This issue of LexCognito, which in Latin means 'awareness about law', seeks to provide you an insight into significant legal and regulatory developments that have taken place very recently in India.

Date: 5 October 2018
Company Tribunal (NCLT) rejects Scheme of Merger on grounds of Tax Avoidance by applying General Anti Avoidance Rules (GAAR)
The National Company Law Tribunal, Mumbai bench ("NCLT"), vide its order dated 30 August 2018 in the matter of Gabs Investments Pvt. Limited Vs. Ajanta Pharma Limited, has rejected a proposed scheme of amalgamation on the ground that the merger was devised primarily to give illegitimate tax benefits to the common promoters of both transferor and transferee companies. This decision is the first of its kind where the Income Tax Authorities ("ITA") had objected to a merger invoking provisions of General Anti Avoidance Rules ("GAAR").

A scheme of merger ("Scheme") was filed before the NCLT proposing to merge Gabs Investments Private Limited ("GIPL") into Ajanta Pharma Limited ("APL"). GIPL being a group company and a so-called promoter of APL held 83,92,262 equity shares of Rs. 2 each in APL (representing about 9.54% of the total share capital). As a result of the proposed merger, the said shares of APL held by GIPL would get cancelled and, in consideration, equivalent numbers of shares were proposed to be issued by APL to the shareholders of GIPL.

The rationale given for the Scheme was to simplify the group structure and reduce the shareholding tiers such that promoters are directly able to hold shares in APL. It was therefore argued that there would be no change in the ultimate ownership of APL.

The ITA had raised objections to the Scheme stating that it was a deliberate measure to avoid tax and that if the amalgamation is approved, it would lead to avoidance of following taxes:

(i) Dividend Distribution Tax (DDT) at 20% of Rs. 134.16 crores: ITA argued that GIPL being a private limited company has to be considered as a separate entity and any “assets” of the private limited company be transferred and distributed to its shareholders would tantamount to distribution of dividends attracting DDT. As such, ITA argued that if shares held by GIPL in APL are directly transferred to the shareholders of GIPL, then such a transaction would have been liable to 20% DDT being in the nature of deemed distribution of dividends. Thus, as per ITA, DDT amounting to Rs. 134.16 crores would be a loss to the exchequer if the Scheme was approved.

(ii) Tax on business income of Rs. 287.50 Crores: ITA contended that under the Scheme “assets” are distributed to the promoters by way of sale of shares. Since GIPL is in the business of investment and dealing in equity/shares, hence, once the equity shares of APL are sold in the market, GIPL will earn business profit. Hence, on that business profit, income tax at the rate of 30% was payable and accordingly Rs. 287.50 Crores income tax would have been payable by GIPL which was being avoided through the Scheme.

According to ITA, the said Scheme was thus purely an Impermissible Avoidance Agreement ("IAA") under the provisions of GAAR and was a deliberate measure to avoid tax burden. The ITA further alleged that the said Scheme of arrangement was nothing but a Round Trip Financing, which included a transfer of funds among the parties to the arrangements through a series of transactions. ITA also pointed out that even Minimum Alternate Tax ("MAT") liability was being avoided by the two companies.

The NCLT held as follows:
  • The submission that GIPL was a promoter company of APL was factually incorrect on the ground that GIPL did not subscribe to the 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.
  • If the Court sanctions the Scheme, the common promoters will escape from complying with the provisions of the SEBI Takeover Code.
  • The Scheme has been devised mainly to benefit four shareholders of GIPL who are also the promoters of APL (common promoters) and to avoid tax liability.
NCLT eventually held that the Scheme appeared to be unfair, unreasonable and not in public interest and, hence, liable to be rejected.

CRI Comment:

In view of the above ruling, all future structuring options should be examined as to whether any such scheme attracts the rigors of GAAR. Now, the company will also have to ensure that there are sufficient commercial reasons for any proposed scheme of merger/de-merger. However, it is equally important to note that NCLT rejected the scheme without discussing the merits of the objections raised by ITA and it simply admitted the datum that there has been tax avoidance as per provisions of GAAR.

It is a settled law that a transaction cannot be unheeded merely because it results in any tax saving to the assessee. The Gujarat High Court in Vodafone Essar Gujarat Ltd. v. Department of Income tax has sanctioned a similar scheme of arrangement and 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 Income Tax Department or other taxing authorities.

Also, the Income Tax Act, 1961 ("Act") clearly recognizes the concept of ‘amalgamation’ and also provides for a specific definition thereof. Under the Act, certain tax benefits have been provided in respect of permissible method of mergers. Hence, it may not be permissible for the revenue to challenge such transactions without establishing any commercial defects therein. Besides, CBDT vide its Circular No. 7 of 2017 dated 27 January 2017 has clarified that GAAR will not interfere 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 feasible or not, would have resulted in different tax results.

In conclusion, though the above decision of NCLT is indeed a path breaking one especially on application of GAAR on mergers through court, it may not be sustained as a good precedent.
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