By TIOL News Service

NEW DELHI, MAY 16, 2016: THE issue is - Whether when assessee was to receive full consideration on transfer of assets, merely manner of discharge of sale proceeds would alter the scheme and decide taxability of capital gains. NO is the answer.

Facts of the case

Assessee claims that it has incurred a short term capital loss of Rs. 11.14 crores on the sale of an undertaking. AO assessed the said transaction as resulting in a short term capital gain of Rs. 25.34 crores. The principal dispute revolved around the quantum of consideration for the sale of the undertaking.

Assessee is a Public Limited company and was engaged in manufacturing television sets, components, office automation equipment, etc. It had five undertakings including one referred to as the “Panasonic Division”. The said division was set up during 1994 to manufacture colour televisions and audio systems in technical collaboration with a Japanese company, Matsushita Electric Industrial Company (MEI). It was decided to hive off the Panasonic Division to a new company – M/s Matsushita Television & Audio India Ltd. (MTAIC) in which MEI agreed to subscribe and hold 55% of the issued and paid-up equity capital.

In order to hive off, the Assessee proposed a scheme of arrangement entailing transfer of the Panasonic Division to MTAIC as on 1st April 1996. The Scheme indicated that the total consideration for the transfer of the Panasonic Division was agreed at Rs. 50.12 crores. In consideration of the transfer of the Panasonic Division to MTAIC, the shareholders of the Assessee were issued fully paid-up shares of MTAIC in the ratio of two shares for every fully paid equity share held by them in the Assessee-company. In addition, Assessee was allotted 48,60,000 fully paid equity shares of Rs.10 each of MTAIC and was also entitled to receive the balance consideration of Rs.27.62 crores within the period of 90 days from the date of the Scheme becoming effective. The Court approved the scheme on 20th September, 1996.

Assessee submitted that it had received a consideration of Rs. 32.48 crores being Rs. 4.86 crores equity shares and Rs. 27.62 crores. Since the cost of acquisition of fixed assets was Rs. 59.94 crores, a short term loss was computed.

AO noticed that the full consideration for the Panasonic Division was fixed at Rs. 50.12 crores and further the WDV of the assets as per the depreciation chart furnished by the Assessee was Rs. 41.09 crores. Thus, short term capital gain was computed.

Assessee contended that it had received only Rs.32.48 crores in terms of the Scheme and the balance amount of Rs. 17.64 crores was discharged by MTAIC by directly issuing fully paid shares to the shareholders of the Assessee; therefore, Rs.17.64 crores could not be considered as a part of the consideration accruing to or received by the Assessee for transfer of the Panasonic Division.

AO rejected the claim of assessee stating that Rs. 17.64 crores was Assessee’s income which was diverted to its shareholders by allotment of shares by MTAIC to them. Such allotment of shares to the Assessee’s shareholders was application of the Assessee’s income and thus was a part of the consideration for transfer of the Panasonic Division. Further the cost of acquisition would be WDV of fixed assets. CIT (A) confirmed the order of AO.

ITAT allowed the appeal of assessee observing that Rs. 32.64 Crores had been received by the Assessee in terms of the Scheme and the amount of Rs. 17.64 crores was given to the Assessee’s shareholders by MTAIC by allotment of its shares. The amount given to shareholders was diversion at the very source and could not be considered to be application of income because sum of Rs.17.64 crores was not received by the Assessee at all. The shareholders of the Assessee had acquired a right to receive shares of MTAIC at an aggregate value of Rs.17.64 crores by virtue of the Scheme which had a statutory binding effect; thus could not be considered as a part of the income of the Assessee as it stood "diverted at the source". Regarding the cost of acquisition of assets, ITAT held that the transfer of Panasonic Division could not be considered as "a case of transfer of any depreciable asset only". The provisions of Section 50B which were introduced with effect from 1st April, 2000 by virtue of the Finance Act, 1999 and held that since Section 50B of the Act was introduced after AY 1997-98, the said provision could not be applied for computing the capital gains in the present case.

Before the Hon’ble High Court, the revenue contended that as per scheme, consideration for sale of Panasonic Division was Rs. 50.12 crores and the fact that part of the consideration was paid by MTAIC directly to the shareholders of the Assessee would not absolve the Assessee from computing the capital gains on the basis of the said consideration. It was further stated that the Court was not required to examine the merits of the Scheme or the commercial wisdom exercised by creditors and the members of the company. Sanction of the Scheme by this Court was merely an approval of the arrangement already arrived at by the stakeholders. The Director's report also indicated that the proposal for issue of shares by MTAIC to the Assessee’s shareholders was made by the Board of Directors of the Assessee to directly benefit its shareholders. This clearly indicated that the arrangement was to divert part of the consideration by the Assessee to its shareholders. In the circumstances, the consideration received by the shareholders could not be excluded from the income of the Assessee.

Assessee contended that the arrangement in terms of which the Panasonic Division was transferred by the Assessee to MTAIC had been approved by this Court and in terms of the Scheme, the Assessee was entitled only to a sum of Rs.32.48 crores, partly by cash and partly by issue of shares. The terms of the Scheme were binding and it could not be considered that Assessee had voluntarily diverted its income in favour of its shareholders. But for the consent of shareholders, the Scheme would not be sanctioned and since the shareholders had consented to the Scheme entailing issue of shares of paid-up value of Rs. 17.64 crores to them, the same could not form part of the consideration, as either received or accruing in favour of the Assessee. Further for the purposes of computing capital gains, the value of consideration should be either "received or accruing”. In the present case, the Assessee had neither received the consideration of Rs.17.64 crores nor the same had accrued in favour of the Assessee in terms of the Scheme.

After hearing both the parties, the Hon’ble High Court held that,

++ mere sanctioning or approval under Section 391-394 of the Companies Act, 1956 would not alter the character of the scheme or the nature of transaction embodied therein for the purposes of levy of income tax under the Act.

++ it is clear that the transaction is essentially of transfer of the Panasonic Division by the Assessee to MTAIC for the consideration as specified in Clause 9 of the Scheme. Paragraph 9 of the Scheme provides for the total consideration for transfer of the Panasonic Division being a sum of Rs. 50,12,00,000 (Rupees fifty crores twelve lakhs only) and agreed to by SIL and MTAIC through their respective Boards. Paragraph 12 of the Scheme provides for the manner in which the above consideration is to be discharged by MTAIC.

++ the identity of shareholders of a company is different from that of the company. The consideration as reflected under the Scheme is clearly for the transfer of title to the assets as well as assumption of obligations of the Panasonic Division. Undisputedly, the title to the assets of the Panasonic Division belonged to the Assessee, so as the obligation to discharge the liabilities of the said division. The Panasonic Division was an undertaking owned by the Assessee and not by its shareholders. Whilst shareholders own shares issued by a company, they have no interest in the assets held by the company.

++ if the provisions of paragraph 9 and 12 of the Scheme are considered in the above context, it is at once clear that only the Assessee was entitled to receive the entire consideration for transfer of its assets; but it had agreed that the sale consideration for the Panasonic Division be discharged in the manner as specified under paragraph 12 of the Scheme which entailed issue of shares to its shareholders.

++ the scheme is an instrument for effecting sale of the Assessee’s assets (the Panasonic Division) where the owner selling its assets (the Assessee) has called upon the buyer to pay a part of the consideration to a third party (its shareholders). Indisputably, the seller would be entitled to the entire consideration for the sale and the fact that at its instance a part of the consideration is diverted to a third party would not absolve the seller from recognizing the entire consideration. The expression "accruing" as used in Section 48 is synonymous to entitlement. If the Assessee is entitled to the consideration, then the same must be taken into account for the purposes of computation of capital gains in terms of Section 48 of the Act.

++ the only inescapable conclusion that can be drawn is that a part of the consideration to which the Assessee was entitled to, had with its consent been diverted to its shareholders. The Assessee cannot escape accounting for such part of the consideration merely on the ground that it did not receive it but was discharged by MTAIC by issuing fully paid shares to the shareholders of the Assessee in terms of the Scheme.

++ thus, the appeal of revenue is allowed.

(See 2016-TIOL-944-HC-DEL-IT)