NCLT approval for corporate restructuring – Assessing the tax impact
Daksha Baxi (Executive Director, Khaitan & Co.)
Business reconstruction and restructuring are used around the world as a major strategy for growth and creating value for investors. It is therefore also necessary that such strategies have approval of shareholders and other stakeholders in the business and are also tax efficient. For these reasons, most jurisdictions prescribe some approval and compliance process and have tax provisions which facilitate tax neutral reorganisations, subject to certain conditions. Under Indian Income Tax Act, 1961 (IT Act) also, mergers and demergers are tax neutral for companies subject to conditions.
As we know, the Companies Act, 2013 (2013 Act), replaces the court approval process with the approval by Tribunal[1]. The Ministry of Corporate Affairs (MCA) notified the constitution of National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal (NCLAT) on 1 June 2016 (Tribunal).
While, the 2013 Act provides for schemes of compromises, arrangements and amalgamations (Schemes) to be approved by NCLT, these sections are yet to be notified. It is interesting to note that the Companies (Second Amendment) Act, 2002 had already intended the approval to be by Tribunal. However, such Tribunal was never notified under 1956 Act. The recent constitution of Tribunal is under the 2013 Act and till such time as the relevant sections are not notified, the Schemes would need to be approved by High Court (HC) under the 1956 Act. It is pertinent to note that the tax neutrality of a Scheme resulting in demerger under the IT Act requires the Scheme to be carried out under sections 391 to 394 of 1956 Act. There is no such requirement for a Scheme of merger, but since the 1956 Act itself requires the Scheme to be approved by HC, the condition is automatic. A consequential change in the IT Act would be needed to reflect the provisions of 2013 Act so that the Scheme is tax neutral when the 2013 Act sections are notified.
It is only a matter of time for the relevant sections of 2013 Act to be notified, and hence evaluation of the Scheme approval procedures under the Tribunal vis-a -vis the HC is opportune.
Scheme of Compromise or Arrangements under the 1956 Act
The 1956 Act, prescribes a procedure to obtain court approval for a Scheme. In the first place such Scheme must be approved by a majority in number representing 75% in value of class of creditors or shareholders. The HC can sanction any such Scheme if it is satisfied that the applicant has disclosed all the material facts relating to the company with an affidavit such as financial statements of the company, auditor’s reports and a notice of meeting along with the statement setting forth the terms of the compromise or arrangement and explaining its effect on the business. Additionally, the HC would also give a notice to the Regional Director, Registrar of Companies, the Income Tax Department and consider their representations before passing the order.
Scheme of Compromise or Arrangements under the 2013 Act
The 2013 Act prescribes additional disclosures if the Scheme involves reduction of capital or if the Scheme is for corporate debt restructuring which has not received consent of 75% of the secured creditors.
It also requires furnishing of an auditor’s certificate stating that the company has conformed to the accounting standards prescribed under the 2013 Act. The 2013 Act also lays down that the notice of the meeting shall be furnished to the Central Government, Tax Authorities, Reserve Bank of India, Registrar of Companies, Official Liquidator and other authorities affected by the Scheme.
It is to be noted that unlike under the 1956 Act, section 233 of the 2013 Act facilitates a Scheme of merger or amalgamation between two or more small companies or between a holding company and its wholly-owned subsidiary or such other class or classes of companies as may be prescribed, subject to satisfying the conditions set out in section 233, without approaching the Tribunal. The Scheme so approved in accordance with section 233 is then required to be filed by the transferee company with the Central Government, Registrar and the Official Liquidator. Such Scheme may be brought before the Tribunal for approval if the Central Government is of the opinion that such a Scheme is not in public interest or in the interest of the creditors. Such application is required to be made by the Central Government within sixty days of the receipt of the Scheme.
The 1956 Act had no such facilitating provision for small companies or for such Schemes between holding and subsidiary companies. The fact that this can be facilitated without either HC or Tribunal involvement should reduce the timeline and efforts required for such Schemes to be implemented.
Jurisdiction of High Court/Tribunal
The procedure prescribed under 2013 Act for approval of the Tribunal is materially the same as that prescribed under the 1956 Act for approval of the HC. The difference that is expected to be experienced in obtaining approval lies in two major aspects:
(i) Tribunals are special authorities constituted to deal with all the approvals which were prescribed under the 1956 Act to be granted either by the Company Law Board (CLB) and/ or by the HC. The jurisdiction for approval of Schemes under 1956 Act lay only with the HC. Since HCs deal with all legal issues referred to them under all and any law of the country, there has been a serious constraint on the time that HCs can set aside for dealing with the commercial matters pertaining to approval of Schemes. It is hoped that constituting Tribunals and finally entrusting them with the approval for Schemes would see significant reduction in the timeline for approval process.
(ii) Merger and Schemes of small companies: Since the 2013 Act facilitates such Schemes without the approval of the Tribunal except in circumstances where the Central Government finds the Scheme to be against public interest, it is hoped that smaller companies would find it easier to implement Schemes.
Several countries in the world follow a similar process of court approval after the majority of stakeholders approve the scheme, though the timeframe within which this is achieved is substantially lower in all such countries.
Role of Tax Authorities
The income tax authorities have objected Schemes on the ground that the Scheme intended to avoid taxes. The Gujarat HC, in the case of Vodafone Essar Gujarat Limited v Department of Income Tax[2], observed that “the ultimate effect of the scheme may result in some tax benefit or even if it is framed with an object of saving tax or it 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 ” Thus, if a Scheme results in tax saving, it cannot be a ground to allege defrauding the Income Tax Department. This view is in line with the established principle that where the taxpayer can organise its affairs in more than one manner, one of which reduces its tax incidence, it is perfectly justified as long as it is not fraud or subterfuge.
Comment
It is generally perceived that if a Scheme is blessed by a judicial authority such as a HC, then the same is kosher and hence less likely to be challenged by the tax authorities for granting tax neutrality. The same perception would prevail for invoking the General Anti Avoidance Rules once they become effective from 1 April 2017. However, one would like to hope that with the tax administration becoming non-adversarial and the companies ensuring that all the compliances are made, the move from HC approval to Tribunal approval should be seen as a step in the direction of making it easier for businesses to restructure and re-organise for achieving growth without adverse tax costs. It is well known that it can take between six to twelve months for HC to approve Schemes and it is hoped that the move to Tribunal should significantly reduce this time frame.
The column is assisted by Vyoma Mehta (Articled Clerk).