Vodafone Essar Gujarat Ltd (Company Petition No. 183 of 2009)
In a recent ruling Gujarat High Court (HC) in the case of Vodafone Essar Gujarat Ltd (hereinafter referred to as VEG/ Transferor/ Tax Payer) [Company petition no. 183 of 2009] on the issue of whether a scheme of demerger of infrastructure assets between group companies for ‘Nil’ consideration could be sanctioned under the provisions of the Indian Tax law (ITL) and Indian Company law (ICL).
The decision of the HC discusses various aspects with regard to the validity of the scheme of demerger u/s 391-394 of the ICL, ITL, Indian Contract Act 1872, laws governing commercial taxes like VAT, Stamp Duty etc.
The HC concurred with the objections placed by the Tax Authority and rejected the scheme of demerger which was viewed as an attempt to evade taxes including income-tax, stamp duty, VAT and to defraud the Tax Authority for its legitimate right to recover its dues out of the assets of the Taxpayer and other group companies. The HC also agreed that the assets were being demerged to a paper/conduit company for a subsequent tax neutral transfer to another infrastructure company.
Contentions of the Tax Authority
- VEIL was a paper company and the whole arrangement under the Scheme was for the purpose of evasion of tax and was against public interest. The scheme was nothing but a garb to legitimise a simple transaction of transfer between two separate commercial legal entities in order to evade the legitimate taxes which would be payable, if the transaction would have been effected by way of transfer simplicitor. Support was drawn from the HC decision in the case of in the case of Wood Polymer Ltd’.
- Transfer of PIAs will enable the Transferee to claim benefit u/s 80IA of the ITL, as per the Report of the working group on the Telecom Sector for the Eleventh Five Year Plan, 2007 – 2012 (Report). This would result in Transferee obtaining tax incentive benefit once again on the same assets on which the VEG has already claimed and exhausted.
- The liabilities of the transferred assets would remain with VEG. VEG would claim deduction of the continuous charge of interest and other liabilities with respect to the said assets in its hands. This would reduce the taxable profit in the hands of VEG in the succeeding years. On the other hand, the books of the Transferee would show inflated income including in respect of income from PIAs. Transferee will claim the benefit of Section 80IA under the ITL. This would result in loss of revenue.
- Additionally, VEG has outstanding tax liabilities amounting to hundreds of crores, with assessments pending for several years. Transfer of PIA by VEG without the corresponding liabilities to VEIL would lead to dilution of assets available to Objector for recovering the outstanding tax dues.
- Tax was sought to be evaded by giving different accounting treatment by the Taxpayers having positive net worth and those having negative net worth. Taxpayers fall under the Minimum Alternate Tax (MAT) regime and by this planning, they would artificially reduce the book profits under MAT provisions of the ITL.
- There is a huge demand of revenue pending against the Taxpayer. Further, assessment of income for certain earlier years pending finalization and additional demand is apprehended. In view of the above, transfer of its assets by the Taxpayers is void u/s 281 of the ITL.
- The Scheme filed by VEG is neither an ‘arrangement’ nor a ‘compromise’ as contemplated u/s 391 of ICL, since it lacked the element of ‘give’ and ‘take’ which was a pre requisite for a scheme to qualify as an arrangement. Further, section 394 of ICL requires an arrangement to be for ‘reconstruction of company’ as against ‘reconstruction of assets’ as was proposed under the Scheme. Accordingly, VEG was not entitled to invoke the jurisdiction of the Court for sanction of its scheme.
- The proposed scheme essentially envisaged gift of PIA by VEG to VEIL, which object was not enlisted in the Memorandum of Association (‘MOA’) of VEG at the time when the Board of Directors of VEG approved the Scheme. Such power was conferred upon VEG subsequent to the approval of the scheme by the Board of Directors vide the Special Resolution passed at the Extra Ordinary General Meeting of the Company. Accordingly, the scheme was ultra vires the MOA of the Company, which could not be later ratified by all the shareholders and hence void.
- Since the proposed arrangement was without consideration, it fell into the category of an agreement without consideration. An agreement without consideration is considered to be void by the provisions of Indian Contract Act, 1872.
Contentions of the –Tax Payer
o There is clear rationale for transfer of the PIAs for ‘Nil’ consideration as the restructuring of assets is within the Vodafone Group. Further the Taxpayer and the Transferee are wholly owned subsidiaries of the Vodafone Group. Accordingly, as there is a clear rationale for non-issue of shares/Nil consideration between the parties inter se for the transfer resulting in tax neutrality, decision in the case of Wood Polymers (supra) is not applicable.
o The segregation of the PIAs will result in enhanced growth and value contributing to income, which the PIAs are not capable of generating currently. The transaction would also result in increased service and network quality standards and the same reflects the current domestic and global trend. Therefore, the Scheme has a valid purpose and object and it is not a mere device to evade the alleged taxes.
o To contend that a reputed company like Vodafone which had invested billions of dollars into Indian economy for development of mobile telecommunication services would propose a scheme to evade a tax liability of a few crores was incongruous.
o A Scheme for transfer of PIA was necessary in order to transfer quotas, rights, licenses, entitlements, legal proceedings, registrations etc in relation to Pl. Therefore, it cannot be said that the purpose of the scheme is to avoid stamp duty.
o Similar schemes of various mobile telecommunication operators to demerge their assets for ‘Nil’ consideration have been approved by various high courts including the present HC, and these schemes have been approved by the courts, with no objections placed by the Tax Authority.
o As per the presently applicable tax provisions, the Taxpayer would be eligible to claim benefit u/s 80IA of ITL if the scheme is not implemented. The Transferee however, does not qualify for tax benefit. Thus, the Scheme does not result in any loss of revenue to the exchequer. The Tax Authority’s contention that the Transferee will be eligible for the benefit in the future based on the mere recommendations in the Report is ex-facie unsustainable.
o Every act which results in tax reduction or exemption cannot be treated as a device of tax avoidance. In any case, the Taxpayer is free to arrange its affairs so as to minimise its tax burden by undertaking permissible steps. Reliance was placed on the decisions of the Supreme Court (SC) in the case of A Raman & Co (1968) 67 ITR 11, Azadi Bachao Andolan, [2004 (10) SCC 1] and of the HC in Banyan and Berry [222 ITR 831 (Guj)].
o Not transferring the underlying liabilities would not prejudice the interests of the Tax Authority, as the net worth of the Taxpayer is more than sufficient to meet any (alleged existing or future) liability under the ITL.
o Reduced payment of MAT under the ITL will reduce credit availability and higher actual payment, while higher payment of MAT will increase credit availability and consequently reduce actual payment of tax. The objection on MAT avoidance is therefore not valid.
o The Scheme does not come within the purview of Section 281. Such transfer cannot be void ab-initio but will be void only as against a claim of tax or other sum payable by a taxpayer, when such sum is ascertained as payable upon completion of the proceedings. There is no question of adjudicating the validity of the transfer prior to stage of actual recovery of any amount that may become due, consequent upon completion of pending proceedings. Reliance in this regard was placed on the Punjab & Haryana HC in the case of B. M. Kapoor HUF (219 ITR 703); Karnataka HC decision in the case of B. A. Batish (128 ITR 434).
o Since the scheme contemplated carrying on of business in an altered form viz telecommunication infrastructure business would be carried on by VEIL and telecommunication services business by VEG by substantially the same persons who were carrying on the entire business prior to demerger, such ‘reconstruction of company’ ought to be called as an ‘arrangement’ as envisaged u/s 394 of ICL.
o Further, since the scheme envisaged rearrangement of the affairs of the company which would affect its future conduct, such a scheme should be regarded as an ‘arrangement’ between the company and its shareholders. Additionally, there was an element of ‘give and take’ since a substantial portion of business which was being removed from the company would now be carried out by the same persons under a different company.
o The scheme of arrangement involved reconstruction of the company by bifurcation of its business. Further, reconstruction of the Company is a statutory right conferred upon a company by the Act and thus no specific power was required in the MOA of the company. Additionally, the MOA of the Company already contained clauses which allowed it carry on any act which was suitable for accomplishment of the main business of the company. Thus it would follow that Scheme was not ultra vires the Company.
o With respect to the Tax Authority’s argument that the scheme is void under Indian Contract Act, the Taxpayer contended that a scheme without Court sanction has no legal effect or consequence and thus it cannot be equated to an agreement between parties as envisaged under the provisions of Indian Contract Act, 1872. Further, reconstruction of company involves give and take and reciprocal promises and obligations which constitute consideration.
o Reliance was placed on the Bombay High Court decision in the case of Jindal Iron & Steel Co. which held that the Tax Authority, does not have locus standi in proceedings for approval of a scheme u/s 391 – 394 of the ICL.
HC Ruling
The HC was unable to accord its sanction to the Scheme as the impugned transaction was in contravention to the provisions of the ICL, ITL as well as the Indian Contract Act, 1872. The Court basically confirmed the contentions of the Tax Authority while delivering its ruling. The pertinent contentions confirmed by the Court are:
