Whether NCLT is within its power to reject the scheme on the ground of tax benefits available to The Transferee Company?

Minda TG Rubber Private Limited (“Applicant Company/Transferor Company) filed scheme of amalgamation with Toyoda Gosei Minda India Private Limited (“Transferee Company”) before the Hon’ble National Company Law Tribunal (NCLT) Delhi & Jaipur Bench,  respectively.

Facts of the case: –

1. The Transferee Company is engaged in the business of manufacturing, distributing, selling, importing, and exporting automotive parts and rendering services in this respect.
2. The Transferor Company is engaged in the business of manufacturing auto components.
3. Rationale for the proposed amalgamation as envisaged under the Scheme were:
   • Achieving business and administrative synergies,
   • Consolidation and simplification of shareholding structure, cost, saving, synergies resulting from rationalization, standardization and simplification of business process,
   • Improved organizational capability arising from a pooling of financial resources,
   • Avoiding unnecessary duplication of cost of administration, distribution, selling and marketing and reduction in legal and regulatory compliances,
   • Maximize the overall shareholders value.
4. Being the registered office of the Transferee and the Transferor Company is in different states, the transferor company filed the scheme in NCLT Delhi Bench and the transferee company in Jaipur Bench.
5. Now as far as The Transferor company is concerned.
   • The Regional Director and The Official Liquidator did not raise any objection to the said scheme in their reports submitted to Delhi Bench.
   • The Income Tax Department filed their No objections with Hon’ble Jaipur Bench with proviso that the company strictly complies with the conditions of Section 72A of the Income Tax Act, 1961 and Rule 9C of the Income Tax Rules, 1962 and secure the interest of the revenues to that extent that if any demand arises then the company may pay demand as and when it arises.
6. Based on the above, the Hon’ble Jaipur Bench allowed the scheme vide order dated 23rd June 2022. The final order of the approved scheme was filed by the transferee company with the Registrar of Companies, Jaipur which was subsequently approved on 30^th December 2022.
7. Interestingly, in Hon’ble Delhi Bench, the Income Tax Authorities filed their report with NCLT citing below mentioned grounds and prayed that scheme be rejected by NCLT. Pursuant to this, Hon’ble Delhi Bench accepted the Income Tax Authorities prayer & rejected the scheme.

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Objections of Income Tax Authorities before Hon’ble Delhi NCLT

1. The assessment of the Minda TG Rubber Pvt. Ltd., was completed for A. Y 2015-16 by making a protective addition of Rs l0,00,00,000 u/s 68 of the Income Tax Act, 1961 and as on date demand of Rs.3,78,02,420/- is recoverable from the Minda TG Rubber Pt Ltd. The Current demand and future demand if any recoverable from the transferor company shall be enforceable against the transferee company and the merger order should not be passed containing otherwise.
2. Toyoda Gosei Minda India Pvt. Ltd. Accumulated Unabsorbed Depreciation as on 31.03.2021 amounting to Rs. 25,38,93,225/-and total Loss carried forward of Rs. 2,90,88,939/- of the transferor company shall be transferred to the transferee company which will result into the decrease in the taxable income of the Toyoda Gosei Minda India Private Limited (which is a profit-making company) by the amount mentioned above and the tax effect will not be in favor of the Revenue.
3. On the aforesaid grounds, the tax department requested the Hon’ble NCLT bench to dismiss the petition.

Reply by the Transferor Company to the objections raised:

The transferor company filed their reply affidavit stating:

1. Pursuant to clause 2(s) of Part II of the scheme – Upon Scheme becoming effective all taxes, benefits of any nature, duties, cesses or any other like payments or deductions available to the Transferor Company under Income Tax. Sales tax, Service tax, Goods and service tax, etc., or any tax deduction/ collection at source tax credit, benefits of CENVAT credits, benefits of input credit relating to the period after the Appointed Date up to the Effective date shall be deemed to have been on account of or paid by the Transferee Company.
2. The transferor company confirms and undertakes that upon the scheme becoming effective, all tax liabilities including income tax Liabilities pending or payable by the Transferor Company (Existing or future), unabsorbed depreciation shall be paid and honoured by the transferee company accordingly.

Hon’ble NCLT Delhi Bench Rejects the Scheme on Following Grounds: –

1. Hon’ble NCLT Delhi bench considered the provisions of Section 72A of the Income Tax Act, 1961 (“ITA”) and basis same observed that Unabsorbed depreciation and losses can be carried forward by the transferee company only on meeting certain conditions as stipulated under Section 72A (2) of Income Tax Act, 1961.
2. Hon’ble bench observed that the clause relating to Compliances of Tax Laws [Clause 12 of the Scheme] was not expressly COMMITS to the compliance of Section 72A of the Income Tax Act, 1961 by the Applicant Company.
3. Further, Section 72A(2)(b) of the Income Tax Act, 1961 has imposed certain conditions regarding the carry forward of the business and holding at least 3/4^th of the book value of fixed assets of the Transferor Company for 5 years from the date of merger. However, Hon’ble Delhi Bench observed that there is neither any mention nor any undertaking in the Scheme that the transferee company shall not dispose of all the assets and shall hold at least three-fourths of the book value of fixed assets of the / transferor company for at least five years and it shall continue the business of the transferor company for next five years.
4. Therefore, Hon’ble NCLT Delhi Bench finds that the proposed scheme is not compliant to the provisions of Section 72A of the Income Tax Act, 1961 and thus, rejected the scheme being non-compliant of Section 72A of the Income Tax Act, 1961.

Conclusion:

The very intention of the lawmakers behind introducing section 72A of ITA was revival of loss-making units through merger by facilitating benefit to the transferee company by way of carry forward accumulated losses and unabsorbed depreciation available with the transferor company.

In an interesting decision, Hon’ble Delhi Bench rejected the Scheme of Amalgamation purely on the ground of non-compliant with one of the Income Tax provisions [carry forward of losses]. Given the rationale as envisaged under the scheme, one may need to consider whether the scheme may be looked only from the lenses of the income tax or should be vetted considered the commercial objectives. It is essential to consider that section 72A (3) provides for reversal of the amount of accumulated losses/unabsorbed depreciation claimed if the conditions prescribed are not being satisfied. So, whether the scheme expressly provides for or not that the transferee company will comply with the conditions required to get set off.

It is important to considered that in case of the transferee company, the Income Tax Department provided No objection stating the Transferee Company strictly complies with the provisions of Section 72A of ITA whereas for the transferor company, the Income Tax Department prayed to dismiss the petition.

Furthermore, one must also consider in the case of “Vodafone Essar Gujarat Ltd v Department of Income Tax (2013) 176 com case 7 (Guj), Hon’ble Gujarat High Court stated that Court cannot refuse the sanction of a Scheme by coming to the conclusion that the only object of the Scheme is to avoid taxes. In its commercial wisdom if the Company has decided to have a particular arrangement by which there may be even benefit of saving income-tax or other taxes, that itself cannot be a ground for concluding that the sole object of framing the Scheme is to defraud the Income Tax Department or other taxing authorities. This has been subsequently followed by Hon’ble National Company Law Appellate Tribunal in Joint Commissioner of Income Tax Vs. Reliance Jio Info comm Ltd. & Ors.

It is also worthwhile to consider that Hon’ble NCLT is exceeding its powers in rejecting the scheme on the ground of tax benefits even though income tax law provides for enough safeguards if the Transferee company fails to comply with any conditions precedent for getting benefits under Sec 72A of the Income Tax Act, 1961.