The Income Tax Department is a statutory authority entitled to notice of a scheme under Section 230(5). Its objections are not binding on the NCLT, but they are not ignored. The Tribunal's task is to determine whether the scheme is a genuine commercial arrangement or a colourable device for tax avoidance, and the recent jurisprudence has drawn a careful distinction between the two.
The Kirloskar Principle: Tax Benefit Is Not Tax Avoidance
The NCLT Mumbai, in sanctioning the merger of The Kolhapur Steel Ltd. with Karad Projects and Motors Ltd. (both Kirloskar group entities), rejected the Income Tax Department's objection that the scheme was structured to utilise the transferor's accumulated losses. The Tribunal found that the merger was part of a group-level rationalisation, that it had a genuine business purpose—stabilising a loss-making entity, preserving employment, and eliminating overlapping overheads—and that the tax benefit was an incident of the commercial restructuring, not its predominant purpose.
The Tribunal also noted that the transaction could be subjected to the General Anti-Avoidance Rules ("GAAR") and to the limitations of Section 72A(6B) of the Income-tax Act, but that those were matters for the tax authorities to examine in assessment proceedings, not grounds for the NCLT to refuse sanction.
The Indiabulls-Embassy Principle: Valuation Is for Experts
The NCLAT, in overturning the NCLT Chandigarh's refusal to sanction the Indiabulls Real Estate–Embassy Group merger, held that the NCLT erred in interfering with a valuation conducted by experts using the Discounted Cash Flow method. The Income Tax Department had objected to the valuation and the share swap ratio, but the NCLAT held that the commercial wisdom of the shareholders, creditors, and boards should take precedence, and that the NCLT does not sit in appeal over a valuation that was conducted by professionals using a recognised method.
The NCLAT's decision does not mean that the NCLT must accept every valuation. It means that the Tribunal's role is to determine whether the valuation process was sound, not to substitute its own view of the appropriate ratio.
The Limits of the Objection
The Income Tax Department's objection is most likely to succeed where the scheme has no independent business purpose, where the sole or predominant object is the avoidance of tax, or where the scheme involves a circular transaction that lacks economic substance. The objection is least likely to succeed where the scheme has a documented commercial rationale, where the tax benefit is incidental, and where the valuation has been conducted by a qualified professional using a recognised methodology.
The NCLT's sanction does not extinguish the tax authorities' recovery rights. The Tribunal's order in the DCM Shriram scheme made clear that the tax department's recovery rights remain untouched and that any default would be dealt with in accordance with law. A scheme that is sanctioned is not a tax clearance.
Call to Action
Anuj Desai & Associates advises companies on the response to Income Tax Department objections to a scheme—from the documentation of the commercial rationale and the valuation defence to the distinction between tax benefit and tax avoidance and the preservation of the authorities' statutory powers. If your scheme is facing a tax objection, we can help you build a record that addresses the Tribunal's concerns.
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