ASSIGNMENT OF CORPORATE TAX PLANNING
TOPIC- Tax Planning And Its Role In Mergers, Demergers And
SUBMITTED TODR.DHIRAJ SHARMA
SUBMITTED BYSHAVETA ROLL NO-5489(C)
as there is no shareholder participation.AN INTRODUCTION AMALGAMATION. However. as the case may be. and the other or others being removed from the register. directly or indirectly – referred to as short form amalgamations. it is a case of demerger. MERGERS AND DEMERGERS: An amalgamation is the means of merging the assets and liabilities of two or more amalgamating companies. transfers one or more of its undertakings to a new company. Reasons for demerger : It is difficult to list out the reasons which give effect to demerger because reasons may differ from time to time. depending on whether the amalgamating companies: 1. researchers have specified some reasons for demerger as noted below : (1) Corporate attempt to adjust to changing economic and political environment of the country. country to country and even industry to industry within the country. X Ltd. Are within a group or have common shareholding.
. with one continuing as the amalgamated company. say X Ltd. is the demerged company and Y Ltd. Are unrelated (there can be exceptions to this) – sometimes referred to as long form amalgamations where compensation for the lost investment represented by cancelling the shares in the company or companies to be removed is the key feature. as covered by sections 219-221 Companies Act 1993.. or 2. is the resulting company. These are short. as covered by section 222(1) or (2) Companies Act 1993. having 10 undertakings. The Companies Act 1993 deals with these in two ways. company to company. say Y Ltd. no notice to shareholders and no public notice.
DEMERGERWhen one company.
S. (5) To realise capital gains from the assets acquired at the time when they were under performing and now no better performance. The above list of reasons for sell out is not exhaustive or conclu-sive as more reasons could be added depending upon the numerous influences emanating from political. (4) To help finance an acquisition. To allow the expenditure incurred for demerger.(2) Strategy to enable others to exploit opportunity effectively to optimise returns when the parent company is unable to do so. (3) To correct the previous investment decisions where the company moved into the operational field having no expertise or experience to run the show on a profitable basis. To extend the benefit of carry forward of loss or depreciation relating to transferred undertaking to resulting company. capital gain can be realised. social and international backgrounds. One thing remains crystal clear that the objective underlying divestitures or sell offs in the corporate world is to ensure resource mobility essential to effective operations of an enterprise and moving these resources from less-valued uses to higher-valued uses. (6) To make financial and managerial resources available for developing other more profitable opportunities.
(iii) (iv) (v)
To extend the benefits like S. (7) Selling unwanted and surplus or unconnected parts in the business as a restructuring strategy to get rid of sick part of the company. Tax neutrality of the demerger for the shareholders of demerged company.
Effect of demerger :
Tax neutrality of the assets transferred to resulting company. to the split off unit. 80IB. etc. 80IA.
(v) In accordance with the conditions notified u/s. (iii) The resulting company issues shares to the shareholders of demerged company on proportionate basis. 19AA) : Conditions : (i) The transfer is pursuant to a scheme of arrangement u/s. authority. general liabilities are to be apportioned in the ratio of assets relating to each business. (viii) Revaluation of assets will be ignored. (vii) Apart from specific liabilities relating to a business. otherwise than by way of acquisition.391 to u/s.Applicability :
(i) Companies incorporated under the Companies Act. State or Provincial Act (iii) A local authority (iv) A public sector company (v) A foreign company (vi) Any institution. (iv) Shareholders holding at least 75% of the share capital become shareholders of resulting company. Conditions of demerger (S.72A(5) by the Central govt. (ix) Reconstruction of any body.
(vi) Transfer should be with reference to transfer of a business activity and not any individual assets or liabilities or any combination thereof. association or body assessed as company or declared by the CBDT as a company. 1956
(ii) Any authority or a body constituted or established under a Central.394 of the Companies Act. (ii) Transfer of all the assets/ liabilities of one or more undertakings by a demerged company to any resulting company at book value on going concern basis.
19AAA) : Demerged company means a company whose undertaking is transferred pursuant to a demerger to a resulting company. In case any of the conditions are not continued to be fulfilled in any of the years after such reorganisation. that proportion which the assets of the undertaking transferred bear to the total assets of the demerged company (xii) Where a firm or proprietary concern is succeeded by a company fulfilling the conditions of S. Definition of resulting company (S. the set off of loss or depreciation shall be in case of the year in which conditions are discontinued to be fulfilled. 2[41A]) : Resulting company means one or more companies to which the undertaking of the demerged company is transferred in consi-deration of issue of its shares to the shareholders of the demerged company. Taxation of shareholders in demerged company :
. (xiii) Accumulated loss relates to the head 'Profits or gains of business or profession (other than speculation business)' only. accumulated loss and unabsorbed depreciation of demerged company shall be allowed to be carried forward and set off in the hands of the resulting company to the extent of : (a) if such loss/depreciation is directly relatable to transferred undertaking — 100% (b) if such loss/depreciation is not directly relatable to transferred undertaking. 47(xiv).
(xi) In case of demerger.(x)
In case the conditions are discontinued to be complied with. the unabsorbed loss/depreciation shall be deemed to be the loss/ depreciation of the successor company for the year in which reorganisation is effected. 47(xiii) or S. the set off of loss or depreciation made in any earlier years in the hands of the amalgamated company shall be deemed to be the income of the amalgamated company taxable for the year in which there is non-compliance. Definition of demerged company (S.
Dividend : S.
. (iv) Benefits available for demerger are also extended to authorities or boards set up by Central or State Govt. 2(22) has been amended by inserting a new clause (v) to provide that no dividend income shall arise in the hands of shareholders of demerged company on demerger. (iii) The accumulated losses and unabsorbed depreciation in a demerger shall be allowed to be carried forward by the resulting company. (ii) Depreciation shall be apportioned between the demerged company and the resulting company in the ratio of number of days for which the assets were used by them. 47 has been inserted to provide that no capital gains shall arise to shareholders of the demerged company on account of receipt of any shares from the resulting company.
(ii) Capital gains : A new clause (vid) in S. Tax benefits to resulting company : (i) Expenses incurred for the purpose of amalgamation or demerger shall be allowed @20% every year from the year in which the demerger takes place.
B. Under Section 47(vii).
The statutory provisions in the Income Tax Act: A. the provisions of Section 45 do not apply to a transfer in a demerger of a capital asset by the demerged company to a resulting company if the resulting company is an Indian company. According to Section 45. But.
C. Under Section 50-B. then. in consideration of the demerger. Clause [iv] is particularly relevant for the present discussion. Section 2(19AA) says that a ‗demerger‘ means a transfer pursuant to a scheme under Sections 391-394 of the Companies Act. while those arising from a slump sale are not. The capital
. its shares to the shareholders of the demerged company on a proportionate basis. It says that the resulting company must issue. 1961 deal with these issues. A slump sale is defined in Section 2(42C) to mean the transfer of one or more undertakings as a result of the sale for a lump-sum consideration without values being assigned to independent assets and liabilities. what exactly is a ‗demerger‘ for the purposes of the exemption from capital gains tax? Can a demerger ever be characterized as a ‗slump sale‘? Several sections of the Income Tax Act.TAX CONSIDERATIONS IN DEMERGERS AND AMALGAMATION: Generally. any profits or gains arising from the transfer of a capital asset are chargeable to capital gains tax. the gains arising from a demerger are exempt from capital gains tax.
D. capital gains arising from slump sales are chargeable to tax. 1956 (by a demerged company of its one or more undertakings to any resulting company) such that a list of seven conditions enumerated in separate clauses is fulfilled.
‗T‘ was transferred by ‗A‘ to ‗I‘. there was no consideration for the transfer – as a practical matter. and ‗A‘ showed the difference in the capital reserve account in the balance sheet. a scheme of arrangement filed before the Bombay High Court provided. For the transfer to be a ‗demerger‘. as the clause would have effect only when there was some consideration for the transfer.
In short. the scheme went on to say “Upon the demerger of „T‟ into „I‟. For this transfer. such liability would arise.
The Facts: The assessee ‗A‘ was a company having two divisions – ‗B‘ and ‗T‘. the value of its liabilities exceeded its assets. instrument or deed… shall stand vested in or deemed to be vested in „I‟ as a going concern…” Significantly. capital gains liability would not arise.gains from such slum sales are to be calculated by subtracting the net worth of the undertaking that is transferred from the lump-sum consideration (as per Explanations 1 and 2 to the Section).
The Department took the view that the scheme would not qualify as a demerger. ―… „T‟ without any further act. leading to negative net worth. A question arose as to whether the gains which accrued to the assessee (as it had transferred more liabilities than assets) would be chargeable to capital gains. Therefore. The value of the assets taken over by ‗I‘ was less than the value of the liabilities. But what happens when one or more of the conditions are irrelevant to a particular transaction? How this may happen is exemplified by the facts of the complex case of Avaya Global Connect v. the
.) The Bombay High Court sanctioned this scheme. ACIT. the conditions mentioned in Section 2(19AA) must be complied with.832/Mum/07 (the judgment is available on the website of the Mumbai ITAT Bar Association. The assessee contended that clause [iv] was inapplicable to the case. it was impossible for there to be any consideration. „I‟ would not pay consideration either to „A‟ or to the shareholders of „A‟…‖ (Emphasis supplied. if a transfer is a demerger under the Income Tax Act. In the case. If it is a slump sale. As there was no consideration whatsoever. ITA No. on the basis that clause [iv] mentioned above was not satisfied. an Indian company.
it was argued by the assessee that the transfer could not have been a slump sale given that no lump-sum consideration was paid. The Tribunal agreed with the lower authorities that there was no ‗demerger‘ in the present case. This was sufficient to constitute consideration received on account of the transfer. the Tribunal faced the following questions: A. and the assessee was liable to pay capital gains tax. Was the transfer to be characterized as a ‗demerger‘ for the purposes of the Income Tax Act.
The AO and the CIT (Appeals) however rejected these contentions. 1961?
B. could it be referred to as a slump sale? If it was a slump sale. It was held that the transaction was a slump sale. Without prejudice. no question of computing capital gains arose. It was held that the legislature must be presumed to have foreseen all practical possibilities while adding the conditions. The fact that there was no consideration whatsoever (as a matter of practical impossibility) would not be sufficient to hold that the condition was inapplicable. it was contended that there being no sale consideration received in respect of the transfer. Further. yet it had transferred liabilities in excess of assets and had credited the difference to its capital reserve account.question of complying with clause [iv] would not arise. The assessee had not received consideration as such. would there be any capital gain on facts (considering the negative net worth of the assessee and the fact that no actual consideration was received)?
The issues before the Tribunal:
Essentially. If not. What would be the position if the transfer was categorized as neither a demerger nor a slump sale?
The decision: A.
the assessee‘s appeal was allowed. Accordingly. the judgment serves to highlight an important point. the transfer in pursuance of that scheme would be not be a result of sale. no capital gains could be levied. It would not be possible to ―… conceptualize the cost of acquisition of … a going concern (or) the date of acquisition thereof…‖ As such. such a transfer will not be a slump sale. when a Court sanctions a scheme under the Companies Act. the capital asset which was transferred in the case was a going concern. it was held that the computation provisions of the Act in Section 48 would fail in the given factual matrix. it appears. and liability to capital gains will depend on whether or not the provisions for computation of capital gains would be workable.B. Also. The presence of a money consideration is essential for a sale. At the same time. the transfer will not be characterized as a demerger for the purposes of taxation. The Tribunal then went on to hold that it is only a transfer as a result of a sale which can be considered as a slump sale. In such a scenario.
The significance: From the point of view of the corporate world.
C. Essentially. Merely because a transfer is carried out in accordance with a scheme for a demerger under the Companies Act sanctioned by the competent High Court.
. The safer course. but would be a result of the operation of law. would be to ensure that the requirements for a demerger under tax laws are complied with in the first place.
Dividend: Section 2(22) has been amended by inserting a new clause (v) to provide that no dividend income shall arise in the hands of shareholders of demerged company on demerger. 2. 1961 provides the tax reliefs to the demerged company. if following conditions are satisfied: § 75% of the shareholders of demerged foreign company continue to remain shareholders of the resulting foreign company. Tax relief to Foreign Demerged Company: As per section 47 (vic). Capital Gain Tax not attracted: As per section 47 (vib) of the Income Tax Act. where a foreign company holds any shares in an Indian company and transfer the same to resulting company in the course of demerger. 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 gain. TAX BENEFITS TO THE SHAREHOLDERS OF THE DEMERGED COMPANY: 1. 394 of the Companies Act will not be applicable. the shareholders of the demerged company. § Capital gains tax is not attracted on the demerged foreign company in the country of its incorporation and S.
.Taxation Aspects of Demerger in India
TAXATION ASPECTS OF DEMERGER The Income-tax Act. TAX BENEFITS TO DEMERGED COMPANY: 1. who are issued and allotted shares in the resulting company in the exchange for the shares held by them in the demerged company and the resulting company which emerges as a result of a demerger. 391 to S. such transfer will not be regarded as ―Transfer‖ for the purpose of capital gain.
(RIL) has transferred four of its businesses to four separate companies. Reliance Industries Ltd. the financial services leg has been transferred to Reliance Capital Ventures Ltd. The telecom leg has been transferred to Reliance Communication Ventures Ltd. Capital Gains: As per section 47 (vid). Tax impact of the above: = Cost of acquisition of Shares held by assessee in the demerged company X
Net book value of assets transferred in demerger. the shareholders transfer these shares subsequent to the demerger. In this case.
. In case. is not regarded as ―Transfer‖ for the purpose of Capital Gains.2. in scheme of demerger. the cost of such shares will be calculated as under: Cost of acquisition of Shares in resulting Company Net Worth of the demerged company immediately before demerger We can illustrate and substantiate the concept by means of an example of Reliance Industries Limited which is the Demerged Company and the new companies of which shares were issued are the Resulting Companies. Consequence of the demerger: The existing shareholders of RIL got one share each in the Resulting Companies for every share that they held in RIL. And lastly the gas based energy business has been transferred to Reliance Natural Resources Ltd. any transfer or issue of shares by the resulting company to the shareholders of the demerged company. the coal based energy system has been transferred to Reliance Energy Ventures Ltd.
The Income Tax Act specifies a complicated formula that takes into account the proportion of the net worth of RIL vis a vis the book value of the businesses transferred to arrive at the new costs of acquisition. However. Relevance of indexation is only for working out the capital gain amount if the same has to be set-off against capital loss. § Indexation of the capital gains. has no tax implications on the shareholders. c) To calculate capital gains when the shares are sold. b) The indexation will start from the date of allotment of the new shares and not from the date of acquisition of RIL. The tax implication will only arise when either the shares of RIL or the shares of the new Resulting Companies are sold. Plus there will be a new cost accorded to the new shares of the Resulting Companies. when the shareholders of RIL are allotted the new shares in each of the four companies. as explained further on. a transaction of demerger. The three issues that arise are: § Whether the new shares (in the Resulting Companies) are long-term assets or short-term. there will be no need of this. The net results of the above calculations are summarized in the following table:
. Your original cost of acquisition of RIL shares will change now on account of the demerger. § Cost of acquisition of the various shares after the demerger transaction a) To find out whether or not shares in the Resulting Companies are long-term or not. for most shareholders. In other words. Tax implications when shares are sold: When the shares of any of the companies are sold. there would be absolutely no tax implication whatsoever.As per the Income Tax Act. the holding period of the RIL shares will be included in the period of holding of the new shares. it would give rise to capital gains tax liability. per se. a vital piece of information is the cost of acquisition.
. post the demerger. Similarly.400) RCVL (38.7% 100. 20.400) RCVL (1. 53. Consequently.Name of Company Reliance Industries Limited Reliance Communication Ventures Limited Reliance Energy Ventures Limited Reliance Capital Ventures Limited Reliance Natural Resources Limited
% of Cost of Acquisition of RIL Shares 52.7% of Rs. the above values be divided by the number of shares. his new costs would as in the table here. Rakesh had purchased 100 shares of RIL for Rs.3% of Rs. his total cost of acquisition would be Rs.898 Rs. Rs. 3. 53.7% 7.400. 277. 53.68. the period of holding RIL will be taken into account. Now. since he has bought the shares on Jan 10th last year. 53.3% 1. 534 on January 10th 2005. For example.400) RNRL (0.g. 27. RIL (52% of Rs.400) REVL (7. 53. 53.3% of Rs.0%
What the above table indicates is the proportion in which your original cost of acquisition of RIL shares will be apportioned to the new shares. 694 374
Rs. for the new shares. 12 months have elapsed and hence the RIL shares will be long-term capital assets. 27.768 divided by 100 which work out to Rs.666 Rs. thereby making these too long-term assets.400
For the per share cost.3% 0. Now lets say he sells the all the above shares on January 15th. Say.0% 38.400) Total Rs.768 Rs. Rakesh's new cost of acquisition of RIL post demerger would be Rs. It Can be understood by an example: e.7% of Rs. 53. As explained earlier.
35DD): Expenses by an Indian company incurred after 1-4-1999 for amalgamation or demerger of an undertaking. shall be amortized @ 20% each year starting from the year in which amalgamation or demerger takes place. Depreciation shall be apportioned between the demerged company and the resulting company in the ratio of number of days for which the assets were used by them. there would be absolutely no tax payable by Rakesh in the entire process.
TAX BENEFITS TO RESULTING COMPANY: 1.Therefore. Amortisation of expenditure in case of amalgamation or demerger (Sec. since long-term capital gains are tax-free. Benefits available for demerger are also extended to authorities or boards set up by Central or State Government. 3. if any or all of the above shares are sold on a recognized stock exchange.
. 2. The accumulated losses and unabsorbed depreciation in a demerger shall be allowed to be carried forward by the resulting company 4.