated with the other so as to reduce the number of layers of share-holding. The objection of tax department was that ideally the company should have sold its investment or property - which is shares in the other company and paid tax on the business income, applicable taxes on distribution of dividend – all of which were avoided by the scheme of amalgamation. Such objections have been raised in the past, but decisions have tended favour applicants for amalgamation reasoning that an otherwise legitimate or commercially sound transaction should not be questioned only because it confers some tax benefits. The principles laid down in various judgments including Azadi Bachao Andolan [See End Note 4] have invariably been followed to hold in favour of the assessee/business rather than the revenue department. However, in the decision under discussion the NCLT distinguished the decisions in favour of the applicant / taxpayer including that of AVM Capital Markets [See End Note 5].


Applicability of GAAR

It is interesting to note that in its Circular 27-1-2017, the CBDT had clarified that GAAR would not apply in case the scheme of amalgamation is sanctioned by the Court after explicitly and adequately considering the tax implications. However, in Ajanta Pharma the GAAR provisions have been cited at the stage of sanction and perhaps, all that the revenue authorities had to show was the likelihood or possibility of detriment. This is a much lesser threshold than the application of GAAR which requires the Assessing Officer to convince the Principal Commissioner and the Approving Panel that GAAR is applicable to the transaction.

GAAR provisions were made applicable in respect of any assessment year beginning from or after 1-4-2018, i.e. transactions upto 31-3-2017 would not attract GAAR. The provisions were made applicable from 1-4-2017 after being deferred a couple of times since 2012 when the provisions were introduced into the Act.

Thus, it would appear that the idea was to give the industry comfort in terms of the applicability of the provisions aimed at tax avoidance. In Ajanta Pharma, the appointed date was fixed as 1-4-2016 though the sanction of the NCLT would have be at a later date, that is after 1-4-2017. The applicability of GAAR to this transaction is not free from doubt.

Determination of an impermissible arrangement under GAAR is a highly subjective exercise. However, in the transaction under discussion, it would seem that establishing that the main purpose (rather than ‘one of the main purposes’ in the original definition) was tax avoidance would be a difficult task.


Way forward

The decision in Ajanta Pharma and the NCLT’s acceptance of the objections raised by the income tax department as being ‘valid objections’ can for sure become hurdle to business plans unless one is able to demonstrate the commercial substance in transactions. This would involve adequate analysis of tax implications of transactions and ensuring that the scheme framed is not seen as being against public interest. The current jurisprudence is largely in the context of the Companies Act of 1956 and GAAR were or could not have been not cited. Hence, the open questions are likely to be addressed only when they are examined by the higher judicial fora.

[The author is a Principal Associate, Direct Tax Team, Lakshmikumaran & Sridharan, New Delhi]


End Notes

  1. [1977] 109 ITR 177 (GUJ.)
  2. Vodafone Essar, [2013] 35 taxmann.com 397 (Gujarat)
  3. CSP No. 995 & 996/ 2017, CSA No. 791& 792 /2017, Order of NCLT, Mumbai Bench dated 30.8.2018
  4. [2003] 263 ITR 706
  5. CSP No. 670/2011, decision of High Court of Bombay dated 12-7-2012.

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