Delhi High Court sanctions Vodafone Essar’s scheme of arrangement involving demerger of the passive infrastructure assets despite opposition by tax department

Recently the Delhi High Court sanctioned the Scheme of Arrangement (Scheme) in case of Vodafone Essar Mobile Services Limited, Vodafone Essar South Limited, Vodafone Essar Digilink Limited (all being the transferor / Petitioner Companies) and Vodafone Essar Infrastructure Limited (being the transferee company) (Judgment dated 29 March 2011 in Company Petition No. 334/2009) filed by the companies under Sections 391–394 of the Companies Act, 1956 for demerger of the Passive Infrastructure Assets (PIA).

Background of the case

• The Scheme envisaged the demerger of PIA of each of the transferor companies into the transferee companies under Sections 391–394 of the Companies Act, 1956.
• The Scheme was to restructure within the Group, the holding of the assets constituting the PIA in a more efficient manner consistent with the diverse needs of the business and does not involve any movement of assets or liabilities to any company outside the Group and that such transfer shall be without consideration.
• Pursuant to public notice for hearing of the Scheme, various objections to the Scheme were raised by the tax department.
• It is important to note that similar objections were raised by the tax department before the Gujarat High Court.

Tax department’s contentions

• ‘Arrangement with members’ as envisaged under Sections 391–394 of the Companies Act, 1956 did not contemplate a gift; an arrangement is in the nature of a contract with a consideration involved, which is missing in the present case. The Scheme proposed is confiscatory (NFU Development Trust Limited (1972) 1 WLR 1548 and State of Punjab & Ors v. Ganpat Rai [(2006) 8 SCC 364] relied upon).

• The Scheme is against public interest for the following reasons:
  • The transferor companies propose to transfer only the assets and not the liabilities, reducing the taxable profits and thereby reducing the tax burden;
  • By proposing to transfer assets at book values, Petitioner Companies were trying to evade payment of capital gains tax which would have been payable if the assets were transferred at market value;
  • The transferee company would reflect an exorbitant and inflated income but due to eligibility of deductions under Chapter VI-A of the Income-tax Act, 1961 there would be loss of revenue for the tax authorities;
  • As the assets are being transferred at book values, the net worth of the transferor companies might be rendered negative and there was likelihood that these companies would be unable to pay their existing and contingent tax liabilities.

• The proposed Scheme was contrary to law and should be dismissed irrespective if the legality of the transaction.

Petitioner Companies’ contentions

• A company may transfer property to another company ^{Hindustan Lever v. State of Maharashtra (2004) 9 SCC 438 (SC)}. Meaning of ‘gift’ in the Income-tax Act must be given the same meaning as in the Gift Tax Act, 1958 (Sanjiv V Kudva v. CIT (1981) 127 ITR 354 (Kar)) i.e. gift is a transfer by one person to another person of any existing movable or immovable property made voluntarily and without consideration. Under the Gift Tax Act, 1958 any person may make a gift and person is defined to include, inter alia, a company. As the relevant clauses of the Memorandum give the power to transfer by way of gift, there is no legal impediment to a company transferring property by gift. Such a transfer is exempt from payment of capital gain tax under Section 47(iii) read with Section 45 of the Income-tax Act.
• Not every transfer without consideration must automatically be declared confiscatory and therefore unacceptable under Section 391 of the Companies Act. The tax department is not in any sort of loco parentis to the shareholders of the transferor companies who have unanimously agreed to the transfer of the assets. Once there is consent, there can be no confiscation.
• There is no requirement in the statute that transfer of any asset needed to be carried out at ‘fair value’. It would remain open to the department to proceed against the transferor companies and / or the transferee company after the demerger is effected. Dispute regarding accounting standards is not sufficient ground to refuse grant of sanction to a Scheme (Hindalco Industries Limited (2009) 151 Comp Cas 446 (Bom)).
• The Petitioner Companies would not take the stand before the tax authorities that issue of taxability cannot be gone into by reason of the order sanctioning the Scheme.
• If any tax liabilities were found payable after the demerger, the transferor companies and the transferee company would continue to generate revenue from their operations and meet the same.
• The Central Government, vide the Regional Director’s report had not objected to the Scheme on the legality of the transaction.
• Scheme, being an internal arrangement between companies who have common ownership is consistent with the policy of the Government of India as reflected in the Report of the Working Group of the Telecom Sector for the Eleventh Five Year Plan (2007–2012)
• Similar schemes of arrangement for demerger of passive infrastructure into a subsidiary company for ‘nil’ consideration, have been duly sanctioned without any objections from the tax department viz. Reliance Telecom Infrastructure Ltd., Bharti Airtel Ltd., Idea Cellular Ltd.

Decision of the High Court

• Policy of the Government of India has also recommended that sharing of infrastructure be promoted and that incentives be given.
• Object of the Scheme is not merely aimed at avoiding tax. The high earnings of the transferee company’s assets would naturally be subject to tax. However, if the transferee company is entitled to other benefits or deductions notified by the Government in its wisdom, the tax authorities cannot complain.
• As regards accounting principles and the validity of their adoption by the companies, the question is left open to the tax department to inquire into the correctness or otherwise of the same, independently of the sanction of the Scheme. The Petitioner Companies have fairly admitted that any question of tax liability is within the purview of the tax department and that it is free to pursue either the transferor companies or the transferee company.
• Further, the Court observed that it is not open to the Court, in the exercise of company jurisdiction, to sit over the views of the shareholders and Board of Directors of the Petitioner Companies, unless their views were against the framework of law and public policy.

Our comments :- With respect to the Scheme, the tax department had raised similar objections before the Gujarat High Court, which after considering the contentions of both, the tax department and the petitioner company had dismissed the petition thereon. The petitioner has filed an appeal against the order of the Gujarat High Court and the same is pending before the Division Bench. The Delhi High Court, contrary to the order of the Gujarat High Court, has relied on settled judicial precedents and has passed the order sanctioning the Scheme.