* Out of the 6 Applicants, 3 Applicants i.e. STEL, Star Asian Movies Ltd. (SAML) and Star Asia Region FZ LLC (SAR) were the amalgamating companies (AmalCos)which were wholly owned by the other 3 Applicants (Shareholders). STEL and SAML are companies incorporated under the laws of British Virgin Islands (BVI) whereas SAR is incorporated under the laws of the United Arab Emirates.
* The AmalCos, a part of the same group, owned certain Indian as well as non-Indian language entertainment channels. For commercial reasons, it was decided to consolidate Indian language channels and, therefore, the AmalCos proposed to amalgamate with SIPL (with SIPL as the surviving entity) so as to obtain operational synergies, enhanced flexibility and to create a strong base for future growth. Prior to commencement of theamalgamation process, STEL and SAML sold their non-Indian language channels to another non-resident BVI company.
* SIPL was held by 2 Mauritius-based companies and was engaged in the business of marketing channels.
* The scheme of amalgamation had been filed with the Bombay HC for approval, as required by the provisions of Indian company law. Once approved, SIPL would issue shares to the Shareholders, in accordance with the share-exchange ratio arrived at by a professional valuation report.
* The Applicants sought a ruling from the AAR on whether the AmalCos and the Shareholders would be exempt from capital gains tax that was likely to arise from the proposed scheme.
Contention of the Applicants
Under the provisions of the ITL, transfer of assets by an amalgamating company to an amalgamated Indian company and, also, the transfer of shares held by the shareholders of an amalgamating company in consideration of allotment of shares in an amalgamated Indian company are exempt from capital gains tax in India, if certain conditions are satisfied. Since, in the present case, these conditions were satisfied, it was argued that there should be no capital gainstax liability in the hands of the AmalCos or the Shareholders.
Contentions of the Tax Authority
* However, the Tax Authority sought to contest the exemption under the ITL on the ground that the amalgamation was a colorable device/scheme, the whole objective of which was to avoid capital gains tax.
* No business/commercial purpose for entering into such a scheme of amalgamation is discernable other than for avoiding taxes and the same, being opposed to public interest, should be disregarded and should not receive any legal recognition. Further, the said application before the AAR should be kept on hold until theamalgamation scheme is considered by the Bombay HC.
* The amalgamation scheme is a well thought-out plan to artificially inflate the profits and reduce the liability of the AmalCos. Moreover, the AmalCos have been stripped of all income-earning assets which it possessed prior to the proposed date ofamalgamation.
* The net result of amalgamation is that the 2 Mauritius-based companies, holding 100% of SIPL, would be left with only 51.09% and the balance would be transferred to the foreign companies holding the shares of the AmalCos. There could be a possibility for the transfer of 49.91% of the holding of the erstwhile shareholders to attract tax liability. Hence, as the question raised relates to a transaction which is designed, prima facie, for tax avoidance, the application should not be considered.
Ruling of the AAR
* The capital gains arising due to such an amalgamation would be exempt from tax in the hands of the AmalCos, as well as the Shareholders, as the conditions prescribed under the ITL have been satisfied.
* An objective for filing an application before the AAR is to have a firm idea of the tax implications in India and such an application can also be filed in respect of a proposed transaction. The contention of the Tax Authority that the acceptance of the application should be kept pending, until the approval of the HC is obtained, was rejected as such an act would lead to the AAR, a statutory authority, refusing to exercise the jurisdiction vested in it by the law. The AAR clarified that the ruling is on an assumption thatthe scheme of amalgamation would be approved by the HC in due course, as required by the provisions of Indian company law. In case the scheme was not approved by the HC, the ruling of the AAR would be inoperative.
* The AAR rejected the contention that the amalgamation scheme would lead to avoidance of taxes due from the AmalCos or the prospects of recovery would be in jeopardy, since such a scheme provides for takeover of liabilities which also includes tax dues.
* Though the Tax Authority wanted the entire scheme of amalgamation to be disregarded and not be given any legal recognition, it had no answer as to what would have happened if the amalgamation scheme was given legal recognition from the HC, on a consideration of the objections of all concerned, including the Tax Authority. Therefore, the contention thatamalgamation scheme is a colorable device to avoid capital gains tax and that there exists no other business purpose, was rejected.
* The Tax Authority’s contention that profits were inflated and liabilities were reduced and, further, that the AmalCos were stripped of the income-earning assets, prior to the proposedamalgamation , appears to be contradictory. This is because, if the Amalcos have been stripped of such assets, then it is not possible to artificially inflate the profits prior tothe scheme of amalgamation.
* Under the ITL, the AAR could reject an application if it is of the view that the transaction is designed, prima facie, to avoid income tax. The expression ‘transaction designed to avoid income tax’ cannot be understood to mean that, in the course of entering into a transaction, a taxpayer is precluded from taking into account the tax implications involved and to minimize its tax burden. It is within the legitimate freedom of the contracting parties to enter into a transaction, which has the effect of extending to the party, the benefit of exemption under the taxation statute.
* The AAR also considered the Supreme Court (SC) decision in Azadi Bachao Andolan [263 ITR 706] and the Gujarat HC decision in Sakarlal Balabhai [69 ITR 186] where the courts have held that it is possible for a taxpayer to enter into a transaction which provides certain legitimate tax exemptions. Only those transactions which are a sham or are devised solely with a view to avoid taxes and without any real and genuine business purpose will be rejected.
* Reference was also made to the Gujarat HC decision in Wood Polymer Ltd. [109 ITR 179] which provided a typical illustration of a deliberate design, aimed only to avoid tax, by taking recourse to amalgamation. Since, in the present case, the amalgamation scheme had a definite business purpose, it could not be set aside by characterizing it as a mere device with the sole objective of avoiding capital gains tax.
Comments
The present ruling reiterates the general tax avoidance principle emerging from decisions of the SC and the various HCs that a taxpayer is not precluded from minimizing its tax burden while entering into a transaction, as long as such a transaction is not a sham or a contrived device which has the sole objective of avoiding tax. This ruling also highlights the importance of embedding business purpose in transactions which seek to mitigate tax to prevent the transaction from being regarded as designed for tax avoidance.
A ruling by the AAR is binding only on the Applicant, in respect of transaction in relation to which the ruling is sought and on the Tax Authority, in respect of the Applicant and the said transaction. However, it does have persuasive value and the Courts in India, the Tax Authority and the appellate authorities do recognize the principles and ratio laid down by the AAR, while deciding similar cases.
