Case Study: Is it merger or distribution of assets?

Brief facts about the case

• Gabs Investments Private Limited (‘GIPL’ / ‘Transferor Company’) is engaged in the business of making investments and primarily hold shares in Ajanta Pharma Limited (‘APL’ / ‘Transferee Company’). APL is a listed pharmaceutical company engaged in development, production and marketing of branded and generic formulations.
• Agrawal family holds 61.17% shares in APL and 100% shares in GIPL. Further, GIPL holds 9.54% of equity share capital in APL.
• Management were considering merger of both companies which would achieve greater efficiency of promoters shareholding in APL

*Balance shareholding is held by public

But the proposed scheme of merger is rejected in NCLT Mumbai Bench on the following grounds:

As per section 230-232 of companies act, approval of statutory authorities like RD, ROC, SEBI, Income Tax etc., need to be taken. While taking the approval from Income Tax department (hereinafter referred to as “department”) made some observations which are as under:

• GIPL being a private limited company has to be considered as separate entity and any "assets" of the Pvt. Ltd. company cannot be transferred and distributed directly. The company has to pay the Divided Distribution Tax (DDT) @ 20%
• Also, the total cost of acquisition of shares of APL by GIPL is INR 48, 73, 20,332/- as per the submissions made by APL. Further, as per the object mentioned in the MOA of GIPL, the investment and dealing in equity/shares is the business of the company and once the equity is sold in the market the business profit will be acquired by GIPL and the amount will atINR958.34 Crores (1007.07 Crore - INR 48.73 Crore). On this business profit, Income tax @ 30% is payable and accordingly INR 287.50 Crores income tax will be payable by the GIPL. Further, in case the applicability of MAT u/s 115JB @ 20% should also be kept in mind, in case the GIPL adopts another method of computation of income. This tax of 287.50 Crores will be lost if this amalgamation scheme is approved by the NCL T Mumbai.

In view of the above computation, total loss to the revenue will be approximately INR 421.66 Crores, if this amalgamation Scheme is approved.

Also, another issue raised was Agrawal Family, persons acting in concert have to comply with either Regulation 3(1) or 3(2) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulation. In this scheme of Amalgamation and Arrangement, no such provision is made and if the Bench sanctions the scheme as proposed, the common promoters of the petitioners company will escape from complying with the Takeover Regulations

Based on the abovementioned issues, NCLT Mumbai rejected the application and held that the scheme appears to be unfair, unreasonable, and is not in the public interest.

My View

Although the company must strictly follow the regulation specified in SEBI (Substantial Acquisition of Shares and Takeovers). But issue raised my Income tax authorities does not stand valid due to the following reasons:

• There is no direct distribution of assets which attracts DDT @20% rather it is mere purchase of assets for a purchase consideration. Although Agrawal family is getting shares in Ajanta Pharma but that is not distribution of assets, rather it is exchange of assets. Agrawal family is getting shares in APL as consideration for surrendering there shares in GIPL. The department failed to understand it is not distribution of assets and therefore causing no loss to revenue authorities.
• Another issue raised by department is, if these shares are sold in open market, it would attract tax and therefore it will be loss to the department if the scheme of amalgamation is approved. But the department failed to understand that ignoring the actual merger transaction and creating an imaginary transaction of selling the shares in open market has no base. Also as per section 49(2), the cost of acquisition in hand of Agrawal family would be the cost of acquisition in hand of Gabs Investment. So, whenever such shares are sold by Agrawal family, tax is levied and there is no loss to the revenue. If the department plea stand valid then every transaction covered in section 47 would not be tax exempt. In other words, every merger should then be taxable. Why there is need to bring section 47?

According to me, NCLT Mumbai order is not correct and must be reversed if appealed in NCLAT.