December 06, 2018

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Impact of GAAR Provisions on Schemes of Arrangement

- Bharat Vasani, Partner [ Cyril Amarchand Mangaldas ]


If India is serious about promoting ease of doing business, the Income Tax department and NCLT need to adopt a more pragmatic approach in invoking GAAR provisions while sanctioning or rejecting schemes under the 2013 Act...

Schemes of arrangement under the Companies Act, 2013 (“2013 Act”) have been a very useful method for implementing M&A transactions and executing corporate restructuring schemes, particularly schemes of mergers and demergers, in many countries around the world. India has adopted its scheme jurisprudence largely from the provisions of the English Companies Act, 1948.

Sections 230-234 of the 2013 Act provide the regime governing schemes of arrangement. Under the Act, a scheme involves a compromise or arrangement between a company and its creditors, or a company and its members. The scheme requires the approval of persons representing majority in number and three-fourths in value of the creditors or members, as the case may be, voting in person or by proxy or by postal ballot. Thereafter, it must be sanctioned by the NCLT. The scheme so approved is binding on the company, its creditors, and members. Several judicial precedents have held that Sections 230-234 (corresponding to Sections 391-394 of Companies Act, 1956) is a ‘complete code’ or a ‘single window clearance system’.1

Under the erstwhile regime in the Companies Act, 1956 (“1956 Act”), High Courts (“HCs”) largely adopted a “non-interventionist” approach in sanctioning schemes of arrangement, intervening only in exceptional circumstances. In 1996, the Supreme Court laid down the principles to be followed while sanctioning schemes under the 1956 Act in the landmark judgment of Miheer Mafatlal v. Mafatlal Industries.2 In this case, it was emphasized that the Court called upon to sanction a scheme of arrangement would not act as a Court of appeal and sit in judgment over the informed view of the parties concerned to the scheme, as the same is best left to the corporate and commercial wisdom of the parties concerned.3 In recent times, changes in the legal regime have led to a departure from the established principles, causing anxiety and concerns in the corporate world.

Key Developments

In England, the jurisdiction in relation to sanctioning of schemes is still retained with the High Court pursuant to the Companies Act, 2006 despite creation of various tribunals for other subjects. However, in India, the 2013 Act transferred this jurisdiction to the National Company Law Tribunal (“NCLT”) (with effect from December 2016) while substantially retaining the original framework of the 1956 Act. It was expected that NCLT would also continue with the same “non-interventionist” approach while sanctioning schemes of arrangement under the 2013 Act. Unfortunately, that seems not to be the case.

In addition to shifting of the jurisdiction to the NCLT, the introduction of the general anti-avoidance rule (“GAAR”) provisions in the Income Tax Act, 1961 (“IT Act”) (Sections 95 to 102) with effect from April 01, 2018 seems to have also altered the rules of the game. Sub-section (c) of Section 96 of the IT Act provides that an arrangement lacking commercial substance constitutes an impermissible avoidance arrangement under the Act. Further, Section 230(5) of the 2013 Act contemplates notice of every scheme filed with NCLT to be sent, inter alia, to the Income Tax authorities, which is then allowed to submit its representation to NCLT on the said scheme. These twin developments have led to a large number of objections by the Income Tax department against schemes of arrangement claiming violation of GAAR provisions.

Court’s Role in Sanctioning Schemes

Generally, while approving schemes, Courts do not act as mere rubber stamps, but at the same time, the intervention of Courts is observed in those exceptional cases where the sanction of the schemes would amount to abuse of the judicial process. A Court is not expected to go into the commercial wisdom of the parties which approved the schemes by requisite majority.4 The following principle laid down in the Hindustan Lever case5 explains the philosophy followed by the Courts:

“The jurisdiction of the court in sanctioning a claim of merger is not to ascertain mathematical accuracy if the determination satisfied the arithmetical test. A company court does not exercise an appellate jurisdiction. It exercises a jurisdiction founded on fairness.”

It is not the case that schemes were not objected to by the Income Tax department in the past. Section 394A of the 1956 Act did contemplate notice to the Central Government and there were certain exceptional cases where objections raised by the Income Tax department were allowed by the Courts. For instance, in the judgment of Justice DA Desai of the Gujarat High Court, the scheme of Wood Polymer Limited6 was rejected on the ground that the sole purpose discernible behind the amalgamation was defeating tax, which was against public interest. The Court lifted the corporate veil to arrest misuse or abuse of benefit conferred by law.

Even in the case of Vodafone International Holdings B.V.7 the Supreme Court in paragraph 332, inter alia , held that – “Needless to say if the arrangement is to be effective, it is essential that the transaction has some economic or commercial substance.”

The Game Changer - Ajanta Pharma Case

Tax avoidance and not tax mitigation should be the criteria for NCLT to invoke GAAR provisions while sanctioning or rejecting schemes of arrangement

Recently, the Mumbai bench of the NCLT did not sanction the amalgamation scheme of Ajanta Pharma8 with its parent shareholder based on the objections raised by the Income Tax department. Briefly, the facts of the case were that under the scheme, Gabs Investments Private Limited (“GIPL”), holding 9.54% of equity shares in the listed entity Ajanta Pharma Limited (“APL”), was proposed to be merged into APL, with shares to be allotted to the shareholders of GIPL in the swap ratio of 1:1. The entire shareholding of GIPL was held by the Agrawal family and both GIPL and Agrawal family were shareholders and promoters of APL. Pursuant to the scheme, the shareholding of GIPL in APL would have been canceled. The rationale behind the scheme was to simplify the group structure and reduce the shareholding tiers allowing the Agrawal family to directly hold its entire shareholding in APL.

The scheme was approved by 99.99% of the public shareholders of APL and was also not opposed by the Regional Director, Official Liquidator, Registrar of Companies, SEBI, or the stock exchanges. However, the Income Tax department objected to the said scheme stating that it was merely a device to avoid tax.

The Income Tax department objected to the scheme, citing GAAR provisions and argued that the scheme was purely an Impermissible Avoidance Agreement. The department argued that if the shares of APL (as held by GIPL) were to be transferred to the promoters, it would have attracted tax liability of INR 421 crores and that the transaction of share transfer to the promoters was being undertaken through a scheme of amalgamation solely to benefit the common promoter shareholder and avoid this tax liability. The Court relied on the ruling of the National Company Law Appellate Tribunal (“NCLAT”) in the Wiki Kids Limited case9 , wherein it was held that if a scheme of arrangement is not fair to all shareholders and only in the interest of the promoters, it cannot be approved.

In this context, it is important to refer to the final report of the Shome Committee on deferment of GAAR (“Committee Report”) which had highlighted the difference between tax avoidance and tax mitigation. According to the Committee Report, tax avoidance involves an arrangement or mechanism executed solely for obtaining a tax benefit, without any commercial motive. On the other hand, tax mitigation refers to a taxpayer using a fiscal incentive available to it under the tax statute. The Committee Report emphasizes that the purpose of GAAR was to prevent tax avoidance and not tax mitigation which is an intended consequence of the IT Act. To clarify the matter, the Committee Report provided a non-exhaustive list of transactions which are in the nature of tax mitigation, against which GAAR should not be applicable. One such transaction in this list was amalgamation and mergers as approved by the High Court.

The Committee Report also stated that GAAR shall not be applicable if the amalgamation is exempted from payment of capital gains tax under Section 47 of the IT Act. Section 47 exempts certain transfers to which Section 45, the charging provision for capital gains tax, is not applicable, for instance, (i) transfers between holding company and its subsidiary; (ii) transfer in a scheme of amalgamation of a capital asset by the amalgamating company to the amalgamated company; and (iii) transfer of shares held by a shareholder in the amalgamating company, in a scheme of amalgamation. It must also be noted that by virtue of Section 49(1)(iii)(e), the cost of acquisition of such assets is deemed to be the cost for which the previous owner of the asset acquired it, as increased by the cost of any improvement of the assets incurred by the previous owner. The cost of the shares acquired by the Agrawal family would therefore be deemed to be the historical cost of the shares in the books of GIPL. As and when the Agrawal family sells those shares, the capital gains tax would be payable on the entire difference between the sale price and the cost of acquisition. Therefore, the IT department’s argument that the scheme was a measure to avoid capital gains tax liability is inaccurate.

Yet another example given in the Committee Report was that of a loss-making company merging into a profit-making company, which results in losses setting off the profits and consequently a lower tax liability. Even in such scenario, GAAR cannot be invoked as Section 72A of IT Act contains specific provisions in this regard.

Even in the case of In Re: Goman Agro-Farms Pvt. Ltd. and Ors.10, it was held that – “The intention of a party to reduce tax liability cannot be said to be contrary to public interest or against public policy.” It can therefore be argued that it was wholly inappropriate for the Income Tax department to have objected to the Ajanta Pharma scheme invoking GAAR provisions.

The Ajanta Pharma case has indeed generated considerable debate in legal and tax circles. Another cause of worry in the reasoning adopted by NCLT in this case is that the approval of the Ajanta Pharma scheme would have meant denial of open offer to the public shareholders under the SEBI Takeover Code, for which, a specific exemption is already provided under the Takeover Code.11 Moreover, since in any scheme of amalgamation or demerger neither party to the scheme realizes any profit, the Income Tax department always has an opportunity to tax the transaction (covered by the scheme) at the stage of assessment.

In the Ajanta Pharma case, NCLT Mumbai rejected the scheme on the ground that it was not in public interest. It needs to be pointed out that while under Section 394 of the 1956 Act there was a reference to public interest, the expression ‘public interest’ nowhere features in Section 232 of the 2013 Act and there is no such requirement that the scheme sanctioned by NCLT has to be in ‘public interest’. Perhaps the NCLT could have relied on one of the principles laid down in the Miheer Mafatlal case which allows Courts to judicially x-ray the scheme if it is contrary to public policy. However, there is a clear distinction between ‘public policy’ and ‘public interest’ which was not examined by the NCLT in this case.


The law laid down by the Supreme Court in the Miheer Mafatlal case was a salutary provision and the NCLTs needed to adhere to the same while sanctioning schemes of arrangement. Abuse of GAAR provisions to object to schemes of amalgamation on the ground that the sanction of the scheme by NCLT would lead to tax avoidance even in cases where there are specific tax exemptions in the Income Tax Act is legally impermissible. Income Tax department and NCLT need to exercise considerable restraint in invoking GAAR provisions to reject any scheme given that the Shome Committee had specifically listed Court-approved schemes as one of the transactions exempt from the application of GAAR. Moreover, NCLT should refrain from encroaching upon the jurisdiction of SEBI/SAT with regard to Takeover Code matters as schemes of amalgamation are expressly exempt under the Takeover Code. Otherwise, the attractiveness of the scheme jurisprudence would fade away and one important mechanism available for undertaking corporate restructuring transactions will remain a viable option only on paper. If India is serious about promoting an environment which facilitates ease of doing business, then the Income Tax department and NCLT need to adopt a more pragmatic approach in invoking GAAR provisions while sanctioning or rejecting the schemes under the 2013 Act.

1. In re Maneckchowk & Ahmedabad Mfg. Co. Ltd. (1970) 40 Comp Cas 819 (Guj); Vasant Investment Corporation Ltd v. Official Liquidator, Colaba Land and Mill Co. Ltd. (1981) 51 Comp Cas 20 (Bom).
2. AIR 1997 SC 506.
3. See also Sesa Industries v. Krishna H. Bajaj and Ors. (2011) 3 SCC 218.
4. Miheer Mafatlal v. Mafatlal Industries AIR 1997 SC 506.
5. Hindustan Lever Employee’s Union v. Hindustan Lever Limited and Ors AIR 1995 SC 470.
6. (1977) 47 Comp Cas 597 (Guj).
7. (2012) 6 SCC 613.
8. CSP No. 995 of 2017 and CSP No. 996 of 2017 in CSA No. 791 and 792 of 2017.
9. (2018) 206CompCas147.
10. (2016)194CompCas214(AP).
11. Regulation 10(1)(d)(iii) of the Takeover Code

Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.


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