Scheme of demerger failed as a valid reconstruction and was rejected for tax-avoidance concerns and public interest issues.

A scheme of demerger and vesting of passive infrastructure assets was held not to qualify as an arrangement or reconstruction under sections 391 to 394 of the Companies Act, 1956 because restructuring of assets is not the same as reconstruction of a company; the continuity test was not met where the passive infrastructure business was separated from the telecom services business and the transferee was to merge with an independent entity. The proposal also lacked consideration and was treated as resembling a gift, placing it outside the statutory concept of arrangement. Objections based on tax avoidance, public interest, ultra vires action and other legal infirmities were upheld, and sanction was refused.

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Issues: (i) whether the proposed scheme of demerger and vesting of passive infrastructure assets could be sanctioned as an arrangement or reconstruction under sections 391 to 394 of the Companies Act, 1956; (ii) whether the objections based on tax avoidance, public interest, ultra vires action, lack of consideration and other alleged legal infirmities barred sanction of the scheme.

Issue (i): Whether the proposed scheme of demerger and vesting of passive infrastructure assets could be sanctioned as an arrangement or reconstruction under sections 391 to 394 of the Companies Act, 1956.

Analysis: The scheme was examined as a purported arrangement and reconstruction, but it was found that restructuring of assets is not synonymous with reconstruction of a company. Reconstruction, in the legal sense, requires substantially the same business to be carried on by substantially the same persons. Here, the passive infrastructure business was to be separated from the telecom services business and the transferee company was to be merged with an independent entity, so the essential continuity test was not satisfied. The absence of consideration and the characterisation of the transaction as a gift also meant that the proposal did not answer the statutory concept of arrangement contemplated by sections 391 and 394.

Conclusion: The scheme did not qualify for sanction as an arrangement or reconstruction under the Companies Act, 1956.

Issue (ii): Whether the objections based on tax avoidance, public interest, ultra vires action, lack of consideration and other alleged legal infirmities barred sanction of the scheme.

Analysis: The objections of the Income-tax Department were accepted as substantial. The Court held that the scheme appeared to be designed to avoid or defer tax consequences, including capital gains, MAT, stamp duty and other revenue consequences, and that public interest could not be ignored where the judicial process was sought to be used to facilitate a tax-avoidance structure. The Court also accepted that the transaction was not convincingly supported as a lawful arrangement, and that the petitioner had not satisfactorily met objections regarding ultra vires action, absence of statutory consent structure, and the effect of the alleged transfer on the revenue's interests.

Conclusion: The objections were upheld and the scheme was not approved.

Final Conclusion: The petition for sanction of the scheme failed, and the proposed demerger was refused approval.

Ratio Decidendi: A scheme under sections 391 to 394 of the Companies Act, 1956 cannot be sanctioned where it is not a genuine arrangement or reconstruction in law and where the material circumstances show that it is structured to avoid tax and offend public interest.

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