Tax Planning relating to Demerger of Companies

TAX PLANNING WITH RESPECT TO AMALGAMATION

Demerger: A demerger is a form of Corporate Restructuring whereby one or more business undertakings of a company are transferred, either to a newly formed company or to an existing company, and the remainder of the company's undertaking continues to be vested in that company.

As per Section 2(19AA) of Income Tax Act,1961 "Demerger" means the transfer of one or more Undertakings to any Resulting Company in such a manner that:

• All the property / liability of the undertaking becomes the properties / liabilities of Resulting Company.
• All the properties / liabilities are transferred at Book Value.
• The Resulting Company issues shares to the Shareholders of the Demerged Company on a Proportionate basis.
• The Shareholders holding at least 75% of the value of shares in Demerged Company become Shareholders of the Resulting Company.
• The transfer of an undertaking is on a Going Concern Basis.
• The Demerger is in accordance with the conditions notified under section 72A(5) of Income-Tax act, 1961.

: TAX BENEFITS IN CASE OF DEMERGER

The tax incentives granted under Income-Tax act, 1961 in case of Demerger of Companies can be grouped as follows:-

I. Tax incentives to Demerged Company

II. Tax incentives to Shareholders of Demerged Company

III. Tax incentives to Resulting Company

I. Tax incentives to Demerged Company:-

1. Exemption from Tax on Capital Gains:- As per section 47(vib) of Income-Tax act 1961, the transfer of any Capital asset by the Demerged Company to the Resulting Company will not be regarded as transfer for the purpose of capital gains thus, it is exempt from tax. It will benefit the Demerged Company because No Transfer = No Capital Gain Tax Liability.

2. Tax Exemption to Foreign Demerged Companies:- As per section 47(vic), where a Foreign company holds any shares in the Indian company and transfer the same to a Resulting company in the course of Demerger, such transfer will not be regarded as transfer and it will be exempted from Tax, if following conditions are satisfied:-

• 75% of the Shareholders of Demerged Foreign Company continue to remain Shareholders of Resulting Foreign Company.
• There is no Tax on such Capital Gains in the country where such Foreign Demerged Company is Incorporated.

II. Tax incentives to the Shareholders of Demerged company:-

As per section 49(2C) of Income-Tax act 1961, where there is any transfer or issue of shares as consideration by the Resulting Company to the Shareholders of the Demerged Company, in a scheme of demerger, it will not be regarded as transfer and will be exempted from tax.

• The tax implications will only arise when the shares of Demerged Company or the new Resulting Company shall be sold.
• The Cost of Acquisition of shares of Resulting Company, as a result of Demerger, shall be calculated using following formula:-

III. Tax incentives to Resulting Company:-

The Resulting Company is eligible for tax relief if -

• The Demerger satisfies all the conditions laid down in section (19AA) of the Income-Tax act, 1961.
• The Resulting Company is an Indian Company.

1. Depreciation on Assets transferred to Resulting Company:- Section 32(1) of Income-Tax act, 1961 provides that the aggregate deduction to the Demerged company and the Resulting Company with respect to depreciation, shall not exceed the Deduction calculated at the prescribed rates in any previous year. Such deduction shall be apportioned on the basis of number of days such asset was used by both, Demerged company and Resulting company.

Simply stated, the Written Down Value (WDV) of Block of assets will be ascertained as follows:-

• In case of Demerged Company: Reduced by written down value of assets transferred to Resulting company.
• In case of Resulting Company: Written down value of assets acquired is to be added to the Block of assets.
• Depreciation is to be apportioned based on the number of days.

2. Expenditure for Obtaining Licence to operate Telecommunication Services [Section 35ABB]:- Where the the Demerged company transfers the Telecommunication Licence to the Resulting Indian Company in a scheme of Demerger, then such Resulting company can claim full deduction in respect of the unamortised amount of 'Capital Expenditure' incurred for obtaining licence to operate Telecommunication Services.

3. Amortization of Preliminary Expenses [Section 35(5)]:- Where an Undertaking which is entitled to claim deduction under section 35(5), is transferred in a scheme of Demerger by the Demerged company to a Indian Resulting company, then such Resulting company can claim Deduction for the remaining number of years.

4. Amortization of Expenditure incurred on Demerger [Section 35DD]:- Under this section of Income-Tax act 1961, any Resulting Indian company who have incurred any expenditure for the purpose of demerger, can claim a Deduction of Expenses on Demerger in 5 equal installments, beginning with the Previous year in which Demerger takes place.

5. Expenditure on Prospecting Minerals [Section 35E]:- Where the Undertaking of an Indian company is entitled to a deduction in respect of expenses incurred on prospecting for or extraction of minerals etc. and if such undertaking is transferred to another Indian company in a scheme of Demerger, then in such a case, the Resulting Indian Company shall be allowed to claim deduction of unwritten-off Expenditure for remaining number of years.

6. Capital Expenditure on Promotion of Family Planning [Section 36(1)(ix)]:- Where an undertaking is entitled to claim deduction under section 36(1)(ix), is transferred in a scheme of Demerger by the Demerged company to Resulting company, then the deduction on account of "Capital Expenditure incurred for Promoting Family Planning" among its employees shall continue to be available to the Resulting Indian company for the remaining number of years.

7. Carry forward and Set-off of Accumulated losses and Unabsorbed Depreciation in certain cases of Demerger [Section 72A]:- In case of Demerger, the accumulated losses and unabsorbed depreciation of the Demerged company shall be treated as follows:-

CASE	TAX TREATMENT
[I] If such loss or unabsorbed depreciation is directly relatable to the undertaking which is transferred to Resulting Company.	Such accumulated loss or unabsorbed depreciation shall be allowed to be carried forward and set-off in the hands of Resulting Company.
[II] If such loss or unabsorbed depreciation is not directly relatable to the undertaking which is transferred to the Resulting Company.	Step 1: Such accumulated losses and unabsorbed depreciation will be apportioned between Demerged company and Resulting company in the same proportion in which Assets of the undertaking have been retained by them. Step 2: The respective accumulated losses and unabsorbed depreciation shall be allowed to be carried forward and set-off in the hands of the Demerged company and the Resulting company, as the case may be.

8. Demerger and Deductions under section 80IAB, 80IB, 80IC and 80IE:- Where an undertaking which is entitled to claim deduction u/s 80IAB, 80IB, 80IC and 80IE of the Income-Tax act, 1961 is transferred by the Demerged company to an Indian Resulting company in a scheme of Demerger, then in such a case, the deduction shall be available to the Resulting Indian company for the unexpired period as if no such Demerger has taken place.

No deduction shall be available to the Demerged Company for the Previous year in which the Demerger takes place.

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