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