Mergers and Acquisitions Alerts

10 June 2020

Where there are varied aspects covered in a scheme and NCLT has approved the scheme as a whole, no separate procedures or approvals to be sought in respect of the actions under the scheme. However, the accounting treatment mentioned in the scheme cannot override the prescribed treatment under applicable Accounting Standards.

Facts of the case:

• The Transferor Companies and the Transferee Company (collectively referred to as ‘Petitioner Companies’) were part of the same group with common shareholders. Transferor Companies were proposed to be amalgamated with the Transferee Company.

• Of the Transferor Companies, Shriram Chits (Maharashtra) Limited (‘Transferor Company 2’) is within the jurisdiction of NCLT, Mumbai Bench and Shriram Chits (Karnataka) Private Limited (‘Transferee Company’) is within the jurisdiction of NCLT, Bengaluru Bench.

• The other Transferor Companies i.e., Shriram Chits Private Limited is within the jurisdiction of NCLT, Hyderabad Bench and Shriram Chits Tamil Nadu Private Limited is within the jurisdiction of NCLT, Chennai Bench.

• As part of and upon the sanctioning of the Scheme, in relation to the Transferee Company, it was proposed to change the name from its current name to ‘Shriram Chits (India) Private Limited’ and to shift the registered office to Tamil Nadu. It was also proposed to increase the authorised share capital to facilitate issue of equity shares under the Scheme. Further, the accounting treatment in the Scheme mentioned that any differences arising due to difference in accounting policies of the Petitioner Companies, will be adjusted in the General Reserve of the Transferee Company.

• On perusal of the Scheme, the Regional Director in his report, inter alia, raised the following observations:

─ Any differences in accounting policy between the Transferor Companies and the Transferee Company, to be quantified and adjusted in the Capital Reserve of the Transferee Company, instead of General Reserve;

─ In relation to the change of name and shift of registered office of the Transferee Company, Petitioner Companies have to undertake to comply with section 13 of the Companies Act, 2013, read with Rules 29 and 30 respectively of the Companies (Incorporation) Rules, 2014;

─ In relation to increase in authorised share capital, the NCLT may pass orders to comply with section 61, read with section 13, section 64 and other sections of the Companies Act, 2013.

Held by NCLT Mumbai Bench:

In respect of accounting treatment in the Scheme:

• The Ministry of Corporate Affairs (‘MCA’), vide notification dated 30th March 2016 , inserted a footnote to paragraph 23 of AS-14 to the effect that “Paragraph 23 shall not apply to any scheme of amalgamation approved under the Companies Act, 2013”, thereby concluding that treatment of reserves in a scheme of amalgamation is now mandatorily to be followed, and the accounting treatment prescribed in a scheme cannot override the provisions of paragraph 23 of AS-14.

• Thus, the Scheme cannot be contrary to any law in force, and the Accounting Standards issued by the Institute of Chartered Accountants of India (ICAI) have the effect of law under section 133 of the Companies Act, 2013.

• Further, this is a scheme involving multiple jurisdictions such as the NCLT’s Benches and each Bench looks at the Scheme as an integrated whole, rather than segregate it into parts with which the particular Bench is concerned. Therefore, the arguments of the learned counsel for the Transferor Company 2, that the accounting treatment prescribed in the Scheme is a matter that NCLT Bengaluru alone should be concerned with, is untenable.

• However, upon the Scheme being sanctioned, Transferee Company alone will be concerned with the accounting entries to be made, which is not within the jurisdiction of NCLT Mumbai Bench. Accordingly, the Transferee Company being within the jurisdiction of NCLT Bengaluru Bench, the NCLT Mumbai Bench did not wish to express any opinion in this matter.

In respect of change in name, shift of registered office and increase in authorised share capital:

• It is now settled law that the provisions to schemes of arrangement are a complete code in themselves, and the separate procedures prescribed for change of name, change of registered office, reduction of capital, etc., under other provisions of the Companies Act are not required to be followed if they are effected as part of the Scheme itself.

• It is also settled law that approval by the members to the Scheme should be treated as approval also under other provisions of the Companies Act. However, certain procedures may be required to be followed consistent with the requirements of the MCA-21 programme, so as to ensure that the changes are effected in the registry maintained by the Registrar of Companies and accordingly, Transferor Company 2 to undertake to abide by all procedural compliances required in this regard.

Conclusion:

Accounting Standards have the effect of law under the Companies Act, 2013 and the accounting treatment in a scheme cannot override provisions of the law.
Further, the NCLT’s view makes it sufficiently clear that an order sanctioning a Scheme is a single window clearance and a complete code in itself. Therefore, once the NCLT approves a scheme, no separate procedure is required. While there might be some procedures required to be followed, the view adopted by the NCLT in the instant case does not impel compliance of separate procedures as long as they are effected as a part of the Scheme. However, certain steps will be required to be undertaken to update the MCA records.
 

4 March 2020

Recently AAR vide an order delivered on 17 February 2020 rejected application filed u/s 245Q of the Income-tax Act, 1961 (Act) denying India-Mauritius treaty benefit on capital gains arising on stake sale in an Indian company

Brief facts of the case:

• M/s Bid Services Division (Mauritius) i.e. BSDM or the applicant, is a Mauritius-based private company, incorporated on 23^rd August 2005. BSDM holds a valid Tax Residency Certificate (TRC) issued by Mauritius Revenue Authority (MRA).
• The applicant is wholly-owned subsidiary of Bidvest Service Division (Proprietary) Limited (BSDPL), South Africa. The ultimate holding company is Bidvest Group Limited (BGL or Bidvest), incorporated and listed on South African stock exchange. The effective control and management of the applicant company is situated in Mauritius.
• Airport Authority of India (AAI) selected the applicant in consortium with GVK Airport Holdings Private Limited (GAHPL) and ACSA Global Limited (AGL) as joint venture (JV) partners of Mumbai International Airport Private Limited (MIAL), a company incorporated in India for undertaking development, operation and maintenance activities (OMDA). Shareholders and OMDA agreement was entered between AAI, MIAL and consortium on 4th April 2006.
• The shareholding pattern of MIAL is as under:

• The applicant entered into a Share Purchase Agreement (SPA) with GAHPL and GVK Industries Limited (GVK) on 1^st March 2011 for transfer of its 13.5% stake in MIAL to GAHPL for purchase consideration of US$ 231 million.
  

Issues for consideration:

The applicant sought ruling on whether gains arising from the transaction of sale of shares to GAHPL pursuant to the SPA would be liable to tax in India having regard to the provisions of Article 13(4) of the India-Mauritius Double Taxation Avoidance Agreement (DTAA).

Key contentions of the taxpayer:

• Revenue authorities cannot question the tax residency status of the taxpayer, as long as the TRC issued by the Mauritian authorities is in existence. Reliance was placed on Circular No 682 and 789 dated 30 March 1994 and 13 April 2000, respectively, issued by the Central Board of Direct Taxes (CBDT) wherein it was clarified that certificate of residence issued by the Mauritian authorities will constitute sufficient evidence of residence as well as beneficial ownership for applying provisions of the DTAA.
• Reliance was also placed on various judicial precedents including Azadi Bachao Andolan¹, E Trade Mauritius Ltd, AAR ruling in the case of D.B.Zwirn Mauritius Trading No. 3 Limited and Ardex Investments Mauritius Ltd, to support the above contentions. Further, reliance was placed on the apex court’s decision in case of Vodafone International Holdings B.V. where the apex court observed that in absence of Limitation of Benefit clause in the India-Mauritius treaty and in view of presence of CBDT Circular no. 789 of 2000 and TRC, the benefits of tax treaty shall be granted at the time of sale/divestment/exit.

• In view of all above decisions and facts of the case, capital gains arising on account of sale of shares of MIAL to GAHPL would not constitute income chargeable to tax in India in view of Article 13(4) of the India-Mauritius DTAA.

• It is general commercial practice on the part of any MNC to be the face of the bid for large and complex projects, so as to highlight the financial and technical competency of the group as a whole. However, while investing in various projects, separate companies i.e. special purpose vehicles (SPVs) are formed for commercial reasons such as for hedging business, geopolitical and economic risk, mobility of investment, ability to raise loan from diverse investments, valuation from growth perspective, tapping global funds etc.

• BSDM was incorporated in Mauritius for commercial reasons as the group was already operating in Mauritius through another entity.

• Without prejudice to other arguments, the beneficial provision of the India-Mauritius treaty cannot be denied in absence of any provision limiting the benefit of the DTAA (as are applicable in the DTAA with the USA or with Singapore) or the provisions of Chapter X-A being in force.

• Section 93 of the Act applies to tax income arising out of transaction, which residents may undertake to externalise the assets, while continuing to enjoy the rights over such income or assets.

• Relying on the observations in the case of Vodafone International Holdings, it has submitted that incorporation of the Mauritian company, immediately prior to investment in the Indian company should not be regarded as an investment for the purposes of tax avoidance and the treaty benefits have been granted in number of cases.

Key contentions of Revenue authorities:

• The AAI had issued an ‘Invitation to Registrar an Expression of Interest’ (ITREOI) on 17 February 2004. In response to the AAI’s ITREOI, the GVK-SA consortium filed its EOI on 20th July 2004. GVK partnered with SA Airport Operators (SA). SA is a JV of three entities viz. ACSA, Old Mutual Life Assurance Company (South Africa) Ltd (Old Mutual) and the BGL.
• The GVK-SA consortium did not include BSDM (i.e. Mauritius entity) as one of the members during the bidding process but brought in just before filing of Technical and Financial bid (TaF). In fact, BSDM was incorporated just two weeks prior to the submission of binding bid by GVK- SA consortium. No prior approval was taken by the consortium regarding substitution of BGL with BSDM, at any stage, before the submission of the bid.
  
• Other arguments taken for supporting no treaty benefit:

- For undertaking project efficiently, Mumbai or South Africa could have been best alternatives. Only advantage of Mauritius was to avail tax benefits.

- Inclusion of BSDM lacked commercial substance and bona fide business purpose, but was clear design to avoid paying legitimate tax to the Indian government; Based on analysis and invocation of Section 93, capital gains arising is deemed as income in the hands of the ultimate holding company. BGL acquired the rights by virtue of which it has the power to enjoy income of non-resident BSDM. BGL had full powers to take decisions on the utilisation of the income received or receivable by BSDM;

- Out of four directors of BSDM, two Mauritian directors had no real powers and the other two common with its holding company, represented BGL. They were citizens of South Africa;

- Parent gave commitment to provide funds needed by BSDM;

- BSDPL received loans / advances from Bidvest and BSDM received loans / advances from BSDPL;

- Reference to judgements² where courts have looked into the substance of a transaction if it can be established that the transaction is a sham.

• As per the India-South Africa DTAA, the capital gains on share sale is taxable in India. If BGL was not interposed, the Bidvest group would have to pay capital gain tax in India on the share sale transaction. The shares of JV were bought in the name of applicant though the beneficial owners were the holding companies in South Africa. There is clear misuse of the treaty and hence treaty benefit should be denied. 

Ruling by the Authority:

• AAR considered the arrangement as mere routing of funds of Bidvest group to Mauritius. It considered BSDM as a shell company incorporated just few days prior to transaction without any tangible assets, employees, office space etc. BSDM had no management experts or financial advisers on its payroll or on hire. Further, Mauritius unlike London or New York, is not a known financial centre or a vibrant business hub from where capital can be sourced at cheaper rates or top-quality professional engineers / consultants could be employed.

• The applicant is unable to provide economic, commercial rationale for interposing of entity such as hiring finance professional for arranging finance, have collaterals for raising finance, provide meeting ground where active discussions could take place, etc. It didn’t even discuss critical needs of project in the Board meeting.

• The shares of the joint venture were bought in the name of applicant though the beneficial owners were the holding companies in South Africa. The applicant kept on noting and endorsing decisions of the holding company in the Board meetings without any contribution or discussion about the decision making process. Merely holding of TRC cannot prevent an enquiry if it can be established that the interposed entity was a device to avoid tax.

• BSDM has no independent sources of funds or sources of income nor has any fiscal independence. All the funds are with the holding companies. The applicant has no tangible assets, business activities except for owning the shares of the JV. Subjecting the facts to various tests - fiscal nullity test, commercial / business substance test, look-at principle test, investment participation test, time duration test, business operations period in India test - the applicant fails the tests being a tax avoidance device where the dominant purpose of interposing is to avoid taxes in India.

• Considering the facts in totality and discussed in preceding paras, AAR did not see any commercial or economic rationale or ease of doing business in incorporating the applicant in Mauritius and interposing it in the JV. It observed that once it is established that the Mauritian company is interposed as a device, it is open to the tax department to discard the device and take into consideration the real transaction between the parties.

• AAR held that the applicant is not entitled to benefit under Article 13(4) of Indo-Mauritius DTAA.

Comments:

• In the context of availing the capital gains exemption under the India-Mauritius DTAA, the position that the exemption can be claimed by merely producing the TRC issued by the Mauritian authorities, is well established by the CDBT Circular as well as by a series of judgements of the Supreme Court and AAR. In this ruling, while the AAR has acknowledged this principle, it has also observed that exceptions are possible in certain situations such as interposing entities as a tax avoidance device.
• Revenue authorities have conducted a detailed enquiry into the purpose, board, funding, assets, timing etc. while determining eligibility to tax treaty. Taxpayers will be well advised to consider this while determining eligibility to tax treaty benefits. 

¹Union of India vs Azadi Bachao Andolan (2003) (263 ITR 706) (SC); E*Trade Mauritius Ltd. (AAR No. 826 of 2009) (2010); D.B. Zwirn Mauritius Trading (AAR No. 878 and 879 of 2010) (2011); Ardex Investments Mauritius Ltd., In Re (AAR No.866 of 2010) (2011); Vodafone International Holdings B.V. vs. Union of India (2012) 17 taxmann.com 202

²Consolidated Finvest and Holdings Ltd [2014]; CIT v Wipro Ltd [2014]; DIT v Copal  Research Ltd., Mauritius [2014]; CIT v Panipat Woolen and General Mills Co. Ltd [1976]; AAR ruling of Seedworks Holdings Mauritius [2017]; Vodafone International Holdings B.V. vs. Union of India (2012) 17 taxmann.com 202

3 January 2020

Ahmedabad bench of the honorable NCLT vide an order delivered on 19 December 2019 rejected petition¹  filed u/s. 230 and 232 r.w.s. 234 of the Companies Act, 2013 (Act) for an outbound demerger involving transfer of pecified undertakings of the demerged company to overseas resulting companies.

Background:

• Sun Pharmaceutical Industries Limited (SIPL / Demerged Company) filed a petition u/s. 230 and 232 r.w.s. 234 of the Act with the NCLT seeking its sanction to a scheme of arrangement in the nature of demerger and transfer of two specified investment undertakings (including equity instruments, debt instruments and loans and advances) of SIPL, on a going concern basis, to its two overseas resulting companies, viz. Sun Pharma (Netherlands) B.V., Netherlands and Sun Pharmaceutical Holdings USA Inc., USA (collectively referred to as the ‘Resulting companies’).
• The Resulting companies are direct / indirect wholly owned subsidiaries (WOS) of SIPL and thus no shares were to be issued or no consideration was payable by the resulting companies pursuant to the demerger. The Resulting companies were holding strategic investments in overseas operating companies and were authorised to undertake financial activities. The Scheme was proposed with an objective to consolidate the holding structure of the overseas direct and indirect WOS of SIPL. 
• The Scheme of arrangement envisages cross border arrangement. Thus, SIPL complied with the provisions of Section 234 of the Act and Foreign Exchange Management (Cross Border Arrangement) Regulations, 2018²  (RBI Regulations) and submitted a compliance certificate to that effect. As per Rule 9 of the RBI Regulations, the above-mentioned compliance tantamount to deemed approval from the RBI. Further, RBI sent a letter to SIPL in which neither any opinion nor any objections were raised by the RBI to the Scheme.
• SIPL also undertook other required compliance as required under the provisions of the Act and as directed by the NCLT. 
• While perusing the Scheme, Regional Director (RD) made an observation that Section 234 of the Act refers only to cross border mergers and amalgamations and that the same does not refer to ‘Demergers’. In reply to the observation, SIPL submitted that provisions of Section 234 are applicable to the Scheme of Arrangement (either in the nature of a merger / demerger) and the Company has thus complied with the applicable rules framed under the RBI Regulations. SIPL referred to judgment delivered by the NCLT in the case of CP (CAA) 90 of 2018.

Issues for consideration:

• Whether provisions of Section 234 of the Act refer to ‘cross-border demerger’?

Ruling of the National Company Law Tribunal:

• NCLT observed that provisions of the Section 230 and 232 of the Act (which relate only to the Indian companies), contain the word ‘compromise’ and / or ‘arrangement’ which is inclusive of the term ‘demerger’. However, Section 234 (which relates to the cross border mergers of Indian companies with foreign companies and vice versa) mention only about the words ‘merger’ and / or ‘amalgamation’ and do not seem to contain the words ‘compromise’ and / or ‘arrangement’ and / or ‘demerger’. Thus, it can be said that provisions of Section 234 of the Act do not provide for (or rather restrict) the demerger from Indian company(ies) into foreign company(ies).
• NCLT further observed that rule 25A of the Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 provides detailed procedure and requirements for cross border mergers. However, it is silent on ‘demerger’ and mentions only ‘mergers’ and ‘amalgamations’.
• It was further stated that the draft RBI regulations defined ‘cross border merger’ to mean any merger, demerger, amalgamation or arrangement between Indian company(ies) and foreign company(ies), in accordance with Companies (Compromises, Arrangements and Amalgamations) Rules, 2016 notified under the Act. However, when the final RBI regulations were notified, the term ‘demerger’ was specifically deleted / excluded from the definition of ‘cross border merger’. Thus, it is crystal clear that the term ‘demerger’ was intentionally removed from draft regulations and it was not to be allowed in the cases of cross border mergers of the Companies with foreign companies.
• Considering the above observations, the NCLT held that Section 234 of the Act does not permit ‘cross border demergers’ as mentioned by the RD. NCLT further said that the function of the court is to administer the law and not to legislate it. If any provisions of law is clear beyond all ambiguity, it is to be implemented regardless of the fact that it causes hardship to a particular party.
• NCLT further mentioned that although the doors have now been opened for Indian companies for outbound mergers, the law is still silent on cross border demergers. While it was possible for a foreign company to transfer its undertaking / business to an Indian company under the erstwhile Act, as Section 394 applied to demergers as well as merger, Section 234 of the Act only refers to ‘mergers and amalgamation’ without any express mention of ‘demergers’.

Comments:
This ruling is first of its kind in case of cross border arrangement and it would be interesting to observe the future approach of other benches of NCLT / NCLAT.
Considering that the current government is keen on taking measures for improving the ease of doing business in India, it would also be interesting to observe the approach of the government / regulators and whether they will consider amending the provisions to facilitate outbound merger.

¹ CP (CAA) No. 79/NCLT/AHM/2019 in CA (CAA) No. 38/NCLT/AHM/2019

² Guidelines issued by the Reserve Bank of India (‘RBI’) vide Notification no. FEMA. 389/20118-RB dated 20 March 2018