Case Law Details

Case Name : Kishore Vadilal (P.) Ltd., In re Smt. Abhilasha Kumari J. (Gujarat High Court)
Appeal Number : Co. Petition No. 142, 143 & 144 OF 2012
Date of Judgement/Order : 30/10/2012
Related Assessment Year :
Courts : All High Courts (4320) Gujarat High Court (370)

In the present case, the observation of the Regional Director that the demerger and transfer of undertaking – III of the demerged company to the resulting company No. 2 would result in non-compliance of section 2(19AA) of the Income-tax Act, 1961, does not appear to be valid as the definition of ‘demerger’ under the Income-tax Act, 1961,

would be relevant only for the limited purpose of ascertaining whether the demerger is tax neutral, or not, compliance of the said provision of law would be made for availing tax concessions and, thus, it cannot be read as a mandatory requirement for all schemes of amalgamation, arrangement or demerger under the provisions of sections 391 to 394 of the Companies Act.

HIGH COURT OF GUJARAT

Kishore Vadilal (P.) Ltd., In re

SMT. ABHILASHA KUMARI,J.

CO. PETITION NOS. 142, 143 & 144 OF 2012

CO. APPLICATION NOS. 175, 176 & 177 OF 2012

OCTOBER 30, 2012

JUDGMENT

1. These petitions have been filed under Sections 391 and 394 of the Companies Act, 1956 (“the Companies Act”) to obtain the sanction of this Court to a Composite Scheme of Arrangement in the nature of Demerger and Transfer of demerged Undertakings II and III of Kishore Vadilal Private Limited (the Demerged Company who has filed Company Petition No. 142 of 2012) to S.A. Innovations Private Limited (the First Resulting Company who has filed Company Petition No.143 of 2012) and Ratnamani Medi Service Private Limited (the Second Resulting Company) who has filed Company Petition No.144 of 2012).

2. The objects for which the petitioner Demerged Company was incorporated are set out in the Memorandum and Articles of Association annexed at Annexure-A to the petition. It is stated in the petition filed by the Demerged Company, that it is engaged in the business of manufacture and marketing of Diamond Core/ Waterwell Drilling Equipments and accessories for Mineral Exploration Geotechnical uses. It has diversified in manufacturing of electronic items through another Unit and further intends to diversify into medical services. It is stated that it has been realized by the management of the petitioner Demerged Company that two of its operating divisions are quite different, involve distinct business dynamics, manufacturing methods and processes and third intended activity, namely medical sciences, which also requires altogether different focus. That, as the strategies for the development and growth of these unrelated businesses require different focus and may find different strategic/ financial investors in the long run, it is proposed to segregate the three activities and bifurcate its undertakings into three different Companies. It is, therefore, envisaged by the Companies that the resultant restructure of business would facilitate the rapid growth of the respective businesses with specific focus. This would be beneficial to its Shareholders as well as Creditors. The details of the commercial advantages that would flow by virtue of the proposed Demerger have been enumerated in the petition.

3. The proposed Scheme provides that (i) Undertaking-I, namely Vatva Unit to be retained with KVPL, (ii) Undertaking-II, namely Electronics Division or Gandhinagar Unit to be demerged to SA Innovations Private Limited, (the First Resulting Company) and (iii) Undertaking-III, namely Residue Undertaking to be demerged to Ratnamani Medi Service Private Limited (the Second Resulting Company).

4. The Scheme of Arrangement has been annexed as Annexure-C to the petition and the material provisions of the proposed Scheme have been set out in detail. It has further been pointed out that the Resulting Companies are promoted by the same group of Management.

5. It is stated that vide order dated 27.04.2012, passed in Company Application No.175 of 2012, the meeting of the Equity Shareholders was dispensed with in view of the written consent letters from all the Shareholders of the petitioner Demerged Company, approving the proposed Scheme being placed on record; whereas separate meetings of the Secured Creditors and Unsecured Creditors of the Demerged Company were directed to be convened for the purpose of seeking the approval from all the concerned parties to the proposed Scheme. Pursuant to the said directions issued with regard to the meetings, and after the due notices to the concerned parties as well as issuance of the Public Notice, the said meetings were duly convened on 14.06.2012, wherein the proposed Scheme was duly approved unanimously at the respective meetings of the Secured and Unsecured Creditors, that is, 100% in number and 100% in value by the Creditors present and voting at the respective meetings.

6. It is stated that in the case of the Resulting Companies, vide order dated 27.04.2012, passed in Company Applications No.176 and 177 of 2012, the meeting of the Equity Shareholders of the said Companies were dispensed with in view of the consent letters being placed on record.

7. The substantive petitions for the sanction of the Scheme were filed by the Demerged Company and the Resulting Companies, which were admitted on 29.06.2012. Notices of the hearing of the petitions were duly advertised in the newspapers, being the English daily newspaper “Indian Express” and the Gujarati daily newspaper “Sandesh”, both Ahmedabad editions, on 21.07.2012. Publication in the Government Gazette was dispensed with, as directed by the orders of the Court. Pursuant to the said publication in the newspapers, no objections have been received by the petitioner or its advocate.

8. Notices of the petitions have been served upon the Central Government and Shri M. Iqbal A. Shaikh, learned Central Government Counsel, appears for the Central Government. An affidavit dated 14.09.2012 has been filed by Mr. Kashmir Lal Kamboj, the Regional Director, North-Western Region, Ministry of Corporate Affairs, wherein two observations have been made to the effect that (i) the proposed Scheme does not fall under the purview of the definition of “Demerger” as per Section 2(19AA) of the Income Tax Act, 1961, and (ii) the purported avoidance of stamp duty. It has been stated by the Regional Director in the said affidavit that the Demerger and transfer of one of the Undertakings as envisaged under the Scheme results into non-compliance of the aforesaid Section of the Income Tax Act, 1961 and avoidance of stamp duty, hence, the Scheme ought to be rejected insofar as the Demerger and transfer of Undertaking-III to the Resulting Company No.2 is concerned.

9. Mr. S.N. Soparkar, learned Senior Advocate with Mrs. Swati S. Soparkar, learned advocate, appearing for the petitioner-Companies, has drawn the attention of this Court to the additional affidavit dated 29.09.2012, filed on behalf of the petitioner-Company whereby, the above observations have been dealt with.

10. I have heard Mr. S.N. Soparkar, learned Senior Advocate for the petitioners and Mr. M. Iqbal A. Shaikh, learned Central Government Counsel for the Regional Director and perused the material on record.

11. It is submitted by learned Senior Counsel on behalf of the petitioners that the Scheme envisages transfer of “property” along with transfer of liabilities and Undertaking. Hence, the transfer of property to the Resulting Company, governed by the provisions of the Companies Act in the present Scheme of Demerger, falls within the purview of Section 2(19AA) of the Income Tax Act, 1961, and is a valid Scheme of Demerger as per the Companies Act. Alternatively, it is submitted that the definition of “Demerger” as per Section 2(19AA) of the Income Tax Act, 1961, is only for the said Act and cannot be read into Sections 391 to 394 of the Companies Act, which permits arrangement in the form of Demerger of an “Undertaking” as well as a property.

12. It is further submitted that it is not necessary that liabilities along with assets are transferred. Section 394 of the Companies Act does not define “Demerger” but clearly speaks of “the whole or any part of the undertaking, property or liabilities of any company”, which cannot be read to mean that liabilities have to be created even if they do not exist and in the absence of liabilities, the Undertaking, property or assets of a Company, cannot be transferred.

13. It is further submitted that if any issues arise under the Income Tax Act, 1961, the same can be examined by the concerned authorities at the relevant point of time and the present Scheme does not provide for any absolution in this regard.

14. In support of the above submissions, reliance has been placed on behalf of the petitioners on a recent judgment of High Court of Delhi in the matter of Spentex Industries Ltd. v. Indo Rama Textile Ltd. – [2012] 173 Comp. Cas. 373 (Delhi), whereby, the Delhi High Court has confirmed the Scheme, rejecting the issues raised on the same ground. Reliance has also been placed upon a judgment of the Division Bench of this Court in Vodafone Essar Gujarat Ltd. v. Department of Income-tax 116 SCL 256 (Guj.) in support of the submission that it is not necessary that liabilities also be transferred along with assets. In the case of Vodafone Essar Gujarat Ltd. (supra), this Court sanctioned the grant to the Scheme of Arrangement under Sections 391 to 394 of the Companies Act while protecting the right of the Income-tax Department to recover the dues in accordance with law irrespective of the sanction of the Scheme.

15. With regard to the observation made by the Regional Director on the issue of purported avoidance of Stamp Duty, it is submitted by learned Senior Counsel on behalf of the petitioners that the same is not at all relevant as the petitioners would pay Stamp Duty in accordance with law. Referring to Article 20(d) to Schedule-I of the Bombay Stamp Act, 1958, it is submitted that any conveyance, so far as it relates to reconstruction or amalgamation of Companies by an order of the High Court under Section 394 of the Companies Act, would be subject to an amount equal to one per cent of the aggregate amount comprising of the market value of the property. It is further stated that, the petitioners would be bound to pay the Stamp Duty in accordance with law and the order of the Court sanctioning the Scheme would be examined by the concerned authorities for the appropriate rate of duty under the Bombay Stamp Act, 1958. Hence, the observation made by the Regional Director for not sanctioning the Scheme on this count, is not a valid one. It is, therefore, submitted that the Regional Director has not advanced any justifiable reason to reject the Scheme as proposed under the provisions of the Companies Act.

16. Mr. M. Iqbal A. Shaikh, learned Central Government Counsel, has submitted that if it is clarified that the petitioners would pay Income Tax if and when assessed by the Income Tax Authorities and would pay the stamp duty as assessed by the authorities under the Bombay Stamp Act, 1958, the apprehensions raised by the Regional Director would be sufficiently addressed.

17. Having heard learned counsel for the respective parties, it would be fruitful to advert to the judgment of the Delhi High Court in Spentex Industries Ltd. (supra), which would appropriately answer the first observation raised by the Regional Director. The relevant extracts of the judgment are reproduced hereinbelow:

“40. Since considerable emphasis was laid by the Applicant’s senior counsel on Section 2(19AA) of the Act, 1961, the same is reproduced hereinbelow for ready reference:

“2. Definitions.-In this Act, unless the context otherwise requires, –

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(19AA) “demerger”, in relation to companies, means the transfer, pursuant to a scheme of arrangement under sections 391 to 394 of the Companies Act, 1956 (1 of 1956), by a demerged company of its one or more undertakings to any resulting company in such a manner that–

 (i)  all the property of the undertaking, being transferred by the demerged company, immediately before the demerger, becomes the property of the resulting company by virtue of the demerger;

(ii)  all the liabilities relatable to the undertaking, being transferred by the demerged company, immediately before the demerger, become the liabilities of the resulting company by virtue of the demerger;

(iii) the property and the liabilities of the undertaking or undertakings being transferred by the demerged company are transferred at values appearing in its books of account immediately before the demerger;

(iv)  the resulting company issues, in consideration of the demerger, its shares to the shareholders of the demerged company on a proportionate basis;

(v)  the shareholders holding not less than three-fourths in value of the shares in the demerged company (other than shares already held therein immediately before the demerger, or by a nominee for, the resulting company or, Co. Pet. 4/2003 Page 30 of 38 its subsidiary) become shareholders of the resulting company or companies by virtue of the demerger,

otherwise than as a result of the acquisition of the property or assets of the demerged company or any undertaking thereof by the resulting company;

(vi)  the transfer of the undertaking is on a going concern basis;

(vii)  the demerger is in accordance with the conditions, if any, notified under sub-section (5) of section 72A by the Central Government in this behalf.

Explanation 1. — For the purposes of this clause, “undertaking” shall include any part of an undertaking, or a unit or division of an undertaking or a business activity taken as a whole, but does not include individual assets or liabilities or any combination thereof not constituting a business activity.”

41. Upon reading of the aforesaid Section, it is apparent that the definition of Demerger in Act, 1961, would be satisfied if the undertaking that is being demerged is hived off as a going concern, that means, if it constitutes a business activity capable of being run independently for a foreseeable future. To ensure that it is a going concern, the Court while sanctioning a Scheme can certainly examine whether essential and integral assets like plant, machinery and manpower without which it would not be able to run as an independent unit have been transferred to the demerged company.

42. However, this Court is not in agreement with the Applicant’s submissions that in a Scheme of Demerger by virtue of Section 2(19AA) of the Act, 1961, all the properties of the undertaking become the property of the resulting company.

43. In fact, it is settled legal position that there is no requirement under the provisions of the Act, 1961 or Act, 1956 for transfer of all common assets and/or liabilities relatable to the Undertaking being demerged. The Applicant’s submission that all common assets that cannot be divided must be transferred to the transferee namely, IRTL overlooks the explicit language of Section 2(19AA)(i) of the Act, 1961, which states that “all the properties of the undertaking being transferred by the demerged company, immediately before the demerger becomes the property of resulting company by virtue of the demerger”. The expression “being transferred” is relatable to such assets as are being transferred to make it a going concern. Moreover, if the applicant’s submission is accepted it would put all the schemes of demerger in a ‘straightjacket’ format and it would also infringe upon the two company’s freedom to negotiate with regard to the transfer of common assets. This Court is of the view that while framing a scheme of demerger, the existing and the resulting companies after ensuring that both of them are a going concern, are free to negotiate which common asset/liability would be transferred to which undertaking. After all, it is on this asset/liability transfer basis that share swap ratio are assessed, determined and allotted.

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46. In ‘The Law and Practice of Income Tax’ by Kanga, Palkhivala and Vyas, it has been observed that ”the provisions relating to taxation of the companies involved in the demerger and their shareholders are applicable only if the demerge fulfils the Section 2(19AA) of the Act, 1961. Mere sanction of the High Court for demerger under the Act, 1956, is, by itself, not sufficient”.

47. Therefore, whether or not Section 2(19AA) of the Act, 1961 has been complied with, is not to be determined pre-merger, but post merger and that too by the tax authorities. In the opinion of this Court, if the Scheme of Arrangement is not tax complaint, then the tax authorities will levy capital gains tax, if any, on the transferor, namely, respondent-IRSL.”

18. In the case of Vodafone Essar Gujarat Ltd. (supra), this Court Court sanctioned the Scheme of Arrangement under Sections 391 to 394 of the Companies Act while protecting the right of the Income-tax Department to recover the dues in accordance with law irrespective of the sanction of the Scheme. The relevant extracts of the judgment are reproduced hereinbelow:

“43. It is, no doubt, true as argued by Mr Thakor that in case the Scheme is sanctioned, it may result into tax avoidance on the part of the appellant, but it is required to be noted that even if the ultimate effect of the Scheme may result into some tax benefit or even if it is framed with an object of saving tax or it may result into tax avoidance, it cannot be said that the only object of the Scheme is tax avoidance. Considering the various clauses of the Scheme it is not possible for us to come to a conclusion that the Scheme is floated with the sole object of tax avoidance. In its commercial wisdom if the 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. It is also required to be noted that identical Schemes have been approved by various High Courts as pointed out earlier. As per the Scheme, it proposed to demerge the passive infrastructure assets of seven transferor companies and transfer them to the transferee company. The transferor companies and the transferee company are wholly owned and subsidiary of transferee company viz. Vodafone Essar Mobile Services Limited. One of the objects for framing of the Scheme is segregation of passive infrastructure business and telecommunication services business is to enable further growth and maximize value in each of the businesses.

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55. In view of the approval accorded by the equity shareholders, secured and unsecured Creditors of the petitioner and the Regional Director, Western Region to the proposed Scheme of Arrangement, as well as the submissions of the Income Tax Department, there appear to be no further impediments to the grant of sanction to the Scheme of Arrangement. Consequently, sanction is hereby granted to the Scheme of Arrangement under Sections 391 and 394 of the Companies Act, 1956 while protecting the right of the Income Tax Department to recover the dues in accordance with law irrespective of the sanction of the Scheme. However, while sanctioning the Scheme it is observed that said sanction shall not defeat the right of the Income Tax Department to take appropriate recourse for recovering the existing or previous liability of the transferor company and the transferor company is directed not to raise any issue regarding maintainability of such proceedings in respect of assets sought to be transferred under the proposed Scheme and the same shall bind to transferor and transferee company. In short, the right of the Income Tax Department is kept intact to take out appropriate proceedings regarding recovery of any tax from the transferor or transferee company as the case may be and pending cases before the Tribunal shall not be affected in view of the sanction of the Scheme.”

19. In the present case, the observation of the Regional Director that the Demerger and transfer of Undertaking-III of the Demerged Company to the Resulting Company No.2 would result in non compliance of Section 2(19AA) of the Income Tax Act, 1961, does not appear to be valid as the definition of “Demerger” under the Income Tax Act, 1961, would be relevant only for the limited purpose of ascertaining whether the demerger is tax neutral, or not. Compliance of the said provision of law would be made for availing tax concessions, thus, it cannot be read as a mandatory requirement for all Schemes of Amalgamation, Arrangement or Demerger under the provisions of Sections 391 to 394 of the Companies Act. There is no material on record to suggest that the Undertaking that is being demerged is not capable of being actively run independently in the near future, therefore, the first observation made by the Regional Director cannot be sustained.

20. With regard to the second observation regarding purported avoidance of Stamp Duty, it is the view of the Regional Director that transfer of Undertaking-III of the Demerged Company to the Resulting Company No.2 is purportedly to avoid payment of Stamp Duty by transferring the immovable property to the Resulting Company under the order of the Court. It has been stated by the petitioner in the affidavit filed by the Demerged Company that this argument on the part of the Regional Director is entirely erroneous because that is not the object of the Scheme. Secondly, the order of the High Court is also “conveyance” under the Bombay Stamp Act, 1958, requiring the Company to pay the duty at the appropriate rate.

21. As it has been stated by learned Senior Counsel appearing for the petitioner that the petitioners would pay Stamp Duty in accordance with law, the apprehension raised by the Regional Director is sufficiently allayed.

22. Considering the entirety of the facts and circumstances of the case, the rival submissions and the judgments relied upon, the Court is of the view that the observations made by the Regional Director would no longer survive.

23. Besides, the Regional Director has not filed any counter affidavit to the affidavit dated 29.09.2012 filed by the petitioner Demerged Company in reply to the observations made by the Regional Director. There is no material on record to indicate that the present Scheme of Arrangement in the nature of Demerger is not in compliance with the provisions of the Companies Act, 1956, or that it is not in the interest of the Shareholders and Creditors of the petitioner-Companies or against the larger public interest.

24. The issues, if any, raised by the Income Tax Authorities or the Authorities under the Bombay Stamp Stamp Act, 1958, may be considered by the concerned Authorities at the relevant point of time while implementing the Scheme. It has already been stated by learned Senior Counsel on behalf of the petitioners that the petitioners shall pay the Stamp Duty in accordance with law.

25. In the absence of any material, and as the Court does not find any legal or valid ground to withhold sanction to the proposed Scheme, the same is hereby sanctioned. The prayers made in terms of Paragraph 22(a) of Company Petition No.142 of 2012 and in terms of Paragraph 15(a) of Company Petitions No.143 and 144 of 2012, are hereby granted.

26. The petitions are disposed of, accordingly.

27. Insofar as costs to be paid to the Central Government are concerned, the same are quantified at Rs. 7,500/- per petition and may be paid to Mr. M. Iqbal A. Shaikh, learned Central Government Counsel.

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One response to “Compliance of sec. 2(19AA) of Income Tax Act not mandatory for all schemes of amalgamation or arrangement”

  1. Vishesh Jain says:

    What if post demerger, 3/4th shareholding condition is violated?
    What are the possible consequences?
    If possible will any one quote any case law on the issue stated above

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