: September 18, 2013 |
: Tax Laws
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Tax Implications on Business Reorganization Schemes
Corporate reorganization and corporate restructuring are interchangeable terms. There are various manners in which a corporate reorganization could take place but let us first look into the reasons as to why a corporation would go for such a change. One reason could be to reduce the risks involved on business and others could be to deal with the tough competition in the market. In between the severe competitions in the market the companies try with their steady enthusiasm for growth, struggle for more and more power through the procedure of corporate reorganization. This is an active procedure which helps companies tactically come under single banner and defend themselves against the rough market trends, fierce competitions by furthering the implementation of best possible scheme by the use of most fitting option to the eventual contentment of the corporate body.
There are various methods of corporate restructuring which could be undertaken by the corporate bodies such as mergers, acquisitions, amalgamation, demerger, business alliances etc.
For the government it is a matter of concern as it affects public welfare at large. As we all know the market competition is very tough in this era of globalization where the companies not only have to compete with other local companies but also international giants. Thus it is very important for the government to take care of the local businessmen and their interest and good reorganization policies is one of the manners in which this could be done. If the companies keep failing then there is also shortage of employment opportunities for people, which also leads to insufficient use of available resources and most importantly it affects the revenue generation of the government which is one of the main sources of funds for the government which are used to run the country and are used for meeting social expenditures for greater human interests. To deal with the scenario the government has come up with a number of provisions under the Income Tax Act and the Companies Act which are favorable to corporate reorganization so that more and more companies resort to restructuring methods in case of situation which could lead to failure of the companies.
Various Methods Of Reorganization
Let us first discuss various methods of reorganization in brief.
Mergers or Amalgamation
As the name indicates, merger means when two or more companies come together to form a single company. In India commonly the term used for merger is amalgamation. Acquisition is a process which also leads to amalgamation of two companies but in case of simple amalgamation the members of both the companies maintain their respective interests in the company and in case of acquisition one company takes over another company by buying controlling stake of the company which is being taken over.
Again as the name suggests it is a process which could be said be just the opposite of merger. Under this restructuring process the undertaking of a company is transferred to another company. The transferor company is called “demerged” and the transferee company is known as the “resulting” company.
Tax Implications On Corporate Reorganization
As discussed above that the government has come up with provisions which are favorable for the purposes of reorganization of corporations, let us now discuss the provisions of Income Tax Act, 1961.
· If capital gains arise on transfer of any capital asset in the scheme of amalgamation, by an amalgamating company to the amalgamated company, such capital gains shall be exempt from tax provided the amalgamated company is Indian.
· If capital gains arise on transfer of shares held in Indian company by amalgamating foreign company to amalgamated foreign company, such capital gains shall be exempt from tax but there is a proviso to this exemption.
· Capital gains arising from the transfer of shares in the scheme of amalgamation on the fulfillment of a few conditions which are given in the act are exempt from tax.
· In case the shares received from the amalgamated company are later sold or transferred, the cost of shares of the amalgamating company shall be the cost of shares of the amalgamated company and also for determining whether the shares in the amalgamated are long-term capital assets or not, the period of the holding shall be computed from the date of acquisition of shares in the amalgamating company.
· Depreciation charge on assets are waived and are not strictly observed in case of amalgamation or demerger of companies where an asset is transferred to an Indian amalgamated or resulting company under the scheme or amalgamation or demerger.
· The chargeability of Section 45(1) under the Income Tax Act to attract capital gains tax liability of capital assets is not to be applied in a scheme of amalgamation or demerger of companies on the presupposition that transfer of asset is not to be constructed as transfer. In terms of Section 43C of the Act, while computing the profit or loss on sale of assets as stock in trade which has become the property of the amalgamated company under a scheme of amalgamation, the cost of acquisition if such asset to the amalgamated company shall be cost of acquisition of such asset to the amalgamating company plus an increase in cost due to any improvement made thereto and expenditure incurred wholly and exclusively in connection with such transfer.
There are several other provisions also but these are some of the main provisions which are very effectively promoting the reorganization of companies because these provisions have really made the taxation policy for the purposes of reorganization very relaxed.
Case Law Study
DIT v. Goodyear Tire and Rubber Company
This is one of the latest and the most relevant case on the issue which needs to be discussed in detail for the purpose of this research.
Facts of the case
Goodyear Tire and Rubber Co. (from now on referred as GTRC), incorporated under the laws of USA, holds 74% stake in Goodyear India Ltd. (from now on referred as GIL), an Indian Company listed on the Bombay Stock Exchange.
Goodyear Orient Co. (Pte) Ltd. (from now on referred as GOCPL) is a wholly owned subsidiary of GTRC. GOCPL is an operating company and manages the worldwide operations of GTRC i.e. natural rubber purchasing, delivery, financing, treasury and quality. As part of its global corporate strategy and to expand the role of GOCPL for the benefit of its other group entities within Asia-Pacific region, GTRC sought to transfer its entire stake of 74% in GIL to GOCPL without any consideration.
In the background of the above facts, an application was made to the AAR by GTRC as well as GOCPL seeking a ruling on the following questions:-
· Whether any profit or gain within the meaning of Section 45 of the Act arose to the Taxpayer on account of transfer of shares in GIL to its GOCPL without consideration?
· Whether GOCPL is liable to tax in respect of contribution of shares of GIL under Section 56(2)(viia) of the Act?
· Whether Transfer Pricing laws were applicable to the aforesaid transaction?
· Whether tax is required to be deducted under the provisions of Section 195 of the Act either by the Taxpayer or GOCPL?
# The proposed transfer of shares of GIL to GOCPL is without consideration in money or money’s worth.
# As the full value of consideration received or accruing as a result of the transfer of shares of GIL is nil, the mechanism to charge the capital gains to tax, as provided under Section 48 of the Act fails.
# Further as contribution of shares is by way of ‘gift’, it would not amount to transfer under Section 45 read with Section 47(iii) of the Act.
# Revenue Department’s contentions
# Transfer is for creation of a better business environment, which itself is a consideration, and the transaction would not be regarded as ‘gift’.
# It is case of ‘treaty shopping’ for avoidance of capital gains tax at a future date since in case the transferee company gifts/ sells these shares to another entity, the transaction will not be taxable in India in view of the tax treaty between India and Singapore and that would not be the case in the context of the tax treaty between India and the USA.
# The bar under proviso to Section 245R (2) of the Act relating to the transaction designed for avoidance of tax covers both present and future scenarios.
Authority of Advance Rulings’ (AAR) decision
Applying the legal position enunciated above and the test laid down by the honourable judges in the cases cited in the rulings of Amiantit International Holding Ltd and Dana Corporation it was held that no consideration would accrue or arise to the applicant by the transfer of shares and the applicant cannot be said to have derived any profit or gain from the transaction. The AAR observed that as the ‘consideration’ is incapable of being valued in definite terms or it remains unascertainable on the date of occurrence of taxable event, the question of applying Section 45 read with Section 48 of the Act would not arise. GIL, being a listed entity, any gains arising on transfer of its shares, being a long term capital asset, is exempt under Section 10(38) of the Act and hence the question of avoidance of tax through treaty shopping by the Taxpayer does not arise. As the transaction is not liable to tax under Section 45 read with Section 48, there was no need to discuss the applicability of Section 47(iii) of the Act. GIL, is a company in which public is substantially interested and hence the provisions of Section 56(2)(viia) of the Act would not be attracted on the proposed transfer of its shares. As regards applicability of the Transfer Pricing provisions to the aforesaid transfer of shares, the AAR held that the provisions of Section 92 to 92F of the Act would not be applicable in the absence of liability to pay tax. As income is not chargeable to tax, the question of withholding of tax under Section 195 of the Act does not arise.
The order of AAR was challenged by the tax dept. in the High Court but the HC upheld the order of AAR.
Amiantit International Holding Ltd.
Facts of the case
Applicant proposed the restructure of the group by contribution of shares of Indian Company (held 70% of the equity shares). No consideration was deliberated. Draft agreement was made. They contended that since no consideration was being provided, no profit or gain would be accruing to the applicant, hence there was no liability to capital gains.
The Authority in this case agreed to the contention of the applicant and held that since no consideration in money terms is being received or receivable as a result of the transfer of shares the liability did not arise under Section 45 read with Section 48 of the Act. Since the reorganization, the transfer of shares was in the form of gift within the meaning of Section 47(iii) and relying on George Henderson and Co. Ltd. it was contended that the term ‘full value of consideration” appearing in Section 48 of the Act cannot be construed as having reference to the Market value of the asset transferred.
A very important observation was made by the court in this case:-
The Court observed as stated in Law and Practice of Income Tax by Kanga, Palkiwala and Vyas:
“….income, profits and gains may be realized in the form of money's worth as well as money, in kind as well as in cash. Even then, the alleged consideration for which the shares are to be transferred should be capable of being evaluated on commercial and accounting principles. The possibility of applicant-transferor improving its overall business by virtue of reorganization and the mere possibility or chance of the applicant making better returns in the near or distant future as a consequence of reorganization can hardly be regarded as a consideration accruing or arising to the transferor when he has no right to receive a definite or an ascertainable amount or benefit from the transferee. A capital gain cannot arise on the basis of uncertain and indefinite future contingencies or hypothetical and imaginary estimations. There is really no effective answer from the Revenue's side to the question as to, what is the valuable consideration that has accrued or arisen to the transferor? How it can be converted into money's worth for the purpose of computing the alleged capital gain?”
Dana Corporation, In re
In case where a consideration of transfer of assets is not determinable then the statutory provisions become redundant and the consideration arising from such a transfer is not taxable under the act. The fair market value of this consideration cannot be held to be the deemed full value unless expressly provided for.
Dy. CIT v. Summit Securities Ltd.
The court observed that under Section 48 the full value of the consideration has to be considered only in case where there has been an amount received as a result of transfer of capital, except where it has been replaced by the fair market value. In the absence of any specific provision, the actual amount received or accruing shall be the full value of consideration receiving or accruing as a result of the transfer of capital asset.
After the above mentioned judgment a new Section 50D was inserted, effective from the assessment year 2013-2014 which lays down that the fair market value of asset shall be deemed to be the full value of the consideration if the actual consideration is not attributable or determinable.
Business reorganization has become a very important aspect of the business world with the increasing level of competition because of which the chances of the failure of companies also increases. But another important issue which is of concern for the law makers is that to what extent the reorganization schemes should be protected from the tax implications. The researcher has mentioned in the introduction the importance of promoting reorganization scheme among the companies so as to protect them from total failure. But too much of anything is not good. If too many tax exemptions are given to reorganization schemes then there is a chance of misuse of such provisions. Dy. CIT v. Summit Securities Ltd. is a good example of a case in which the court’s intervention helped in restricting the extension of exemption to the amount which was not liable to be exempted. The authorities have taken a good step by introducing Section 50D as it is very important to keep a check on misuse of provisions which were laid down for the protection of companies at large. The law makers have to keep coming up with new Acts and provisions so as to maintain a balance between regulation and leniency. Insertion of Section 50D is a good example of check to misuse of lenient provisions.
# http://www.asiaone.com/Business/SME Central/Dollars & Sense/Story/A1Story20101005-240707.html
# Mergers, Acquisitions and Corporate Restructurings, Patrick A. Gaughan, 4th ed., p12.
# Ibid 13
# Section 47(vi), Income Tax Act, 1961
# Section 47(via), Income Tax Act, 1961
# Section 47(vii), Income Tax Act, 1961
# Section 14(2), Income Tax Act, 1961
# Section 32, Income Tax Act, 1961
# W.P.(C) 8295/2011
#  Taxman 149 AAR No. 817 of 209.
#  186 Taxman 187 (AAR-New Delhi)
# http://taxguru.in/income-tax-case-laws/transfer-shares-indian-company-consideration-group-reorganization- liable-tax-india-aar.html
#  Taxman 149 AAR No. 817 of 209.
#  186 Taxman 187 (AAR-New Delhi)
#  19 TAXMAN 102 (Mum) (SB)
#  19 TAXMAN 102 (Mum) (SB).
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