| Mar-19-2021

Whether GAAR is a concern for NCLT while sanctioning Merger

Background

The GAAR (General Anti Avoidance Rules) provisions were introduced in the Income Tax Act, way back in Later, on it was postponed till March 2017. Ultimately, this was made  effective  from 01st April 2017 by adding new sections, i.e.,  section  95 to 102  in  the Act.

As per GAAR provisions, any arrangement can be  impermissible  if  main purpose or one of the purposes, is to obtain tax benefit and it:-

• creates rights, or obligations, which are not ordinarily  created between persons dealing at arm’s length;
• results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
• lacks commercial substance or is deemed to lack commercial substance under section 97, in whole or in part; or
• is entered into, or carried out, by means, or in a manner, which is not ordinarily employed for bona fide purposes

As per said provisions, any arrangement can be struck down by tax department if it lacks substance and is being executed merely for tax benefit. But moot question arises about timing of invoking GAAR provisions by tax department. Whether it can be considered or applied on any transaction at any time  or  only  during  assessment/reassessment of concerned taxpayers?

As per section 144BA(1) of the Income-tax Act, 1961,

“If, the Assessing Officer, at any stage of the assessment or reassessment proceedings before him having regard  to  the  material and evidence available, considers that it is necessary to declare an arrangement as an impermissible avoidance arrangement and to determine the consequence of such an arrangement within the meaning of Chapter X-A, then, he may make a reference to the Principal Commissioner or Commissioner in this regard”

As  per  above  provisions,  the  tax  officer  can  and  only  can  start  the proceedings  to  invoke  the  GAAR  during  assessment  or  re-assessment stage.  Thereafter  a  detailed  process  has  been  defined  in  the  section 144BA  about  request  to  principal  Commissioner  by  Assessing  Officer, approving panel, objections by assessee and so on.

Companies  Restructuring  Provisions  under  Companies  Act, 2013

2.  As per section 230 (5) of the Companies Act 2013 and Rule 8 of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016, after initial approval by NCLT, the amalgamating company shall send the notice in Form No. CAA.3, accompanied with a copy of the scheme of compromise or arrangement, the explanatory statement and the disclosures mentioned under rule 6, to the  Central  Government, the income-tax authorities, the Reserve Bank of India,  the  Securities and Exchange Board, the Registrar, the respective stock exchanges, the Official Liquidator and such other sectoral regulators or authorities which are likely to be affected by the compromise or arrangement and shall require that representations, if any, be made by them shall  be made within a period of thirty days from the date of receipt of such notice. If any of the authorities to whom aforesaid notice  is  sent,  desires to make any representation under sub-section (5) of  section  230, the same shall be sent to the NCLT within a period of thirty days from the date of receipt of such notice and copy of such representation shall simultaneously be sent to the concerned companies. In case no representation is received within the stated period of thirty days by the NCLT, it shall be presumed that the authorities have no representation to make on the proposed scheme of compromise or

Rejection of Merger scheme by NCLT on the charge of Tax evasion by Tax Dept.

3. In recent ruling by NCLT, Mumbai in case of Gabs Investments (P.) Ltd. & Ajanta Pharma Ltd. (CSP 995/996 of 2017 and CSA 791/792 of 2017), NCLT rejected a proposed scheme of amalgamation by considering the same as being devised mainly for tax benefits. Possibly, the said decision is a first decision by NCLT after introducing GAAR provisions in the income-tax law, wherein the such provisions have  been invoked to reject a merger

The question arises whether NCLT is having such powers to invoke GAAR? As per scheme envisaged in the Act, there is set procedure to invoke GAAR provisions and that is only during assessment or re- assessment stage. It means, that while doing assessment or re- assessment of tax payers, if Assessing Officer comes across any such arrangement or agreement of which one of the motives  is  tax  avoidance, he can invoke GAAR proceedings.

In the aforesaid case, in replying to the NCLT by Income  Tax department during merger process, tax department envisaged  the  GAAR situations and they objected to the scheme of amalgamation. NCLT followed the tax department’s objections  and  rejected  the  merger scheme.

3.1 Facts about aforesaid case law – A scheme was proposed to merge M/s. Gabs India (P.) Ltd. (GIPL) with M/s. Ajanta Pharma Ltd. (APL). GIPL was a promotor company of APL and it held 9.54% equity capital in APL. Shareholders of GIPL were also promotors of APL to the extent of 64.24%. GIPL had no other business except investments into APL.

Merger  was  proposed  to  amalgamate  one  of  shareholder  companies (GIPL) with amalgamated company (APL). Pursuant to merger, GIPL will  subsume  with  APL  and  APL  to  issue  same  number  of  shares (9.54%)   to   the   shareholders   of   GIPL.   In   other   words,   Promotors holding will be increased to 73.78% (64.24 plus 9.54) in APL.

Exemption for Merger and Tax Dept’s concerns

4. As per section 47(vi) of the Act, any transfer, in a scheme of amalgamation, of a capital asset by the amalgamating company to the amalgamated company if the amalgamated company is an Indian company, is not chargeable to capital gain

Section 47(vii)-any transfer by a shareholder, in a scheme of amalgamation, of a capital asset being a share or shares held by him in the amalgamating company, if—

• the transfer is made in consideration of the allotment to him of any share or shares in the amalgamated company except where the shareholder itself is the amalgamated  company, and
• the amalgamated company is an Indian company;

The said provisions provide exemption to the amalgamating company   as well the shareholders of amalgamating company. But in aforesaid Ruling, the proposed scheme has been objected to by Tax department   by referring to possible loss of tax revenue if merger scheme would be sanctioned by NCLT.

Law  provides  exemption  from  charging  of  capital  gains  tax  with  the intent to promote the merger or demerger. On One side exemption was granted   and   on   other   side   tax   department   itself   opposed   merger scheme  by  mentioning  that  instead  of  adopting  the  route  of  merger, transfer  of  shares  should  have  been  adopted.  By  doing  so,  the  profits on transfer of shares would have been chargeable as business income in the hands of amalgamating company, since it had no business other than investments. Not only business profits, tax authorities also went beyond  its  presumption  and  said  that  after  earning  said  business profits,   amalgamating   company   ought   to   have   distributed   such business profits as dividend to the promoters which would have given another kitty of revenue in terms of dividend distribution tax (DDT) to the  Government.  After  having  all  presumptions,  the  tax  authorities computed    the    possible    tax    loss    of    421.66    Crores    by    notional computation  of  business  profits  on  transfer  of  shares  and  dividend distribution  tax  on  notional  distribution  of  profits.  Department  also contented   that   in   view   of   the   GAAR   provisions,   the   scheme   was deliberate measure to avoid tax using NCLT as media. The scheme was envisaged round trip financing to facilitate transfer of funds among the parties  to  arrangement  which  qualified  as  Impermissible  Avoidance Agreement.

Though NCLT Order does not mention about detailed response of the  tax authorities, but aforesaid theory of notional business profit and its distribution, perhaps is not defendable under the provisions of Act. Business profit or capital gain is a fact driven matter,  merely  investment in object clause of amalgamating company, cannot be a ground for charging profits on investments as business income.

From  Capital  gains  tax  point  of  view,  merger  scheme  is  a  tax  neutral transaction. Promotors whose holding would have increased to 73.78% pursuant   to   the   merger,   cost   of   acquisition   of   shares   in   APL (amalgamated company) will be the actual cost of acquisition of shares in GIPL (amalgamating company). In other words, as per section 49(2) of the Act, if promotors sell their investments in APL (which represents shares equivalent to 9.54% to be issued due to merger), the tax would have  been  chargeable  on  the  amount  of  sale  price  as  reduced  by  the cost of acquisition of shares in GIPL. There is no step cost benefits to shareholders of amalgamating company.

Right of a taxpayer to mitigate tax liability

5. In case of Union of India Azadi Bachao Andolan [2003] 132 Taxman 373 (SC) hon’ble Apex court held that an act which  is  otherwise valid, in law, can not be treated as non-est merely on  the  basis of some underlying motive supposedly resulting  in  some  economic detriment or prejudice to the national interests, as perceived by the respondents. In other words, a taxpayer has all rights to arrange his affairs in any manner permitted so as to minimise the tax liability.

In case of Union of India v. Ambalal Sarabhai Enterprises Ltd. [1984] 55 Comp. Cas 623 (Guj.), the Hon’ble Gujarat High Court accepted the said scheme, inter alia, observing that in spite the scheme sanctioned may result in some tax benefit, it cannot be said that the only object of the Scheme was tax avoidance

The Hon’ble Bombay High Court in case of AVM Capital Services (P.) Ltd., In re [2012] 23 taxmann.com 222/115 SCL 81, while dealing with similar  facts  of  merger  of  promoter  holding  company  into  operating company,  it  held  that  there  was  nothing  illegal  or  unlawful  in  the Scheme and the same was a perfectly legitimate permissible by law and thereby rejected the objection for scheme being a tax avoidance device. Every  transaction  or  arrangement  permissible  under  law  having  an impact of reducing the tax burden of the assessee is not to be treated as a   tax   avoidance,   relying   on   aforesaid   ruling   by   Apex   court.   A transaction  should  not  be  held  as  a  colourable  device,  provided  it  is within the framework of the law.

The guidance issued by department on GAAR also suggests that “GAAR will not interplay with the right to the taxpayer to select or choose method of implementing a transaction”. Hence, even under the GAAR regime, there is adequate sanctity to the right of a taxpayer to select the method which minimises his tax liability, as long as the main purpose   of any arrangement is not tax avoidance and the actions are backed up by adequate commercial rationale.

Conclusion

6. Though the applicant for merger is having the powers to challenge aforesaid NCLT Ruling at NCLAT, yet at preliminary level it sets the precedents to invoke GAAR wherever slightest to slightest chances are available. Going forward, the taxpayers have to justify by strong commercial rationale for any proposed arrangement or