Scheme of Merger of WoS with its Holding Company Approved – Despite of Objections from IT Department

Yuflow Engineering Private Limited (“Petitioner Company 1/Transferor Company) filed scheme of amalgamation with Yuken India Limited (“Petitioner Company 2/Transferee Company”) before the Hon’ble National Company Law Tribunal (NCLT) Bengaluru (Bangalore) Bench.

Facts of the case: –

1. Transferor Company is a wholly owned subsidiary (WoS) company of Transferee Company.
2. The Transferee Company is a profit-making company whereas the Transferor Company has been a loss-making company for the last two financial years.
3. The Income Tax Department filed its report for the Transferee Company stating that there is no objection for the Merger subject to compliance of section 79 of Income Tax Act and continuation of proceedings against Transferee Company.
4. Transferee Company gave an undertaking that the company undertakes to comply with provisions of Section 79 of Income Tax Act and continuation of proceedings in the name of the Transferee Company.

Coming to the Transferor Company, The Income Tax Department filed its report for the Yuflow Engineering Private Limited (Transferor Company) citing certain observations and raising objections to the scheme as follows: –

Points from report by the Income Tax Department

It is observed by the Income Tax Department that from the financials submitted along with scheme documents the Transferor Company is loss-making company and the Transferee Company is a profit-making company.

It is also observed from the Income Tax return filed by the Transferor Company for AY: 2021-22 that it is having total loss to be carried forward to future years to the tune of Rs.8,09,04,600/- (Business Loss Rs.6,69,94,054/-, and unabsorbed depreciation of Rs.1,39,10,546/-).

Therefore, it is evident that the scheme is for avoiding payment of tax by merging loss-making and profit-making companies.

It is observed from the Scheme of arrangement that 99.80% of shares of Transferor Company are held by Transferee Company. Entire assets of the Transferor Company are being transferred to the amalgamated company in the garb of amalgamation, wherein capital gain arising out of the transfer of shares will be exempted u/s. 47 (vii), resulting in avoidance of capital gain tax benefitting the transferee company.

Hence, it may be construed that the condition laid down for amalgamation in section 2(1B) of the Income Tax Act, 1961 is not fulfilled.

Reply by the Transferor Company to the objections raised:

• The Transferor Company is a wholly-owned subsidiary of the Transferee Company and as per the Scheme, all assets and liabilities of the Transferor Company are proposed to be transferred to the Transferee Company under the Scheme. Further, it is submitted that the amalgamation of the Transferee Company and the Transferor Company is primarily to streamline the business operations of the companies, as the Transferor Company manufactures products and components which are in turn used by the Transferee Company. In order words, the products manufactured by the Transferor Company complements the products manufactured by the Transferee Company and therefore, the amalgamation would enhance business synergies between the companies. It is therefore commercially, financially, and operationally beneficial to the stakeholders of both the companies.
• Since the Transferor Company is a wholly-owned subsidiary of the Transferee Company, the Transferee Company has always been consolidating the financials of the Transferor Company with its financials as mandated under law. Further, the Scheme is in accordance with accounting treatment prescribed under Section 133 of the Companies Act, 2013 and the copy of the Certificate issued by the Statutory Auditors has already been submitted before this Hon’ble Tribunal. Further, the Transferee Company is a consistent profit-making company (except for the period affected by COVID-19 pandemic) and the tax paid by the Transferee Company is substantially high. Even if the Transferee Company is eligible to set off against the losses carried forward after amalgamation, the same would be negligible and insignificant compared to the taxes that are paid by the Transferee Company. Therefore, it is submitted that the scheme is not for avoiding payment of taxes as observed by the Income Tax Department.
• The Transferor Company is a wholly-owned subsidiary of the Transferee Company and as per the Scheme all assets and liabilities of the Transferor Company are proposed to be transferred to the Transferee Company under the Scheme. Further, since entire share capital of the Transferor Company is held by the Transferee Company, the Scheme only provides for cancellation of the shares held by the Transferee Company upon the Scheme coming into effect and there will be no new issuance of any shares. It is further submitted that the Scheme is in accordance with accounting treatment prescribed under Section 133 of the Companies Act, 2013 and the copy of the Certificate issued by the Statutory Auditors has already been submitted before this Hon’ble Tribunal.

It is further submitted that the Transferee Company undertakes to pay all legitimate dues to the Income Tax Department in respect of the present Scheme as per applicable laws.

Reply/Rejoinder by Income Tax Department

• Income Tax Department contested the reply of the Company that there will be insignificant tax effect on set off of brought forward losses of the transferor Company:-  Since the brought forward losses are Rs.8 Crores, the tax effect at the rate of 30% was Rs.2.4 Crores.

• For point 2.8 – Income Tax Department, relied upon the decision dated 13.07.2017 of Hon’ble NCLT, Hyderabad Bench in the matter of M/s. Wiki Kids Limited and M/s. Avantel Limited, in which the Scheme of Amalgamation was rejected; and the same was also upheld by the Hon’ble NCLAT (NATIONAL COMPANY LAW APPELLATE TRIBUNAL) vide order dated 21.12.2017.

Response of the Transferor company to the rejoinder filed by Income Tax Department: –

• Case law on which the Income Tax Department placed reliance does not apply to the present case, and the same can be distinguished in facts and in ratio from the Petitioners case.

Key Points in the matter of M/s Wiki Kids Limited for ready reference: –

• The applicant referred to the decision of Hon’ble Supreme Court in the case of Vodafone Essar Gujarat Ltd. Vs. Department of Income Tax in support of their reply.

Details of the Present Scheme: –

1. Transferor Company has been carrying on business from the date of its incorporation and the same is evident from the financial statement furnished by the Transferor Company.
2. The losses suffered by the Transferor Company are on account of operational losses.
3. Carry forward losses:- Carry forward losses of the Transferor Company claimed to be set off in the Transferee Company after amalgamation shall be in terms with Section 79 and other applicable provisions of the Income Tax Act, 1961 and therefore, the IT Department may disallow the carry forward of losses if the Petitioner Companies are disentitled under law even after sanctioning of the Scheme by this Hon’ble Tribunal.

Hon’ble NCLT Bangalore Bench approved the Scheme on Following Grounds: –

1. M/s. Wiki Kids Limited and M/s. Avantel Limited decided on 21.12.2017, which was relied upon by the Income Tax Department for objecting to the Scheme, it is correctly explained by the Petitioner that the ratio of the decision was distinguishable on facts, thus the same is not applicable to present case.
2. The Transferor Company was in regular operation; and the loss incurred was operational loss in business. Therefore, it is not a case that a Company which was defunct since its incorporation and doing no business at all for 13 years; was merged with a Listed Company; so that the common promoters get allotment of Listed Companies shares in exchange of shares of this defunct company having no business. Thus, the Petitioners have emphasized that this amalgamation was for increased business synergies and efficiency, and on an entirely different footing altogether on facts.
3. There were sufficient safeguards built in for the revenue by providing for the conditions U/s. 72A (2); when the Assessing Authority can disallow the claim for carry forwards and set off losses if these are not satisfied. It is correctly stated by the Petitioners that the Assessing Officer is free to disallow such a claim in the Income Tax Assessment proceedings; even if the Scheme is approved u/s. 230-232 of the Companies Act, 2013; depending on the satisfaction of conditions under the Income Tax Act, 1961.

Conclusion:

Thus, it can be stated that since there are sufficient safeguards available for Income Tax Authorities to carry forward and set off losses under provisions of the Income Tax Act 1961. Thus, scheme cannot be objected to on mere grounds that there are tax benefits available to Transferee Company. Further,  in the case of Vodafone Essar Gujarat Ltd.” (Supra), the decision of the Hon’ble Gujrat High Court was affirmed by the Hon’ble Supreme Court in “Department of Income Tax v. Vodafone Essar Gujarat Limited ─ (2015) 16 SCC 629, which it was observed that Income Tax Department is entitled to take out appropriate proceedings for recovery of any tax statutorily due from the transferor or transferee company or any other person who is liable for payment of such tax due. The pending proceedings against the Transferor Company shall not be affected in view of the sanction given to the Scheme by this Court.

One more thing to note is that we saw a similar scheme with similar objections from the Income Tax Department. In the article which we covered in the February Issue, the scheme was rejected by the Delhi Bench of NCLT but approved by the Jaipur Bench. The least to take from this is that the companies going for a restructuring need to look at the compliances from other departments in a more comprehensive way.