Scheme of Compromise or Arrangement
resulting in reduction of tax liability does not
furnish a basis for challenging its validity

Facts of the case

• Reliance Jio Infocomm Limited’ (Petitioner Co. 1), ‘Jio Digital Fibre Private Limited’ (Petitioner Co. 2) and ‘Reliance Jio Infratel Private Limited’ (Petitioner Co. 3) moved joint petition under Sections 230-232 of the Companies Act, 2013, seeking sanction of the Composite Scheme of Arrangement among the Petitioner Co. 1, 2 and 3 and their respective shareholder and creditor.
• The scheme was approved by NCLT. The appellants have made an appeal against the scheme to NCLAT.
• According to the Appellants, by way of the composite scheme, there is an indirect release of assets by the demerged company to its shareholders which is used to avoid dividend distribution tax which would have otherwise been attracted to tax liability.
• As per the law, Dividends arising out of preference shares can only be paid by the company out of its accumulated profits. However, when preference shares are converted into loan, the shareholders turn into creditors of the company. There are two consequences of such conversion of preference shares into loan.
• Firstly, the shareholders who are now creditors can seek payment of the loan irrespective of whether they are accumulated profits or not.
• Secondly, the company would be liable to pay interest on the loan to its creditors, which it otherwise would not have had to do to its shareholders. Payment of Interest on such huge amounts of loan would lead to reducing the total income of the company in an artificial manner which is not permissible in law.

Decision

NCLAT held that mere fact that a Scheme of Compromise or Arrangement may result in reduction of tax liability does not furnish a basis for challenging the validity of the same.
Thus, NCLAT upheld the decision of NCLT, Ahmedabad bench and in view of the liberty given to the Income Tax Department decided not to interfere with the Scheme of Arrangement as approved by the Tribunal and dismissed the appeals filed.

Our Opinion

The NCLAT held that without providing any evidence before the Tribunal, the Income Tax Department was not open to hold that the overall scheme of arrangement between the petitioner companies and their respective shareholders and creditors was giving undue advantage to the shareholders of the company. And overall planning of the system results in tax avoidance.

Vikas Agarwal, Senior Executive, SW India