Can an allegation of tax avoidance be the sole basis to reject a scheme of arrangement? NCLT Order in case of Ajanta Pharma Ltd. Dated 9 th Sept 2018

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1 Can an allegation of tax avoidance be the sole basis to reject a scheme of arrangement? NCLT Order in case of Ajanta Pharma Ltd. Dated 9 th Sept 2018 On September 9, 2018, the Hon ble National Company Law Tribunal (NCLT) has passed an order rejecting the scheme of amalgamation sought between Gabs Investments Private Limited (GIPL) and Ajanta Pharma Limited (APL). Under said Scheme, it is proposed that GIPL, a promoter company of APL (a public listed company), which holds 83,92,262 Equity Shares of Rs. 2 each in APL (representing about 9.54% of the total share capital), be amalgamated with APL, as a result of which the said shares would get cancelled and in consideration of amalgamation, equivalent number of shares would be issued by APL to the shareholders of GIPL. As a result of the proposed restructuring, there would have been no change in the ultimate ownership of APL as the shares presently owned by the promoters through GIPL would have been held directly by the promoters. Further, the proposed scheme would have no impact on the interest of the public shareholders of APL, since it would not impact either their share holding proportion or any asset or liability of APL. Even the cost of the said scheme was proposed to be borne by either GIPL or the promoters directly. Accordingly, the said scheme had been blessed by 100% shareholders of GIPL and 99.9% shareholders of APL. Further, neither the Regional Director nor the Official Liquidator or the Registrar of Companies objected to the said scheme. However, the Income-tax Department objected to the said Scheme stating that it was a deliberate measure to avoid tax and that if the amalgamation is approved, it would lead to avoidance of : - Dividend Distribution Tax 20% of Rs crores; and - Tax on business income of Rs Crores that GIPL would have become liable to pay had it sold the shares of APL in the market. 1 P a g e

2 The Tax Department also pointed out that even Minimum Alternate Tax (MAT) liability could have arisen. According to the tax department, said Scheme is purely Impermissible Avoidance Agreement under the provisions of General Anti-Avoidance Rule (GAAR) and therefore should not be allowed. It has also been alleged that said Scheme results in Round trip financing!!! From the bare perusal of the order and even without detailed scrutiny of details of the case, it is apparent that the foregoing objections of the tax department are at the least without any merit. I. Possibility of DDT liability to the tune of Rs crores is impossible / inconceivable. Undoubtedly, dividend distribution tax liability under section 115-O of the Income tax Act, 1961 ( the Act ) can arise only when any dividend is actually distributed/paid by a company. In the present case, payment of dividend of said magnitude by GIPL (which could lead to DDT liability in crores) could possibly arise only in the following two scenarios: - where GIPL distributes the shares of APL to the promoters (i.e. GIPL shareholders); or - where GIPL sells the shares of APL in the open market and distributes the entire sale consideration to the promoters. Clearly, both the foregoing possibilities are not conceivable. Firstly, it is a settled law that a company cannot pay any dividend in kind to its shareholders. Section 123(5) of the Companies Act, 2013 clearly prohibits payment of dividend in any mode other than cash. Referring to said provision, the Hon ble Bombay High Court in Indian Seamless Enterprises Limited, In re (61 taxmann.com 289) has held that a company cannot give to its shareholders shares held by it in another company, since it would be in violation of section 123(5) of the Companies Act, From the foregoing provisions of law, it is certain that GIPL cannot give away its shareholding in APL to the promoters as dividend. The only alternate for GIPL to distribute dividend of said magnitude would be to encash the value of shares in APL and distribute the said amount to the promoters. Clearly, even the tax 2 P a g e

3 department would not be expecting that the promoters should dilute their shareholding in APL (thereby risking the control of the promoters in their group) so as to pay such DDT liability to the department. Accordingly, since the both possible scenarios are either impermissible in law or absolutely ludicrous, the question of any DDT liability foregone due to proposed Scheme is inexplicable. II. Gain on sale of shares of APL was exempt under section 10(38) of the Act. The Department has assumed that the gain on sale of shares by APL would be treated as business income of GIPL. Firstly, the question of gain could arise only if there is a sale and there could be a sale if the promoters pay cash to GIPL. Now, there is no flow of cash from the promoters to the company. To presume a sale is re-writing an arrangement which may commercially not be possible or viable. The tax department cannot re-write a transaction and assume a position which in reality is not existant. Secondly, GIPL being a promoter company of APL, it is very unlikely that the shares of APL were held by GIPL as stock in trade. As per the facts provided in the decision, it appears that GIPL has only been acquiring the shares of APL over several years and not sold them during said period. Hence, the premise of the department treating the same as stock-in-trade is highly questionable. Ideally, the holding of GIPL in shares of APL would be regarded as an investment of GIPL, sale of which would have resulted in capital gains in the hands of GIPL. Shares of APL, being listed on recognised stock exchange, their sale would have been subject to STT, as a result of which, the resulting gain would have been exempt from tax under section 10(38) of the Act in the years 2016/2017 (period under the Scheme). Besides, to allege that in this merger, there is transfer of shares of the transferor company in exchange of shares of the transferee company and therefore, there is avoidance of capital gains tax would mean that no scheme of amalgamation is tax neutral because every scheme would entail extinguishment (i.e. transfer ) of the shares of the transferor company in exchange of shares of the transferee company. Now, the tax department s allegation that in this case there is a transfer of shares and hence this transaction results in tax avoidance would render the exemption in section 47(v) of the Act otiose. Accordingly, the objection of the department that said Scheme would result in avoidance of tax of Rs crores is bizarre. Equally bizzare is the contention of the tax department that MAT liability is avoided. There are several provisions in the Act that 3 P a g e

4 indicate that amalgamation and demergers are supposed to be tax neutral and in every amalgamation and demergers there is a tax neutral transfer not entailing any MAT implications as well. In any case, MAT is only in the nature of advance tax, credit for which is allowable in subsequent years and hence its mitigation does not have the effect of long term tax erosion. III. GAAR provisions are not applicable. In any case, same cannot be invoked summarily Under section 95 of the Act, GAAR provisions are applicable only from assessment year and onwards. Rule 10U(d) clearly provides that GAAR provisions would not apply to any income accruing or arising to any person from transfer of investments made before the 1st day of April, 2017 by such person. Now, the proposed Scheme was to take effect from April 1, Hence, at the outset, the tax department was wrong in applying the GAAR provisions to the said Scheme. In a Scheme where no cash was proposed to be paid as consideration, the tax department has alleged that said Scheme is nothing but round trip financing, which includes transfer of funds among the parties to the arrangements through series of transaction! This clearly shows the prejudice of the department towards the schemes filed by the corporate world. Besides, the Act provides for various safeguards to the assessee before the GAAR provisions can be invoked. Under section 144BA, before GAAR provisions can be invoked, the same needs to be sanctioned by the Principal Commissioner, who also needs to give an opportunity of hearing to the assessee. If even the Principal Commissioner decides to invoke GAAR provisions, then the matter needs to be referred to an Approving Panel, which comprises of a judge of a High Court, a member of Indian Revenue Service not below the rank of Principal Chief Commissioner or Chief Commissioner of Income-tax and an academic or scholar having special knowledge of matters, such as direct taxes, business accounts and international trade practices. Such diverse constitution of the panel has been ensured so that the onerous provisions of GAAR are not summarily invoked by the tax department and that all factors (both legal and commercial) are considered before an arrangement can be considered as impermissible. Said Approving Panel after hearing the parties and making such enquiries as it deems necessary decide whether the GAAR provisions can be invoked. It is uncanny that the 4 P a g e

5 tax department has alleged the proposed Scheme to be impermissible avoidance agreement under the onerous GAAR provisions, without following said procedure. In view of the foregoing observations from the apparent facts of the case, the allegations of the tax department that the Scheme results in huge tax losses to the department does not appear to be defensible and sustainable. Besides, it is settled law that a transaction cannot be ignored merely because it results in any tax saving to the assessee. Indian courts have recognised the difference between the permissible arrangement and impermissible arrangement even prior to GAAR and held that though tax evasion cannot be accepted, it is sound law and certainly not bad morality for anybody to arrange his affairs to reduce the brunt of taxation to a minimum. The Supreme Court in McDowell and Co. Ltd. v. CTO (1985) 3 SCC 230, while holding that colourable device cannot be a part of tax planning also held that tax planning may be legitimate provided it is within the framework of law. In the later decision in Vodafone International Holdings B.V. vs. UOI (341 ITR 1)(SC), the Supreme Court has held that it cannot be said that all tax planning is illegal/illegitimate/impermissible. It held that in the application of a judicial anti-avoidance rule, the Revenue may invoke the substance over form principle or piercing the corporate veil test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant. The Gujarat High Court in Vodafone Essar Gujarat Ltd. v. Department of Incometax (35 taxmann.com 397), which has been affirmed by the Supreme Court in Department of Income-tax v. Vodafone Essar Gujarat Ltd (66 taxmann.com 374), has held that if in its commercial wisdom, a 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 Incometax Department or other taxing authorities. The Supreme Court in Union of India and Another vs. Azadi Bachao Andolan and Another (263 ITR 706) has categorically held that an act which is otherwise valid in law cannot be treated as non est merely on the basis of some underlying motive supposedly resulting in some economic detriment or prejudice to the national interest. In the case of Banyan and Berry vs. CIT (222 ITR 831), Gujarat High Court after considering the decision of Supreme Court in the case of Mc Dowell and Co. Ltd. (154 ITR 148) has held that the Apex Court in the said decision has nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to 5 P a g e

6 which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of the legitimacy or genuineness of the act. The principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same falls in the category of colourable device. Hence, what is essential is to see if the scheme is a sham or a colourable device. However, the tax department has not pointed out any reason why the proposed scheme is a sham or a colourable device. Indeed, under said scheme the shareholding structure of the group is proposed to be simplified whereby the promoters would directly hold the shares of the operating company. It would also result in reduction of one layer of shareholding structure thereby reducing the compliance burden of the group. If the companies had not opted for this option, it would have to dispose off all its assets, settle all its liabilities and apply for winding up and dissolution, which involves various steps.accordingly, a scheme backed by commercial rationale cannot be considered impermissible merely because it allegedly results in tax savings. Besides, the tax department itself has, in the Clarifications provided on implementation of GAAR provisions under the Act vide Circular No. 7 of 2017 dated January 27, 2017 clarified that GAAR will not interplay with the right of the taxpayer to select or choose method of implementing a transaction. Hence, when the assessee is permitted to choose between permissible options to implement a transaction, the tax department cannot invoke GAAR merely because it believes that another option, whether commercially viable or not, would have resulted in different tax results. Also, when something is done as per a specific provision under the Income-tax Act and is in compliance with the conditions specified therein (which conditions inherently ensure that there is no abuse made by the assessee), can the Tax department be allowed to treat the same as an impermissible arrangement and deny the incidental benefits attached to it? The Act clearly recognises the concept of amalgamation. It provides for a specific definition for the same, only on compliance of which, can the beneficial provisions in respect thereof be claimed by the assessees. Accordingly, the tax benefits arising from such specific provisions of the Act ought to be regarded as a permissible tax benefit. 6 P a g e

7 Accordingly, if the parties have opted for said permissible method to undertake a transaction, it may in fact be justly wrong for the department to challenge the same without even pointing out any commercial defect in the scheme. It is clearly not open for the department to decide whether the manner in which the companies should arrange their affairs. From the perusal of the NCLT order, it is not clear as to whether the foregoing arguments were before the Tribunal while deciding the matter. The Scheme has been rejected by the NCLT on the ground that the Scheme only benefits the promoters of the company and is a deliberate measure to avoid tax. Similar issue had arisen before the Bombay High Court in AVM Capital Services (P.) Ltd., In re (23 taxmann.com 222). In that case, a similar scheme of arrangement was before the Court, to which the tax department had objected alleging tax avoidance. The Bombay High Court however upheld the scheme of arrangement and held that where as a result of the scheme, the promoters directly held shares in the operating company, there is nothing illegal about the same and it does not result in any tax avoidance. The relevant extract from the decision reads as under: The purpose of the scheme is to provide long-term stability and transparency in the transferee-company. The transferor-companies are in existence since It was felt that it would be in the interest of the transferee-company to merge the five transferor-companies with the transferee-company, and to enable the promoter thereof to hold shares directly in the transferee-company rather than indirectly. The object of the scheme is not to avoid any tax. Even till date the shares are owned/controlled by the same promoter albeit through the transferor-companies. Under the scheme the only difference is that the promoter will now hold shares directly in the transferee-company. It is correctly submitted by the transfereecompany that there is nothing illegal or unlawful or dubious or colourful in the scheme and the same is a perfectly legitimate scheme and permissible by law. Therefore, the objection of the objector that the scheme is a tax avoidance device and ought not to be approved, stands rejected. The said decision was pointed out to the Tribunal, however, unfortunately, the same does not find place in the operative part of the order. Besides, from the order, various other incongruities have been noticed, which could have contributed to the rejection of the Scheme. The Tribunal has observed that the submission of the petitioners that GIPL is a promoter company of APL is factually incorrect on the ground that GIPL did not subscribe to the 7 P a g e

8 shares of APL at the time of its formation or at the time of IPO of APL and that it had acquired shares of APL only in the secondary market over several years. Apparently, the definitions of the terms promoter and promoter group under the SEBI (ICDR) Regulations were not before the Tribunal, as per which GIPL would clearly form part of the promoter group. The Tribunal has also observed in the order that the Scheme would have triggered the SEBI Takeover Code and accordingly, the Scheme liable to be rejected also because it is not in compliance with the provisions of the said Code. Again, with all due respect, the provisions of the Code which specifically exempt the applicability of the code to inter-se promoter transfers of shares as well as transfer of shares under a scheme of amalgamation has not been considered while rendering this decision. Considering the foregoing apparent oversights, it would be in the interest of justice if the decision is revisited or reconsidered in light of all the foregoing decisions and discussion. 8 P a g e