Merger & Acquisition Tax And Regulatory Updates

Taxation Updates

From the Judiciary

Pune ITAT: Deletes addition for share premium under Section 68 for a non-operational company in view of justified business plans

Citation: Mahalaxmi TMT Pvt. Ltd [TS-323-ITAT-2021(PUN)]

During AY 2010-11, Assessee, Mahalaxmi TMT Pvt. Ltd, issued 4 million equity shares of face value of INR 10 for a share premium of INR 90 per share. The assessee received a sum of INR 370 million through banking channels. The AO noted that while the assessee company was established in FY 2004-05, it did not carry on business activities until the relevant year. The AO also observed that the investor of the assessee company was either showing meager income or losses and the source of funds that were invested in the assessee company was not satisfactorily explained by the Investing companies. Accordingly, the AO dissatisfied with the genuineness of money received by the assessee treated the sum of INR 360 million as unexplained cash credit under Section 68 of the Income-tax Act, 1961 (the Act).

The Pune bench of ITAT upheld the decision of CIT(A) and deleted the impugned addition made by the AO on the following grounds:

• The initial onus is upon the assessee to establish three things necessary to obviate the mischief of Section 68:
  • identity of the investors;
  • their creditworthiness/investments; and
  • genuineness of the transaction.
• The assessee has discharged its onus by furnishing the necessary details in support of the identity and creditworthiness of the parties and genuineness of the transaction.
• The details filed by the assessee were cross verified by the Revenue from the respective parties and no infirmity was pointed out in the same except doubting the creditworthiness of the parties.
• Conversely, the AO has not brought anything on record suggesting the amount credited in the books of the assessee does not belong to respective parties, but the same belongs to the assessee.
• The Revenue has accepted part of the amount shown as share application money pending for allotment as correct with respect to the identity/ creditworthiness of the party as well as genuineness of the transaction. The AO has erred in accepting part of the amount as genuine and at the same time denying part of the amount as not genuine.
• ITAT also held it is the subscriber's wisdom to acquire the shares at a premium. Thus the AO has no role to play in questioning the shares issued at the premium, particularly in the circumstances where the assessee has discharged its onus cast under Section 68 of the Act.
• Basis the documents submitted by the assessee, it cannot be said that there was no business activity carried out in the year under consideration. The assessee was in the process of setting up the plant.
• The Revenue’s allegation stated that the assessee had inflated its project cost, the cost which the assessee has shown in its books of accounts has been compared with the data obtained by the AO from the Internet, which is not viable.

Our Comments

By virtue of amendment in Section 68 w.e.f. from A.Y. 2013-14, the onus on the companies receiving the funds is expanded to prove the source of source of funds, i.e., the source in the hands of the shareholder. In the post-amendment era, the above decision may not hold relevance and can fall under the ambit of Section 68 if the assessee is not able to substantiate the source of funds of the shareholders. However, once the assessee submits these necessary details, the onus shifts to the tax authority to substantiate the addition if he refutes or is dissatisfied with the details received. Furthermore, this decision once again manifests that the tax authorities questioning the viability of a business or prudence of an investor is beyond its jurisdiction.

AAR rejects application over taxability of share transfer by holding that the transaction was designed prima facie for the avoidance of tax

Citation: Capex Com Ltd [AAR. No. 1373 & 1374 of 2012]

The applicants, Capex Com Ltd. (CCOM) and Capex Communications Ltd. (CCLM) are Mauritius-based companies forming part of Capex group. CCOM and CCLM held 6.19% and 15.85% stake, respectively, in Vortex Capital Limited (VCL), an Indian company. CCOM and CCLM hold TRCs issued by the Mauritius Revenue Authority and do not have any tax presence or Permanent Establishment (PE) in India.

The applicants made the investment in shares of VCL by utilizing the funds received from Capex group entities. Subsequently, such shares of VCL were pledged against the loan taken for the benefit of the Capex group entitles. In 2011, the applicants sold their stake in VCL to Aura Atlantic Sec. Ltd. (AASL), a non-resident company and the sales proceeds from the transfer of such shares were utilized to repay the aforementioned loans.

The applicants received the consideration from AASL after withholding tax at 21.012%. Prior to the above transaction, AASL had moved to the AAR to seek a ruling on the withholding liability on the amount payable to the applicants, which was admitted by AAR. Notably, the Applicants joined the proceedings as intervenors. The application was “dismissed as withdrawn” in July 2011 on the command of AASL in the presence of the Applicants’ representatives. No liberty was given to file a fresh application on the same subject matter.

After the dismissal of AASL’s application, the applicants moved to the AAR without seeking liberty to file a fresh application before the AAR on the same issue. The issues raised by the applicants were as under:

• Whether the gains arising from the transfer of VCL shares in the hands of the applicants is chargeable to tax in India; and
• Whether the Revenue Authorities should refund to the applicants the tax deducted at source by Aura Atlantic Sec. Ltd. from payments made to the applicants.

The AAR declined to comment on the merits of the questions posed before them and held that applications are not maintainable and liable to be dismissed based on the following observations:

• The transaction, prima facie, is meant for tax avoidance
  • The acquisition of shares of VCL was made by Capex group by routing the funds through the applicants. Shares were bought, pledged, sold by Capex group and the applicants merely lent their name to seek treaty benefits;
  • Certain loans were raised by Capex Group by pledging shares of VCL held by the applicant for Capex group’s benefit;
  • Consideration received for the sale of shares was immediately utilized for the repayment of the loans availed by Capex Group; and
  • The sole purpose, it seemed, was to transfer the situs of ownership of 15.85 % in VCL to Mauritius in order to avoid capital gains tax in India
• While filing the application before the AAR, the applicants did not disclose the fact that that they were intervenors in AASL’s application and thus, the applicant suppressed material facts
• No liberty was sought and granted to applicants to file a fresh application on the same subject matter, which formed a part of AASL’s application. AAR had granted permission to the Interveners to put forward whatever contentions they have at an appropriate stage in ‘other proceedings,’ but this does not include filing of fresh application.

In view of the above, AAR rejected the application under clause (iii) of the first proviso to Section 245R (2) where the question relates to a transaction or an issue that is designed prima facie for the avoidance of tax.

Our Comments

The decision retouches upon the highly litigated issue of taxability of transfer of shares of Indian companies by the Nonresident entities, not having PE India, where the transaction is so designed that it leads to avoidance of tax in India.

Regulatory Updates

Securities Law and Compliances Corner

Amendment to SEBI (Listing Obligations and Disclosure Requirements) Regulations, 20215 (Regulations)

Following key amendments were made to the SEBI LODR vide notification dated 5 May 2021:

Business Responsibility and Sustainability Reporting (BRSR)

Regulation 34(2) of Regulations introduced new reporting requirements in respect of top 1000 listed companies on ESG (Economic, Social and Governance) parameters called BRSR.

The BRSR seeks disclosures from listed entities on their performance against the nine principles of the ‘National Guidelines on Responsible Business Conduct’, and reporting under each principle is divided into essential and leadership indicators. The BRSR is intended towards having quantitative and standardized disclosures on ESG parameters to enable comparability across companies, sectors and time. Such disclosures will be helpful for investors to make better investment decisions.

Applicability of Regulations

The amendment provides that certain provisions of Regulations that become applicable to entities on the basis of market capitalization will continue to apply even where the entities fall below the prescribed threshold.

Furthermore, certain regulations relating to corporate governance viz. 17, 17A, 18, 19, 20, 21, 23, 24, 24A, 25, 26, 27 and clauses (b) to (i) of sub-regulation (2) of regulation 46 and para C, D and E of Schedule V of the Regulations which are at present exempt to a listed entity having net worth below prescribed minimum. Once such listed qualifies prescribed net worth, the above regulations shall have to be complied with within six months therefrom.

It is also provided that once the above regulations attract, it will continue to be applicable to the listed entity even if their net worth again falls below the prescribed minimum unless it remains as such for three consecutive years.

Alignment with Companies Act, 2013 (Act)

The requirement of having a separate meeting of independent directors is aligned with provisions of the Act to provide that such meeting will be held in ‘financial year’ in place of ‘a year.’

A new clause has been inserted to make it compulsory for the listed company to publish Annual Rerun, consolidated financial on its website in line with the provision of the Act.

A new subclause has been inserted to mandate listed entities to obtain secretarial audit reports in line with the provision of the Act, in addition to the existing requirement of obtaining compliance reports.

Risk management Committee (RMC)

The amendment inter alia seeks to change the following requirements w.r.t. RMC:

• The provisions of RCM shall be applicable to top 1000 listed companies (previously top 500);
• Specifies that RCM shall have a minimum of three members and majority shall be board members;
• Stipulates that at least one independent director in RCM;
• RCM to meet minimum twice in a year and time gap between two meetings shall not exceed 180 days;

The roles and responsibilities have been elaborated to include formulating risk management policy, overseeing the implementation of the same, monitoring and evaluating risks basis appropriate, methodology, processes and systems, appointment, removal and terms of remuneration of Chief Risk Officer.

Disclosure of shareholding

As per the amendment, all entities falling under promoter and promoter group shall be disclosed separately in the shareholding pattern appearing on the website of all stock exchanges. Whereas, earlier, the holding of promoter and promoter group could be disclosed on a consolidated basis.

Re-classification of any person as promoter/public

The amendment regulations have brought in certain changes to the conditions basis which the stock exchanges permit reclassification of promoter/promoter group to the public. The changes are as below:

• The time gap meeting the Board Meeting approving the reclassification and putting it up for approval of shareholders has been reduced from three to six months to one to three months;
• An exemption has been granted to a person seeking re-classification (a) where the promoter(s) seeking reclassification and persons related to the promoter(s) seeking re-classification, together, do not hold more than one percent of the total voting rights in the listed entity; (b) where re-classification is pursuant to a divorce;
• The process does not apply if re-classification is in pursuance of resolution plan approved under Section 31 of the Insolvency Code or pursuant to an order of a Regulator under any law subject to the condition that such promoter(s) seeking re-classification shall not remain in control of the listed entity

Our Comments

These amendments consolidate various circulars as well as bring provisions in line with the Act. The amendments also modified the language of the Regulations to bring more clarity and bring gender neutrality which was lacking in the regulations.

Relaxation in timelines for compliance with regulatory requirements by Debenture Trustees due to COVID-19

SEBI, in the wake of the surge in COVID-19 cases, decided to extend the timelines for the following regulatory requirements of the SEBI circular dated 12 November 2020 for the quarter/half year/ year ending 31 March 2021 (hereinafter referred to as Circular), which were required to be performed by debenture trustees periodically:

Our Comments

The said relaxations would bring much-required relief to the Debenture Trustees in these difficult times.

Companies Act, 2013

The Ministry of Corporate Affairs (MCA) has provided various relaxations to ease the compliance burden on corporate during the COVID-19 situation. Following are key relaxations provided by the MCA

Relaxation in the timeline to file forms and additional fees [General Circular No.06/2021 dated 3 May 2021]

Granted relaxation to companies and LLP’s in timeline to file certain forms (due for filing during 1 April to 31 May 2021) and additional fees payable on such forms till 31 July 2021.

Relaxation of time in filing forms relating to charges [General Circular No. 07/2021 dated 3 May 2021]

Provided relaxation in delay in filing forms relating to creation/modification of charges on the companies. Accordingly, the timeline from 1 April to 31 May 2021 shall not be reckoned while counting days for filing of the form.

However, the said Circular shall not apply in the following cases:

• The filing of e-Forms CHG-1 and/or CHG-9 is done before the issue of Circular, i.e., 3 May 2021;
• The timeline for filing of e-Forms CHG-1 and/or CHG-9 has already expired prior to 1 April 2021 (that is 120 days from the date of creation or modification of charge);
• If the filing of e-Forms CHG-1 and/ or CHG-9 is delayed beyond 120 days from 1 June 2021, despite the relaxation given of time till 31 May 2021;
• Filing of e-Form No. CHG -4, for the Satisfaction of Charge.

Gap between two Board Meetings [General Circular No. 07/2021 dated 3 May 2021]

Relaxed the mandatory requirement of having an interval of not less than 120 days between two board meetings as per Section 173 of the Companies Act, 2013. The same stands extended as 180 days for the next two quarters for the Financial Year 2021-22.

Accordingly, the gap between two consecutive Board Meetings may extend to maximum 180 days during the quarter- from April to June 2021 and from July to September 2021, instead of 120 days.

Clarification on the spending of CSR funds for ‘creating health infrastructure for COVID care’, ‘establishment of medical oxygen generation and storage plants’ etc. [General Circular No. 09/2021 dated 5 May 2021]

MCA issued a circular in continuation to Circular No. 10/2020 dated 23 March 2020, wherein it was clarified that spending of CSR funds for COVID-19 is an eligible CSR activity.

It further clarified that spending of CSR funds for ‘creating health infrastructure for COVID care’, ‘establishment of medical oxygen generation and storage plants’, ‘manufacturing and supply of oxygen concentrators, ventilators, cylinders and other medical equipment for countering COVID-19’ or similar such activities are eligible CSR activities under item nos. (i) and (xii) of Schedule VII of the Companies Act, 2013 relating to the promotion of health care, including preventive healthcare and, disaster management respectively. The companies, including Government companies, may undertake the activities or projects or programs using CSR funds, directly by themselves or in collaboration as a shared responsibility with other companies, subject to fulfillment of Companies (CSR Policy) Rules, 2014 and the guidelines issued by this Ministry.

Clarification on offsetting the excess CSR spent for FY 2019-20 [Circular dated 20 May 2021]

MCA had made an appeal on 30 March 2020 to MDs/CEOs of top 1000 companies in terms of market capitalization to contribute generously to “Prime Minister’s Citizen Assistance and Relief in Emergency Situations Fund” (PM CARES Fund). It was stated that such contribution to ‘PM CARES Fund’ may include unspent CSR amount, if any, and any amount over and above the minimum prescribed CSR amount for FY 2019-20, which can later be offset against the CSR obligation arising in subsequent financial years.

In relation to that, it is now clarified that where a company has contributed any amount to ‘PM CARES Fund’ on 31 March 2020, which is over and above the minimum amount as prescribed under Section 135(5) of the Companies Act, 2013 (Act) for FY 2019-20, and such excess amount or part thereof is offset against the requirement to spend under Section 135(5) for FY 2020-21 in terms of MCA’s aforesaid appeal, subject to the conditions that:

• the amount offset as such shall have factored the unspent CSR amount for previous financial years, if any;
• the Chief Financial Officer shall certify that the contribution to ‘PM CARES Fund’ was indeed made on 31 March 2020 in pursuance of the appeal and the same shall also be so certified by the statutory auditor of the company; and
• the details of such contribution shall be disclosed separately in the Annual Report on CSR as well as in the Board’s Report for FY 2020-21 in terms of Section 134 (3) (o) of the Act

Our Comments

The relaxations are helpful as, due to the COVID-19 situation administratively, it becomes difficult and painful to meet the compliance timelines. Also, clarifications on CSR give much-needed clarity, especially during pandemic where helping hand from corporates plays an important role.