1 Business Restructuring :
In the fast changing corporate environment, business restructuring has become very common. Some of the more common modes of business restructuring are as under :
- Merger/Amalgamation of Companies
- Takeover of One Company by Another
- De-Merger of Companies
- Sale of Business
- Transfer of Business to a Joint Venture
- Lease of Business to Another Company
- Conversion of Partnership into a Company
- Restructuring through part IX of the Companies Act, 1956.
The Finance Act, 1994 and Service Tax Rules, 1994 do not contain specific provisions for implications arising out of different modes of business restructuring. However, CENVAT Credit Rules, 2004 (CCR) contain Rules for transfer of Unutilised Credit Balance under certain circumstances.
2 General Implications :
On amalgamation or merger, the running business of amalgamating entity as going concern, vests by virtue of Court Order in the amalgamated entity. The amalgamated entity thus steps into the shoes of the amalgamating entity and takes over all assets and liabilities including rights under contracts/agreements, etc. of amalgamating entity without break in continuity of business.
3 CENVAT Credit :
The provisions contained in Rule 10 of CCR are briefly stated as under :
a) Transfer of Unutilised Credit Balance in CENVAT Credit Account from the Transferor to the Transferee is permitted in case of change in ownership or change in site resulting from the following :
– Sale
– Merger
– Amalgamation
– Lease or
– Transfer to a joint venture
b) The arrangement of transfer should explicitly provide for transfer of liabilities of the old factory/business.
c) According to Rule 10(3) of CCR, transfer of CENVAT Credit shall be allowed only if the stock of inputs or in process or capital goods are also transferred along with the factory or business premises to the new site or ownership. Further, the same are to be duly accounted to the satisfaction of the Dy Commissioner/Asst Commissioner of Central Excise. (DC / AC).
4 Some Issues :
4.1 What is Sale, Merger, Amalgamation, etc. for the purpose of CCR :
The different modes of business restructing specified under Rule 10(1) of CCR are not defined under CCR. Hence, recourse would have to be made to meanings attributed to the said terms in common parlance/relevant statutes/judicial pronouncements, etc.
Some of the meanings attributed to the different modes of restructuring under Dictionaries/Judicial Rulings, etc., are given hereafter for ready reference :
a) Sale :
According to Section 2(h) of Central Excise Act, 1944
‘Sale’ and ‘purchase’ with their grammatical variations and cognate expressions, mean any transfer of the possession of goods by one person to another in the ordinary course of trade or business for cash or deferred payment or other valuable consideration.
b) Merger/Amalgamation :
- According to HALSBURY’S LAWS OF ENGLAND : “Neither reconstruction nor ‘amalgamation’ has a precise legal meaning.”
- ‘Amalgamation’ is a blending of two or more existing undertakings into one undertaking, the shareholders of each blending company becoming substantially the shareholders in the company which is to carry on the blended undertaking. There may be amalgamation either by transfer of two or more undertakings to a new company or by the transfer of one or more undertakings to an existing company. [Halsbury’s Laws of England, 4th Edn. Vol. VII, para 1539 (Page 855). [See also Baytrust Holdings Ltd. vs. I.R.C. (1971) 3 All ER 76 : (1971) 1 WLR 1333 : Brooklands Selangor Holdings Ltd. vs. Inland Revenue Commissioner, (1970) 2 All ER 76 (Ch D].
- The term ‘amalgamation’ contemplates not only a state of things in which two companies are so jointed as to form a new company, but also the absorption and blending of one by the other. [Re. : Walker’s Settlement, (1935) 1 Ch 567 : (1935) 5 Com Cases 412]
- In a decision of the Andhra Pradesh High Court ‘amalgamation’ is explained as a state of things under which either two companies are so jointed as to form a third entity or one is absorbed into or blended with another. [Cf. S. S. Samayajulu vs. Hope Prudhomme & Co. Ltd., (1963) 2 Comp LJ 61 (AP).]
c) Transfer :
The word ‘transfer’ is comprehensive and is regarded generally as comprehending within its scope transfers both voluntary and involuntary. In the absence of distinct genus or category, no presumption can arise that the word ‘transfer’ must be construed in the sense of a voluntary act of transfer since ‘sale’ ‘exchange’ or ‘relinquishment’ are, in the normal acceptation of those terms, voluntary acts. The words (a) sale, (b) exchange, (c) relinquishment, and (d) transfer must, accordingly, be given their plain and natural meaning and there is no justification for restricting the wide comprehension of the last of the four words to voluntary transfers by the application of the ejusdem generis rule. [Mangalore Electric Supply Co. Ltd. vs. CIT 113 ITR 655 (SC)]
d) Joint Venture :
Joining together of two or more business entities or persons in order to undertake a specific business venture. A joint venture is not a continuing relationship such as a partnership. [Barron’s Dictionary of Accounting Terms]
e) Lease :
- An agreement whereby the lessor conveys to the lessee, in return for rent, the right to use an asset for an agreed period of time. [‘Guidance note on accounting for leases’ issued by ICAL]
- An agreement conveying the right to use property, plant, or equipment (land or depreciable assets,) usually for specified purposes and for a stated period of time. [Dictionary for accountants by Kohler.]
- Legal agreement whereby the lessee uses real or personal property of the lessor for a rental charge. The contract may provide for the time period of lease, designated purposes and restrictions. [Barron’s Dictionary for accounting terms.]
4.2 Modes of business restructuring not specified under CCR:
Rule 10 of CCR provides for transfer of Unutilised CENVAT Credit Balance only in 5 specific situations, viz. Sale, Merger, Amalgamation, Lease or Transfer to a Joint Venture. A question could arise as to what would happen in a case not strictly falling under the aforesaid specific situations. Strictly speaking there could be practical difficulties.
However, as regards situations which are strictly not covered by Rule 10(1) of CCR, it is felt that though the sub-rule does not contain clear-cut provision, since the procedures prescribed under the erstwhile Proforma Credit Scheme would apply mutatis mutandis to the MODV AT [CENVAT] Scheme, a recourse could be made to the procedure laid down in Ministry’s Circular No. 14 / 79, dated 7-4-1979 in terms of erstwhile Rule 56A(6) of erstwhile Central Excise Rules. It would appear that the same would be equally relevant for CCR.
4.3 Capital Goods:
Under CCR, in regard to capital goods, only 50% of the Credit can be availed in the year of receipt and balance 50% can be availed only in the subsequent year.
In this regard, Rule 4(2)(b) of CCR is reproduced hereafter for ready reference:
“The balance of CENV AT credit may be taken in any financial year subsequent to the financial year in which the capital goods received in the factory of the manufacturer, or in the premises of the provider of output service, if the capital goods other than components, spares and accessories, refractories and refractory materials, moulds and dies and goods falling under [heading 6805, grinding wheels and the like, and parts thereof falling under heading 6804] of the First Schedule to the Excise Tariff Act, are in the possession of the manufacturer of final products, or provider of output service in such subsequent years.
Hence, in case of business restructuring, if 50%” of credit is availed by a Tranferor company prior to merger, issues could arise as to whether in- such cases balance 50% can be availed by the new Transferee entity after merger.
In the case of Shri Chamundeshwari Sugar Mills Ltd. vs. CCE (2007) 217 ELT 65 (Tri.-Bang) capital goods were leased out with the unit and 50% of duty credit was availed wherein the unit was not in possession of lessee. However, the entry was reversed and Cenvat Credit was never utilised. Under the said circumstances, the Tribunal held that availment of credit was irregular, but in view of reversal, penalty and interest was not imposable.
It would appear that the matter needs to be addressed through appropriate amendment under CCR.
4.4 Transfer of all assets & liabilities:
Rule 10(3) of CCR specifically provides that transfer of business of a service provider, should specifically provide for transfer of liabilities of such business.
An issue that arises for consideration is, whether in cases where through inadvertence a specific mention is not made in the takeover document for transfer of liabilities, can the Service Tax Authorities deny transfer of Unutilised Credit Balance at the end of transferor?
In the case of Reliance Petrochemicals Pvt. Ltd. vs. CC & CE (2007)215 ELT 254 (Tri.-Mum), the takeover document did not specify that the Transferee took over the liabilities also of the Transferor with assets. However, at the time of surrender of registration, the Transferee had by way of letters, undertaken to assume the liabilities of the Transferor arising on and after the date of transfer. In light of the above, the Tribunal held that there was sufficient compliance of Rule 10(2) of CCR.
Despite the above ruling, it would appear that proper care should be taken while drafting takeover documents.
4.5 Existence of Stocks at the end of Transferor:
Rule 10(3) of CCR provides that transfer of CENVAT Credit shall be allowed only if stock of inputs/Capital goods is also transferred alongwith the business premises and inputs/ Capital goods on which Credit has been availed of are duly accounted to the satisfaction of DC/ AC.
An issue that arises for consideration is, whether physical existence of stocks of inputs/Capital goods is necessary, for transfer of UnutiIised Credit Balance at the end of transferor to the transferee.
It is a settled principle laid down by the Supreme Court in CCE vs. Dai [chi Karkaria Ltd. (1999) 112 ELT 353 (SC) that MODVAT/ CENVAT mechanism does not require one to one correlation between inputs and outputs.
There has been a consistent attempt by the Central Excise Dept. to deny transfer of Unutilised Credit Balance in cases where there are no physical stocks at the end of the transferor .
However, the trend of judicial rulings appears to be consistent as well, to the effect that existence of physical stocks is not necessary if other conditions under CCR are complied with. In this regard, reference can be made to the following rulings:
- Aar Aay Products vs. CCE, (2003)157 ELT 40 (Tri.-Delhi).
- CCE vs. Dr. Reddy’s Laboratories Ltd., (2005) 191 ELT 660 (Tri.-Chennai)
- CCE vs. Smithkline Beecham Consumer Health Care Ltd., (2007)209ELT96 (Tri.-Chennai).
- Shree Ram Multi-Tech Ltd. vs. CCE, (2007) 217 ELT 136 (Tri.-Chennai).
- Kevin Enterprises Pvt. Ltd. vs. CCE, (2007) 219 ELT 181 (Tri.-Mumbai).
4.6 Transfer of Unutilised CENV AT Credit in proportion to duties paid in stocks at the time of transfer
Efforts are often being made by the Central Excise Authorities to restrict the transfer of Unutilised CENVAT Credit Balance to the extent of duties paid in stocks at the time of transfer.
As stated earlier, since no one-to-one correlation is required between inputs and outputs, matching of duties in Stocks and Balancein CENVAT Credit Account would be against the settled principles laid down by the .r Supreme Court.
In this regard, attention is drawn to a recent Madras High Court ruling in CCE vs. CEST AT (2008)230 ELT 209 (MAD) wherein it has been held that CENVAT Credit Rules do not require transfer of Credit corresponding only to the quantum of inputs transferred.
