THE issues before the Bench are - Whether money kept in escrow account is available to the assessee or the Revenue, when it is kept specifically to indemnify the purchaser of shares against any income tax liability arising on the assessee; Whether Revenue can invoke the provisions of section 226 to settle its tax demand against such held back amount, although it is clear from the language of the Share Purchase Agreement that under no circumstances would the money held in escrow be released either to the assessee company or to the Department; Whether a company can stake claim to any part of the consideration as shares in a transaction relating to sale and purchase of shares inter-se the selling shareholders and purchasers; Whether when the assessee company is neither a party to the Share Purchase Agreement or the Escrow Agreement can claim any sum from the parties to the Escrow Agreement; Whether as per section 226 of the Income Tax Act, the AO steps into the shoes of an assessee with respect to recovering sums owed to or held by the garnishee on account of the assessee; Whether section 226(3) neither confers jurisdiction nor provides a machinery for an AO to adjudicate the indebtedness of a third party to the assessee; Whether the AO has the jurisdiction to proceed u/s 226, when the third party has disputed his liability to pay any money to the assessee and Whether Income Tax Act has any provision similar to Order 21 Rule 46C of the CPC which confers jurisdiction on the AO to adjudicate the question regarding indebtedness of a third party to an assessee who disputes the same. And the assessee's writ allowed.
Facts of the case
The assessee, Escorts Heart Institute & Research Centre Ltd. was earlier a charitable society under the name of Escort Heart Institute and Research Center Delhi which was merged with another non charitable society Escorts Heart Institute and Research Center, Chandigarh and subsequently, the same was converted into a company incorporated under the Companies Act. The AO denied the exemption to the assessee company u/s 35(1)(ii) as it got merged with a non charitable society and passed an assessment order for the AY 2001-2002 raising a demand of Rs. 124.36 crores. The said demand was disputed by the assesssee company. A share purchase agreement was entered into between the Sellers and the Purchaser. The consideration for the sale of 18,00,300 shares of the assessee company was agreed at Rs. 585,00,97,485 @ Rs. 3249.51 per share. As agreed under the share purchase agreement, the purchaser was required to deposit the entire consideration with the escrow agent and the sellers agreed to deposit certain documents including share transfer deeds and instructions with the escrow agents in order to consummate the transaction for sale and purchase of an aggregate of 18,00,300 equity shares of the assessee company. These terms were governed by the Escrow Agreement entered into between the Sellers, Purchaser and HDFC Bank Ltd.
It was agreed between the Sellers and the Purchaser that the escrow agent would release the consideration to all the sellers except a sum of Rs. 64,99,02,514 which would be withheld in the Escrow Account. This amount was the entire consideration payable to AAA Portfolio Pvt. Ltd., Big Apple Clothing Pvt. Ltd. (Concerned Sellers) for sale of their shares in the assessee company to the Purchaser. The purpose for withholding the sum of Rs. 64,99,02,514 from the sale consideration payable by the purchaser was on account of the income tax liability of the assessee company that was being contested. The terms of release of this heldback amount amount/consideration amount has been explained in the above diagram.
The AO issued a notice u/s 226(3) to HDFC Bank Ltd. (Bank) in respect to the amount held as an escrow agent in terms of the Escrow Agreement. The said notice was objected to and it was clarified by the Bank that it was not holding any money on account of the assessee company. This notice was challenged through a writ petition by the Concerned Sellers. An interim stay was granted by the High Court and the matter was remanded to the Assistant CIT to determine whether the Concerned Sellers had a locus standi in the matter.
It was contended before the AO on behalf of the Concerned Sellers that the action u/s 226(3) was in the nature of garnishee proceedings where the Revenue steps into the shoes of the assessee and recovers money directly from a third party who owes money to the assessee. It was further contended that the Bank does not either hold any money on account of the assessee company or owe any money to the assessee company and therefore, the sums held by the Bank in escrow pursuant to the Escrow Agreement cannot be demanded by the revenue. In support of this, an affidavit was also furnished by the Bank. However, the AO held that the since the tax liability had arisen on the assessee for merging with a non charitable society, the said amount was kept in the Escrow Account for discharging this liability.
Having heard the parties, the High Court held that,
Power of AO u/s 226
+ section 226(3) of the Act confers upon an Assessing Officer a special jurisdiction to proceed directly against a person, other than an assessee, for recovery of income-tax demands due from the assessee. The Assessing Officer steps into the shoes of an assessee with respect to recovering sums owed to or held by the garnishee on account of the assessee. An Assessing Officer is not conferred with any additional rights in respect of any amount due from the garnishee other than that which are available to the assessee. Section 226(3) of the Act neither confers jurisdiction nor provides a machinery for an Assessing Officer to adjudicate the indebtedness of a third party to the assessee and the provisions of section 226(3) must be confined to those cases where a third party admits to owing money or holding any money on account of the assessee or in cases where it is indisputable that the third party owes money to or holds money on account of the assessee. However, in cases where there are contentious issues raised by a third party who disputes his liability to pay any money to the assessee there is no mechanism provided or jurisdiction conferred upon the Assessing Officer to proceed further in the matter and take upon himself the mantle of adjudicating the said disputes;
+ a Court cannot issue garnishee order under Order 21 Rule 46 of the CPC against a debtor of the judgment debtor who disputes his indebtedness unless an issue in this regard is struck and tried as provided under Order 21 Rule 46C of the CPC. Unlike the CPC, Section 226(3) of the Act does not have any provision similar to Order 21 Rule 46C of the CPC which confers jurisdiction on the Assessing Officer to adjudicate the question regarding indebtedness of a third party to an assessee who disputes the same. Once the third party noticee has disputed that he owes any money or holds any money on account of the assessee, the Assessing Officer would not have any jurisdiction to proceed further against the third party. This is also abundantly clear from the language of clause (vi) of Section 226(3) of the Act;
+ in view of our finding that the decision of the Assessing Officer to proceed further despite the affidavit dated 07.12.2012 furnished by respondent no. 2 bank is without jurisdiction, it is not necessary to examine the question whether the amount held by respondent no. 2 bank pursuant to the Escrow Agreement could be stated to be any money which is due or may become due to the assessee company or which is held for and on account of the assessee company. However, we have heard counsel for the parties in this regard and deem it appropriate to examine the same;
Nature of money held in escrow account
+ a plain reading of the Share Purchase Agreement dated 25.09.2005 and the Escrow Agreement dated 27.09.2005 would indicate that the conclusion drawn by the Assessing Officer that respondent no. 2 held any money on account of the assessee company is patently erroneous. Neither the Share Purchase Agreement nor the Escrow Agreement provides for any contingency which would enable the assessee company or any other party to insist that the funds held by the respondent no. 2 bank in escrow be paid either to the assessee company or to the Income-tax Department on account of the assessee company;
+ the reason why the purchaser and the sellers agreed to keep part of the sale consideration paid by the purchaser in escrow with respondent no. 2 bank is apparent from the terms of the Share Purchase Agreement and the Escrow Agreement. The assessee company whose shares were being transacted had been converted from a society with whom a charitable society had been merged. As per the Revenue these transactions had resulted in an income-tax liability upon the assessee company which was disputed by the assessee company. In the event, the income-tax as demanded was finally adjudicated to be payable, it would have an adverse effect on the value of the shares of the assessee company which were subject matter of the transaction. Thus, in order to indemnify the purchaser against such adverse effect in the value of the shares of the assessee company being acquired by the purchaser, an amount of Rs. 64,99,02,514/- (referred to as “Heldback Amount no.2” in the Share Purchase Agreement and the Escrow Agreement) was agreed to be withheld and kept in escrow with respondent no. 2 bank, from the consideration payable for purchase of the shares of the assessee company.
+ It is clear from the language of the Share Purchase Agreement that under no circumstances would the money held in escrow be released either to the assessee company or to the Income-tax Department. This clearly indicates that no amount was held by respondent no. 2 on account of the assessee company;
+ there is also no reason why either the purchaser of shares of a company or the selling shareholders have any occasion to pay any part of the consideration for sale and purchase of shares of a company to the company. A company is an independent entity completely distinct from its shareholders. A transaction relating to sale and purchase of shares is a transaction inter-se the selling shareholders and purchasers and a company cannot stake claim to any part of the consideration as shares of a company are not the assets of the company but those of its shareholders. The assessee company is neither a party to the Share Purchase Agreement or the Escrow Agreement nor can claim any sum from the parties to the Escrow Agreement. No money is due to the assessee company by respondent no.2 or is held by or may subsequently be held by Respondent no. 2 on account of the assessee company. The conclusion of the Assessing Officer that the amount of money kept with respondent no. 2 in escrow is available to the assessee for meeting its income-tax demand is thus erroneous.
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