Gujarat High Court rejected a Scheme of Arrangement (Scheme) filed by Vodafone Essar Gujarat Limited (Petitioner or Company) for demerger of its passive infrastructure assets (PIA) into Vodafone Essar Infrastructure Limited (VEIL) on various grounds including evasion of tax being primary motive behind the Scheme and also non conformity with essential elements of Section 391/394 of the Companies Act, 1956 (Companies Act).

Background of the case

• The Scheme filed by the Petitioner envisaged vesting of PIA into VEIL without consideration, which required the sanction of the High Court under Section 391 to 394 of the Companies Act.

• Pursuant to the public notice for the hearing of the Scheme, objections to the scheme were raised by the Income tax Department (IT Department) in view of the huge demand of revenue pending against the Petitioner.

• Further, the Tax department contended that:

-the Scheme is against public interest and policy in as much as it is ultravires the company’s memorandum, void under Section 25 of the Indian Contract Act and Section 281 of Income-tax Act, 1961 (the Act);

-the Scheme is nothing but a device and a conduit having the sole purpose of avoiding and evading taxes including Income Tax, Stamp Duty, Registration Charges and VAT;

-The purpose being tax avoidance is explicit from the fact that different accounting treatment are accorded to transferor companies having positive net worth in comparison to the ones having negative net worth.-

– The present Scheme is neither an arrangement nor a compromise as contemplated under Section 391 of the Companies Act.

Petitioner’s contentions

• The estimated net worth of the Petitioner, post completion of demerger, would be more than sufficient to meet the cumulative amount of disputed income tax liability;

• Since assets are transferred with an intent to restructure the holding of capital assets within the same group of companies, no consideration is issued. Similar schemes filed and approved for other telecom companies –Idea, Bharti and Reliance Telecom.

• The term ‘arrangement’ is of wide import which is evident from the inclusive definition under Section.390 (b) of the Companies Act, 1956. There is no reason to restrict the ambit of the term ‘arrangement’ particularly since the legislature has not done so.

• Scheme is consistent with report of the working group on telecom sector for Eleventh 5 year plan. Demerger was intended to mobilize passive resources into productive assets and hence not against public policy.

• Scheme is not ultravires the objects of the company, since right to enter into Scheme of Arrangement is a statutory right conferred by Companies Act. Even otherwise, the object was inserted in the Memorandum at the time of hearing before the Court.

• Scheme is not void as per provisions of Section 25 of the Indian Contract Act, since the terms of the arrangement cannot be enforced by or against the company or its members even if many of them have agreed to the Scheme. It is only upon the sanction of the Scheme, that the same becomes binding on all the members and also on the company and legal consequences ensue including those provided under Section 394.

• Tax department has failed to identify the relevant provisions of the Act, the Central Sales Tax Act or the Gujarat Value Added Tax Act upon which it relies to support its allegation that the scheme results in the ‘evasion’ of capital gains tax or any other tax. Every legitimate tax planning transaction is not tax evasion {Azadi Bachao Andolan case (2004) 10 SCC 1 (SC), CIT v A Raman & Co (1968) 67 ITR 11 (SC), Banyan & Berry v. CIT (1996) 222 ITR 831 (Gujarat).}

• It is permissible for taxpayer’s to minimize their tax liability by arranging their state of affairs through legitimate arrangements.

• Upon the Scheme of demerger, the relevant capital assets would be transferred for Nil consideration. Such a transfer is exempt from tax under section 47 (iii) read with section 45 of the Act.

• PIA is presently not generating any revenue and the Transferee Company is not eligible to 80IA benefits, thus, there is not loss to the revenue.

• Argument of MAT reduction ought not to survive since also it overlooks the revenue neutrality and that MAT is only a timing issue i.e. any MAT paid is available as credit in future and thus reduction in MAT will reduce credit availability and enhance payment of tax in future.

• The declaration under Section. 281 of the Act that a transfer during the pendency of the proceedings is void is restricted both as to time and purpose. Such transfer will be void only as against a claim in respect of tax or other sum payable by a taxpayer and that too when such sum is ascertained as payable upon completion of the proceedings.

• The fact that it is presently under contemplation by Bharti, Idea and Vodafone to merge the tower infrastructure assets into a JV – Indus Towers Ltd. has no bearing on the issue of taxability under the present Scheme.

• The Order of the High Court is liable for stamp duty under Article 20(d) of the Schedule to Bombay Stamp Act (Gujarat Amendment).

Decision of High Court

The Gujarat High Court dismissed the petition for demerger ruling that:

• The present Scheme does not fall within the parameters of Section 391 of the Companies Act as “arrangement with members”.

• Reconstruction can only be subservient to an arrangement or compromise. In the current case, there being no consideration and therefore no give and take between parties, the same is not an arrangement under Section 391 and therefore not a reconstruction capable of being sanction under Section 391/ 394 of the Companies Act.

• Gift cannot be given under Section 391 of Companies Act, as a “gift” is voluntary and with free consent. Section 391 of Companies Act contemplates a forced agreement since the same is binding even on dissenting shareholders on sanction by Court.

• Further, the Scheme is void under Section 25 of the Contract Act since transfer is without consideration.

• Board resolution for scheme approval is ultravires and cannot be subsequently ratified.

• Similar schemes by Idea, Bharti & Reliance are distinguishable based on facts.

• The Petitioner claims that there is a consideration for company law purposes for sanctioning the Scheme while for availing the income tax exemption there is no consideration and is gift under Section 47(iii) of the Act. The petitioner cannot, therefore, be allowed to blow hot and cold at the same time.

• The Transferee company shall be claiming benefit under Section 80IA of the Act once again on same set/ block of assets, on which the transferor Companies have already claimed the benefit under Section 80IA of the Act, in future once it becomes “eligible undertaking”, which is likely to happen in light of the recommendations in the working committee report.

• The Scheme appears to be a camouflage to circumvent the mandatory provisions of section 281 of the Act which may make the transaction void.

• Had the PIA been transferred at market value for exchange of consideration, then capital gains tax, stamp duty and Value Added Tax would have been payable which are sought to be avoided.

• Scheme will artificially reduce MAT in view of different accounting treatment provided for different Transferor Companies.

• The Transferee Company is nothing but a paper company being only intermediate for transferring passive Infrastructure assets from transferor companies to Indus Tower Limited for the purpose of tax evasion.

Our Comments:-It is interesting to note that in spite of settled judicial precedents on the position that tax planning is legitimate, the Company Court has apparently rewritten the transaction in an attempt to identify the potential loss of revenue. The Court has also not commented on the merits of Bombay High Court decision in case of Jindal Iron & Steel Company Ltd v. ACIT (Application No.123 of 2004), wherein it was held that the income tax authorities can investigate into the affairs of the Petition even after completion of the Scheme, if it so desires. Thus, the views of the higher forum would be eagerly awaited in this case, particularly due the fact that there are enough provisions under respective laws for tax authorities to scrutinise “tax evasions”, if any, post effectiveness of the Scheme.

Vodafone Essar Gujarat Limited (Judgment dated 9th December, 2010 in Company Petition No 183 of 2009) ,  Gujarat High Court

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September 2021