May 26, 2022

NCLT Ruling In Panasonic Merger Case: An Affirmation of Tax-payers’ Rights to Conduct Affairs Tax-efficiently

The conflict of the right of a tax-payer to arrange its affairs in a tax-efficient manner and the structuring of transactions as a tax avoidance device has been a recurring leitmotif in tax litigation in India for years. While the former has been approved and affirmed by the Courts, the latter has been a subject to judicial censure.

In the context of amalgamations and demergers, it is not uncommon for schemes of arrangements to be assailed by the Income-tax Department (“ITD”), as being merely device or arrangements, whose main objective is to obtain a tax-benefit. This is despite the fact that the Income-tax Act, 961 (“IT Act”) assures certain tax-neutrality and related benefits to amalgamations and demergers, which satisfy the prescribed conditions.

The propensity of the ITD to challenge such schemes, including by invocation of the statutory General Anti-Avoidance Rule (“GAAR”) provisions, is again, not a new feature. Chapter X-A of the IT Act contains an elaborate framework for invocation of GAAR by the tax authorities on an arrangement that qualifies as an “impermissible avoidance arrangement”. Under the GAAR provisions, subject to the prescribed procedural safeguards, the tax authorities have wide powers to, inter alia, disregard or recharacterize an “impermissible avoidance arrangement”. Interestingly, the GAAR provisions equally apply to domestic transactions as well as international transactions.

While the Government has expressly clarified [1] that GAAR will not interplay with the right of a tax-payer to select or choose a method of implementing a transaction, it has also been clarified that the mere fact that a transaction or arrangement has been sanctioned by a Court or National Company Law Tribunal (“NCLT”) will by itself not protect it from application of GAAR, unless such Court/ NCLT has “expressly and adequately” evaluated the tax implications while sanctioning such arrangement.

As a matter of practice, NCLT orders expressly clarify that a sanction to a scheme of arrangement shall not operate as a bar from the ITD exercising its rights under and in accordance with the applicable tax law. Despite this, the tax authorities have repeatedly objected to schemes of arrangement before NCLT on the grounds that it is merely a device for tax avoidance or that it is amenable to GAAR.

The Chandigarh Bench of the NCLT, vide its order dated May 19, 2022, in the case of Panasonic India Private Limited, dealt with the objections of the ITD to the scheme as being a tax-avoidance device.

In the said matter, the scheme of arrangement (“Scheme”) provided for an amalgamation of Panasonic India Private Limited (“Transferor Company”) into Panasonic Life Solutions India Private Limited (“Transferee Company”). The rationale for the amalgamation, as provided in the Scheme, was reduction in operating and marketing costs, economies in procurement, increased value to customers, offering holistic customer solutions, besides enhancing shareholders’ value.

The ITD objected to sanction of the Scheme, inter alia, on the grounds that (a) the Transferor Company had accumulated losses of around 1437 cr for AY 2020-21; hence, the main object of the Scheme was to enable the Transferee Company to take benefit of these accumulated losses and set them off against the income of the Transferee Company in future periods.

Accordingly, if the Scheme were to be allowed, it would result in a substantial loss of around INR 359 cr to the ITD; (b) there would be a loss to the ITD on account of potential non-payment of capital gains tax by the shareholders of the Transferor Company upon sale of shares of the Transferee Company in future, since the shareholders would be entitled to benefits under India-Netherlands and India-Singapore tax treaties; and (c) prima facie by receiving 25,91,034 shares of the Transferee Company, pursuant to the amalgamation, the shareholders of the Transferor Company would stand benefited despite the Transferor Company having negative net-worth.

The ITD relied on several precedents, including orders in the Ajanta Pharma [2] matter and Wiki Kids matter [3] to allege that the amalgamation was nothing but a vehicle to transfer accumulated losses from the Transferor Company to the Transferee Company, which would attract GAAR.

The NCLT rejected the contentions of the ITD and sanctioned the Scheme. While doing so, the NCLT distinguished between the precedents relied upon by the ITD, including the Ajanta Pharma matter [4], on the grounds that while those matters merely involved simplification of shareholding structure and reduction of shareholding tiers to streamline the promoter group shareholding, the Scheme in the instant case had an identified commercial rationale which would lead to operational synergy between the Transferor Company and the Transferee Company. The NCLT noted that the Scheme was for business consolidation and tax arrangements were merely a consequential fallout of the implementation of the Scheme.

The NCLT relied upon the Apex Court judgment in Vodafone International Holdings B.V. [TS-23-SC-2012], where the Court had held that so long as the sole motive of the transaction was not to avoid tax, which otherwise did not lack commercial substance, the same cannot be interfered with. Reliance was also placed on the Delhi Bench order of NCLT in NIIT [5] matter, where the plea of tax avoidance and GAAR by the ITD was expressly rejected by the NCLT.

It was also noted by the NCLT that despite having been supplied a copy of the valuation report and share exchange ratio report, the ITD had failed to point out any adverse issue in relating to the inter-se valuation. As regards the ITD’s allegation that the Scheme was a device to permit transfer of accumulated losses from the Transferor to the Transferee, the NCLT noted that sections 72A and 79 of the IT Act, read with applicable rules, provided for a comprehensive framework for carry forward of NCLT Ruling In Panasonic Merger Case : An Affirmation of Tax-payers’ Rights to Conduct Affairs Tax-efficiently losses. Hence, the ITD was not precluded from evaluating these issues in accordance with the said provisions at the time of appropriate assessment of the applicant companies. The sanction of NCLT did not bar or prejudice the ITD’s rights to evaluate the tax issues pertaining to the transaction in accordance with the IT Act. Similarly, with regard to invocation of GAAR, again the NCLT noted that the ITD would be free to invoke GAAR provisions in accordance with the procedure under the IT Act during assessment/ reassessment proceedings, if it believed that the transaction was an impermissible avoidance agreement.

This order is a welcome step and affirmation by the NCLT of the tax-payer’s right to arrange its affairs in a tax-efficient manner provided the sole objective behind the transaction is not to obtain a tax-benefit. This order also upholds the proposition that sanction to a scheme cannot be denied unless it can be demonstrated that it lacks a commercial substance and is merely a device. Therefore, the fact that a scheme of arrangement may result in consequential tax benefits for the parties should not be the determinative factor in withholding sanction to a scheme, provided it is bona fide and has a commercial rationale.

Circular No. 7/2017, dated January 27, 2017.
[2] Order dated September 5, 2018 in CSP No. 997/ 2017 and CSP No. 996/ 2017 in CSA Nos. 791/ 2017 and 792/ 2017 (NCLT Mumbai Bench). In this case, which involved the amalgamation of a promoter holding company into the transferee, the NCLT accepted the ITD’s contentions that the scheme was a device to benefit the individual promoters and if sanctioned, would lead to a substantial loss to the revenue. According, the NCLT refused sanction to the scheme.
[3] Order dated December 21, 2017 in Company Appeal (AT) No. 285/ 2017 (NCLAT).
[4] Supra note 3.
[5] Order dated November 12, 2018 in Company Petition CAA – 284/ND/2017 connected with CA (CAA) 85/ND/2017. In this case, the scheme was formulated with the intent of succession planning of the promoter families and sought to collapse the promoter holdings into the listed company (i.e. the amalgamated company) via an amalgamation. The ITD contended that the scheme was a device being used for evasion of income tax liabilities and that the scheme was intended to solely benefit the family trusts, being the shareholders of the two amalgamating companies. The NCLT, while relying on the Bombay High Court’s decision in the matter of AVM Capital Services Private Limited, upheld the petitioner companies’ stance that pursuant to the scheme, the promoter family trusts, which were earlier holding the shares in the listed amalgamated company indirectly through the amalgamating companies would now directly hold the shares without any change in the promoter shareholding.

Following the decision of the Supreme Court in McDowell and Company Limited v/s Commercial Tax Officer (1997), the NCLT observed that it was incorrect to say that every attempt at tax planning is illegitimate, or that every transaction or arrangement which is perfectly permissible under the law but has the effect of reducing the tax burden of the tax-payer must be looked upon with disfavor. Accordingly, it held that in the absence of the ITD being unable to demonstrate precisely how the proposed transaction amounted to tax evasion, there was no reason to reject the scheme.





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