2016 (3) TMI 696 - HC - Companies Law

Sanction of scheme of de-merger - Held 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 nonfunctional 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. Thus 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. The scheme of de-merger cannot therefore be sanctioned - Decided against petitioner company

Issues Involved:
1. Compliance with Sections 391-394 of the Companies Act, 1956.
2. Validity and necessity of the de-merger scheme.
3. Alleged tax evasion and public interest.
4. Existence of a real estate division in the company.
5. Issuance of preference shares instead of equity shares.

Issue-wise Detailed Analysis:

1. Compliance with Sections 391-394 of the Companies Act, 1956:
The petitions sought sanction of a de-merger scheme under Sections 391-394 of the Companies Act, 1956, read with Rule 57 of the Company Court Rules, 1959. The court emphasized its supervisory jurisdiction, ensuring the scheme is fair, reasonable, just, and not contrary to public interest. The court noted that while it cannot sit in judgment on the commercial merits of the scheme, it must ensure the scheme does not violate any law or public policy.

2. Validity and Necessity of the De-merger Scheme:
The petitioner argued that the de-merger was necessitated by a family arrangement among shareholders to maintain cordial relations and allow each family branch to operate independently. The court, however, found that the company had only engaged in the manufacturing and sale of vanaspati and edible oil since its inception in 1973. The purported commencement of a real estate business in 2010 was not substantiated by any turnover, income, or profit in the financial statements.

3. Alleged Tax Evasion and Public Interest:
The Regional Director opposed the scheme, arguing it was a sham designed to evade capital gains tax and stamp duty, causing a significant loss to the public exchequer. The court agreed, finding that the scheme appeared to be a device to avoid tax obligations. The court cited the Supreme Court's judgment in M/s. Macdowell and Company Limited Vs. Commercial Tax Officer, which held that tax planning cannot include colorable devices to avoid tax.

4. Existence of a Real Estate Division in the Company:
The petitioner claimed the company had a real estate business, supported by a capital expenditure of Rs. 75,000 for land leveling. The court found this claim unsubstantiated, as the company's financial statements did not reflect any real estate activity. The land was not listed under current assets, and no real estate turnover or income was recorded. The court concluded that the company did not have an operative real estate business or undertaking, a prerequisite for de-merger under the Income Tax Act, 1961.

5. Issuance of Preference Shares Instead of Equity Shares:
The scheme proposed issuing non-cumulative compulsorily redeemable preference shares to the shareholders of the demerged company, rather than equity shares. The Regional Director argued this indicated the scheme was a land transfer, not a genuine de-merger. The court agreed, noting that preference shares do not grant ownership or management rights, further supporting the conclusion that the scheme was designed to avoid tax liabilities.

Conclusion:
The court dismissed the petitions, holding that the scheme of de-merger could not be sanctioned. The company did not have a pre-existing real estate division, and the scheme appeared to be a device to avoid tax obligations, contrary to public interest and the explanation to Section 2(19AA) of the Income Tax Act, 1961. The court's discretion could not be exercised in favor of the petitioner company.

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