Rajasthan High Court - Jaipur
Unknown vs Calcutta Discount Company Limited on 12 February, 2016
Author: Alok Sharma
Bench: Alok Sharma
IN THE HIGH COURT OF JUDICATURE FOR RAJASTHAN AT JAIPUR BENCH ORDER 1. S.B. Company Petition No.14/2012 In the matter of Uma Enterprises Private Limited 2. S.B. Company Petition No.19/2012 3. S.B. Company Petition No.20/2012 4. S.B. Company Petition No.21/2012 5. S.B. Company Petition No.22/2012 6. S.B. Company Petition No.23/2012 7. S.B. Company Petition No.24/2012 8. S.B. Company Petition No.25/2012 9. S.B. Company Petition No.26/2012 10. S.B. Company Petition No.27/2012 Date of Order: February 12, 2016. PRESENT HON'BLE MR. JUSTICE ALOK SHARMA Mr. Gunjan Pathak, for the petitioner company. Mr. R.D. Rastogi, Addl.SG with Mr. Ashish Tiwari, for the Union of India. Mr. Mukesh Meena, for Regional Director. Mr. Amol Vyas, for respondents. BY THE COURT:
These petitions came up on second motion under Section 391-394 of the Companies Act, 1956 (hereinafter `the Act of 1956') read with Rule 57 of the Company Court Rules, 1959 (hereinafter `the Rules of 1959') seeking sanction of the scheme of de-merger of Uma Enterprises Private Limited (hereinafter `the company') into nine resultant companies aside of demerged company as approved and adopted by the shareholders and creditors of the company so as to be binding on all concerned.
The facts of the case are that the company applied to this court at the first motion for holding of meetings of its shareholders and unsecured creditors for considering and if thought for approving with or without modifications the demerger of the company as proposed. Vide order dated 31-5-2012 it was directed by the court that meeting of shareholders and unsecured creditors of applicant company be convened and held at its registered office on 30-6-2012 under the chairmanship of Ms.Pallavi Mehta and Mr. Rachit Sharma respectively. In the consequent meetings as directed by this court, the scheme of demerger was approved and adopted at the meetings of 30-6-2012 and reports of Chairpersons of the meetings as appointed by the court submitted to the court. Hence this application on the second motion seeking sanction of the approved scheme of de-merger.
Notices were issued by this court on 26-7-2012 to the Regional Director, Ministry of Corporate Affairs. Publication of notices in two newspapers, one English, the other vernacular, as directed was done on 2-9-2012. Copies of notices published in the newspapers have been filed before this court.
The company Uma Enterprises Private Limited was incorporated under the Companies Act, 1956 on 23-10-1973. It engaged in the business of production, processing and sale of edible oils and other related activities. The Company owns 40,400 sq. meters of land. Under the scheme of de-merger under consideration the shareholders and creditors of the company have approved transfer 26023 sq. meters of its land purportedly the nine real estate divisions of the company to nine resultant companies, each of which will then work independently for enhancement of shareholders' value. Counsel for the petitioner has submitted that the scheme of de-merger was necessitated for reason of compulsion of implementing family arrangement between the shareholders of the company who are all related. The de-merger as approved at the meeting of the shareholders and creditors will facilitate continuing cordial relations within the extended family and promotors of the company. Each branch of the family will have an independent right to operate the respective resultant companies coming to its control and conduct business operations relating thereto with their own vision and determination. The arrangement envisaged eschews potential defences and dispute in the future between the extended members of the family, all shareholders in different measure in the applicant company. It has been submitted that the scheme of de-merger will also facilitate proper management, focus on core businesses to advance the interest of the shareholders by each of the resultant demerged and resultant companies. It has been submitted that total value of land in the ownership and possession of the company as per its books is Rs.2,43,051 of which a sum of Rs.75,000/- is constituted of capital expenditure towards development work on the company land by levelling it and redying it for real estate business. Subsequent to the de-merger/ hiving out of 26023 sq. meters under the real estate division into the nine resultant companies, land value of de-merged company will be Rs.73,727/-. It has been contended that the scheme of de-merger is in compliance of all laws and this court on a second motion moved under Sections 391-394 of the Act of 1956 having only supervisory jurisdiction confined to ensuring that the scheme is fair, reasonable, just and not contrary to public interest, should sanction the scheme.
On receipt of notice, the Regional Director, North Western Region Ministry of Affairs has filed four affidavits on 13-5-2014, 25-11-2014, 26-1-2015 and 24-2-2015 and opposed the sanctioning of the scheme of demerger approved by the various stakeholders as required under the Companies Act and set up before this court. Mr. R.D.Rastogi, Additional Solicitor General appearing for the Regional Director has submitted that the de-merger scheme of which sanction is sought is evidently a sham and a mere ruse to convey the company's land to third parties circumventing liability towards capital gains under the Income Tax Act, 1961 (hereinafter `the Act of 1961') and stamp duty under the Rajasthan Stamp Act, 1998 (hereinafter `the Act of 1998'). It is in a clear attempt to evade taxation and is against public interest, submitted counsel, and if it is sanctioned would cause huge loss to the public exchequer amounting to crores of rupees on account of stamp duty and capital gains tax. It was pointed out that 26023 sq. meters of valuable land with market price of over Rs.1 lac per meter is worth Rs.260 crores odd but is being transferred on face value of Rs.1.61 lacs under the colour of the demerger scheme. It was submitted that the purpose and intent of the de-merger scheme is not so much efficacy of existing businesses or enhancement of shareholder value by transferring an ongoing concern/ undertaking/ division of the company for better results but to circumvent the laws of the land and use of this court as a medium to solely advance private interest of the promoters and shareholders of the company to public detriment of lost revenues. It was submitted that under the purported scheme of demerger 26023 sq. meter of land in a posh area of Jaipur Metropolitan is sought to be transferred to independent entities for a face value of Rs.1.69 lac whereas its market value at a conservative estimate of Rs.1 lac per sq. meter i.e. Rs.260 crores. The device adopted by the applicant company through abuse of the benefits of the statutory provisions of Sections 391-394 of the Act of 1956 will bring about loss of about 50 crores to the revenue on account of capital gains and about Rs.15 crores on account of stamp dutyall to the detriment of public interest. Collection of due tax is the highest public interest. The Addl. Solicitor General has also submitted that the scheme of de-merger is also malafide founded as it is upon incorrect statement of facts as to the existence of real estate division in the company as an ongoing concern/ undertaking/ division. It has been submitted that no real estate business at any point of time has been carried by the company as evident from the fact that no turnover, income or expenditure from the said business from the very inception of the company in 1973 is reflected in its annual financial statements as apparent from the balance-sheet as of 31-3-2012. It has been submitted that the Tax Audit Report dated 11-9-2013 and 19-9-2014 also shows the applicant company only engaged in the manufacturing activity and sale of vanaspati and edible oils. The Addl. Solicitor General then pointed out that no land has been shown in the inventory of the company in its books under the head of current assets as required if the purported real estate business of company was operational as a going concern. Even in the return of 2014-15 the applicant company's land has been shown as Fixed Assets. It has been submitted that the purported capital expenditure of Rs.75,000/- towards levelling of applicant company's land post 2010 is fraudulent as when asked for vouchers in respect thereof only a plain paper of purported expenses unsigned and unpaid was presented where oddly the contractor engaged asked not to be paid but instead for a credit in respect thereof to be reflected in the books of the company. It was submitted that this nebulous suspect entry as a capital expenditure on the company's land on account of its alleged levelling cannot be taken as a commencement of the company's real estate business or creation of real estate division/s. It was submitted that the process of this court is sought to be mis-utilised as are the salutary provisions of Section 392(2) read with 394 of the Act of 1956 by camouflaging the conveyance of the company's land as a demerger solely to avoid the taxation events which would otherwise follow in the ordinary course of law in respect of a conveyance. It was further submitted that the scheme of de-merger of which sanction is sought being a sham is also buttressed by the fact that the proposed de-merger does not fall within the ambit of Section 2 (19AA) of the Income Tax Act, 1961 and Explanation I thereto. According to the Additional Solicitor General the explanation aforesaid provides that a de-merger can be brought about only by way of transfer of an undertaking or any part thereof or a unit of an undertaking or a business as a whole, and when the holder of equity shares in the demerged company have similar interest in the resultant company/s. It has been submitted that from the facts on record, specifically the company's own balance-sheet as also its profit and loss account, and turnover, no real estate undertaking obtained in the company's business since its inception which could be de-merged under the Income Tax Act, 1961. It has been submitted that public policy would not allow the court's discretion being exercised to allow a demerger under Section 392(2) read with 394 of the Act of 1956 in the cross hair of an existing law. It has been submitted that what is proposed/ approved by the shareholders in the de-merger scheme before this court is that bare land be transferred to resultant companies. It has also been emphatically submitted that while in a genuine scheme of demerger, the shareholders of the demerged company are allotted shares in the resultant company, oddly in the instant case contrary to general practice, the shareholders of the demerged company are to be allotted under the scheme only non-cumulative compulsorily redeemable preference shares and not equity shares, thus clearly separating them from ownership/ interest in the resultant companies. This clearly establishes that the demerger is not a bonafide restructuring but a sale of assets under a device to circumvent tax liability.
Per contra, Mr. Gunjan Pathak, counsel for the petitioner company has submitted that the scheme of de-merger is in compliance with all operative laws and fully within the legal frame work of the Companies Act, 1956. If any taxation event under the Act of 1961 or the Act of 1998 attracts to the demerger sanctioned by this court, law will take its own course. It was then submitted that if the de-merger scheme entails saving of capital gains, tax or stamp duty, it is of no consequence. Counsel submitted that the Apex Court has constantly held that where a scheme of arrangement under the Act of 1956 does not violate any provision of law, the mere suspicion of alleged avoidance of tax cannot be a ground for not sanctioning the scheme, otherwise lawful and valid. Referring to the judgment in case of CIT West Bengal Vs. Calcutta Discount Company Limited, [1974)3 SCC 260] it has been submitted that an assessee is free in law to arrange his/ its affairs with intent to minimise the tax burden. It has been submitted that the applicant company has a real estate business as would be evident from the fact that it expanded Rs.75,000/- as recorded in its books of account as capital expenditure towards levelling the company's land. Counsel submitted that where expenditure is revenue or capital is a matter of identification by the statutory auditor of the company who is fully competent and authorised to comment and qualify the expenditure. It has been submitted that Rs.75,000/- having been described by the statutory auditor of the company as capital expenditure, and so accepted by the Income Tax Department, it does not lie in the mouth of the Regional Director to argue to the contrary that the company is not engaged in any real estate activity of which it is seeking de-merger. It has been further submitted that for the commencement of a business mere intention to do so suffices and no rule, regulation or law applicable to a private limited company has been cited by the Regional Director to show it is as the company's obligation to disclose the factum of commencement of a business in its financial statements. It has been submitted that in the year 2010 a resolution was passed at the extraordinary meeting of shareholders of the company duly convened to approve as the company's other objects commencement of real estate business on the land available with it. The resolution was approved and on 4-6-2010 whereby the company adopted clause 9, 10, and 11 of part C of III in the Memorandum of Association of the company in this regard. The aforesaid clauses relate to business activities which the company was authorised to carry out in the interest of its shareholders. On the issue of compulsorily redeemable preference shares related to the demerged company by the resultant companies as proposed in the scheme of de-merger to which objection was taken by the Regional Director as indicative of the scheme being that of transfer of land and not of a de-merger of a unit/ division of the company, it was submitted that the issue of preference shares in lieu of equity shares in a case of de-merger of a company is a matter of practice and does not in any way render the proposed scheme of de-merger illegal or fraudulent.
I have perused the scheme of de-merger approved and adopted by the shareholders and unsecured creditors of the applicant company and heard counsel for the petitioner company as also the Additional Solicitor General for the Regional Director.
The jurisdiction of a company court in sanctioning a scheme of arrangement by way of amalgamation or de-merger is well delineated under Sections 391 to 394 of the Act of 1956 and profusely expounded in a catena of judgments of the Apex Court and this Court. It is well settled that the scheme of arrangement under Sections 391-394 of the Act of 1956 is fundamentally a commercial document based on the commercial wisdom of the shareholders and creditors of the company. The company court cannot sit in judgment thereof on merits as if in appeal and seek to evaluate the scheme meticulously prior to grant of sanction. That however is not the end of the matter or the complete statement of law. For it is equally well settled that the sanction of the court under sections 391(2)-394 of the Act of 1956 is not to be mechanically granted on the mere askance as if the court were a mere rubber stamp. The company court has to wisely exercise its discretionary jurisdiction vested in it to sanction the scheme, having regard to various aspects such as considering the background and material facts of the case, determining the good faith and foundation of scheme under consideration, ascertaining the purpose of scheme, ensuring that it is not prejudicial to the public interest, that it does not violate any provision of law rendering it contrary to public policy and is not a mere device to evade tax. The scheme should be bonafide to advance business efficacies and shareholders interest without compromising public interest. It should not be a ruse to indirectly achieve what is prohibited in law. It is within these parameters that the objections to the sanction of scheme by the Regional Director have to be considered.
It is quite apparent from the facts on record that ever since its inception in 1973, the company has been only engaged in the business of manufacturing and sale of vanaspati and edible oil. It is indeed true that in the year 2010 the object clause of the company as disclosed in its Memorandum of Association was amended to include among the company's other objects real estate business. However, as submitted by the Additional Solicitor General it is manifest that the company did not carry out any real estate activity as neither was such activity reflected in its books of accounts by way of turnover, income and profit therefrom nor for that matter was the land of the company included in inventory under the head of Current Assets warranted under applicable Generally Acceptable Accounts Principles (hereinafter 'GAAP') for real estate businesses. As per the tax audit report even upto 19-9-2014 the company has at all times only engaged in the business of manufacturing and sale of vanaspati: edible oil and not in the business of real estate. No separate assets or liability of the purported real estate business has been shown. And these facts were not disclosed in the application for sanction of the scheme. Instead, what was given out is that the company seeks to de-merged its real estate divisions as if the real estate business was operative and a going concern.
I am unable to accept the contention of counsel for the petitioner that the mere intent to commence the business of real estate and the purported expenditure of Rs.75,000/- debited to the capital account towards levelling of land constituted commencement of business to bring it within the scope of Section 2 (19AA) of the Income Tax Act, 1961 and allow for a demerger. I am of the considered view that in the facts obtaining it cannot be held that the company had an operative real estate business or undertaking, which is a prereqisite for a de-merger under the law of the land. It cannot be disputed that while sanctioning a scheme the court in the exercise of its jurisdiction under Section 391(2) read with 394 of the Act of 1956 cannot negate other laws as it would be plainly contrary to public policy to do so. In the circumstances the sanction of the scheme of de-merger as sought, as rightly argued by the Addl. Solicitor General appears to be a mere device to avoid tax capital gains and stamp duty which would be otherwise leviable in the event of the land of company otherwise being transferred to a third party. The compulsorily redeemable preference shares in lieu of equity shares being allotted by the resultant companies to the demerged company is further indicative of the arrangement/ demerger under consideration being a plain transfer of land not a restructuring of the applicant company. An important criterion for restructuring of a company as by way of demerger is that the same persons carry on the business restructuring. This is not the case as holders of non compulsion compulsorily redeemable preference shares have no rights in the business or its management but only right to dividends. Even though it is correct to contend that mere suspicion of alleged avoidance of tax and stamp duty cannot entail holding the scheme under Sections 391(2)-394 as unlawful/ invalid, yet the fact remains that where a scheme under sections 391-394 appears to have been formulated, approved and adopted by the shareholders solely with the intent to avoid tax and is without any evident fundamental purpose for the benefit of the shareholders and efficacies of a restructured business, it would tantamount to a sanction being sought contrary to public interest owing to which it cannot and ought not to be sanctioned. The Apex Court in the case of M/s. Macdowell and Company Limited Vs. Commercial Tax Officer [(1985)3 SCC 230] has held that though tax planning may be legitimate within the frame work of law, yet colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by dubious methods. It was further held that it is the obligation of every citizen to pay taxes honestly without resorting to subterfuges as there is behind taxation laws as much moral sanction as is behind any other welfare legislation. It was then held that where a transaction is a device to avoid tax, more so by resort to judicial process to accord approval thereto, it cannot be countenanced and it is upto the court to take stock to determine the nature of the device, to expose the device for what it really is and to refuse to give it judicial benediction.
The Gujarat High Court in the case of Wood Polymer Limited [(1977) 109 ITR 177 (Guj.)] has held that if the object of a scheme of amalgamation (and by extension demerger) is just to defeat tax provisions it would be against public interest to approve it and hence should not be approved by the court. The Court in the aforesaid case delineated the concept of public interest in company law holding that rampant laissez faire was not countenanced under the Act of 1956. Instead the Act of 1956 also very consciously provided for regulation of companies in public interest, inasmuch as in several fields even the joint will of the management and the stake-holders has to reckon with public policy. It was held that all taxes are levied by the State in public interest and where a citizen/ corporate seeks to circumvent its obligation to pay taxes by subterfuges and even misuse and abuse of salutary provisions dehors their context and purpose, the enterprise should not be promoted by the court. In the context of amalgamation and public interest considerations for sanction thereof it was held by the Gujarat High Court in its opinion that the scheme of amalgamation must accordingly fulfill some felt needs, some objects and it must have some correlation to public interest. If the only purpose behind the scheme is defeating tax obligations and prior to the arrangement a phoney situation is created wholly unreal for milking the enabling provisions of law it would distinctly establish appear that the provisions of such a scheme were sought to be utilised for the avowed object of defeating tax liability.
On consideration of the second motion, submissions of counsel for the petitioner company and the counsel for the Regional Director, with reference to facts of the case, I am of the considered view that the sanction to the scheme of de-merger as sought by the petitioner company cannot be granted. The company does not appear to have had any real pre-existing real estate division since its inception. It is evident that the petitioner company was all along engaged in the business of manufacturing, processing and sale of vegetable oil alone. As evident from the facts on record no income or profit and loss on account of real estate business has been reflected in books of accounts of the company. The land of the company also has not been shown in the inventory under the head of current assets of the petitioner company as it would have been and warranted by the General Accounting Principles, if the company indeed had a real estate business. A bare look at the explanation to Section 2(19AA) of the Income Tax Act, 1961 makes it manifest that for a demerger a pre-existing undertaking is a prerequisite. That pre-requisite is found absent in the facts of the instant case. To sanction the scheme of demerger of purported (not real) and non-functional real estate business of the company as sought would also be in the cross hair of a statutory provision i.e. explanation to Section 2(19AA) of the Act of 1961. The Apex Court in Hindustan Lever Vs. State of Maharashta [(2004)9 SCC 438] has reiterated the view in the judgment in case of Miheer H. Mafatlal Vs. Mafatlal Industries Ltd. [(1997)1 SCC 579] and inter alia held that the company court before sanctioning a scheme should ensure that the arrangement is not violative of any provision of law, aside of not being contrary to public policy/ interest.
In summation, I would hold that the scheme of demerger of which sanction is sought appears to be only a device for avoidance of obligation towards capital gains tax and stamp duty and also falls foul of Explanation to Section 2(19AA) of the Income Tax Act of 1961.
In the circumstances, the discretion of this court therefore cannot be exercised in favour of the petitioner company. The scheme of de-merger cannot therefore be sanctioned.
The petitions are dismissed.
A copy of the order be placed in each file.
(Alok Sharma), J.
arn/ All corrections made in the order have been incorporated in the order being emailed.
Arun Kumar Sharma, Private Secretary.