Transfer of shares to step-down subsidiary for corporate re-structuring not tax-exemptible gift: Madras High Court rules against Redington India

In allowing appeals by the Revenue department against Redington (India) Limited, the Madras High Court has ruled that transfer of shares by an assessee to its step-down subsidiary as part of corporate restructuring could not be termed a "gift" exempted from income tax payment..In this case, the Bench of Justices TS Sivagnanam and V Bhavani Subbaroyan found that the assessee (Redington India) had used its subsidiaries, including those in Mauritius and the Cayman Islands, as conduits to avoid income tax..The manner in which the transfer was effected and ultimately the investment landing in a tax haven will clearly show that it is a sham transaction devised to avoid tax in India.Madras High Court.The Court ruled that the share-transfer was "a circular transaction and is a measure adopted to avoid tax.".The Bench also took note of the findings by the Transfer Pricing Officer (TPO) that there is a loss in real income and loss of revenue by shifting profits outside the country. .Senior standing counsel for the Income Tax Department/Revenue, R Hemalatha and T Ravi Kumar appeared for the appellants. Senior counsel Percy Pardiwalla, appearing for Advocate NV Balaji, argued for the respondent/assessee. .Factual background.The relevant chain of facts prior to the transfer of shares, as recounted by the Court, is as follows:.Shares in Redington (Gulf) was acquired by the Redington India Limited (assessee) with effect from April 1, 2004 for a consideration of Rs.2141.12 crores.About four years later, the assessee set up a wholly-owned subsidiary company in Mauritius, RM.This company in turn set up its wholly-owned subsidiary in Cayman Island i.e. RC. Consequently, RC became a step down subsidiary of the assessee.In November 2008, the assessee transferred its entire shareholding in RG to RC.Within four days of such transfer, 27.17% stake in RC was transferred in favour of a private equity fund Investcorp, IVC, for a consideration of USD 65 million (Rs.325.78 Crores)..The assessee later admitted a taxable income of Rs 125,57,70,310 for the year 2009-10, which was made subject to scrutiny on the ground that the assessee had international transactions exceeding Rs 15 crores. .The Transfer Pricing Officer (TPO) and the Dispute Resolution Panel, Chennai (DRP) ruled against the assesee, whereas the Income Tax Appellate Tribunal (ITAT) ruled in the assesee's favour. The ITAT ruling was challenged before the High Court..The assessee claimed that the transfer of its shares from RG to RC was a gift under Section 47 (iii) of the Income Tax Act and, therefore, exempted from capital gains tax under Section 45..The Revenue challenged this contention, asserting that the transfer for shares were a way of re-structuring the company's investment, adding that the transaction would be a taxable international transaction, as set out in Section 92B, Explanation (e) of the Income Tax Act. .Inserted via an amendment in 2012, Explanation (e) to Section 92B defines "international transactions" to include "a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date.".The Revenue also pointed out that there was no mention of the share transfer being a "gift" either in the Board Resolution nor in the deed of share transfer. The Board Resolution itself states that the transfer of shares was towards restructuring, it was submitted..Against this factual backdrop, the Revenue authorities asserted that the three ingredients of a "gift" under the Transfer of Property Act were also missing in this case, i.e. that the transfer should be (i) voluntary, (ii) without consideration and that (iii) the property so transferred should be accepted by the donee. .Share transfer was not voluntary, rules High Court."If there were factors, which were working behind the scene which led to the approval of the proposal to transfer the shares, then obviously, it would mean that the transfer of share is not voluntary and would not qualify as a valid gift", the Bench noted. .The Court ultimately found that there were extraneous considerations that had compelled the assessee to make the transfer of shares, thereby rendering the transfer involuntary and not a valid gift. The entire transaction was structured to accommodate a third party investor, who had put certain conditions even prior to effecting the transfer, the Bench observed..As such, the Court pointed out, ."The chain of events speak for themselves; the decision of the Board of the assessee in resolving to approve the transfer of shares with or without consideration is a clear indicator to show that the transaction is not voluntary. This is so because, within less than a week after effecting transfer, a private equity fund Investcorp (IVC) comes in the picture, investing USD 65 million in RC for 27.17% stake ... much prior to effecting transfer, there were other transactions, which were in the pipeline. The sole intention of the assessee was for corporate re-structuring, which is stated to have identified a third party investor who holds the investment in Cayman Island. Therefore, the voluntariness in the transfer of shares stands excluded.".... it is evidently clear that the incorporation of the company in Mauritius and Cayman Island just before the transfer of shares is undoubtedly a means to avoid taxation in India and the said two companies have been used as conduits to avoid income tax.Madras High Court.Other findings.This apart, the High Court also set aside ITAT's decision to allow (i) the deletion of Corporate and Bank Guarantee related tax liabilities and (ii) exemptions for a claim of having paid trademark fees by the assessee to a Singapore subsidiary. .As far as the trademark fee issue was concerned, the High Court upheld the TPO's findings that it was illogical for a subsidiary company to claim Trademark fee from its parent company (assessee), especially when there was no documentation to show that the subsidiary was the owner of the trademark. Moreover, the assessee was found to have been using the trademark in question even prior to the formation of the subsidiary. Therefore, there is no genuine rationale behind the payment of trademark/ license fee, the TPO held. .With respect to tax liabilities for the assessee executing Corporate Guarantee and Bank Guarantee in favour of its subsidiaries, the TPO had concluded the same to be a financial service, a finding upheld by the DRP. .The DRP had added that the "the same treatment, which was given in the previous Assessment Year should be extended for the Assessment Year under consideration." .The High Court proceeded to uphold the findings of the TPO and DRP, opining: "The finding that the very same transaction for the previous Assessment Year was subject matter of TP (transfer pricing) adjustment, has not been disputed by the Tribunal rather not even dealt with by the Tribunal. Therefore, the finding rendered by the Tribunal is utterly perverse.".The Court also rejected a contention made by the assessee that the explanation inserted to Section 92B, Income Tax Act by way of the Finance Act, 2012 was prospective in effect. .While pointing out that the provision was inserted with effect from April 2002, the Court added, "An Amendment made with the object of removal of doubts and to clarify, undoubtedly has to be read to be retrospective and Courts are bound to give effect to such retrospective legislation.".In view of these reasons, the High Court ultimately allowed the Revenue's appeals. .Read the Order: