Jurisdiction Of The National Company Law Tribunal In Corporate Restructurings: Protecting Tax Revenue As Public Interest

Jurisdiction Of The National Company Law Tribunal In Corporate Restructurings: Protecting Tax Revenue As Public Interest

The National Company Law Tribunal (“NCLT”) is an adjudicating authority in India responsible for deciding matters related to amalgamations, mergers, insolvency and restructuring processes. In deciding such matters, one critical function of the NCLT is to balance the commercial objectives of companies with the interests of public stakeholders and regulators, ensuring that corporate restructurings do not compromise public interest.

Section 230(5)¹ of the Companies Act, 2013 (“Companies Act”) mandates that regulators must be notified during corporate restructurings, giving them an opportunity to raise any concerns relating to areas under their jurisdiction. For instance, the relevant Regional Director and Official Liquidator are required to provide their reports to NCLT in relation to regulatory compliances. One of the stakeholders in a corporate restructuring process is the Income Tax Department (“ITD”). Tax officers of the companies involved in the restructuring are expected to consider compliance with income-tax laws, and present objections before NCLT if they consider the restructuring to be prejudicial to the interests of revenue.

GENERAL ANTI-AVOIDANCE RULES

The General Anti-Avoidance Rules (“GAAR”) introduced by the Income-tax Act, 1961 (“IT Act”), aim to prevent tax avoidance by targeting transactions or arrangements made primarily to gain tax benefits without any significant commercial substance. Applicable from April 1, 2017, GAAR provisions allow the ITD to recharacterize or disregard such arrangements if the tax benefit exceeds INR 30 million (approximately USD 350,000) in a financial year.

The introduction of GAAR provisions has significantly altered the framework in which the ITD evaluates restructurings. GAAR provisions are wide and permit the ITD to re-characterize a transaction or raise valuation concerns. As a result, a merger that is considered to have a "tax avoidance" purpose may be challenged if the arrangement is considered to lack genuine business substance or artificially reduces tax liabilities or results in unjust tax reliefs, even though it checks all specific compliance requirements prescribed under law.

While applicability of GAAR falls under the purview of tax authorities, the jurisdiction of the NCLT often overlaps with the ITD in matters of corporate restructurings before the NCLT.

PUBLIC INTEREST

The term “public interest” is not explicitly defined under the Companies Act. In a general sense, it refers to the broader welfare of society and stakeholders, going beyond the interests of the merging companies or their shareholders. In the context of NCLT approval for a corporate restructuring, the ITD is focused on ensuring that the proposed restructuring does not result in a loss of revenue to the government or allow the companies involved to evade or avoid paying taxes that are rightfully due. In such cases, “public interest” is viewed through the lens of protecting the broader economic and fiscal interests of the nation.

Courts and tribunals in India have generally recognized that "public interest" is not limited to shareholder or corporate interest but includes the protection of state revenue.

This note discusses case law where NCLT took into account tax matters, evaluating impact of such matters from the lens of “public interest”, thereby setting important precedents in Indian corporate jurisprudence.

CASE LAW

1. Scheme of Amalgamation of Wiki Kids Limited²

Wiki Kids Limited (“WKL”), a non-operational company since its inception, sought to merge with Avantel Limited (“AL”), a public listed company. The key commercial rationale provided in the merger scheme was synergy, growth and diversification of AL’s business to improve revenue potential. However, despite receiving shareholder approval and no objections being received from relevant regulatory authorities (including the ITD), the NCLT, Hyderabad rejected the scheme, highlighting that the merger served primarily to benefit the “common promoters”, who would achieve significant financial gain from an “exchange of shares” pursuant to the sanction of the scheme.

The NCLT found that the valuation method that was used benefited only the promoters who were common to both entities. The NCLT further noted that the valuation was speculative and lacked commercial substance, as WKL had never generated business income since its inception. Additionally, the NCLT found that the share exchange ratio was calculated without sufficient clarity on financial gains for public shareholders.

In appeal, the National Company Law Appellate Tribunal (the “NCLAT”) upheld the NCLT’s findings, stressing that a scheme which disproportionately benefits promoters without any substantial benefit to the company or its public shareholders does not satisfy an overriding public interest requirement under Sections 230-232 of the Companies Act, irrespective of the fact that it is approved by the shareholders.

The NCLAT’s ruling reinforced principles of judicial oversight in corporate restructurings especially in cases involving listed companies with significant public shareholding. It emphasized that while commercial decisions are generally left to the wisdom of shareholders and company management, the NCLT retains the responsibility to examine the fairness and justifiability of such schemes to prevent misuse for tax avoidance or promoter enrichment. The NCLAT reiterated that courts must ensure schemes do not solely benefit a small group of shareholders.

In this case, both the NCLT as well as the NCLAT concluded that the scheme was unjustly designed in a manner to extend financial benefit to the common shareholders, affirming the rejection of the merger as aligned with the principle of protecting public interest.

2. Scheme of Amalgamation of Ajanta Pharma Limited³

A scheme involving a merger of Gabs Investments Private Limited (“GIPL”) with its affiliate company Ajanta Pharma Limited (“APL”) was filed with NCLT, Mumbai. GIPL is a privately held company while Ajanta Pharma is a public listed pharmaceutical company. GIPL is owned entirely by the promoters of AIPL. The scheme proposed transferring all shares of APL held by GIPL as a part of the merger to the individual promoters, effectively dissolving GIPL without winding up. The primary rationale provided in the scheme was to simplify the promoter group's shareholding structure by eliminating one layer of ownership, which would streamline the promoters’ direct control over the listed company.

However, the scheme was scrutinized by the ITD for potential tax avoidance under GAAR provisions and the ITD raised concerns regarding the merger, citing loss of tax revenue. Additionally, it was noted by the ITD that GIPL was primarily a holding company for APL's shares, and the proposed merger disproportionately benefited the four common individual promoters of both companies, who would gain shares worth a substantial amount without incurring significant tax liabilities.

The ITD calculated that the proposed amalgamation would lead to a significant tax loss, primarily from (i) unpaid dividend distribution tax (that would have been levied on GIPL pursuant to distribution of ‘assets’ to its shareholders, otherwise than on amalgamation); and (ii) capital gains tax (that would have been levied if the shares of APL were to be sold by GIPL in the open market). The ITD argued that the scheme was designed to benefit the promoters, allowing them to transfer shares of GIPL without paying these taxes, and thus it would result in tax avoidance.

Based on these objections, NCLT rejected the scheme, ruling that it was designed for the sole benefit of promoters and no benefit was accruing to the public shareholders of APL. While pronouncing the ruling, NCLT relied upon the judgement of the NCLAT in the matter of Wiki Kids Limited v. Avantel Limited⁴ (discussed above) wherein NCLAT held that if the scheme is not in public interest, it can be rejected by the NCLT.

3. Scheme of Amalgamation of Gujarat Woodlam Products Private Limited⁵

The NCLT, Ahmedabad dealt with a case involving a joint petition filed by Gujarat Wood-Tech Private Limited (“GWTPL”), Gujarat Mica-Products Private Limited (“GMPPL”), Gujarat Plylam Sales Agencies Private Limited (“GPSAPL”), and Gujarat Woodlam Products Private Limited (“GWPPL”), seeking approval for a scheme of amalgamation of GWTPL, GMPPL, GPSAPL (“Transferor Companies”) with and into GWPPL. The stated rationale for the proposed amalgamation was to simplify the corporate structure and improve business efficiency.

The ITD invoked GAAR provisions and raised objections, arguing that the scheme lacked commercial substance and was primarily structured as a device to transfer assets of the Transferor Companies to GWPPL, without incurring any tax liabilities and thereby leading to tax avoidance. If the assets were to be transferred otherwise than pursuant to the scheme of amalgamation, the transfer would have been subjected to either capital gains tax or dividend distribution tax for the Transferor Companies. The ITD further contended that the Transferor Companies were generating minimal revenue and that the scheme was designed to facilitate tax avoidance for the promoters.

The applicant companies rebutted the ITD's arguments by asserting that the amalgamation was legitimate and aimed at business synergy, not tax avoidance. It was argued that the transfer of assets of the Transferor Companies to GWPPL pursuant to amalgamation fell within the purview of Section 47(vi) and 47(vii) of the IT Act, which exempts certain transfers from being considered taxable events. Additionally, it was argued that there were no instances of profit distribution or dividend payments triggering dividend and that the applicant companies had complied with all legal requirements. Also, it was submitted that the applicant companies were carrying legitimate business activities since their inception and the amalgamation was not being undertaken for any tax avoidance since the applicant companies were not loss-making companies.

Ultimately, the NCLT sanctioned the scheme, acknowledging the ITD's concerns but noting that GAAR provisions are codified in the law, giving the ITD the right to recover tax dues (if any) post-approval. NCLT ruled that the amalgamation was in the interest of shareholders and creditors but clarified that the approval did not exempt the merged entity from tax liabilities.

4. Scheme of Amalgamation of Panasonic India Private Limited⁶

This scheme involved merger of Panasonic India Private Limited (“PIPL”) with and into Panasonic Life Solutions India Private Limited (“PLSIPL”). The ITD raised objections that the scheme is designed for tax evasion since PIPL had accumulated losses which ought to be set-off by PLSIPL against its future profits. The ITD argued that the merger was aimed to benefit Panasonic Corporation, Japan, through the set-off of PIPL’s accumulated losses against the profits to be generated by PLSIPL by virtue of Section 72A of the IT Act, thereby causing a loss of revenue.

It was further contended by the ITD that there could be a loss of revenue on account of possible non-payment of tax on capital gains derived by the shareholders who are residents of Singapore and Netherlands at the time of transfer of shares of PLSIPL (merged entity) in future owing to the beneficial provisions available under the India-Singapore and India-Netherlands tax treaty. Essentially, the shareholders would be able to claim exemption from capital gains on the incremental value achieved due to consolidation of the companies. The ITD relied on the judgements of Ajanta Pharma and Wiki Kids and asserted that the scheme was non-arm's length and lacked commercial substance.

In response, Panasonic argued that the merger was commercially driven and designed to achieve operational synergies, cost savings, and enhanced shareholder value. The merger complied with the conditions laid down under Section 2(1B) and Section 47 of the IT Act, allowing for tax-neutral treatment, and stated that the requirements under Section 72A of the IT Act and Rule 9C of the Income-tax Rules, 1962 would be met to justify carrying forward and setting-off the losses of PIPL by PLSIPL. Further, it was contended that capital gains tax concerns were mitigated under India’s tax treaties with Singapore and Netherlands, which would apply to non-resident shareholders regardless of the merger.

The NCLT, Chandigarh concluded that a scheme cannot be denied solely due to tax advantages if it has a legitimate commercial purpose. The NCLT sanctioned the scheme and ruled that the proposed merger had valid commercial purposes and did not appear solely tax-driven, distinguishing it from cases where schemes had been rejected. It noted that the IT Act has adequate safeguards (for example, Section 72A for carry-forward losses) to prevent abuse and observed that the ITD could revisit these concerns in future assessments, if necessary.

CONCLUSION

The regulatory framework in India for approval of corporate restructuring grants an opportunity to the ITD, among other regulators, to raise objections before the NCLT if a restructuring is perceived by them to be prejudicial to the interests of revenue. The NCLT is required to give due consideration to any such objections in making its decision in the context of specific facts and circumstances of a particular case. Accordingly, it becomes important for companies contemplating any corporate restructuring to ensure that the proposed restructuring has sufficient commercial and business rationale and is not strictly driven by tax incentives.