The Hindu Business Line : The transfer mix-up

T. C. A. Ramanujam analyses a recent Gujarat High Court decision which highlights the dichotomy between corporate and tax laws in treating transfer by subsidiary companies.

COMPANIES enjoy a special status under the tax law. Apart from the tax rate, even the substantive provisions of the law differ in their application to companies. Tax managers dealing with corporate taxation have to be thorough in company law matters. The inter-mix of tax law and the corporate law produces results that are often a corporate lawyer's delight. A definition as understood under company law need not necessarily be valid under tax law. The same terms may have different connotations under the two branches of laws. There are different types of companies — such as private, one in which the public are substantially interested, deemed public, domestic, foreign and companies with shares of varying denominations. The impact of the definitions can produce varied results in tax assessments.

Capital gains

Section 45 of the Income-Tax Act, 1961 brings to charge profits or gains arising from the transfer of capital assets. Certain types of transactions are exempted from the levy. There may be transfer of a capital asset, yet the transactions are taken out of the charging Section 45. There are 10 sub-sections in Section 47 enumerating transactions that do not amount to transfer for purposes of the levy of capital gains tax.

For applying Section 45, it is mandatory that there should be transfer as contemplated by Section 2(47). Both Sections 47and 2(47) will have to be applied. Specific kinds of transfers are identified by Section 47 in order to lay down the circumstances under which the transactions will be taken out of the definitions of `transfer', and thus out of the levy of tax under Sections 45, 47(iv) and 47(v), which deal with transactions between companies.

A company is a juristic person having common seal and perpetual succession, and encompassed by Section 2 (31)(vii). A holding company and a subsidiary company are two separate and independent persons.

Yet the relationship, inter se, of a 100 per cent holding company and a subsidiary company is such that the legislature deemed it fit to consider that a transfer of a capital asset in such a case from one to another shall not be treated as a transfer. `Transferor', for the purpose of capital gains under Section 45, does not include a holding and a subsidiary company

The exemption from the levy is subject to certain conditions, as enunciated in Sections 47 (iv) and 47(v), being satisfied. The basic conditions for attracting Sec 47(iv) are: i) capital assets are held by a parent company; ii) the said company has a subsidiary company; iii) the said subsidiary is an Indian company as defined in Section 2(26) of the I-T Act; iv) the entire share capital of the said subsidiary company is held by a) the parent company, or b) the nominees of the parent company; and v) the asset is not transferred as a stock-in-trade.

These conditions are cumulative and, if any of them is not satisfied, the exemption under Section 47 (iv) will not be available, and the transaction could attract Section 45 resulting in the levy of capital gains tax in the hands of the transferor company.

The subsidiary

The crucial part of the exemption clause concerns the subsidiary. What is a subsidiary? There is no definition of this term in the I-T law. Black's Law Dictionary defines a subsidiary as one that is under another's control and is run and owned by another company. In normal parlance, the term is used to describe a company in which another corporation owns at least a majority of the shares and thus has control. It may also happen that the parent company may have less than half of the ordinary shares but has an unfettered power to appoint or remove all or the majority of the directors of the subsidiary. The Oxford Law Dictionary has this to say on the subject: If Company A controls Company B, which itself controls Company C, then Company C is the subsidiary of both Company A and Company B. Group accounts are required to be exhibited in respect of the holding and subsidiary companies.

The very concept of holding and subsidiary companies is the legacy of the English law. Section 4 of the Companies Act, 1956, deems a company to be a subsidiary of another only if that other company controls the composition of the board of directors or the other company holds more than half of the equity shares. Section 4 (1)(c) also lays down that the subsidiary of a subsidiary will also be deemed to be a subsidiary of the parent company. There is an illustration given in Section 4: Company B is a subsidiary of Company A and Company C is a subsidiary of Company B. Company C is a subsidiary of Company A by virtue of Clause (c).

The Kalindi case

In Kalindi Investment (P) Ltd vs CIT (171 CTR 99), the company claimed in its return short-term capital loss of Rs 1, 26,201 arising out of sale of shares to a subsidiary Ambernath Investments (P) Ltd.

The income-tax officer (ITO) rejected the claim on the grounds that Ambernath was a subsidiary of Kalindi and, therefore, Section 47(iv) was applicable. This will be deemed to be as not amounting to transfer under the said clause. It so happened that Ambernath was a wholly-owned subsidiary of Kaveri Investments (P) Ltd, which in its turn was a wholly-owned subsidiary of Kalindi. This appears to be a case covered by Section 4.

The company took the matter in appeal to the Gujarat High Court. It resisted the application of Section 47 (iv) on the ground that Kalindi did not hold the whole of the share capital of Ambernath. The definitions given in the Companies Act, it was argued, should not be imported into the I-T law. It was pointed out that if the transaction had resulted in a gain, the Revenue would have argued that Section 47(iv) was not applicable and the gain was taxable. The Revenue contended that in the absence of a specific definition in the I-T law, there was nothing wrong in evoking the company law provision. Section 4(1)(c) read with the illustration thereof were clearly attracted.

The Gujarat High Court, prima facie, found the Revenue's arguments attractive. However, it saw no justification for transporting the definition of the holding company given under the Companies Act into Section 47 of the I-T Act automatically. The Companies Act has been enacted to consolidate and amend the law relating to companies and certain other associations. Various regulatory provisions contained in the Companies Act are meant to make companies accountable for their activities to the authorities as well as to the shareholders and creditors. The company law gives an expanded definition of a holding company in order to ensure that a company having controlling interest in another company does not escape the liabilities of the other company. On the other hand, the I-T Act is a taxing statue. Since there could be a borderline transaction, the legislature had taken care to provide in Section 47 that certain transfers shall not be considered as transfers for the purpose of the levy of capital gains tax. Section 47 (iv) refers to a subsidiary company thus: "As per the ordinary grammatical construction, it contemplates only the immediate subsidiary company of the holding company, as the holding company holds the share capital only of its immediate subsidiary company."

When the legislature did not choose to incorporate an express provision in the I-T law on the lines of Section 4 of the Companies Act, there was no need to read Section 4 of the said Act into Sections 47 (iv) and 47 (v) by necessary implication. The criteria for dealing with a holding and a subsidiary company happen to be different under the two laws. The I-T Act has carved out a smaller number of holding and subsidiary companies for the purposes of Sections 47 (iv) and Sec 47 (v). The wider definitions of a holding company with emphasis on `control' as the guiding factor has not been adopted in Section 47.

The Gujarat High Court observed: "The legislature, while enacting the I-T Act, therefore made a clear departure from the definition of the holding company as contained in the Companies Act. In this view of the matter, there is no justification for invoking Clause (c) of sub-section (1) of Section 4 of the Companies Act while interpreting the provisions of Clauses (iv) and (v) of Section 47 of the I-T Act, which lays down two specific conditions for applicability of the said clauses and which are quite different from the criteria laid down in sub-section (1) of Section 4 of the Companies Act, 1956 for giving a more expanded definition of a holding company to subject more companies to regulatory control under the companies Act.

On the other hand, the object underlying Section 47 of the I-T Act is to lay down exception to the legal provision of Section 45 for taxing gains on transfer of capital assets. The general rule is to construe the exceptions strictly and not to give them a wider meaning."

The court ruled that Ambernath was not a subsidiary of Kalindi for purposes of Section 47 (iv) with the result that the short-term capital loss came to be to be allowed in the return.

The court ruling is, however, open to criticism. As far as the concept of the holding and subsidiary companies is concerned, both the company law and the income-tax law are in pari materia.

The I-T law is more stringent in its application since it insists on the holding of the entire share capital of the subsidiary company, unlike the company law, which refers to majority holdings.

There have been instances when Section 4 has been applied to situations under the I-T law (Swadeshi Match Co. vs CIT (139 ITR 833) and Petrosil Oil Co. Ltd vs CIT (236 ITR 220)). In CIT vs United Breweries (189 ITR 17), the Mysore High Court accepted the position that the transfer to the subsidiary of a subsidiary can be considered as artificial and unreal. Obviously, the Revenue would have taken a totally opposite stand if it had been a case of capital gains instead of capital loss.

The case highlights the need for harmonisation of the tax and company laws

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