The Indian
Income-tax Act, 1961 (‘Act’) contains
a provision under
which a transaction of sale of shares can be declared as ‘void’
by the Indian tax authorities under certain circumstances. The said provision,
when invoked by the Indian tax authorities, may result in a loss to the
purchaser. This may so happen
notwithstanding that but for the said provision, the ‘title’ of the
shares was clear at the time of sale by the seller.
The above
referred provision is contained in section 281 of the Act. The section provides that where on the date of sale of shares
by the seller, any tax demand is outstanding and payable or any tax proceeding is pending against the seller
(which results in creation of a tax demand against the seller), the sale of shares shall be void to the extent of any tax claim raised against
the seller. In other words,
where the tax department cannot
recover such taxes from the seller,
they may invoke section 281 to declare the sale as void (so as to treat the
asset as still belonging to the seller and recover taxes by attachment and sale thereof).
However, there
are following two exceptions where section 281 of the Act will not apply, that
is, the sale shall not be void:
(i)
where the sale is made for adequate
consideration and without
the notice of the pending tax proceedings or outstanding
tax demands concerning the seller; or
(ii)
where the sale is made with the previous permission of the
tax officer (‘Section 281 NOC’).
Further, there is a de-minimus
exemption from the applicability of the provisions of section 281 of the Act. However, the limits are
too low for being of any relevance (i.e., where the taxes or other sums payable
or likely to be payable by the seller do not exceed INR 5,000, or the sale
consideration does not exceed INR 10,000).
The above
provision has resulted into creation
of an action point virtually in all transactions of acquisitions of shares,
whether the seller is a person resident or non-resident of India. The reason is
fairly simple – no buyer would like to lose the shares after having paid the
commercially negotiated price for the shares. So how do the buyers protect
themselves from section 281 risk? Invariably, the starting point
for a buyer is to ask the seller to obtain a Section
281 NOC from its tax officer (except in a few clear cases, for example, where
the seller is a non-resident and the buyer is convinced that the seller has no
presence in India or pending tax
proceedings or outstanding tax demands). However, there may be practical
challenges in this approach from the seller’s perspective particularly where
the seller is involved in tax litigation or there are significant tax amounts outstanding as payable. There
may be reluctance or resistance from the seller in applying and
procuring Section 281 NOC notwithstanding that
the Central Board of Direct
Taxes have issued
guidelines regarding the process and timelines
etc.
The scope of
the first exception referred to above (i.e., purchase of shares at ‘adequate
consideration’ and the buyer not being aware of pending tax proceedings or
outstanding tax demands concerning the seller) is very narrow. Further, there
are concerns around this as well: (a) the very premise of the exception is that
the purchase of shares is for ‘adequate consideration’ and one may not be too
sure that the tax authorities will not question that, and
(b) the buyer
may be aware of the pending tax proceedings or outstanding tax demands against
the seller arising from the due diligence on the seller.
If the above
options do not work (i.e., the seller is unwilling to procure Section 281 NOC
and the buyer does not want to take the risk of shelter
under the first
exception) and the buyer still wants to go ahead with the purchase of shares, probably,
the only option
left with the buyer is to rely on representations from the seller in the share purchase
agreement and indemnity. The scope
of representation may be narrow if the due diligence indicates pending tax proceedings
and outstanding tax demand against the seller. As regards ‘indemnity’, one
would need to be careful as the general tax indemnity, if any, contained in the
share purchase agreement may not be adequate to cover the peculiar nature of
section 281 of the Act.
A pertinent question which arises
is as to what a buyer should do if and when the proceedings under section 281 of the Act
are initiated by the tax department, and whether the buyer can protect the
shares by paying the outstanding tax demand (regardless of whether or not the
buyer can recover the same subsequently from the seller, in pursuance to
indemnity or otherwise)? Depending upon the facts,
this may also be an option to consider should
the need so arise.
It is relevant
to add that section 281 of the Act applies not only on ‘shares’ but certain
other assets as well viz. land, building, machinery, plant, securities and
fixed deposits in banks except where they form part of the stock-in-trade of the business
of the seller. Further, section 281 of the Act applies not only
on ‘sale’ but also where the possession is transferred by way of mortgage,
gift, exchange or other mode of transfer
whatsoever or any charge is created on the relevant assets.
A few relevant aspects which the parties
would need to keep in mind may be as under:
1.
The specified assets on which section 281 of the Act applies,
includes ‘plant’ as well. One would need to be careful regarding width of the
meaning of the word ‘plant’.
2.
Whether the provisions of section 281 of the Act will be attracted
on transfer of intangible
assets also?
3.
Whether the provisions of section 281 of the Act will be attracted
on slump sale, mergers
and demergers also?
4.
Whether a representation that the ‘title’ of the specified
asset is clear and free from any encumbrances, will provide any protection
regarding any proceeding by the tax department under section 281 of the Act?
5.
Whether the tax department, where it initiates proceeding
under section 281 of the Act, can straight away declare the transaction as void
or it would need to approach the relevant civil court for getting the
transaction declared as ‘void’?
6.
What happens when there is a bonafide sale of the said shares
by the buyer before the tax department invokes proceedings under section 281 of
the Act? Whether the subsequent buyer should
also peep into the history
of the first transaction as to how the buyer had addressed section 281 issue?
Obviously, the
above are contentious issues and there are no straight forward answers to the same. The parties would need to assess their facts situation carefully to protect
the value (and not merely the purchase
consideration) and avoid ‘avoidable’ litigation with the tax authorities and the courts. Last but not the least, the decision as to whether
in a particular case, the buyer
should proceed on the basis
of Section 281 NOC or indemnity, needs
to be taken carefully on an overall assessment of facts
including seller’s situation and profile; equally important is drafting of the
indemnity clause carefully so as to avoid any surprises in an unfortunate
situation where section 281 proceedings
are initiated by the tax department.
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