KPMG FLASH NEWS
KPMG in India
10 August 2015
Even if the composite scheme of arrangement is not a ‘demerger’ under the
Income-tax Act, the scheme shall be approved and liable to appropriate tax
implications
Background
Recently, the Bombay High Court (the High Court) in the
case of the ‘Composite Scheme of Arrangement and
Amalgamation’ between A Ltd. and B Ltd./C Ltd.
(collectively referred to as petitioners) and their
respective shareholders and creditors held that if a
scheme of arrangement, which is otherwise permissible
both under the Companies Act, 1956 (the Companies
Act) and the Income-tax Act, 1961 (the Act) but does not
amount to 'demerger' within the meaning of the Act, may
have certain tax implications but cannot be prohibited.
Further, the High Court observed that the sanction of the
scheme, does not in any way bind the tax department to
take any particular view of such scheme, insofar as the
tax implications of the transactions are concerned.
The High Court has approved the present scheme even
though the consideration for transfer of the undertaking
is issued in the form of shares of a company other than
the transferee company since the consideration is
accepted by the shareholders is not against the public
interest and does not contravene the provisions of the
Companies Act.

The transferor company, i.e. A Ltd, is a listed
public company engaged in the business of
vacation ownership and leisure hospitality. The
two transferee or resulting companies, namely, B
Ltd. and C Ltd., are respectively engaged in the
business of corporate agency for travel insurance,
and integrated travel and travel related services.

The scheme consists of two parts, one of which
consists of the demerger of an undertaking of A
Ltd. pertaining to the time share and resort
business on a going concern basis from A Ltd.
and its transfer and vesting in B Ltd. The other
part consists of an amalgamation of the residual
undertaking of A Ltd. with C Ltd. as a going
concern.

After demerger and amalgamation as aforesaid,
the scheme envisages dissolution of A Ltd. on
and with effect from the effective date. The
consideration of the demerger and amalgamation,
respectively, is the allotment of certain equity
shares of C Ltd. in lieu of the equity shares of A
Ltd.

The transferee companies have presented this
scheme petition for sanction of the High Court
under Sections 391 to 394 of the Companies Act.
Facts of the case

The petitioners are companies incorporated under
the provisions of the Companies Act and have their
registered office in India.

The petitioners filed petitions before the High Court
to seek sanction of a composite scheme of
arrangement and amalgamation of A Ltd. which is a
transferor company, with B Ltd. which is a resulting
company and C Ltd. which is another resulting
company and their respective shareholders and
creditors.
Objections by the Regional Director of the
Ministry of Corporate Affairs

The Regional Director of the Ministry of Corporate
Affairs opposed the scheme on the ground that
having regard to the provisions of Section 394 of
the Companies Act, only a transferee company
can allot shares towards consideration of transfer.
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

In the present case, for demerger and transfer of the
undertaking of the resort business of A Ltd, the
shares have been allotted by C Ltd which is a parent
company of the transferee company, namely, B Ltd.
Further, B Ltd. which is the resulting company
insofar as the demerger part is concerned, is not
issuing any shares and therefore, the scheme is not
in consonance with the provisions of the Companies
Act.
Further the scheme is also against the provisions of
the Act having regard to the definitions of 'demerger'
and 'resulting company' contained in Section
2(19AA) and 2(41A) read with Section 2(19AAA) of
the Act.
Non-compliance with the provisions of the
Companies Act

The provisions of Section 394(1)(i) to (vi) of the
Companies Act, which the court may make whilst
sanctioning a scheme, are merely enabling
provisions. The said provisions are not in the
nature of conditions for the exercise of the power
of the Company Court under Section 394 of the
Companies Act. These enabling provisions,
therefore, cannot be construed as compulsory in
any sense.

The said provisions provide that if and to the
extent the compromise or arrangement provides
for allotment or appropriation by the transferee
company of any shares, debentures, policies or
other like interests in that company as part of the
consideration of the scheme, the Company Court
while sanctioning the scheme may make
appropriate provisions in respect of such
allotment or appropriation.

It is not that in every case the consideration for
transfer of an undertaking as part of a scheme of
arrangement must come in the form of an
allotment of shares of a transferee company or for
that matter allotment of any shares.

The consideration for such transfer can be any
legitimate consideration, which the transferor is
entitled to accept for a contract of transfer. The
scheme may, thus, not provide for any allotment
of shares at all or provide any other appropriate
consideration including allotment of shares of a
holding company of the transferee company.

Acceptance of any particular consideration is part
of the commercial wisdom to be exercised by the
shareholders of the transferor company. As long
as such consideration is not against public
interest or in any other manner illegal or
inappropriate, it is not for the Company Court to
accept or reject such consideration. The same
has been held by the Supreme Court in the case
1
of Miheer Mafatlal vs. Mafatlal Industries Ltd.

There is no harm to public interest insofar as the
present scheme is concerned. Also, this court
cannot reject the consideration, which is accepted
by the shareholders of the transferor company,
who are parties to the present arrangement.

This court as well as other High Courts have
accepted several schemes where the
consideration for transfer of an undertaking is
issued in the form of shares of a company other
2
than the transferee company .
High Court’s ruling
Non-compliance with the provisions of the Act

If a scheme of arrangement, which is otherwise
permissible both under the Companies Act and the
Act, does not amount to 'demerger' within the
meaning of the Act, it may have certain tax
implications for the companies in question. However,
there is no prohibition contained in the Act to a
scheme such as in the present case.

There is a provision in the present scheme that a
part of the scheme, namely, the demerger, has been
drawn up to comply with the conditions relating to a
demerger as specified under Section 2(19AA) of the
Act.

The scheme indicates that if any terms or provisions
of the scheme are inconsistent with the provisions of
Section 2(19AA) of the Act, such provisions shall
prevail and the scheme shall stand modified to that
extent. Accordingly, the framing of the scheme and
the corresponding sanction by this court do not in
any way prejudice the application of Section 2(19AA)
of the Act.

Also, by sanctioning the present scheme, this court
is not in any way accepting the company's case that
the scheme, as framed, complies with the provisions
of 'demerger' within the meaning of Section 2(19AA)
of the Act.

Further, the High Court clarifies that the sanction of
the scheme, as proposed by this court, does not in
any way bind the tax department to take any
particular view of the scheme of arrangement
sanctioned by this court insofar as the tax
implications of the transaction are concerned.
_____________________________
1
Miheer Mafatlal v. Mafatlal Industries Ltd. [1997 (1) SCC 579]
Pantaloon Retail (India) Limited [Company Scheme Petition No. 338/2010
decided on 24 August 2010 (Bom)], Keva Aromatics Private Limited
[Company Application No.455/2013 decided on 10 December 2013 (Bom)],
Seven Wonders Holidays Private Limited [Company Petition Nos.184 & 185
of 2010 decided on 1 August 2010 (Del)], M/s. IVRCL Limited [Company
Petition Nos.58, 59, 60 and 61 of 2012 decided on 2 July 2012 (AP)]
2
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Accordingly, the objections raised by the Regional
Director were quashed.
Our comments
In line with this decision, the Bombay High Court in an
another case held that the sanction of the scheme does
not in any way bind the tax department to take any
particular view of the scheme of arrangement sanctioned
insofar as the tax implications of the transaction are
concerned. Referring to the provisions of the Companies
Act, the High Court also held that the consideration may
not necessarily come in the form of allotment of shares
of a transferee company and it may well be in the form of
shares of a holding company of the transferee company.
It would be interesting to understand the view of the tax
authorities on the meaning of the term ‘Resulting
Company’ under Section 2(41A) of the Act read with
Section 2(19AA) of the Act.
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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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