T N Pandey: Need to check tax avoidance tactics

TAXING MATTERS

An advertisement in an economic daily, dated April 20, 2004, read:
"Wanted company with accumulated losses for take-over: We require a private ltd or mid-cap listed company with assessed loses of Rs 5-10 crore and preferably without any other assets, liabilities or activities for immediate take-over. Please furnish relevant details to ..."

This advertisement raises the issue why there is desire to take over a company with accumulated losses, preferably without assets and liabilities.

Prima facie, the motive seems to be to avoid the income tax liability of the company, desirous of taking over a loss-making company. A take-over, in essence, is acquisition and both the terms are generally used interchangeably.

It is an approach to business combinations and hence akin to merger or amalgamation. The take-over process is, by and large, unilateral and the offerer company decides about the price to be paid and in regard to other matters.

Take-over can be achieved by purchase of assets or shares of a target company or by means of scheme of arrangement, following the procedure laid down under the Companies Act, 1956, under sections 391 to 396A. Take-over can be friendly or hostile.

To control hostile take-overs, the Substantial, Acquisition of shares and Take-overs Regulations, 1997, has been made. But these aspects are not relevant in the present context. The take-over can be forward or reverse. A reverse take-over implies merging of a profit-earning firm into a loss-making company.

The finance minister's Budget speech for 1999 shows that the central government favours mergers, take-overs and amalgamations in public interest and has given number of concessions under the Income Tax Act and in other respects. In the present discussion, it is proposed to consider only income tax implications of company reorganisations like mergers, amalgamations and take-overs.

With effect from April 1, 1978, a new Section 72A was inserted in the Income Tax Act, which greatly liberalised carry-forward and set off of losses and unabsorbed depreciation. This section was substituted by a new Section 72A from April 1, 2000 by the Finance Act, 1999.

In the circular No 779 of September 14, 1999 of the Central Board for Direct Taxes, the objective behind business reorganisations has been stated as under:-"The business and economic reorganisation of the country has thrown up need for better utilisation of resources, which has become necessary, to enabling the Indian industry to re-structure itself to become globally competitive."

To achieve this objective, considerable liberalisation in the matter of carry-forward of losses has been done. Section 72 has been amended to do away with the requirement of continuation of the business in which loss was incurred for claiming the benefit of carry forward and set of in normal course.

Further, the new Section 72A permits carry forward and set off of accumulated losses in cases of reorganisations by take-overs on fulfilment of the prescribed conditions. These conditions are holding of assets and continuation of the same business for five years. The benefits given are available only when the reorganisation is in public interest - not in private interest.

The advertisement reproduced earlier is clearly an attempt to escape the tax liability in the case of a prosperous company by way of setting off the loss against the profits and also not be bound by keeping assets of the company taken over for 5 years.

All this is to be in private interest - not public interest, and hence, needs to be dealt with sternly. The tax department can disregard the arrangements where the assesses artificially manipulated their affairs.

In this situation, Justice O Chinnappa Reddy's observations in the McDowell's case, 154 ITR 148 (SC), fully apply.

According to him, evil consequences of artificial tax avoidance devices are:

• Substantial loss of much needed public revenue, particularly in a welfare State, like ours;
• Serious disturbance caused to the economy by piling of mountains of block money;
• Causing large hidden loss to the community;
• Sense of injustice and equity, which such devices arise in the minds of those, who are unwilling or unable to profit by it;
• Ethics (or lack of it) of transferring the burden of tax liability to the shoulders of guideless good citizens from those of artificial dodgers.

Justice Reddy has summed up by saying: "We now live in a welfare state, whose financial needs, if backed by the law, have to be respected and met. We must recognise that there is behind taxation laws as much moral sanction as behind any other welfare legislation, and it is pretence to say that avoidance of taxation is not unethical and that it stands on no less moral plane than honest payment by taxation".

Persons, resorting to colourful devices of the above nature, which are mere subterfuges (in the words of Justice Rangnath Misra in the McDowell's case) should be intelligently scrutinised by the tax department and the persons, resorting to these, should be severely punished.