(This article was first published on Taxsutra on 25 November 2016)
Large conglomerates engaged in various businesses often undertake internal group reorganization in order to best align their businesses and derive synergy in order to maximize value for its stakeholders. The Income-tax Act, 1961 has stipulated many provisions which ensure tax neutrality at the time of business reorganization. However, such business reorganizations may become subject to tax litigations due to differing interpretations by the assessee and the revenue authorities.
One such restructuring which has been subject of litigation is the hive-off of telecom business by Aditya Birla Telecom Limited (‘ABTL’ or ‘assessee’) to Idea Cellular Limited (‘ICL’) without any consideration pursuant to a Scheme of Arrangement which was approved by the jurisdictional High Courts.
What did the Scheme envisage?
ABTL owned a Unified Access Services License for providing telecom services in Bihar (including Jharkhand). ABTL was a wholly owned subsidiary of ICL. ABTL and ICL had entered into a Scheme of Arrangement (‘Scheme’) under sections 391 to 394 of the Companies Act, 1956. The Scheme envisaged the following:
- Transfer of telecom business (‘Undertaking’) of ABTL to ICL without any consideration;
- Revaluation of an investment in Indus Towers Limited (‘Indus’), an asset separate from the Undertaking, in the books of ABTL and creation of a business restructuring reserve in its books.
The Scheme was sanctioned by the High Courts.
Ruling in favour of ABTL, the Mumbai ITAT held that such transfer of telecom business without considerations was not subject to capital gains tax. This judgement added significant clarity and certainty pertaining to a plethora of legal nuances typically involved in any business reorganization.
How did the Revenue sought to tax the Transfer?
Prior to delving into the legal facets dealt by the Mumbai ITAT, it would be pertinent to look into the basis upon which the transfer was sought to be taxed. During the course of assessment, the Assessing Officer (‘AO’) served a show cause notice as to why transfer of Undertaking under Scheme should not be subject to capital gains tax u/s 45 of the ITA.
The Revenue Authorities contended that it was not a demerger within the meaning of ITA and therefore, ABTL is not entitled for any exemption from capital gains tax u/s 47 of the ITA. It further contended that for the purpose of computing capital gains tax, the full value of consideration accruing to ABTL is the revalued amount of investment in Indus which ABTL retained with itself; thereby, denying the exemption of “gift” u/s 47(iii) of the ITA.
Further, the Revenue Authorities contended that such transfer was a slump sale within the meaning of section 50B read with section 2(42C) of the ITA. Consequently, the AO computed the capital gain in the hands of ABTL considering the revaluation of the investment in Indus as full value of the consideration.
Dealing with Legal Facets
Mumbai ITAT dealt with the following legal facets which are typical to a business reorganization and which are usually the bone of contention between the assessee and the Revenue Authorities:
(i) Absence of Consideration – Computation Mechanism fails
The Supreme Court in the case of B.C.Srinivasa Setty [TS-2-SC-1981-O] and PNB Finance Limited [TS-96-SC-2008-O] had observed that the charging section and the computation provisions together constitute an integrated code and when the computation provisions cannot apply at all, it would imply that such case could not fall within the scope of charging section and hence not subject to tax.
The Scheme specifically provided that the transfer is without consideration. Therefore, in the present case, as one of the ingredients for computation of capital gains was absent (i.e. consideration accruing for such transfer), no capital gains could be levied due to failure of computation of capital gains altogether.
(ii) No substitution of Artificial Value
In order to levy tax on capital gains accruing to an assessee, no artificial value could be imputed in lieu of actual consideration even if it is nil as in the present case.
In essence, what can be taxed in the hands of the seller is the real gain that accrues from transfer of the assets and hence, in absence of any sale consideration, no notional gain can be imputed in the hands of the seller, on the basis of a hypothetical consideration, just for taxing the same. Reliance was placed on various judicial precedents, including, rulings of the Supreme Court in the case of Shivakami Company P. Ltd [TS-5012-SC-1986-O] and CIT vs George Henderson & Co. [TS-3-SC-1967-O]
(iii) Capital Gains accruing as a result of Transfer
Any consideration that accrues to the assessee has to necessarily have a nexus with the transfer of the concerned capital asset. It can not arise out of an independent transaction by a unilateral act of the assessee.
In the present case, apart from the fact that the revaluation of investment in Indus and transfer of Undertaking formed a part of the same Scheme there was no nexus between the two. The creation of Business Restructuring Reserve was merely an accounting entry passed on account of revaluation of its investment and bore no nexus with the transfer of the telecom undertaking
(iv) Non-Applicability of Section 50C and 50D of the ITA
Although land or building, being part of the Undertaking, were transferred pursuant to the Scheme, there being no itemized transfer of land or building, appellate authority held that section 50C of the ITA cannot be applied to the present case.
Similarly, the Scheme specifically provided for transfer of Undertaking at NIL consideration and therefore, section 50D of the ITA did not have any applicability since it cannot be said that the consideration was indeterminate or not ascertainable.
(v) Not a slump sale within the meaning of section 50B of the ITA
Since the transfer of Undertaking was as a result of Scheme, it would not tantamount to a “sale”. Further, any “slump sale” presupposes presence of “lump sum consideration” and in absence of consideration, it could not tantamount to “slump sale”. Therefore, provisions of section 50B which deal with computation of capital gains in case of a “slump sale” did not have any applicability.
(vi) Exemption u/s 47(iii) of the ITA
Voluntary transfer of property by any person without any consideration is permissible by a corporate entity provided that such an act is permitted by the company’s Memorandum of Association. Further, it is not a prerequisite that a gift can only be made between two natural persons. Therefore, the transfer of Undertaking by ABTL without consideration would squarely fall within the ambit of “gift” and exemption u/s 47(iii) of the ITA would be applicable and the said transaction would not be subject to tax as capital gains.
(vii) Exemption u/s 47(v) of the ITA
In the factual matrix of the present case, since ABTL had transferred the Undertaking to its 100% Indian holding company, the exemption u/s 47(v) should squarely be applicable and such transfer should not be subject to tax as capital gains.
Paving the Way Forward…
This judgment of the Mumbai ITAT has dealt with many legal nuances. This judgment could serve as an important precedent for internal corporate reorganizations.
For instance, in case of a slump exchange, where the consideration is discharged in the form of issue of shares for transfer of undertaking, the cost of acquisition of the undertaking as a whole is not determinable in absence of specific computation mechanism. Therefore, since one of the key elements for computation of capital gains, being cost of acquisition would be absent, this could lead to non-taxability of slump exchange. Similar view was taken by the Bombay High Court in the case of Bharat Bijlee Ltd. [TS-5680-HC-1997(BOMBAY)-O]
Similarly, in case where shares of a company are transferred by one corporate entity to another without any consideration, then subject to applicability of section 56(2)(viia) of the ITA in the hands of the recipient, such transfer should not result in taxation under the head capital gains in view of specific exemption u/s 47(iii). Further, the Revenue Authorities would not have the authority to tax such transaction on the basis of a hypothetical consideration u/s 50D since this would be a case of NIL consideration.
While a host of judicial precedents were available on each facet of law, this judgment provides a combined analysis of all the facets and provides even more certainty on corporate restructurings. This judgement should be paving way for many such transactions witnessed recently in infrastructure and telecom sector undertaken by various conglomerates. This judgement confirms validity of various steps in the Scheme, however, in light of anti-abuse provisions in the form of GAAR kicking from 1 April 2017, it would be interesting to see how the revenue authorities look at similar transactions undertaken thereafter.