Purchase of Own Shares under Scheme of Arrangement: Dehors Buyback & Capital Reduction?

Case Law: Cognizant Technology – Solutions India Pvt. Ltd [TS-531-ITAT-2023(CHNY)]

Facts of the Case:

• M/s.Cognizant Technology Solutions India Pvt. Ltd (“Applicant Company” or Cognizant”) is a Private Ltd. Co. and is engaged in the business of software development and related services/solutions.

• During the FY 2016-17 relevant to AY 2017-18, the assessee had purchased 94,00,534 equity shares of face value of Rs. 10 each (representing 54.70 % of the outstanding number of equity shares) at Rs.20,297/- per share aggregating to Rs.19,080.26 Crs. from its shareholders in terms of Scheme of Arrangement and Compromise (the Scheme) u/s.391 to 393 of the Companies Act, 1956, approved by the Hon’ble High Court of judicature at Madras.

• Applicant Company deducted TDS on consideration paid as follows:

• The Applicant Company had received a communication dated 22.03.2018 from the Office of the AO to explain ‘as to why’ an order u/s.115-O of the Act, cannot be passed in respect of consideration paid for purchase of its own shares as deemed dividend u/ss.2(22)(a) / 2(22)(d) of the Act.

The Applicant Company’s submission:

1. The ‘Scheme of Arrangement & Compromise’ sanctioned by the Hon’ble High Court of Madras in terms of Sections 391 to 393 of the Companies Act, 1956, cannot be considered as buyback of shares in terms of provisions of Sec.77A of the Companies Act, 1956, and also reduction of capital in terms of provisions of Sec.100-104/402 of the Companies Act, 1956. The Scheme u/s.391 to 393 of the Companies Act, 1956, has been held to be complete code in itself and such power is independent and de horse Buyback and Capital Reduction.
2. Treating Scheme pertaining to the purchase of own shares as a scheme for capital reduction in violation of scheme itself and the order of the Hon’ble High Court of Madras.
3. By referring to the Scheme documents, the Scheme is voluntary in nature and expressly provides for the provisions of Sec 2(22) or Section 115-O or Section 115QA of ITA (Income Tax Act,1961) are not applicable to the purchase of own shares as envisaged under the scheme.
4. The Applicant company submitted that purchase of shares and extinguish thereof does not amount to reduction of capital as envisaged u/s.100-104/402 of the Companies Act, 1956. The company must perforce cancel/extinguish shares purchased from the shareholders due to bar in law. thus, payment of consideration to the shareholders for purchase of own shares cannot, therefore, be said to be occasioned on account of reduction of capital, and consequent reduction of capital cannot be said to be a ‘causa causans’ or proximate/direct cause of the payment to the shareholder but ‘causa sine qua non’ since the extinguishment/cancellation of shares is a consequence of the purchase of shares.
5. The provisions of Sec.2(22)(d) of the Act, does not applicable in the present case, because the deeming fiction provided therein is triggered when payment is made to the shareholders upon reduction of share capital. In the instant case, the company had under the scheme made an offer to purchase its own shares from its shareholders and acceptance of such offer by the shareholders a contract comes into existence. Therefore, the shareholders tendered whole, or part of the shares held at the discretion of the shareholders to the company and the company, accordingly, made payment to the shareholders in discharging of the consideration agreed for purchase of shares.
6. The provisions of Sec.46A of the Income Tax Act, 1961 submitted that, provisions of Sec.46A of the Act provides for taxation of capital gains arising to its shareholders on purchase of shares and applies to all kinds of buyback/purchase of shares by the company from its shareholders and the same is not restricted to Sec.77A of the Companies Act, 1956, alone.
7. The scheme of arrangement once approved by the Hon’ble High Court operates as judgment in ‘rem’ because, in terms of provisions of Sec.394A of the Companies Act, 1956, notice of the scheme of arrangement was required to be given to the central government, which was empowered to rise objection and representation to the Court.

Department’s view:

1. Assessee was originally a fully owned subsidiary of CTS, USA. In the FY 2011-12, there was a restructuring of various business directly or indirectly through a Court approved scheme of amalgamation between group companies & the shares were allotted on 1:1 swap based on number of shares held by the shareholders of all entities and the swap was not in proportionate to the market value of the shares in the individual companies. This resulted in CTS, USA holding only 22.92% shares in Assessee Company, whereas CTS, Mauritius is holding 76.68% of the share capital of Assessee Company. There has been an artificial shifting in profit base from USA to Mauritius for which there is no commercial sense.
2. The dates and events, it is clear that the entire scheme was moved in a hurried manner which is evident from the fact that on 29.02.2016, amendment to sec.115QA of the Act, was announced and was in the public domain. The assessee was convened a board meeting on 10.03.2016 and on 05.04.2016, the details of the scheme were sent to the Registrar of Companies. The Hon’ble High Court of Madras has approved the scheme on 18.04.2016. The assessee has implemented the scheme on 18.05.2016 and on 01.06.2016, amendment to sec.115QA of the Act, came into force. it is abundantly clear that the assessee has designed a scheme in a hurried manner so as to distribute accumulated profits to its shareholders without coming into taxation net as per provisions of the Income Tax Act, 1961.
3. Considering the manner in which shares purchased mechanism envisaged in the scheme, the net effect of the scheme was that post sanction of the scheme, the entire shareholding of CTS-USA and Market RX Inc. USA, would be purchased by the assessee. The only shareholders would be CTS-Mauritius holding 99.87% of the entire shareholding and remaining 10,000 equity shares would be held by CSS Investment LLC, USA. Therefore, from the above, it is undoubtedly clear that the scheme was floated only for two purposes,
   • (I) to effectively shift the complete profit base to Mauritius and
   • (II) to distribute around Rs.19,000Crs. by claiming that the same is not taxable.
4. The funds out of which the payments for purchase of shares would be effected is given under Clasue-7.2 and as per said clause, to the extent of face value paid up shares capital shall be adjusted and the difference between the face value and the total consideration shall be paid out of the accumulated credit in the P & L A/c. Further, several clauses in the Scheme clearly provides that the Scheme will not attract s.2(22), s.115-O or S.115QA of ITA or would not amount to reduction of share capital u/s.100 and also would not amount to buyback of shares u/s.68 of the Companies Act, 2013. Therefore, there are three inescapable conclusions that arise from the present transaction are (i) the entire scheme is a colorable devise to try to avoid payment of tax dues (ii) there is capital reduction & (iii) there is distribution out of accumulated profits.
5. There is no merit in the submissions of the Ld. Counsel for the assessee that the judgment of the Hon’ble High Court of Madras in sanctioning the ‘Scheme of Arrangement & Compromise’ u/s.391-393 of the Companies Act, 1956, is operates as judgment in ‘rem’ and is binding on the Revenue, because, the order sanctioning the scheme itself clearly provides that the sanction shall not grant any immunity to the assessee from payment of taxes under any law for the time being in force.
6. The transactions of the assessee would have to fall either under purchase of own shares u/s.391- 393 r.w.s.77 and sec.100 of the Companies Act, 1956, or sec.77A of the Companies Act, 1956. Those are the only two methods under which a company can purchase its own shares as per the Companies Act, 1956. There are no other methods through which purchase of own shares is contemplated.
7. Sec.46A is only applicable to buyback u/s.77A and not to any other forms of purchase of shares.
8. The facts of the present case, it is abundantly clear that the scheme as such is only a colourable device intended to evade legitimate tax dues and such colourable devices which do not have any commercial purpose cannot be excluded as a fiscal nullity and the AO is empowered to “Look Through” rather than “Look At” the transaction.

Hon’ble ITAT Decision:

1. From the previous restructuring & the manner in which shares were purchased under the current scheme, it is clear that there has been an artificial shifting shareholding base from USA to Mauritius solely with a aim of claiming DTAA benefits, because, as per India Mauritius DTAA capital gains on transfer of equity shares is not taxable in India, as per the Indian Tax Laws.
2. It is important to note that the entire scheme itself was moved in a hurried manner, which is evident from the dates and events brought on record by the AO. Therefore, it is necessary to ‘look through’ the scheme in light of relevant provisions of the Companies Act, 1956 and the Income Tax Act, 1961, to analyze the tax implications.
3. The role of the High Court in approving the scheme is very limited. The Company Court will look at the scheme and act as an umpire to just verify whether the requisite meetings u/s.391(1)(a) of the Companies Act, 1956, have been complied with, and further, it has requisite majority. The Hon’ble Court will also look into the scheme is fair to all members and reasonable to a prudent man. Therefore, the Hon’ble High Court, while sanctioning the scheme will merely look at the commercial wisdom of the creditors and approve the same if it is just and fair and there are no illegalities. The tax consequences and otherwise would be for the AO to look into the scheme in light of relevant provision of the Income Tax Act, 1961.
4. There cannot be any purchase of own shares just u/s.391-393 without relate back to sec.77 r.w.s.100-104 or sec.77A of the Companies Act, 1956.
5. Sec.46A is only applicable to buyback u/s.77A and not to other forms of purchase of own shares. The words used in Sec.46A are identical to the language in Sec.77A and a reading of the Memorandum explaining the provisions of the Finance Act, inserting Sec.46A, makes it clear that it was done to clarify that buybacks u/s.77A necessitated a clarification as to whether the same ought to be taxed as capital gains or dividends.
6. It is undoubtedly clear that the scheme as such is only a colourable device intended to evade legitimate tax dues. Such colourable devices which do not have any commercial purpose can be excluded for physical nullity and the AO empowered to ‘look through’ rather ‘look at’ the transactions
7. The consideration paid by the assessee for purchase of its own shares in accordance with scheme sanctioned by the Hon’ble High Court of Madras in terms of provisions of Sec.391-393 of the Companies Act, 1956, amounts to distribution of accumulated profits which entails release of all or part of assets of a company on reduction of capital which attracts provisions of Sec.2(22) of the Income Tax Act, 1961.

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